Wednesday, February 18, 2009

Addressing Fitzgerald's Comments on the Sixteen Directives

Michael Fitzgerald on BNET makes valid points and asks interesting questions regarding my previous post on the sixteen directives for economic recovery policy design. I'll try to address them in this post.

I'd like to start by explaining why I used the word "directives" instead of "suggestions" or "proposals." It was intended to be a tongue-in-cheek commentary on the tendency of governments to present principles of action as orders. The irony behind these "directives" is that they regulate government more than anything else -- just as our Constitution does.

Why is it important to have these "directives"? To avoid the unintended consequences and abuses of government power that tend to creep up during periods of crisis. It also avoids the use of the crisis as an excuse to promote special interests. Naturally, this is all easier said than done.

Now, let me address Michael's comments. Regarding directive 4, "the government will partially or totally recover the cost of recapitalization by auctioning equity of recapitalized firms. No equity of recapitalized firms will remain on the hands of the government." Michael asks:

This one would seem to have the benefit of setting a clear value for bank stocks and other failing firms, toxic assets and all. On the downside, there will not be the chance for taxpayers to earn big profits on the stock if the firms recover.
This is certainly true, but I think this is good, not bad, for the following reasons:
  1. Markets are supposed to price the firms correctly once they've been recapitalized. Besides, stock prices may end up not increasing by any significant amount after auctioning, or may even fall, so why wait? Is the government supposed to know how to price them better than markets? Is the government able to predict the future? I don't think so. As a principle, governments must never hold equities anyway (the referee cannot be one of the players).
  2. I don't like the idea of letting the government second-guess the right moment to sell equities. Dangerous stuff (did I mention yet that the referee cannot be one of the players?).
  3. The cost of cleaning up assets will have to be borne by society one way or another. Policy cannot change this, but it can alter economic incentives (leading to more efficient outcomes) and the distribution of costs, benefits and risks (who bears what). Cheap prices during auctioning of recapitalized firms for example would create incentives for investors to bet on the economic recovery, despite elevated risks reflected in cheap prices. Would this be a bad thing? Probably not. On the other hand, if the government doesn't auction cheap stocks and holds equity, the government will be the one taking the risks implicit in the low prices. Should taxpayers carry the risk burden through government ownership of equity? Clearly not.
  4. Will there be distributional effects in case of economic recovery? Sure there will be. However, the redistribution in this case will at least be aligned with correct incentives and will be based on merit (although judgments of merit are subjective, and therefore open to discussion).

Regarding directive 5, "the government will not be allowed to have executive powers in recapitalized firms." Michael asks:

It seems straightforward on the surface. But does it actually suggest that the government should not be able to regulate even firms it has saved? Should the government not have a car czar for Detroit? What about Freddie Mac and Fannie Mae? And how should we represent taxpayers’ interests for firms that have been deemed worthy of saving, such as AIG?

Sorry, maybe I didn't make myself clear. "Executive powers" here means "administrative powers", not "executive power" as in government separation of powers. To make the point clear: I believe that governments by definition must have regulatory powers -- that's exactly what governments are made for. However, I also believe that governments should never be allowed to manage firms (again, always a referee, never one of the players). I think economic theory and historic evidence are very clear regarding the problems created by governmental management of enterprises.

In practice, apply to recapitalized firms the same administrative framework that's usually adopted during bankruptcy procedures until equity is auctioned out. Government has no business in managing firms.

Regarding directives 10, "fiscal stimulus will operate mostly through permanent or temporary tax cuts that promote consumption and investment," and 11, "the government will not create obstacles to firms and households that wish to reduce their levels of indebtedness and will not suggest that they should do otherwise," Michael asks:

Numbers 10 and 11 seem contradictory. If the government is not to suggest we increase our debt levels, why should it also promote consumption? Not that we have to buy things on credit, but that does seem to be the pattern here. Also, as much as I feel overburdened by taxes, cutting them seems likely to create more debt for my kids’ generation.

The idea here is simple: assuming that a fiscal stimulus is necessary, it's up to each one to know how to spend the money, it's not up to the government. It implies no big economic theory argument: I don't think any macroeconomist really knows how to compare tax cuts and government spending based on their potential to stimulate the economy as a single criterion. The debate is not technical, it is political, and my preferences are clear: I don't want mayors to spend my money for me; I want to spend my money myself. I understand however that some people prefer politicians to spend their money for them -- particularly when politicians also spend other people's money on them.

Besides, I doubt that anybody at this point wants more indebtedness. However, some people may not see it as a problem, and may want to consume more if they get tax breaks, and some other people may think that their way out of trouble is through reduction of indebtedness. The government should not be meddling with this, and above all should not be moralizing on those issues, after all who is the government to be moralizing on indebtedness management anyway.

Regarding directive 12, "reduction of indebtedness will not be done through contractual breaches and rewrites or through excessive inflation," Michael asks:

How about a Jubilee year?

Joke or not (I've seen some Jubilee ideas floating around), involuntary contract rewriting and excessive inflation are not only theoretically unsound (create all kinds of wrong incentives and long-term credibility problems for the "referee"), but have been shown throughout history to be another way to create economic disasters, just ask Argentina and Brazil.

Regarding directive 13, "negative income tax benefits or lump-sum transfers will be used as the primary tools to help the poor and unemployed. Terms and benefits of unemployment insurance will not be extended or improved to avoid long-term negative consequences to employment," Michael asks:

The first part of 13 makes good sense. But the idea of constraints on unemployment insurance don’t seem to mesh with recent work by Ivan Werning and Robert Shimer (see, for instance, Liquidity and Insurance for the Unemployed).

You got me here Michael: I'm sure that there's a better (more efficient) unemployment benefit policy than the one that exists now. That's not however the point of this directive. I don't think that this is the time to mess with that, and I believe that we should first make sure that resources are available for the current unemployment benefit program as it is, and that those funds are not wasted with less important programs, and that they're also not wasted with changes in unemployment benefits rushed by politicians without any serious informative debate. I'm also sure that, if changes are made now, under the current political climate, they will probably be for worse, on the lines of what nobody else than Larry Summers once wrote regarding the causes of long-term unemployment.

Regarding directive 14, "no government action will empower worker or industry unions of any kind," Michael asks:

I’m not sure where he’s going with this. Does he want to ban unions? Is he bashing unions for trying to create better lives for their members, especially in the wake of the 1930s? Is he reacting to contracts that now make management look spineless, and blaming the unions for these?

I go with Miron here. Although I accept the fact that worker and industry unions are economic institutions that can even have positive roles, for example, by reducing labor conflicts, organizing technical standards, etc. They should be allowed to exist however only independently of the state. Directive 14 exists to make sure that we don't end up going the way of Mussolini's Italy or Peron's Argentina because of a recession.

Regarding directive 16, "no government officer will suggest that the world will end and the mountains will crumble to the sea, no matter how tempting it may be to do it," Michael asks:

Hear, hear. (But what if it’s true?)

Well, then we should start praying, because I'm sure that in this case the government is not the one that'll save us anyway (grinning)...

Anyway, I want to thank Michael for the comments.

1 comment:

ENNYMAN said...

Impressive defense... and I wholly concur that referees need to be impartial, and cannot be one of the players.... or coaches or owners.