Is Depression III possible?

Krugman argues that it is possible because of policy failure to spend more when spending is inadequate, leading to large unemployment and deflation. The earlier two depressions were the Long Depression (Panic of 1873 after years of deflation and instability) and the Great Depression (financial crisis of 1929-31 after years of mass unemployment).

"We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. 

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy. 

I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times. 

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again." 

Industrial and trade policies as competitiveness policy

Reis and Farole argue that industrial and trade policies are here to stay, especially after the economic crisis, which decreased confidence in the market system (it has not wiped confidence completely; it should not. We just need to doubt some of the hyped virtues of markets). If government activism is here to stay then how can it promote competitiveness rather than resort to old-school industrial policy that accentuates import substitution policies. They explore areas where governments can use industrial and trade policies to enhance competitiveness of domestic firms.

First, how are we sure that there will be more government activism in the coming years. The authors point three reasons for active involvement of governments in implementing industrial policy and trade policy after the economic crisis.

1. The crisis has discredited some of the over-blown virtues of laissez-faire approach. Governments will be more active in designing policies to shape markets that the market itself would try to bypass.
2. Diversification of sectors, products, and trading partners will be top of the policy agenda in most of the developing countries, opening more room for government activism. Diversification lowers export-led growth volatility. Also, see this blog post.
3. Still, most of the developing countries’ products are not competitive in the international market despite sweeping liberalization since the 1980s. Governments would be designing policies to make their industrial products price and quality competitive.

Governments need to use industrial and trade policies in such a way that it fosters competition, not distort market incentives and diminish the gains from trade liberalization. They should play a critical role in overcoming market failures. Governments can help by ensuring the supply of inputs to private firms and creating a good functioning market environment where firms can operate. These policies can include facilitation of self-discovery (Hausmann & Rodrik 2002) and promotion (and realization) of the benefits of agglomeration economics (Porter 1990).

The authors argue that governments should focus on enhancing both macro (long term)- and micro-economic environment. Macroeconomic/long term environment include enhancing human capital, creating sound macroeconomic foundations, and instituting basic institutions such as property rights, the rule of law, and effective regulation. The microeconomic environment induce:

• Aligning micro incentives (removing tariff and nontariff barriers, real exchange rate misalignment, fiscal health, easy of doing business, etc.)
• Reducing trade-related costs (improving ICT services, improving capacity and coordination among government services, RTAs, improving logistic services constraints, reducing transportation costs, etc.)
• Overcoming government and market failures (promotion of technology creation and adoption, product certification standards, trade finance, SEZs, industrial clusters, etc.). The more effective the export-promotion agencies, the more will be the survival rate of the exporters (see the figure below) Export promotion agencies work but small and focused ones are better.

Brazil’s success with the green industrial policy is discussed here. Asia’s experience and their standing in 2030 discussed here. Justin Lin demystifies the Chinese miracle and export-led growth. Finland’s experience with industrial policy discussed here. Degol Hailu explains the developmental state in Indonesia. Industrial policy in the US after the crisis discussed here. Industrial policy ain’t protectionism. Jeff Madrick explains why government intervention works. Catch-up growth is facilitated by active government involvement. South Africa’s experience with electricity crisis and government activism discussed here.

Growth in developing countries after the economic crisis and the prospect for outward-oriented growth strategy discussed here. The use of industrial policy after the economic crisis by governments around the world discussed here. Indeed, industrial policy is back, argues Rodrik. Robert Wade on industrial policy here. Ha-Joon Chang calls for constructive debate on industrial policy.

A discussion of export-led growth and the growing importance of South-South trade here. More on the future of export-led growth here. Stiglitz on the role of governments here and here. The NAFTA’s achievement shows that trade policy does not necessarily mean development policy.

Economic discourse & accountability in Nepal

My latest op-ed/column is about the need for economic discourse and accountability in Nepal. There is a severe lack of discussion about economic issues. The way the economy is heading right now will define the way of life of the Nepalese people. The better the economy performs, the better will be the lives of the citizens.

