Danny Quah's Blog

I have to recommend -in the strongest way there is- Danny's blog. In particular this post about how Economics is a Martial Art. Danny Quah has been a sort of seal of quality in the MSc Economics at LSE in at least 10 years. He is not every other economist as he has been referenced in one of the most difficult text books one can find in the profession. Check the references in Hamilton's Time Series and you'll know what I'm trying to get across.

Danny is a world class economist, not because Tom Sargent was his PhD advisor, but because he can understand, comunicate and teach the most difficult topic, just as if he were talking about apples and oranges. I was lucky enough to be his student in both Macroeconomics and Time Series. I can only say that the amount, clarity and quality of the material presented is outstanding.

Moreover, while listening his lecture one can be able to grasp more than a few things, however, after doing some reading and serious studing of the material and listen the lecture recorded again, you can feel that you actually learned a lot, and I mean a lot. If any one knows about VAR and Error correction Form Time Series, probably will find it hard to believe that Danny taught those topics in less than two hours. By following the methodology I described above, he did it with outstanding quality and intuition. No, I'm not kidding, he can squizze intuition out of the VAR and Error Correction Form topics.

Finally I must say that I used to fear the Time Series analysis. Now I find it exciting.

Recent Readings II

I had to change the readings I planned. Now I'm reading for the second time Alan Greenspan's book along with the 2009 interviews of the Region (the Minneapolis Fed´s magazine). I have to say that the former Fed Chairman is not among my favorite policy economists. The book however, is quite enjoyable and has the narrative of very interesting moments in both the economic history of the U.S. and the personal development of Greenspan's thoughts.

There is one particular paragraph that has caught my attention. If you look at chapter 6 “The Fall of the Wall“, towards the end, you'd find the following: “Black markets, with their unregulated prices and open competition, seemingly replicate what goes on in a market economy. But only in part. They are not supported by te rule of law. There is no right to own and dispose property backed up by the enforcement power of the state. There are no laws of contract or bancruptcy, and no opportunity to take disputes to court resolution.“

While reading this paragraph, is hard not to think about countries with a weak power of the law. Particularly thinking of Mexico, it seems like the end of our Revolution War provided with weak institutions for the foundation of free markets. At present, Mexico fits -sadly- the paragraph above with ever larger black markets for all kinds pf goods and with citizens defenseless against monopolies, mobs and criminals. The bancruptcy part is an important one, as is presented in the top of the list of reasons why comercial banks lend so little and focus on making profits with charges for other uses of the payment system.

From the reading of the Rajan´s interview in the link above, another idea that would be worthy of exploring is the fact that fierce competition among banks in the U.S. caused instability in the system. This would be so because competition forces banks to look for alternative investments in order to keep up the profit rates they present to their shareholders. This is a partial view of course, the set up given by regulation is also to blame for reckless lending and investment, the idea however remains interesting. Mexico has had a less-than-competitive financial system that is endlessly "consolidating" for over a decade, and the claim that competition should be enhanced has been in the top of the priorities of the policy makers. Now, in light of Rajan's comments, should they still push for more competition accepting a tradeoff with stability? Further thinking is needed.

Recent Readings

I recently finished two books: Superfreakonomics and Freefall. Very different of course, but both have interesting things to say. About the Levitt and Dubner's the one chapter on global warming its very interesting. The book overall is better than the first one. At least is more relevant in its topics and less anecdotic.

The Stiglitz's Freefall has interesting thoughts on what went wrong in the U.S. before and during the crisis, but is rather repetitive. Each chapter goes on and on how bankers and policy makers abused taxpayers with the bailouts. On the bright-side however, it explains really well all the informational problems that financial markets have. And all pending regulations to overcome this informational issues. In particular the chapter on reforming economics is interesting as a summary of how the macro science developed in the last thirty years and places over the table that frictions in financial markets should play a central role in modelling.

