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August 8, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

"A Gift the Wealthy Don’t Need"

Posted: 08 Aug 2010 12:33 AM PDT

Stimulus opponents -- those who said it wouldn't work -- want to extend the Bush tax cuts because the economy needs more stimulus:

A Gift the Wealthy Don't Need, by Robert Frank, Commentary, NY Times: A central lesson of the Great Depression was that economies mired in deep downturns seldom recover quickly on their own. Consumers won't spend because they're worried about losing their jobs — if they haven't lost them already — and are busy paying down debt. Companies won't invest because they already have more than enough capacity to satisfy existing demand. That leaves government. It's the only remaining actor with both the means and the motive to bolster total spending substantially.
Yet in 2009, when economic stimulus legislation was proposed in Congress, many people insisted that the extra government spending would do no good. ... [S]timulus opponents — a group that includes most Republicans in Congress and sometimes a handful of Democrats — have gone on to advocate cutting existing programs, like food stamps and Medicare. They have repeatedly blocked extensions of long-term unemployment benefits. Most recently, they have joined European deficit hawks in calling for further spending cuts to prevent national insolvency — a threat that financial markets have discounted.
Now stimulus opponents want to extend the tax cuts of President George W. Bush — cuts that are scheduled to expire at year-end. Almost all professional economists believe that those cuts have already increased the national debt by hundreds of billions of dollars. Even Alan Greenspan ... has publicly opposed their extension. The Obama administration wants to eliminate the tax cuts for families earning at least $250,000 a year, and for individuals earning at least $200,000.
WWhy, then, do stimulus opponents want to keep them? Brace yourself: it's because the economy needs additional stimulus, they say. As the Senate minority leader, Mitch McConnell of Kentucky, said..., "Raising taxes in the middle of a recession is not a good idea." ... With the economic recovery clearly sputtering, could they be correct to insist that the Bush tax cuts on the wealthy be extended?
Alas, no. ... Because most poor and middle-income families consume their entire income, higher tax rates for those families would indeed deprive the economy of much-needed short-run stimulus. But extending the Bush tax cuts for the wealthiest families would be one of the worst possible ways to stimulate spending. These families typically consume much less than their income. Instead of trying to use up all their savings before they die, most prefer to leave substantial bequests. Letting their tax cuts expire might reduce those bequests, but it will not reduce their current consumption significantly.
It will, however, generate revenue that could be used to bolster spending in a host of ways that would be useful even apart from the stimulus effects. Because state and local government budgets are in shambles, hundreds of teachers, police officers and firefighters are being laid off every week. Federal grants could keep them on the job. ...
To bolster current spending without adding more to deficits than necessary, we have no better option than to let the Bush tax cuts on the wealthy expire as scheduled.

"History Versus Expectations in Sub-Saharan Africa"

Posted: 08 Aug 2010 12:30 AM PDT

Rajiv Sethi:

History Versus Expectations in Sub-Saharan Africa: Ngozi Okonjo-Iweala believes that sub-Saharan Africa "is on the verge of joining the ranks" of the so-called BRIC nations... She supports these claims with a wealth of data on recent trends in growth, inflation, exchange reserves, foreign direct investment flows, receipts from international tourism, spreading democratization, declining gender disparities, and improved security.

But Ngozi is also careful to note that this projected take-off is by no means a foregone conclusion. She argues that a concerted development effort is necessary, including a "big push" on investments in education and infrastructure. ... While such an initiative would help close an infrastructure funding gap over the next few years, Ngozi maintains that its most important effect would be to "change perceptions overnight about Africa as a place to do business."

