Economic Policy Framework
for the 21st Century
Professor Dermot McAleese
MSc EPS Hilary Term 2011 (S1)
1
OUTLINE
The new consensus
Why policy adopted
Implications of model
Will the consensus last?
New directions for policy post
2008
2
THE NEW CONSENSUS
Competition and the market system
Macroeconomic stability
Globalisation
3
A Successful Strategy for
Growth Requires:
openness towards international trade
limited government intervention in the economy,
and
macroeconomic stability
IMF, World Economic Outlook, May 1997, p 92
4
COMPETITION AND THE MARKET SYSTEM
Pro-competition policies
Labour market flexibility
Privatisation
Deregulation
Enterprise-friendly environment
5
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 20036
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
7
Inward Foreign Direct Investment in India
Columbia FDI profiles March 2010
8
9
The OECD on Greece Nov 2009
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.
10
MACRO-STABILITY
Price stability (independent central bank,
‘hard’ exchange rate)
Budget balance
Control of government spending
FINANCIAL STABILITY
11
Consensus brings low inflation
12
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 14
The OECD on Greece November 2009
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
15
Consensus turns Keynesian
(% of GDP)
IMF Oct 2009 ch 1 16
GLOBALISATION
Free trade
Foreign investment
Liberalisation of capital
Labour mobility
17
WTO Members and Observers August 2009
(August 2009)
Members
Observers
Others
18
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
22
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 25
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 Other
Externalities?” Happiness and Public Economics Conference, Centre for
Economic Performance London 23-24 Sept 2006 30
US Income Distribution after tax 1979-2000
31
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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Faultline 2: Vulnerability
‘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
33
Some think that the WTO view is too optimistic …..
‘ 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
34
Faultline 3: The problem of private sector
debt
Public (government) debt a problem ….
…… but also private debt
(Discussed in S4)
35
(% GDP)
Public Debt = Central Govt + all govt agencies
36
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
37
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
40
Pressures on New Consensus
Who cares about competition policy?
Nationalisation of banks
Labour market flexibility -- all that good?
Unemployment
--------------------------------------------
Budget deficits, escalating public debt
Deflation
Household debt and consumption
---------------------------------------------------
Protectionism and Competitiveness
Competitive 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. …..
43
14th Sep 2007
Northern Rock
THINGS FALL APART,
THE CENTRE CANNOT
HOLD …….
24th Sep 2008
Bank of East Asia
44
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
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