Tuesday, September 29, 2009

Zoellick calls for "Responsible Globalization"

Robert Zoellick, President of the World Bank Group, gave a speech today at SAIS. He shared his views on the crisis, especially what's up after the global financial crisis. He blames the rational choice theory and the lax oversight by central banks. He argues that the US won't have the same economic clout as it had before the crisis. China, India, Brazil and other developing nations will emerge more stronger than ever. This won't mean that the US will totally lose its clout. It will still have influence over economic and political matters but not to the extent prevalent before the crisis. He opines that that addressing large deficits and controlling inflation would determine the strength of the dollar and the US economy. Trade protectionism due to the global financial crisis has been a "low-grade fever but the temperature is rising." Similar point was also made by other economists as well. He also called for harmonization of the Doha Round with regional agreements. The IMF's managing director also gave similar speech last week.

Some seeds of today’s troubles were sown by the responses -- or lack of them -- to the financial crises of the late 1990s. After the Asian financial crisis, developing countries determined they never again wanted to be exposed to the tempests of globalization. Many “insured” themselves through managing exchange rates and building huge currency reserves. Some of these changes contributed to imbalances and tensions in the global economy, but for years governments muddled through amidst generally good growth.

...the alluringly simple design of “rational markets” theory led regulators to take a holiday from the realities of psychology, organizational behavior, systemic risks, and the complexities of markets and humans.

The current assumption is that the post-crisis political economy will reflect the rising influence of China, probably of India, and of other large emerging economies. Supposedly, the United States, the epicenter of the financial crisis, will see its economic power and influence diminish.

The future for the United States will depend on whether and how it will address large deficits, recover without inflation that could undermine its credit and currency, and overhaul its financial system to preserve innovation while adding to safety and soundness.

Over 10 to 20 years, the Renminbi will evolve into a force in financial markets.Countries and markets may also experiment with financings denominated in Special Drawing Rights –or SDRs— which reflect a portfolio of major currencies. [...] Of course, the U.S. dollar is and will remain a major currency. But the Greenback’s fortunes will depend heavily on U.S. choices. Will the United States resolve its debt problems without a resort to inflation? Can America establish long-term discipline over spending and its budget deficit? Is the country restoring a healthy financial sector capacity for innovation, liquidity, and returns, without producing the same risk of big bubbles and institutional breakdown? The dollar’s value will also depend on the extent to which we see the return of a dynamic, innovative private sector economy.

Central banks performed impressively once the full force of the crisis hit. But there are reasonable questions about how they handled the build-up, including asset price inflation and significant failures of supervision. We have yet to see whether Central Banks can handle the recovery without letting inflation get out of control.

On the protracted Doha Round:

The Doha Round could cut, discipline, and even eliminate some agricultural subsidies that for years were left outside the rules-based trading system. It could modestly open markets for manufacturing and agricultural goods in developed and major developing economies. It could “bind” barriers of major developing countries at much lower levels, increasing the sense of mutual contributions and limiting the risks of big jumps in tariffs. The Doha Round could also open service markets and cut developed country tariff peaks that limit basic manufacturing and value-added production in poorer countries. The Round could correct rules that have been bent to limit trade too freely. These are real gains and would demonstrate the capability of developed and major emerging economies to compromise to achieve a mutual and systemic interest.

We need more help for the poorest countries that have been less able to seize growth opportunities from trade. [...]The new agenda needs to build on early efforts by WTO’s Director General, Pascal Lamy, supported by the World Bank Group, to link trade facilitation to aid for trade. To capitalize on lower barriers to trade, poorer countries need: regional integration to build bigger markets and access for land-locked countries; energy; infrastructure; logistics systems; ready access to trade finance; assistance with standards; and streamlined customs and border procedures.

On Africa's potential:

Over time, Africa can also become a pole of growth. The messages I hear in most African countries are the same: Africans want energy, infrastructure, more productive agriculture, a dynamic private sector, and regionally integrated markets linked to open trade. It is a message one might have heard in a devastated Europe 60 years ago.

China’s African prospects -- which include resource development and infrastructure -- are likely to be complemented by others. Brazil is interested in sharing its agricultural development experience. India is building railways. These are the early days of a trend that will build.

Monday, September 28, 2009

Kahneman on the financial crisis and behavioral economics

The present issue of Finance & Development profiles Daniel Kahneman, who was awarded the Nobel Prize in Economics in 2002 for pioneering work that focused on the integration of aspects of psychological research into economic science (which is now labeled as behavioral economics). Especially after the global financial crisis, this field of study has been more relevant now than ever. Behavioral economists have shown the limits of human cognition and busted the ideology that human beings are always rational agents. Behavioral economics challenged standard economic rational-choice theory and injected more realistic assumptions about human judgment and decision-making. He propounded “prospect theory”, which basically says that individuals often make divergent choices in situations that are substantially identical but framed in a different way.

Standard economic models assume that individuals will rationally try to maximize their benefits and minimize their costs. But, overturning some of the traditional tenets, behavioral economists show that people often make decisions based on guesses, emotion, intuition, and rules of thumb, rather than on cost-benefit analyses; that markets are plagued by herding behavior and groupthink; and that individual choices can frequently be affected by how prospective decisions are framed.

“One of the main ideas in behavioral economics that is borrowed from psychology is the prevalence of overconfidence. People do things they have no business doing because they believe they’ll be successful.” Kahneman calls this “delusional optimism.” Delusional optimism, he says, is one of the forces that drive capitalism.

“Entrepreneurs are people who take risks and, by and large, don’t know they are taking them,” he argues.In the United States, a third of small businesses fail within five years, but when you interview those people, they individually think they have between 80 percent and 100 percent chance of success. They just don’t know.”

He argues that there is a need for stronger protection for consumers and individuals; there is a need to look beyond the markets because failure of markets has much wider consequences; and there is always limits to forecasting because of tremendous volatility in the stock markets and financial systems (huge uncertainty).

Noam Chomsky on crisis and hope

A very interesting and provocative article by Noam Chomsky:

As the fate of Bangladesh illustrates, the terrible food crisis is not just a result of “lack of true concern” in the centers of wealth and power. In large part it results from very definite concerns of global managers: for their own welfare. It is always well to keep in mind Adam Smith’s astute observation about policy formation in England. He recognized that the “principal architects” of policy—in his day the “merchants and manufacturers”—made sure that their own interests had “been most peculiarly attended to” however “grievous” the effect on others, including the people of England and, far more so, those who were subjected to “the savage injustice of the Europeans,” particularly in conquered India, Smith’s own prime concern in the domains of European conquest.

The distribution of concerns illustrates another crisis, a cultural crisis: the tendency to focus on short-term parochial gains, a core element of our socioeconomic institutions and their ideological support system. One illustration is the array of perverse incentives devised for corporate managers to enrich themselves, however grievous the impact on others—for example, the “too big to fail” insurance policies provided by the unwitting public.

There are also deeper problems inherent in market inefficiencies. One of these, now belatedly recognized to be among the roots of the financial crisis, is the under-pricing of systemic risk: if you and I make a transaction, we factor in the cost to us, but not to others.

The architects of Bretton Woods, John Maynard Keynes and Harry Dexter White, anticipated that its core principles—including capital controls and regulated currencies—would lead to rapid and relatively balanced economic growth and would also free governments to institute the social democratic programs that had very strong public support. Mostly, they were vindicated on both counts. Many economists call the years that followed, until the 1970s, the “golden age of capitalism.”

