Transcript What Lessons Do Developing Countries Have for

What Lessons Do Developing
Countries Have for Fiscal
Policy in the US?
Jeffrey Frankel,
Professor, Harvard University
STERN SCHOOL & INDIA PLANNING COMMISSION WORKSHOP
ON “REVIVING THE FOCUS ON LONG TERM GROWTH AND
EMPLOYMENT IN THE ADVANCED ECONOMIES”
Stern School of Business, NYU, Oct. 7-8, 2010
Where to look for lessons?
• Two decades ago, many had drawn a lesson from the 1980s:
Japan’s variant of capitalism was the best model;
– other countries around the world should & would follow it.
– But the Japanese model quickly lost its luster in the 1990s.
• A decade ago, many thought that the lesson of the 1990s
was that the US variant of capitalism was the best model,
– that other countries should and would follow.
– The American model lost its attractiveness in the 2000s.
• So, where should countries look now, in 2010,
for models of economic success to emulate?
• Perhaps to the periphery of the world economy.
2
Big lessons from small countries
• Some smaller and less-rich countries have experimented
with policies & institutions that could usefully be adopted
by some of the “advanced countries.”
• Two illustrations from microeconomics:
– 1st, Singapore pioneered the use of the price mechanism
to reduce traffic congestion in its urban center.
• London emulated Singapore, successfully adopting congestion
pricing in 2003; other big cities should do the same.
– 2nd, Mexico pioneered Conditional Cash Transfer programs,
• making poverty benefits contingent on children’s school attendance.
• They have been emulated widely, embraced even in NYC.
3
On the larger theme that advanced economies
could learn some things from developing countries
• This line of argument is not meant as an attack
on Western values or modes of thought.
• It is not a celebration of Confucian values
or native folk remedies in the Andes or Africa.
• In my view, when Americans lectured others on the virtues
of fiscal discipline, market-based economics, the rule of
law, and electoral democracy, they were mostly right.
• Where they were wrong:
– the failure to see that their own country needed to be
on the receiving end just as much as developing countries,
• the “crony capitalism” point made famous by Simon Johnson.
4
Advanced economies could learn some things
from developing countries, continued
• Countries that are small, or newly independent,
or far-away, or emerging from a devastating war,
are often more free to experiment,
– than is the US or other large established countries.
• Not all the experiments will succeed.
• But some will.
• The results may include useful lessons.
5
Advanced economies could learn some things
from developing countries, continued
• In some cases, Western institutions were successfully
transplanted to other countries in the past,
and now needed to be re-imported.
• An analogy.
– In the latter part of the 19th century
the vineyards of France were destroyed by
Phylloxera vastatrix, a microscopic aphid.
– Eventually a desperate last resort was tried:
grafting susceptible European vines
onto resistant American root stock.
– It saved the European vineyards.
– The New World had come to the rescue of the Old.
6
What should be the overall stance
of US fiscal policy?
• Expansionary during down-times
– 2010. It isn’t.
• Moving back toward discipline in up-times
– 1993-2000. It did.
– 2003-2007, It didn’t.
– 2012- ?
7
The last decade has seen a historic reversal
in roles between advanced countries
and emerging/developing countries
regarding fiscal policy.
• Some of the latter took advantage of the 2002-08 expansion
• to run surpluses, pay down debt,
• and provide for future pension costs;
• allowing budget deficits in the 2008-09 recession.
• = A counter-cyclical fiscal policy
• The US, UK & some other advanced countries
have forgotten how.
8
Previously, fiscal policy tended to be
procyclical in developing countries
-- that is, destabilizing:
• Governments would raise spending in booms;
• and then be forced to cut back in downturns.
• Kaminsky, Reinhart & Vegh (2004), Talvi & Végh (2005),
Alesina, Campante & Tabellini (2008), Mendoza & Oviedo (2006),
Ilzetski & Vegh (2008) and Medas & Zakharova (2009).
• Especially Latin American commodity-producers.
• Gavin & Perotti (1997), Calderón & Schmidt-Hebbel (2003) and Perry (2003).
9
Correlations between Gov.t Spending & GDP
procyclical
Kaminsky, Reinhart & Vegh (2004)
countercyclical
G always used to be pro-cyclical
for most developing countries.
