Mexico and the Swine Flu

The current outbreak in Mexico, fastly moving to different countries, presents itself as a great challenge, not only for authorities in Mexico City and Federal Government, but to all of us. We must learn to live a reality that struck one of the worst weaknesses of Mexico. A poor public health care system and the expensive private one.

Even though the probability of contagion is lower than having a car accident (yet) people is taking great caution. Maybe a good reason to be in panic is that if one gets sick, one is on the impression that health care system is particularly bad. Moreover, symptoms are easily mistaken with other kinds of flu, so going to the hospital at the least sign is an equilibrium strategy.

It is often written and said that ignorance is the mother of panics and chaos, media and governments at all levels have put a lot of effort to inform population about contagion means and preventive measures. They also have created a soup words in terms of the severe consequences of the illness. A common citizen must distinguish between probable cases of swine flu, corroborated cases and deaths.

So maybe the number of deaths, although considerably high for a flu, is lower than deaths claimed at traffic accidents related to alcohol. The very nature of this kind of disease is the reason that creates scarcity of anti-viral medicine and mask faces all over the country. One can not know instantaneously if is contaminated or not. A whole lab test is necessary. Panic would be certainly less if we all were doctors, or if we all could have a home test for it. But there is not, and timely attention is critical in the odds of get cured, so the equilibrium strategy is the same.

But one should take a second and evaluate that if one is contaminated with low probability with the swine flu, going to a hospital will only increase -exponentially- the probability of being contaminated. A self-fulfilling disease arise then. Because one entered the hospital without the swine flu, but walked out with it, contaminating people around.

The best way to go is getting all the RELIABLE OFFICIAL INFORMATION there is,and take all precautions, we will not always live in this Saramago-like setting. Patience and precautions.

Social Net Reform in Mexico

A few days ago the lower chamber in Mexico passed a reform that allow unemployed workers in the formal economy to withdraw a higher fraction of their pension savings once every five years, thus working as a kind of unemployment insurance. It is different form an unemployment insurance in some sense, workers are exchanging future consumption in order to get more consumption today, clearly because he/she is unemployed, so government is not subsidizing this benefit. Furthermore, rules established imply that withdrawing is a one time action every five years, as opposed to the social benefit in the United States where a monthly payment is made.

In macro terms this new rules are designed not to make a government further liable of pension resources, but to improve automatic stabilizers. Consumption will certainly increase in the short run, since unemployed workers will have a full month pay. In the long run consequences are less clear. It is true that the flow income of pensions will not stop, however, the inverted population pyramid demands ever increasing present savings. The reform will certainly not increase present savings.

The only way to escape a future (sooner) collapse of the pension system is to achieve a higher saving rate in future employees. This is, that current unemployed, with the expectation of getting a job sooner or later, will more than compensate for present withdraws.

The subject then is a good counter-cyclical measure, but it will not solve any pervasive incentive there is in Mexican pension system. In this context, further reforms to achieve perfect mobility across public systems (there are two public systems one for public service workers and the one for the rest of population). There are, otherwise, inefficiencies arising from people having, or looking for, more than one job in public sector, and alike.

Much more emphasis should be posed in automatic stabilizers yet, revenue tax is a mechanism that present a great gap between its present situation and its perfect functioning.

Agriculture Outcomes

For those of you who like to praise agricultural development as a priority of public policy, take a look of what Salvador has to say on the latest outcomes. Sadly, we need to think further over the incentive structure for this sector, in the mean time, a debate over food autarky must be addressed by experts, this is a valuable link.

Is China finally helping with global imbalamces adjustment?

It is necessary to assess whether China is taking the right steps by increasing is money supply in such a magnitude, 25.5 percent. Clearly, global imbalances have as a starr the Asian giant, however, the increase in lending from its central bank to commercial ones is a risky move for the world as opposed to let the yuan appreciate.

Let's not forget than any country with a currency peg losses it's monetary autonomy. Thus, by increasing it's money supply, China is pressing further on the opposite direction of the appreciation needed. So how can this policy help global economy out of recession? It can not.

This policy can help China to get out of it's slow growth but it will not correct global imbalances. It is true that there are no incentives for China to correct it's huge trade surplus, but an increase in public spending -as opposed to a monetary one- can yield two desirable effects. First it will cause the yuan to appreciate, thus reducing further the trade surplus -recent figures show that it has dropped significantly in the first quarter of 2009 by 45 percent with respect the previous quarter. Second, it would drive domestic consumption up, increasing China's demand for imports and correcting further global imbalances, helping deficit countries such as the U.S., U.K. and Spain in their delevereage.

So, the increase on money supply is only good news for China and serious structural problems must wait to be addressed.

