Monday, June 22, 2009

Alternative Approaches to solve Global Imbalances

The World Bank has proposed a provocative way to get the world out of recession: Expand developing countries aggregate demand. This really makes sense. Remember that current imbalances show that rich economies save too little, and emerging ones save too much.

Despite differences among emerging economies, one truth abides: imbalances must be corrected. There are three straightforward ways: either China, India, Brazil and alike consume more; the U.S. the U.K. Spain and alike save more; or both.

Some aspects of political economy in the second and third alternatives are important; they automatically imply that rich countries must renounce to some extent to its quality of life. Saving more resources imply consuming less, or as the basic economics lessons say: exchange more current consumption to get more future consumption.

The latter idea respects the same spirit as the World Bank's. According to this approach economic policy pulling aggregate demand should be seen, far more among developing countries than in rich countries. One setback of the World Bank's approach relies in the principal-agent issue. If rich countries are not credit worthy, then how a developing country can fulfill the lower-risk demand of financial markets?

The idea from the World Bank is clear, capital flows into emerging economies are just a quarter of what they just to be a year ago. Rich countries' currencies are appreciating, then higher risk aversion is a binding constraint in capital markets.

So there are at least two major obstacles to shift the power of aggregate demand from rich to emerging economies. However difficult, this would correct global imbalances, would also strengthen infrastructure in rich economies and would create jobs in developing ones. It will probably lower wages in the former and increase them in the latter. Sounds like a nice solution, if the loss of quality of life was not true. Unfortunately this sounds like a dead-end: there is not enough wealth for all countries in the world.

Neo-Classical theory states that further investment should be done in order to create wealth, this sounds like a feasible way out of the dead-end. The latter needs capital flows restored from rich to emerging economies, maybe this is a necessary endeavor the World Bank and the International Monetary Found will have to undertake.

Friday, June 19, 2009

Global Imbalances from the IMF

Olivier Blanchard wrote this piece in Financial Times. Consensus is growing stronger. China should consume more, US should consume less. As simple as that.

Monday, June 15, 2009

The Political Economy of the Next Fiscal Reform

Mexico will have to face a crude fact. A deep fiscal reform can not be postponed any more. In fact there are a few reasons to expect it in the last quarter of the present year. Starting with basic facts, Mexico's tax revenues are just above 8 percent of its GDP, there are just two countries in Latin America with a lower proportion, Haiti and Costa Rica. Lets just add to the latter that marginal tax rates in Mexico are just about the average of OECD countries, Value Added Tax (VAT) of 15 percent Corporate Income Tax (CIT) of 28 percent and the Personal Income Tax (PIT) with 4 brackets, its highest of 28 percent.

Another important fact that reveals the weakness of the present tax system is found in the figures of tax evasion and delusion. The Tax Management Service (SAT) published in 2006 that evasion of the entrepreneurial activities income tax (EAIT) for individuals related to earnings had a 5 to 1 ratio. This is, for every peso earned from this tax, 5 were not payed illegally. Taking the same ratio for the CIT it was 5 to 6. For the VAT it was 11 to 20, and for PIT 1 to 7. Clearly all efforts in the next fiscal reform should aim to EAITand the CIT.

In 2007, the last fiscal reform, an innovation of tax policy born. The Entrepreneurial Tax of Single Rate (so called IETU), became law after long discussions in the lower chamber. This tax aimed to reduce evasion of the CIT and the EAIT, however, its design has not helped to increase tax revenue since it looks to be far more pro-cyclical than the VAT, even though it works mostly as an indirect tax.

This is the current picture of the tax system, intermediate pollings in July have provide with a deterrent to propose major tax changes. It is also necesary to assess the fact that oil prices, although recently their trend is upwards, are still volatile, furthermore, they have just equalized the price projected in the public budget.

Government has invested a lot of effort, political capital and resources to the public safety issue, but is not clear that the latter helps to win the intermediate pollings. Moreover, without political support from opposition parties, a fiscal reform will not only will be weak but it may be impossible.

This is probably why Government has put a lot of attention to political campaigns lately. It surely needs to balance to its favor all votes of the lower chamber. This is also why we will not see a fiscal reform package until July. Of course it is not profitable in terms of votes to rise taxes, however, this may not be necesary since the problem are not the marginal rates, but the exception rules that apply in the CIT and the EAIT. Other tax reforms should aim to reduce inefficiencies in the production chain.

Unfortunately, there are some taxes in Mexico that are implemented not to increase efficiency and thus employment, but to protect some industries. Sugar refinery and alcohol processes are an example. Ecological taxes such as a higher price for gasolines will be surely evaluated. It is hard to avoid the latter discussion given a high positive correlation between income and car ownership, and income distribution and car traffic levels. The more income a city shows, the more cars it has.

A new fiscal reform will face the usual political obstacles, but it is becoming ever harder to stop.

Taintedness in Economics

Press and politicians have helped maverick economists to taint some terms in economics.

When people hear surplus, it is often associated to a positive stance of policy. Oppositely, a deficit is attached to a miss-management or to policy mistakes. What if there is no right and wrong? We have witnessed how China has build upon a huge trade surplus and is hard to defend the hypothesis that Chinese live considerably better now that when their international reserves were a third of today's. Wolf offers a chart with the current account balance to see how it has evolved.

It is also hard to argue in favor of a policy to save natural resources -such as oil- for the future. What happens if the next year a new source of energy leaves oil useless? Then a country would have had missed the chance to have an alternative revenue source, very well, with a surplus of oil.

It is a striking reality how few analysts -which you could classified as serious- do not attach an adjective after a number. They usually point at the advantages as well as the dis-advantages of some policy, or they name all positive and negative results of a policy.

One must be careful when forming an opinion and be sure that it relies in serious analysis and not just judgmental adjectives. Having said that, it is ever more worrisome that both China surplus and U.S.' deficits are still growing. This leads to the question of several students of economics: why are we economists so worried about equilibrium? It's natural answer should include an analogy: equilibrium in economics work as a compass to the captain of a ship. It tells us where we are heading, whether it is ever farther or closer to what a policy pursue.

Also, an equilibrium is a risk-free situation. We sure know all pros and cons of having a trade deficit or surplus, but we know it is riskier than having a trade balance. Let us not forget that inherently to a trade surplus build upon an overvalued exchange rate a country will face high inner prices and less improvement in productivity. Incidentally two of the necessary conditions to have long-run growth.

So an equilibrium must be pursued then, but surplus and deficits should not be tainted by positive or negative adjectives.