10
The historic reversal in developing countries
• Over the last decade many emerging market countries finally
developed countercyclical or stabilizing fiscal policies:
• They took advantage of the boom years 2003-2008
– to run budget primary surpluses.
– By 2007, Latin America had reduced its debt to 33% of GDP,
• as compared to 63 % in the United States.
• Debt levels among top 20 rich countries (debt/GDP ratios ≈ 80%)
are now twice those of the top 20 emerging markets
.
• Some emerging markets have earned credit ratings
higher than some so-called advanced countries.
–
–
•
Korea now has a better credit rating that Portugal.
Not only Chile & China, but also Malay sia, Mexico, Poland & South Africa, now have higher credit ratings than Greece or Icela nd.
As a result these countries were able to ease budgets
in 2008-09, helping recovery from the recession.
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Two stories of the past decade:
One set in U.S., the other in Chile
Story #1: US fiscal policy
• When the Bush administration took office in January 2001,
it forecast $5 trillion in cumulative budget surpluses for the decade.
• One component of this over-optimistic forecast:
An incoming political appointee at OMB raised an obscure parameter
– the share of labor income in GDP –
from its long-time technocratic (CEA) estimate.
12
Budget forecasts by the Bush White House
then had to be revised down every year
400
300
200
US$ bn
100
0
-100
-200
-300
-400
-500
Jan.
2001
Source: OMB
Aug.
2001
Jan.
2002
2002
Aug.
2002
Jan.
2003
2003
2004
Aug.
2003
Jan.
2004
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US fiscal policy over the past decade, continued
• The forecasted surpluses helped Bush launch
a 10-year path of irresponsible fiscal policy:
– tax cuts
– & accelerated spending
• > twice Clinton’s rate of spending growth.
• The results:
– a cumulative $5 trillion in decade budget deficits.
– Today, in 2010, despite a weak economy,
Washington feels constrained by its debt
to withdrawal fiscal stimulus.
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Story #2: Chile in 2000
instituted a structural budget rule
• The institution was formalized in law in 2006.
• The rule: the structural budget deficit must be zero,
• where structural is defined as output & copper price
equal to their long-run trend values.
• I.e., in a boom the government
can only spend increased revenues
that are deemed permanent;
any temporary copper bonanzas
much be saved.
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• Chile’s fiscal position strengthened immediately.
– allowing national saving to rise from 20.6% to 23.6% by 2005.
• Government debt fell sharply as a share of GDP
and the sovereign spread gradually declined.
• By 2006, Chile achieved a sovereign debt rating of A,
– several notches ahead of Latin American peers.
• By 2007 Chile had become a net creditor.
• By June 2010, its sovereign rating had climbed to A+,
– ahead of some advanced countries:
– Israel & Korea (A), let alone Iceland (BBB-) or Greece (BB+).
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• By 2008. with copper prices spiking upward,
the government of President Bachelet was
under intense pressure to spend the revenue.
– She & Fin.Min.Velasco held to the rule, saving most of it.
– Their popularity ratings reached historic lows.
• When the recession hit and the copper price came
back down, the government increased spending,
mitigating the downturn.
– The Ministers’ popularity
reached historic highs in 2009.
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• A budget target of zero may sound familiar
– like the budget deficit ceilings that
supposedly constrain members of euroland
(deficits < 3 % of GDP under
the Stability & Growth Pact)
– or like the occasional U.S. proposals
for a Balanced Budget Amendment (deficit = 0).
• But those attempts have failed,
because they are too rigid to allow
the need for deficits in recessions,
counterbalanced by surpluses in good times.
• Specifying the budget rule in structural terms does
not solve the problem, if politicians are the ones
who judge what is structural and what is cyclical.
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Official budget forecasts are biased toward optimism
especially if GDP is currently high & especially at longer horizons
Budget balance forecast error
as % of GDP, Full dataset
(1)
(2)
(3)
33 countries
One year ahead
Two years ahead
Three years
ahead
GDP relative
to trend
0.093***
0.258***
0.289***
(0.019)
(0.040)
(0.063)
0.201
0.649***
1.364***
(0.197)
(0.231)
(0.348)
Constant
Observations
398 up with the year 300
Variable is lagged so that it lines
in which the forecast 179
was made.