Automatic Stabilizers and Adjustment

Further attention must be posed in the so called Automatic Stabilizers. A definition must include features that tame the business cycle, every direct tax that observes progressiveness is an example of an automatic stabilizer, in this way whenever the business cycle expands tax revenues increase, as opposed to when the business cycle contracts. This, however, leads to a direct increase in debt issued by governments to fulfill expenditure levels.

The latter explains, part of the efforts for stimulate the economy, the other part comes from discrete actions taken. The IMF estimates the impact of automatic stabilizers on the fiscal balance of Mexico, for example, around -0.3 percent of GDP for 2008 and -0.8 percent of GDP for 2009. They find a strong correlation between the size of the government -measured by the size of public spending relative to the size of GDP- and the size of the effect from the automatic stabilizers.

Why are they so important? Because they provide a mechanism to reestablish balance and control that is not subject to a political process. Their effectiveness depends on the design of the tax system. The personal income tax (PIT) provides an excellent example of this mechanism. As the personal income increases, the PIT assures a greater tax revenue for the government, remember the rule: the more you earn, the more taxes you pay relative to your income. The contrary is also true, thus in a recession low taxes paid by the PIT provide a positive incentive to work more hours than before, thus helping the economy getting out of recession.

Discrete measures, opposed to automatic stabilizers, depend heavily on political arrangements and incentives, so they can violate optimality, they can be allocated poorly and, most importantly, they do not allow persons to make their own decisions.

Other forms of automatic stabilizers can be find in social benefits and unemployment insurance, these help in recession times to increase consumption demand and tame the lack of income, both mechanisms at work increase further public spending.

Finally, an important stabilizer, although not from the tax system, is the external trade. The U.S.' trade deficit is back from historical high levels to those of 1999, the latter as a result of a decrease in import demands from the U.S. and a some adjustments on exchange rates that make its exports cheaper. In the long run imbalances will disappear, the cost is the painful unemployment.

Reforms that address the weakness of automatic stabilizers should be pursued in those countries with low levels of automatic adjustments. Mexico is one of them.

Modern Macro in the textbook

Mankiw is about to conclude the updating of his excellent Macroeconomics. It includes a new chapter that introduce to Dynamic Stochastic General Equilibrium Models (DSGE). These models are used in policy making and are at the frontier of Macro-research. If you are a Macro guy, take a close look at it.

As a Corolary, this models are used in a new branch of research called New Dynamic Fiscal Policy.

Diesel prices

Diesel prices at Mexico has stopped growing since the President announced an emergency economic program to stimulate growth and support household income. Before the announcement price fuels such as gasoline and diesel had an increasing path, the cause underlying ever higher prices was the high-historic-prices of oil, and thus, of fuel.

At the beginning of this series of increases, the diesel price in Mexico was only a third of that in the US. Subsidies to fuel in all 2008 reached 218 thousand millions of pesos, this is, almost 2 per cent of GDP. Now trucks syndicates claim that since international diesel prices has slumped, Mexican prices should too.

Government has not showed any intention to reduce diesel or gasoline prices, and it is the right thing to do. Let us not forget that tax revenues at Mexico are slightly above of 9 per cent of GDP, only Haiti has lower tax revenues in terms of its product. High fuel prices -or positive fuel taxes- happen to have a number of good features. First, they are a reliable source of tax revenues since their elasticity converges to zero. Second, they tax -whether implicitly or explicitly- the use of motor vehicles, thus the price of pollutants increase. Third, diesel pollutes much more -in relative terms- than gasoline, it is used in heavy work vehicles, thus, high prices provide an incentive to change motor technology.

The immediate answer to the latter argument is based in some kind of inflation pass-through from increases in fuel prices to overall inflation, specially of diesel since it is used in heavy trucks, which in turn transport food from one place to another. Interestingly, there is no recent research of the latter subject, so maybe here is a case of the so called conventional wisdom, where it is easy to attach high (changes in) price levels to high oil prices, but correlation is not necessarily strong, at least not through channels thought.

A challenging counter-example is the correlation between changes and general price level changes in the U.S. Logic should lead us to conclude that since the U.S. consume much more fuel than Mexico and since prices can overshoot -like they did in 2008's summer- then, for example, food prices should have had increase considerably as a consequence of the former. They did not.

Take now the following fact. In September of 2007 a fuel tax was approved of 2 per cent. As political opposition sounded alarms on the consequences, Mexican government agree that the tax would be levied until January of 2008. Strikingly, consumer prices went up more in the last quarter of 2007 (by 0.505 percent on average) than they did in the first quarter of 2008 (by 0.495 percent on average).

So, it should be interesting to measure whether Mexicans respond more to fuel price increase announces than actual higher fuelprices. If this is the case, an environmental tax is plausible, government should not lower diesel prices.