Tuesday, June 30, 2009

Indonesia: Economic crisis and the developmental state

Degol Hailu argues that policy responses to the economic crisis is turning Indonesia into a developmental state. I think the same can be said about pretty much every country that initiated some trade restrictions and implemented fiscal stimulus in the past two years. We are becoming more Keynesian than ever!

In the first quarter of 2009, rubber exports fell by 32 per cent. Farmers have suffered most. In some provinces tapping has completely ceased. The policy response was to cut shipments of rubber exports by 700,000 tons, a cartelist measure that was taken in concert with Thailand and Malaysia. The hope is to keep prices high and maintain constant income levels, just as the Organisation of Petroleum Exporting Countries (OPEC) does.

The price of tin, another major Indonesian export, fell from US$23,595 per ton in July 2008 to US$12,355 in April 2009. The government suspended the quota system that set minimum limits on tin exports. When prices were high, provinces such as Bangka Belitung and the Riau Islands were required to export at least 90,000 and 15,000 tons of tin, respectively. By suspending the minimum quota, the government is encouraging producer to cut their output and keep prices stable in the face of slow global demand. As a result, tin production fell from an average of 120,000 tons between 2005 and 2007 to 80,000 tons in 2008.

The target for the footwear and textile industry is to switch the above percentages: 60 per cent for domestic consumption and 40 percent for exports. As part of its stimulus package, the government is providing direct subsidies for the purchase of machinery under the Machinery Revitalisation Programme.

Rcently, the footwear industry received a cash subsidy of US$5.17 illion, and US$22.1 billion was provided to the textile industry. The government stepped in and launched a scheme to increase cotton output to 48,000 tons in the next few years, and to double the area under cultivation to 40,000 hectares. The provision of subsidised seeds and farm inputs has already started in Gunung Kidul, Yogyakarta, Pati, Kudus, Blora, East Java, and South Sulawesi provinces.

The government’s response to the crisis has also included macroeconomic policy changes. The interest rate was cut to 7.8 per cent in 2009 from 9.5 per cent in 2008. A fiscal stimulus of US$7 billion, or 1.4 per cent of GDP, has also been announced. The stimulus comes in the form of tax cuts (76.5 per cent of it), infrastructure expenditure (16.8 per cent) and direct subsidies (6.7 per cent). Fortunately, 2009 started with a fiscal deficit of 1.2 per cent of GDP, which gave the government room for deficit financing.

Monday, June 29, 2009

Agriculture subsidy working in Malawi

A carefully designed state-led agriculture subsidy program successful in Malawi:

The farmers’ success is not a coincidence: After facing a famine four years ago that threatened one-third of the country’s 13 million people, around half of whom live in poverty, tiny Malawi has utilized a $60 million policy of state subsidies for agriculture to become a net grain exporter. Malawi has transformed itself from a ward of the international community into one of the most successful agricultural economies in southern Africa: The landlocked, geographically diverse country, covered in green rolling hills and dotted with freshwater lakes, now exports thousands of pounds of corn to neighboring, starving Zimbabwe, a nation once known as the breadbasket of the region.

State agriculture subsidies are hardly what the doctor–or, in this case, the international aid community and the World Food Program–ordered. But Malawi triumphed precisely by ignoring the world’s leading pro-privatization agricultural experts. In fact, the "Malawi model" could turn out to be one of the only African success stories in recent years.

[…] Starting in 2004, it launched the nationwide Agricultural Inputs Subsidy Program, in which roughly half of Malawi’s small farmers were given coupons to buy fertilizer and seed at a rate far below the market price. Critically, the government focused the program not on the most destitute, but on the poor farmers who at least had some land and the ability to work the plots, thus guaranteeing a return on their investment in the form of more efficient grain output. At the same time, the government invested in training programs, helping farmers learn about new types of irrigation and management to improve their yields. And once the farmers produced, the Malawian government created funds designed to buy a percentage of the maize crop and store it for future emergencies. In this way, the state hoped to ensure that it would never be caught in a famine having to rely upon private traders to supply staple crops.

And, the danger of getting overly obsessed with “invisible hand” (liberalization and privatization) in vulnerable sectors, i.e. sectors whose performance would have a direct bearing on the very survival of poor people!

In many poor countries, when governments stopped handing out seeds and fertilizer, or providing warehouses to store farmers’ grain, the meager private sector was not equipped to fill the void. Unlike in the developed world, home to giant agribusinesses, in Africa the small private grain sellers and buyers have little capital or ability to raise money. And with little financing, it is nearly impossible for the private sector to develop large stocks of seed and fertilizer, or to build large warehouses necessary to store significant quantities of staple foods. Forced to rely upon the private sector, farmers in turn could not buy large quantities of seed, or store grain between harvests; and even if the resources were available, farmers often could not afford to buy fertilizer and seed. In many nations that had liberalized agriculture, crops simply rotted.

