Tag Archives: MPA

THE POLITICS OF MARKET REFORM

THE POLITICS OF MARKET REFORM

K. Weyland

Chapters V and VI

A Summary

 

In a Nutshell

Weyland interprets the conversion to market economics using prospect theory. This essentially postulates that the crisis affecting Brazil, Argentina and Peru meant that a majority of the population saw themselves in the “domain of losses” mostly due to inflation. They thus made a risk seeking response in electing political outsiders (Collor, Menem and Fujimori respectively). These new chief executives also saw themselves in the domain of losses thus becoming highly risk acceptant and therefore led their countries down a path of market reforms. They were not tied down by previous decision bias, and they had learnt from the recent failure of heterodoxy. In choosing the reform measures they were far more drastic and draconian than even the IFIs were advocating. They imposed high short-term costs on important sectors, and strata of society. Yet, the public were initially supportive. This fact reflects the acceptance of costs due to risk seeking in the domain of losses.

 Venezuela’s public did not accept the reforms. Perez was not a political outsider, and when tried to push through reforms there were major riots in the streets. The driving factor behind acceptance in the other cases, and failure for Venezuela was the severity of the crisis. In Venezuela, inflation had not reached anything like the levels it had in Peru, Argentina, Brazil, and as such the majority did not see themselves in the domain of losses meaning that the high costs imposed by stabilization were thought to be unjustified.

 The politics of this time should be classified as neo-populist due to reliance on the anti-establishment credentials by the politically outsider presidents of BAP, as well as the invocation of the will of the people against entrenched interests.

 The Rise of Political Outsiders

  • The huge losses suffered due to hyperinflation looked set to continue, so in Braz, Arg and Peru, the voters took a risk by electing political outsiders with weak track records. By contrast, Venezuelans elected a former president, Perez, as the economic decline was much more gradual and so the populace did not see themselves in the domain of losses.
  • The governments of BAP had been thoroughly discredited (collapse of spring plan [Arg], summer plan [Braz]). Thus risk seeking in the domain of losses induced voters to reject decisively the incumbents. Critically for the argument, there were much more moderate alternatives, that offered change at a much lower risk than the candidates actually chosen as they had technical know-how, organizational capabilities etc. However, the risk seeking led electorates to reject the political class as a whole and vote for outsiders. The politicians themselves reinforced their outsider credentials by populist campaign rhetoric which attacked established elites.

 The Initiation of Drastic Adjustment

The Depth of the Crisis

  • On taking office the presidents were privy to the previously private information about the full extent of the crisis, so they took over under much worse economic conditions.
  • Conditions varied: Venezuela did not have hyperinflation. Argentina was worse than Brazil as Arg had been in stagnation for years whereas Braz had been growing. Also Brazil was fully indexed so the population did not feel the effects of inflation in the same way. The burden there fell mostly in the large informal sector.

 External Constraints and Pressures

  • IFIs recommended orthodox adjustment. But in none of the countries was this decisive. The IMF had a lot of influence in Venezuela and Peru, but the programmes in Argentina and Brazil were designed by domestic economists, although they did follow broadly the Washington Consensus. All plans were radically bolder and more risky (e.g. debt moratorium and capital freezing in Brazil, and the convertibility plan in Arg) than the IFIs recommended who were worried about domestic backlash. 

 Learning from Prior Experiences

  • Heterodoxy had lost its appeal.
  • So there was learning, but no real learning about how to enact market reform. Additionally, the experience of Chile was not good – the early stabilization there caused a huge increase in poverty and eventually the crisis of the early 80s. There were only really positive results when reforms were made in a more incremental way with sustained growth. Moreover the violent reaction by the people of Venezuela to the neoliberal reforms was widely interpreted as a rejection of the paradigm.

 Domain of Losses

  • The presidents overshot IFI influence and owned the policies. As soon as the crisis passed and growth resumed they reverted to risk aversion.
  • They were not tied down by prior decision bias so could chart a new course.
  • They saw themselves in the domain of losses. This led them to choose particularly risky policies.

