Who reads Hayek correctly? Sachs or Easterly?

My econ professors Andrew Farrant and Edward McPhail, Dickinson College, argue that Jeff Sachs was right in interpreting Hayek's view on welfare state and the road to serfdom!(Btw, here is Easterly explaining the Hayekian insight on economic development) Read the full paper (can't find an online version) for more discussion on how people have failed to interpret what Hayek really meant when he discussed welfare state. They also claim that Glenn Beck and Rush Limbaugh have misread Hayek.

"A relatively recent example of the debate over whether Hayek’s arguments are intended to apply exclusively to full-blown command planning or to command planning and the welfare state alike is provided by the 2006 exchange between Jeffrey Sachs and William Easterly over the merits or otherwise of Hayek’s thesis and the relevance of Hayek’s arguments to debates over contemporary policy. Sachs contended that Hayek intended his argument to have ready applicability to the postwar welfare state. Sachs argued moreover that Hayek’s argument largely missed its mark, and the postwar performance of the Nordic social democracies—together with their clear failure to mutate into totalitarian polities—provided especially telling evidence against Hayek’s thesis.

In his rejoinder to Sachs, William Easterly (seemingly fully in agreement with Bruce Caldwell’s oft-repeated claim that Hayek’s thesis has no bearing on contemporary policy debates over the welfare state per se) suggests that Hayek’s thesis was intended to only have applicability to a system of wholesale state planning.4 In reply, Sachs rightly pointed to Hayek’s 1976 utterance that he deemed The Road to Serfdom to have much applicability to command planning and the redistributive Nordic-style welfare state alike.

Sachs notes that Hayek suggested “that high taxation would be a ‘road to serfdom,’ a threat to freedom itself” (Sachs 2006, 42). Similarly, Sachs maintains that “Hayek was wrong. In strong and vibrant democracies, a generous social welfare state is not a road to serfdom” (ibid.; emphasis added).

Unsurprisingly, Sachs’s reading of Hayek attracted much online commentary. For example, one leading authority on Hayek’s work insisted that Sachs had seriously misread “Hayek’s Road to Serfdom thesis” (Boettke 2006).

Our aim here, however, is not to evaluate whether Sachs and Easterly are correct per se in their claims and counterclaims about the growth performance (whether sterling or otherwise) of the Nordic social democracies. Instead, we argue that Sachs’s “welfare state” reading of Hayek’s thesis is accurate. Indeed, the Sachs-Easterly exchange is merely the latest spark on this particular issue to rise from the rather heated intellectual fire that Hayek’s book immediately lit upon its initial appearance in 1944 (see, e.g., Hansen [1945] 1947). Moreover, there is much clear evidence that Hayek himself had always intended his argument to apply with equal stringency against command planning and the welfare state alike (see, e.g., Hayek 1948, [1956] 1994, 1960, and [1976] 1994). Indeed, as we shall show, Hayek—during the 1940s and after—frequently argued that the logic supposedly set into play by any policy of persisting with the mixed economy, Keynesian demand management policy, and welfare state practices would lead to full-blown central planning. Importantly, Hayek frequently claimed that the “middle of the road” policies—pretty much the welfare state and demand management (Toye 2004)—adopted by the 1945–51 Labour Government in Britain aptly illustrated the veracity of his thesis in The Road to Serfdom."

This is what I commented last time when professors Farrant and McPhail published an interesting paper on Samuelson, Hayek and the inevitability thesis:

"Consider this by Hayek (Foreword to the 1956 American paperback edition of The Road to Serfdom, pp44 in the definitive edition of The Road to Serfdom):

The hodgepodge of ill-assembled and often inconsistent ideals which under the name of the Welfare State has largely replaced socialism as the goal of the reformers needs very careful sorting out of its results are not to be very similar to those of full-fledged socialism. This is not to say that some of its aims are not both practicable and laudable. But there are many ways in which we can work toward the same goal, and in the present state of opinion there is some danger that our impatience for quick results may lead us to choose instruments which, though perhaps more efficient for achieving the particular ends, are not compatible with the preservation of a free society. The increasing tendency to rely on administrative coercion and discrimination where a modification of the general rules of law might, perhaps more slowly, achieve the same object, and to resort to direct state controls or to the creation of monopolistic institutions where judicious use of financial inducements might evoke spontaneous efforts, is still a powerful legacy of the socialist period which is likely to influence policy for a long time to come.

