Governments today wish they had the equivalent of a Joseph, the biblical hero, appointed to Pharaoh’s court whose prudent advice spared the land of Egypt from hunger during seven years of severe famine. The thing is: there were josephs in our midst; they are known as economists who predicted the current crisis and the severity of its impact (Nouriel Roubini being one of them).
Apart from Norway and Chile, a country long considered a model of policymaking no other country seems to have taken the lesson of this biblical story to heart. Regarding Chile, The Economist reports
As a small, open economy it (Chile) is uncomfortably exposed to the world recession—the price of copper, its main export, has fallen by almost two-thirds since mid-2008 … The government forecasts this year’s fiscal deficit at 2.9% of GDP, but it can easily afford this. That is because it has stuck to a rigorous fiscal rule … requiring it to save much of the revenue gained when the copper price rises. Not only is public debt minimal (4% of GDP in December), but the government has also piled up $20.3 billion (about 12% of GDP) in a sovereign wealth fund which it can now spend.
Why aren’t other countries, particularly resource rich ones in the developed world, following the Chilean countercyclical example? Well, the answer depends on whom you consult, for example:
Political economists will point to the “Dutch disease” phenomenon that afflicts resource rich countries. During boomtimes, GDP accelerates past the long-run steady state of the economy. This windfall tempts governments of the day to increase spending on social services (as in the case of Holland in the 1980s) or reduce taxes or a combination of both (as in the case of Australia). When the boom ends, growth moves below the steady state, making the contraction all the more painful as social services are cut, taxes raised, etc. In fact, Jeffrey Sachs has built a general equilibrium model that mimics this phenomonen in action in the Venezuelan economy.
Institutionalists will identify the agency costs associated with the exercise of control over windfall profits. Especially in developing economies with weak judicial systems and endemic corruption, decision-making with regards to such wealth becomes diabolically problematic.
Behaviouralists will point to the lack of rationality and self-control that creates perceptual biases that prevent a proper assessment of the risks involved by not saving. Planners could suffer from optimistic or hindsight bias as a result.
A rational observer might comment that these explanations aren’t good enough. Anyone with common sense would intuitively sense that “all good things eventually come to an end” and see the wisdom in “saving for a rainy day”. As it turns out, neuroscience is helping to uncover the reason for this irrational behaviour.
Any standard economic model would use exponential discounting to determine the optimal amount of consumption and saving a household or government should engage in. This only works when temporal or time preferences are consistent. If humans were completely rational, they would follow this mode. It now appears that our preferences for rewards change depending on the length of time being considered. This has led to the method of hyperbolic discounting which takes into account our being “present-biased”.
So it would seem that when faced with two options of having a reduction of taxes in the long-run through savings made in the short-run versus receiving a short-term benefit in the form of a one-off payment/increased social services paid for by higher taxes in the future, that taxpayers will by and large opt for the latter even if in the long-run, they would benefit more from the former. This is by the way the reason why households over-consume and over-borrow. Given that their governments suffer from the same imperfection in judgement, it is not surprising that they would give in to this populist urge.
On the other hand, a paternalistic State such as Chile, would recognise that given our flawed judgement, the necessity of enactomg legislation that automatically sets aside above average fiscal benefits in the short run to smooth over shortfalls in the long-run. This would reduce the need to go into debt when markets head south and unburden future generations from interest payments. This, to me, seems the only sensible way to go about discounting our very nature.
too many illusionists and Chile as an ecoomic model the peso crisis was not that far back
ReplyDeletei agree, a lot of views, but the behavioural one comes closest to the neuroscientific evidence.
ReplyDeleteon Chile, you're right about the 1981 peso crisis when they were still getting their act together. the Chicago school economists helped to develop the economic policies that are still in place today that have made it a paragon of good governance
that's why my prof would say the Philippines is a latin american country transplanted in Asia while Chile is an east asian country transplanted in south america.
cheerio
Your last thought is an interesting one.
ReplyDeleteI am never ever that sure about the Chicago school pro Friedman pro monetarism the old freshwater school I am not that big on neo classical price theory and libertarianism and lower taxation and much less private sector regualtion and yet support for governmet regualaed monetary policy. To me it leaves too much up too Central banks that use stale information worry too much about inflation and the workings of the capital market and react with too few effective policy levers.
again i agree with your comment that neoclassical economic theory is not perfect. one thing it remains quite good at though is general equilibrium or unintended consequences. which should caution any of us intending to intrude or interven in private decisions.
ReplyDeletethat's why the paternal or regulatory libertarian approach is quite intriguing to me because it creates policy space without imposing unnecessary costs.