International Monetary Fund. External Relations Dept.
Published Date:
January 1991
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Stefan Gerlach and Peter A. Petri (editors)

The Economics of the Dollar Cycle and The Political Economy of American Monetary Policy

The Economics of the Dollar Cycle

The MIT Press, Cambridge, MA, USA, 1990, vii + 381 pp., $37.50.

Thomas Mayer (editor)

The Political Economy of American Monetary Policy

Cambridge University Press, New York, NY, USA, 1990, ix +314 pp., $42.50.

Here are two books dealing with different facets of monetary economics: one international, the other domestic. Both provoke thought more by explaining why the right policies are hard to formulate than by trying to find easy answers to difficult questions.

To start with the international issues: Why did the US dollar rise so dramatically in the first half of the 1980s and then fall even more sharply in 1985-87? How did that cycle affect the world economy? And was this a problem that calls for a policy response, or should the market be left alone to determine exchange rates and payments balances? In December 1987, an outstanding group of academic economists gathered at Brandeis University to wrestle with these questions and to try to assess the implications of the dollar cycle for economic policy. The papers presented at that conference have now been collected and edited by two Brandeis professors, Stefan Gerlach and Peter A. Petri. The result is a generally quite clear and policy-directed compilation, which includes some stimulating discussion of the papers as well.

The questions posed above are obviously daunting, and it should not be surprising that even the finest economists are hard pressed to find convincing answers. Consequently, the most interesting papers in this volume are those that eschew trying to build castles in the sand and try instead to explain why we cannot know all that we seek to know. Paul Krugman, for example, discusses the failures of many popular explanations for the swings in the dollar’s value, and he concludes with a call for a modest but elusive reform: We cannot draw lessons for policy, he notes, “until there is some willingness to abandon positions that have been decisively rejected by experience—even if those positions make for nice models” (p. 117). Peter Garber reviews the debate over whether the dollar’s strength in the mid-1980s was just a speculative bubble, and he argues that we cannot answer that question until we first are able to evaluate the fundamental determinants of the dollar’s value; but that prior issue has also proved elusive.

As for the future, there seems to have been a reasonably general agreement at the conference that if the United States hoped to balance its external accounts, it should not only reduce its budget deficit but allow the dollar’s exchange value to decline further as well. That argument was made by James Tobin, Ralph Bryant, Rudiger Dornbusch, and others. It is worth noting, then, that three years later, the dollar had depreciated by a further 10 percent in effective terms, while the budget deficit had remained stubbornly high. The US current account deficit had declined from around 3½ percent of GNP to just under 2 percent, but further progress was proving difficult. This configuration of events is only part of a complex picture, but it does tend to vindicate the mainstream view of what was required.

On the domestic front, “Fed watching”—studying the decisions and the decision-making process of the US Federal Reserve System—has long been a favorite pastime of financial journalists, bankers, and others who in various ways depend on the Fed for their livelihood. In 1987, an American journalist, William Greider, carried this vocation to an apparent extreme with an 800-page book (Secrets of the Temple: How the Federal Reserve Runs the Country) that studied the institution, its leaders, and its role in American society in more depth (and with more vituperation) than one would have thought imaginable. Most monetary economists, on the other hand, have been content to study the results of monetary policy, without devoting much time to the human processes that give rise to those results.

Thomas Mayer, for the past three decades a University of California economics professor and a student of US monetary policy, decided that the topic “need not be left to journalists,” and he invited some two dozen economists to write papers analyzing Federal Reserve policy making. The overwhelming impression one gets from reading these papers is that the individual policymakers and their responses to political pressures and bureaucratic biases are as important as the economic theories that underpin their work. Several chapters argue that Federal Reserve decisions cannot be adequately explained by estimating reaction functions, or by appeal to maximization of either the public welfare or the policymakers’ own self-interest. The Federal Reserve is subjected to pressure from both the Congress and the Administration, but its leaders have worked hard and with much success to maintain a measure of independence from those pressures. The Fed’s policies consequently have been formulated and implemented with discretion and have not generally been subjected to formal rules.