Superfreakonomics relies on the modern techniques of econometrics for empirical micro. I must say that even though there are updated references on the topic like the Angrist and Pishke's book causality issues are far from well developed as I see them. I'm no fan of econometrics anyway but at least economists are increasingly happy with the answers the counterfactual approach yields, that means that progress has been made (I'm not sure if current state of affairs is good enough).

If you read the Freefall book and you are interested in the new ways the macro should expand you will find valuable ideas. Just be patient while professor Stiglitz unload his fury on the "pure-market-believers". One thing I really dis-like about the book is its continuous reference to an unfair wealth redistribution from taxpayers to bankers. Is not that he is wrong. There was indeed a redistribution in the named direction. It is also true, however, that the U.S. economy has been living beyond its means. That is true for all economic activities and all income levels. My guess is that Raghuram Rajan's new book addresses the same topic from a more centered perspective.

It would be interesting to see if at some point in history taxpayers did not pick the tab after a banking crisis. I'm trying to learn about this in Reinhart and Rogoff's recent book. Mexico had its own episode of banking crisis in the second half of the 90's decade. And yes, taxpayers paid bankers' lack of care on credit allocation. Citizens lost their mortgaged homes. Credit card interest rates hit new historic ceilings. Long-story short, after fifteen years of the banking crash there is still outstanding debt issuance from the official entity on charge (IPAB). But just as true is the fact that there was no other way to fix the problem.

I'm a bit puzzled by the saying of Reinhart and Rogoff: the "This time is different" syndrome. Today Spanish banks are under pressure to get funds in international markets. This is a direct result from the fiscal deficit that Spain faces and the problems that Greece faced recently. Spanish banks are debtors of more than 50 per cent of Mexican savers. Whenever someone asks whether or not there will be problems for the Mexican subsidiaries the prompt answer is: this time is different. It may be so. In fact this banks may well manage to separate their business in each country they operate. The truth is nobody knows because there is no acces to their (full) balance sheets.

After serious thinking I find that is not possible to continue learning macroeconomics without looking at the financial crisis. Not only the current one, but to have a comprehensive view of them. To complement Reinhart and Rogoff's reading I choose Roubini's about the economy at crisis, he was one of the few that saw the crisis coming.

Central Banks and Objectives

In the last fifteen years the role of monetary policy has converged to be a matter of rules. In particular, rules on inflation and this has the name of Inflation Targeting (IT). While successful in keeping inflation low through a clear mechanism that aims to control expectations, IT has been blamed to cause an excess of liquidity in the world. I think criticism overstates the weaknesses of IT. In particular let me discuss the mindset rather than the IT per se that drives the criticism. A disclaimer is in order, I think IT has its days counted as the sole objective of a Central Bank. This however, does not make its achievements irrelevant.

The mindset of the critics bluntly blames IT for an excess of liquidity before and during the current financial crisis. They forgo in the process that inflation is at least as painful as unemployment. In their mindset they still have a negative-sloped-Phillips-Curve. Moreover, they disregard any important role of expectations (and thus the vertical-Phillips-Curve). There are many opinions around this subject and the consensus of the forward-looking Phillips Curve is facing a real challenge.

Behind any criticism is the underlying notion of a non-taken path that would have yielded a better outcome. Interestingly this is just an assumption. Is there any guarantee whatsoever that taking the non-IT path back in early 90's would have delivered a lower unemployment rate and avoided the financial crisis? I think the best answer is: we will never know. Counterfactual outcomes (the path non-taken) are as fictitious as any army that Quijote fought. They are based in a number of assumptions. Many of this assumptions are based, in turn, in the path taken, thus violating the counterfactual nature.

It is my believe that economist should take more seriously the optimality principle: any policy decision made today must be optimal taken as given the state of affairs. To argue that the non-taken path was better and flawless hardly helps a better understanding of reality. Furthermore, our training as economists has not helped us to acknowledge that some policies are inherently finitely lived. That is, maybe IT's was the best policy to follow and now is not. That does not mean that we were wrong all along in following IT prescription.