With private traders unable to store crops, governments selling off their warehouses to the private sector, and no one investing in agricultural research, developing nations have been left dangerously short of any food reserves. Yet for years, donor nations ignored the downside to privatization, even as country after country suffered through famines made worse by a lack of food stockpiles–and as rich countries, in a great irony, subsidized their own farmers. As former President Bill Clinton told a United Nations conference on food security last year, referring to wealthy nations’ push for agriculture privatization: "We all blew it."

A simulation of potential trade policy scenarios under the WTO showed that small country like Malawi would emerge as losers of agricultural trade liberalization. So, it does not make sense to argue for complete agriculture trade liberalization. Also, it does not make sense to blindly follow the market principles, though the best system if certain conditions are predetermined, and argue for full privatization, deregulation and liberalization of the agriculture market. Another relevant question here is: Would the developing countries lose or gain from agriculture trade liberalization (includes scrapping agriculture subsidies in the US, the EU, and Japan? Some say the developing countries would be worse off if agriculture subsidy in the West is eliminated. It really depends on if (households) a country is a net exporter or importer, its production and distribution cost structure, and demand of such goods in the global market, among other factors.

Wednesday, June 24, 2009

Aggregates of global crisis and development impact

This one comes from Duncan Green’s blog post about summary of the development impact of the global crisis:

Unemployment (ILO)

  • Gender impact of the economic crisis in terms of unemployment rates is expected to be more detrimental for females than for males in most regions of the world and most clearly in Latin America and the Caribbean (only regions where expected to be less detrimental for women are East Asia, developed economies, and non-EU south-eastern Europe and CIS)
  • Global unemployment could rise to 220 million people (6.8 per cent) in 2009, up 39 million on 2007.
  • Number of working poor (people unable to earn enough to lift themselves and their families above the poverty line) could rise to 1.3 billion ($2/day), 746m ($1.25/day).
  • Under a worse case scenario, global unemployment could be as high as 239 million (7.4 per cent) in 2009.
  • Under a worse case scenario, the number of working poor could rise to 1.4 billion ($2/day), 857m ($1.25/day).

Economic Growth (IMF / UN-DESA / World Bank)

  • World economic output is expected to contract by 1.3 [2.6] {2.9} per cent in 2009, down from growth of 3.2 [2.1] {1.9} per cent in 2008, and 5.2 {3.8} per cent in 2007 (IMF [UN-DESA] {World Bank}).
  • Economic output in emerging and developing economies [{developing economies only}] is expected to grow by 1.6 [1.4] {1.2} per cent in 2009, down from 6.1 [5.4] {5.9} per cent in 2008, and 8.3 {8.1} per cent in 2007 (IMF [UN-DESA] {World Bank}).

Bank Bailouts (IMF / calculation for Oxfam by James Henry)

  • As of February 2009 headline support to the financial sector by advanced economies had reached 43 per cent of their GDP, compared with 2 per cent in emerging economies (IMF).
  • On a worldwide basis, as of January 2009, banks and other financial service firms have already digested at least $8.7 trillion of state sponsored financing ($903 billion of government capital injections, $661 billion of toxic asset purchases, $1.38 trillion of subsidized loans, $5.76 trillion of debt guarantees). N.B. This is not all upfront cash - guarantees reflect the value of the insured assets (James Henry).

Fiscal Stimuli (ILO)

  • Total fiscal stimulus packages are currently (March) 3.16 per cent of global GDP.

Poverty Impacts (UN-DESA)

  • Between 73 and 103 million more people will remain poor or fall into extreme poverty in comparison with a situation in which pre-crisis growth would have continued.
  • Most of this setback will be felt in East and South Asia, with between 56 and 80 million likely to be affected, of whom about half are in India. The crisis could keep 12 to 16 million more people in poverty in Africa and another 4 million in Latin America and the Caribbean.

Remittances (World Bank)

  • Officially recorded remittance flows to developing countries were estimated to be $305 billion in 2008, up 8.8 per cent from $265 billion in 2007; but in real terms, remittances are expected to fall from 2 per cent of GDP in 2007 to 1.9 percent in 2008.
  • In 2009, remittances to developing countries are expected to fall by 5.0 per cent to $290 billion – 1.8 per cent of developing countries’ GDP.
  • Considering that remittances registered double-digit annual growth in the past few years, an outright fall in the level of remittance flows as projected now will cause hardships in many poor countries.
  • The persistence of the migrant stock will contribute to the persistence (or resilience) of remittance flows in the face of the crisis.
  • South-South remittances from Russia, South Africa, Malaysia and India are especially vulnerable to the rolling economic crisis. Also the outlook remains uncertain for remittance flows from the GCC (Gulf Cooperation Countries) countries.

