Monday, March 10, 2014

Blog interrupted?

To my dear readers and followers, I have accepted a new assignment to do development work in the Philippines for an internationally funded aid project that will have me occupied until the end of this year. This means that the entries to this blog will be far less frequent than before. As I make the transition now from my role as a policy analyst to that of an implementer of change, I expect new insights and ideas to come. The experience of working on the front-line of the field will provide me with a different perspective, undoubtedly. I am not sure how this will alter the topics and themes that I will choose to write about from now on. Hopefully, it will help me gain a more well-rounded perspective. This may be the end of The Cusp as we know it!

Thursday, January 9, 2014

Lessons from Rwanda

Twenty years on since the Rwandan genocide how has the country transitioned into a more stable society and been able to punch above its weight in good governance and growth?

Landlocked, under-endowed, war-ravaged, Rwanda a nation of 10.5 million people has faced a number of disadvantages, not the least of which was the ethnic strife between the Hutus and Tutsis that has ravaged the country in the past. And yet it in spite of these setbacks, it has experienced very respectable growth figures (averaging 7.4 per cent per annum) and improving social indicators over the past decade.

Rwanda has undertaken significant efforts to reform its regulatory environment. Just consider the following:

  • The World Bank ranks Rwanda the 4th best country in Africa to do business, after Mauritius, South Africa and Botswana.
  • It only takes 3 days to set up a business, the 8th shortest time in the world.
  • The country is in the 71 percentile rank with a score of 53/100 in Transparency International’s Corruption Perception Index, placing it in the same class as Malaysia and South Korea.

So how has a country which suffered many years of war and as much corruption as any other impoverished nation, managed to turn things around?

Well the short answer is they did this through an accommodative political settlement and the help of both conventional and unorthodox institutions and economic strategies.

Rwanda has had a long history of ethnic violence between the two main rival tribes.  From pre-colonial times up to 1959, the pastoralist Tutsis were the ascendant political class over the agriculturalist Hutus. Ethnic differences were exaggerated under colonial rule. In the lead up to independence in 1962, Belgian colonists transferred their support to Hutu elites. This led to mass killings of Tutsis many of whom fled the country.

Two Hutu regimes ruled the country from 1961-94. Having a single-party dominate politics for most of this period did not prevent the nation from succumbing to decentralised rent-seeking and clientelist behaviour. A group known as Akazu was at the apex of this system. It was related to but not controlled by the administration.

Tutsis sought to regain control of the country through an invading Rwanda Patriotic Army. This culminated in the genocide of 1994 by retreating Hutus. After consolidating their hold on the country, the Rwanda Patriotic Front (RPF) established a government of national unity incorporating moderate Hutus, one of whom led the country as its president.

Although a certain amount of political repression in the guise of preventing a return of “ethnic ideology” has occurred, the coalition governments comprised of all legal parties in parliament being proportionately represented in cabinet (the ruling RPF holds no more than fifty per cent of the portfolios) has succeeded in keeping the nation stable. This inclusiveness along with its program of restorative justice known as gacaca has fostered reconciliation and allowed the country to experience improvements in social and human development not seen previously.

The intrusive intervention of government in everyday life at times borders on social engineering as the government has sought to follow the Singaporean model in both economic and social policy implementation. President Paul Kagame (elected in 2003 and then again in 2010) has been labelled the global elite’s favourite strongman for improvements to public service delivery, particularly in health and education.

Departmental line agencies have been managed through an institution of performance contracts known as imhigo which Tim Kelsall describes as “modern performance agreements supported by a significant component of moral pressure and neo-traditional gloss.” This combination of formal scientific management theory and homegrown practices has permeated down to the grassroots by roping in local officials and civil servants.

On the economic front, Rwanda has applied a hybrid approach to investment promotion. On the one hand, it has adopted policies and institutional arrangements considered best practice by the World Bank’s Doing Business surveys. Responsibility for managing this has been assigned to the Rwanda Development Board (RDB). But this works in parallel with a more activist approach in industrial policy with the RPF’s holding company, Tri-Star Investments getting involved in joint ventures and start-up companies.

Tri-Star helped the RPF raise funds during the Congo wars to overthrow Zairean dictator Mobutu Sese Seko through trading metals in international markets. The surplus achieved was then channeled towards domestic private sector development. The holding company has initiated many successful ventures with demonstration effects for the rest of the economy. Telecoms is one example. When Tri-Star sold part of its stake in Rwandatel in 2007, it got five to ten times its initial investment in the company.

