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!)

RCTs in education

Esther Duflo has an article in NBER’s quarterly newsletter Reporter about how randomized controlled trials (RCTs) were used to find out what works and what does not work in education sector reform in the developing countries. She discusses the RCTs done in India and Kenya to find out what requires (what does not) for high quality learning (good in heterogeneous student setting), lower teacher absentee, and re-empowering parents (not much effect) in the education reform process. She argues that a likely case would be that the government could be better in getting the schools work better for the poor (rather than giving ownership to local communities or parents). Strange finding given the fact that huge amount of resources are spent by multilateral donors in handing over responsibility of managing schools to local communities in countries like Nepal and India.

Does better access to inputs (textbooks, teachers) affect school outcomes (attendance, test scores) — and if so, by how much? The motivating theoretical framework was very simple, but the results were surprising. For example: Glewwe, Kremer, and Moulin found that lowering the student-textbook ratio from 4 to 2 had no effect on average test scores. Banerjee, Jacob, and Kremer found that halving the student-teacher ratio also had no effect on test scores.

These negative results prompted new reflection on the barriers to education in poor countries: If simply providing inputs does not increase the quality of education in poor countries, then it must be necessary to change the organization of teaching in schools, both the pedagogy and the incentives faced by students and teachers. This led to a new round of field experiments motivated by the general question: Can changing the organization of teaching in schools affect education outcomes? For the most part, these more recent projects have varied more than one factor at a time in different experimental groups, making randomization a powerful tool for examining the role of incentives, spillovers, and other key questions in the economics of education.

Together, a series of randomized evaluations of education programs in developing countries have taught us something about how education in developing countries can be improved: focus teaching on skills students need to progress further; find ways to motivate teachers. Neither of these is necessarily an easy, ready-to-implement prescription. Much more work is needed to develop programs that can achieve these two objectives on a large enough scale, especially given the political economy of education in developing countries. While neither suggests plug-and-play prescriptions, they do give us ample direction about where to search.

What’s more, these experiments have also taught us something about how to search, how we can learn about learning. Each experiment answers some questions and asks new ones; the next study builds on the previous one, progressively suggesting a model of education which is ready to be enriched over time.

The relationship between load shedding and pregnancy

This news is interesting. Following rapid fall in hydro electricity generation, the government of Nepal cut power supply for almost 16 hours a day (this means, only 6 hours of power in 24 hours!). This has restricted most people in their houses (and increased the time invested with family members).

The unintended consequence: more number of pregnancies reported at hospitals. Could increasing hours of load shedding lead to higher population growth rate? I hope not, especially for a poor country like Nepal, which already has one of the highest population growth rates in the world! This could potentially further lower per capita at a time when real income is already expected to decrease due to high inflation rate hovering at around 14%.

According to media reports, the number of women with bulging bellies visiting Prasuti Griha (a top maternity hospital in Kathmandu) has risen sharply, and this has been attributed to the almost round-the-clock cut in power, leaving Nepalis with no other means of entertainment except copulation. There is no reason why the G-8 nations cannot bring about a baby boom if they follow in Nepal’s footsteps.

NEA, however, should be prepared to face the government’s ire once the census figures are out in 2011 and it realizes that all its efforts to bring down population growth to replacement level has gone for a toss.

Meanwhile, I have been told that young couples venturing out for candlelight dinners has taken a nosedive, much to the chagrin of restaurant owners. “Why go out and waste money, when you can enjoy romantic evenings everyday in the confines and comforts of your own apartment,” they say.

With load-shedding excepted to continue for at least another four to five years, I recommend restaurant owners to shut down their business and use that space instead to open maternity clinics. Makes perfect sense, right?

Forever Globalization!

Globalization is such a diverse, broad-based, and potent force that not even today’s massive economic crash will dramatically slow it down or permanently reverse it. Love it or hate it, globalization is here to stay.

The bottom line: Nationalism never disappeared. Globalization did not lessen national identities; it just rendered them more complex. Even in a Bill Gates era, today’s Otto von Bismarcks still wield great power. Globalization and geopolitics coexist, and neither is going anywhere.

More here.