Most of the authors represented in Professor Mayer’s book are critical of the Federal Reserve, and many of them would prefer a system of rules that would subject both the Fed and its political overseers to greater accountability. Even those favoring discretionary countercyclical policy, such as Elmus Wicker, find that the practice of it has fallen far short. Suggested reasons for the failures of Fed policies include incomplete use of available information (Wicker), reliance on poor forecasts (Raymond Lombra and Nicholas Karamouzis), reluctance to admit mistakes (Mayer), an absence of incentives to establish accountability (Edward Kane), and the reluctance or inability of the Congress to develop effective oversight (Nicholas Beck and James Pierce).

What is missing from these studies is a clear set of prescriptions for improvement. It is doubtful that any of these authors would argue that Congress could be counted upon to establish a set of rules that would lead to better outcomes. Independence and discretion in the implementation of rules will always be required, and perhaps the strength of this book —like that of Gerlach and Petri—is that it avoids looking for simple solutions for an extremely complex problem.

James M. Boughton

The Competitive Advantage of Nations

Michael E. Porter

The Free Press, New York, NY, USA, 1990, xi + 855 pp., $35.

Porter’s objective in writing this volume is to extend his earlier work on the competitive strategy of firms to the national context. He hopes to learn why some nations prosper and others do not. Much interesting information is presented—a virtual shower of anecdotes that is often repetitive—but the author is more successful at presenting suggestive hypotheses than at developing or testing a theory.

The first few pages quickly shift from the basic issue—the determinants of national productivity and productivity growth—to a focus on the success of industries in international markets, which absorbs the rest of the book. Porter terms such success “international competitiveness,” which he defines as significant exports of goods and services, or significant foreign direct investment by an industry. The empirical link between national productivity and international competitiveness is not presented, but merely asserted. No mention is made of what determines the productivity of industries producing nontraded goods. For example, one reason for the high level of productivity in the United States is the high productivity of US service industries, but these industries are not big exporters. And success in exporting commodities and simple manufactured goods need not imply high productivity.

Part I covers over one hundred case studies of industries in ten leading developed nations. Each of these case studies is of an internationally competitive national industry. How these industries were chosen from the many hundreds of possible cases is not explained. A few are presented as self-contained case studies in Part II. An analysis of these cases leads Porter to identify four major determinants of international competitiveness: factor conditions (land, labor, and capital); demand conditions (composition and size of home market demand and its relation to foreign demand); related and supporting industries (presence of such industries that are already internationally competitive); and firm strategy, structure, and rivalry. Other minor determinants are chance and government policy. The four major factors provide an organizing framework used to analyze why selected industries are internationally competitive.

Porter describes the current competitive situation (in terms of industrial exports and economic performance) of eight countries (Germany, Italy, Japan, Korea, Sweden, Switzerland, the United Kingdom, and the United States) in Part III. Then in Part IV, he goes on to make suggestions about appropriate strategies for companies to pursue and appropriate policies for governments to implement, along with presenting diagnoses and suggestions for the eight countries reviewed.

The problem posed in the book is the matching of industries and nations, each of which has many varied attributes. The question is: Which nations are the best locations or home countries for which industries? The analysis is carried out by reviewing the findings of the numerous case studies on almost an individual basis, and the transition from these instances to the overall performance of the country is unsupported. This leads to a lack of clarity, much repetition, and little hard measurement. This work would be much enhanced by more use of statistics and less use of example.

The author persistently refers to his analytic framework of four principle determinants as a theory. The framework is not tested in a rigorous way, nor is it used to predict which firms will emerge as internationally competitive in which countries. The author states that his framework could be used for predicting future industry evolution (p. 175), but he never uses it for this purpose. What the book presents is a rich set of hypotheses about the determinants of export success, with little analysis of the relative importance of various determinants.

