February 19, 2013
Revenge of Keynes: Ecuador’s Success Story

Mark Weisbrot discusses the popular success of Ecuadorian president Rafael Correa, a Phd economist who has used “big government” economics to get his country back on its feet:

[Ecuador’s] Unemployment fell to 4.1% by the end of last year – a record low for at least 25 years. Poverty has fallen by 27% since 2006. Public spending on education has more than doubled, in real (inflation-adjusted) terms. Increased healthcare spending has expanded access to medical care, and other social spending has also increased substantially, including a vast expansion of government-subsidised housing credit.

If all that sounds like it must be unsustainable, it’s not. Interest payments on Ecuador’s public debt are less than 1% of GDP, which is quite small; and the public debt-to-GDP ratio is a modest 25%. The Economist, which doesn’t much care for any of the left governments that now govern the vast majority of South America, attributes Correa’s success to “a mixture of luck, opportunism and skill”. But it was really the skill that made the difference.

Correa may have had luck, but it wasn’t good luck: he took office in January of 2007 and the next year Ecuador was one of the hardest hit countries in the hemisphere by the international financial crisis and world recession. That’s because it was heavily dependent on remittances from abroad (eg workers in the US and Spain); and oil exports, which made up 62% of export earnings and 34% of government revenue at the time. Oil prices collapsed by 79% in 2008 and remittances also crashed. The combined effect on Ecuador’s economy was comparable to the collapse of the US housing bubble, which contributed to the Great Recession.

And Ecuador also had the bad luck of not having its own currency (it had adopted the US dollar in 2000) – which means it couldn’t use the exchange rate or the kind of monetary policy that the US Federal Reserve deployed to counteract the recession. But Ecuador navigated the storm with a mild recession that lasted three quarters; a year later it was back at its pre-recession level of output and on its way to the achievements that made Correa one of the most popular presidents in the hemisphere.

How did they do it? Perhaps most important was a large fiscal stimulus in 2009, about 5% of GDP (if only we had done that here in the US). A big part of that was construction, with the government expanding housing credit by $599m in 2009, and continuing large credits through 2011.

But the government also had to reform and re-regulate the financial system. And here it embarked on what is possibly the most comprehensive financial reform of any country in the 21st century. The government took control over the central bank, and forced it to bring back about $2bn of reserves held abroad. This was used by the public banks to make loans for infrastructure, housing, agriculture and other domestic investment.

It put taxes on money leaving the country, and required banks to keep 60% of their liquid assets inside the country. It pushed real interest rates down, while bank taxes were increased. The government renegotiated agreements with foreign oil companies when prices rose. Government revenue rose from 27% of GDP in 2006 to over 40% last year. The Correa administration also increased funding to the “popular and solidarity” part of the financial sector – co-operatives, credit unions and other member-based organisations. Co-op loans tripled in real terms between 2007 and 2012.

The end result of these and other reforms was to move the financial sector toward something that would serve the interests of the public, instead of the other way around (as in the US). To this end, the government also separated the financial sector from the media – the banks had owned most of the major media before Correa was elected – and introduced anti-trust reforms.

Weisbrot concludes by saying what’s on everybody’s mind:

[T]he conventional wisdom is that such “business-unfriendly” practice as renegotiating oil contracts, increasing the size and regulatory authority of government, increasing taxes and placing restrictions on capital movements, is a sure recipe for economic disaster. Ecuador also defaulted on a third of its foreign debt after an international commission found that portion to have been illegally contracted. And the “independence” of the central bank, which Ecuador revoked, is considered sacrosanct by most economists today. But Correa, a PhD economist, knew when it was best to ignore the majority of the profession.

Other countries have used similar “big government” policies in the past to salvage their economies. In Sweden, where government spending continues to hover around 50% of GDP and the top income tax rate is 57%, the government has been running regular surpluses since 1998.  While some are determined to credit Sweden’s success on free-market reforms, Sweden’s recent economic success over the past two decades was largely due to getting its banking industry under control in the 1990’s, and utilizing an activist Central Bank that employed an expansionary monetary policy to reduce unemployment.  Switzerland’s central bank did the same thing in 2011.  And Japan’s central bank purposefully inflated its currency in late 2011 after large Japanese manufacturers "blamed the strong Yen for hurting their profits."  

If anything, these examples demonstrate that there’s a time and a place for every economic policy.  Clearly “big government” economics are not always appropriate for every economic situation.  but in Ecuador’s case, the “big government” approach appears to have worked.  Sweden and Switzerland have also experienced economic success with central banks that intervene far more aggressively in the economies than the Federal Reserve.  And despite Sweden’s purported free-market reforms, the Swedish government continues to fund a rather robust welfare state with high income tax rates, steady economic growth, and regular budget surpluses.  Surplus-driven welfare states are not only possible, but we currently have many excellent examples of them working in different parts of the world.

July 14, 2012
"The discussions that sex workers have, for example, within the Rose Alliance sex workers’ organization, are neither black nor white as they seem in this House. There is often discussion about the so called ‘whore stigma,’ about why you feel [like] an outsider and why you do get the best treatment when you access the social services. A woman who has children and is a prostitute, and therefore a sex worker, or who is in the porn or stripping business is terrified of seeking help. The first thing that happens is that they say to you: You are a bad mother we are going to start by taking your children away from you."

Frederick Federley, May 12, 2011, member of the Swedish Riksdag (Parliament), speaking out in opposition against a bill in the Swedish Riksdag that would double the jail time available for violators under the Swedish Sex Purchase Act.  Federley was the only member of the Riksdag to vote against the bill, which passed 282 for, 1 against, 66 absent.   Maggie McNeill noted at the time:

[J]ust one year ago a Swedish police press release claimed that the ban had actually increased [sex] trafficking in Sweden by making it a more lucrative market, just as prohibition of drugs makes drug dealing more profitable.

