A post on government debt and your ultimate willingness to accept a larger government

 

Do you believe that countries should borrow more now? Many of you will say yes, and many will also say no, but few will say maybe, that is until you read to the end of this post 😊. Your answer will partly reflect where you live. In the U.S. your answer will likely reflect your political affiliation. In previous communist states your answer might be a resounding no on the basis of bad experiences. There seems to be no clear-cut answer on whether countries, and in particular governments, should borrow more.

It sounds like we need a framework. Boring, yes! But exciting in the sense that it will help us talk through the pros and cons of our decisions.

Let us first try to understand why borrowing is on the minds of everyone. Let us evaluate the intentions of our actors.

Spending can be justified

Sensible people agree that emergency spending is justified. Think of wars, of famines, and pestilence.  Societies do not like these. It wants to minimize the impact of those things on our lives. Society reduces the lost utility from minimizing the impact of wars, famine, and pestilence on everyone. It makes sense to spend since the cost of not spending seems higher than the cost of spending. Since our governments supposedly act out the wishes of the people, spending ought to reflect those wishes. Those wishes are often tied to our utility of things (e.g., here we want to avoid further damage).

As a general rule we want government spending to be well targeted, timely and temporary (or the 3 T’s of fiscal policy). Targeted in the sense that citizens know what is spent on (and that it reflects voter wishes) and that the returns to that expenditure achieves its objectives (e.g., growth or income distribution) in the most efficient manner. It should be timely – i.e., what is the purpose of infrastructure spending during a pandemic? Infrastructure spending takes time to have an economic impact (it depends on how long construction projects become usable). It should be temporary in the sense fiscal policy ought to be also sustainable and not crowd out private consumption and investment.

How well do you think your government is doing with respect to the 3 T’s? Do fiscal operations reflect your views? Do they reflect society’s views?

But make sure you understand the consequences of a larger government

If governments do not reverse spending once emergencies subside, then it implies a larger government. No one is talking about this, which for me is baffling.

Put aside, just momentarily, your philosophical views about whether you like big government or not. A bigger government will mean that society will face a reduction in personal incomes via higher taxes. Taxes in this case come in the form of inflation, if debts are monetized, or taxes in the ordinary sense of the word – the decrease in take-home pay at the end of every month.

If governments reflect the views of its citizenry, then most people will not mind that more of their incomes are given to governments.

To tax the economy fully, partially or not at all, depends on what society values.

What we do know is that expenditures, on average, should not exceed revenues to a point where debt becomes explosive. Communism would want all assets to belong to the state, or at least exercise significant control of what is purchased and sold, while competitive markets would want as little state intervention as possible (not zero – since we also don’t want markets to be sneaky). Both ideologies critically depend on what society values. Most countries value some form of government and the tax rates should reflect that.

So, it seems that there is some minimum level of government that most people would be satisfied with.

The goods and services that the government provides tend to be non-exclusive and non-rival goods. This simply means that everyone has access to the public good and that consumption of the public good does not imply less consumption of that good for another person. Properly structured, the size of government would adhere to some principles of equity. Examples may include a free and good education system, which provide opportunities to narrow the gap between rich and poor, and the provision of critical healthcare as basic human good.

However, the notion of a “free” good is slightly misleading.

Someone has to pay for the school or park or doctor. It is not really the government that provides these goods and services. Rather, the government is the administrator of tax funds that are used for paying the service or good. It still adheres to the principles of non-exclusive and non-rival; however, it should not be taken for granted that - it is still a paid service.

The cost of education and healthcare would be priced according to market fundamentals if there was no government. I.e., the price of education would reflect demand and supply. However, if the market for education and healthcare was somehow controlled by a few schools and healthcare providers (i.e. a lack of competition) then large markups would be charged over what a typical person would want to pay. Unfortunately, the demand for healthcare and education may be price inelastic – meaning that schools and medical-care providers can charge above the market clearing price making it perhaps too expensive to send children to school and providing healthcare for those who need it. If society values healthcare and education, and society is willing to pay for those that cannot afford it, then the government can serve as the middleperson to administer the process. Unfortunately, governments are tied to a political party, which may lead to a wedge between what society values and what the politician values.  

If society agrees that taxpayers should pay for certain non-rival and non-exclusive goods and services, we need to ensure that taxpayers are not cheated.

This entails that every $1 tax generates equivalent spending of $1 that goes the intended targets. This implies zero leakages (such as corruption) and a fast rollout of activities (i.e. no bureaucratic delays). However, governments often cannot meet this requirement. Taxes are often used to pay for other things, which includes government salaries and wages, transfers and public infrastructure spending. In cases where governments are inefficient or corrupt, the $1 spent on education and healthcare is much less.

In many countries, governments are elected representatives. If they are voted into power, and the people like what the elected government is doing, then they will continue to receive support from the people. If they do not like what the government is doing, then politicians run the risk of being replaced. The incentives of corruption and inefficiency rise when the penalty of shirking is not strong enough, or the rule of law not respected.