Venezuela:

  • Raised public sector prices, reduced public spending, opened up the country to trade.
  • Deep recession caused by enactment at high speed.
  • The oil bonanza of 1990-91 caused Perez to slack off it austerity program, using the funds for public spending to ease the pain of adjustment.

Argentina:

  • Menem also proceeded at high speed, diverging from his campaign rhetoric by trying to dismantle ISI model
  • 1st plan failed at end of 1989, so he upped the ante by forcibly retaining financial assets (highly risky due to offence caused to capitalists).
  • Convertibility plan tied the government’s hands to non-intervention in ex-rate policy which sent a signal to international investors.

Brazil:

  • Collor chose the most radical plan on the table.
  • Spending cuts, tax hikes, privatization, liquidity confiscated for 18 months, froze savings accounts.

Peru:

  • Abrupt devaluation, tax increases
  • Painful stabilization especially given the already high level of poverty.
  • In all cases the paths chosen had lower expected values than some of the more prudent alternatives. Yet they held the promise of a quick turnaround, and this promise was enough to risk potentially total economic meltdown. The more moderate response was particularly feasible in Venezuela due to the absence of hyperinflation.

 The Popular Response

  • Divergence in the severity of the problems facing the citizens determined the different levels of support for reform.
  • Presidents diverged from their campaigns, and could not have foreseen the popular support, showing that they did not act as simple agents of the citizens.
  • In BAP initial support was very strong. There was even support when Fujimori closed down the Congress. Not the case in Venezuela.

 Neo-Populism

  • Outsiders + heterogeneous support networks + “will of the people” rhetoric against special interests, meant that neoliberal economics and populist politics went hand in hand [although the working classes were the hardest hit by the reforms, so their welfare was not at the top of the priority list as it was with more traditional populism].
    • They weakened interest groups, extended personal latitude, dismantle bureaucratic structures etc. which allowed them to assault the numerous subsidies and protections that were part of the reform.
    • Neo-populist rhetoric legitimized the reforms
    • Increase tax takings allowed new forms of discretionary spending further boosting support. [See Schamis].
    • In the end Collor went the same was as Perez whereas Fujimori and Menem won re-election. Whereas Collor was constrained by the Brazilian congress, Fujimori was able to shut congress due to the extraordinary depth of the crisis in Peru which made such an action acceptable.

 Slowdown of Reform

  • The Argentine convertibility plan controlled inflation and growth between 1991-1994 reached 7.5%.
  • Peru grew at 7% in 1993 and 14% in 1994.
  • As the economies recovered, leaders and population entered into the domain of gains, so Menem and Fujimori gave up their initial boldness and became much more cautious. Labour market deregulation and social security reform languished in congress, and continued privatization required ever more concessions.
  • The Mexican crisis of 1994 motivated the Menem government to give a renewed push.

 Political Failure of Neoliberal Reform in Brazil

  • Collor was unable to achieve stabilization. Prices were on the rise again in 1991 after two shock plans had failed. He was politically isolated without much political support so was unable to enact audacious reforms like the convertibility package in Argentina. He lacked the clout to push policy through congress.
  • He did however set in motion the processes that enabled the subsequent Franco government to undertake adjustment efforts.
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THE POLITICAL ECONOMY OF RECENT CONVERSIONS TO MARKET ECONOMICS IN LATIN AMERICA

THE POLITICAL ECONOMY OF RECENT CONVERSIONS TO MARKET ECONOMICS IN LATIN AMERICA

D. E. Hojman

Journal of Latin American Studies, Vol. 26, No.1 (Feb., 1994)

A Summary

 

In a Nutshell

The free market reforms that occurred in LA in the 1990s were remarkable particularly as they occurred under conditions of democracy at a time when it was thought such reforms could only be successfully implemented under authoritarian rule. However, there is no single sufficient factor that can explain the conversion. Different factors took on different significance in different countries, and what was of particular importance was the differing interaction between factors. Hojman outlines the 6 most important factors.