What a surprise.

August 16, 2011
Rescuing Capitalism From Itself

Nouriel Roubini worries about the state of the global marketplace:

So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.

Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China – and soon enough in other advanced economies and emerging markets – are all driven by the same issues and tensions: growing inequality, poverty, unemployment, and hopelessness. Even the world’s middle classes are feeling the squeeze of falling incomes and opportunities.

To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.

How about a surplus-driven welfare State? Like Sweden?

In the last decade, from 1998 to present, the [Swedish] government has run a surplus every year, except for 2003 and 2004. The surplus for 2011 is expected to be 99 billion ($15b)kronor.[31] 

July 1, 2011
Keynesian Lessons From Sweden

Neil Irwin did an interesting piece last week looking at lessons from Sweden about the economic recovery. What’s fascinating about it is how incredibly boring it is in most respects. The ‘lessons’ basically all just amount to bog standard orthodox Keynesianism. Sweden’s right-wing government (which of course is wildly socialistic by American standards) went in to the recession with the budget in good shape, rather than the Bush approach of tax cut-induced structural deficits and expensive wars. Then when the recession hit, Sweden has massive automatic fiscal stabilizers, and tacked on some discretionary stimulus in the form of tax cuts and infrastructure projects.

On top of that, the Swedish central bank employed highly expansionary monetary policy. It used an explicit inflation target to keep expectations anchored (the Fed let inflation expectations plummet), it dropped short-term nominal rates to zero (the Fed did the same), it did massive QE (equivalent to 25% of GDP, the Fed did 15%), and it started paying a negative interest rate on excess bank reserves (the Fed started paying a small positive rate). When the value of the krona fell, Swedish politicians didn’t run around freaking out about debasing the currency, they recognized that such a currency dip can be useful in promoting a recovery. The upshot of doing a lot of expansionary policy has been a rapid economic expansion.

Note that there’s no miracle here. It’s not like Sweden has shot forward into some bold new era of unknown prosperity. They were plugging along before the crisis, the crisis caused output and employment to plummet, but then what all the expansionary policy did was allow for a period of rapid growth so that Sweden can catch back up to the trend. Then with that out of the way, it’s time to return to normal politics where different figures have different ideas about the best long-term strategy.

June 8, 2011
The Awful And Terrible Wages Of Democratic Socialism

I’ve been thinking a lot about Hayek lately, and his admonishments against collectivism and Socialism.  His famous cri de couer The Road To Serfdom was nothing if not an assault on collectivism, despite saving a little space for saying Universal healthcare is completely compatible with free markets.

Then I read ilyagerner’s recent post on Liberalism and Immigration, which contains this snippet from a 1992 interview Hayek did with Reason magazine:

Reason: Yet Sweden is reasonably successful…

Hayek: Yes. But there is perhaps more social discontent in Sweden than in almost any other country I have been. The standard feeling that life is really not worth living is very strong in Sweden…

Indeed, Socialism has sucked the life out of Sweden.  I mean, if you just google Sweden, you can see the damage done by decades of Democratic Socialism to Swedish society, such that no sane person would ever want to move to Sweden:










Actually, Sweden looks pretty awesome.

March 26, 2011
Full Employment, Inflation Control, And The Fed

Some great commentary by Lane Kenworthy on the relationship between Inflation and the Employment rate:

Sweden succeeded in keeping unemployment below 4%  [from 1960 to 1989] by coupling employment-oriented monetary and fiscal policy with wage restraint. But Sweden’s central bank at that time was subordinate to the government. Ours, the Federal Reserve, is independent. Since the late 1970s, independent central banks such as the Fed almost always have prioritized low inflation, rendering low unemployment difficult to achieve. If the Fed isn’t on board, even a workable plan for full employment supported by the American public and our elected officials probably won’t be enough.

What about Pollin’s second precedent, the United States in the late 1990s? During those years the Fed, under Alan Greenspan, did keep interest rates low enough for the unemployment rate to drop below 4%. But Greenspan held rates low despite opposition from other Fed board members, who were concerned about potential inflationary consequences — particularly given the internet-driven stock market bubble. Greenspan took this stance in part because his belief in the self-correcting nature of markets led him to worry less than others about the bubble. In light of the painful consequences of the 2000s real estate bubble, I doubt we’ll see the Fed take that approach again for some time.

8:41pm  |   URL: http://tmblr.co/ZMMjnx3rdXIh
Filed under: politics economy sweden 
March 10, 2011
Remarks At London School Of Economics, Anders Borg, Minister Of Finance For Sweden

This speech was given in January.  I wanted to highlight the following remarks:

Given the magnitude of the fiscal problems in many of the OECD countries, the fiscal consolidation must be substantial, in some cases up to about 3% percent of GDP per year. For this kind of consolidation to be credible, the government must use all means available, which implies increasing taxes and reducing spending. Only focusing on expenditure cuts would excessively harm socio-economically disadvantaged groups, who rely extensively on the social programmes that would inevitably suffer. This is neither politically desirable nor politically acceptable. Only relying on tax hikes would massively distort incentives to work. Moreover, empirical evidence shows that fiscal consolidation based solely on higher taxes is not as effective and does not create as lasting effects as a balanced consolidation, with sizeable expenditure reductions. The key is hence to find an appropriate balance between tax and expenditure adjustments.

In order to achieve its programme of fiscal consolidation in the mid-1990s, the Swedish government chose to rely heavily on both tax increases and expenditure cuts, although spending cuts accounted for a slightly larger proportion of savings (53 percent of total savings versus 47 percent from higher taxes).

We had an opportunity to do this with Simpson-Bowles.  We blew it.

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