The “golden age” saw not only unprecedented and relatively egalitarian growth, but also the introduction of welfare-state measures. As Keynes and White were aware, free capital movement and speculation inhibit those options. To quote from the professional literature, free flow of capital creates a “virtual senate” of lenders and investors who carry out a “moment-by-moment referendum” on government policies, and if they find them irrational—that is, designed to help people, not profits—they vote against them by capital flight, attacks on currency, and other means. Democratic governments therefore have a “dual constituency”: the population, and the virtual senate, who typically prevail.

The synergy of running corporations and controlling politics, including the marketing of candidates as commodities, offers great prospects for the future management of democracy.

One of the reasons for the radical difference in development between Latin America and East Asia in the last half century is that Latin America did not control capital flight, which often approached the level of its crushing debt and has regularly been wielded as a weapon against the threat of democracy and social reform. In contrast, during South Korea’s remarkable growth period, capital flight was not only banned, but could bring the death penalty.

Where neoliberal rules have been observed since the ’70s, economic performance has generally deteriorated and social democratic programs have substantially weakened.

The phrase “golden age of capitalism” might itself be challenged. The period can more accurately be called “state capitalism.” The state sector was, and remains, a primary factor in development and innovation through a variety of measures, among them research and development, procurement, subsidy, and bailouts. In the U.S. version, these policies operated mainly under a Pentagon cover as long as the cutting edge of the advanced economy was electronics-based.

The crucial state role in economic development should be kept in mind when we hear dire warnings about government intervention in the financial system after private management has once again driven it to crisis, this time, an unusually severe crisis, and one that harms the rich, not just the poor, so it merits special concern.

Selective application of economic principles—orthodox economics forced on the colonies while violated at will by those free to do so—is a basic factor in the creation of the sharp North-South divide.

People cannot be told that the advanced economy relies heavily on their risk-taking, while eventual profit is privatized, and ‘eventual’ can be a long time.

There was a dramatic increase in the state role after World War II, particularly in the United States, where a good part of the advanced economy developed in this framework.

Returning to what the West sees as “the crisis”—the financial crisis—it will presumably be patched up somehow, while leaving the institutions that created it pretty much in place.

Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here

Friday, September 25, 2009

Aid harmonization in education sector in Nepal

So, the good news is that the aid agencies are harmonizing their effort to better education sector in Nepal. Despite my skepticism about the effectiveness of certain kind of donor funded projects, the intervention in the education sector has produced impressive results.

The program focuses on three pillars of access, inclusion and quality. The program is supported by eight other development partners who will also pool their resources, together with the World Bank and government resources. In addition, five non-pooling partners will support the program directly, adds the statement.

The total cost of the five-year program ending 2013/14 is estimated to be about $2.6 billion, of which pooled development partners have committed approximately $500 million.

As a sector wide approach, the program will finance salaries and benefits for nearly 120,000 government school teachers. It will also finance salaries of around 100,000 community recruited teachers through salary grants. Financing for all additional teachers to be recruited during the program period will be made through a per capita child financing formula that takes into account the number of students enrolled in a particular school, the release added.

I hope aid harmonization will be followed up in other sectors as well. The British government has unveiled $5 billion health care plan for six countries (Nepal being the only one from Asia). I hope other aid agencies harmonize their efforts with that of the British government. DFID has done quite a good job in education and health care sector in Nepal.

Sunday, September 20, 2009

Strauss-Kahn on financial crisis and low-income countries

Managing Director of the IMF, Dominique Strauss-Kahn, gave a speech at a CGD event on Sept 17. He talked about how the IMF is becoming flexible in helping developing countries cope with severe shortage of funds after the global financial crisis.

He argued that low-income countries have been hit harder than what was expected in March 2009 and now they remain highly vulnerable and face severe financing problems. These countries have been battered by multiple shocks--food and fuel price shock, global financial crisis, and drought and famine. The IMF estimates that low-income countries’ exports of goods and services could drop this year by 16 percent. A decline in remittances, by up to 10 percent, would further aggravate the plight of poor countries. Additionally, FDI flows to low-income countries might fall by 25 percent in 2009. Almost 17 million people are facing severe food shortages and may need emergency food aid, he said. Moreover, due to the global financial crisis an additional 90 million people will be pushed into extreme poverty.

Strauss-Kahn expects a recovery in 2010 and the developing countries would be able to “ride the wave of rising world demand”. [But, at a time when almost all the countries are aiming to increase exports, it is unclear how much the developing countries would benefit even if the world economy rebounds in 2010.]

He argues that there is something new about domestic policy responses in the developing countries this time-- most of them are “home grown”.

Some of this good news is home grown—always the best kind. Since many of these countries ran good policies, they built foundations to ward off the storm. This is something new. In the past, many low-income countries facing such a financial squeeze would have been forced to slash government spending, put administrative constraints on imports, or simply not pay their bills—making the crisis worse.

But this time is different. Debt positions had improved substantially, creating the breathing space for countercyclical policy. In fact, we estimate that almost two-thirds of low-income countries are at low or moderate risk of debt distress—this flows from better policies, and also from more aid and debt relief.

More than three quarters of low-income countries let budget deficits get bigger as revenue fell. One third also introduced a discretionary fiscal stimulus.Of 27 low-income countries with available data, 26 have preserved or increased social spending—no mean feat in the current environment.

The IMF is increasing funding and making the process much more flexible. He also spoke something about conditionality (apparently, admitting that some conditionalities were in fact counter productive):

It’s no secret that our lending programs attracted some criticism over the years. People said our conditions were too harsh, too intrusive, or even misguided. I accept some of that criticism. We made mistakes, but we always try to learn from our mistakes. Overall, I think the PRGF was a success. Countries with sustained program engagement over the past two decades saw bigger boosts to growth than those without such involvement.

Still, we need to make sure that the medicine does not harm the patient. Over the past few years, we have been streamlining our conditionality, focusing on core policy measures that are critical for macroeconomic stability, poverty reduction, and growth. Too many conditions in too many different areas can reduce effectiveness and lead to a loss of legitimacy. Across low-income country programs, the number of conditions has fallen by one third compared with the beginning of the decade. About 40 percent of these conditions are now focused on improving public resource management and accountability—such as expenditure control and tax administration.

Recent reforms have gone even further. From now on, our loans no longer include binding conditions on specific measures. Instead, programs will focus on meeting the overall objectives of the reforms, giving governments more leeway in reaching their goals.

Need to harmonize WTO with RTAs

Carnegie Endowment organized an event about WTO and how we can move forward with existing agreements so that the institution is relevant in the days ahead.It was argued that trade negotiations should be flexible to accommodate emerging thorny issues in the developing countries. Stalled trade negotiations could be passed if negotiations focus on liberalizing the sectors that are already moving forward in that direction due to independent initiative from individual countries. If the Doha Round has a slim chance passing in its entirety, then it can be passed by diluting the deal to accommodate new concerns of emerging and developing nations.

Uri Dadush presented a policy brief (WTO Reform: The Time to Start is Now), where he argues that the next round of WTO negotiations should be more flexible and tailored to the needs of individual countries and trading groups. He raised a very interesting perspective that most of the achievements under the WTO were in fact already moving forward in that direction due to bilateral and regional agreements among nations. The WTO just formalized and incorporated those already existing agreements under its framework. The most thorny issues related to subsidies are yet to be sorted out and this is what plagues the protracted Doha Round. Reductions of applied tariffs on trade in goods since 1995 is attributable to autonomous liberalization (65 percent), implementation of the Uruguay Round (25 percent), and regional arrangements (10 percent).