Trade Flows (Bloomberg / IMF / World Bank)

  • The Baltic Dry Index (a benchmark indicator of shipping costs, which serves as a proxy for world trade flows):
  • Is 58 per cent lower than its one year high in June 2008
  • Has recovered from its one year low in Dec 2008 (93% below June ’08 peak)
  • IMF expects world trade volumes to contract this year, falling by 11.0 per cent
  • World Bank expects world trade volumes to contract this year, falling by 9.7 per cent

Foreign Direct Investment (Institute of International Finance / World Bank)

  • Volume of net private capital flows to emerging markets is likely to decline dramatically to $141 billion in 2009, after an estimated $392 billion in 2008, and a record volume of $888 billion in 2007 (IIF).
  • A modest revival of flows is now starting to become evident and the IIF projects that the 2010 volume will reach $373 billion (IIF).
  • Net private capital inflows to developing countries fell to $707 billion in 2008, a sharp drop from a peak of $1.2 trillion in 2007. International capital flows are projected to fall further in 2009, to $363 billion (World Bank).

Vulnerable Countries (World Bank / IMF / Economist)

  • According to the World Bank, 43 developing countries are highly exposed to the poverty effects of the crisis (with both declining growth rates and high poverty levels).
  • The IMF identifies 26 highly vulnerable low income countries.
  • The Economist identifies 17 vulnerable emerging-market economies on the basis of current account, short-term debt, and banks’ loan/deposit ratio.

Food and Oil Prices (FAO)

  • Are now on the rise again after bottoming out in Jan/Feb.

No lowering of interest rates in Nepal

A piece about Nepal’s banking sector on Bloomberg. The governor makes sense here--

Kshetry said he can’t lower interest rates to support economic expansion because of high inflation. Nepal’s inflation rate climbed to 11.9 percent in March from 9 percent a year earlier because of a shortage of food and fuel, Kshetry said.

The central bank raised the cash reserve ratio to 5.5 percent from 5 percent and the key bank rate to 6.5 percent from 6.25 percent in October 2008. It has kept policy rates unchanged since, Kshetry said.

Troubled banks in Nepal

A day after liquidating Nepal Development Bank (NDB), of which I argued for immediate liquidation, it has been know that another bank (I suspect there are many such low performing banks who play with balance sheet) is in trouble. World Merchant Banking and Finance Limited, after a year in operation, loaned Rs 9 million to a contracting company without properly assessing the loan-seeker’s ability to pay back the loan. Being unable to recover loans and to avert a negative balance sheet, it created a fictitious story-- that it recovered loan from the company and lent it to someone else.

When all this happened, the central bank was completely kept in dark by the incompetent management of the bank. Okay, it is partly the central bank’s fault to not tap on this shady practice for over five years.

This illegal practice of transferring the ´troubled´ loan into a new person´s name continued for five years till 2007, when borrowers started asking the finance company to release some of the land held as collateral by the finance company. "To coax the management the borrowers paid back Rs 700,000 of the loan amount. But we did not agree," said the source. Then subsequently, the borrowers started claiming they did not owe any money to the finance company and it had failed to deduct the installment amount that borrowers had paid over the years, which, the finance company calls a "total lie." "We challenge the borrowers to show cash receipt if they had truly repaid the loan amount," said the source.

Then the matter went to the police and in January 2008, it asked the finance company to submit all the documents involved in the loan transaction. Then the central bank became wary of malpractices going in the financial institution and in April 2008 it warned World Merchant to discontinue the illegal practice of transferring liability of loan amount to new persons.

And, a persistent problem of moral hazard because of the institutionally (and human resource wise) deficient and inefficient central bank.

On June 14 this year, Binit Mani Upadhyaya, CEO of the finance company, was arrested after borrowers lodged a complaint at the Commission for the Investigation of Abuse of Authority. Since then depositors have withdrawn around Rs 400 million from the finance company. "But we are not facing cash crunch as the central bank is indirectly pumping money into the financial institution," the source said.

M2 is going up and so is inflation, despite a deflation in India. If this continues, then the Nepalese financial market will be hit by a terrible storm!

Sunday, June 21, 2009

Roads, connectivity and markets

The importance of roads in establishing a link between production site and market:

As recently as 5 years ago, farmers in Belanting had to pay Rp15,000 ($1.26) to take 100 kilos of rice to the market, a fee that significantly cut into their already narrow profit margins. Today, Mr. Maca says he only pays Rp1,000-less than 10% of what he previously did- and profits from his farm have more than doubled.

That’s from a project funded by ADB in Philippines.

Why Nepal Development Bank (NDB) should be put to rest?


My latest op-ed about why a troubled bank in Nepal should be put to rest (I provide the links to some stuff here):


Let NDB go away


The banking sector is one of the few industries performing reasonably well most of the time. This has been one of the most attractive industries for employment and internship and investors, thanks to impressive performance of commercial banks and some development banks. However, there are some banks- whose balance sheet is weak; liabilities are in far excess of assets; who engage in risky deposit schemes with unreasonably high interest rate offers just to entice depositors; and engage in shady practices with backing from incompetent management and promoters- whose dismal performance is fueling anxiety among depositors and investors.

The failure of few of these banks to correctly assess their own capacity and ability to cater to the interests of depositors and investors has created an environment where the public is questioning soundness of the entire banking industry. This has impeded efforts to foster healthy competition, ensure market confidence, and promote a bankable banking industry where a run on one bank would not become a contagion and drag the whole industry down.

