Sen on Smith and capitalism

Amartya Sen on Adam Smith, current financial crisis, and capitalism

All the affluent countries in the world – those in Europe, as well as the US, Canada, Japan, Singapore, South Korea, Taiwan, Australia and others – have depended for some time on transactions that occur largely outside the markets, such as unemployment benefits, public pensions and other features of social security, and the public provision of school education and healthcare. The creditable performance of the allegedly capitalist systems in the days when there were real achievements drew on a combination of institutions that went much beyond relying only on a profit-maximising market economy.

The need for supervision and regulation has become much stronger over recent years. And yet the supervisory role of the government in the US in particular has been, over the same period, sharply curtailed, fed by an increasing belief in the self-regulatory nature of the market economy. Precisely as the need for state surveillance has grown, the provision of the needed supervision has shrunk.

Despite all Smith did to explain and defend the constructive role of the market, he was deeply concerned about the incidence of poverty, illiteracy and relative deprivation that might remain despite a well-functioning market economy. He wanted institutional diversity and motivational variety, not monolithic markets and singular dominance of the profit motive. Smith was not only a defender of the role of the state in doing things that the market might fail to do, such as universal education and poverty relief (he also wanted greater freedom for the state-supported indigent than the Poor Laws of his day provided); he argued, in general, for institutional choices to fit the problems that arise rather than anchoring institutions to some fixed formula, such as leaving things to the market.

Meanwhile, here is one of the most realistic statements about what economics is all about by Rodrik:

Economics is really a toolkit with multiple models - each a different, stylized representation of some aspect of reality. One's skill as an economist depends on the ability to pick and choose the right model for the situation. Economics' richness has not been reflected in public debate because economists have taken far too much license. Instead of presenting menus of options and listing the relevant trade-offs - which is what economics is about - economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favoring one set of social arrangements over others.

More here

VDIS: Guilty have the upper hand!

I got a lot of angry comments (okay, I got good ones as well) when I wrote this opinion piece defending the government of Nepal’s decision to implement Voluntary Disclosure of Income Scheme (VDIS), which was designed to give an opportunity to tax evaders to reveal sources of their assets and income and pay 10% of it to clear outstanding tax payments before they face the regulatory music. I had hoped that the government would enforce this provision to the fullest. Sadly, the government is bowing down to the illegitimate demands of business executives, who are the principle tax evaders.

It is ironic that the government has yielded to demands of tax evaders, who are in a way guilty of committing a crime, i.e. conceal true worth of assets and income and not pay taxes to the government. The government has spared application of VDIS in investments made in labor-intensive industries like hydropower, physical infrastructure, and “other productive services” (uff, another loophole!).

I can’t understand why the FNCCI, the apex representative body of the business sector, is so ferociously arguing against VDIS. Is this an indication that the business executives have amassed more ‘black money’ than is thought? It is a golden opportunity for them to turn ‘black money’ into ‘white money’. They are ignoring this at their own peril!

The Maoists government should live up to its promises and proposed policies. People have already heard too much (and redundant) rhetoric. Time for action! By this, I mean real action, which might often come at the expense of few crooked business executives going down or behind bars! The VDIS is one of the few policies I have been supportive of the Maoists government.

Why let the guilty have an upper hand?

Documentary on the financial crisis

Very interesting video from Frontline:

Getting Keynes and animal spirits right

Robert Shiller explains:

Adherents to Keynes’s message were so eager to get this simple policy implemented, on both sides of the Atlantic, that they failed to notice – or perhaps they intentionally disregarded – that the General Theory also had a deeper, more fundamental message about how capitalism worked, if only briefly spelled out. It explained why capitalist economies, left to their own devices, without the balancing of governments, were essentially unstable. And it explained why, for capitalist economies to work well, the government should serve as a counterbalance.

The key to this insight was the role Keynes gave to people’s psychological motivations. These are usually ignored by macroeconomists. Keynes called them animal spirits, and he thought they were especially important in determining people’s willingness to take risks. Businessmen’s calculations, he said, were precarious: “Our basis of knowledge for estimating the yield 10 years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing.” Despite this, people somehow make decisions and act. This “can only be taken as a result of animal spirits”. There is “a spontaneous urge to action”.

To a remarkable extent we have got into the current economic and financial crisis because of a wrong economic theory – an economic theory that itself denied the role of the animal spirits in getting us into manias and panics.

It is the role of the government at two levels to see that these events do not occur. First, it has a duty to regulate asset markets so that people are not falsely lured into buying snake-oil assets. Such standards for our financial assets make as much common sense as the standards for the food we eat, or the purchase medicine we get from the pharmacy. But we do not want to throw out the good parts of capitalism with the bad. To take advantage of the good parts of capitalism, when fluctuations occur it is the role of the government to see that those who can and want to produce what others want to buy can do so. It is the role of the government, through its counterbalancing fiscal and monetary policy, to maintain full employment.

The principles behind such an economy are not the principles behind a socialist economy. The government insofar as possible is only creating the macroeconomic conditions that will allow the economy to function well.

That is the role of government. Its role is to ensure a “wise laisser faire”. This is not the free-for-all capitalism that has been recommended by the current economic theory, and seems to have been accepted as gospel by economic planners, and also many economists, since the Thatcher and Reagan governments. But it also is a significant middle way between those who see the economic disasters and unemployment of unfettered capitalism, on the one hand, and those who believe that the government should play no role at all.

The idea that unfettered, unregulated capitalism would invariably produce the good outcomes was a wrong economic theory regarding how capitalist societies behave and what causes their crises. That wrong economic theory fails to take account of how the animal spirits affect economic behaviour. It fails to take into account the roles of confidence, stories and snake oil in economic fluctuation.