The WTO is increasingly bypassed in trade reform by unilateral, bilateral, and regional processes, and no new liberalization of trade in goods has come from multilateral negotiations since the institution was founded in 1995.

The WTO is nowhere to be found in several areas of crucial concern, including food security, international financial regulation in the wake of the global financial crisis, and climate change.

The WTO must break away from its splendid isolation and move from a single-minded focus on reciprocal multilateral concessions based on consensus and find ways to participate actively in arenas where actual liberalization is taking place.

The Doha Round is more complex and is hard to pass in its entirety because not all countries would agree to its provisions without diluting some of them to fit their national interest. The Doha Round has been complicated by the increased sensitivity of agricultural issues, the complexity of trade-offs in behind-the-border regulations in services sector, the growing number of diversity of trading partners, and the increased influence and assertiveness of large players and of groupings (LDCs). It is hard to reach a consensus incorporating all the members’ concern. This does not mean that consensus cannot be reached. Consensus can be reached in a diluted form, i.e. dealing with easier issues now and leaving thorny issues for later [we already did this one with the previous five rounds of negotiations and the most thorny issues were left to deal with for the Doha Round!]. How many issues can we leave now and then how much can achieve from the Doha Round? Hard to answer. However, Dadush feels that concluding the Doha Round is essential to preserving the credibility of the WTO as an institution and to avoid writing off the gains made in the last eight years of costly negotiations.

At at time when regional agreements are flourishing, the WTO should find a way to honor and incorporate provisions under such agreements within its global system. This will keep on the relevancy of the WTO. Generally, regional agreements are fast to come up with because of it is easy to form a consensus with few players. They are also designed to address country-specific needs and lessen discrimination: a low external tariff, simplified rules of origin, and coverage of all forms of trade. Dadush argues:

Establishing effective rules to govern regional agreements should be the WTO’s long-term objective, but its constructive engagement with regional processes is a prerequisite to achieving that goal.

In fact, the WTO seems to have realized this aspect and is arguing for giving more policy space to individual countries to help them weather unexpected demand and supply shocks. A recent WTO World Trade Report emphasized for inclusion of “trade contingency measures”. The contingency measures discussed in the report include safeguards measures, anti-dumping and countervailing measures, the re-negotiation of tariff commitments, the raising of tariffs up to their legal maximum levels, and the use of export taxes. These are needed because too little flexibility in trade agreements may render trade rules unsustainable. At the same time, too much flexibility may weaken the value of commitments and trade rules. An appropriate balance between flexibility and commitment is required for the success of trade agreements. There are some who argue that RTAs undermine full gains from global trade but evidence is not that strong in the light of increasing South-South trade. There are more gains to be made by encouraging WTO to engage in “opportunistic multilateralism” by strategically expanding existing RTAs into other relevant areas.

Steve Charnovitz, one of the panelist, argued that though judicial and executive branches of the WTO are working fine, it is not the same with the legislative process. He maintains that the existing WTO is out of sync with developments in the real world. Its limits on national regulation are not consistent with the changed market structure in place right now, especially in the new regulatory structure after the global financial crisis. Also, this is an era of huge government subsidies to almost all the crucial sector in an economy. This is not in line with the WTO regulations. Since the situation is bad everywhere and almost all of them are engaging in propping up flagging sectors, no one is complaining. He opines that the WTO should hold public hearing on each new PTA. He wants WTO to have a mix of states, NGOs, and private actors--like IUCN does.

Arvind Subramanian argued that new forms of protectionism is emerging out despite other restrictions from the WTO: exchange rate policies to prop up domestic exports and resource nationalism (export restriction or rice and gas last year).

Tuesday, September 15, 2009

Economics at work, Festival edition

One of the biggest festivals in the Hindu calendar is approaching and people are excited for family reunion and celebration. This comes up with the tendency by each household to build up stock of goods and services, thus drastically driving up demand for essential goods while supply being more or less constant for some period (until the adjustment occurs). However, before the adjustment occurs, the drastic rise in demand jacks up prices so high that it seems that the goods market is punched hard by sudden inflation hurricane. This is where we need a government food stocking and distribution agencies to smooth out supply of such goods and services.

Anyway, here is a story about increase in price of goats (not uncommon though):

With just days to go before Nepal's biggest religious festival of the year, the capital Kathmandu is suffering a severe shortage of goats for ritual sacrifice, the government said Tuesday.

As a result, the government food agency has ordered officials to travel to the countryside and buy up goats to be brought into the capital, where they will be sold for slaughter to mark the main Hindu festival of Dashain.

... the price of the animals had risen by around 25 percent in the capital as the festival approached, and the government was hoping to bring in around 6,000 of them

Thursday, September 10, 2009

Is Nepal gaining from becoming a member of the WTO?

In my latest op-ed, I look at how Nepal has fared since it joined the WTO in 2004. Quite surprisingly, overall trade has declined and employment situation in the manufacturing sector became worse. May be Nepal should focus more on the nearby markets where trade takes places the most (say, South Asian Free Trade Agreement-SAFTA) rather than eying markets in developed countries.


Is Nepal gaining from WTO?

A recent Ministerial Meeting in New Delhi decided to resume trade negotiations to pass the Doha Round, which came to a grinding halt in July last year over differences concerning special safeguard measures and agricultural subsidies offered by rich nations. The WTO Director General Pascal Lamy hopes that a Doha deal is doable by 2010. The Doha deal is expected to not only help countries expand trade but also help developing countries achieve development goals.

An increase in trade of goods and services in the international market has helped many countries achieve rapid economic growth. In the context of Nepal, we need to inquire what benefits we would have from the Doha Round in particular and the WTO in general. Nepal joined the WTO on April 23, 2004, becoming the first LDC to join the trading bloc through full working party negotiation process. So far, there have not been discernible benefits – in terms of growth, employment, poverty reduction and industrial production – from joining the WTO. In fact, exports have declined, imports increased and the manufacturing sectors, especially the ones that weighted high in the exports basket, have been going downward.

It is time to evaluate the progress made since joining the WTO and the possible impact on growth and employment due to planned reduction in tariffs in the coming years. No study has been done so far to figure out how much would Nepal gain by joining various trading blocs and under what trading scenario (tariff and subsidy rates) would Nepal lose and gain in what kind of sectors? What would be its impact on employment, which should be one of the main barometers for evaluating long-term success of trade?

It is surprising to note that trade (as a percentage of GDP) has declined since 2004, quite contrary to what is expected after joining trading blocs. It was 46.14 percent in 2004 but 45.28 percent in 2007. In the six years before joining WTO, on average, trade was 52 percent of GDP. In post-WTO period, on average, trade was 46 percent of GDP. Imports have been consistently rising since 2004 but exports have been decreasing. In FY 2003/04, exports (as a percentage of GDP) were approximately 16.7 percent whereas it was 12.1 percent in FY 2007/08. However, imports in FY 2003/04 were 29.5 percent of GDP but it was 32.7 percent in FY 2007/08. This means trade deficit is ballooning (increased by 23.3 percent last fiscal year). Had it not been for increasing remittances, balance of payments would have been negative. The investment situation also is not that encouraging. In FY 2007/08, gross investment (percentage of GDP) was 29.7 percent, down from 24.5 in FY 2003/04. Similarly, there has not been much change in foreign direct investment.

This means that even after joining the WTO, the country has failed to reap potential benefits; instead, it is at a disadvantage in terms of export promotion, public investment to prop up key industries and employment generation.