(Grossman 1987) suggests a way to measure the optimal size of the government (measured either in terms of GDP or employment). Government is either a benevolent force seeking to correct for excesses of an unrestrained marketplace (the Pigovian view) or as a source of distortions from being used by special interest groups (the Public choice view).

Grossman’s interesting paper attempts to reconcile the two views by making government an input into the private sector’s production function. The theoretical model (which is backed up by an empirical analysis for the U.S.) shows that early stages of government development benefits the public and can be productive by limiting externalities or failures in the market. However, as the government grows it becomes beholden to special interest groups, which exerts a negative influence on welfare and productivity. It is thus optimal to reduce the size of the government in order in increase output. If government enters the utility function of households, then an increase in government spending (financed by taxes) reduces growth and savings in the long run. However, under the assumption of a Cobb-Douglas production technology[1] the optimizing government can still satisfy the conditions for productivity efficiency (Barro 1990).

Ultimately, the size of the government should be determined by the utility that society derives from a government. There is also a cost.

We have a mental framework for this value function. Welfare analysis builds on an egalitarian framework (where welfare is equal to the utility of the worst-off member [Rawlsian] or where each individual is endowed with the same amounts of resources) or a utilitarian [Benthamite] framework (where welfare is equal to the aggregate utility of society). The two welfare functions are often at odds with each other since the latter cares not necessarily about equality, while the former does. Can larger governments achieve greater welfare then – in any of the definitions? And if it can, can it do so better than the private sector?

Part of the answer has to do with an individual’s willingness to lay down certain freedoms at the altar of the government in exchange for free or cheaper education, government as an employer and provider of health care. These sacrifices include transferring earnings and wealth to the government, relinquishing control over privacy – location, tax numbers, financial details, health indicators and what gets taught at schools to be managed by government. Apart from individual sacrifices, one would have to manage and reward hard work and innovation differently, since monetary compensation used to be the encouraging medium.  

The flip side of how much value society should attach to the government needs to be weighed against the efficiency and competency of the private sector. Can the private sector, however, not also deliver education, healthcare and provide employment and construct roads, building and ports? It can and does, but it needs funding. Taxpayers in communities, or representatives in communities can hire the services directly from the private sector if the law allows for it. Instead of just allocating funds to the government, societies should be free to determine their needs and how to acquire it. If the right regulations are set up (i.e. ones that enforce fair play and allows for competition), then prices of goods and services should reflect market fundamentals. This is the free market. Unfortunately, not all players in the market play by the rules. Community representatives can be bribed, big companies can completely kill competition by undercharging and then later hiking prices, or first mover firms can limit competition early in the development process. The literature identifies that curbing excessive mergers and acquisitions and promoting firm entry is important in ensuring the correct incentives for private sector innovation (Aghion et al. 2009).

Controversial topic: Taxpayers should have a say on government determination

A good question that should be asked more regularly in the public space is whether taxpayers should have anything to say about the expenditure envelope of the government. Some might rightly argue that they do have a say because most governments are elected in a democratic fashion. Unfortunately, not all governments necessarily represent the views of the taxpayer – especially if the tax incidence falls on a much smaller group of individuals and firms relative to the larger voting population.

Fiscal lessons from the past should be internalized much better than what we currently observe. Mistakes are repeated and this will come at a large cost (i.e., you don’t have an infinite government budget – governments can default, and these defaults can be costly!). To avoid persistent fiscal policy errors and to close the gap between voter wishes and fiscal outcomes a better system of monitoring and voting could be set up.

In this section I argue that two parallel voting systems should be set up. One where the general population votes an individual or party to represent their needs (which is currently the case for many countries) and a second where taxpayers decide on the execution and possibly the allocation of expenditures. Furthermore, this system should utilize innovations in electronic voting platforms to increase voting frequency and the range of topics.

Why do we need an outdated mode of voting when electronic advancements provide the platform for real-time votes on all matters pertaining to society?

Can society not change its utility function when it becomes more informed or when it learns? If society pays taxes, then surely it is society, not the elected members from a four to five-year voting cycle, that should determine where and how funds are allocated. Society should also determine the size of the government. The government should not be arrogant to think that it knows better than society. And even if society makes poor choices, then at least the responsibility of fixing the failures should be on all members of society. Elected officials who do not do their work adequately should be replaced at a click of a button. This also eliminates the traditional view of parties. A two-party system, as an example, can never meet the needs of the general public fully. Having representative candidates, where representation is on a policy or project, not party, might get closer to servicing the needs of communities.

A couple of serious questions come to mind. (1) Will an increased voting frequency not be destabilizing? (2) Do we not need time to see through reforms rather than just replacing officials for under-delivery? (3) What stops people from “gaming” the system – i.e. can any person come up with any policy and then how does the pass or fail of the policy proceed?