  1. Lessons learnt from the debt crisis and its aftermath
  2. More highly qualified technocrats
  3. Development of an entrepreneurial middle class
  4. Exhaustion of ISI
  5. Tax reform, export diversification and financial modernization
  6. Public opinion

 The Debt Crisis and Environment of Ideas

  • Free market reforms are easier to accept if the country is in crisis [Weyland – and the depth of the crisis may help understand the strength of the response, and public support for it]. Additionally policy makers may have learnt from recent mistaken attempts at heterodoxy e.g. the Menem government that followed Alfonsin in Argentina. Indeed, reforms did occur post crisis, but not always e.g. Chile in the 70s.
  • Temptation to see structural reform as imposed, but it is important to distinguish between stabilization and structural adjustment. Often academics confuse the two notions, but it was only the latter that was required by the IFIs. Part of the reason for the confusion is that structural reforms were undertaken as stabilization measures [see Weyland piece summarized this week].
  • There was an intellectual shift toward free market reforms. Whereas this had previously only been supported by the Chicago school economists, now MIT (Dornbusch) and Harvard (Sachs) were on board too.
  • Free market policies are rewarded by loans and investment, and populism is punished by withdrawal. This aspect is related to the internationalization of the world economy. Perhaps the forces of globalization were simply not capable of being resisted.
  • Chile’s reforms had little to do with the debt crisis. The reforms were a continuation of past experiments at export promotion, and perhaps inspired by the Chicago boys who were very active in that country.
  • Mexico can be more directly linked to the crisis, but there were important factors such as the new presence of highly trained technocrats, as well as the pressures arising from the close proximity to the US, and the lure of gains to be had from the NAFTA agreement.
  • Bolivia follows partly the crisis/acceptance idea [Weyland].

 Technocrats

  • Colombia has always had high academic standards in the finance and related ministries. A PhD is a prerequisite. This may explain the absence of populist policies in recent history as well as relative macroeconomic stability.
  • Venezuela is the opposite. They have been unable to train and maintain tax specialists, meaning tax reform has been very slow etc.
  • Chile’s reforms under the military regime were suggested by the Chicago economists.
  • Not present in Bolivia.
  • Technocrats could not persuade Brazil to adopt reforms.

 Entrepreneurial Middle Classes

  • The presence of a middle class does not start free market reform, but it may help sustain it. [I am not sure on what basis he says that reforms have ideological or political rather than sociological bases, but it is stated as a given in the text.] The main evidence for this is that middle classes have been developing for some time in LA, but it was not until the 80s that free market reforms were enacted in a broad range of economies.
  • The Sachs thesis that populist policies are easier to accept in countries with higher inequalities as the poor have little to lose seems to fit here. Chile had the most advanced middle class, and they were also the first to go for market reforms. Argentina likewise has a more even distribution than say Brazil, and this meant that reforms were more readily accepted.
  • In Mexico, a large middle class associated with the maquilas sprung up and demanded more openness. They were clearly to benefit from the NAFTA agreement.

 Exhaustion of ISI

  • Exhaustion had been forecast since the 1960s, but in the 80s/90s, many scholars now saw its decline as inevitable and irreversible.
  • The effects of this were felt differently in the different economies. In the medium sized economies of Chile, Colombia, Peru etc. exhaustion was felt earlier as domestic markets were too small to sustain industry. This meant some protection levels were at 1000% for the car market for example. The Andean pact was an attempt to extend ISI by increasing the market size, but it failed. In the larger economies such as Brazil, Argentina and Mexico, ISI continued to be more or less successful and there as an eventual switch to export promotion alongside ISI.
  • The size etc. of Brazil can explain why free market reforms were slower and less enthusiastically adopted there than in other states. Subsidies are still high, and industries are supported e.g. computer industry. Additionally, free market reforms are associated with Collor and he was thrown out on corruption charges so they have a bad name.
  • There was a significant demonstration effect provided by the East Asian miracle growth countries.