The analysis of government policy is very modest and is covered for developing countries in only five of the book’s 735 pages. Governments should foster a competitive environment, promote education, invest in infrastructure, and expand research capacity. In addition, increasing the level of savings and investment and promoting the development of efficient capital markets are deemed crucial for growth. The author is not enthusiastic about the efficacy of macroeconomic policy in general, nor of devaluation in particular as a stimulant for international competitiveness. However, he sees a greater role for government policy in developing than in developed countries.

This book is a bountiful source of information about specific industries, and it provides a useful taxonomic device for analyzing successful industries. Firm managers will find much that is relevant, but there is little in the way of specific recommendations for government policymakers or for the analyst of developing countries.

Gregory K. Ingram

Socially Relevant Policy Analysis

Lance Taylor (editor)

Socially Relevant Policy Analysis

The MIT Press, Cambridge, MA, USA, 1990, x + 379 pp., $37.50.

The phrase “socially relevant” in the title of this book does double duty. The book is essentially a collection of structuralist computable general equilibrium (CGE) models for developing countries, and the phrase “socially relevant” is meant to apply both to its structuralist (as opposed to neoclassical) approach as well as to the CGE methodology, which lends itself to a much greater degree of microeconomic detail than is typically found in small mainstream macroeconomic models. The book consists of a lengthy overview essay by Lance Taylor, followed by twelve chapters consisting of applications to individual countries by various authors. The overview essay appropriately provides a useful description of the tenets of structuralism and a brief synopsis of CGE methodology. Of these, the former is by far of greatest interest.

Taylor identifies structuralism with a number of general hypotheses about developing country macroeconomics. These include the recognition that (1) many agents possess significant market power; (2) LDC macro-causality tends to run from “injections,” such as investment, exports, and government spending, to “leakages,” such as imports and saving; (3) money is often endogenous; (4) the structure of the financial system can affect macroeconomic outcomes in important ways; and

(5) in the LDC context, imported intermediate and capital goods, as well as direct complementarity between public and private investment, are likely to be empirically important. In spite of the occasional polemical tone of the essay, many of these hypotheses would command wide agreement among developing country macroeconomists, suggesting that structuralism—at least in this sense—may have made its point.

The country-specific applications, which comprise the rest of the book, embody many of these structural features. The CGE methodology is applied consistently in these chapters, though the structures of the models differ in major ways depending on the policy questions being addressed. The chapter on Mexico, for example, departs substantially from CGE tradition by incorporating a fairly detailed financial sector. This is necessitated by that chapter’s focus on the effects of devaluation in a “dollarized economy” (i.e., where a large number of US dollars are held by residents). Overall, the quality of the exposition in the applied chapters is good, and the workings of the country models are fairly transparent. The analysis is indeed focused on “socially relevant” questions, such as the optimal design of food subsidy programs in Mexico, the distributional effects of price controls in Nicaragua, the effects of raising administered prices in India, and so on. In general, the findings are reasonable and would not offend many nonstructuralists. It is not surprising to find, for example, that devaluation can be contractionary if imported intermediate inputs are important, that targeted food price subsidies are superior to income transfers and general price subsidies, or that raising administered prices can be stagflationary.

All told, whatever one thinks of the CGE methodology, this is a collection of sensible papers that address, in a careful way and with attention to country circumstances, policy issues that repeatedly confront developing country macroeconomists. As the papers here illustrate, the macroeconomic tradition that this book reflects continues to contribute to the formulation of responsible macroeconomic policy in developing countries.

Peter J. Montiel

Cheating the Government: The Economics of Evasion

Frank A. Cowell

Cheating the Government: The Economics of Evasion

The MIT Press, Cambridge, MA, USA, 1990, xii + 267 pp., $27.50.

This book is a comprehensive state of the art primer on the economic analysis of tax evasion. Though he makes no concession to those who cringe at mathematical modelling, Cowell succeeds in combining technical elegance with a healthy dose of facts and anecdotes, excellent writing, and frequent wit. The notes to the chapters are a particularly rich source of material.