In case (1), I argue that an increase in the frequency of voting will lead to a stationary distribution very quickly. I.e., learning to vote occurs at a fast pace. The ability to vote in real time will allow for error correction and a reversal of bad policies. Bad policies tend to punish all of us. What hinders us is to correct the mistake quickly. The problem with four, or five-year voting cycles is that policy errors can be locked in and that policies do not necessarily reflect the views of the voting public at all points in time.  There is also the question of path determinacy. If a country should reach an inevitable point in the future, then four-year voting cycles might delay that outcome. An increase in voting frequency could speed up the pace of reaching that goal.

We know that we can hardly express society’s welfare function (due to Arrow’s impossibility theorem – see Arrow (1950)).[2] We thus retain the idea of a majority voting scheme as a second-best pareto optimal allocation and that through trial and error (tâtonnement) society will move towards maximum social welfare.[3] The majority voting scheme adheres to the pareto and nondictatorial axioms (a single agent does not determine society’s preferences), but fails in terms of the transitivity axiom (rankings are not transitive in the sense that if A > B and B > C then A > C does not necessarily hold – called the Condorcet Paradox) and the axiom of pairwise independence (i.e. that A and B are independent of C).

However, with real-time frequent voting platforms, agent preferences and errors can be corrected. As an example, preferences may change and voting schemes may entail stages where the optimal choice is elected through means of elimination.

Question (2) is addressed by allocating some public funds to research and setting up the contractual agreements that determine the duration of policies. A state auditor as an example will verify if the public officials comply with administering the policy. The official agrees to terms with the public that voted for her and the terms of reference include certain quality markers on projects and policies. Failure to deliver results in a change in representative.

A four-step process could be followed to overcome gaming. I illustrate this with an example. Assume that a person is interested in removing labor brokers. In step 1 that person should put the policy up for discussion. This is done on the voting platform. This requires as many upvotes to be deigned of public interest. If the interest breaches a threshold number of the population (e.g., 50%), the policy is escalated to a team of diversified researchers who study the costs and benefits of the policy. The research group needs to include skilled, educated, and nonpartisan individuals on a topic. Once the research is done it is released for public comment – that is step 2. Once enough information about the policy is obtained then it goes to the electronic voting platform where it is put to a vote – this is step 3. In the final step the policy, if enacted, should be rolled out and administered by the community or country representative that was voted into power. These representatives earn their salaries from the taxpayer.

However, the application of expenditures, once society has voted on the policies, lies with those who pay taxes. Taxpayers are shareholders who can appoint a government representative. If the government representative fails in her duties, then the taxpayers may quickly judge the efficiency of the representative. This avoids party systems that protect corrupt officials. It limits state capture since the power is in the hands of a voting public who can make real-time decisions, instead of behemoth governments who slow down processes.  This should ensure that expenditures are much more efficient and entails fewer leakages. It improves the mapping of expenditures to the intended targets.

Error-correction is contingent on the terms of references. If the policy was unsuccessful after a specified period, then the voting system should allow for a reversal of the policy. There should be no corner solutions or “sticky” outcomes within this framework.

Figure 5: Voting framework

Since voting is now done on a wide scale of subjects one might be inclined to see this system as a burden on citizens’ time. Many of the proposal will take energy and time to set up in the beginning. But once policies work (i.e. no more need for error-correction), then the process could be monitored and only reviewed when needed. This implies significant noise in the beginning of this voting methodology. However, due to urgent reforms and general public interest, the outcomes should reflect voter needs much faster than in current systems.

In many ways this system represents a modernized version of referendums. Referendums are traditionally only held infrequently and on important subjects. However, who decides what is important? Politicians may mask agendas by holding referendums or society might make a mistake by voting in policies during a referendum with unfortunate and unforeseen consequences (regret). Utilizing frequent votes will represent the views of the society and not stakeholders and will allow for corrections. The cost of voting is also significantly reduced when using electronic systems. These systems need not be insecure. We use electronic banking regularly as an example. Perhaps the biggest obstacle is the roll-out of internet and access to electronic devises in developing countries. I venture a guess that if we were able to reduce inefficient expenditures, we might be able to provide internet access to everyone…

 

 

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[1] A mathematical formulation that describes the bundling of factor inputs to produce outputs.

[2] Arrow was against plurality voting systems that are done on the basis of ranking. An alternative voting system is based on approvals. For more details see https://electionscience.org/commentary-analysis/voting-theory-remembering-kenneth-arrow-and-his-impossibility-theorem/.

[3] The Pareto principle states that one cannot improve the utility of some members of society while reducing the utility of another member. Social welfare can thus be improved when policies improve the welfare of some individuals while not decreasing the welfare of others. Sometimes equity is of greater societal concern than efficiency (who determines this?), which suggests an alternative welfare function specification.

Uhm - I told you that the SARB is likely to increase rates

In the previous post I discussed what the SARB intends to do with interest rates. The MPR 2015 documented hinted at an increase in many places. This is exactly what the SARB did - it increased the repo rate by 25 basis points to 6 percent. It is strange considering that the latest inflation is 4.7%...

