Thursday, 28 April 2011

Aid - How far can the political consensus diverge from UK public opinion?

By Spencer Henson

Campaigners for increases in the UK’s aid to developing countries can sit back in satisfaction, knowing that there is broad-based political consensus in support of achieving the United Nation’s target of 0.7% of national income by 2013. Further, this consensus is being played out in practice given that we are seeing significant increases in the budget of the Department for International Development (DFID), whilst almost every other area of public expenditure is being slashed. Soon, the UK will be able to hold its head high within the donor community as one of the few countries ‘putting its money where its mouth is’.

But where do the UK public stand on this commitment to increase aid spending? Recent research at IDS using the UK Public Opinion Monitor (UKPOM) indicates that upwards of 70 per cent of the general public support reductions rather than increases in aid spending, in the context of efforts to counter the UK’s budget deficit. Supporters of any increases in aid spending, let alone significant increases in spending, are a small minority, and their numbers are in decline. The stark contrast between the political consensus and public opinion should send the alarm bells ringing. When public services directed at the UK public are being cut, and when large swathes of the press are pointing a sceptical lens at the work of DFID, how wide a gulf between the political consensus and public opinion is sustainable? At what stage will the government ‘blink’ and begin reflecting on the political expediency of increasing aid spending?

Of course, the public’s views on aid are held in the context of little or no knowledge of how much aid the UK gives to developing countries, how it is spent and where. This unawareness highlights the need for aid proponents, and especially the government, to engage more actively and effectively with the public on development issues and the role of UKaid. This is not something for the future, but for now. Paradoxically, however, DFID is cutting back rather than enhancing its public engagement activities, in the context of the curtailment of ‘marketing’ spending across government as a whole. Who then will make the case for aid? Who then will counteract the almost inevitable increasing scepticism that now is not the right time to increase aid spending?

Tuesday, 19 April 2011

Mickey Mouse economics

By Neil McCulloch

There can be few better examples of the globalisation of culture than the pervasive influence of Disney. If you have children, Disney is everywhere – on TV, in films, books and DVDs. And the pinnacle, if that is the right word, of Disney is Disneyland, which is where I spent the day last Tuesday. 

Disneyland, for those fortunate enough not to know, is a huge theme park (I went to the one outside Paris) consisting of a set of immaculately reconstructed make-believe lands (Fantasyland, Adventureland, Frontierland, you get the idea). It’s main feature is the bewildering array of rides that one can go on, ranging from the tame (twirling tea cups) to the truly hair raising (why did no one tell me about the 360 degree loop in the Indiana Jones and the Temple of Doom ride?). 

With the rides come queues – horrendous queues.

It says something about humankind’s need for thrills that we willingly queue for almost an hour for just three minutes of excitement. But, as an economist, I also found it fascinating because it says something very interesting about the clash between values and making money. How so?  Because queues mean scarcity and there is a well known solution in economics for scarcity – it is known as ‘price discrimination’. 

Imagine Disneyland were trying to make as much money as possible (which, given the amount of merchandising would seem a reasonable assumption). Then they would recognise that people have different willingness to wait: some people are impatient and would happily pay extra to jump the queue; others, on tighter budgets, would prefer a few minutes extra in the queue.

Consequently, the most economically ‘efficient’ solution (in the sense that it would both give consumers what they want and also maximise income for Disneyland) would be to allow people to pay different amounts for different lengths of wait. This would allow Disneyland to have a super-cheap ticket for those happy to wait for long periods, and a super-expensive ticket for those who want to get straight in on rides, and everything in between. (Rather bizarrely, I have proposed a policy for ameliorating financial crashes which draws on exactly this idea – see my Panic Tax Policy Brief).

Equity versus efficiency?

So the interesting question is – given that Disneyland do not appear to be averse to trying to extract as much money as possible from their customers – why do they not do this?  There are two possible answers. The first answer is a boring one – it might just be too complicated to organise since it would require extra staff adjudicating entry into different parts of the queue – in this view, ‘transaction costs’ prevent the application of the efficiency solution. 

But I suspect the answer is actually more interesting. I suspect the reason that Disneyland don’t do this is because it is wrong.

Most people would fundamentally object to the idea that richer people could buy themselves a better place in the queue. We may have different means, but, after you have bought your ticket for Disneyland, we are all the same and should be treated as such. To my mind, this says something important about the value that we place on equity, that, instinctively we place this above achieving more efficient solutions. It seems the economics of Mickey Mouse is not so Mickey Mouse after all.