Apparently, Hayek overstretched his warnings and considered that economic planning and reforms would lead to (ultimately result in) a totalitarian state. For the sake of justifying freedom, he blinded himself to the  possibility of having a managed mixed-economy. See the success of the Nordic countries. Also, it is hard to believe that  the US (and other Western countries) would end up being  totalitarian states, especially after the financial crisis (with all those bail-out interventions and activist government policies)."

Nepal's fiscal budget 2010/11 & Economic Survey 2009/10

There is hardly anything to say about the “special budget” worth Rs 110.21 billion rolled out by the caretaker government. It is meant to finance regular bureaucratic activities and is devoid of development and growth agendas. The inability of the political leaders to forge consensus on major economic issues is extremely frustrating because this budget is not going to do anything in addressing the major macroeconomic and development challenges faced by the nation. Unfortunately, misplaced political ambitions of the main political vision less leaders is holding hostage the aspiration of Nepalese people.

 

I usually assess and comment on the fiscal budget but this one is not even worth commenting because it lacks details about key economic expenditure and revenue issues. There is Rs 78.81 billion allocated for appropriate heads (parliament approval needed) and Rs 31.40 for chargeable items (parliament approval not needed). With such a half-hearted and incomplete budget, we should not be expecting much from the government in terms of spurring growth, development, and employment in the upcoming fiscal year. The messy macroeconomic situation will persist (or even worsen).

Meanwhile, the Ministry of Finance (MoF) released Economic Survey 2009/10 this week. It is one of the most anticipated reports coming out of the MoF. Here is an excellent summary and interpretation, based on the Economic Survey, of the state of the Nepalese economy. Here is my take based on the main message of the report: The economy is in a mess, growth is sluggish, and macroeconomic troubles are imminent. The government urgently needs to address the non-economic constraints such as bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages, among others, to kick-start the jammed growth engine of the Nepalese economy.

 

The economic growth rate (real GDP) in the current fiscal year 2009/10 is estimated to be 3.5 percent – lower than 4 percent achieved last year. Government argues that the decline in production of crops (blaming monsoon and adverse weather for growth stagnation!) and sluggish non-agricultural sectors contributed to the slowdown of Nepal’s growth engine. The non-agricultural sectors were (and are) plagued by frequent but fickle bandas, deteriorating industrial relations and labor strikers, power shortages, and supply-side constraints such as deficient supply of infrastructure. Meanwhile, real per capita GDP is nevertheless expected to increase by 2.3 percent, reaching US$562 per year – about 20 percent higher than last year’s figure.

As a percentage of GDP, gross investment is expected to increase to 38.2 percent as compared to 31.9 percent in the last fiscal year. Meanwhile, gross national savings is expected to decline to 9.4 percent from 9.7 percent of GDP in the same timeframe. The gap between gross domestic savings and gross investment, as a percentage of GDP, is expected to be negative 28.8 percent. It is widening by about six percentage points from last year’s figure. This essentially means that we are consuming more and have little money to fund projects and trigger capital accumulation.

The net export of goods and services is estimated to expand by almost 10 percentage points to a negative 28.4 percent of GDP. Exports are estimated to decrease to 9.2 percent of GDP from 12.4 percent last year. Meanwhile, imports are estimated to increase to 38.1 percent of GDP from 34.6 percent last year. Hence, trade deficit is expected to widen by 41 percent. The growth of remittances income is expected to slow down to 7 percent from 47 percent last fiscal year. The contribution of remittances to GDP is expected to stand at 19 percent, compared to 21.2 percent last fiscal year. This is leading to current account deficit of Rs 27.60 billion, which is an estimated negative 2.3 percent of GDP. Note that the current account balance was Rs 41.44 billion surplus last year. Overall, the Balance of Payments (BoP) deficit is projected to be Rs 19.57 billion.