There has been no change in production structure and a shift to new productive activities is not happening. The top five export items – carpets and rugs, garments, jute goods, pulses and raw jute and jute cuttings – have not changed. Almost 80 percent of the exported items are manufactures and 60 percent of total export items go to India. The other top export destinations are the US, the EU, China and Bangladesh. Meanwhile, major import destinations are India (53 percent), China, the EU, Singapore and Malaysia. Of the total imports, 65 percent is manufactures, 15 percent agricultural products and the remaining fuels and mining products.

The rate of increase in volume of trade is not matched by the disappointing progress in economic growth rate and employment generation. The average growth rate in the post-WTO period is 3.5 percent while the average growth rate in trade in the same period is 46 percent. Worse, the employment level has been miserable in the manufacturing sector. Generally, low-skilled manufacturing activities are expected to increase along with a surge in employment in these sectors after joining the WTO. This is true for developing countries where wage rate is low and there is abundance supply of labor. However, in Nepal, the main export industry (garment and carpet) is close to being grounded now, which has already shed almost 90 percent employment and less than 20 firms are in operation.

Two main problems bedevil the exports sector: A lack of price and quality competitiveness. The former is a linked to exogenous factors such as road obstructions, high transportation costs, industrial strikes by politically-motivated trade unions and high cost of procurement of intermediate goods. All of these increase the cost of production. The second one is linked to endogenous factors like unwillingness of the export-based firms to explore innovative means of production and shift production to more productive activities with potential for comparative advantage. It is partly associated to their habit of excessively relying on trade under preferential agreements. A guaranteed low tariff and quota free access to markets abroad led to depression of incentives to innovate by the existing exporters. As per WTO agreement, when the quota system was phased out in 2005, the export-oriented firms went bust because other international competitors started eating up previously guaranteed market share.

The government has not been able to facilitate linkages between productive activities by reducing coordination failures. There are virtually no production and capital linkages between the existing goods that Nepal exports with comparative advantage and those that it could potentially do in the future. The capital and human resources of one industry are not readily available or useful to other industries, leading to a lack of synchronization in innovation of new goods and services.

The process of innovation and synchronization of similar industrial activities have not been made any easier by the government. The talks of establishing special economic zones (SEZ), which comprise of export processing zones, special trading zones, tourism/recreation and simplified banking facilities, have still not materialized due to political bickering and a lack of effective lobby from the industrial sector. The government has been planning for years to establish SEZs in Bhairahawa, Birgunj, Panchkhal and Ramate. Typically, the firms based in SEZs are responsible for producing quality goods and for exporting over 70 percent of their total production. The government has failed to give enough incentives in the form of tax credit, human resource training and technical expertise to the industrial sector.

The stalemate in production structure in the country even after six years of joining WTO is disappointing. No one knows how much will Nepal gain or lose if the Doha Round is completed by 2010. The government and think tanks need to analyze gains and losses under different WTO trading scenarios, especially tariffs reduction and subsidies elimination. Since more than half of the trading activities take place with India, it makes sense to focus on opening up markets for more goods and services between India and Nepal, than with the rest of the world. Also, given the increasing volume of trade among the SAARC members, it might be prudent to seek trading opportunities under much more liberal terms with SAFTA members than hoping to reap far-fetched benefits under the WTO regime.

Source: Republica, September 9, 2009

Global Competitiveness Report 2009-2010

The World Economic Forum (WEF) has published its annual global competitiveness report, which ranks countries based on how competitive their economies are (Global Competitiveness Index). This time the US fell to second place, overtaken by Singapore as the most competitive nation.

The GCI is based on 12 “pillars of competitiveness”, providing a comprehensive picture of the competitiveness landscape in countries around the world at all stages of development. The pillars include Institutions, Infrastructure, Macroeconomic Stability, Health and Primary Education, Higher Education and Training, Goods Market Efficiency, Labour Market Efficiency, Financial Market Sophistication, Technological Readiness, Market Size, Business Sophistication,and Innovation.

Here is a list of the top ten competitive nations:

Regarding Nepal’s standing, here are few details:

Overall, it ranks 125 out of 131 nations considered in the report. Specifically, institutions (123), infrastructure (131), macroeconomic stability (86), health and primary education (106), higher education and training (124), goods market efficiency (117), labor market efficiency (122), financial sophistication (99), technological readiness (132), market size (96), business sophistication (126), and innovation (130). Overall, Nepal had four “advantages” and 116 “disadvantages”. Gloomy report for Nepal!

Wednesday, September 9, 2009

Doing Business Report 2010--Nepal edition

The IFC has published its annual ease of doing business ranking-- Doing Business Report-- yesterday. This recent report is seventh in a series of annual reports published by the IFC and the World Bank. The report, Doing Business 2010: Reforming through Difficult Times, lists Singapore as a consistent and top reformer this year as well. The other top reformers on the list are New Zealand, Hong Kong, the US, the UK, Denmark, Ireland, Canada, Australia, Norway, and Georgia. Here is the full ranking. Here is an overview.

The report notes that despite global economic crisis, over 70 percent of the 183 economies covered by the report made progress. Reformers around the world focused on making it easier to start and operate businesses, strengthening property rights, and improving commercial dispute resolution and bankruptcy procedures.Two-thirds of the reforms recorded in the report were in low- and lower-middle-income economies. For the first time a Sub-Saharan African economy, Rwanda, is the world’s top reformer of business regulation, making it easier to start businesses, register property, protect investors, trade across borders, and access credit. The top ten reformers for this year are Rwanda, Kyrgyz Republic, Macedonia, FYR, Belarus, UAE, Moldova, Colombia, Tajikistan, Egypt, and Liberia. Rwanda has made fascinating progress in almost all the indicators.

The major indicators used are: starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and closing business. Note that these indicators do not assess market regulation or the strength of the financial infrastructure; macroeconomic conditions, infrastructure, workforce skills and security.

However, the regulatory environment for business influences how well firms cope with the crisis and are able to seize opportunity when recovery begins. Where business regulation is transparent and efficient, it is easier for firms to reorient themselves and for new firms to start up. Efficient court and bankruptcy procedures help ensure that assets can be reallocated quickly. And strong property rights and investor protections can help establish the basis for trust when investors start investing again.

So, how come the countries that are always in the top ten list consistently and persistently sticking around the top. It is because:

They follow a longer-term agenda aimed at increasing the competitiveness of their firms and economy. Such reformers continually push forward and stay proactive. They do not hesitate to respond to new economic realities. Consistent reformers are inclusive. They involve all relevant public agencies and private sector representatives and institutionalize reforms at the highest level. Successful reformers stay focused, thanks to a long-term vision supported by specific goals. 

In South Asia, Pakistan was the top reformer, followed by Maldives, Sri Lanka, Bangladesh, Nepal, Bhutan, India, and Afghanistan. It is surprising that India is in the second last position in South Asia.

How is Nepal doing this year?

Nepal’s rank is unchanged at 123 position in terms of ease of doing business. Specifically, starting a business was harder in Nepal (rank 87 in 2010 but 75 in 2009); dealing with construction permits was slightly harder (rank 131 in 2010 and 130 in 2009); employing workers also became difficult (rank 148 in 2010 but 147 in 2009); registering property became easier (rank 26 in 2010 and 29 in 2009); getting credit became difficult (rank 113 in 2010 but 109 in 2009); protecting investors became harder (rank 73 in 2010 but 70 in 2009); paying taxes also became harder (rank 124 in 2010 but 111 in 2009); trading across borders became cumbersome (rank 161 in 2010 but 159 in 2009); no change in enforcing contracts (ranking maintained at 122); and no change in closing business (ranking maintained at 105).

