Archive for February 14th, 2008

Financial inclusion for inclusive growth

February 14, 2008

Vijay Kelkar’s speeches are usually excellent.

I came across this good speech on financial inclusion where he suggests how it can be used to achieve inclusive growth in India. He gave the speech as NP Sen Memorial Lecture at Hyderabad on 13 Jan., 2008.

He says financial inclusion is a quasi public good and so government has to provide it with the help of other agencies. He looks at the way financial inclusion has expanded in India (via 2 channels- banks and micro-finance institutions) and the various programs under the two channels.

He then suggests some new ways in which it could be expanded .

Overall a nice primer on the subject with respect to India.

Applying Public Choice theory

February 14, 2008

The recent clashes in Mumbai led to two debates. The first one was on migration, which has been discussed across numerous forms of media (my version is here). The second one asked a broad question- which political party would gain from the clashes? Before we look to answer these questions, let us look at what fields of economics has to say on the issues.

There is a popular stream of economics called Public Choice Theory that analyses the political developments in an economy.  It applies economic tools to understand the various issues within the political system. It studies the behavior of voters, politicians, and government officials and their interactions in the social system. The theory was developed by James Buchanan Jr.and Gordon Tullock (both of George Mason University) and former got a Nobel Prize for his effort in 1986. (I have pointed to their interviews here)

The theory just like classical economics assumes politicians and bureaucrats as rational agents. By rational it means they try to maximize their interests first and produce goods for others as a by-product. Just like a businessman would make those decisions first which lead to higher profits, the politician would make polices that maximize his chances of winning the next election.

 The moment we apply this framework we get a different perspective on many political decisions. The findings of the theory can be applied to understand politics worldwide, even in developed countries. Basically, the policies should be developed to keep the long-term interests of the country but what we see mostly is opposite. Most policies are short-term in nature with the objective to please the current electorate, even if it creates some substantial long-term losses. Like the US attacked Iraq and Afghanistan (short-term policy to please the public) but it led to substantial losses as far as budget deficit is concerned. 
 

There are number of examples to reduce government’s short-term policymaking behavior. The best example is the independence of Central Bank. In the past, the governments were often found to exert pressure on their respective Central Banks to ease its policy (lower interest rates) in order to perk-up growth and more so just ahead of elections. The economic conditions may not warrant an easy policy and the outcome in the long-run (after the election) was high inflation and a problem for everybody. Thus, it was decided to make Central bank independent of Government actions with a focus on price stability. The performance of Central Banks has improved dramatically since then. The world has witnessed low volatility in both inflation and growth (also termed as Great Moderation) and monetary policy has been attributed as one of the main reasons for the same (However, in the recent subprime crisis the central banks in the developed countries have lost a lot of credibility). Another good example in Indian context is the passing of Fiscal Responsibility and Budgetary Maintenance Act that aims to reduce the current expenditure of the Central Government.

 

Now coming back to the main point, why do politicians and bureaucrats make such policies. They are not the only ones to be blamed. The large part of the blame also lies on the electorate. The politicians frame their decisions on the basis of what appeals to the electorate. It is a simple demand and supply issue. 

 

This article from Al Ries analyzes Barrack Obama’s election campaign. Ries called it a brilliant execution built around the main theme of “Change”, something the American population believes in. Similarly, we have politicians taking decisions elsewhere in the world as well.  

 

It is easy to criticize certain policies and how this political party has not done anything for the region. However, the electorate is also to be blamed. The percentage of voters is still very low and quite a few still don’t vote thinking nothing can be done. The end result is poor policies and more criticism. We must keep in mind that politician is also like us and is interested in his own welfare. So, if we want a change it has to be within us and the political parties will make the changes accordingly.  

Addendum:

I just came across this excellent review of the subject and didn’t realise Bryan Kaplan has worked on the “electorate is also a problem” arguement. He has written a book called ‘The Myth of the Rational Voter’ which has been discussed widely in blogs and media.

I also didn’t realise that this argument is actually antithetical to the entire public choice theory. Public Choice theory looks more at the politician’s behavior and not much at the voters. Kaplan turns the idea on its head saying public is not getting bad policies that they don’t want, rather the public get what it demands.

Frankly, I didn’t realize that there has been research on the same as well. So, didn’t add Kaplan in the original post. 

Alternatively, I can also say that my thinking isn’t that bad :-)

Assorted Links

February 14, 2008

1. MR says subprime was not a housing bubble . The housing prices have shifted to a new equilibrium. He says at best it was overshooting from the new equilibrium.

2. WSJ Blog says stocks are from Venus and credit from Mars. It has some more discussion on Fed’s monetary policy

3. Rodrik points to a new school of development economics. He also points to the first WTO case against China.

4. PSD Blog points Walmart should win the Nobel peace prize.

5. TTR on drawing lessons from leadership classes.


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