Monday, June 22, 2015

Institutions and Policies

If Institutions are so important, why do we talk so much about economic policies?" This excellent question was the subject of a Round Table of the First World Congress of Comparative Economics, held at the University of Rome Tre, on 25-27 June 2015, with the participation of Josef C. BRADA (Arizona State), Michael KEREN (Jerusalem), D. Mario NUTI (Rome Sapienza), Chaired by Marcello SIGNORELLI (Perugia). The Round Table took place on 26 June, 2.15-4pm, at the Department of Economics, Aula Magna, Via S. D'Amico 77, 00145 Rome.

Immediately afterwards (4.30-6.15pm) at the Congress there was a session on my own contributions to Comparative Economics, organised by my friends Renzo Daviddi (EU) and Milica Uvalic (Perugia). Renzo focused on Utopias, Milica on Participation, other friends: Saul Estrin (LSE) on Socialism, Jan Svejnar (Columbia) on Transition, and Bozidar Cerovic (Belgrade) on Integration (chaired by Saul Estrin). Most of my publications can be viewed and downloaded freely from my website, where the respective PPT presentations will be available shortly.

My views on If Institutions are so important, why do we talk so much about economic policies?" are summarised here.

In any modern capitalist economy the State – i.e. the set of government, other political institutions and the Public Administration - has at its disposal a wide range of instruments of economic policy.  A classic textbook by Ian Tinbergen, Economic policy: Principles and Design. Amsterdam, 1956, 1978, distinguished between qualitative and quantitative policy instruments.

Within the context of our Panel, I regard qualitative instruments as the creation and manipulation of economic institutions: from bankruptcy legislation to corporate governance, from competition policy to health insurance, from unemployment insurance to anti-corruption laws. They include automatic stabilizers (which in truth are only dampeners of economic fluctuations).

Quantitative instruments were classified by Tinbergen under four headings:

1) Direct controls of economic activity;

2) Fiscal policy: the level, composition and balance of government direct and indirect taxation and other revenues and expenditures (including subsidies);

3) Monetary policy: the quantity of money, the associated level and structure of interest rates, credit policy, the exchange rate regime and trends; with the management of government debt necessarily linking monetary and fiscal policy;

4) The price and investment policies of (wholly or partly) state owned enterprises. 

For Tinbergen the structure of the economy could be summarized by a macroeconomic model quantifying the relationships between economic magnitudes, such as consumption, investment, employment, trade balances, the price level, the rate of inflation and so on - simultaneously with the values assigned by the government to quantitative policy instruments. Through the choice of appropriate instruments the government could determine consistent, feasible values of policy targets, while accepting the corresponding values of “indifferent” variables. Tinbergen was a pioneer of such an approach to model-building and economic policy. 

Note: Policy targets are often labelled “priorities”, but this is incorrect, because they cannot be ranked in absolute but only relatively to the trade-off between targets preferred by the government.

For about thirty years from the end of the Second World War this framework can be used to characterize public policy in advanced countries. Thanks to Keynesian policies sustaining demand, employment and growth, we experienced a golden age of unprecedented prosperity: reconstruction, industrialisation and growth, accompanied by re-distribution policies to protect the weaker strata of the population: the unemployed, the aged, the sick, the poor, children. That approach was less successful in keeping under control inflation and/or public debt, primarily because of inconsistency between, on the one hand, high and stable employment and economic growth and, on the other hand, low inflation and/or public debt. 

The 1980s and 1990s, however, saw the demise of Keynesianism and the victory of neo- or hyper-liberalism, exemplified by Reaganite or Thatcherite economic policies. This was due to three major developments:

1)  Margaret Thatcher was elected as conservative Prime Minister of the UK from 1979-1990, and Ronald Reagan was elected as Republican President of the USA (1981-1989, and was influential even earlier as Governor of the State of California); 

2)  the extension of the neo/hyper-liberal model to the countries of the post-socialist transition in the early 1990s, encouraged by foreign advisers, the EU and the international organisations (World Bank, IMF, OECD etc.), and

3)  the passive, mis-timed adoption of neo/hyper-liberalism by several social-democratic governments in the 1990s, such as the Third Way of Tony Blair, Bill Clinton and most European Union governments in the late 1990s.

“Reaganomics" was characterized by supply-side economics, tax reductions expected to promote economic growth, restrictive monetary policies to control inflation, economic de-regulation, reduction of public expenditure, anti-Trades Unions policy, hostility and re-armament against communist countries (the Evil Empire), support for anti-communist movements (Grenada’s invasion).  Although Reagan negotiated with Gorbachev the first Treaty for reduction of nuclear weapons (INF Intermediate-range Nuclear Forces Treaty, 1987).