Overall, there was improvement in just one indicator-- registering property. Nepal’s Finance Act 2008 reduced the fee for transferring a property from 6 percent to 4.5 percent of the property’s value. Nepal did not make doing business any easier in the economy this year as well and it languished at the bottom. It is kind of expected because of transportation obstructions, forced closure of industries, labor union strikers, depleting industrial security, no improvement in infrastructure, severe power shortage, and labor market rigidities.

In order to start a business in Nepal, it still takes 7 procedures, 31 days and cost equivalent to 53.6 percent of income per capita. This cumbersome process and high cost exist despite no minimum capital requirement for starting a business. Compare this with doing business in South Asia: it takes 7.3 procedures, 28.1 days, cost equivalent to 27 percent of income per capita, and minimum capital requirement equivalent to 26.9 percent of income per capita.

In dealing with construction permits (the procedures, time, and costs to build a warehouse, including obtaining necessary licenses and permits, completing required notifications and inspections, and obtaining utility connections), it takes 15 procedures, 424 days, and cost equivalent to 221.3 percent of income per capita. Compare this with South Asia,it takes 18.4 procedures, 241 days, and cost equivalent to 2310.6 percent of income per capita. Compare this with OECD average: it takes 15.1 procedures, 157 days, and cost equivalent to 56.1 percent of income per capita.

In employing workers, the difficulty of hiring index is 67, rigidity of hours index is zero, difficulty of redundancy index is 70, rigidity of employment index is 46, and redundancy costs is equal to 90 weeks of salary. Compare this with South Asia:  the difficulty of hiring index is 27.8, rigidity of hours index is 10, difficulty of redundancy index is 41.3, rigidity of employment index is 26.3, and redundancy costs is equal to 75.8 weeks of salary. And, to OEDC average: the difficulty of hiring index is 26.5, rigidity of hours index is 30.1, difficulty of redundancy index is 22.6, rigidity of employment index is 26.4, and redundancy costs is equal to 26.6 weeks of salary. Note that each index assigns values between 0 and 100, with higher values representing more rigid regulations. The Rigidity of Employment Index is an average of the three indices.

In registering property, it takes 3 procedures, 5 days and cost 4.8 percent of property values. Compare this with South Asia: it takes 6.3 procedures, 105.9 days and cost 5.6 percent of property values. And to OECD average: it takes 4.7 procedures, 25 days and cost 4.6 percent of property values.

In getting credit, strength of legal rights index is 5, depth of credit information index is 2, public registry coverage (% of adults) is zero, and private bureau coverage (% of adults) is 0.3. Compare this with South Asia: strength of legal rights index is 5.3, depth of credit information index is 2.1, public registry coverage (% of adults) is 0.8, and private bureau coverage (% of adults) is 3.3. And with OECD average, strength of legal rights index is 6.8, depth of credit information index is 4.9, public registry coverage (% of adults) is 8.8, and private bureau coverage (% of adults) is 59.6. Note that the Legal Rights Index ranges from 0-10, with higher scores indicating that those laws are better designed to expand access to credit. The Credit Information Index measures the scope, access and quality of credit information available through public registries or private bureaus. It ranges from 0-6, with higher values indicating that more credit information is available from a public registry or private bureau.

In protecting investors, extent of disclosure index is 6, extent of director liability index is 1, ease of shareholder suits index is 9, and strength of investor protection index is 5.3. Compare this with South Asia: extent of disclosure index is 4.3, extent of director liability index is 4.3, ease of shareholder suits index is 6.4, and strength of investor protection index is 5. And with OECD average, extent of disclosure index is 5.9, extent of director liability index is 5, ease of shareholder suits index is 6.6, and strength of investor protection index is 5.8. Note that the indicators above describe three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index), shareholders’ ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index) and Strength of Investor Protection Index. The indexes vary between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection.

In paying taxes, an entrepreneur have to make 34 payments per year, spend 338 hours per year preparing tax stuff, pays 16.8 percent tax on profits, labor tax and contributions equal to 11.3 percent, other taxes equal to 10.7 percent and total tax rate is 38.8 percent of profit. Compare with South Asia: an entrepreneur have to make 31.3 payments per year, spend 284.5 hours per year preparing tax stuff, pays 17.9 percent tax on profits, labor tax and contributions equal to 7.8 percent, other taxes equal to 14.2 percent and total tax rate is 40 percent of profit. Compare with OECD average: an entrepreneur have to make 12.8 payments per year, spend 194.1 hours per year preparing tax stuff, pays 16.1 percent tax on profits, labor tax and contributions equal to 24.3 percent, other taxes equal to 4.1 percent and total tax rate is 44.5 percent of profit.

In trading across borders, it takes 9 documents, 41 days, and costs US$ 1764 per container to export a standardized shipment of goods. Meanwhile, it takes 10 documents, 35 days, and US$ 1825 to import a standardized shipment of goods. Compare this with South Asia: it takes 8.5 documents, 32.4 days, and costs US$ 1364.1 per container to export a standardized shipment of goods, while it takes 9 documents, 32.2 days, and US$ 1509.1 to import a standardized shipment of goods. And with OECD average: it takes 4.3 documents, 10.5 days, and costs US$ 1089.7 per container to export a standardized shipment of goods, while it takes 4.9 documents, 11 days, and US$ 1145.9 to import a standardized shipment of goods.

In enforcing contracts (commercial), it takes 39 procedures, 735 days, and costs 26.8 percent of claim. Compare this with South Asia: it takes 43.5 procedures, 1052.9 days, and costs 27.2 percent of claim. And with OECD average: it takes 30.6 procedures, 462.4 days, and costs 19.2 percent of claim.

In closing a business (resolve bankruptcies), it takes 5 years, costs 9 percent of estate and recovery rate is 24.5 cents on the dollar (claimants recover from the insolvent firm). Compare with South Asia: it takes 4.5 years, costs 6.5 percent of estate and recovery rate is 20.4 cents on the dollar. And with OECD average: it takes 1.7 years, costs 8.4 percent of estate and recovery rate is 68.6 cents on the dollar.

Tuesday, September 8, 2009

Nepal to cap CEO’s pay

Nepal’s central bank has decided to cap CEO’s pay to eight to 10 percent of total expenses made on employees of their respective institutions.

[…] a ceiling on the salary and benefits of CEOs was needed to check existing practice of handing out huge amount of perks and benefits to the head honchos, even if the financial condition of the bank concerned is not very sound. Similarly, the huge pay has been used by some executives cum promoters to “quietly” recoup their investment, in the form of remuneration.

The NRB study also concluded that the practice of awarding huge pay to the CEOs and other subordinates was also putting pressure on the management, especially of new banks, to increase earnings by many folds to pay the increased liabilities. This often instigates the management to make massive risky investment in unproductive sectors like land and real estate that are rejected by established banks, said the official.

Sounds good to reduce malpractices in the (bubbling) banking sector and to decrease widening income inequality!

Are economists to blame for the crisis?

Yes, says Krugman. But the economists he is talking about are neoclassicals and their variants, who have been pretty much driving economics and economic policy for a long time. He argues that the neoclassical stuff is neat and clean but wrong and its alternative is messier and not straight forward but right.

one thing’s for sure: we don’t have that beautiful final theory now, so the current choice is between ideas that are beautiful but wrong and a much messier hodgepodge.

Here is how he feels about economics, economists, and the whole profession. This is a good rundown of the trouble with economics and economists for people how have not read Krugman’s book ‘The Depression Economics and the Crisis of 2008’, which I have reviewed here.

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.

