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Thursday, September 21, 2017

Is there a cure to stabilize an economy?

Posted by steve on July 24, 2012

The modern economy has undoubtedly given better lives to millions.

However, despite years of experience and development of macroeconomic theory, despite decades of Nobel prizes in Economics, there still doesn’t appear to be a way to run an economy without putting severe hardship on a large percentage of the population.

And this state of affairs is generally accepted.

Especially women, wives and mothers, it is women who end up suffering take from  this hardship.

The other thing that I know that women particularly care about is the environment. Again, it is also generally accepted that pollution is unavoidable and depletion of natural resources the unavoidable price for economic stability. The costs of pollution and depletion are not paid for directly by the producers or consumer, but by society as a whole. They are called externalities. Externalities, it seems, are unavoidable if we want a stable economy.

But let us not just give in. Let us look at possibilities.

I would like to explore ways of stabilizing economies, making sure demand – and thereby prosperity – remain high whilst responsibly stewarding natural and mineral resources.

Let us take a step back a moment and question our assumptions. Let us look not through the eyes of a business economist, but through the eyes of a macro economist. To see a nation not as a collection of competing businesses but as a functioning economic entity.

We see the national economy as one household. In this household everyone should get fed, and the money coming in is enough to cover the bills. Simple.

Or could we see the economy as a patient in hospital. If we are the doctors, is it possible to treat it in a way so as to keep it comfortable, to keep every healthy cell, every limb alive and healthy, to nurse it back to prosperity?

Maybe we could see the national economy as a football match. Of course there are winners and losers, but the footballers on both sides are doing what they love, the spectators have a great day out and everyone goes home to a good meal.

Let us look at this patient together.

Following the first great financial crisis of this millennium, many nations are struggling with high unemployment, soaring budget deficits and crippling debt servicing costs.

The temptation arises to introduce economic austerity measures and shock therapies. However, these measures reduce demand, reduce investments, reduce production and increase unemployment. These measures are unproductive, destructive and unfair. And poor people – the ones who have the least blame for the crisis – become losers and suffer.

Actually if we, from our macroeconomic vantage look at who owes money to whom, we will see that all domestic financial debts are, by definition, also domestic financial assets.

Using the household expenses picture, we could say that the bills are covered by the money coming in.

So no matter how large the public debt, it does not automatically mean that the country or that population as a whole is poor. An extreme example; Japan is a rich country and the Japanese are a rich people (On average) despite Japanese public debt per capita being the largest in the world. The Japanese public debt is simply owed to (albeit rich) people in Japan.

An accumulated foreign debt, on the other hand, is a problem which may have a greater impact on the country as a whole and especially on future generations. Such a debt will force future generations to work harder and to give up a considerable portion of their income to pay for the debt financed consumption of the previous generation.

The temptation could be to relax environmental constraints on firms, giving them an economic advantage. Although this lowers costs and may drive demand, the costs will be transferred to society and the resources depleted, again affecting future generations.

So what possibilities are there to stabilize recovery?

Well, we live in the information age. Most transactions are now digital. We can get masses of information, in almost real time, about how the economy is performing. And we can inform whole nations quickly – governments can explain and introduce measures and fees and prices can be made flexible.

The London congestion charge gives one small example of introducing a measure along with a flexible fee.

Most of the globe is working with a market economy. If a sound enough incentive structure can appear in the economy – an incentive harmonizing private good and long term public good – and at the same time externalities are internalized in the market, then, by definition, market forces will automatically work to solve the problems.

This is the same as in medicine. It is ultimately the body that heals itself, the role of the doctor is to harness and stimulate the process.

Could this approach work for the real estate market?

This market is vital as it serves as the underlying security of the financial system.  A real estate bubble collapse is often accompanied by serious and sometimes dangerous financial disturbances affecting the whole economy.

Returning real estate prices to pre-crisis value would do much to strengthen the economy.

So what instruments and medicines could we apply? How could we stimulate demand, and growth in prices?

We could introduce a house purchase subsidy. (Not unlike the new car subsidies in US and Germany or the eco-car subsidies in Sweden). And we could make it flexible.

Every house purchase would receive a subsidy as a percentage of the purchase price of the house.

T he subsidy would come out of a real estate market control fund when the deed had been properly registered.

Money for the fund comes from a percentage fee on the sale of property.

This is how it could work: Publicly announce that the purpose of the subsidy and the market control fund is to restore the value of the stock of real estate to the value it had before the collapse and then to secure its value to safeguard the securities in the finan­cial system.