 Tax Reform, Financial Modernization and Export Diversification

  • None of these are necessary nor sufficient, but they did help the implementation of the reforms as once they are performed regression to a more backward policy regime is harder to achieve.
  • Colombia pioneered tax reform. Followed by Uruguay and Chile. They have generally been value added rather than progressive income taxes. Thus it has been necessary to leave behind the idea of income redistribution through taxation.
  • Diversification of exports has occurred. Between 1970 and 1990 primary exports fell from 66% to 41% of total exports, as manufactures rose from 11, to 35%. Export diversification occurs when a number of domestic products become competitive on an international market and as such is not the result of subsidies, but of micro-processes connected to the discovery, adoption and diffusion of technological capabilities etc. This is more a result of rather than a cause of free market reforms. But once it occurs and new middle classes of exporters arise, dynamic pressures are generated to pursue the reforms further.

 Public Opinion

  • Media has been behind the reforms (Chile ESP.).
  • There is broad support for the reforms.
  • Voter learning.
  • It is often argued that reform damages the poor [which I agree with in terms of poor design, sequencing, lack of focus on the poverty etc.]
  • [See Weyland piece for more in depth analysis of public opinion.

Other Possible Factors

  • Collapse of Soviet Union.
  • Bolivia demonstrated the ability to cut inflation from 1000s to single digits – i.e. a bandwagon.
  • Mexico encouraged by special relationship with US

OVERVIEW OF THE BUREAUCRATIC-AUTHORITARIAN MODEL

OVERVIEW OF THE BUREAUCRATIC-AUTHORITARIAN MODEL

D. Collier

In D. Collier (ed.) The New Authoritarianism

 A Summary

In a Nutshell

Modernisation theory in development literature suggested that socio-economic modernization and democracy go hand in hand, this is why the conversion to authoritarianism in LA proposed such a challenge to academics. More generally the change happened in an era where the expectations of the 50s and 60s that greater economic and social equality would lead to a more democratic form of politics, were eroded. In place of these ideas it was now suggested that in late developing nations, more advanced industrialization may coincide with the collapse of democracy, and an increase in inequality. Indeed it was posited that the social, political and economic tensions generated by the particular type of dependent capitalist industrialization led to the collapse of the populist regimes, and hence as the popular sector as one of political strength. The elimination of the popular sector from politics, and the associated regressive move of income toward the middle and upper classes greatly increased inequality under BA.

The remainder of the chapter summarizes the key points of the O’Donnell thesis:

Political Systems and Change

  • Regime: the structure of politics – repression, representation, freedoms etc.
  • Coalition: class and sectoral composition of dominant political forces.
  • Policies: specific tools for allocating resources.

There are three types of “constellation” for O’Donnell that have different patterns of regime, coalition and policy

  1. Oligarchic: limited political competition. The elite is based upon primary product exports, and policy is geared toward this end (open economy). The system is not yet incorporating or excluding as the popular sector is not yet activated
  2. Populist: incorporating, multi-class coalition of urban-industrial interests including industrial elite and working classes. Economic nationalism is common. The state promotes industrialization based upon consumer goods.
  3. Bureaucratic-Authoritarianism: excluding systems that are non-democratic. Central actors are technocrats, military and civilian. Policy is concerned with advanced industrialization, and representation, elections etc. are eliminated.

The political transformations that move us from one to the other derive from social and political tensions produced by industrialization and by changes in the social structure. There are three particularly relevant factors:

  1. Industrialization: different phases linked to political changes as payoffs accrue to different class groups. Consumer goods production associated with the move from oligarchy to populism. This allows for the incorporation of the working class as wage setting can be generous without import competition, and also beneficial in expanding the domestic market. Thus workers receive important material benefits. Once this phase is complete, there are tensions as opportunities for expansion become more limited. The cost of importing the capital and intermediate goods is driving inflation, a balance of payment deficit, foreign indebtedness etc. Thus a shift to more orthodox policies is needed to create deepening of industry through domestic manufacturing of intermediate and capital goods. However in order to do this technology, managerial experience and capital is needed, and these things are often associated with multinational corporations. The need to attract this type of investment drives the adaptation of the move to orthodoxy.
  2. Activation of the Popular Sector: The popular sector will challenge the move to orthodoxy. There is thus a gap between demands and policies leading to strikes, and political/economic crisis.
  3. Technocratic Rules: Technocrats perceive high levels of popular sector mobilization as an obstacle to economic growth. They are thus bale to form a coup coalition.