Because profits from Tri-Star that are not ploughed back into its businesses revert to RPF, the party is financially independent. It uses this to fund its political campaigns without having to resort to political donors. Kelsall explains what this does:

The RPF’s financial solvency obviates the need for party officials to engage in election-related corruption, which in turn allows the party to take a very tough line on corruption among its leading supporters and in the bureaucracy.

Apart from Tri-Star the government has also orchestrated the formation of other funds, the Horizon Group belonging to the army, which undertakes socio-economic projects to produce productive enterprises, and the Rwanda Investment Group, a consortium led by domestic and diasporic elite.

The purpose of the second group is to raise capital other than through foreign borrowings to invest in projects of strategic national importance. Without such an interventionist approach, much of the agricultural and industrial transformations currently underway in different sectors of the economy simply would not be happening.

The case of Rwanda demonstrates many similar traits to that of the Northeast Asian developmental states. The RPF led government faced existential threats from the opposition in exile and from a potentially hostile ethnic majority at home just as the South Korean and Taiwanese states did from North Korea and from mainland China.

These threats have kept the ruling RPF focused on improving social and economic well-being for its citizens to maintain its legitimacy and hold on power. The regime has exercised a capacity for long-range vision and forward planning contained in its Vision 2020 roadmap, free from the influence of rent-seeking, private interests. It has ruthlessly pursued its policies at times through heavy-handed regulations and enforcement of rules.

The low crime, low corruption, low red-tape environment this has fostered was not enough. The RPF has used its clout to address market failures and encourage the adoption of productivity enhancing new technology. Through its holding company and other private-led investment groups that it has brought into being, jobs have been found for talented managers and skilled workers that might have otherwise gone overseas.

The Rwandan experience demonstrates the capacity of poor nations to bring about a system of governance that is relatively competent and free from corruption within a short span of time using home-grown institutions, resources and talent. The extremely harsh and disadvantageous position it faced did not become a hindrance, but rather provided greater incentive for it to go down the road it has followed. Surely, any emerging economy seeking to do the same should take heed the lessons from Rwanda.

Monday, November 18, 2013

A Sustainable Climate Policy

In the wake of Typhoon Haiyan, one of the strongest to ever make landfall, the Philippine delegate to the climate talks in Warsaw made a desperate plea for nations to act on climate change. President Aquino when asked by CNN’s Christiane Amanpour whether he believed the warming of the planet had a direct link to the severe weather event affirmed the position. British Prime Minister David Cameron made a similar statement.

The Inter-governmental Panel on Climate Change says that severe weather events will be the consequence if carbon pollution is not abated. And yet what we find is advanced countries like Australia, Canada andJapan, that are all led by conservative governments, back-tracking or weakening their stance on the issue. 

Governments around the world from Beijing to Washington are grappling with the problem to avoid what economists call “the tragedy of the commons”. This is a situation where when a certain market activity has a negative by-product (such as emitting GHG into the atmosphere) and people are free to do (no cost is attached to it), then it will be engaged in excessively to the detriment of all. The only way to avoid this outcome is to make economic agents absorb the cost associated with abating the negative by-product.

The question that policymakers worldwide are grappling with is who should absorb the cost and what mechanisms are needed to make them absorb it? A carbon tax gives residents the right to free air and imposes the cost of abatement on the polluter. The problem is that polluters will then pass on the cost on to consumers.  An alternative would be to pay polluters to stop polluting using taxpayer’s money.

From an economic perspective, it does not matter which mechanism is used as long as no one has the ability to "game" or influence the system. From a political point of view, however, framing the policy as a tax or incentive may have enormous consequences as the Australian Labor Party painfully realised in the last election.

Beyond the theatre and drama of the climate change debate, the political players have to find some kind of common ground, though to make whichever solution is opted for credible and sustainable. One prime example of this is the climate change policy adopted by British Columbia (BC), which has been in place since 2008 and whose popularity remains intact and has even increased.

It involves a tax that puts a price on carbon that is returned to citizens and businesses through reduced income taxes and increased tax credits or benefits. The tax is broad based covering the use of fossil fuels for electricity and vehicles. The policy has reduced the consumption of taxed fuels per capita by 19 per cent in the BC relative to the rest of Canada. GHG emissions in the province fell 10 per cent between 2008 and 2011, compared to a fall of 1.1 per cent for the rest of Canada.

