Economic Policy Framework for the 21st Century

Professor Dermot McAleese

MSc EPS Hilary Term 2011 (S1)

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OUTLINE

The new consensus

Why policy adopted

Implications of model

Will the consensus last?

New directions for policy post 2008

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THE NEW CONSENSUS

Competition and the market system

Macroeconomic stability

Globalisation

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openness towards international trade

limited government intervention in the economy, and

macroeconomic stability

IMF, World Economic Outlook, May 1997, p 92

A Successful Strategy for Growth Requires:

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COMPETITION AND THE MARKET SYSTEM

Pro-competition policies

Labour market flexibility

Privatisation

Deregulation

Enterprise-friendly environment

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IZA Appeal to German Policymakers May 2003 signed by 300 German economists

Germany needs to relax the regulations for layoffs, reduce sharply the maximum duration of unemployment benefits, abolish incentives to retire early, increase competition in the health sector to lower the cost of medical coverage, and reduce expenditure so that taxes become less onerous. Nothing less than the future prospects of this nation will depend on the successful outcome of the current reform process.

Source: Gary Becker “A Little German Reform would go a long way” BusinessWeek, 1 Dec 2003

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India needs more reforms (Economic Survey of India OECD 2007)

India’s success over the past two decades is largely the result of market based reforms that gave a greater role to the private sector by reducing the presence of the State in economic affairs

Angel Gurria, Sec-General OECD Oct 2007

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Inward Foreign Direct Investment in India

Columbia FDI profiles March 2010

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Increasing labour and product market flexibility will be important to achieve high rates of growth. (P 178)

The Economist “Greece’s sovereign-debt crunch” Feb 6 2010

… need for deep reform in Greece. Successful firms overtaxed … Greece’s higher inflation is partly explained by a lack of competition in parts of the economy. As in Italy and Spain, wages are set centrally with too little regard for differences in productivity across industries and companies.

The OECD on Greece Nov 2009

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MACRO-STABILITY

Price stability (independent central bank,

‘hard’ exchange rate)

Budget balance

Control of government spending

FINANCIAL STABILITY

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Consensus brings low inflation

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People’s Bank of China

The objective of monetary policy is “to maintain the stability of the renminbi and thereby promote economic growth”

Art 3 of the Law of the PBC

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OECD on Portugal -- June 2010

OECD Economic Outlook p. 172

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A credible commitment to reducing fiscal imbalances on a sustainable basis is essential for restoring market confidence, creating room for future budgetary manoeuvre and meeting the rising costs of an ageing population. To achieve this, strict control of spending and curbing widespread tax evasion are vital. Long-term fiscal viability also calls for further pension and health care reform. P 278

The OECD on Greece November 2009

16IMF Oct 2009 ch 1

(% of GDP)

Consensus turns Keynesian

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GLOBALISATION

Free trade

Foreign investment

Liberalisation of capital

Labour mobility

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(August 2009)

Members

Observers

Others

WTO Members and Observers August 2009

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Globalisation means ….

Open door policies Extending the scope of international trade

Emphasis on export promotion

Multilateral and regional trade agreements

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Three pillars are interdependent ….

Flexible labour markets are needed if a country is to move workers from import substitution to export industries and benefit from globalisation

Globalisation creates pressure on macroeconomic policy to maintain price stability

Keeping the economy competitive a key priority for small open economy in 21st century

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IMPLICATIONS FOR BUSINESS

lower taxes

weaker trade unions

rewards for managers, skilled workers

supportive government

But ….

more competition

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OECD Economic Outlook May 2007 p. 18

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IMPLICATIONS FOR WORK ENVIRONMENT

labour market flexibility

less job security

more jobs (many of them temporary, contract)

structural adjustment

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IMPLICATIONS FOR GLOBAL ECONOMY

More trade in goods and services

More foreign investment and the multinationals

More capital mobility and the shifting balance of

economic power

World Trade Organisation (WTO) more important

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IMPLICATIONS OF CONSENSUS

Business climate lower taxes weaker trade unions rewards for managers, skilled workers less government but, more competition

Work environment labour market flexibility less job security more jobs structural adjustment

International economy World Trade Organisation (WTO) a key institution foreign investment and multinationals in ascendant capital mobility and the shifting balance of economic power mutuality of benefits

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Questions for group

Q1. Outline the three pillars of the new economic consensus. Show how policy changes along new consensus lines can lead to better economic performance.

E1. Outline the contemporary economic policy stance in a country of your choice and indicate how closely it approximates the new policy consensus.

Q3. Is the new economic consensus likely to last? Will the present world economic downturn undermine it?

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Questions for groups

Q3. Is the new economic consensus likely to last? Will the present world economic downturn undermine it?

• Reading ‘ Economists Rethink Free Trade’

Explain the author’s claim that ‘something momentous is happening’ in the debate about the merits of free trade. How well founded are these doubts? What can be done to reassure people about the advantages of trade?