The hike could only mean that the SARB anticipates higher inflation from various underlying pressures and that it thinks it right to act now (or the SARB is simply importing foreign monetary policy decisions...Brazil!). It should be interesting to see how the economy responds - watch out mortgage defaults, debt service costs and household consumption expenditure.

Tickle tickle - how monetary policy announcements could go wrong

Interest rate announcements and forward guidance
In this post I look at a potential problem central bankers face. Hint: it has to do with forward guidance - the way a central bank communicates its interest rate decisions to us. I picked the South African Reserve Bank's (SARB) latest (April 2015) Monetary Policy Review (MPR) to highlight these issues. The MPR, I think, tells us that everyone should be aware of a rate tightening cycle. Is it nice of them to "warn" us of an impending rate hike? Does it intend to adjust our expectations? Or can it backfire? Let's start by looking at some of its communication tools:

The fan chart:

Fan charts look pretty cool. Fan charts are sometimes used as a forecasting tool and depicts various paths of a variable with a confidence interval. It looks something like the figure below (source: 2015 MPR, SARB). The dark line is the median of the forecast while the lighter areas represent increasing confidence intervals. An easy way to think of this is by inverting the figure and plot a bell shaped curve where the light areas measure the standard deviation.

Why would a central bank produce such a figure ? 1.) It acknowledges that models are only partial representations of reality and that significant forecast errors exist (inflation is forecast to be anywhere from 3% to about 11% in 2017); 2.) to communicate what it might possibly do with interest rates (only if the central bank targets inflation). The fan chart produced below is a split-normal distribution (i.e. it is not perfectly symmetrical on both sides of the median). In fact all the "risk" to the forecast seems to be on higher inflation. Depending on how seriously the SARB takes these forecasts, it could mean that is pricing in a high probability of an interest rate increase.

Announcements or hints

In the latest MPR from the SARB: "Underlying inflationary pressures are resilient and expectations have converged at the top of the target range. This makes a sustained breach of the inflation target more likely...Given all these factors, monetary policy remains in a tightening cycle". There might be a slight contradiction in this statement - if expectations have converged at the top of the target then why would we have a sustained breach of the target? Converged expectations mean anchored expectations (admittedly at the upper limit of the target). Some models allow for backward indexation in the hybrid Phillips curve (more on this later), which means that past inflation and future inflation affects current inflation.

Sounds like the SARB wants to increase interest rates...

This sounds to me like the SARB is seriously thinking of increasing interest rates. Is this what we call forward guidance? The SARB does not make an explicit statement regarding interest rates. The fact that the fan chart for inflation ranges between 3% and 11% suggests that there is huge monetary policy uncertainty (monetary policy uncertainty is a shock over and above actual changes to interest rates see this).

On the one hand the SARB in their models often target expected inflation as opposed to realised inflation. If they believe inflation in the future (say 18 months from now) is above the target level they might very well increase interest rates. However, if they announce that they are in a tightening cycle and consumers and firms believe them, then economic participants might decrease consumption. Especially when higher expected interest rates affect credit and investment decisions. In this case expected inflation should decrease. Thus, consumer and firm decisions are conditional not only future inflation but also future interest rates.

This makes monetary policy incredibly difficult and somewhat counteracts forward guidance. Since the information set that monetary policy makers face is too big to make useful numerical estimates of inflation, they often revert to simple models. The modelling team at a central bank will usually produce inflation and output forecasts and then the MPC will decide on the interest rate path. It would be interesting to do a study the deviations of the policy advice coming from these models from the final MPC decision.

How do we create such a figure?
With a model that captures economy-wide effects. The smallest of such a model includes an equation for interest rates (Taylor rule), for inflation (Phillips curve equation) and output (IS equation).

• Taylor rule: Interest rates are set according to a rule that weights both inflation and output (usually output deviation from potential output) and a disturbance term (which could capture monetary policy uncertainty depending on how the model is solved). The parameters that fit the equation are of particular interest. In many estimates of the equation, interest rates increase by more than 1% for a 1% increase in inflation. An estimate lower than 1 often yield indeterminate equilibria (not a single path solution for the variables).
• Phillips curve: Inflation is a function of future (and sometimes past) inflation and output. If output is above potential output than inflation increases.
• IS curve: Output is a function of the real interest rate (repo rate minus inflation) and future (sometimes past too) output.

To generate the figure the SARB has to make an assumption of the underlying distribution of the disturbance terms. They may decide that all shocks can be drawn from a multivariate normal distribution and solve the model many times. With an adequate amount of solutions they can plot the distribution of the forecasts for each variable. 

So what?
Here is the tricky part: Inflation has been pretty stable around the 6% mark for a while. This has happened despite many negative shocks hitting the economy. Interest rates have also remained pretty much at a similar level. Is this proof for the Neo-Fisherian school (inflation in the long-run follows the monetary policy rate)? Thus when interest rates go up, there might be a little fall in inflation, but then inflation increases. This could be further substantiated by looking at stationary path of inflation. It seems as though inflation is a mean reverting process, but it takes a long time to revert to its mean following a shock.