The carbon tax was originally set at C$10 per tonne of carbon dioxide equivalent emissions and was increased by C$5 each year until it reached C$30 in 2012, when it was subject to a review and fixed following the release of a report in 2013. The report suggested that the tax did not seem to have an impact on BC’s economy, although certain sectors such as the agri-food and agriculture sector needed additional relief, which is forthcoming.

The success of BC’s climate change policy matches that of Quebec and California, which introduced a cap on GHG and an emissions trading scheme. BC and other North American states in the Pacific coast, Oregon and Washington have been encouraged to set up similar schemes and to link their systems together. They could soon be joined by provinces along the coast of China. China is working to develop a nationwide approach after 2015.

Getting to a harmonised global scheme is quite challenging, but not impossible as the efforts of some of these jurisdictions are showing. 

Monday, July 1, 2013

The entrepreneurial state: more shoving, less nudging

What is the role of the state?

Since conservative ideology gained ascendancy in the 1980s, most people tend to regard the state as a sluggish, unwieldy and overbearing beast which often gets in the way of private enterprise and creativity by imposing higher taxes and burdensome regulation. 

Those advocating for a minimalist role for the state say that the growth of debt has caused the crisis in the EU, which makes the need for austerity paramount in rebuilding its fortunes.

Mariana Mazzucato, professor of economics at Sussex University has recently published a book called the Entrepreneurial State. The title will sound like an oxymoron especially to those steeped in the tradition of Adam Smith’s Invisible Hand and David Ricardo’s theory of Comparative Advantage in which the market not the state holds primary importance in the economic life of a nation.

Under this rubric of market ideology, the role of the state is to get out of the way of business. State investments are frowned on for “crowding out” private investment. Any type of intervention in the free market only leads to distortions that prevent capital from flowing to those sectors which deserve them the most. 

Today even the task of countercyclical spending when business and consumer sentiment collapses espoused by the Keynesian school of economics is challenged by pro-austerity advocates who question the effectiveness of stimulus measures.

The only place where the importance of the state is acknowledged in promoting growth and industrial diversification is in the developing and emerging world. But even there, the role of the state has been confined to that of a ‘facilitator’: nudging businesses along, addressing ‘market failures’, reducing transactions costs like corruption, providing basic infrastructure, the protection of property rights and the rule of law.

In the advanced economies of the West, where the state is relatively corruption free, where market institutions are mature and where economies operate on the edge of the technological frontier, there does not seem to be any role for the state except in providing tax credits for innovation, improving human capital and supplying basic research and development.

In popular culture, prestige is given to the entrepreneurial class, those rugged individuals who take risks, great visionaries that have given birth to new industries. The stories of Google, Apple and Microsoft are seen as shining examples of this. These are popular myths that Mazzucato’s book seeks to dispel.

Through programs funded by obscure agencies like DARPA, ARPA-E, the National Science Foundation, the National Institute of Health and the Small Business Investment Company, the US government developed the technological building blocks with which these companies built their innovative products. Far from being a bastion of the "market friendly model", the American state has in fact conducted industrial policy by stealth, according to the book. 

Far from being risk averse, these state actors showed the capacity to take risks, support nascent industries, took the role of “patient finance” as opposed to private venture capitalists who came in late in the piece and piggy backed on the wave of technology that the state generated. 

But instead of supporting the entrepreneurial state, what many iconic companies that have benefited the most from it have done is seek to diminish it by availing of tax loopholes.

This leads to another key theme of the book: the socialisation of risk and privatisation of reward deepens inequity in society. A certain amount of wealth creation and concentration is a natural consequence of disruptive innovation which gives rise to massive profits or rents. 

Although the state did much of the heavy lifting in producing general technologies which became the basis for such wealth, it is unable to reap a share of the rewards from it.

There are a number of policy implications presented by Mazzucato including the need for new risk-reward models in public private partnerships. She proposes income contingent loans as a possible alternative, allowing the state to be rewarded when the start-ups it funds become profitable. 

A model that would allow the state to recover its losses from some bad investments by making a killing from a few good ones sounds sensible.

The growing number of sovereign wealth funds in advanced, emerging and developing economies presents an opportunity for entrepreneurial states to fund the next round of innovation. For advanced economies, this would allow them to get out of the productivity rut that has been noticed since the 1990s. 

For emerging economies, it allows them to avoid the middle income trap by moving up the value chain. For developing countries, it would help them “catch-up” in the technological race.