Nepal Development Bank (NDB) - which aspired to “enter the new millennium with profitability, size and efficiency on par with the best of the banks in the world”- is one of the zombie banks that have been a victim of its own irresponsible acts (recall the fate of Nepal Bangladesh Bank in 2006). The central bank has asked NDB management to furnish details on why it should not be liquidated. In any case, given the mess NDB is right now, it is in the interest of depositors, investors and the whole banking industry to liquidate NDB immediately.

According to media reports, the central bank estimated that NDB had bank deposits and cash worth Rs 196.20 million and its cumulative loss amounted to Rs 690.2 million (the bank management did not even know the full scale of its losses and claimed it amounted to Rs 640 million only). The non performing loans (NPL) comprised over 50 percent of its loan portfolio. The negative capital adequacy ratio of 48.31 percent was far less than 11 percent allowed by the central bank.

What is surprising is that even with dubious balance sheet and mounting losses, NDB management showed sheer irresponsibility by asking the NRB not to liquidate the bank. The irresponsible management team’s stubbornness is being amplified by lobby groups such as the Association of Nepali Development Banks (of which NDB is not even a member!) and the Association of Finance Companies. They have asked the central bank to revive the dead bank. For what? To vindicate NDB management of its reckless and stupid decision as if nothing wrong happened. The bank should have been liquidated back in 2004 and action taken against the then executive chairman and promoter Uttam Pun, who, unfortunately, went roundabout NRB’s weak regulatory power and used Appellate court, which itself is ineffectual in dealing with financial cases, to rescind the central bank’s action.

The central bank has rightly intervened and has also tried to calm down wary depositors and the market. Its plan to liquidate NDB to contain further losses and not let the bank operate with phony balance sheet that does not even satisfy minimum requirements, let alone prospect for profits, for sound banking practices is exactly what is needed at the moment. The NRB, despite regulatory and institutional weaknesses, has to show that it is tough and capable of reigning in banks that taint the image of the otherwise healthy banking industry. To avert the spread of contagion (of bank run) arising from the failure of NDB, NRB has also assured safety of deposits. This is required at the moment but should not be a permanent stamp due to fears of moral hazard. Now is the time to ponder upon establishing a national deposit insurer that would insure deposits up to a certain limit.

If the central bank does not liquidate banks like NDB, then the banking industry might engage in risky lending and unsustainable deposit schemes hoping that ultimately the government and NRB will bail them out in case of bankruptcy. The NRB needs to send a strong signal to the market that it is a responsible and strict watchdog of the banking industry.  Veering away from this responsibility might foster unhealthy banking practices, where a single bank failure could pose a systemic risk to the whole banking industry. At the moment, the failure of NDB does not pose this kind of risk. However, failure to let it go would foster malpractices by unscrupulous board of directors, loss of taxpayer’s money and risk consumer’s deposits, leading to more sicker and zombie banks whose downfall might be contagious. Continued existence of banks like NDB would decrease the industry’s competitiveness, which is the last thing the economy needs at a time when successful international banks are preparing to enter the Nepali financial market in 2010 according to the WTO rules.

For now, the government and the central bank should fully liquidate NDB, take action against its management team and promoters, and send a signal to depositors that their deposits are safe and to the market that the central bank is vigilant and committed to fostering healthy competition in the banking industry.

Friday, June 19, 2009

Samuelson on Mankiw, dollar, and bubbles

Part II of an interview with Samuelson:
In one of Greg Mankiw's articles, he said that maybe when the interest rate gets down to zero and it's threatening to be negative, you should give a subsidy with it. Well, that's what fiscal policy is!

I think it's almost inevitable that, with a billion people in China wide awake for the first time, and a billion people in India, there's going to be some kind of a terrible run against the dollar. And I doubt it can stay orderly, because all of our own hedge funds will be right in the vanguard of the operation. And it will be hard to imagine that that wouldn't create different kind of meltdown.

But there never has been a true macro efficient market. You just have to look at the record of economic history the ups and downs. Bubbles are self-generating. And I'm not sure most of the people that get caught up in the middle of a bubble can be described as irrational. It seems pretty rational to buy a house and flip it in the next few weeks at a profit when that's been happening for along time. It works both ways.

I think it would be surprising if, down the road -- not in the long long run but in the somewhat short run -- we don't have some return of inflation. On the other hand, I'm of the view that if we come out of this with some kind of temporary stabilization at least, and the price level is let's say 10-12% above what it was before we got into the meltdown, I think that's a price I would be willing to pay!

I'm against inflation, but what I worry about is continuing, galloping, self-reinforcing inflation. I would not try to roll things back to some sacred earlier price level.

Thursday, June 18, 2009

Links of Interest (06/16/2009)

Interview with Paul Samuelson (Part I)

I am a cafeteria Keynesian. […] Well, reasonable men are not reasonable when you're in the bubbles which have characterized capitalism since the beginning of time.