Friday, 15 April 2011

I am sorry about the F in Tax

By Neil McCulloch

On Monday I spent an intriguing day in Brussels at the European Tax Policy Forum’s meeting at the Centre for Economic Policy Studies (CEPS). The topic was taxation of the financial sector. 

Now, I do appreciate that taxation policy is not everyone’s idea of an exciting subject, but taxation of the financial sector has become something of a hot topic of late. This is principally because the vast majority of citizens of rich countries think that banks should pay back the huge sums they were given to bail them out, and should stop paying billions of pounds of bonuses to the already extremely rich people whose actions helped to get us in the mess in the first place (see Oxfam’s recent poll on this).

Governments have responded to this sentiment by introducing a raft of new regulations (most notably the new Basel III rules which increase the amounts of capital banks must have) and by considering a range of new taxes. Three in particular are under discussion:  the Financial Stability Contribution (FSC), the Financial Activities Tax (FAT), and the Financial Transactions Tax (FTT), and it was the relative merits of these three taxes that was the topic of discussion in Brussels (driven in part by the European Commission’s current consultation on the topic). 

  • The FSC is IMF-speak for Bank Levies. The idea is that you tax a Bank’s liabilities, after taking out Tier 1 capital (mostly equity). The effect of this tax therefore is to discourage Banks from taking on lots of debt – banks’ high ‘leverage’ was seen as one of the reasons they got into trouble in the crisis, so this is a good thing.
  • FAT taxes basically try to apply VAT to financial services. Currently they don’t pay it, principally because it is technically very difficult to apply. The FAT tries to get around this by saying just tax profits and pay. Since profits and pay is the value-added of a firm, the FAT effectively achieves VAT in a different way. But some argue that the FAT should be thinner i.e. that it shouldn’t tax all profits and pay, but just ‘excess’ profits and ‘excess’ pay. And others argue that financial services are intermediate goods anyway and so good economic theory would suggest that they shouldn’t be taxed at all.
  • Finally FTTs, which would charge a tiny percentage of every financial transaction, have been proposed by development NGOs, churches and unions through the Robin Hood Tax campaign, as a way of funding efforts to combat climate change, and poverty in both rich and poor countries. I’ve recently completed a Systematic Review of the evidence both for and against FTTs – you can read the policy briefing on this, and the final Research Report will be out shortly.

In Brussels, Prof. Michael Devereux, the Director of the Oxford Centre for Business Taxation, laid into the FTT saying that it would do nothing to solve the problems that caused the crisis and that it wasn’t at all clear that it would rob from the rich to help the poor. As I pointed out, he is right on both counts, but neither are good reasons to be against the FTT. The FTT isn’t intended (and wouldn’t) solve the structural problems that caused the crisis – the FSC and better regulation is a much better tool for that – but it is a reasonably efficient way of raising a large sum of revenue. 

That leaves the issue of who would pay it and here, alas, we have very little evidence.  But it would seem highly unlikely that a tax on transactions of assets which are predominantly owned by the better off, would ultimately be paid by the poor (or at least it seems improbable that it would be any worse than, for example, VAT).

So which F tax should governments go for?  A nice presentation by Emrah Arbak from CEPS showed the pros and cons of each of these taxes. But personally I think this is the wrong question  – we should do all three. The FSC discourages excessive leverage; the FAT ensures banks pay VAT; and the FTT raises considerable sums at a time of fiscal tightening.  Of course, doing all three raises the possibility that the banks will be taxed too much. That, ironically, is a real risk – but I suspect it is one that most citizens are prepared to take.

Monday, 11 April 2011

Brazil - The challenge of sustaining growth and social transformation

By Xavier Cirera

I have just returned from Brazil, where I have been working on my project on firm export diversification. In the present climate of economic pessimism in Europe, where all seems bad news, it is refreshing and inspiring to visit one of the BRICs. You can feel the dynamism and optimism of a country that has been growing substantially in the last decade, and a city, Rio de Janeiro, preparing to host the football World Cup and Olympic Games.

Commodity prices have played an important role in Brazilian growth. While we always focus on consumers who are experiencing the hardship of high food prices, the other side of the coin includes large food and agriculture exporters like Brazil. This growth allowed Lula da Silva’s government to implement some quite successful social programmes. Some of these started under Fernando Henrique Cardoso’s government, but Lula’s government significantly enhanced and expanded them. The success of some of these programmes is transforming the country and reducing its endemic inequality.