The basic premise of the argument is that the problem of tax evasion or, more generally, cheating the government, is intrinsic to public finance. Self-interested individuals will not voluntarily finance the optimal amount of public goods, preferring instead to maximize their own consumption, while enjoying the public works provided by others. This creates a need for a government tax enforcement strategy.

The first few chapters are devoted to the definition of the problem and an examination of its scope. Cowell compels the reader to admit that the line between illegal evasion and legal avoidance is fine indeed and clearly varies from country to country. This point is important later on when optimal enforcement policy is discussed and provides an entry into the issue of the appropriate extent to discourage evasion or avoidance. Furthermore, the existence of ambiguity in the tax law implies that harsh penalties may not be viewed by society as fair, if the rules of the game are not simple and well understood.

The middle chapters proceed with the development of models of taxpayer behavior and the empirical evidence supporting them. The standard theoretical results are presented—that evasion depends on the probability of being caught, the severity of the penalty, and the risk aversion and income levels of individuals. Another important factor, and one that Cowell has examined in greater depth elsewhere, is the availability of tax avoidance strategies, tax shelters, and the possibility of “exiting” to the informal or underground economy. Building on the models of taxpayer behavior, the last chapters address the issue of the appropriate government response.

An important theme underlying the last chapters, on policy agenda and policy designs, is that, although, on paper, eliminating evasion is a trivial task—merely increase the penalty to the point where no sane individual would dare cheat—there are significant problems with this solution, primarily that in most societies the nature of the crime must bear some relation to the nature and magnitude of the punishment. Tax evasion is not viewed in most societies as a particular evil act and unduly harsh penalties for evasion would not be enforced. In addition, high penalties raise the issue of the potential venality of tax collectors, who would be all the more tempted to make side deals. Consequently a more sophisticated strategy for tax enforcement is necessary.

An optimal strategy would depend on a number of factors. One important guideline is to allocate resources so that an appropriate relation is maintained between the cost of enforcement and the revenue received directly from those audited, and indirectly from any increase in general honesty. A second consideration, one having important equity implications, is the appropriate trade off between penalties and enforcement effort. At a more microeconomic level, the design of optimal audit strategies depends on the information available to the government. This area has been researched quite actively of late and indicates that significant improvements over “blind” audit strategies are available that may greatly improve the efficiency of the tax collector. An improvement in the use of information—mainly from tax returns—may, however, lead to an exodus to the underground economy. The possible resultant economic losses would mitigate the gains from effective enforcement.

The primary strength of the argument in this book may be, for some readers, a source of disappointment. Having carefully constructed a treatise on tax evasion, the author maintains his intellectual honesty by shunning sweeping arguments and proposals. The issues are fundamental, complex, and interesting. Readers of “Cheating the Government” will obtain much useful insight, but will find no quick and simple solutions to the puzzles posed therein.

Peter Stella

Blueprint for a Green Economy

David Pearce, Anil Markandya, and Edward B. Barbier

Blueprint for a Green Economy

Earthsoan Publications Ltd., East Haven, CT, USA, 1989, xvi + 192 pp., $13.95.

Originally written as a report to the UK Department of the Environment, this little book is both a primer on environmental economics for politicians and a challenge to economists to wake up to the critical importance of the environment for economic theory and policy. The topics covered include the meaning of sustainable development, valuing the environment, environmental accounting, project appraisal, discounting the future, and market-based incentives for environmental improvement. The book is intended for the layman, even though some rather advanced discussion is encountered in the chapter on discounting. In general, the authors have done an admirable job of advancing the discussion, while at the same time remaining within the intellectual confines of neoclassical economics. But, the book bears the mark of its origins—a government report done under a deadline with no time for second thoughts and polishing. A more polished discussion of the same material is provided by Pearce in his recent text with R. Kerry Turner— Environmental and Resource Economics—which is also highly recommended.