Milton Friedman. Friedman had a solid MV = PQ doctrine from which he deviated very little all his life. By the way, he's about as smart a guy as you'll meet. He's as persuasive as you hope not to meet. And to be candid, I should tell you that I stayed on good terms with Milton for more than 60 years. But I didn't do it by telling him exactly everything I thought about him. He was a libertarian to the point of nuttiness. People thought he was joking, but he was against licensing surgeons and so forth. And when I went quarterly to the Federal Reserve meetings, and he was there, we agreed only twice in the course of the business cycle.

Krugman on new financial regulations

Good review of Dead Aid

A short (incomplete) review of (free) market system in Nepal

Remittances expected to fall by 5 to 8 percent in 2009

Health and growth

Tuesday, June 16, 2009

The hungry people are watching!

Javier Blas reviews Enough: Why the World’s Poorest Starve in an Age of Plenty. This paragraph shows the irony of ‘invisible hand’ belief.

“Much of the chronic, everyday hunger in the world is now a man-made catastrophe, caused one anonymous decision at a time, one day at a time, by people, institutions and governments doing what they thought was best for themselves or sometimes even what they thought at the time was best for Africa,” they write.

The global food industry typifies a market dominated by few players, vested interest groups, and predatory pricing in the form of food aid, which is not only lowering food prices (crucial for meeting household needs of a farmer in the developing world) but also discouraging farmers from engaging in agriculture business (because the rate of return is very low). The aid industry is tied up with food industry and basically supply their surpluses to developing countries leading to two fiscal effects: (i) increase in debt, and (ii) decrease in revenue as farmers get displaced by the inflow of cheap food from the West. The poor always remain poor and the masters always prevail!

Nothing could illustrate the shortcomings of US food aid policy, in which Washington sells American farmers’ output in Africa rather than sending money to buy local food, better than a dialogue between an Ethiopian farmer and a US executive at a food aid meeting in Addis Ababa. The farmer asks the executive enthusiastically: “Can you help our farmers sell their beans in America?” He receives an unexpected answer: “Actually, we represent American bean growers.”

Advice from the western world has not helped, however. It is telling that one of the best agricultural programmes in Africa – a subsidy system for fertiliser and high-yielding seeds in Malawi that has transformed the country into a net exporter of corn – was objected to, even to the point of threats to withhold some aid, by the Washington-based World Bank and the Department for International Development in Britain.

Monday, June 15, 2009

Collier on ‘investing in investing’ for the bottom billion

Paul Collier on investing in investing for the bottom billion:

… in Africa the average investment rate to GDP is less than 20 percent, whereas to catch up, to converge with other economies, it needs to be over 30 percent. So they must move from under 20 to over 30. … It means an agenda of raising the capacity to invest productively. I call that a phase of investing in investing. It is something that has partly a macroeconomic agenda, but also a microeconomic agenda. If we just say it’s hopeless, the country doesn’t have a capacity to invest, it drives them into what I call the economics of Polonius: “Neither a borrower nor a lender be.” … That is the strategy for investing in investing, building the capacity to make good investments.

[…] the typical low-income country should be investing something like 30 percent of GDP. And for low-income countries that are depleting natural assets, it should be higher than that. […] We need a phase of investing in investing, and this goes back to my earlier point. An investing-in-investing phase is even more important in the resource-rich low-income countries.

[…] Typically, there is somewhat of a bypass of the domestic construction sector by bringing in foreign construction firms, and that’s throwing the baby out with the bathwater because potentially the construction sector can generate a lot of employment in these economies; in postconflict situations, that’s enormously valuable. In technical terms, the shadow wage of young men in postconflict environments is negative. It’s worth spending money employing them even if they were to do nothing. But actually you can get them productively employed in the construction sector.

And on the role of IMF:

I think that there are three different roles for the IMF. First, for governments of low-income countries, the Fund is a source of money. Second, the Fund provides a commitment framework for donors through its programs. And the third role, which I think is the most important, is one of providing a conceptual and coordination framework to assist the many different players in the low-income development field, including various agencies and the different governments. But my larger point is that the right macro answers depend on resolving the micro and institutional issues. The right macro answers, taking the micro and institutional as given—which is what the IMF has been doing—are the wrong macro answers for development.

Sunday, June 14, 2009

Fiscal policy defined

Horton and El-Ganainy explain the basics of fiscal policy, a topic of much discussion in recent days especially relating to fiscal stimulus in almost all countries in the world. A very basic explanation that gives a taste of intro to macro econ, chapter one!

Fiscal policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty. The role and objectives of fiscal policy have gained prominence in the current crisis as governments have stepped in to support financial systems, jump-start growth, and mitigate the impact of the crisis on vulnerable groups. […] Fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or “loose.” By contrast, fiscal policy is often considered contractionary or “tight” if it reduces demand via lower spending.