State of the Nepalese economy (2001/02 to 2009/10):

Has Nepal exhausted the sources of growth?

Not really. But the government officials tend to think so. They are making high pitch over implementing import-substituting and import consumption curbing measures. I disagree. This is a very convenient conclusion to the most pressing challenge of the Nepalese economy. We need to think hard and better to find a way out of this economic mess. It is doable without resorting to import substituting policies.

I think in order to narrow down the balance of trade and balance of payments deficits, the government should instead look for ways to  boosting exports and to channeling domestic transfers to productive sectors. If there is a need to curb imports, then the imports of luxury items should be curbed; not daily consumption goods that Nepalese producers cannot produce at the same international price quality. There is a danger of further inflaming inflation rate if more tariff on imports of consumption goods are imposed. For further discussion, read my latest op-ed here. 

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Convenient Conclusions?

At the end of each fiscal year, the Ministry of Finance (MoF) publishes Economic Survey (ES), which provides rundown of the state of the economy in that year. It is one of the closely watched reports published annually by the MoF. The message of ES 2009/10 is hardly surprising: the economy is in a mess, growth is sluggish, and macroeconomic troubles are imminent. The policies being contemplated are aimed at curbing consumption rather than creating opportunities to channel disposable income, fuelled by the inflow of remittances, to productive sectors. This is misguided policy. Industrial and exports sectors could still be the primary sources of growth.

The economic growth rate (real GDP) in the current fiscal year 2009/10 is estimated to be 3.5 % - lower than 4.0 % achieved last year. Government argues that the decline in production of crops (blaming monsoon and adverse weather for growth stagnation!) and sluggish non-agricultural sectors contributed to the slowdown of Nepal’s growth engine. The non-agricultural sectors were (and are) plagued by frequent but fickle bandas, deteriorating industrial relations and labor strikers, power shortages, and supply-side constraints such as deficient supply of infrastructure. Meanwhile, real per capita GDP is nevertheless expected to increase by 2.3 %, reaching US$ 562 per year - about 20 % higher than last year’s figure.

As a percentage of GDP, gross investment is expected to increase to 38.2 % as compared to 31.9 % in the last fiscal year. Meanwhile, gross national savings is expected to decline to 9.4 % from 9.7 % of GDP in the same time frame. The gap between gross domestic savings and gross investment, as a percentage of GDP, is expected to be negative 28.8 %. It is widening by about six percentage points from last year’s figure. This essentially means that we are consuming more and have little money to fund projects and trigger capital accumulation.

The net export of goods and services is estimated to expand by almost ten percentage points to a negative 28.4 % of GDP. Exports are estimated to decrease to 9.2 % of GDP from 12.4 % last year. Meanwhile, imports are estimated to increase to 38.1 % of GDP from 34.6 % last year. Hence, trade deficit is expected to widen by 41 %. The growth of remittances income is expected to slow down to 7 % from 47 % last fiscal year. The contribution of remittances to GDP is expected to stand at 19 %, compared to 21.2 % last fiscal year. This is leading to current account deficit of Rs 27.60 billion, which is an estimated negative 2.3 % of GDP. Note that the current account balance was Rs 41.44 billion surplus last year. Overall, the BOP deficit is projected to be Rs 19.57 billion.

These numbers matter because if we want to avoid macroeconomic crisis, we have to figure out a way to reduce BOP deficit, maintain sufficient policy space for fiscal expansion in productive sectors and roll out social protection programs for the vulnerable and poor people. The only way to do this is to either boost exports or to find ways to reduce imports. Both are difficult routes. But, based on experiences from other successful economies, the former is preferred, however improbable it might seem at the moment.

