Archive for May, 2010

The Political Fallout of Fiscal Adjustment

In a recent VOX column, Alberto Alesina argues that the conventional wisdom surrounding the political economy of fiscal adjustment — that governments that raise taxes and/or cut spending to get fiscal balances under control tend to be voted out of office — is wrong.  This is intended to be encouraging to European governments today, almost all of which face the need for immediate and sustained fiscal adjustment.  But I’m not sure how comforting Alesina’s analysis really is.

The table below shows Alesina’s data for the 10 significant fiscal adjustments undertaken in Western Europe over the past 25 years.  The fourth column shows the number of times a sitting government was upended, while the fifth shows cases where a government survived an election (or a new government was installed with a similar political orientation).  Alesina notes that there were a total of 13 government changes compared to 26 non-changes, meaning government changes made up 33% of the total.  In the full sample of these countries from 1975 to today government changes were 39% of the total, suggesting that governments that were pursuing fiscal adjustment were no more likely to be removed from office.

So far, so good.  However now look at the final column, which shows the average annual growth rate during that period (not included in Alesina’s table but added here using IMF data).  Not surprisingly, governments that ruled over periods of fiscal adjustment and economic growth were considerably more likely to survive.  Of the ten cases above, in those for which average growth was above 2 percent governments were removed from office less than 30 percent of the total.  But when growth was below 2 percent, governments were removed a full 50 percent of the time.

Fiscal adjustment during a period of growth is in some ways quite a different undertaking than during periods of low or no growth.  To begin with, when an economy is growing, fiscal adjustment can occur “naturally”: in raw terms tax receipts will increase, so simply holding the level of service provision constant will help bring the budget balance back in line.  Moreover, during eras of low or no growth fiscal adjustment means a pro-cyclical, anti-Keynesian reduction in aggregate demand just when it is needed most.  It appears voters can swallow higher taxes and/or lower services much more easily during periods of overall economic expansion.

Now, guess what the IMF forecast is for average annual growth in the Eurozone over the next five years? 1.6 percent.  (And this was estimated before the worst of the Greek crisis, so if anything is probably slightly lower today.)  Do you think governments should still be comforted by Alesina’s analysis?

The Limits of the China/Japan Comparison (hint: look at GDP per capita)

Yesterday the NYT ran an article comparing China’s tremendous recent economic expansion with that of Japan some two decades prior.  The basic story line is that, sure, today China looks poised to overthrow the  US and take over the global economy, but a generation ago this is what we were saying about Japan, and look how that turned out:

From China’s threefold economic growth in a decade to today’s swarms of five-star hotels and six-figure autos, it is a cliché to say that the world has never before seen anything like this juggernaut.

Actually, the world has. Twenty years ago, Japan was the juggernaut, a silky economic machine poised, according to conventional wisdom and more than a few best sellers, to dominate world trade and global diplomacy in the decades to come.

This has become a fairly frequent subject of discussion (see another NYT article from last year here, and earlier takes in the Christian Science Monitor and Independent), so I thought it was worth at least briefly addressing.  There are some similarities, of course: both are Asian challengers to US economic dominance, built on state-run mega corporations succeeding in international markets.  And there are important differences, including political systems and openness to foreign investment and global competition, which is much greater in China today than in Japan of twenty years ago.

To their credit, all of the articles cited mention these differences, and none claim that China is doomed to follow Japan’s path.  But there’s a much more fundamental difference between the two experiences that I think most people are missing, which can be explained with some very basic facts about economic development and some 3rd-grade level math.

Economic development, at its heart, is a story about GDP per capita, not GDP.  The process of going from a poor country to a rich country is best demonstrated by convergence in per capita income (and hence living standards, levels of technology, etc.) with developed economies.  Japan achieved this: in 1960 Japan’s GDP per capita was just 16 percent of that of the US, and by 1980 the two were equal.  By 1995, helped by a buoyant Yen, Japan’s GDP per capita was 150 percent of that of the US.

The reason Japan never took over the world economy (and with it global diplomacy) does have something to do with the economic malaise of the past 20 years, but it’s really about population size.  Japan’s population is less than half of that of the US; in order for Japan’s economy to overtake that of the US, it would therefore need to be twice as rich on a per capita basis.  This was never going to happen.

But now consider China, which, at 1.3 billion, has a population about four times that of the US, and hence will have the largest economy in the world when it’s per capita income hits one quarter of American levels.  (It’s currently less than 10 percent of that of the US.)

It’s true that in some ways China today looks like Japan of the late 1980s, poised to take over the global economy but with questions about its model of economic development.  But at a more basic level I think the China of today looks like the Japan of about 1950, at an early stage of development with great potential for catch-up growth over the coming decades.  Whether this is scary or reassuring I’ll leave up to you.

The Sarkozy Threat

I’m still not really sure what to make of Sarkozy’s reported threat to pull out of the eurozone during negotiations for the €750bn safety net announced last week.  I always thought it was strange how small a role the French have been playing in the Greek drama, with Germany seemingly calling all the shots, despite the fact that French banks hold some €34bn of Greek bonds, compared to just €20bn for German banks.

So is it better to have the French sitting on the sidelines, or making bombastic threats they (presumably) won’t follow through on?  Was this simply a negotiating ploy, or would Sarkozy actually consider dropping the euro, and if so what would that look like?  Recall that in the lead-up to the April 2009 London Summit, Sarkozy threatened to walk out if there weren’t “concrete” results on financial regulation.  Are empty threats and ultimatums now the cornerstone of France’s international economic policymaking?

On a related note, I’m surprised there seems to be little momentum behind the Johnson/Boone argument that Dominique Strauss-Kahn faces a significant conflict of interest between his current position as head of the IMF and his widely known aspirations for the French presidency.  Especially when DSK demonstrates he’s not shy about discussing European economic policy by, for example, calling for fiscal transfers between euorozone countries, which would be a rather radical step (which doesn’t mean it’s not a good idea, but just that it’s one only European politicians can take).

It’s easy to imagine a policy disagreement between Strauss-Kahn and Sarkozy seamlessly translating into political talking points for the 2012 campaign, and clear that both would be eager to claim credit for restoring health to the French/European economy.  And from that point it’s not a stretch to wonder whether, as DSK shapes the IMF’s response to the European crisis, is he thinking about the interests of the 186 member nations he’s meant to be serving, or those of potential French voters?



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