Besides providing goods and services, fiscal policy objectives vary. In the short term, governments may focus on macroeconomic stabilization—for example, stimulating an ailing economy, combating rising inflation, or helping reduce external vulnerabilities. In the longer term, the aim may be to foster sustainable growth or reduce poverty with actions on the supply side to improve infrastructure or education. Although these objectives are broadly shared across countries, their relative importance differs depending on country circumstances. In the short term, priorities may reflect the business cycle or response to a natural disaster—in the longer term, the drivers can be development levels, demographics, or resource endowments. The desire to reduce poverty might lead a low-income country to tilt spending toward primary health care, whereas in an advanced economy, pension reforms might target looming long-term costs related to an aging population. In an oil-producing country, fiscal policy might aim to moderate procyclical spending—moderating both bursts when oil prices rise and painful cuts when they drop.

Many countries can afford to run moderate fiscal deficits for extended periods, with domestic and international financial markets and international and bilateral partners convinced of their ability to meet present and future obligations. Deficits that grow too large and linger too long may, however, undermine that confidence. Aware of these risks in the present crisis, the IMF is calling on governments to establish a four-pronged fiscal policy strategy to help ensure solvency: stimulus should not have permanent effects on deficits; medium-term frameworks should include commitment to fiscal correction once conditions improve; structural reforms should be identified and implemented to enhance growth; and countries facing medium- and long-term demographic pressures should firmly commit to clear strategies for health care and pension reform.

Friday, June 12, 2009

Does South Asia need a counter-cyclical fiscal policy?

Yes, yes, says that World Bank as the fear of inflation is now replaced (Nepal has over 12% inflation rate right now???) by declining growth and the impact of global slump on poverty.

South Asian countries do not have automatic stabilizers or social safety nets to counter the negative effects of economic slump. So, the only option left is Keynesian fiscal policies (as expected). However, the WB argues that the extent to which this can be used is constrained by the bloc’s high public debt. This should be least of the worries because right now all that matters for countries like Nepal (which has over 12% inflation rate) is how to balance a rise in general price level and ensure economic growth. As is popular right now, the WB recommends investment in public infrastructure such as roads, schools, and hospitals.

South Asian countries may have missed the opportunity to strengthen their fiscal position during good times, which would have enhanced their capacity to counter downturns. Timing is of the essence. Any counter-cyclical policy needs to be tailored to conditions in individual countries. The capacity of a country to undertake counter-cyclical fiscal policy depends on its ability to finance the resulting fiscal deficit, which is easier when public debt is low and external balances are in good shape.

It is essential to protect core public spending in social and physical infrastructure in the face of declining revenues. Spending targeted at vulnerable groups may need to increase. This would require reallocation of expenditures from other areas, as well as greater reliance on borrowing or grants. However, it will always be a risky proposition especially for countries with a weak track record of controlling spending and where there are fears of inflation. Once introduced such spending may be hard to reverse.

According to a number of Economists, a fiscal stimulus program for countering an economic downturn needs to fulfill the 3-Ts; it needs to be timely, targeted, and temporary in order to be effective.

Wednesday, June 10, 2009

When will people read Keynes correctly?

Robert Skidelsky writes a very interesting article about the cycle of ideological debates and what Keynes actually meant (I wonder why people are still not (trying) understanding the simple, common sense concept put forth by Keynes in the 1930s). The beauty of classical economics and its different variations is that their models can be proved mathematically in a very slick and convincing fashion (ceteris paribus). This does not mean that they represent reality cent percent. Economics is a social science and not all things can be simplified without missing some stuff. What matters is good judgment arising from some sort of economic model (may or may not be comprehensive). This is what Keynesians do!

And remember, when resources are idle, economy is not in full employment, and market forces hesitate to function as they should (due to, say, crisis of confidence arising from self-fulfilling and reinforcing prophesy of some speculators/investors), government can turn the tide around by managing demand/using fiscal policies to put idle resources to work. Things could go awfully wrong even in a stable market economy, when then needs an escort to safety. Isn’t this a common sense?

For 30 years or so Keynesianism ruled the roost of economics – and economic policy. Harvard was queen, Chicago was nowhere. But Chicago was merely licking its wounds. In the 1960s it counter-attacked. The new assault was led by Milton Friedman and followed up by a galaxy of clever young disciples. What they did was to reinstate classical theory. Their “proofs” that markets are instantaneously, or nearly instantaneously, self-adjusting to full employment were all the more impressive because now expressed in mathematics. Adaptive Expectations, Rational Expectations, Real Business Cycle Theory, Efficient Financial Market Theory – they all poured off the Chicago assembly line, their inventors awarded Nobel Prizes.

No policymaker understood the maths, but they got the message: markets were good, governments bad. The Keynesians were in retreat. Following Ronald Reagan and Margaret Thatcher, Keynesian full employment policies were abandoned and markets deregulated. Then along came the almost Great Depression of today and the battle is once more joined.

Keynes had proved that such crowding-out could occur only at full employment: if there were unemployed resources, fiscal deficits would not drive up interest rates without also expanding the economy. Prof Ferguson’s ignorant remarks only confirmed that “we’re living in a Dark Age of macroeconomics, in which hard-won know-ledge has simply been forgotten”.