Using the equations specified above, I illustrate two features of monetary policy: 1.) what happens to the economy when the SARB increases interest rates temporarily where the shock is unanticipated and 2.) where there is a permanent shock while it is anticipated (people have perfect foresight; or the SARB guides the public's expectations).

Scenario 1 is depicted in Figure 1. The results seem pretty standard: An increase in the repo rate decreases inflation. However, Figure 2 shows that an increase in interest rates lead to an increase in inflation. Hmmm...why? This is the idea of the Fischer identity in most central bank models: r=i-p (where r is the real rate, i is the nominal rate and p is inflation). Once we rearrange this identity and make p the object of interest, an increase in i will increase p and vice versa.

Figure 1

Figure 2

  What does all of this mean for forward guidance?
There are some who claim that the SARB has not been able to anchor expectations (Kabundi and Schaling, 2013) and some who claim that the interest rates do not affect inflation as expected (Bonga-Bonga and Kabundi, 2015). If these claims are right then it should matter little what the SARB communicates to the public. Inflation adjustments will simply be backward looking.

If the SARB is very credible and can influence expectations then it still faces some tough decisions. With a perfect foresight model inflation could simply follow interest rates (assuming that the Fisher identity holds). Or people might see the possible hike as a signal for higher inflation in which case firms adjust prices to higher inflation expectations. But, we see that short run unanticipated shocks reduce inflation. The Fisher effect works only really in the long run. The SARB nudges interest rates to control for various shocks, and as such perfect foresight models are not always ideally suited to reality. Models with bounded rationality or learning might be better suited to analyse the economy where some foresight (i.e. SARB forward guidance exist).

On the other hand forward guidance may lead to a reduction in inflation as the potential hike makes consumers and investors cut back on credit and spending now, thus lowering inflation expectations. If the SARB then does not react to its initial "guidance" then it could hurt its credibility and may not be able to anchor inflation expectations.

Perhaps the SARB is much smarter than we think- it knows how to influence our expectations and thus are perfectly aware of what the effects of policy announcement are. I for one am waiting for a paper on this.

References

Kabundi, A. and Schaling, E.(2013). Inflation and inflation expectations in South Africa: an Attempt at explanation. South African Journal of Economics, 81(3): 346-355.

Bonga-Bonga, L. and Kabundi, A. (2015). Monetary policy instrument and inflation in South Africa: Structural Vector Error Correction Model approach. Munich Personal Repec Archive, MPRA Paper No. 63731.

South Africa's economic time bomb

Ok. So it has been a while since I last posted anything. I needed a break. But I am back and I have been fuming over recent South African events. One cannot help but be affected by the political turmoil at home. A lot of people complain about South Africa's economic woes, but few offer simple viable solutions. This post summarises some policy proposals.

South Africa's policy prescriptions - what should they be? South Africa followed a standard textbook example in responding to the financial crisis in 2008/09. Its demand side policies consisted of: (1) Decreasing the primary balance and run consecutive deficits; (2) Decreasing monetary policy interest rates to historic lows and keeping them there (except for one weird 25 basis points hike that seemed to match what our emerging partners were doing); (3) Allowing the exchange rate to depreciate substantially in the hope of generating foreign demand for locally produced goods.

Apart from following the standard textbook model South Africa also had to cope with new banking regulations put forth by Basel. The government continues to delay much needed electricity supply (bad management is to blame, although it looks a bit ridiculous that the Treasury keeps missing the implementation date of the new power stations). It had to deal with sovereign debt downgrades (explains one part of the weak exchange rate story) up to the point where we are one notch away from being non-investment grade (S&P) and two notches away according to Moody's (admittedly I think the rating agencies have made a mistake on this one - South Africa was not close to any default - but bad ratings increases the likelihood of default - this to me implies that the rating agencies are trying to create a self-fulfilling prophecy). It seems like the Treasury has caved a bit under pressure by increasing tax rates at a time when the economy is hardly growing - in my view a mistake by the Treasury. Inflation at its upper limit of the target range also increased the pressure to raise wages (at a time when government is trying to reduce the deficit). Let's leave aside all the political turmoil for a moment and analyse what, if any, additional measures the government can take to speed up the economy.

Suspend ridiculous wage demands temporarily. One thing is certain; the wage hikes do not match productivity growth - the economy is forecast to grow 2% in real terms while wage demands exceed inflation by anything above 3% (inflation seems to fluctuate around 6%). Perhaps it is government's strategy to reduce income inequality by increasing wages rather than growing the economy, decreasing unemployment, keep inflation stable etc. The consequences of higher wages when economic activity is suppressed = higher unemployment. The demand for labour in standard textbook economics depends on maximizing productivity subject to inputs (wages and labour, capital and rent). Higher wages reduce company profits and reduce expansions. Now take a low growth environment and add business pressure by increasing wage demands...unemployment bam! We are already witnessing lower growth in government employment amidst an increase in the working age population.