Adjust the subsidy sufficiently often, the amount of adjustment depending on the rising or falling of prices in relation to the publicly announced target.

If prices rise higher and faster than intended, the sub­sidy could become negative. Then, by definition, the buyer will pay a buying fee to the fund as the seller receives a selling subsidy.

If done frequently enough,    a control subsidy futures market will emerge spontaneously  as a means to reduce risk exposure.

And with house prices stabilized and under control,  we have set the conditions for a stabilization of aggregate demand, which stabilizes employment.

Even aggregate demand could be stimulated with a consumption flexible subsidy.

Financed by a flat income tax, the subsidy would be highest at the point where aggregate demand has fallen off. Monitoring the average wage index and the consu­mer price index closely and adjusting the subsidy regularly and suffici­ently often,  a con­sumption control subsidy futures market will emerge spon­taneously.

Fees for harmful emissions could be introduced in the same way.

Money collected could be put back into the economy thanks to a societally beneficial redistribu­tion of the purcha­sing power.

This would drive the development of sustainable consumption.

But what about the balance of trade?

Trade imbalances which persist for long periods of time tend to warp the infrastructure of the economy and create imbalances which will harm the economy in the long run. Sooner or later these structural imbalances will have to be remedied at a cost.

The sole purpose of the export is to pay for the import. Just like the need for  a household budget to balance outgoings with incomings, Acting according to this principle is the only long-term, responsible and sustainable way of handling the trade between countries.

Viewing a large trade surplus as positive indi­cators in the econo­my and failing to take action or even worse; trying to increase the amount of exported goods and services by various means, above what is needed to pay for the import, is harmful. The harmful side effects include warping the structure of the economy both in countries with an export surplus and in countries with an import surplus.

There are some straightforward methods to eliminate an accumu­lated trade debt and to turn a trade deficit into a balanced trade. The method is to charge a, sector neutral, import control fee, designed as a flat percen­tage of the value, on all imported goods and services.

It must be publicly and internationally announced that the sole purpose of the import control fee is to achieve a gradual and steady, controlled shift towards a sustainable, balanced trade.

It must also be made totally clear that the import control fee is not a trade-impeding measure but instead a measure to improve the balance of trade both regionally and globally and make it long-term sustain­able and beneficial for all countries.

The income from the import control fee can be used, in full, as a budget revenue. Another possibility is to use the income from the fee to pay for an export control subsidy using the same percentage as the import percentage fee. As long as the value of the import is greater than the value of the export, there will be a net budget revenue.

The import and export markets should be continuously monitored and the percentage fee should be adjusted regularly and sufficiently often for a control fee futures market to emerge spontaneously.

For countries with a trade surplus the import fee can be replaced with an import control subsidy and the export subsidy can be replaced with an export control fee following the same basic logical principles as the control of the above mentioned import control fee and export control subsidy.

To minimize the total societal cost of creating a sustainable econo­mic structure and balancing the trade, the trade control fees should be used with caution and the restructuring of the economy is best done over a period of several years. However the beneficial psychological effects on the market can be immediate as soon as the principle and the long-term effects of the trade control measures are understood.

The trade control fee should not be viewed as a permanent solu­tion to the prob­lem of trade imbalances. These problems need to be solved by proper control of the credit volume and the rate of credit expan­sion in the economy so that the average real wage, in the long term, can reflect the ave­rage real labor produc­tivity and so that the rate of consumer price infla­tion and the rate of asset price inflation can be harmonized within the region.

So. the solution I am proposing in principle is to set clear goals for the economy as a whole

– or to use my analogy in the beginning – to clearly define the goal posts. Then, introduce a flexible system of subsidies and fees. Adjust these often enough to stimulate the market to ensure targets are met. The uncertainty created will mean futures markets will emerge spontaneously. The financial sector will then start to follow even more closely factors salient to reaching targets including real estate, pollution abatement, aggregate demand and balance of payments.

This, I believe, is the right strategy for the modern economy. To spare citizens the unfair hardships of laissez faire whilst avoiding the stifling restrictions of a planned economy approach.

The ideas I put forth today are not new. All the principles proposed   regarding human psychology,  incentive structures and stabilizing feedback control are based on an abundance of well proven know­ledge freely available from fields outside economics. I propose they are made part of the national economic paradigm.

So to sum up, communicating clearly, setting acceptable targets, using control system thinking, market forces can drive the change for good, and sustainability. We can ensure that business does that which it does best: in a way that women understand best -providing a good life for all citizens.

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