Wednesday, April 29, 2009

The Pros of Counter-Cyclicality

. Wednesday, April 29, 2009

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.


The Pros of Counter-Cyclicality




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