This is to take economics to be like a natural science, which Keynes never believed it was, because he thought its subject matter was much too variable over time.

Markets could behave in ways described by the classical and New Classical theories, but they need not. So it was important to take precautions against bad behaviour. Ultimately, the Keynesian revolution was a triumph not of good science over bad science, but of good judgment over bad judgment.

Tuesday, June 9, 2009

Can additional funding to the developing countries through the IMF be helpful?

Economists at the CEPR say, No unless…! The $108 billion in new funds for the IMF approved by the US Senate is not going to counter the world recession, they say. Why? Because without reforms in the IMF itself, additional funding injections would not be helpful. (The G20 pledged $500 billion for the IMF to lend to struggling economies)

Contrary to remarks by IMF Managing Director Dominique Strauss-Kahn that rich country contributions to the IMF make "this…the most coordinated stimulus ever," the IMF has been mandating economic conditions for countries receiving new loans, including deficit reduction, monetary tightening, and inflation-targeting measures that run counter to the worldwide need for an increased economic stimulus.

"Throwing $108 billion at the IMF without any reforms is a mistake, and one that Americans will later regret."

"There's little evidence that the IMF has actually helped boost GDP growth in developing countries over the past 30 years, and a lot of evidence to the contrary," Weisbrot said. "Giving the IMF this money without reform conditions is a mistake, and one that will come back to haunt us in the future."

Also, see this one:

Almost all of the agreements that the IMF has concluded since the global economic crisis began have included the opposite of stimulus programs: for example spending cuts or interest rate increases. The amount of money that will help poor countries is tiny. And it is difficult to see why the IMF would need hundreds of billions of dollars to help governments with balance of payments support: for sixteen Standby Arrangements negotiated since the crisis intensified last year, the total has been less than $46 billion.

And, here is Kevin Gallagher:

Kevin Gallagher argues that the IMF, in its emergency assistance plans for developing countries, is still imposing harsh conditionalities that limit rather than expand government spending. “If the IMF is to receive significantly higher lending authority, it should be forced to abandon its draconian austerity policies, which are more inappropriate than ever in the current crisis,” he argues.

Monday, June 8, 2009

Some Keynesian stuff

Keynesianism works in Australia

Australia went early and hard with a substantial cash handout to households in December 2008, followed by another round of cash stimulus delivered a month or two ago, and then a large-scale infrastructure program. The national accounts for the March quarter (which should include the effects of the first round of stimulus) have just come out, and show growth of 0.4 per cent, compared to a 0.6 per cent contraction in the December 2008 quarter


IMF loves to apply Keynesian principles in Africa

The main focus of fiscal stimulus should be on the expenditure side, particularly infrastructure and social spending given pressing needs, as reducing tax rates may be inequitable and the scope for doing so is limited given low revenue ratios. Other countries will have to adjust, in a way that will not affect critical spending. Additional donor support would reduce the need for adjustment. In all cases, countries should give priority to expanding social safety nets as needed to cushion the impact of the crisis on the poor.

And, this is very interesting-- The Phillips machine: Using water to predict the economy

Friday, June 5, 2009

Industrial policy in the US

Any doubts that the ongoing series of bail outs of financial institutions and key industries in the West is not an industrial policy. Well, it is definitely an industrial policy (under different trade regimes) of a different form that somewhat resembles the policies of South Korea, Japan, Taiwan and China, writes Gallagher. This is not necessarily protectionism. And yes, the government can fill up the gap where the private sector cannot. The best way to do it: go for PPP but with more accountability.
Many will cry that industrial policy – government fostering of specific sectors, industries or firms – is protectionism. It certainly can be. These policies are justifiable only to the extent they correct for market failures in the economy. Of course we all know that the free market is failing to supply credit to firms in the real economy. There is also an underproduction of green technologies, because firms are not compensated for the environmental benefits they bring. This is accentuated because dirty producers don't have to pay for their environmental sins.

If US policy rectifies market failures, these policies should be seen as correctionism rather than protectionism. Asian countries such as Japan, South Korea, Taiwan and China have all successfully experimented with industrial policy. Conventional economic theories would have told these nations to produce rice, fish and perhaps some clothing for the world economy. However, over time governments enabled firms like Toyota, Kia, Hyundai, Acer and Lenovo to become household names across the world.

When countries succeed at industrial policy they usually form public-private partnerships, put conditions on favoured recipients and have systems for government accountability. Public-private partnerships help alleviate the problem of governments picking winners by creating mechanisms whereby governments get important input from the private sector. Enforceable conditions are also important, such as performance requirements to export a certain percentage of output before receiving additional support. Government accountability needs to be ensured as well.

Thursday, June 4, 2009

New op-ed about the Nepali economy under the Maoist-led government

This op-ed is the same as the blog post published earlier.