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FAULTLINES IN NEW CONSENSUS

UNEQUAL INCOME DISTRIBUTION

GLOBALISATION AND VULNERABILITY

PRIVATE DEBT AND PUBLIC DEBT

FINANCIAL INSTABILITY AND REGULATION

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Faultlines: Income distribution in the US 1949-79

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Income distribution in the US before tax 1979-2003

Source: Robert Frank “Are Positional Externalities different from OtherExternalities?” Happiness and Public Economics Conference, Centre for Economic Performance London 23-24 Sept 2006

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US Income Distribution after tax 1979-2000

Frank 2006

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Top 1% of households owns around 40% of America’s wealth – the highest proportion since 1929. In the 1970s they accounted for just 20%.

(The Economist May 12th 2007 p.75)

Top 1% of income earners in the US account for 25% of total US consumption (McKinsey Global Institute, Sept 2009)

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‘The gains from trade liberalization should not only be seen through a narrow economic lens. Trade has also been a vehicle for promoting broader political objectives, especially peace and stability. Trade establishes mutually beneficial links among nations, creating interest in cooperation. It cements relationships among disparate peoples and societies, lessening the risk of conflict, and it strengthens the commitment of governments to rules in the place of realpolitik’

World Trade Organization, Annual Report, 1998

Faultline 2: Vulnerability

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‘ Globalisation’s most fundamental limitation is that , although trade increases the mutual economic dependence of the countries that engage in it, it does not make the peoples of those nations any fonder of each other. Thus, when relations deteriorate because of issues that have nothing to do with commerce, each side starts to resent the dependence on the other, and goodwill can rapidly unravel.

James Kinge China Shakes the World: The Rise of a Hungry Nation London 2006

Some think that the WTO view is too optimistic …..

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Faultline 3: The problem of private sector debt

Public (government) debt a problem ….

…… but also private debt

(Discussed in S4)

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(% GDP)

Public Debt = Central Govt + all govt agencies

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UK Household Debt as % of Income

1977 2008

80 160

UK: Average Size of Mortgage

1999 2008

£40,000 £160,000

Source V Cable The Storm: The World Economic Crisis and What it means London 2009

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The New Consensus lives on …..

To improve its [economic] performance, Portugal needs more flexible labour laws, less bureaucracy, a better educated workforce, more competition and a smaller state. As the IMF states in a recent report, Portugal’s problems are domestic, not global, in nature

Economist 2 May 2009 p.29

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WILL THE CONSENSUS LAST?

Only as long as it delivers, in terms of faster growth and acceptable income distribution

reservations about new consensus policies: Argentina, Venezuela , Iran etc …

Convincing outcome requires: correct sequencing of the new policies consistent application of reforms attention to income distribution international cooperation

State intervention at macro and micro level an essential complement to private sector

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Where do we go from here?

“The outcome [of the current economic collapse] will be nothing less than a regime change in which the next stage in globalisation and integration is characterised by:

More diversified engines of global growth

Reduction in global trade and payments imbalances

More pronounced inflationary pressures

More diversified allocation of investible funds around the world.”

Mohamed El-Erian When Markets Collide: Investment strateg9es for the age of Global Economic Change McGraw Hill 2008

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Pressures on New Consensus

Who cares about competition policy?Nationalisation of banksLabour market flexibility -- all that good?Unemployment --------------------------------------------Budget deficits, escalating public debtDeflationHousehold debt and consumption---------------------------------------------------Protectionism and CompetitivenessCompetitive devaluations (e.g. Switzerland Mar09) FDI, “Buy our goods” campaigns

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Stiglitz on the Post-Washington Consensus

There are important advantages to the Washington consensus approach to policy advice. It focuses on issues of first-order importance, it sets up an easily reproducible framework and it is frank about limiting itself only to establishing prerequisites for development.

but …….. Policies advanced by the Washington consensus

are not complete and they are sometimes misguided.

Professor Joseph Stiglitz 1998, Nobel prize winner, former Chief Economist The World Bank

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DMcA (2004) p 10 “Threats to the new consensus have come and gone during the past decade. A succession of financial crises in Mexico, East Asia, Russia, Brazil and Argentina cast doubt on one element in the packages – free capital mobility – as well as underlining the vulnerability of open, competitive economies to changes in ‘market sentiment’. To date most economies have managed to survive these traumas. The advent of a financial crisis occurring at the heart of the Western economy, following a stock market collapse, would be more serious. Were it to be combined with simultaneous problems in the form of oil price increases and a general economic downturn the attractions of globalisation, competition and price stability could easily pall. …..

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14th Sep 2007

Northern Rock

24th Sep 2008

Bank of East Asia

THINGS FALL APART,THE CENTRE CANNOT HOLD …….

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Search for a second-generation policy consensus

How to find effective ways to deal with 21st century MEDIUM-TERM problems:

Poverty in midst of plenty

Nutrition, obesity and health

Pensions and ageing

Environment and climate change

Competitiveness