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Economics

[2558] Introducing unemployment benefits in Malaysia may be good

There was a piece of news recently that the government plans to introduce unemployment benefits in Malaysia. By default, as a libertarian, this should be a repulsive idea to me. But really, I can be supportive of the benefits on at least one condition.

I like rule-based policy and I mostly dislike discretionary one, especially when it comes to fiscal policy. I distrust the government in managing its finance because the government, especially one that is especially susceptible to populist demand, may easily spend with much disregard to public finance. This is especially so in times of recession. I in fact distrust the government in even committing to a complete counter-cyclical spending. The typical reaction to a typical recession by those in government is a Keynesian one: spend. In good times, the necessary austerity is not taken.

I dislike stimulus program not only because of ideological reason but also because of practicality. Stimulus spending is slow and open to abuse if one wants to make it effective and quick. It is open to abuse because, after all, it is a large discretionary spending. Besides, its multiplier effect is not really that clear and because it is slow, government demand may crowd out private demand especially during recovery period.

An unemployment benefit system is like a fiscal stimulus except that it is an automatic stabilizer. That means it is fast, direct and it is more transparent than a discretionary orthodox fiscal stimulus. It is based on rules.

The presence of an automatic stabilizer may reduce the temptation to engage in a massive fiscal stimulus like what happened in 2008 and 2009 in Malaysia and indeed all around the world during the now-dead Keynesian resurgence.

True, it does cost money and it does increase the size of government. But I have a suspicion that an automatic stabilizer like the unemployment benefits, if properly designed to help the unemployed rather than take away the incentive to work, can be cheaper than a fiscal stimulus. It can prevent a worse evil.

There is an added benefit to having an unemployment benefit mechanism in place: better and timely data to gauge the labor market. In the US, labor data through initial claims is produced weekly and lagged by only a week. Professional economists in Malaysia will appreciate this. Right now, only the heaven knows, economic reporting in Malaysia is lagging behind advanced countries by a long shot. Economic data is not really forthcoming.

Categories
Economics

[2557] Did the LTRO fail?

So after the rumor of bailout, the official denial and later the external pressure, Spain has finally requested for a bail out from Europe. The bailout is expected to be utilized, in turn, to bail out Spanish banks. The money will come from either the EFSF or the ESM, whichever is politically expedient.

Even before the request, the Spanish government has already bailed out its fourth largest banks just recently.

I find the bailout in Spain as curious because it raises one question: whatever happened to the LTRO?

Aren’t the LTRO with money worth EUR1 trillion meant to bail out banks implicitly?

Did the LTRO fail to do what it was meant to do, which was to give European banks very cheap refinancing options over 3 years? Did Spanish banks not gain access to the LTRO? What did the Spanish banks do with the LTRO?

Categories
Economics

[2556] The tradeoff between internal and external consistency

A good theory has two characteristics: internal consistency and external consistency. An internally consistent theory is one that is parsimonious; it invokes no ad hoc or peculiar axioms. An externally consistent theory is one that fits the facts; it makes empirically refutable predictions that are not refuted. All scientists, including economists, strive for theories that are both internally and externally consistent. Yet, like all optimizing agents, scientists face tradeoffs. One theory may be more “beautiful,” while another may be easier to reconcile with observation.

The choice between alternative theories of the business cycle—in particular, between real business cycle theory and new Keynesian theory—is partly a choice between internal and external consistency. Real business cycle theory extends the Walrasian paradigm, the most widely understood and taught model in economics, and provides a unified explanation for economic growth and economic fluctuations. New Keynesian theory, in its attempt to mimic the world more accurately, relies on nominal rigidities that are observed but only little understood. Indeed, new Keynesians sometimes suggest that to understand the business cycle, it may be necessary to reject the axiom of rational, optimizing individuals, an act that for economists would be the ultimate abandonment of internal consistency. [Real Business Cycles: A New Keynesian Perspective. Gregory N. Mankiw. Journal of Economic Perspectives. Volume 3, Number 3. 1989.