This is not to say that history should be neglected. If a policy yields bad results it should be replaced, but, at the same time, it should be evaluated against itself and according to its reality.

Having said this, I think that IT contributed to a low inflation level that is remarkable. Sadly it is not enough to help the economy grow. Central Banks should put a lot more attention to developments in financial markets. In particular, market concentration and excessive trading should be closely observed and corrected. By excessive trading I mean a large number of intermediaries in the financial market. It is clear now that there are at least two ways to make money in the financial market 1) the traditional one where resources are lent to profitable investments and gains are shared by investors. 2) By intermediating. This second form has been criticized for not creating wealth, but only redistribute it.

This is part true. Think of a corn producer. In order to put the corn in the hands of the final consumer, the producer has to go in to the city and spend valuable time selling the corn. If there exist an intermediary who can work full time selling corn there are gains for the three individuals (producer, intermediary and final consumer). What happens if I add a fourth individual, a second intermediary? If this individual is identical (in its functions) to the other intermediary then profits for the producer go up along with consumer surplus, and the identica intermediaries see how their profits go down. Now, further assume that the second intermediary is not identical to the other, but he is between the latter and the final consumer, now profits of the producer and consumer surplus are lower. What is going on is a redistribution of wealth from consumers and producer to intermediaries.

This is a key question financial markets cant regulate by themselves. The number of heterogenous traders (intermediaries) grows ever larger, diminishing savings returns and available funding for investment. Here lies an important role for the central bank as the vigilant of the well functioning of the payment system. This kind of objective should be added to IT. And if it represents a conflict with it, society preferences should decide which is more important.

Young's Tyranny of Numbers

I have always thought that an important part of the explanation of rapid growth of the so called Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) was productivity. Turns out that is not necessarily the case. LSE's professor Alwyn Young has this famous paper "The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience". Young's estimates of productivity -a key feature of economic growth according to the neoclassical model- for these Asian countries is not particularly different from countries such as Mexico, Brazil or Canada.

The paper argues for a different reason why economic growth boomed in the region. A -sort of- one time shock of education, participation and investment. It seems that underlying fast growth is the laggard progress they had before World War II. So its not that they are particularly good at something. Nor it is that they are productive workers. Not even that real wages are low. These economies grew because they were far away from the needed level of capital human, investment and participation. Once they achieve these levels, employment along with exports pulled these economies.

When policy recomendations for countries like Mexico point to follow the Asian Tigers, the only thing there is to follow is the improvement of investment, participation and human capital levels, not necesarily the productivity indicators. Productivity should push prices down, but it takes more than that to increase aggregate output.

Mexican Senate organized a forum to recollect the opinion of experts to increase productivity and competition. According to Young's argument, competition should be addressed as a priority, including the increase in investment - GDP ratio. Taking official series at constant prices, the ratio's growth rate has lately fall to negative levels in Mexico. This should be a policy lesson.

Lucas talks on the Critics of the Economics Profession

Robert Lucas from University of Chicago has a strong argument published in The Economist against those dooming modern macroeconomic models. It is worth reading.

A few thoughts from Animal Spirits

After completing the Animal Spirits book I have a few thoughts that I think deserve some discussion. I sustain that the book does not provide a way to model the Animal Spirits as defined by the authors. It does provide a list of topics and questions that macro guys should address soon if it wants to contribute to decisions among policy makers.

There are some interesting examples of how generalization in markets analysis may not be the right path to think of their behavior. The book includes an interesting and revealing example from Keynes. It goes like this: Assume there is a beauty contest where judges are rewarded if they price contestants as the majority of judges does. With this simple assumption, it is farly straight to conclude that every judge chooses what he thinks every other judge will choose -maybe- instead of his true first preference. The latter illustrates perfectly how the stock market works.