Other features of the neo/hyper-liberal approach, extended to the post-socialist world include:

- Immediate unilateral opening of foreign trade, frequently revoked and therefore premature;

- Exceptionally rapid liberalization of capital flows, in contrast to the experience of other European economies after World War Two;

- Large scale privatisation, especially (with a few exceptions for instance in Hungary) unprecedented mass privatization through the distribution to the population of free or symbolically priced vouchers, convertible into state assets or shares in state enterprises – a macroscopic experiment in social engineering of debatable effectiveness;

- The demotion of the role of the state, leading to delays or gaps in market regulation, especially in financial markets (see the diffusion of banking pyramids), shareholders protection and corporate governance;

- The dismantling of the welfare state, formerly provided by state firms;

- A costly reform of the pension system from a Pay As You Go, defined benefits, distribution system (whereby pensioners are funded by the contributions of current employees), to a capitalization, defined contributions or funded system (with pensions paid out of the revenue earned on accumulated past contributions);

- A low and uniform rate of direct taxation (flat tax), therefore at best only mildly progressive, on households and companies, mostly without taxation of capital gains but with higher indirect taxation;

- Lack of consultation and concertation between social partners and with the government;

- A very flexible labour market, with weak trade unions and a low incidence of collective bargaining; the principle of market sovereignty was not applied to the labour market, frequently subjected to widespread wage ceilings enforced through punitive taxes;

- A central bank not only independent but exceptionally independent and free from any controls, without coordination with fiscal policy, pursuing a strict policy of inflationary containment and high interest rates, with the pursuit of positive real rates even in the presence of currency appreciation (therefore attracting foreign capital but making the sterilization of the ensuing monetary expansion very costly); 

- In general, a dominant weight of markets as against other institutions. 

The Third Way was characterised by

- The acceptance of the primacy and desirability of markets, both domestic and global;

- Rejection of public ownership and public enterprise, supporting private entrepreneurship and continued privatisation; and, above all,

- Affordability, i.e. fiscal discipline and monetary restraint, rejecting inflation and public deficit and debt. 

In many ways the Third Way approach went too far, in neglecting the increasing inequality involved in market allocation and the dangers of de-regulations (two major causes of the 2007 crisis), privatising on a vast scale (more assets per year in France under Lionel Jospin, in under 2 years 1997-98, than by Thatcher), and in endorsing the EU ruinous policies of fiscal austerity, not to speak of war-mongering and the dereliction of civil liberties. 

In other ways the Third Way did not go far enough, as in pursuing the reduction of the working week for an unchanged wage, resisting the increase in pensionable age in the face of rising longevity, or failing to promote environmental protection and reclamation. And the whole project had an authoritarian bias. 

Such excesses and deficits of the Third Way are at the root of the subsequent current crisis of the Left especially in Europe.

Today the traditional quantitative instruments of economic policy discussed by Tinbergen in 1956 and 1978 have been disabled:

- Direct controls have completely given way to market-determined processes;

- Monetary policy has been delegated by governments to independent central bankers, and completely disconnected from fiscal policy; exchange rates have been left largely floating, while membership of the Eurozone has eliminated that instrument completely for member states; 

- Fiscal policy has been constrained by the straight-jacket of balanced budget over the cycle, indeed of budget surplus “in normal times” (UK Chancellor George Osborne, 10 June 2015; “There is no economic reason for Osborne’s surplus plan. It’s time Labour stopped playing catch up… Osborne is using the budget as an excuse to reduce the size of the state. Labour must not follow his lead”, Simon Wren-Lewis, NewStatesman, 18 June 2015); with heavy penalties and costly automatic provisions for rapidly reducing debt (the Fiscal Compact);

- State-owned enterprises have been privatised or are scheduled for further reduction under pressure from EU and international institutions.

Qualitative instruments, on the other hand, today are restricted to the sole adoption of neo/hyper-liberal institutions, under the euphemistic label of “economic reforms”.

A reform should be, by definition, a change for the better, but there is no consensus on desirable reforms: I might regard income re-distribution to the poor as a desirable reform, others might regard the ending of such re-distribution as desirable. In post-Stalinist Soviet-type economies – as Yanis Varoufakis recently noted - there was frequent talk of “reform” to indicate projects of economic and political de-centralization. Today, on the contrary, reforms are an authoritarian design to dismantle the welfare state, reduce pensions, eliminate collective bargaining and labour employment protection, and to privatise state assets at any price regardless of opportunity costs.

Official EU and IMF documents recognise that both austerity and most of these “structural” reforms are at best ineffective (in particular labour market liberalisation, unlike product market liberalisation especially in services) or at worst positively counterproductive (see Amartya Sen, The economic consequences of austerity, NewStatesman, 4 June 2015), but unelected officials perversely persist in forcing their implementation as a condition of their statutory support. And if and when “reforms” might be effective they only operate in the medium-long term, often with adverse short term effects that turn them into investments that are not necessarily attractive. Amartya Sen likens the unholy and unnecessary combination of austerity and reforms to a mixture of rat poison and antibiotics given to a sick person.

The Great Recession that began in 2007 and is still on-going is concomitant with the general crisis in public economic policy. We must re-think and re-found the theory and practice of economic policy, restoring both traditional quantitative instruments and broadening the range of eligible qualitative instruments, either within the constraints of globalisation or shifting away from some of those constraints; we need more and different instruments of economic policy, quantitative and qualitative, i.e. a much wider range of policies and institutions. Otherwise we remain passive victims of chaotic and costly global processes, aided and abetted by rulers who are undemocratic and ultimately destructive.