The Pros of Counter-Cyclicality

It gives you much-needed flexibility in the bad times. Dani Rodrik passes along a nice anecdote from Chile:

Until the current crisis hit, Chile's economy was booming, fueled in part by high world prices for copper, its leading export. The government's coffers were flush with cash. (Chile's main copper company is state-owned, which may be a surprise to those who think Chile runs on a free-market model!) Students demanded more money for education, civil servants higher salaries, and politicians clamored for more spending on all kinds of social programs.

Being fully aware of Latin America's commodity boom-and-bust-cycles and recognizing that high copper prices were temporary, Velasco stood his ground and decided to do what any good macroeconomist would do: smooth intertemporal consumption by saving most of the copper surplus. He ran up the largest fiscal surpluses Chile has seen in modern times.

This didn't make Velasco very popular. Last November, public sector workers marched in downtown Santiago, burning an effigy of Velasco.

But by the time the financial crisis hit Chile, Velasco (and the Central Bank governor Jose de Gregorio, another fine macroeconomist) had accumulated a war chest equal to a stupendous 30% of GDP.

The surpluses accumulated during the good years has given the Chilean government unusual latitude in responding to the crisis. As a result, the economy is doing much better than its peers. As Bloomberg reports, "the country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund."

And does good economics pay off politically? Eventually, yes. Five months after being burned in effigy, Velasco is currently President Bachelet's most popular minister.

It is often difficult for politicians in democratic countries to enact sound policy and stay in office long enough to fully implement it. It is much more politically expedient to spend the surpluses from the boom periods, as most of the world has done. Unfortunately, when the bad times come, there is no surplus to fall back on. Many countries could learn from Chile, especially those that are heavily-dependent on commodity exports to fuel the economy.

What We Can Learn from Chile

Quite a lot, says Kaufmann of the World Bank:

To respond to the economic slowdown, the government has put together a counter-cyclical stimulus plan of about US$ 4 BN, being in a comfortable position to use the vast reserves (amounting to about US$21 BNs) accumulated in its stabilization fund during the surplus years. Thus, there is a solid macro-economic basis for this stimulus plan. Contrast this with what Argentina has done, for instance, where the government has raided the private pension funds!

The micro-economics of the stimulus package of Chile is also sound and worth looking into, since its composition is rather effective. It balances the needs of infrastructure, small enterprise development, and low income households. A notable absence in the package, which is worth emphasizing in the US today, are footprints from corporate (and lobby) capture by vested interests or pork barrel politics (and obviously there is no 'Buy Chilean' provision!).

More here and also here. We hear a lot about how Sweden and Japan have responded to past episodes, but mush less about other countries. To be sure, there are major differences between Chile and the U.S., so a direct comparison isn't wise. But that doesn't mean that lessons can't be learned.