And in the wake of the crisis, the fault lines in the economics profession have yawned wider than ever. Lucas says the Obama administration’s stimulus plans are “schlock economics,” and his Chicago colleague John Cochrane says they’re based on discredited “fairy tales.” In response, Brad DeLong of the University of California, Berkeley, writes of the “intellectual collapse” of the Chicago School, and I myself have written that comments from Chicago economists are the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten.

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.

About Keynes:

Keynes did not, despite what you may have heard, want the government to run the economy. He described his analysis in his 1936 masterwork, “The General Theory of Employment, Interest and Money,” as “moderately conservative in its implications.” He wanted to fix capitalism, not replace it. But he did challenge the notion that free-market economies can function without a minder, expressing particular contempt for financial markets, which he viewed as being dominated by short-term speculation with little regard for fundamentals. And he called for active government intervention — printing more money and, if necessary, spending heavily on public works — to fight unemployment during slumps.

It’s important to understand that Keynes did much more than make bold assertions. “The General Theory” is a work of profound, deep analysis — analysis that persuaded the best young economists of the day. Yet the story of economics over the past half century is, to a large degree, the story of a retreat from Keynesianism and a return to neoclassicism. The neoclassical revival was initially led by Milton Friedman of the University of Chicago, who asserted as early as 1953 that neoclassical economics works well enough as a description of the way the economy actually functions to be “both extremely fruitful and deserving of much confidence.” But what about depressions?

[..] Eventually, however, the anti-Keynesian counterrevolution went far beyond Friedman’s position, which came to seem relatively moderate compared with what his successors were saying. Among financial economists, Keynes’s disparaging vision of financial markets as a “casino” was replaced by “efficient market” theory, which asserted that financial markets always get asset prices right given the available information. Meanwhile, many macroeconomists completely rejected Keynes’s framework for understanding economic slumps. Some returned to the view of Schumpeter and other apologists for the Great Depression, viewing recessions as a good thing, part of the economy’s adjustment to change. And even those not willing to go that far argued that any attempt to fight an economic slump would do more harm than good.

[…]“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time.” So wrote John Maynard Keynes in an essay titled “The Great Slump of 1930,” in which he tried to explain the catastrophe then overtaking the world. And the world’s possibilities of wealth did indeed run to waste for a long time; it took World War II to bring the Great Depression to a definitive end.

About faulty models:

[…] It’s hard to argue that this transformation in the profession was driven by events. True, the memory of 1929 was gradually receding, but there continued to be bull markets, with widespread tales of speculative excess, followed by bear markets. In 1973-4, for example, stocks lost 48 percent of their value. And the 1987 stock crash, in which the Dow plunged nearly 23 percent in a day for no clear reason, should have raised at least a few doubts about market rationality.

These events, however, which Keynes would have considered evidence of the unreliability of markets, did little to blunt the force of a beautiful idea. The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward — the so-called Capital Asset Pricing Model, or CAPM (pronounced cap-em) — is wonderfully elegant. And if you accept its premises it’s also extremely useful. CAPM not only tells you how to choose your portfolio — even more important from the financial industry’s point of view, it tells you how to put a price on financial derivatives, claims on claims. The elegance and apparent usefulness of the new theory led to a string of Nobel prizes for its creators, and many of the theory’s adepts also received more mundane rewards: Armed with their new models and formidable math skills — the more arcane uses of CAPM require physicist-level computations — mild-mannered business-school professors could and did become Wall Street rocket scientists, earning Wall Street paychecks.

To be fair, finance theorists didn’t accept the efficient-market hypothesis merely because it was elegant, convenient and lucrative. They also produced a great deal of statistical evidence, which at first seemed strongly supportive. But this evidence was of an oddly limited form. Finance economists rarely asked the seemingly obvious (though not easily answered) question of whether asset prices made sense given real-world fundamentals like earnings. Instead, they asked only whether asset prices made sense given other asset prices. Larry Summers, now the top economic adviser in the Obama administration, once mocked finance professors with a parable about “ketchup economists” who “have shown that two-quart bottles of ketchup invariably sell for exactly twice as much as one-quart bottles of ketchup,” and conclude from this that the ketchup market is perfectly efficient.

Saltwater economists vs. Freshwater economists:

Forty years ago most economists would have agreed with this interpretation. But since then macroeconomics has divided into two great factions: “saltwater” economists (mainly in coastal U.S. universities), who have a more or less Keynesian vision of what recessions are all about; and “freshwater” economists (mainly at inland schools), who consider that vision nonsense.

Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work, a premise violated by the story of the baby-sitting co-op. As they see it, a general lack of sufficient demand isn’t possible, because prices always move to match supply with demand. If people want more baby-sitting coupons, the value of those coupons will rise, so that they’re worth, say, 40 minutes of baby-sitting rather than half an hour — or, equivalently, the cost of an hours’ baby-sitting would fall from 2 coupons to 1.5. And that would solve the problem: the purchasing power of the coupons in circulation would have risen, so that people would feel no need to hoard more, and there would be no recession.

[…]Meanwhile, saltwater economists balked. Where the freshwater economists were purists, saltwater economists were pragmatists. While economists like N. Gregory Mankiw at Harvard, Olivier Blanchard at M.I.T. and David Romer at the University of California, Berkeley, acknowledged that it was hard to reconcile a Keynesian demand-side view of recessions with neoclassical theory, they found the evidence that recessions are, in fact, demand-driven too compelling to reject. So they were willing to deviate from the assumption of perfect markets or perfect rationality, or both, adding enough imperfections to accommodate a more or less Keynesian view of recessions. And in the saltwater view, active policy to fight recessions remained desirable.

But the self-described New Keynesian economists weren’t immune to the charms of rational individuals and perfect markets. They tried to keep their deviations from neoclassical orthodoxy as limited as possible. This meant that there was no room in the prevailing models for such things as bubbles and banking-system collapse. The fact that such things continued to happen in the real world — there was a terrible financial and macroeconomic crisis in much of Asia in 1997-8 and a depression-level slump in Argentina in 2002 — wasn’t reflected in the mainstream of New Keynesian thinking.

Even so, you might have thought that the differing worldviews of freshwater and saltwater economists would have put them constantly at loggerheads over economic policy. Somewhat surprisingly, however, between around 1985 and 2007 the disputes between freshwater and saltwater economists were mainly about theory, not action. The reason, I believe, is that New Keynesians, unlike the original Keynesians, didn’t think fiscal policy — changes in government spending or taxes — was needed to fight recessions. They believed that monetary policy, administered by the technocrats at the Fed, could provide whatever remedies the economy needed. At a 90th birthday celebration for Milton Friedman, Ben Bernanke, formerly a more or less New Keynesian professor at Princeton, and by then a member of the Fed’s governing board, declared of the Great Depression: “You’re right. We did it. We’re very sorry. But thanks to you, it won’t happen again.” The clear message was that all you need to avoid depressions is a smarter Fed.

And as long as macroeconomic policy was left in the hands of the maestro Greenspan, without Keynesian-type stimulus programs, freshwater economists found little to complain about. (They didn’t believe that monetary policy did any good, but they didn’t believe it did any harm, either.)

It would take a crisis to reveal both how little common ground there was and how Panglossian even New Keynesian economics had become.

[…] saltwater economists, who had comforted themselves with the belief that the great divide in macroeconomics was narrowing, were shocked to realize that freshwater economists hadn’t been listening at all. Freshwater economists who inveighed against the stimulus didn’t sound like scholars who had weighed Keynesian arguments and found them wanting. Rather, they sounded like people who had no idea what Keynesian economics was about, who were resurrecting pre-1930 fallacies in the belief that they were saying something new and profound.