I agree with a statement of Akerlof and Shiller: it is hard to believe that every single day there is an explanation for the recent stock market movements. I think that being a stock market columnist must require a vast stock of creativity, specially in days of many fluctuations.

Another example of "special" markets is a common one in Mexico. Physicians are rarely choose from the yellow pages. They get most of their patients because a satisfied patient recommends his services. Literature books are read not only because of their publicity, but because of some recommendation. So these two markets -physicians and books'- have in common that information is a strong determinant in decisions. This is not new, what is interesting is that prices may not reflect all information there is needed to make a "good choice".

The utility provided by a book -or a physician- can be explained by tastes, but the great supply makes it necessary to ask for a recommendation before making a transaction. So stock markets -books and physicians- may need a different framework to be analyzed.

Another part of the reading that kept me thinking is the efficiency wages theory and its implications in rigidities, it is indeed natural to conclude that this theory explains reality of rich countries. In poor countries the same effect of costly layoffs can be largely explained by unions.

There is another reality that can not be drawn out of the analysis: that is the skills and fairness issues in the problem of determining wages. The latter is very important in recent tax design literature, and create a major problem arguing in favor of the non-negative slope Phillips curve.

We economist must always have in mind the important difference between normative and positive economics. The former must be the target, but the latter is our reality and must be understood too. If economist can diagnose what is wrong -using normative economics- we should also know how to deal with actual problems -with positive economics.

The book tries to take away the profession from a normative to a positive fashion, but both are essential, Skidelsky goes even further asking for a change in universities' economics programs adding a philosophical background and letting math aside.

A Big Obstacle Rebalancing Global Imbalances

The widely accepted assertion of macro theory which states that after a public budget deficit, a currency appreciation will follow can help to know when stop spending. Several mechanisms work and translate in to a -temporal- wealth effect for residents of the named country. This certainly could not contribute to an export rising.

This having said, it appears now that the future budget deficits of the U.S.' economy will play against economic growth. The latter is easily infered from Martin Feldstein's statement that even though savings in the U.S. are rising and could replace foreign one -known as capital inflows- there will not be a dollar depreciation which is a necesary condition for having economic growth and a current account re-balance.

Taking as a -disputable- truth that the increase in spending has helped improve the economic outlook world-wide, the effect pointed by Feldstein may perfectly work as a sign to know when to stop spending and let the economy re-balance by itself.

The need for new Macro

There is a vast consensus around the need for the -rapid- improvement of macroeconomics. It certainly can not be neglected. Although the path of the Animal Spirits may have a number of weaknesses, it argues boldly for reforming the way macro is done can not wait anymore. De Grauwe writes an interesting opinion about the latter.

Maybe the need for understanding the so called Herd Economics can help in completing macro models that fail to model the financial market as an imperfect market. The current macro profession crisis will also prove valuable for those in search of a thesis.

Animal spirits -After some reading-

In a recent post, I described a lecture given by one of the authors. After the completion of the 9th chapter out of 14 my impressions have not changed much. The book proposes some new "variables" that modern economic theory does not use. The so called "animal spirits". Defined as a set of variables such as confidence, money illusion, stories and corruption.

The approach of the book can be shortly summarized in the following: Macroeconomics has taken too far rationality assumptions. After more than 100 pages, evidence and arguments presented are in my view far from conclusive.

The authors construct most arguments based not on facts but on frequent guessing. No doubt behavioral economics rely it's findings on an interesting psychological framework. No doubt it will eventually develop to a sounder stage. But the animal spirits theory contributes little to economic modeling.

It is hard in the profession to consider seriously a theory without a model to assess reality. Not to mention in economic policy-making. The only animal spirit that could be tested at present is the one that is based in stories. Something particularly similar to adaptative expectations. The Economist magazine made available a bold description of the current state of the economist profession in terms of those soft spots of macro.