South Africa has a low savings rate and consumers are current consumers (i.e. the spend most of what they earn rather than save). When wages are indexed to inflation and consumers do not save we have a situation where inflation increases - which will lead to higher wage demands, which will lead to higher inflation etc. (you get dizzy swirl). We need to note two additional features of the South African economy - despite the very weak exchange rate (historically) the current account deficit has not subsided. Those sneaky economists who wish to invoke the J-curve as an explanation has ran out of time - we have had a persistent depreciation for a long time. Exports have increased - but imports have increased too. Thus add the high wage growth to the weak rand and you would expect higher inflation. Note that inflation is rather high given that potential and actual GDP growth is already low.

      Lower the inflation target. If wage spirals become a serious concern then the SARB should lower the inflation target. There are many reasons for doing this (admittedly many reasons to keep it this high too). A high inflation target is often associated with more volatile inflation (in contrast to keeping inflation stable -wink wink SARB). Yes I know that inflation has been lower and more stable since SA adopted inflation targeting. I am saying that it can be lower and even more stable by simply lowering the target (see http://www.voxeu.org/article/how-are-inflation-targets-set). Anchored inflation expectations at a lower rate also mean that interest rates should be lower. The costs of higher inflation seem to outstrip the benefits substantially (these include the costs of adjusting prices, investment uncertainty, higher debt service costs, discourages savings, higher taxes due to bracket creep etc.). In addition, an inflation rate of 6% implies that R1 will be worth less than 50 cents in twelve years from now (i.e. value of assets are halved every twelve years if there is no interest compensation).

      Make banking more competitive. Banking costs in South Africa constitute a crime in my books. The fact that almost all the banks charge similar interest rates on loans and provide ridiculously low savings rates is a modern day travesty. Millions of household face unreasonably high interest payments on their loans because (1) credit access rules are not stringent enough and (2) because interest rates are super high. The banks don't seem to care that much since households meet their liability obligations even if it leads to debt traps. Now take whatever savings you have and deposit it into a bank account...oh crap after a few years you will have less in real terms since you started depositing funds because inflation is higher than deposit rates...is it then strange that South Africa has such a low household saving rate?

Education - need I say more? Sustainable and high long term growth depends on good education. No, not access to education (South Africa has done a decent job), but quality of education. The economics department of the University of Stellenbosch has done a lot of good research on this topic. Unfortunately there seems to be a widening gap between the academic view and the government. Our children do not compete well against our African neighbours in standardised tests. We don't have enough teachers and we don't have good teachers. South Africa already struggles to absorb labour. A lot of South Africans are simply unemployable (we don't have jobs that match the supply of unskilled labour). We will have to contend with generations of unskilled labour the more we procrastinate on fixing the education system. This too is a crime against children who deserve to have a decent education. I am sorry to say, but the ANC is still messing up and is hardly taken to task.

Implement a rules based fiscal policy. South Africa's budget system is one of the world's most transparent systems. However, as with any forecast it had to adjust its fiscal figures on many occasions. If the government says that debt will be x% next year and debt comes out as x%+5% then it might lead to credibility issues. Uncertainty, whether caused by government or not, does not sit well with institutional investors and rating agencies. To address these uncertain terms government has to offer handsome returns for holding bonds. Debt service costs have become one of the biggest expenditure items which avert resources away from investment spending. To make government more credible it could be more specific about its expenditures and implement a rule that is not too stringent when forecast errors occur (something that is inevitable). Each province and municipality should be held accountable for its expenditures and revenue collection. We see that municipalities do an excellent job at remunerating its workers, but do not spend on service delivery or investment (once again making the argument that wage growth should be tied to productivity as opposed to inflation). This is an increasing trend which begs the question of whether government should become more centralised. What is the use of having a decentralised government if it cannot meet its objectives? The taxpayer foots the salary bill of high paying officials that simply renege on their obligations and responsibilities. Pooh pooh!

Increase the VAT rate dammit. What tax is least distortionary? What tax exempts certain goods from being taxed? What tax has a low rate? What tax base as a percent of GDP is seriously high? What tax could possible nudge people to save more if its rate increased? What tax could cover a lot of silly expenses such as e-tolls without having to burden specific users when the whole country benefits in economic terms from improved traffic flow? What tax could decrease the fiscal pressure to consolidate? Hmmm...oh can it be Value Added Taxes? You bet! But why does the government increase capital gains when it hardly makes a dent in the deficit? And what is up with small increase in income taxes - it sounds like it is more of a signaling thing and not meant to change behaviour. VAT has a single rate that all people face. Certain goods, such as food for sustenance, are VAT exempt or zero rated (there is a difference between the two), which means that the poor are not that adversely affected. Internationally, South Africa has relatively low VAT rate, although it is one of the government's main sources of revenue. This is only because the VAT tax base, consumption, is very high. Increasing VAT is not a panacea for South Africa's current economic woes, but it will lessen the pain somewhat - like morphine for a severely injured patient. I really do not understand why the government hesitates to increase VAT, but quite easily increases taxes that hurt the economy while collecting very little revenue...really!