*** p<0.01, ** p<0.05, * p<0.1
Robust standard errors in parentheses, clustered by country. 19
Official budget forecasts are more biased toward optimism
in countries subject to a budget deficit rule (SGP)
Budget balance forecast error
33 countries
SGPdummy
as a % of GDP, Full Dataset
(1)
(2)
(3)
(4)
One year
ahead
Two years
ahead
One year
ahead
Two years
ahead
0.658
0.905**
0.407
0.276
(0.398)
(0.406)
(0.355)
(0.438)
0.189**
0.497***
(0.0828)
(0.107)
SGP dummy *
(GDP - trend)
Constant
Observations
0.0330
0.466*
0.0330
0.466*
(0.228)
(0.248)
(0.229)
(0.249)
399
300
398
300
*** p<0.01, ** p<0.05, * p<0.1
Robust standard errors in parentheses, clustered by country. 20
The crucial institutional innovation in Chile
• How has Chile avoided over-optimistic official forecasts?
– especially the historic pattern of
over-exuberance in commodity booms?
• The estimation of the long-term path
for GDP & the copper price
-- and so how much of a copper bonanza can be spent -is made by two panels of independent experts,
– and thus is insulated from political pressure & wishful thinking.
• Other countries could usefully emulate Chile’s innovation
– or in other ways delegate to independent agencies
estimation of structural budget deficit paths.
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The US public discussion is framed like a battle between
conservatives who philosophically believe in strong
budgets & small government, and liberals who do not.
Not the right way to characterize the debate. [1]
• (1) The right goal should be budgets that allow
surpluses in booms and deficits in recession.
• (2) The correlation between how loudly an American
politician proclaims a belief in fiscal conservatism
and how likely he is to take corresponding policy steps < 0.
[1] Forget that small government is classically supposed to be
the aim of “liberals,” in the 19th century definition, not “conservatives.”
My point is different: those who call themselves conservatives in practice tend to
adopt policies that are the opposite of fiscal conservatism. I call them “illiberal.”
“Republican & Democratic Presidents Have Switched Economic Policies” Milken Inst.Rev.222003.
Three pieces of evidence to support the claim
that “fiscal conservatives” are not:
• (i) The voting pattern among the 258 Congressmen
who signed an unconditional pledge not to raise taxes:
– As of 2004, they had voted for more spending
than those who did not sign the pledge. [2]
• (ii) The pattern of spending
under Republican presidents.[3]
• (iii) The pattern of states whose Senators win pork
& other federal spending. [4]
•
•
•
[2] William Gale & Brennan Kelly, 2004, “The ‘No New Taxes’ Pledge,” Tax Notes, July.
[3] JF “Snake-Oil Tax Cuts,” EPI, Briefing Paper 221. 2008.
[4] JF Red States, Blue States and the Distribution of Federal Spending, 3/31/2010.
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(ii) Spending & deficits both rose sharply when
Presidents Reagan, Bush I, & Bush II took office.
Vs. the 1990s: The Shared Sacrifice approach succeeded in
eliminating budget deficits, importantly by slowing spending.
Spending and Budget Balance(inverse) as % of GDP (Current US$)
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13
22
11
20
9
18
7
ρ = 0.86
5
16
G.W. Bush
R. Reagan
G.H.W. Bush
10
1
-1
-3
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008 Est
2009 Est
2010 Est
12
J. Carter
14
W.J. Clinton
3
Spending/GDP
Budget Balance/GDP
Source:
24
OMB
(iii) States ranked by federal spending received
per tax dollar paid in 2005
versus party vote ratio in preceding election
“red”
states
“blue”
states
big inflow of US $
Republican states take home
significantly more federal $
(relative to taxes paid)
than Democratic states
low inflow of US $
25
U.S. fiscal policy in 2010-2011?
• What changes in American fiscal policy
would be desirable at the current juncture,
– if politics were not an obstacle?
• On the one hand, the economy is still weak.
• On the other hand, the U.S. can’t wait until the recovery
is complete to tackle the long run fiscal problem.
• A two-part strategy:
• Current steps to extend the fiscal stimulus,
– designed to maximize bang for the buck.