[…] Why should it take mass unemployment across the whole nation to get carpenters to move out of Nevada? Can anyone seriously claim that we’ve lost 6.7 million jobs because fewer Americans want to work? But it was inevitable that freshwater economists would find themselves trapped in this cul-de-sac: if you start from the assumption that people are perfectly rational and markets are perfectly efficient, you have to conclude that unemployment is voluntary and recessions are desirable.

Keynesian fiscal stimulus:

During a normal recession, the Fed responds by buying Treasury bills — short-term government debt — from banks. This drives interest rates on government debt down; investors seeking a higher rate of return move into other assets, driving other interest rates down as well; and normally these lower interest rates eventually lead to an economic bounceback. The Fed dealt with the recession that began in 1990 by driving short-term interest rates from 9 percent down to 3 percent. It dealt with the recession that began in 2001 by driving rates from 6.5 percent to 1 percent. And it tried to deal with the current recession by driving rates down from 5.25 percent to zero.

But zero, it turned out, isn’t low enough to end this recession. And the Fed can’t push rates below zero, since at near-zero rates investors simply hoard cash rather than lending it out. So by late 2008, with interest rates basically at what macroeconomists call the “zero lower bound” even as the recession continued to deepen, conventional monetary policy had lost all traction.

Now what? This is the second time America has been up against the zero lower bound, the previous occasion being the Great Depression. And it was precisely the observation that there’s a lower bound to interest rates that led Keynes to advocate higher government spending: when monetary policy is ineffective and the private sector can’t be persuaded to spend more, the public sector must take its place in supporting the economy. Fiscal stimulus is the Keynesian answer to the kind of depression-type economic situation we’re currently in.

What needs to change?

So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.

Many economists will find these changes deeply disturbing. It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty that characterizes the full neoclassical approach. To some economists that will be a reason to cling to neoclassicism, despite its utter failure to make sense of the greatest economic crisis in three generations. This seems, however, like a good time to recall the words of H. L. Mencken: “There is always an easy solution to every human problem — neat, plausible and wrong.”

When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.

Thursday, September 3, 2009

Thoughts on Paul Mason’s book ‘The End of the Age of Greed’

I just finished reading Paul Mason’s book Meltdown: The End of The Age of Greed. I found the book very informative and enriching. While reading the book, sometimes you feel that the blame for the whole financial crisis should be heaped upon the corporate elites and the policymakers, who aided elite’s greedy nature in order to fulfill their own greed. The nexus between the corporate elites, who only cared about increasing profits and dividends by often going roundabout laws and lobbying for easier rules, and politicians who shared similar ideology (economic) in principal was something much deeper than what I had imagined.

He walks readers through events like the repealing in 1999 of Glass-Steagall Act of 1933 in the US and the wave of deregulation (propounded by conservative policymakers by flowing with the partisan findings of conservative think tanks, which are funded by the business community that have vested interested in profit- making only), separating investment banking from regulation, allowing the sub-prime market to deliberately bloat, giving derivatives markets to free ride without supervision, and a deep-rooted belief on a flawed ideology (to borrow Krugman’s words “crank philosophy”) among others, all of which contributed to the global financial crisis.

Mason offers a fairly detailed timeline and description of the events that occurred during the makeup to and after the crisis. I will briefly note and quote the stuff I find interesting in the book.This blog post is not a review of his book.

In human terms, the commodities craze was the shortest, steepest and most disastrous of the bubbles. If subprime ruined the credit scores of millions of Americans, the commodity inflation took food out of the mouths of mouths of children from Haiti to Bangladesh, and made many middle-income people in the developed world feel instantly poor. [...] G7 politicians generally tried to address the combined credit freeze and commodity inflation with the old tools and the old obsession. The inflation hawks fought inflation; the monetarists flooded the system with money; fiscal conservatives attacked government profligacy. And economists, consulting their graphs, saw the end of a cycle instead of the end of an era.

He argues that the credit freeze and commodity prices boom originated in the parts of the financial system that were impenetrable to public scrutiny. The derivatives market had no surveillance despite it being about six folds the size of global real GDP. Similar was the case with credit default swaps, whose market was valued at $58 trillion. He believes that a blind belief in neoliberal ideology, which is focused too much on self-interest and self-regulation, is partly the cause of this crisis.

Neoliberalism, like all ideologies, needs to be understood exactly as it wishes to avoid being understood: as the product of history. [...] Neoliberalism fought its way to dominance against the power of the Keynesian establishment: against Nixon, Carter, Callaghan; against the Marxist and Keynesian influence in the academia. Above all it was a doctrine of conflict and vision. [...] The problem with neoliberalism's critics, for now, is that they have no coherent world view to take its place. There are elements of such a world view, scattered within the writings of neo-Keynesians, the anti-globalisation left and the Stiglitz critique of neoliberalism.

He maintains that information technology has shaped our lives and lifestyles beyond what we could imagine. This, along with political changes and heavily funded conservative think tanks, has also accelerated the adoption of neoliberal ideas across the society.

It is too crude to say the silicon chip 'causes' the rise of the free market, globalisation and finance capitalism. But the silicon chip and the internet protocol were surely key to their rapid rise to dominance.

He gives details of works of two economists who more or less predicted periodic booms and busts in the market. First, he talks about Kondratiev wave, a path first described by Russian economist Nikolai Kondrative. It predicts that capitalism moves through, on average, fifty-year cycles in which periods of economic growth are followed by periods of crisis and then depression. This theory explains the booms and busts except for the period after 80s and 90s, when the gold standard was abandoned, central banks developed new measures to expand credit and tame inflation, and  the Berlin Wall fell down.

He then talks about Hyman Minsky, who laid out the reasoning and tools to predict the crisis and recommended how to resolve it. Minsky argues that capitalist society is inherently flawed and when it is uncontrolled, the government has to step in to remedy the uncontrolled aspects. He warned, "The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciation, unemployment and poverty in the midst of what could be virtually universal affluence- in short ... financially complex capitalism is inherently flawed." We need to live with the fact that capitalism is flawed; it is not perfect and efficient; and policymakers can use policy tools to mitigate the effects of downsides of capitalism.

Minsky's proposed solution to financial crisis (which is more or less is close to what Krugman and other Keynesian economists have been rightly saying):

... state intervention in two fronts: the government should run a big budget and the central bank should pump money into the economy. It will be noted, despite Minsky's pariah status in economics, that his remedy is exactly what has been adopted- in the US, the UK, the eurozone and much of the developed world. The problem is, it has not so far worked. Trillions of dollars of ready money, tax cuts and state spending were shoveled into the world economy to stop the credit crunch producing another Great Depression. yet all those trillions are up against a powerful backwash of collapse within the real economy.

I think Mason is misguided here and is taking a very short-sighted view about the impact of stimulus. First, the global fiscal stimulus is just above a trillion dollars and is not expected to kick in until early 2010. Second, the fiscal stimulus was small if we look at the historic nature of this slump. In the US economy, Krugman has been calling for a stimulus equivalent to 4 percent of GDP, which is not politically feasible though it would have been the best policy move if enacted. The global economy needs to be heated (because the economy still is slightly close to deflationary point) and slight inflation with budget deficit must be tolerated. In fact, the global economy, especially the emerging Asia and some EU nations, have rebounded from the first quarter of 2009. So, the fiscal stimulus (clearly worked in China, France, Germany, Australia) along with liquidity injection from the central banks have worked for now. It needs to be seen if the current nascent recovery is sustainable.