The above process was evident in Brazil (1964), Argentina (1966, and 1976), Uruguay and Chile (1973). The case of Mex was once where phases one ISI was completed in an already fairly authoritarian society meaning the transition to advanced industrialization were accompanied by a continuity of political institutions.

The Evolution of Bureaucratic-Authoritarianism

  • Groups that initially supported the coup (entrepreneurs and middle classes) soon find themselves hurt by the orthodox polices. This means the principal class that supports the government is foreign capital. After a while there are increased called for this relationship to expand to include the middle classes.
  • This transition occurs according to the level of threat existent in the pre-coup society. i.e. the greater the threat to capitalism in the pre-coup era, the stronger the technocratic coalition will be, and so they will be better able to maintain order. This is seen in Brazil where the pre-coup crisis was severe and the subsequent regime strong, as compared to Argentina where the crisis was far less serious meaning elite cohesion post-coup was weaker which ultimately led to the regime falling.

Conclusion

  • At a general level the framework focuses on the interaction between crucial features of politics in LA – dominant collation, regime and policy.
  • At a more specific level it focuses on economic problems associated with different levels of industrialization and the perception of threat as a driving force of the evolution of BA.

POLITICS, DONORS AND THE INEFFECTIVENESS OF ANTI-CORRUPTION INSTITUTIONS

POLITICS, DONORS AND THE INEFFECTIVENESS OF ANTI-CORRUPTION INSTITUTIONS IN UGANDA

R. Tangri & A. Mwenda

Journal of Modern African Studies, 44, 1 (2006)

A Summary

 

In a Nutshell

Anti-corruption drives in Africa have been focussed largely on reducing routine levels of corruption. Replacing the state economy with market mechanisms, promoting accountability and transparency in government operations and other measures have reduced the opportunities for corruption as well as increasing the chances of getting caught. However, the reforms necessary to reduce corruption at the highest level, such as promoting political competition, and institutions that oversee the prosecution of corruption at high levels depend for their effectiveness to a large degree on both financial capability (which is often low), and cooperation from the elite leaders (which is often absent). This latter phenomenon persists despite continued rhetoric by leaders as to their willingness to tackle corruption.

This indicates that the nature of a country’s political system cannot be ignired when thinking about corruption. For example, Uganda has been a virtual one party system for decades and this constrains the possibility of the legislature and the judiciary holding the government to account. Whilst corruption is undoubtedly used for private gain, it is also used to perpetuate the regime through the use of funds for campaigning, and this explains why top political leaders have shown limited political will to contain such corruption. It also means that those charged with overseeing corruption prosecutions have an incentive not to proceed as they depend for their existence on one very firm set of political benefactors. Because elite corruption is am important means of consolidating the government in power, top leaders have influenced and controlled anti-corruption bodies whenever they have threatened to expose the corrupt ways of Uganda’s state elites.

Also at fault are IFIs and donors who are more focussed on economic goals than corruption reduction.

THE PARTISAN POLITICAL ECONOMY

THE PARTISAN POLITICAL ECONOMY

From Unequal Democracy: The Political Economy of the New Gilded Age

L. Bartels (2008)

In a Nutshell

Escalating income inequality is neither an “economic reality” nor a natural consequence of the US capitalism; it is the result of policy choices. Different patterns of inequality growth reflect consistent differences between the Republican and Democratic policy actions. Under Republican administrations real income growth for the middle and lower classes has consistently lagged behind income growth for the rich. Under Democratic regimes the lower and middle classes see much greater real income growth. Indeed under Democratic regimes inequality reduces slightly whereas it escalates under Republican governments. The data do not support the notion that these cycles are part of some cycle of calibration whereby Democrats expand the economy unsustainably and then the Republican government much see it contract. Nor can oil price shocks be blamed, as the results indicate that oil shocks affect households more or less equally and so have little effect on inequality.