This explanation is much more centered than Akerlof and Shiller's. It states an important fact too. We economist prefer an elegant and formal theory. Not because of vanity, but because science grows based on sound facts and abstraction of them. We now know for a fact that financial markets can not regulate by them selfs. It seems that this is the most notable weakness of modern macroeconomics, not the rationality assumptions for the rest of the economic agents, nor the microeconomic foundations that modern macroeconomist agree are important. Including recent advances of the Dynamic Stochastic General Equilibrium Models.

The article of the Economist says also, that we consider only theories that can be modeled. That is true. Again not for vanity but for its usefulness for real life problems. An example. Keynes's breakthroughs in economics translated in to reality with a deep and a comprehensive fashion until Hicks developed the IS-LM model, until then, keynesian theories were only provocative philosophical arguments.

Maybe behavioral economics will provide the theory for serious improvements of macroeconomic theory. The Animal Spirits book does not provide a model for this end.

Is the IS-LM Model Outdated?

As an undergraduate student, I used to disdain the IS-LM model as an obsolete tool of macro policy analysis. In time I have come to the conclusion that there is not a sounder model out there. Despite its limitations -such as its static set up, ad-hoc nature and lack of microfundations- the IS-LM model provides accurate information on the behavior of some variables after a public policy decision.

The lack of microfoundations is important in second order. Lets not forget that it is, at the end, a general equilibrium model. Moreover, the IS-LM model is a synthesis of the goodnes of general equilibrium economics and comparative advantages of Keynesian economics.

Although Paul Krugman is lately a maverick economist, opposing to every other collegue, it is worth taking a look at Krugman's thoughts of the IS-LM model. Personally, I have more respect now for the model. Not because its limitations are minor, but because its usefulness has been proved over years of economic policy.

The fact that international agencies such as the IMF or central banks use the model -along with some dynamic stochastic general equilibrium- shows its value for the profession. I find it hard to believe that after tons of macro papers written out there, only a small proportion has proven useful for macro policy.

Two facts have changed my view of the model: First, I prefer to be an "engineer macroeconomist" in Mankiw's definition. Second, when learning advanced models of economic growth and policy, the IS-LM provides the right intuition. So it makes it easier to understand the important results.

Hopefully the current economic crisis will trigger interest in making economic modelling closer to reality. It is true, economic science evolves slower than it looks. Maybe modern macro models are over a path in o a new and more useful model than the IS-LM. In the mean time, it is not a waste of time to learn it well if you like macro.

The Economist on Mexico's last Election

It is fairly straight to conclude that the following three years -before elections for President- will be the hardest of the Calderon administration. The Economist sum-up a clear picture of it.

The liberal magazine also displays the only way out of the "political gridlock", stating that co-governance with the PRI party is a necessary condition, with the implicit hope that the PRI will allow for critical reforms and thus would receive a country in expansion. If you are interested in estimated numbers of the low chamber composition, Eduardo's Blog provide some from the media.

The Economist's view of Mexico it's almost fully accurate, it only fails to mention the low proportion of total votes with respect to registered citizens, and all nule votes.

With the Congress majority leaned to the PRI party, much of economist's creativity should be invested in the next fiscal reform. VAT in food and medicines will not be an option.

IMF Issues Debt!

The IMF will issue debt soon according to the FT. The latter rises some interesting questions. How will IMF's debt affect economic variables? Will prices in countries be distorted? If so, in which countries lenders or borrowers? To what terms would be issued? John Cochrane explains how can long term debt be useful for a government trying to exchange present for future inflation. Will effects like this lack of importance?

It sounds like some details should be discussed, one thing for sure is that the US will stop receiving savings from surplus countries, if the dollar depreciates, trade deficit in the western hemisphere will fall, still, trade surplus in Asia will not necessarily fall.

Another interesting feature is that if the IMF's absorbs saving excess, the consumption and investment components of aggregate demand in rich countries will suffer. There are a few untied ends of the proposal, but it is probably in the right direction. A popular direction at present.