In the last day of his role as prime minister, the Maoist premier Pushpa Kamal Dahal claimed that his administration gave “utmost importance to economic transformation” and made “major contribution to economic revolution”. Unlike his boss, former Finance Minister Dr. Baburam Bhattarai was a bit modest in laying claims about economic progress achieved under his leadership. In assessing the economic policies and progress under the Maoist administration, it is unclear how the dismal performance, especially in encouraging private sector and utilizing development expenditures, amounts to or leads to “economic revolution”.


The economy is far from being transformed. There were some successes in revenue collection and welfare programs. However, there were even more problems-- industrial relations deteriorated, allocated development money remained unspent, investors and donors remained skeptical of Maoists policies, price level spiraled upwards, and there was a severe shortage of energy, which further crippled the industrial sector, among others.

Unfortunately and mistakenly, I emailed the same article to two (rival) dailies in Nepal. I have no desire to publish the same op-ed in two dailies (Republica and The Kathmandu Post) on the same day. I bear responsibility for the confusion (and tension) it created there! This should not have happened.

Wednesday, June 3, 2009

Green on Moyo and the effectiveness of aid

Duncan Green is not satisfied with Moyo’s analysis and the alternatives she proposes:

But it is Dead Aid’s purported alternatives to aid that seem particularly feeble: African governments should issue lots of bonds (not too many takers at the moment - bad luck on the timing there); trust in China (and thus get stuck in commodity dependence, let alone the human rights issues); rich countries should remove barriers to trade (fine, but it won’t make much difference except in a few particular products like cotton) and invest in infrastructure (does anyone disagree with that?) and access to microfinance needs to be increased (sure, but it’s not even close to a magic bullet).

What is most noticeable is what’s missing – the book claims to be about finding better ways to finance development, but she barely mentions taxation or redistribution. Maybe it’s that Goldman Sachs/Zambian elite thing coming through again.

Overall, I was intrigued by Moyo’s politics/ideology. She manages to combine an entirely understandable resentment to the patronizing ways of aid donors and their crass portrayal of her continent (in Tony Blair’s awful soundbite) as ‘a scar on the conscience of the world’, an uncritical celebration of the rise of Chinese and Indian influence in Africa, and a highly conventional international financier’s assumption that free capital markets will solve every problem. A kind of third worldist neoliberalism, or right wing version of the old ‘aid as imperialism’ line.

Earlier discussion on the same issue here

Monday, June 1, 2009

Ram Saran Mahat talks sense!

Former finance minster of Nepal Ram Saran Mahat zeros down on growth and Maoist led government’s progress (I largely agree with his assessment):

Their focus was on distribution, not on production. We believe in production. Without creating production and employment opportunities you cannot raise the economic status of the people. They believed that distributing government resources would take care of everything. […] They believe in government intervention even in production and trading. They believe in re-nationalisation.

[…] distribution of wealth takes time, it cannot happen overnight. We could have done better, but even with the type of development we saw in the private sector, the living conditions at the bottom have improved a lot. Look at the real wages in the rural areas. Now it is difficult to get labour for agriculture, the wage rate is very high. Real wages have gone up. If you look at the National Living Standard Survey (NLSS), it shows that the consumption level of people across regions, across ecological bases, of all income groups have increased significantly. Employment opportunities have increased, there is demand for more labour, more employment. So while it is true that market forces increase disparity, it increases the income level of the poor also. To raise the economic status of lower income groups, of course, you need a separate package of economic reforms. More consideration needs to be given to the social sector -- health, education, rural development, agriculture.

Even in the early days our development programme, our budget distribution and expenditure pattern, the focus was on creating infrastructure in rural areas. We strongly believed that without basic infrastructure in place -- like access roads, electricity, education, basic health services -- no matter how much you spend for the downtrodden, it will have no meaning. And infrastructure is not created overnight, it takes time. Now you have started seeing results. Karnali is accessible, you have road links to Kalikot, Jumla. Districts that were not touched by road networks 10-15 years ago now have road access not just in their headquarters but practically in all VDCs. Electricity has reached to far corners of the country. That has helped a lot in improving the status of the common man. Because of improved infrastructure in rural areas, people are now producing for the market. Even from the far corners of Nepal, you see agricultural production coming into the market. So our emphasis was different.

The Maoist-led government failed because they allocated budgeted programmes, ill-conceived, half-baked programmes, without much study. They didn't allocate funds in well-studied, well-prepared programmes. They allocated huge sums of money without any preparation. But how can you spend money? Of course, there are financial rules and regulations that need to be followed. This is why they couldn't deliver.

The Maoists also failed miserably on the price front. The irony is that at the international level prices have been declining. Prices decline during a recession. Indian inflation is almost at 0 now. Fuel prices have gone down. But Nepal's inflation rate is going up. This is because of government mismanagement. There is more purchasing power in the hands of the people without production. Production should go side by side with income. The emphasis on distributive policies leads to easy money in the hands of the people, which leads to inflation. Bandas, hartals, disruptions in the supply chain are also responsible for this.