The (uncertain, baffling, and ever-prolonging) political deliberations going on right now will mean nothing if the economy comes to a grinding halt or becomes dysfunctional. Since the people do not discuss economic issues as widely as it should have been, there is hardly any accountability. Furthermore, the talking heads and commentators rarely discuss these issues. They either do not understand what is going on or they can’t find experts to plainly explain what is going on in the economy. Hence, people do not judge political parties (including elected representatives) and their policies based on their pre-election commitment versus post-election delivery. More and more people need to discuss economic issues as they do with political issues.

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Economic Discourse & Accountability

The macroeconomic health of our economy is in a terrible shape. This dire warning is repeatedly trumpeted in the media and public sphere by politicians, economists, and commentators. Sadly, a majority of the population is unable to make much sense of it. Nevertheless, this issue will continue to pop up until we find a way to fix the Rs 22 billion hole in the country’s balance of payments (BoP), which basically is an accounting record of all the monetary transactions between Nepal and the rest of the world. Rather than incessantly drumbeat possible causes of the BoP crisis, let me discuss one issue rarely highlighted by talking heads and commentators: Economic accountability and its relation to our economic woes.

The gloomy economic conditions we are in right now are self-inflicted. It is a product of deficient as well as defective economic policies abetted by a political culture that is infected by corruption and a lack of accountability. With so much analysis and reporting going on about the BoP deficit, double-digit inflation rate and wobbly monetary situation, hardly any analyst has clearly explained how these economic conditions relate to a citizen’s consumption and living habits. How does it affect the lives and livelihoods of people residing in, say, Darchula, Rukum, Syangja, Sarlahi, and Solukhumbu? The failure to effectively convey this message has discouraged the public from actively discussing the very economic issues that will affect their lives and livelihoods in all possible ways. This is fostering a lack of accountability and scot-free pillaging of taxpayers’ rupees by the politicians.

Economic accountability is effective when citizens consciously demand one from their elected representatives. One way to induce this is through the dissemination of actionable analysis and interpretation of policies that can be easily comprehended by the public. The public demand for accountability is strong when they are aware of the way their tax rupees are spent by their leaders.

The people need to know how a particular economy policy to counter the BoP deficit would affect their disposable income, consumption, and livelihoods. If this is explained in plain language, then the people from all walks of lives will start discussing why the BoP crisis emerged in the first place. Then they will potentially start demanding explanations from their elected officials. The media, economic analysts and commentators could play a catalytic role in facilitating this process.

Unfortunately, the virtual absence of conversation about economic issues and the lack of demand for accountability by the public is a testament to the fact the media, analysts and commentators have not done an effective job in interpreting economic policies and conveying its impact on the citizens. For instance, there needs to be a wider discussion about the impact of land reform policy proposed by UCPN (Maoist), who wants to get away with private ownership of land and institute cooperative-style ownership. The people need to know how it will impact production, productivity, employment and economic growth.

Likewise, they also need to know if reverting back to import substituting policies, as recently suggested by Finance Minister Surendra Pandey, will help narrow the BoP deficit, or exacerbate it. Likewise, the public has to be furnished with answers to why they have to live under 54 hours of power cuts every week despite millions of rupees ‘invested’ in developing hydropower and in maintaining the bloated, inefficient bureaucracy of Nepal Electricity Authority. They also need to know why aid dollars and domestic tax rupees are wasted without any result in sight from the Melamchi Water Supply Project. The people need to know the impact of busting the real estate bubble in their lives and livelihoods. Moreover, they should be made aware of the costs of bandas, and its affect on their income and productivity.

The citizens should be explained the position of each political party on key economic issues. So far, no political party has clearly identified their core economic principles and policies, their intended policy prescriptions to the most pressing economic issues, and their strategy in kick-starting the jammed growth engine. If the public knows the position of each party on all major economic issues, then they will automatically judge the performance of their elected representatives on the basis of post-election achievement versus pre-election promises. There will be citizen-led pressure on the leaders to deliver results, not just empty promises.

The civil society and think tanks in Kathmandu have to do a better job in analyzing and explaining how a specific economic policy affects particular regions, industrial clusters, and livelihoods. The think tanks should play a vital role in stimulating discussion about the pros and cons of any economic policy before they are voted in the parliament. Meanwhile, the government needs to promote an open battle of ideas and ideals so that the final policy prescription is well analyzed by analysts and acceptable to a majority of the citizens.