The idea that coordinated optimism about the future prospects of a region could be a critical determinant of its subsequent growth performance was advanced in a classic paper by Rosenstein-Rodan in 1943, building on earlier work by Allyn Young. The argument is based on the fact that the development of any particular industry may only be privately profitable if an entire set of interlocking industries were emerging simultaneously. Hence the need for a "big push":

Complementarity of different industries provides the most important set of arguments in favour of a large-scale planned industrialisation... It might easily happen that any one enterprise would not be profitable enough ... out of its own profits. But the creation of such an enterprise... may create new investment opportunities and profits elsewhere... If we create a sufficiently large investment unit by including all the new industries of the region, external economies will become internal profits out of which dividends may be paid easily.

Or, as Paul Krugman put it in his influential paper on history versus expectations, "the doctrine of Rosenstein-Rodan" entails the following claim: "the willingness of firms to invest depends on their expectation that other firms will invest, so that the task of development policy is to create convergent expectations around high investment." 

Krugman's goal in that paper was to point out that there are a many contexts in which multiple equilibria of the kind that concerned Rosenstein-Rodan arise, and to address the question of how one of these is eventually selected: 

Once one has multiple equilibria, however, there is an obvious question: which equilibrium actually gets established? Although few have emphasized this point, there is a broad division into two camps... On one side is the belief that the choice among multiple equilibria is essentially resolved by history: that past events set the preconditions that drive the economy to one or another steady state... On the other side, however, is the view that the key determinant of choice of equilibrium is expectations: that there is a decisive element of self-fulfilling prophecy...

The ... world in which history matters and a world of self-fulfilling expectations are different from the standard competitive view of the world, but they are also significantly different from each other. Obviously, also, there must be cases in which both are relevant. Yet in the recent theoretical literature models have tended to be structured in such a way that either history or expectations matter, but not both... in the real world, we would expect there to be circumstances in which initial conditions determine the outcome, and others in which expectations may be decisive. But what are these circumstances? 

It's clearly an important question, and in order to address it Krugman builds a simple two-sector model with increasing returns in one sector and constant returns in the other. There are two long run equilibria, each of which involves complete specialization in one of the two goods. If the initial state of the economy involves incomplete specialization there will be movement of resources across sectors. But in which direction? ...

Krugman shows that there is a range of initial conditions, which he calls the overlap, from which either one of the two long run states can be approached if and only if it is expected to be realized.  If initial conditions lie outside this range, then history is decisive, otherwise expectations matter a great deal in affecting the eventual pattern of specialization.

The overlap may be viewed as a zone of uncertainty within which coordinated optimism can have major economic effects. Outside this zone, for better or worse, we are shackled by our history. Within it, expectations become crucially important. 

The question, then, is whether or not sub-Saharan Africa is now in or around this zone of uncertainty where expectations can be a critical determinant of its future development performance. Shanta Devarajan has recently pointed to a number of success stories that seem to suggest the stirrings of something major:

In recent years, a broad swath of African countries has begun to show a remarkable dynamism.  From Mozambique's impressive growth rate (averaging 8% p.a. for more than a decade) to Kenya's emergence as a major global supplier of cut flowers, from M-pesa's mobile phone-based cash transfers to KickStart's low-cost irrigation technology for small-holder farmers, and from Rwanda's gorilla tourism to Lagos City's Bus Rapid Transit system, Africa is seeing a dramatic transformation.  This favorable trend is spurred by, among other things, stronger leadership, better governance, an improving business climate, innovation, market-based solutions, a more involved citizenry, and an increasing reliance on home-grown solutions.  More and more, Africans are driving African development.

I quoted this passage in an earlier post as a counterpoint to William Easterley's rather startling claim that "78 percent of the difference in income today between sub-Saharan Africa and Western Europe is explained by technology differences that already existed in 1500 AD – even before the slave trade and colonialism." My quarrel is not with this statement as an empirical claim, but rather with its implication that the heavy hand of history will continue to weigh inexorably upon the region. Sometimes we are bound by the past and sometimes not, and it is important to recognize opportunities to break free when they arise. And such an opportunity may well be emerging right before our eyes in Africa. ...

links for 2010-08-07

Posted: 07 Aug 2010 11:01 PM PDT

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