Mason outlines three rational alternatives for the developed world: (i) revive the high-debt/low-wage model under the more controlled conditions (pretty much the one agreed by G20); (ii) abandon high growth as an objective altogether; (iii) a return to higher wages, redistribution and a highly regulated finance system. The third one is close to what Minsky argued for-- a high-growth economy that transcends the limitations of both Keynesian and neoliberal models (nationalization/semi-nationalization of banking and insurance industries; strict limits on speculative finance; address inequality by changing tax structure so that the bottom half of the income scale benefit from growth; and consumer demand sustained by growth itself; create permanently benign conditions for entrepreneurs by limiting the power of large-scale enterprises).

On a side note, I think Mason does not fully explore Sachs’ prescribed "shock therapy" that created mess during Russia’s transformation from socialist to capitalist economy. He is favorable of Sachs and wrongly attributes some of the events to Sachs’s academic and policy activism. That said, he does mention the role played by Sachs, and Stiglitz, in making policymakers aware that the IMF-prescribed policies to East Asia after the 1997 crisis was flawed.

He thinks that the Minsky model would be the likely outcome because of heavy government involvement in the market (as was necessitated by the mess created by the markets):

As the crises worsens, it is becoming commonplace for pundits to observe, while capitalism is collapsing, that nobody has thought of an alternative. This is not true. The Minsky alternative- a socialised banking system plus redistribution- is, I believe, the ground on which the most radical of the capitalist re-regulators will coalesce with social justice activists. And it may even go mainstream if the only alternative is seen to be low growth, decades of debt-imposed stagnation, or another re-run of this crisis a few years down the line. It is also possible that a socialised banking system, by allowing the central allocation of financial resources, could be harnessed to the rapid development and large-scale production of post-carbon technologies.

Overall, a very good and informative book about the meltdown. John Kay reviews Mason's book here.

Is the global economy rebounding?

Carnegie Endowment hosted a session about global recovery in the aftermath of the global financial crisis yesterday. Four analysts shared their forecasts and views about where the global economy is heading now.

Hans Timmer, lead economist of Development Prospects Group at the World Bank, argued that though gradual recovery is happening , the pace would depend not only on performance of the US economy but also on the magnitude of rebound in the emerging economies. During the crisis, the emerging economies plunged the most, so in order to rebound strongly, they have to grow strongly. He argued that Fareed Zakaria's misread the numbers in his recent column in the sense that he holds the view that if the US spends enough, things will be okay. Rebound in the developing countries, especially the emerging economies, will determine how fast the global economy will be pulled out of this mess. In the emerging economies, the decline in imports was higher than the decline in exports; the opposite is true for high-income countries. The developing countries reconsidered their investment projects and used up their inventories while reducing imports, deepening the crisis.

He opined that the present rebound (industrial production), which has been visible since the first quarter of 2009, does not reflect a real recovery and might just be a "technical rebound". In the last five months, Asian exports and imports have increased. Japan’s growth is driven by imports by other Asian nations. Commodity prices have also begun to move up. The strength and sustainability of rebound would depend on investment levels and inventories build up and the looseness of international credit supply.

Jorg Decressin, division chief of European Department at IMF, argued that the global recovery is definitely real but is heavily policy dependent. It is a subdued recovery. Consumer confidence is gradually rebounding and so is trade. Interest rate is near zero and a lot of liquidity has been injected into the global economy. However, for sustainable recovery, private demand has to take the place of public demand. Moreover, global imbalances in trade have to be corrected and fiscal deficits have to be brought down. External deficit countries will have to invest less and save more while external surplus countries have to invest more and save less. China alone cannot do it because Chinese total consumption is almost 25 percent of the total US consumption. The Middle East countries also have to step in but they too are constrained by their own challenges. So, rebalancing will take time and recovery will be slow. It is not a self-sustaining recovery.

Philip Suttle, director of Global Macroeconomic Analysis at IIF, argued that the rebound is real and does not look “technical” to him. He made six points:

  • Inventories will be rebuilt steadily rather than suddenly in the coming quarters
  • Global financial condition is getting better. The transmission mechanism of money is working pretty good
  • There is an upward revision to capital spending plans
  • Housing collapse appear to be ceasing, especially in the US and UK
  • Fiscal stimulus is starting to kick in.
  • Labor market conditions will begin to improve.

All these positive signs signal that rebound is real and the trend is upwards. However, there are chances of “double-dip”, as happened during the first half of 1980s, but is not very likely. Events that could cause “doubled-dip” are (but unlikely):

  • Emerging markets don’t deliver
  • More financial turmoil (like Lehman Brothers debacle)
  • High inflation forcing policymakers to tighten up monetary and fiscal policies (he argues that this is possible because our errors in predicting inflation have typically been on the high side)

Uri Dadush, director of International Economics program at Carnegie, argued that stimulus and credit restoration has led to nascent recovery. Rebounding might be slow but it cannot be too slow because it is already a very low level. He argued that in six to twelve months from now, the stimulus will have to be withdrawn. The recovery will then depend on how much the private sector will be able to pick up from the public sector-driven growth path. In the next six months, recovery will persist. Asia, the Europe, and the US have to rely on their own restructuring and domestic demand for sustained growth, he said.

The discussion was focused exclusively on the emerging economies and the OECD countries, though the panelists kept on saying ‘developing countries’, trying to mean as if they were talking about the whole world. Nobody even mentioned Sub-Saharan Africa (except for Hans, who briefly said the focus of the next G20 would be on the developing countries, poverty reduction, and the financial crisis’s impact on the poor). No trading blocs like SAARC, SADC, AU, MENA, and BIMSTEC, among others were mentioned. It might partly be because only a handful of countries drive the global trade and economy and if they don’t grow, others might not as well.

Also, it appeared that the recovery they were talking about was based on the existing system. What would a recovery look like in a reformed system, where some banks are nationalized and investment banks and hedge funds are under tight supervision? The looseness in credit from these institutions is already restrained. Moreover, a huge chunk of liquidity and investment source-- derivatives markets-- is pretty much in doldrums now. So, the recovery now look like just stocking up of inventories. After it is near-full, the real recovery would actually depend on how we fill up the liquidity void created by busted investment banks, hedge funds, subprime markets and derivates markets. Due to these markets’ absorptive capacity, inflation was pretty low despite high liquidity in the past seven years (?!?). It won’t be the same now. So, where will the trend in recovery stop or satiate?

Tuesday, September 1, 2009

Climate and life in Nepal, as seen by a BBC reporter

This article is based on a recent Oxfam report:

But an Oxfam report released earlier this week has warned that poor harvests, water shortages and extreme temperatures - the consequences of climate change - will plunge millions of rural poor in Nepal into hunger.

In Bhattegaun, an hour's walk away from the road through forested hills, the effects are already apparent. A stream that provides water has dried up to a thin trickle.

Each day 35-year-old Naina Shahi gathers what she can for her three children and carries it back to her two-room hut.

Prabin Man Singh, who works for the international aid agency, Oxfam, says that with the changes in weather patterns the daily struggle for survival has been accentuated.

"Food production has fallen because of variable rainfall, so they don't have enough to feed the whole family. "There is a water scarcity in the hills and women have to walk a longer distance to get water," he says.

Two issues warrant immediate and close monitoring:

(i) late monsoon will decrease agriculture production, which is the backbone of the economy and more than 70 percent of the population depend on it for living. This will also have a huge impact on economic growth rate and per capita income.

(ii) late but heavy monsoon might wreak havoc, especially destroying property, landslides, farmed land (further decreasing production), increase the number of internally displaced people, and cause starvation, among others. This might fuel social conflict.