The reason for the difference between the effects on inequality that the parties have is largely due to different macroeconomic policy. Democrats are more likely to run the risk of higher inflation in order to pursue expansive policies designed to yield lower unemployment and extra growth. Republicans fight inflation with tight fiscal policy etc. The result is that unemployment under Democrats is on average 2 % lower and real output about 6% higher. These elements of the economy have the most salient effects on lower income households and very little effect on rich households.

In terms of taxes the parties have very different philosophies. For example Kennedy instituted tax cuts at the lower end of the income distribution in order to stimulate demand to boost the economy. Reagan gave tax cuts to the rich as they have a larger role in saving and investment. Democrats come at the problem from the demand side, and the Republicans from the supply side. Reagan presided over a dramatic redistribution of the tax burden from corporations and the wealthy toward the middle and lower classes. A similar cycle was seen in the Clinton/Bush years.

TESTING MODELS OF DISTIRBUTIVE POLITICS



TESTING MODELS OF DISTIRBUTIVE POLITICS USING EXIT POLLS TO MEAUSRE VOTERS’ PREFERENCES AND PARTISANSHIP

V. Lacinese, J.Snyder & C. Testa

Centro Studi Luca d’Angliano Development Studies Working Paper No. 278 (Nov., 2009)

 

A Summary

 

In a Nutshell

This is an empirical test of three theories of distribution:

1.       The “swing voter” hypothesis which predicts that a larger share of distributive goods will go to groups or areas that contain larger numbers of swing voters (indifferent between parties on ideological grounds).

o   If voters  can trade off their ideological stances in exchange for public funds and projects then it is cheaper for politicians to “buy” the votes of the indifferent voters  so this will lead to a disproportionate allocation of funds to areas that contain many such voters.

2.       The “electoral battleground” hypothesis whereby distributive goods are allocated to areas where the share of supporters for each party is close to 50%. This is particularly relevant for FPTP systems with two major parties and well defined constituencies.

3.       The “partisan supporters” hypothesis in which politicians favour those areas that contain a larger percentage of their core supporters.

o   This could be a rational strategy in low turnout elections if spending primarily mobilizes voters. Thus it would make sense to target areas with core supporters.

o   It could also reflect the fact that politicians are to some extent policy oriented.

 

In all three it is assumed that all politicians care about is winning elections.

They use exit poll data on self-identification rather than voting results as voting is endogenous to the model of distribution so this tends to bias estimates in studies that use such data. By using the exit poll data they can construct a measure of “independent voter” that should be relatively clear of measurement error.

 

Data

·         US data

·         Dependent variables: total federal spending pc.; total spending other than direct transfers to individuals (the most manipulable items of the budget); federal grants pc. (the most targetable).

·         Poll data measuring the share of independents based on self-identification. They show a clear positive correlation between self-identification and voting behaviours meaning that their measure can be thought of as a reliable indicator of partisanship.   

 

Results

·         There is no evidence that states with more swing voters receive more funds. The swing voter hypothesis is not supported by this data set.

·         There is no support for the battle hypothesis either.

·         The is limited support for the partisan supporters hypothesis, although significance is extremely sensitive to the specification, and as voting is endogenous to the model, the use of vote data means that the estimate is probably largely overestimated. Thus it appears there is some evidence that states with a higher proportion of supporters for the party of the president receive more votes.

·         It also appears that states that have received more funds do not reward the incumbent in the polls. On the contrary, partisanship and ideology have large significant effects which is consistent with with Bartels who finds a strong impact of partisanship on voting behaviour both at presidential and congressional level.

 

Caveats

·         If candidates typically fulfill their promises to voters regarding spending then there would be little correlation in the data between funds received and votes for incumbents as there would be no out-of-equilibrium behaviour.

·         It could be that institutional factors that are particularly strong in the US meaning that the behaviour these hypotheses predict are not feasible. For example checks and balances may prevent a tailoring of budgets to suit a politician’s preferences. Committees and agenda setting are also relevant. In other words perhaps although the politicians would like to engage in such behaviour they are unable to, and thus in states with fewer institutional checks, the data may return stronger support for one or more of the hypotheses that found little support in the US data.  