The more discussion there is about economic policies at the policy level, in the media, and in the public sphere, the finer would be the eventual policy agendas. This would contribute a whole lot in terms of making our leaders accountable to the people. A failure to do so is already reflected in the inconsistent, incongruent, and impractical policies in the recently introduced Industrial Policy 2010.

To ensure economic accountability, there has to be an extensive discussion of economic issues in the public sphere. The media, analysts and commentators have to effectively break down the multidimensional impact of economic policies in the simplest form. This will help people associate economic policies with their lives, leading to exchange of ideas and ideals at individual, society, community and national levels. There is no better path to accountability than the one where citizens actively demand such from their elected representatives.

[Published in Republica,June 16, 2010, pp.7]

Keynesian perspectives last week

Krugman explains "That 30's Feeling": “Many economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession.”

Robert Skidelsky is not happy with the British government’s decision to slash spending and asks "Who governs?" : financial markets or government. “ These propositions are a re-run of the famous “Treasury view” of 1929. By contrast, Keynes argued that demand can fall short of supply, and that when this happened, government vice turned into virtue. In a slump, governments should increase, not reduce, their deficits to make up for the deficit in private spending. Any attempt by government to increase its saving (in other words, to balance its budget) would only worsen the slump. This was his “paradox of thrift”. The current stampede to thrift shows that the re-conversion to Keynes in the wake of the financial collapse of 2008 was only skin-deep: the first story remains deeply lodged in the minds of economists and politicians.”

Krugman wonders why Greenspan is regretting that deficits have not yet increased interest rates. Krugman explains: “deficits in the face of a liquidity trap don’t drive up interest rates and don’t cause inflation — lends credence to the Keynesian view.”

Export-led growth and volatility

How does export-led growth affect volatility? Here is an interesting discussion on this issue. There are four main mechanisms at play in the relationship between outward oriented growth strategy and volatility.

• Terms-of-trade volatility and output: TOT can directly affect output and growth. Decline in exports and export prices would severely affect balance of trade and revenues.
• Domestic market volatility and output: As export sector operates in tune with overseas market, domestic demand and supply shocks are less strongly correlated with output.
• Diversification and volatility: As countries diversify export items in tandem with more reach in overseas market, growth volatility decreases. More on this here.
• Specialization and volatility: Specialization in exports reduces growth volatility if the specializing and exporting nation is a high income one. The demand for their product is pretty much inelastic.

Policy lessons:

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“The stabilization effects of export product diversification are noticeably more consistent than that for export market diversification. This finding suggests that developing-country policymakers should emphasize measures that help broaden their countries’ manufacturing base, and expand the range of exportable products.

There are also a number of steps that governments can take domestically to help the private sector diversify its export base. Rather than protecting domestic producers with “infant-industry” tariffs—a classic inward-oriented strategy—policymakers can remove barriers to domestic market entry, and thereby encourage innovation and development of new markets by companies at home.

There is also strong evidence that better trade facilitation (that is, the reduction of fixed and variable costs associated with moving goods across borders) can be highly effective in promoting export diversification. Practical steps—such as the removal of red tape affecting exports and imports, and developing trade-related infrastructure and services—can make a major contribution to export diversification and help manage outward orientation.”

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Women in parliament and GDP per capita

It shows the ratio of female to male members in parliament with respect to GDP per capita. See Nepal (NPL) there, close to 50 percent despite low GDP per capita!

Source: Michael Clemens' presentation at ABCDE 2010 conference

Asia in 2030

At a time when the developed countries are bearing the burnt of economic crisis and an increasing market uncertainty due to mounting debt and deficit,  the Asian economies (save the very low income ones) are on a different track. They are helping in global growth recovery. Also, they have strong domestic demand and pretty resilient exports sector. If this trend continues, then Asia will be the largest economic region by 2030, according to Anoop Singh's piece in the latest Finance & Development magazine.

For this to happen, Singh argues, Asia needs to continue good policy reform and watch out for few issues thorny issues:

• Surge in capital flows need to be managed to prevent overheating and to decrease vulnerability
• Shocks in the developed countries might transmit to the Asian economies (exports decline and credit tightening)
• Needs to keep on building domestic demand to make it a main source of growth
• Strengthen social safety nets
• Development of national and regional infrastructure to reduce transportation costs and foster regional integration