The Political Economy of the Next Fiscal Reform -After the election-

Results of the election show that the Revolutionary Party (PRI) will be the first minority in Mexican lower chamber with more than 210 seats. A strong position with respect to its present 106 seats. The official National Action Party (PAN), will have 133 seats a big lost from the former 206. In the last three years, history has recorded that whenever the PAN wanted to go ahead with any major reform, it had to agree with the PRI first.

Now all negotiations will be harder for the official party. Taken PRI's ambitions to return ruling Mexico in 2012 as given, a fiscal reform that raise the tax base or the marginal tax rate of existing tributes looks ever more difficult.

Taking a glimpse in to the future, and assuming the PRI is willing to raise tax revenue, the optimal strategy for the Democratic Revolution Party (PRD) will be -with emphasis- to condemn those taxes and then trying to re-gain the second place in voters' preferences. The PRD did very bad too in the recent election, it will have only 67 seats nearly half of its current number 126.

All the latter would leave the PAN in a historical weak position and as an all time looser. The PAN would present to the 2012 elections as a party with the poorest performance in both economic and public safety terms. Taken the last election as an advanced indicator of the 2012's, the PAN should focus in not loosing its place as the second major party.

One of the few ways a fiscal reform would take place, must involve the PRI's akcnowledgement of the fact that without enough revenues, Congress alocates fewer resources. At the same time, the fiscal reform should include all parties, so that none of them could make campaign against it.

Sadly, evidence of reforms including all parties in the current period shows that they have turned out to be weak when compared with its motivations. The latter is the case of the last fiscal, energy and voting system reforms.

Only reforms agreed by a small number of parties are near to satisfy the needs reality demands, such as the pension reform of the State workers of 2007.

Mexico's President will face tougher obstacles now, with its safety policy struggling to convince Mexicans it is the right way, an economý faltering and expected to grow slowly, added to low expected public revenues, the PAN has to take serious action and deal with the PRI, otherwise, the country of 2012 will be ever more distant from that promissed in 2006. Voters acknowledge that.

Animal Spirits -A First Glance-

Berkeley economics' professor George A. Akerlof and Yale's Robert J. Shiller recently published a book that awake interesting feedback so far. The title reads "Animal Spirits" invoking a popular phrase of J. M. Keynes regarding the underlying factors that come to play when it comes to investment decisions.

This already shows some biased in the convictions of the authors, which can be summed up in the following: governments should play a more active role in the economy than free-market advocates claim.

I have not read the book yet -I will soon- however, I have a clearer picture of its contains. Shiller visited recently the LSE and gave a lecture on it. One of the central points made was that, unlike we economist assume, individuals make decisions based in shakier, less technical premises. One in particular caught my attention. Akerlof and Shiller state that individuals base their decisions in "stories". This is, in someone else's experiences. Frankly, this falls in place if we look to how investment decisions are made in cities like Guadalajara, in Mexico.

It is fairly common to hear that someone decided to get in the carwash bussines because he heard how well someone else was doing. It is easy to replicate the latter in mobile phone stores, haircutt shops, caffe internet, real state buying, and so on. There are no feasibility studies behind, just stories from acquaintances.

Of course, it is true that not only Guadalajara corroborates Akerlof and Shiller's hypothesis, just as is true that there are hundreds of counter examples. Nevertheless, the "stories" story seems a lot like the forgotten adaptative expectations. So, in a way, the authors suggest that models -such as the modern macro models- should be re-assessed to include the latter and delete the "rational" approach.

This is my hope at least, otherwise it would be hard to model those indivuduals' "animal spirits". Still, there is some reading to do.

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.

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.

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.

Global Imbalances

The global imbalances story explaining the current crisis is gaining ever more adepts. It's fairly straight that U.S. officials claimed it, looking for guilt abroad will always be far easier, but now academics are pledging the same. Eichengreen wrote a piece based on the imbalances story that is worth reading.