• Current steps to lock in future progress
back toward fiscal discipline in the long run.
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U.S. fiscal policy in 2010-2011, continued
• Maximizing bang for the buck ≡ fiscal stimulus that
gives the most demand per $ added to long-term debt.
• Example that would minimize bang for the buck:
– proposal to make permanent the 2010 estate tax abolition .
– Almost as poorly targeted: proposal to prevent the Bush tax
cuts from expiring in 2011 for those households > $250,000.
• If the stimulus has to take the form of tax cuts,
then the best options are:
–
–
–
–
extending President Obama’s “Make Work Pay” tax cuts,
fixing the Alternative Minimum Tax, and
extending the Bush tax cuts for those households < $250,000.
Some business tax cuts could also give high bang for the buck.
• such as temporary credits for investment or hiring.
27
U.S. fiscal policy in 2010-2011, continued
• But spending boosts demand more than tax cuts do,
– because the latter are partly saved.
• Extend elements of the Obama stimulus
– such as infrastructure investment and
– giving money to the states
• so that they don’t have to lay off teachers, policemen,
firemen, subway drivers & construction workers.
28
U.S. fiscal policy in 2010-2011, continued
• How does one take steps today
to lock in future fiscal consolidation?
– Not by raising taxes or cutting spending today (see above);
– nor by promising to do so in a year or two (not credible).
– There are lots of economically sensible proposals
• for spending to eliminate,
• more efficient taxes to switch to,
• and “tax expenditures” to cut.
29
U.S. fiscal policy in 2010-2011, continued
• One big reform might work best:
pass legislation today to put Social Security
on a sound financial footing in the long term.
• It would consist of a combination
– of raising the retirement age
• just a little (in proportion to lengthening life spans)
– and slowing the growth of benefits for future retirees
• just a little (perhaps by “progressive indexation).
• If Washington could fix Social Security,
– it would address the long-term fiscal outlook,
– yet would create no drag on the current fragile recovery.
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Appendices
• Econometric tests of hypotheses regarding bias
toward optimism in official budget forecasts.
• The political success of the Chilean
government’s fiscal strategy, 2008-09.
32
Econometrically supported hypotheses
regarding bias toward optimism in
official budget forecasts.
•
•
•
•
•
Official forecasts of budgets & GDP in a sample
of 33 countries are overly optimistic on average.
The bias is stronger the longer the forecast horizon.
The bias is greater among European governments that
are politically subject to the budget rules in the SGP.
The bias toward optimism is greater at the extremes
of the business cycle, particularly in booms.
The key macroeconomic input for budget forecasting
in most countries: GDP.
In Chile: the copper price.
33
Econometrically supported hypotheses regarding bias
toward optimism in official budget forecasts, continued.
•
Real copper prices mean-revert in the long run,
–
–
but this is not always readily perceived.
A mere 30 years of data cannot reject a random walk.
•
Uncertainty (option-implied volatility) is higher when
copper prices are toward the top of the cycle.
•
Chile’s official forecasts are not overly optimistic.
•
Chile has apparently avoided the problem of official
forecasts that unrealistically extrapolate in boom times.
34
Poll ratings of Chile’s
President over time
In 2009, the popularity of the Socialist President of Chile Michelle Bachelet
rose sharply (both with respect to handling of the economy and overall),
to the highest levels since the restoration of democracy 20 years earlier.
More remarkable: the rise in the polls, from very low to very high, came just as the
economy moved from rapid growth to slow growth -- not the usual pattern. Why?
Chart source: Eduardo Engel, Christopher Neilson & Rodrigo Valdés, “Fiscal Rules as Social Policy,” Commodities Workshop, World Bank, Sept. 17, 2009
35
Poll ratings
of Chile’s
Presidents
and Finance
Ministers
And the
Finance
Minister?:
August 2009
In August 2009, the
popularity of the
Finance Minister,
Andres Velasco,
ranked behind only
President Bachelet,
despite also having
been low two years
before. Why?
Chart source: Eduardo Engel, Christopher Neilson & Rodrigo Valdés, “Fiscal Rules as Social Policy,” Commodities Workshop, World Bank, Sept. 17, 2009
36