So what better legacy for Dilma Rousseff’s government? The challenge for the new government is to consolidate these reforms. This will not be an easy task. The economy is clearly overheated. There has been a boom in domestic consumption. Public sector wages have increased substantially. While this has been positive for domestic firms, it has created substantial inflationary pressure. I have visited the country twice in the last two months and prices of transport and services have increased more than 10%. In addition, the Brazilian Real continues to appreciate against the dollar, damaging manufacturing exports and increasing imports.

The challenge for Rousseff’s government is, therefore, to deal with the overheated economy and avoid a hard landing. The best socially responsible macroeconomic policy is one that smoothes the business cycle and avoids adjustment turning into a recession. The poor suffer disproportionally more during recessions due to their lack of assets and insurance, and some of the shocks they experience can have long lasting effects, that would jeopardise some of the achievements regarding social transformation. Balancing the current needs for adjustment with economic growth and expansion of social programmes is a very difficult task indeed, but real social transformation can only be achieved through sustainable measures.

Wednesday, 6 April 2011

Exorbitant privilege - Why the US dollar will no longer be the global currency

By Neil McCulloch

Barry Eichengreen is a soft spoken man. But as one of the world’s leading authorities on the international monetary system, it is worth straining to hear what he has to say. The week before last I listened to him present at the London School of Economics (LSE) the key ideas behind his new book - Exorbitant Privilege: the Rise and Fall of the Dollar.

As the title suggests, he has some controversial ideas. His bottom line was two clear messages:
  1. In 10 years time, the US dollar will no longer dominate as the world’s global currency – the position will be shared between three currencies, the US$, the Euro, and the Renminbi (the Chinese currency).
  2. This is a good thing.
The US$ is now by far the most dominant global currency – 85% of all foreign exchange transactions in the world involve the US$ and 61% of reserves are held in dollars. The idea that, in as short a period as 10 years, this ‘Exorbitant Privilege’ might be eroded is therefore quite shocking. Eichengreen argues that this will happen for three reasons.
  • First, the political stalemate in the USA has made effective measures to tackle the US’s huge structural deficit almost impossible. As a result investors are already getting nervous that the value of the dollar will fall and are beginning to put their money elsewhere.
  • Second, Eichengreen has a surprisingly upbeat view for the Euro. He believes that exit from the Euro would be a catastrophe for Greece, Ireland, Portugal or any other currently troubled economy. They therefore have no choice but to stay.
  • Third, the Chinese are committed to making the Renminbi an international currency by 2020. Of course this will involve huge reforms – commercialisation of the banking sector; removing links with State Owned Enterprises, flexible exchange rates and so forth. But Eichengreen argues that this can be done just as the US$ took over from the £ Sterling in the 10 years from 1914 to 1924.
So what does all this mean? Eichengreen argues that a tri-polar world could be a good thing. It would bring market discipline to the fiscal and monetary policies of the three blocs, particularly the US, discouraging the inflation of enormous bubbles such as the one that precipitated the most recent financial crisis.

But there are risks. The part that I found least convincing was his confidence in the future of the Euro. As the Economist has been repeatedly arguing, the periphery of Europe is broke. The right solution to this is to recognise it and allow an orderly and substantial reduction of these sovereign debts. But the politics of Europe makes this difficult. It seems just as likely that further political turmoil from the heavy costs of adjustment being experienced by these countries might result in the exit of at least one from the Euro. This would create huge uncertainty and undoubtedly weaken the position of the Euro as a global currency.

Interestingly, Eichengreen takes a different view. His most serious concern is with the US. If the political stasis in the US prevents it from addressing its yawning structural deficit, there could be a flight from the dollar and a much more rapid shift to other currencies. Will the markets wait for an orderly transition to a tri-polar world? As Eichengreen puts it 'we have 10 years to get this right, but history shows that financial crises happen roughly once every three years!'.

Monday, 4 April 2011

Our business is putting our noses into your business

By Noshua Watson

A management consultant would ask us development scholars, ‘What business do we think we are in?’. Many of us would say that our job is to provide money, advice and technical support for programs that decrease economic inequality, provide global public goods and provide basic services around the world.

I’d say we’re really in the business of changing how people organise. We try to provide incentives for people to organise themselves and their activities in new or better ways that increase their well-being. Our problem is convincing people that they should do things differently than how they’ve always done them.