Just because there is widening BOT deficit, declining growth of remittances, surging BoP deficit, and perennially sluggish agricultural sector, it does not make sense to resort to curbing imports, especially for consumption purposes. Even if import consumption curbing and import-substituting policies are rolled out, it will not slow the flow of money outside the country because consumption habits and preferences, fuelled by the flow of remittances, hardly change. It is encouraging that the government is mulling over promotion of production of agro-products so that the country won’t have to rely on agro-products on external markets. This is expected to narrow down BOP deficit. However, can the Nepali producers satisfy domestic consumers by providing them with equally competitive and varied products?

It feels like the policymakers have in principle concluded that we have exhausted the sources of growth. They are talking about curbing consumption rather than looking to channel some portion of consumption demand to investment spending. To stimulate economic activities, we need to find new sources of growth. This could be either through stimulation of domestic economic activities for internal consumption and investment purposes or by finding novel ways to increase exports. Implementation of widespread import curbing and import substituting measures is certainly not needed - only the import of luxury goods needs to be reduced.

The main cause of sluggish growth rate is slowdown in economic activities engendered primarily by unstable and highly unpredictable internal political bickering, creating uncertainty in markets. The bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages, among others, are the strongest constraints on economic activity. Rather than addressing these thorny non-economic issues headlong, the government is taking them as unalterable. These non-economic factors are also contributing to rise in inflation rate, which is hovering around 12 percent.

The contraction in external markets is not an issue for decline in Nepal’s exports. It is our inability to export goods that are price and quality competitive. The same non-economic factors discussed earlier and the inability to implement production and trade-promoting measures affected competitiveness of this sector.

The economy is in a messy condition. But, it is not unmanageable. The BOP deficit can be fixed, exports increased, and manufacturing sector propped up, if only we start by addressing the most binding non-economic constraints.

[Published on Republica, July 14, 2010, pp7]

Reading research papers 101

Excellent piece from Daniel Drezner. Below is his recommendation. Read the full discussion here.

1)  If you can't read the abstract, don't bother with the paper.  Most smart people, including academics, don't like to admit when they don't understand something that they read.  This provides an opening for those who purposefully write obscurant or jargon-filled papers.  If you're befuddled after reading the paper abstract, don't bother with the paper -- a poorly-worded abstract is the first sign of bad writing.  And bad academic writing is commonly linked to bad analytic reasoning. 

2)  It's not the publication, it's the citation count.  If you're trying to determine the relative importance of a paper, enter it into Google Scholar and check out the citation count.  The more a paper is cited, the greater its weight among those in the know.  Now, this doesn't always hold -- sometimes a paper is cited along the lines of, "My findings clearly demonstrate that Drezner's (2007) argument was, like, total horses**t."   Still, for papers that are more than a few years old, the citaion hit count is a useful metric.

3)  Yes, peer review is better.   Nothing Megan McArdle wrote is incorrect.  That said, peer review does provide some useful functions, so the reader doesn't have to.  If nothing else, it's a useful signal that the author thought it could pass muster with critical colleagues.  Now, there are times when a researcher will  bypass peer review to get something published sooner.  That said, in international relations, scholars who publish in non-refereed journals usually have a version of the paper intended for peer review. 

4)  Do you see a strawman?  It's a causally complex world out there.  Any researcher who doesn't test an argument against viable alternatives isn't really interested in whether he's right or not -- he just wants to back up his gut instincts.  A "strawman" is when an author takes the most extreme caricature of the opposing argument as the viable alternative.  If the rival arguments sound absurd when you read about them in the paper, it's probably because the author has no interest in presenting the sane version of them.  Which means you can ignore the paper. 

5)  Are the author's conclusions the only possible conclusions to draw?  Sometimes a paper can rest on solid theory and evidence, but then jump to policy conclusions that seem a bit of a stretch (click here for one example).  If you can reason out different policy conclusions from the theory and data, then don't take the author's conclusions at face value.  To use some jargon, sometimes a paper's positivist conclusions are sound, even if the normative conclusions derived from the positive ones are a bit wobbly.  

6)  Can you falsify the author's argument?    Conduct this exercise when you're done reading a research paper -- can you picture the findings that would force the author to say, "you know what, I can't explain this away -- it turns out my hypothesis was wrong"?  If you can't picture that, then you can discard what you're reading a a piece of agitprop rather than a piece of research. 