Also see this opinion piece by Martin Wolf

The need for CCTs during the financial crisis

The credit crisis has hit almost all the countries in one way or the another. Now, it is just a matter of how severely are they hurt. Getting credit has not been more difficult, even in the developing countries. This increases vulnerability of the already vulnerable population and the need for social protection increases as the crisis digs deeper holes into the global economy. It seems this is the most opportune time to push for social protection programs such as Conditional Cash Transfers (CCTs) to help cushion household income and also to help achieve MDGs of education and healthcare.

CCTs, born out of Mexico’s Oportunidades, is already successfully implemented in Latin America and in small scale in some African and East Asian countries. CCTs have boosted the use of preventive health care services in Colombia, Honduras, Mexico, and Nicaragua by between 8 and 33 percentage points, according to the WB. See this report for a detailed discussion about the impact of CCTs on poverty, education, and healthcare.

As might be expected, the effect on poverty reduction is greatest when the size of the cash transfer is generous. In Mexico, the poverty gap—or shortfall from the poverty line—among CCT beneficiaries in rural areas was reduced by 19 percent. Household consumption patterns have changed among CCT beneficiary households, in part because cash transfers are made to women. The evidence shows that women spend more than men do on food, high-quality nutrition, and other things that benefit children. CCTs have been so successful against poverty because they largely target poor households. Also, they have not, as some feared, led to adults reducing their work outputs in response to the steady income supplement.

CCTs have clearly increased the use of education services in country after country. In Pakistan, for instance, a CCT program increased the school enrollment of 10-14 year-old girls by 11 percentage points. And in Mexico, the Oportunidades program decreased dropout rates between the 6th and 7th grade by 9 percentage points.

The report shows that CCTs can indeed help poor households weather shocks ranging from an economic crisis to unemployment, illness, or death of a breadwinner. CCTs can also help ensure that households don’t cut back on children’s basic health and schooling. That said, CCTs are really designed to help get rid of long-term structural poverty than deal with sudden, short-term, income shocks, which require a more flexible social insurance instrument.

The ideal transfer program to deal with transient poverty (i) does not involve a long-term commitment such as school enrollment, (ii) is self-targeted and doesn’t involve complex administrative decisions for exit or entry, and (iii) involves the participation of beneficiaries in activities (for example, job-related) that address the source of the shock. While workfare programs or unemployment insurance are better suited to deal with transient poverty, having a CCT program in place during a crisis is clearly much better than not having any large-scale social assistance program at all.

CCTs are considered innovative for several reasons: (i) their targeting mechanisms; (ii) beneficiaries receive cash rather than in-kind benefits; and (iii) the transfers are conditional. CCTs are designed to increase the human capital of beneficiaries by making transfers conditional on certain requirements, such as school attendance, visits to health clinics and renewals of immunization. Additionally, CCTs aim to alleviate poverty in the short-term.

It offers qualifying families cash in exchange for commitments such as taking babies to health clinics regularly or sending children to school. These programs, now found in over two dozen countries, can reduce poverty both in the short and long term, particularly when supported by better public services. CCT programs help to reduce poverty in participating households and to protect them from the worst effects of unemployment, illness, or other income shocks. Participating households also tend to spend more on food and improved nutrients than comparable households who don’t receive the transfer, according to the WB report.

Nepal’s tourism industry: High hopes amidst weak foundation

It seems like this spring break is getting productive(I still have to finish my thesis by the end of this break!). On the first day of the break, I wrote this opinion piece about Nepal’s tourism industry and the need to rethink promotion campaigns and policies amidst global recession. The need for price competitiveness without compromising on quality of service has not been higher. I argue that the government needs to formulate realistic policies and targets that are consistent with Nepal’s macroeconomic situation (especially exchange rate appreciation), regulatory structure, and infrastructure. I use the latest Travel and Tourism Competitiveness Report to back up my arguments.

Travel and tourism (T&T) industry has been playing a vital role in sustaining GDP growth rate, which has been stagnating at 3.8 percent in the past decade. At a time when the industrial sector is going bust due to power cuts, labor disputes, and declining price competitiveness, a prosperous tourism industry is of supreme importance. The travel and tourism industry has been one of the largest employers (more than 548,000 in 2008) and fastest entry-vehicle into the workforce for youths.

To lure more tourists, the government announced Visit Nepal 2011 in January with the aim of attracting one million international visitors. The targeted number seems pretty ambitious because during a similar campaign in 1998, Nepal hosted only 464,000 tourists, earning US$ 24.8 million in revenue.

Does Nepal have the appropriate supporting regulatory structure, flexible policy framework and basic infrastructure that would increase price competitiveness without compromising on quality of service? According to the latest Travel & Tourism Competitiveness Report, published annually by the World Economic Forum, the answer to this question does not look that encouraging. Out of 133 countries, Nepal ranks 118 in travel and tourism competitiveness. It was ranked 116 in 2008’s report, which means competitiveness of this industry has actually declined.

Tourists are highly sensitive to price competitiveness and value added services provided by this industry. Generally, three factors – macroeconomic risks, regulatory structure, and tourism infrastructure – are essential to improve price competitiveness and to induce more per capita visitor spending in the Nepali tourism industry.

Read the full opinion piece here

Links of Interest (03/08/2009)

The poverty trap facing low-income countries

The need for a new paradigm in economics to explain current global crisis

Remaking the WB in a time of crisis

The state of maternal mortality in Nepal

Visa-restriction index 2008

Two pics sourced from Nepal: A Himalayan Kingdom in Transition by Karan and Ishii (reminds me of my village and work on the field!)