Why do people organise themselves the way that they do? We’re familiar with Ronald Coase’s seminal observation that people organise and firms emerge in order to reduce transaction costs. However, the transactions costs are a reflection of the social conditions among the participants and the decision-making information available to them. As a result, management professor William Ouchi saw three ways to control transactions: the market, the bureaucracy and the clan.

  • Making a market transaction requires the participants to trust that the exchange will be reciprocal and have good information about prices. Market exchanges will be more efficient when the participants can easily evaluate each other’s performance and it doesn’t matter if they have common goals. However, the participants are vulnerable to the opportunism of the other party.
  • An alternative is to make transactions within a bureaucracy, like a firm. In order for bureaucracy to work, there need to be norms of reciprocity, but also norms of legitimate authority (who’s in charge!). The participants in a bureaucracy don’t necessarily need price information to make an exchange, but there have to be explicit rules about how to make decisions. This way of organising tends to succeed under conditions of moderate performance ambiguity and moderate goal incongruity between participants. The continuing relationship between employee and employer decreases the level of opportunism.
  • Ouchi adds clans, which can be more efficient when it’s hard to evaluate participants’ performance, but they have goals in common. Clans can be found even in for-profit environments, like startup companies. Clans rely on norms of reciprocity, legitimate authority, and common values in order to make transactions. In order to transact, the participants need information about the implicit rules of the group, which can be hard to learn without being fully immersed in the culture.

In development, we frequently try to shift the way people do things from clan to market or market to bureaucracy and so on. But we don’t always bring that together with a knowledge of what social norms and information are needed to change the organisational structure of those transactions.

To move from a clan transaction to a market transaction, the participants have to be convinced to exchange and participate in collective action without direction from those with legitimate authority. They have to be persuaded to do business with people whom they don’t know and probably don’t trust. They also need to be assured that they will not be vulnerable to opportunism due to information asymmetries. Even in a bureaucracy, where people know each other and know who’s in charge, they need training and socialisation to make the rules of exchange explicit.

If we’re going to convince people to make, buy, or borrow for a better life, we have to make sure they know who is involved, who’s in charge, what’s in it for them and who they can go to with complaints. Even then, people’s needs may be too culturally-specific or irreconcilable for exchange to happen. But we can use what we know about organisations to avoid being caught unawares.

Friday, 1 April 2011

Does China provide an 'alternative model' of development?

By Jing Gu

Is China's development strategy really very new? Scholars (including Gordon White, Tian Yu Cao, and Pan Wei) have for more than a decade explained a 'model' based on China’s development experiences. The ‘Chinese Model’ is said to be characterised by China’s experiences of high levels of foreign direct investment, industrial exports orientation, and state funding of high-level infrastructure.

Some scholars also equate a Chinese model with a 'Beijing Consensus' (such as Joshua Cooper Ramo, Scott Kennedy (2010) and Suisheng Zhao (2010)). This holds that China’s development strategy represents an 'alternative model' distinct from that of the club of advanced industrial economies. China, as a strong developmental state that rejects a US-led ‘Washington Consensus’, welcomes multilateralism and focuses on globalisation and development, but from an avowedly South-South perspective.

The current debate highlights that the alternative model offers a potentially attractive example to governments drawn to a more neo-authoritarian style, with questionable commitments to civil and human rights, political accountability, or Western-style political cultures advocating, at least in declaratory terms, values of political 'good governance'. However, China appears as a rather unitary agency and perhaps some further breakdown of internal governmental differences over development policy might add to the debate.

China’s 'Opening Up and Reform' has been very successful over the last 33 years. Yet China’s development focused exclusively upon economic growth. The result was a rapidly growing economy, but one where social development lagged behind.

Domestically, the phenomenon that China’s cities are like Europe and its villages like Africa needs tackling. The Chinese people still face transition challenges. But by increasing social expenditures in an effective development strategy, it’s time for China to reward its own people.

Now Chinese Government attention is focusing on harmonious and scientific development. One important agenda during the March sessions of the National People's Congress (NPC), China's parliament, was to review and approve the outline for the nation’s 12th five-year plan covering the period for 2011 to 2015. It prioritised improvement in people’s livelihoods and quality of life through 'human-centred' development.

China needs to elaborate a coherent sustainable development strategy and actively promote it. China’s development challenges are international. The implications of China’s new role in Africa are the subject of sharp debate. Indeed, the implications of China’s role are critical for implementing sustainable development policies. We live in a world of complex interdependency. China must develop its own development policies dealing with global issues. Time is pressing; it is opportune to act. China has become a significant global development actor with all the associated responsibilities.