7)  Fraudulent papers will still get through the cracks.  Trust is a public good that permeates all scholarship and reportage.  Peer reviewers assume that the author is not making up the data or plagiarizing someone else's idea.  We assume this because if we didn't, peer review would be virtually impossible.  Every once in a while, an unethical author or a reporter will exploit that trust and publish something that's a load of crap.  The good news on this front is that the people who do can't stop themselves from doing it on a regular basis, and eventually they make a mistake.  So the previous rules of thumb don't always work.  The  publishing system is imperfect -- but "imperfect" does not mean the same thing as "fatally flawed." 

Dani Rodrik on the ideology of markets

"Unlike economists and politicians, markets have no ideology. As long as they make money they do not care if they have to eat their words.  They simply want whatever “works”—whatever will produce a stable, healthy economic environment conducive to debt repayment. When circumstances become dire enough, they will even condone debt restructuring—if the alternative is chaos and the prospect of a greater loss.

This opens up some room for governments to maneuver. It permits self-confident political leaders to take charge of their own future.  It allows them to shape the narrative that underpins market confidence, rather than play catch-up.

But to make good use of this maneuvering room, policymakers need to articulate a coherent, consistent, and credible account of what they are doing, based on both good economics and good politics. They have to say: “we are doing this not because the markets demand it, but because it is good for us and here is why.”

Their storyline needs to convince their electorates as well as the markets. If they succeed, they can pursue their own priorities and maintain market confidence at the same time."

More here. Krugman adds more here.

Listen to Lord Keynes!

"A wide gulf, therefore, is set between the ideas of lenders and the ideas of borrowers for the purpose of genuine investment; with the result that the savings of the lenders are being used up in financing business losses and distress borrowers, instead of financing new capital work.

At this moment the slump is probably a little overdone for psychological reasons. A modest upward reaction, therefore, may be due at any time. But there cannot be a real recovery, in my judgment, until the ideas of lenders and the ideas of productive borrowers are brought together again; partly by lenders becoming ready to lend on easier terms and over a wider geographical field, partly by borrowers recovering their good spirits and so becoming readier to borrow. If the diagnosis is right, the slump may pass over into a depression, which might last for years."

Déjà vu! The 2008/09 crisis seems like the one witnessed in 1930s. More here.

Is monetary policy relevant in Africa?

John Weeks, Professorial Research Associate, Center for Development Policy Research (CEPR), SOAS, argues that the IMF is mistaken in emphasising the reliance on monetary policies in sub-Saharan Africa because few countries have viable domestic markets for government bonds or commercial banking sectors interested in lending for private-sector investment. As a result, central banks often have to offer high rates of interest on government bonds to induce banks to buy them. Thus, a significant share of the public budget is diverted into debt servicing that ends up fattening banking profits.

In most sub-Saharan countries the demand by commercial banks for bonds does not readily respond to changes in the interest rate. One reason is that there is little competitiveness in domestic bond markets and another is that the bonds of African governments have extremely low credit ratings from Standard and Poor’s or Moody’s—if they are rated at all.

The main impact of the central bank’s raising of the bond interest rate will be to induce commercial banks to replace loans to the private sector with government bonds because the relative return from the former has fallen. This is a perverse result because when bonds increase the assets of commercial banks, they should expand their creation of credit. But because of the high yields received by banks on government securities, it is profitable for them to hold excess reserves instead of lending. 

This process is fundamentally different from the so-called ‘crowding out’ of private investment, about which the IMF repeatedly warns national policymakers. But the ultimate effect is the same. ‘Crowding out’ allegedly occurs when government borrowing to cover public expenditures competes with private borrowing. The dynamic that we are describing is different because the increase in the central bank rate does not originate from a need to cover public expenditure, but from the false expectation that the higher rate would appreciate the exchange rate and reduce inflationary pressure. 

The conclusion is pretty surprising (at least if we consider standard economic theories): "The reality in sub-Saharan Africa is that, with very few exceptions, monetary policy has no meaningful impact on inflation or the real exchange rate."