On the definition of sustainable development, the report rejects the “nondeclining utility approach” as fundamentally non-operational and advocates a definition in terms of constant total capital stock, later sharpened to constant natural capital. In spite of the difficulties of defining constancy of capital, their case seems very convincing. Certainly ecologists would also find this approach more satisfactory. So too, should economists, since this is a generalization of J.R. Hicks’ definition of income as the maximum annual consumption that still leaves capital intact at the end of the year—only capital is now taken to refer mainly to natural capital.

For those involved in environmental projects, the chapters on project appraisal and on discounting the future will be of special interest. The most promising suggestion for integrating sustainability into project appraisal is simply to require that every project be sustainable—that is, that it not degrade the natural capital stock on which it depends either for regeneration of its raw material inputs or absorption of its waste outputs. If a project does either of these things, as frequently must be the case, then that project must be coupled with a joint or shadow project that will rebuild the degraded natural capital, such that the two together meet the condition of maintenance of natural capital stock. The two are then considered as a unit and ranked against other sustainable projects by conventional criteria. This seems to me a proper principle, even though there will surely be difficulties in carrying this through. What is really surprising, however, is that the authors then immediately retreat from this principle saying that “at the level of each project such a requirement would be stultifying. Few projects would be feasible.” They advocate applying the principle at a program (multi-project) level, so that the nondegradation of natural capital stock criterion would only hold on the average for the set of projects in the program and not for each project. This does not seem to help at all and in fact sacrifices efficiency by “socializing” the costs of sustainability among all the projects in a program, instead of making each project bear its own full marginal social opportunity cost—a principle eloquently defended elsewhere in the book. Nevertheless, the basic principle is a powerful one and the question of the best way to apply it merits more discussion by economists.

The chapter on discounting is the best short discussion I have seen of the issue. The authors’ basic point is that the discount rate should reflect the combined influence of time preference and productivity, and should not be altered to take account of environmental externalities. The latter should be incorporated directly in the cost and benefit estimates of the project and not indirectly in a doctored discount rate. Indeed, they argue, it is hard to know which is more environmentally friendly, a high or low discount rate. A high discount rate speeds up depletion of nonrenewables and rotation periods of renew-ables, and thus seems unfriendly to the environment. But a low discount rate lets a greater total number of projects be approved, all of which also put demands on the environment. It is hard to tell a priori whether the total investment effect will be greater or less than the more rapid exploitation effect—another topic that should engage the discussion of economists.

Herman E. Daly

Sharing Innovation: Global Perspectives on Food, Agriculture, and Rural Development

Neil G. Kotler

Sharing Innovation

Global Perspectives on Food, Agriculture, and Rural Development

Smithsonian Institution Press, Washington, DC, USA, 1991, v + 265 pp., $12.95 (paper).

This very readable book presents the papers and proceedings of an international colloquium on food and agriculture held at the Smithsonian Institution, in conjunction with the awarding of the 1989 World Food Prize to Dr. Verghese Kurien, chairman of the National Dairy Development Board (“Operation Flood”) in Anand, India.

The papers review a number of success stories in agricultural development: the Awe community project in Nigeria; the green revolution in Asia; advances in dryland farming technology in India; the Iringa integrated nutrition project in Tanzania; the growth of Chile’s fruit and vegetable export industry; and the “Operation Flood” dairy development program in India. With few exceptions, the authors played vital roles in the developments they describe, and unlike books written by “outside” experts, there are clear messages here from key practitioners about the factors that they think led to success.

Despite the’diversity of experiences reported, a clear message emerges about the importance of involving local, community-based, and often private institutions in any development project. Farmers and rural communities must have the freedom and flexibility to act in accordance with their own perceived needs, and development endeavors must begin with a proper understanding of those needs and a clear vision of how to reinforce a community’s ability to act. Remarkably, there is very little emphasis in the papers on the role of the public sector, other than with respect to maintaining a conducive policy environment.

The book includes a verbatim account of the discussions that followed the presentation of the papers. While some useful condensation might have been achieved with the aid of rapporteurs’ reports, there are sufficient gems (e.g., Dr. Kurien’s informal comments on what really makes Operation Flood work, pp. 224-28) to make much of the discussion a useful read.

Peter Hazell

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