INEFFICIENT REDISTRIBUTION

INEFFICIENT REDISTRIBUTION

D. Acemoglu, J. Robinson

American Political Science Review Vol 95, No. 3, (Setp., 2001)

A summary

In a Nutshell

Redistribution often takes inefficient forms. For example it would be much more efficient to redistribute to farmers on the basis of lump sum transfers rather than price mechanisms which distort the market. Similarly it would be better to finance protected industries directly rather than distorting world prices and domestic resource allocation by the adoption of tariff measures. It is argued that such redistribution occurs because governments cannot credibly commit to the honouring of income redistribution by either itself, or by future governments. Thus, the ability of certain sectors to continue to be able to extract redistribution will depend in some way on the strength of the group in question. This in turn indicates that policies that maintain or even increase group size could be preferred, as larger groups in general have larger political clout supposing that they can overcome the collective action problems associated with larger groups. These policies will typically be inefficient. For example, for farm subsidies to be tied to production means that farmers are encouraged to stay in the sector, and new entrants are encouraged meaning that group size, and thus influence, is maintained. This implies that inefficient redistribution is more likely when the group is under threat from political marginalization i.e when its voting power is diminishing. It seems generally to be the case that declingin industries receive the most distorting transfers. Additionally where skills are relatively non-specific (meaning a worker/producer/member could transfer easily through the labour market) then inefficient redistribution is more likely as it will be harder for the group to maintain its size if it is easy to leave the group.

Alternative Explanations of Inefficient Redistribution

Inefficient methods are harder to reverse and so they serve in effect as a commitment device. [This seems somewhat implausible, there is no real logical reason why it should be harder to repeal a direct transfer law as opposed to a production subsidy law. However it does touch on another point being that subsidies etc. were initially intended to promote output growth, especially in the EU, and they are particularly hard to deal with due to entrenched interests. The economic history of subsidies in the EU offers a challenge to this model, as farmers did not choose the subsidies as they were in decline, in fact they were a very strong and large part of society. Rather output needed to be boosted after the war.]

Where politicians care about one subset of voters they use inefficient redistribution to confound the rest of the electorate. Whereas the giving of direct transfers would reveal his preference for the subset over the majority, a subsidy etc. can be made to look as though it addresses market failure whilst still achieving income distribution.

Application of the Model

Agricultural Policy

Farm policy cannot be explained by market failure and direct subsidies could save considerable resources although it does not appear a viable option. The model states that the current policy mix is designed to maintain a critical mass of farmers.

Labour Market Policy

Severance pay, although it is a good form of insurance, is inefficient. There would be increased efficiency from other means that do not distort the market leading to unemployment etc.

The reason such labour laws exist is to increase “insider” power. i.e. unions to remain powerful in order to continue to bargain for increasing wages, thus it is important that workers cannot be fired easily which would reduce the critical numbers of union members.

INCOME DISTRIBUTION, MARKET SIZE AND INDUSTRIALIZATION

INCOME DISTRIBUTION, MARKET SIZE AND INDUSTRIALIZATION

K. Murphy, A. Shleifer, & R. Vishny

Quarterly Journal of Economics 1989

A summary

In a Nutshell

In order for industrialization to occur within an economy domestic demand must be sufficient to allow for manufacturing activities that display increasing returns to scale to be undertaken profitably. This will occur more readily in countries which have a large population, relatively homogenous tastes, and concentrated population centres. Critically however, this cannot occur in societies with a radically unequal income distribution, as the natural consumers of manufactured goods are the middle classes. Thus an extreme concentration of wealth in a small minority will manifest itself in demand for handmade and imported luxuries rather than for domestic manufactures. This was seen for example in Colombia in the 19th century when there was a boom in tobacco exports, and subsequently another boom in coffee exports. As tobacco is conducive to cultivation on large plantations, the export earnings were concentrated in the hands of a few wealthy landowners who spent it on luxury imports. Coffee on the other hand could be grown on small family farms meaning that resulting wealth was spread much more evenly throughout the agricultural sector to a large number of people that demanded domestic manufactures thus spurring on industrialization. In general, expansion of domestic demand will involve

Domestic income distribution would not be relevant to industrialization if world trade were costless and free of barriers. In practice however penetrating foreign markets is hard given different tastes, protectionism, transport costs etc. Thus size of local market continues to be of great importance for many goods in many countries. For example at the time of writing 80% of goods manufactured in the developing world were consumed domestically.

