Why a fiscal stimulus makes sense, and why we shouldn’t have spent so much of the mineral boom revenue windfall

From Dani Rodrik’s blog.

Macroeconomics doesn’t get much plaudits around now, but here is a real-life story that should hearten those who think the field is really broken.  It concerns Andres Velasco, a distinguished macroeconomist who is currently the minister of finance in Chile, and who also happens to be a good friend, colleague and co-author

Until the current crisis hit, Chile’s economy was booming, fueled in part by high world prices for copper, its leading export.  The government’s coffers were flush with cash.  (Chile’s main copper company is state-owned, which may be a surprise to those who think Chile runs on a free-market model!)  Students demanded more money for education, civil servants higher salaries, and politicians clamored for more spending on all kinds of social programs. 

Being fully aware of Latin America’s commodity boom-and-bust-cycles and recognizing that high copper prices were temporary, Velasco stood his ground and decided to do what any good macroeconomist would do:  smooth intertemporal consumption by saving most of the copper surplus.  He ran up the largest fiscal surpluses Chile has seen in modern times. 

This didn’t make Velasco very popular.  Last November, public sector workers marched in downtown Santiago, burning an effigy of Velasco.

But by the time the financial crisis hit Chile, Velasco (and the Central Bank governor Jose de Gregorio, another fine macroeconomist) had accumulated a war chest equal to a stupendous 30% of GDP.

The price of copper plummeted 52 percent from Sept. 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies…  Velascos stimulus spending, includ[ed] 40,000-peso ($68.41) handouts to 1.7 million poor families…

The surpluses accumulated during the good years has given the Chilean government unusual latitude in responding to the crisis.  As a result, the economy is doing much better than its peers.  As Bloomberg reports, “the countrys economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund.”

And does good economics pay off politically?  Eventually, yes.  Five months after being burned in effigy, Velasco is currently President Bachelet’s most popular minister.

This entry was posted in Economics and public policy, Politics - international. Bookmark the permalink.
Subscribe
Notify of
guest
6 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
pedro
pedro
12 years ago

Nick, that article makes the case for saving for a rainy day, but it does not make a case for a fiscal stimulus from borrowings.

The article also suggests that if you have a temporary commodity price surge then you should not spend it on public servants. That is not quite the same thing as letting the commodity price surge filter into the private sector through higher profits.

I agree that there is a case for a government saving fund against a rainy day, but I would then worry that such a fund would be “invested” in things like railway lines and broadband plans.

Butterfield, Bloomfield & Bishop
Butterfield, Bloomfield & Bishop
12 years ago

It is interesting to speculate on what surpluses Howard and Costello should have brought in when the commodities boom was going.

I would have thought a structural surplus of around 2-3% of GDP would be about right.

This would mean well over $100b ready and waiting when financial calamity struck.
You of course wouldn’t need to spend much of it.

Fancy investing in railways, broadband or even roads. It would only increase potential output.

The other interesting development is that the budget naturally goes into deficit because of the economy when the economy is a lot worse.

Butterfield, Bloomfield & Bishop
Butterfield, Bloomfield & Bishop
12 years ago

I should have added Velasco simply folowed basic Keynesian practices.

Tel_
Tel_
12 years ago

pedro: It’s kind of difficult for publicly traded private companies to save for a rainy day. If one share is paying good dividends and the other is paying poorly, the shareholders will move across to the high dividend company. So any company director wanting to save for a rainy day must be willing to also be “burned in effigy” by their own shareholders as they watch their price slump in the middle of a boom.

There’s a problem for a government too: if they run a steady foreign trade surplus (like China did) and will not spend the money, their currency floats up killing the golden export goose (or at least choking her until she coughs a bit). The only long-term way to “save for a rainy day” is buying foreign bonds in some shape or buying some import that will be useful to the country when times are bad, or just printing more money each time it tries to float up. Either way, there’s a risk because the foreign bonds can sour during a downturn (as China also discovered) and it’s difficult to know what material goods you are going to need given that you don’t really know when and how the bad times will hit.

Tel_
Tel_
12 years ago

Not always. Some investors like the share price to go up and dont care about the dividend. They like to see a big cash balance, they think of it as a warchest for expansion.

But if even a medium number of shareholders abandon the company, the price won’t go up (or not until shareholders who want dividends have been flushed out, which might take a while). The tech industry is all about future potential, the mining industry is more cut and dried, you work a mine, it delivers some return then it’s gone and trees get planted.

MS is an interesting case in particular because theyve generally stated their cash balance in terms of how long they could survive. They had cash enough to last 5 years with no income; thats how they put it. Gives you a sense of the thinking at Microsoft.

MSFT was a steady rise until 2000, after that it has struggled ever since (with increasing volumes of shares changing hands at lower prices in recent years). The market predicted that the company reached it’s peak long before anyone believed it, and I’d guess that 2000 was about the year that Linux became viable as a mainstream OS (maybe also around the time that Apple flipped over to BSD). I’d also argue that Windows 2000 was probably their best effort at an operating system, before they went down the DRM path. XP was just a layer of graphic wankery trying to pointlessly outdo Apple (which was a waste of time because MS customers already knew what they wanted and it was NOT Apple, and Apple customers already knew what they wanted too).

But this is getting away from the idea of saving for a rainy day, except to say that sitting on loads of cash in the current environment is OK for now, but the specter of inflation can’t stay under the couch forever. I give it no more than 6 months before we see serious inflation hitting in the US at least, then the inevitable mad scramble for hard assets will start.

pedro
pedro
12 years ago

Tel, I agree with you and I think the case for rainy day saving is limited. but we have been doing it with the future fund. I am always happy to acknowledge that governments are more likely to waste money than use it wisely.

Nick’s point is that the rivers of tax from the commodity boom could have been salted away and I think that is true to an extent, but you are right about the risk the government takes with the money because it does have to go somewhere. It could have been deposited with domestic banks under control of a board of trustees and with hindsight, that would have been the best place for the money. Though we don’t know if that would have made our banks take more risk with their lending book.

The meme at the time was that the Libs should have spent that money on infrastructure, which clearly would not have done much good for the current problem. first, it would have driven up demand at the time when construction was already maxed and second there would be even less useful things to spend the current stimulus on.