Obviously policy decisions are more nuanced. The fact remains that other countries are able to implement small changes with huge economic benefits. The Treasury and the SARB have excellent policy makers and academia reminds the government that implementing certain policies is beneficial to all. The ANC for some logic-defying reason resists these proposed changes. Instead it seems that the ANC is intent of focusing on weird redistributive policies such as BBBEE and land ownership. They are weird because the benefits have not been quantified and the majority of the country is still poor. Imagine if the ANC instead focused on simple growth strategies. Redistribution will improve and wealth will increase. I think the ANC do this to their detriment and they will bleed votes because of a lack of policy foresight and additionally slow economic growth for decades to come. Sad really. 

Oil - always in a pickle

Watching oil prices change is very entertaining. Oil prices over the last few months have declined sharply. It almost looks odd when we look at the data. I for one cannot help wonder why oil prices decline so sharply over such a short period of time.

Another interesting aspect is that there are large standard deviations and the mass of the distribution seems to be around $100 (this is only from 2007 and is not the growth in oil prices). 

James Hamilton at Econbrowser argues that a fall in the demand for oil is partly to blame for the lower oil prices. The US Energy information agency also shows that US oil production has increased quite sharply.

Despite various assertions I am still a bit sceptical that oil prices would plummet that quick because a few countries have economic problems. For one, the world economy has not recovered to pre financial crises levels and two we have not discovered a major oil resource in the last three months where production has increased. Sure demand for oil might be weakening due to slower world economic growth - but the major consumers of oil (mainly the Western and Northern hemispheres) are in their winter months. This means that the demand for gas will surely increase. On top of that, US economic growth has improved quite a bit - suggesting that the demand for oil should increase.

I tried to get an update on oil consumption and production, but the latest available (and free) data that I could found was until October. The interesting months were November and December. Another interesting observation is the increased volatility in the NYMEX oil open interest contracts. Now it seems that even traders are trying to profit from these swings (when haven't they?).

Finally, one might be tempted to see a correlation between oil prices and the debt problems in Venezuela and the sanctions against Russia - something for the conspiracy theorists. A Bloomberg and a FT story discuss the debt agreement between Venezuela and the Dominican Republic (has to do with oil). The intermediary is Goldman Sachs (the same guys that once upon a time announced that there was a real likelihood that oil prices will hit $200 per barrel). Basically with the fall in oil prices the debt swap is done at a massive discount (not good for Venezuela). Furthermore, oil is one of Russia's biggest export commodities - the fall in oil prices will surely hit their economy hard. But of course all of this might be simple coincidence...

Sources:

http://blogs.ft.com/beyond-brics/2014/12/03/venezuelas-new-best-friend-goldman-sachs/

http://www.bloomberg.com/news/2014-12-04/venezuela-said-to-discuss-swapping-dominican-oil-debt-for-cash.html

http://econbrowser.com/archives/2014/12/supply-demand-and-the-price-of-oil

https://www.quandl.com/

One the convergence between the Christian equality and the material equality

Kierkegaard in Work of Love (2009 - Harperperenial; p. 82-83) writes that "it [Christianity] allows all distinctions to stand, but it teaches the equality of the eternal. It teaches that everyone shall lift himself above earthly distinctions. Notice carefully how equably it speaks. It does not say that it is the poor who shall lift themselves above earthly distinctions, while the mighty should perhaps come down from their elevation - ah, no, such talk is not equable, and the likeness which is obtained by the mighty climbing down and the poor climbing up is not Christian equality; this is worldly likeness. No, if one stands at the top, even if one is the king, he shall lift himself above the distinction of his high position, and the beggar shall lift himself above the distinction of his poverty. Christianity lets all the distinctions of earthly existence stand, but in the command of love, in loving one's neighbour, this equality of lifting oneself above the distinctions of earthly existence is implicit."

There are many such treasure passages in Works of love. This passage, and a large majority of the book, emphasises love for one's neighbour. In loving one's neighbour you throw away any distinction of class and truly unconditionally care for everyone. One's object of love is not one's choosing (e.g. one's spouse or friends), but it is the obedience to God's command that one shall love one's neighbour. Kierkegaard is clear to point out that our neighbour is everyone.

What does this mean from an economics perspective? While politicians and policy makers might greatly care for people, I wonder whether this care is synonymous to loving one's neighbour. In economics we focus on elevating (at least trying to do so) one group of people (the marginalised, the poor and the needy) and lowering the status of another group (usually the wealthy). This is often the aim of progressive taxation and is definitely at the heart of heavy capitalism vs. communism discussions.

In an ideal world, where people truly loved one's neighbour, all types of economic class distinction would disappear. One can imagine that love would spur the other to do everything in his/her power to ease the suffering of a neighbour. Love, unconditional love, would expect nothing in return and would gladly sacrifice. The wealthy person who lifts himself above his "high" position would not care for that position - he is above that and hence would care little for his wealth.