The authors do not attach any normative value to industrialization, although they do note that it is often correlated with welfare improvements, growth etc. Technological spillover promotes further growth and capital accumulation etc.

Agriculture as the Leasing Sector

A boost in agricultural productivity can substantially increase the size of the markets for manufactures. This is because the increased productivity means agricultural employment falls as output rises, meaning that wages increase for those left in the sector. Their earnings may be such that the goods demanded will now include manufactures rather than solely food. Additionally, the labour that is freed from agriculture is absorbed by industry as output rises in the already industrialized sectors. This implies increased living standards and further increasing demand for manufactures.

Technological change in agriculture thus fosters industrialization.

[This would seem to imply that the Latin American economies that focused ISI on manufacturing sector at the expense of the agricultural sector were missing a more sustainable way of increasing domestic demand. Additionally, it would appear that development strategies should incorporate agricultural development as much as direct industrialization promotion.]

Failure to Industrialize

If all consumers are just buying food, there is no space for industrialization. In a poor society this failure to industrialize could happen in two ways: total equality, and high inequality. Total equality in a poor country could mean than no consumer has sufficient disposable income to spend on manufactures. In a highly unequal economy there are not enough people to make profitable a conversion to increasing returns to scale processes. There are not enough people to cover the fixed costs of industry so it will not arise. This result suggests that industrialization will occur more readily in countries with a larger population. [This was in fact the case in Latin America. By the 1960s it became clear that if ISI was to succeed throughout the region, domestic markets had to be expanded, as the only countries that experienced large scale competitive industry formation were Brazil, Mexico and Argentina which all had sufficiently large internal demand structures. The smaller countries of the region did not have sufficient domestic demand and so various projects of regional integration were started to try expand demand and hence increase specialization and industrialization.]

The higher is the fraction of profits in the hands of the middle classes the greater the demand for manufactures.

Thus in a poor country income inequality could be a driver behind the failure to industrialize even where there is sufficient investible capital within the state to get industrialization off the ground.

Redistribution

If there is a redistribution from the upper to the middle classes, but not so much that the identities of the members of those groups is changed then demand for domestically produced manufactured goods increases at the expense of luxury import items. Thus the extent of industrialization increases as does employment in those sectors.

A RATIONAL THEORY OF THE SIZE OF GOVERNMENT

A RATIONAL THEORY OF THE SIZE OF GOVERNMENT

A. Meltzer & S. Richard

Journal of Political Economy, Vol 89, No. 5 (Oct., 1981)

A Summary

In a Nutshell

Tax rates have been rising in the UK/US for a century, but why exactly? In the framework set out for analyzing tax policy, the size of government is chosen by rational utility-maximizing individuals who are fully informed about the state of the economy and about the consequences of taxation and redistribution. The key is that the size of government will be determined by the relation between the mean income, and the income of the decisive voter, which for democracies, means the median voter. If income distribution is skewed to the right, the mean income is above the income of the median voter and thus the median voter has an incentive to choose redistribution by taxation on incomes higher than his own. Therefore, any voting rule that means that the income of the median voter is pushed farther away from the mean income implies that the size of government will increase. As the last 120 odd years of British history has seen the franchise extended to include more people below the mean income, there have been increased votes for redistribution.

The logical extension of this argument is that the median voter will prefer expropriation and total equalization of incomes, however this ignores the incentive effects of taxation, meaning that as taxes and redistribution reduce the incentive to work, this provides a natural limit to the potential size of government. This is because a tax rate increase has two effects: each $ of earned income raises more revenue but earned income declines; everyone chooses more leisure and more people choose to subsist on redistribution. The median voter has to take this into account when he seeks to maximize his own utility.