Far from being an inhibitor of growth, the state according to Mazzucato provides the impetus for it:

And this is the punchline: when organized effectively, the State's hand is firm but not heavy, providing the vision and the dynamic push (as well as some 'nudges'- though nudges don't get you the IT revolution of the past, nor the green revolution today) to make things happen that otherwise would not have...This requires understanding the State as neither a 'meddler'nor a simple 'facilitator' of economic growth. It is a key partner of the private sector - and often a more daring one, willing to take the risks that business won't.

Saturday, May 25, 2013

"Strategic deficits" from Australia

Image credit: The Australian
The Australian Parliamentary Budget Office (or PBO), a non-partisan, government agency tasked with evaluating election promises, this week released a very interesting set of numbers in which it estimated the structural budget balance from the last two terms of the conservative government under PM Howard up to the subsequent two terms of the Labor government under PMs Rudd and Gillard.

The PBO shows that prior to the 2007 elections in which the conservatives were defeated, the Howard government was structurally in the red. Structural is the word used because if it had not been for the mining boom which had yielded a large tax bonanza, the government's expenses would have exceeded its revenues.

The reason for this deficit was Mr Howard's propensity to engage in "middle class welfare" through tax cuts and benefits such as the "baby bonus" which were not means-tested but applied to all. This was his secret to political longevity. The minerals price boom gave him the means to do it. The IMF earlier this year had called this tendency an act of "fiscal profligacy".

During the 2007 election, the conservative treasurer Peter Costello sought to lock-in the next government into a new round of tax cuts. The then opposition leader Kevin Rudd supported the tax cuts but said, "this reckless spending must stop," signalling his intention to take the mantle of fiscal responsibility from Mr Howard.

A little over a year into office though and Mr Rudd's government faced the daunting task of dealing with the effects of the global financial crisis. This forced him to commit to a large fiscal stimulus program to counter the economic downturn and guarantee the financial system. It worked. Australia avoided a recession, but something else changed. Tax revenues took a hit due to lower corporate income and consumer spending.

Mr Rudd's successor Ms Gillard succeeded in passing a carbon and minerals resource rent tax after a very contentious transition in 2010, but in order to gain the required number of votes in parliament, she had to "overcompensate" the various stakeholders affected, and as commodity prices declined, the revenues which these taxes were meant to generate failed to materialise.

This has left her government scrambling to fill this budget hole not only to regain some economic credibility but to pay for some of her government's signature programs such as school reform and disability insurance. She has sought to unwind some of the so called "middle class welfare" entitlements of the Howard era.

As polls indicate a turnover back to the conservatives in the September election this year, her treasurer Mr Swan in his latest budget sought to tie the hands of the incoming government to fund its social programs in its first term of office out to 2016-17.

This behaviour by incumbent governments to reduce the fiscal space of their successors to either increase spending for social programs (if the incumbents are conservative) or reduce the size of government (if they are progressive) is consistent with strategic budget theory which has been used to explain why governments of advanced economies have been chronically in deficit since the 1970s.

What is clear in all this is that while both sides of politics often talk of being fiscally responsible, neither one is really serious based on the evidence. Both sides play the game; and unfortunately, it is the taxpayer that eventually has to deal with the consequences.

Sunday, January 13, 2013

The California School of Economic History

In the Great Divergence, Kenneth Pomeranz states that

Much of modern social science originated in efforts by late nineteenth- and twentieth-century Europeans to understand what made the economic development path of western Europe unique; yet those efforts have yielded no consensus.

From Adam Smith's The Nature and Causes of the Wealth of Nations, to Max Weber's The Protestant Ethic and the Spirit of Capitalism, to Karl Marx's Das Kapital right down to recent books like Hernando de Soto's The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else and Daron Acemoglu's and James A. Robinson's Why Nations Fail the search for the causes of European or western "exceptionalism"continues.

These works have either focussed on the development of institutions beginning with the ideal free market as per Smith's description or of superior cultural norms as per Weber's thesis, or of superior "modes of production" as in the case of Marx.

"Economists seek the 'causes' in a timeless theory of economic development, while economic historians find them in a dynamic process of historical change," wrote Robert C Allen. "Economic history has become particularly exciting in recent years since the scope of the fundamental question - 'why are some countries rich and others poor?'- has gone global. Fifty years ago, the question was 'why did the Industrial Revolution happen in England rather than France?' Research on China, India, and the Middle East has emphasized the inherent dynamism of the world's great civilizations, so today we must ask why economic growth took off in Europe rather than Asia or Africa."