In this sense there is no convergence between the Christian ideal of equality and the material ideal of equality. The former speaks of everyone lifting themselves above their station in life to equality, while the latter attempts to bring a balance by lowering the status of some and simultaneously raising the status of others. The economic equality needs a definition of distinction while the Christian equality makes no distinction. Furthermore, the economic equality requires a benevolent dictator (or a decent government) to do the job, while the Christian equality requires the individual raise himself. The ideal of economic equality requires constant intervention, while that of Christian equality is once-off. Economic equality requires a select group to achieve equality, while everyone is responsible for the other in Christianity.

The fact that so many people are still starving today, that inequality is growing, that individuals amass more than they need while brothers and sisters have nothing, point to our failure in keeping up with this command. Of course there are a handful of people that have sacrificed everything in keeping this command.

It brings some comfort in the midst of failing policies and selfish individuals that God does not distinguish between income, race and gender. That everyone is invited to participate in something that elevates them above the misery in this world - if they so choose it. It should be the ideal of all people to do away with distinctions. Once we are able to do that then individuals will take responsibility for the lives of others and stop waiting for governments, or those that already work hard in making a difference, to achieve said goals.

Solace in hierarchies...

I found a passage in the Žižek and Gunjević book, God in pain, quite interesting. (I am not putting forth any solutions - it is just a curious passage that I wanted to share).The passage looks at hierarchal structures in society and specifically how to eliminate the "pain" associated with falling in an inferior class structure. I almost paraphrase the entire section (taken from p.66) - most of this is quoted from Jean-Pierre Dupuy in Petite métaphysique des tsunamis.

There are four procedures of hierarchy, whose function is to make the relationship of superiority non-humiliating to subordinates:

1.          Hierarchy itself: Experiencing one's lower status as independent of one's inherent value.

2.       Demystification: The relationship between superiority and inferiority is not based on meritocracy, but are the result of ideological and social struggles. I.e. One's status depends on social processes and not on merits. This helps us to avoid painful conclusions that the other's superiority is a result of merit and achievement.

3.       Contingency: One's position on a social scale depends on a natural and social lottery. I.e. lucky are the ones who were born with better dispositions and into rich families.

4.  Complexity: Superiority or inferiority depends on complex social processes independent of individuals' intentions or merits. E.g. despite me being smarter and working harder, my neighbour's success outweighs mine.

The pillars do not threaten hierarchy, but is supposed to make it palatable. Dupuy  -"what triggers the turmoil of envy is the idea that the other deserves his good luck and not the opposite idea which is the only one that can be openly expressed".

Dupuy further states that it is a mistake to think that a society that thinks it is just and proclaims that it is just will be free of resentment. And in these societies it is the people who occupy inferior positions that will burst out in violent resentment.

Žižek quotes Rousseau's example of perverted self-love: One cares more for the destruction of one's enemies (they serve as an obstacle to one's happiness) as opposed to one's own happiness.

What does this have to do with South Africa?

South Africa proclaims that it is a democracy. It claims that it is just and free. Yet, there seems to be social turmoil every day. There are clear class distinctions and those that fall in the inferior classes are supremely unhappy about it. High income inequality, affirmative action (i.e. exclusive rights for some and isolation for others) and corruption are just a few examples of how unjust the country really is. The consequence is violent uprisings undermining every economic and social activity (strikes, destruction of property, crime are a few examples). South Africans, and many others in the world, then surely make a great mistake (in context of Dupuy) in thinking that South Africa is just and proclaiming it is just.

The ideal of demolishing hierarchy stands in opposition to the idea of making hierarchy palatable. Are we really able to demolish hierarchy? In effect this would imply some form of communism. History is definitely not kind to the examples of communism we have seen - numerous people have lost their lives for this ideal and almost always the ideals were perverted by the leaders who exploited the general population. Is the alternative better? Is it better to accept that things are simply unfair and unequal? That no matter what skills or abilities a person has, that person is subject to factors outside his control, or in the very least try to make something from nothing in what we call capitalist societies (there is no promise that hard work and ability will be rewarded). Unfortunately accepting ones circumstances does nothing to help starving people, and a system that proclaims equality cannot truly promise equality and food portions of the same size for everyone. 

These are deep philosophical questions that touch all of us.

While the South African government has done a great deal to improve the lives of the poor since 1994, it never, or hardly, acknowledges its shortcomings (the opposition parties and newspapers do a reasonable job at highlighting inefficiencies). (We also don't know whether future governments will do any better). Perhaps this is what Dupuy wants - societies should acknowledge its mistakes and maybe people will find solace in that - it is sometimes the government and its policies that constrains me and not my merit or ability and on the other spectrum that this same government that constrains me helps another who might be more in need (not always Pareto optimal, and not always welfare enhancing) It does not make it fair, but it surely helps ease the psychological pain of being unfairly treated.