Categories
Economics

[2555] What is the best banking system for high-skilled service industry?

During the launch of IMF Regional Outlook a few months ago, Anoop Singh, the IMF director for the Asia-Pacific Region mentioned how the financial system is not ready for high-skilled service industry.

As his argument goes, banks usually demand collateral before providing any loans to businesses (or, mostly, anybody for that matter). This is perfectly fine for capital-intensive businesses but it becomes an issue when it comes to labor-intensive businesses. With little capital, there is little to function as meaningful concrete collateral. There are other things that can replace collateral like personal guarantee but such guarantee has to be credible and eventually means the businessowner’s personal assets. You still require some concrete assets in the end.

But what if you are nobody but you have a great idea that is labor-intensive?

Here, labor-intensive means just you and your partners maybe sitting down writing codes or running some weird but amazing business that, in the extreme for illustrative purpose, is one of pure brainpower, negligible capital requirement and no muscle, manned by individuals of limited wealth.

There are venture capitalists and that is usually the solution to the problem. But imagine a widespread proliferation of such industry that it becomes the dominant industry in an economy. Venture capital setup will be woefully inadequate as a source of funding.

The virtue of a bank (commercial bank) is its capability to pool large capital through aggregation of savings and to redistribute it elsewhere pretty painlessly. Venture capitalists are decidedly not as good as a traditional commercial bank at pooling resources.

This leads to a question, what is the solution?

I am unclear about that.

The banking system is inadequate as Mr. Singh points out but I am unsure if banks should evolve to not require concrete collateral to accommodate for the so-called new service industry if ever we come to that fork. Identifying a problem, while helpful, is very different from formulating a solution.

And an evolved banking system designed to not require collateral sounds like recipe for a banking crisis. A large percentage of businesses fail and without collateral, the banking system of such evolved banks would quickly be brought down to their knees. And a banking crisis, in the modern economy, will quickly turn into a widespread, horrible, economic crisis.

What about the government?

The problem of business failures will still be relevant but at least it addresses the banking system concern by socializing losses. I doubt the taxpayers will be happy with that.

Categories
Economics

[2554] Is the real interest rate too high?

Those whom keep a close eye on monetary policy will realize that the real interest rate at the moment is positive. My data suggests it is above 1% mark right now given how the Overnight Policy Rate is at 3% and inflation is hovering around 2% with core inflation being slightly lower than headline inflation.

Despite an abstraction and not directly observed like the everyday nominal interest rate, it is the real interest rate that is crucial in determining decision between consumption and saving/investment in most cases. This is not to say the nominal interest rate is not an abstraction. It still is but real interest rate is not immediately understood or observed by laypersons as nominal interest rate.

The reason I am bringing up the issue about real interest rate is that I think there is a worry of a slowdown in the domestic economy, especially with European and Chinese economies showing signs of stress. And I am always not keen of shoring up the economy with fiscal policy in the traditional way as long as monetary policy can do the jobs well. I also think that monetary policy has done an excellent job in the past few years amid serious unprecedented crisis despite Keynesian’s liquidity trap theory, which appears to be irrelevant: as market monetarists have successfully argued, the fixation on interest rate is overrated in zero-interest rate situation. Market monetarists, the successor to the monetarism of the 1970s, of course, argue more about monetary policy but let us leave that aside for now because I know they would not like my fixation with interest rate here.

With more than 1% real interest rate, this creates the incentive to save more than to spend in the economy. Or to invest less. The bottom line is that it has a negative impact on economic growth.

One also has to remember that the OPR is the base rate. There are other rates based on the OPR and they are priced higher. This means the relevant real interest rate are higher than 1% for consumers and businesses.

Furthermore, in the free (or rather, maybe, just efficient?) market, I would assume the optimal real interest rate is 0%. This suggests that even under free market environment, the real interest rate is too high.

There are other considerations in the settings of the rate. One big consideration is the management of inflation. But with demand-pull inflation coming down and with downside risk as far as growth is concerned, I think there is room to make the real interest rate more accommodative to economic growth without scaring the hawks away.