Jack Goldstone has given a name to a group of fellow scholars who have for over a decade now tried to piece together the story behind the world economy as the California School of Economic History. He says that

Instead of seeing the rise of the West  as a long process of  gradual advances in Europe while the rest of the world stood still, they have turned this story around. They argue that societies in Asia and the Middle East were the world leaders in  economics; in science and technology; and in shipping, trade and exploration until about AD 1500. At the time Europe emerged from the Middle Ages and entered its Renaissance, these scholars contend, Europe was far behind many of the advanced societies elsewhere in the world and did not catch up with and surpass the leading Asian societies until about AD 1800. The rise of the West was thus relatively recent and sudden and rested to a large degree on the achievements of other civilisations and not merely on what happened in Europe. Indeed some of these scholars suggest that the rise of the West may have been a relatively short and perhaps temporary phenomenon.

The new institutional economic thinking regarding the "rise of the West" which comes from the work of Douglass North and Barry Weingast which look at the political foundations of capitalism have gained ascendancy in recent times. The World Bank and the World Economic Forum collect and produce data in the form of league tables which compare the legal, cultural and scientific institutions across the globe and rank countries based on how well they conform to western norms.

The augmented Washington Consensus espoused by the International Monetary Fund emphasises the role of
markets and institutions. This is based on the theoretical models of economists and the empirical, econometric "validation" of such theories. This leads to a sort of timeless theory which sceptics like William Easterly have deconstructed by highlighting the methodological flaws inherent in their methods.

This is why the findings of economic historians are all the more valid and significant. Allen states that

According to the California School, China's legal system was comparable to Europe's and property was secure, the Chineses family system kept the fertility rate low so that the population grew no more rapidly in China than in Europe, markets for commodities and for land, labour, and capital were as evolved as those in Europe. As a result, productivity and living standards were similar at both ends of Eurasia. The reason that the Industrial Revolution happened in Europe does not, therefore, lie in institutional or cultural differences but rather in the continent's accessible coal reserves and gains from globalization.

Peer Vries talks about its impact on the age old question as follows

The California School has changed the way we look at the economic history of the world, especially the pre-industrial world of Eurasia. It has rightly pointed at the enormous importance of Asia in the economy of the early modern world and at its very high level of development. It has done so in a couple of years. It is no longer possible to write a book on the rise of the West like the one David Landes wrote only ten years ago, with immense success. That alone is a major feat. One should not, however, thereby be tempted to confront it uncritically. The biggest compliment one can make colleagues in scholarship is to seriously engage with them.  

Wednesday, October 31, 2012

Redistributing Wealth and the US Election

In their book Innovation Economy, authors Robert D Atkinson and Stephen J Ezell talk about the competing ideologies with regard to the tax system and wealth redistribution between the Democratic and Republican parties that were clearly debating points in this closely fought US presidential election of 2012. They say that
Washington economic politics has become a redistributionist battleground between ...the Right, seeking to funnel resources to their Main Street members (small business), and ... the Left, seeking to funnel resources to their Main Street members (low- and moderate-income Americans).
Behind this tussle between the Left and the Right in America is a fundamental question about what grows the economy. The Democrats using the arguments of John Maynard Keynesian essentially believe that growth occurs by supporting demand from the middle class. The Republicans borrowing from the thinking of Robert Mundell and Arthur Laffer and supported by Milton Friedman believe that growth comes by supporting the supply side of the economy through entrepreneurs and small business.

Atkinson who also wrote the book Supply-side Follies has been arguing that this debate is the wrong one to have. Borrowing from the ideas of Joseph Shumpeter, Douglass North and Mancur Olson, he believes that the reason why the US economy has stagnated in recent years has been because of existing policy failures to encourage investments in technology and innovation.

Over time, he believes the US tax system has diminished the incentives for innovative activity. The problem was created by economic advisers of both parties who advocate for flatter tax rates with a broader base. In line with this, broad based tax cuts have been offered to corporations and small business owners in exchange for disallowing tax deductions for productivity enhancing measures.

As a result, much of the tax cuts aimed at the top income bracket have been wasted on businesses that don't trade with the rest of the world or invest in productivity enhancing innovation. Rather than squander these tax cuts on the wealthy, it would be better spent targeting future wealth-creators. This includes entrepreneurs that are forced to innovate in order to remain internationally competitive as well as universities and research institutions that prepare scientists and engineers to become innovators.

This targeted approach for spurring innovation through tax policy is what is missing from the current debate which has focused more on the justification for auto bailouts, renewable energy companies, and the loosening of business regulation. Not a lot of attention has been devoted to what really drives growth in the economy, structural as opposed to cyclical growth. And that is perhaps why the race is so dead even.