Lounsbury: Reproducing a comment, developing economies

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February 17, 2004

Reproducing a comment, developing economies

I wrote this for: http://www.calpundit.com/mt/mt-comments.cgi?entry_id=3284 but wanted to share.

Follow ons:

(a) in re Government.
Let me clarify, I am not one of those idealistic fools who thinks government will wither away, that someone one can operate without government.

My original background was in pharma, actually a specific niche therein (Let's say Monsanto was long an archenemy), I very well value the positive externalities that appropriate, market oriented regulation can achieve, and reject categorically the idea that markets can do all. I have seen market failure straight up in emerging markets, very ugly they are.

No, my attack on government is in the context of the reality of how governments generally operate in the part of the world I deal in, i.e. the Arab states, and to a much lesser extent (in terms of my exposure / operations / connexioins) Africa.

Inappropriate government, inappropriate regulation, inappropriate structures are every bit as evil as the ideologues on the Libertarian fringe would have all regulation be. A socio-economic context is necessary for any given range of institutions, try to create an institution without a good social-economic base, you create a rent-seeking vampire. That's what much very well-meaning and well-intended governmental intervention has meant in the developing world. Inappropriate, misconcieved regulation and government has meant rent seeking and leaching.

(b) Monetary Policy:
Devaluation is not inflation of the currency, and in fact the commentator gets the effects 100% backwards. Over-valuation of a currency, above market demand strangles domestic activity, it is in effect a subsidy to the rest of the world, paid for by the (poor) taxpayers. Certainly in the case of brutal devaluations, when things have become so out of whack that the devaluation arrives all at once, in a crash (Argentina, Asia in 98), people suffer.

However the long term real value of savings is in their ability to be mobilized in investments for the savers - an overvalued currency reduces the attractiveness of investment in the home country (artificially depressed competitiveness of home production, artificially increased consumptive buying power - meaning several things (holding things constant, ceteris paribus) (i) less investment at home [capital flight] due to less ops (ii) depressed wealth creation at home (iii) depressed job creation.). Over the life span of the policy, that creates more economic damage (thus damage to the wealth) hidden behind the facade of nominal growth than the actual crisis - or put it better, the currency crises and devaluations are simply the fever of a suppressed disease breaking. It is rather typical, however, to see people mistake symptoms the disease.

Of course, in emerging markets, over-valued currencies (in the name of 'stability') are often popular because they subsidize consumption by the "apparatchiks" - the officials in government and the like- of imported goods. I point to the devaluation of the Franc CFA in Africa in 1994, which produced much howling on the part of "intellectuals" (aka state bureacrats) who spouted nice little leftist lines about capital this and that, in fact it reduced their buying power which was being subsidized by who? By the mass of impoverished citizens who had few opportunities to consume imported goods, and whose agricultural production was priced out of the market, artificially, for the benefit of an elite few dressed up in 'progressive' clothes. Hypocrisy, and pure blindness to be sure.

Sometimes it also is a subsidy to expensive capital goods, which may seem rational, but nota bene, it is a subsidy to using capital intensive methods of production when in fact labor intensive methods of production are more desirable. However, one also notes the perverse incentives in politically directed investment, above all governmental in weak states, of over-investing in prestige projects, inevitably capital intensive.

In the end, simple minded Leftists and "progressives" who maintain an understanding of economics on the level of anectdote have ended up promoting policies that in fact subsidize capital (if often state capital versus private capital) at the expense of the little guy.)

(c) Liberal thought
Rob gets this perfectly wrong.
Liberalism at its roots began as the combination of both political and economic liberalism. Economic liberalism is much more than simple "market fundamentalism" -which I find rather more often among my friends on the right who are rather innocent of proper economics and understand things at a econ 101 level, i.e. largely simple platitudes. There are no proper economists who are not economic liberals, however there is a wide range within solid economic theory for admitting market correcting interventions when one takes into account total cost of events, etc. - what we might call negative externalities, or costs to society that a market, for whatever reason, does not capture (external to the market, externalities, positive externalities are obv. the pluses).

(d) Policies in the developing world
It is indeed true that moving from general theoretical frameworks to trying to find ways to move developing markets to more efficient levels is easier said than done and there is little consensus.

Among the problems is not so much the lessons of what needs to be done, but rather the assumptions about how it can get done in poor institutional environments, and were incentives and responses to incentives are not what classical, neo-classical or other flavors of economic theory would suppose (although people are people in the end, and I think one can, to use an ugly term, 'incentize' once one understands the parameters of their world view).

Thus the emerging works in behaviour economics and related fields to grapple with that. In my journal during the summer I railed on about how the CPA-Iraq in its privatization program was making all kinds of enormously idiotic assumptions, above all about Iraqi capacity to respond to privatization. I note from Juan Cole's blog that Stiglitz (nice to share such company) makes similar points in a recent article.

A question of institutional habits, of ingrained responses, of a variety of cultural and social mores that will take time to grapple with the very necessary move to privatize the economy. I am 100 percent for privatizing every chunk of Iraq, get it out of the hands of the rent-seeking, citizen abusing bureaucrat (mind you, I am not one who dislikes bureaucrats ipso facto, I have immense respect for those who serve well, however my experience in the Arab world teaches that the worst vision is the normal vision here) and into the hands of Iraqis.

However, one can not do that magically, the habits of Western economies, which took a long time to emerge [and for good reason] will not just spring up. The economic habits in the region have deep seated reasons, some good, some bad, some outdated, etc. They will not disappear, and to make a brutal shift to a fully private economy now, in Iraq, to use the example, will only discredit the move, and that is what I fear.

February 17, 2004

Reproducing a comment, developing economies

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