A path for an economic recovery: an institutional perspective

I never knew we had so many economic experts in Lebanon! Thanks Thawra! However, a true economist must belong to a school of thought, defend the philosophy and conclusions of that school and, more importantly, master the techniques it advocates to reach the sought-after goals. Unfortunately, when it comes to recommendations related to fiscal and monetary policies, we hear these days conflicting confusing opinions from some so-called economic experts repeating what they read in randomly chosen textbook sections, or what they learned from a first year course of Macroeconomics.

Some of the economic experts swamping every mass media type these days have never studied economics. They might have a degree in Finance or in Statistics or they might have started a degree in economics but have specialized in a discipline, such as a master in market finance or in corporate finance or in environmental economics, that doesn’t give them a comprehensive knowledge of economic policy. When the expert hasn’t specialized in economic policy, he might fall into the trap of recommending incoherent incompatible policies selected from different schools of thought, thus, leading to inefficiencies.

My second criticism relates to the general nature of the solutions suggested in the plethora of reports on the economic crisis published recently, such as the need for a balanced budget or for increasing exports, with no concrete measures on how to reach these targets. However, one must admit that the need for “true” accurate data or for a pool of skills from diverse disciplines (economics, management, finance, accounting, law) impedes the formulation of more detailed reforms.

The point is that in any comprehensive economic strategy, the success, soundness and efficiency of reform measures is conditioned by their belonging to the same economic philosophy with defined objectives. In addition, implementation requires a pool of expertise from different scientific and social disciplines.

Economic schools of thought have long debated the determinants of growth. Some believe in stimulating demand to increase production, while others, with the fear of inflation, call for increasing supply by enhancing productivity through technological progress or education. Thus, while stimulating demand calls for an active direct intervention of the government and the Central Bank, the role of the economic authorities for encouraging productivity is to stabilize the goods and services markets and financial markets for the private sector to thrive.

Of course, none of these schools has proven to be always in the right in all circumstances since the problems of unemployment, inflation, recession and unbalanced relations with the foreign sector in many countries, all of which trigger short term business cycles, are yet to be solved because of uncertainties and constraints. Nevertheless, growth trends in the long run are only guaranteed by coherent policies.

Despite an easier transfer of technology and knowledge brought about by globalization and digitization, the still existing gap between developed and developing countries can be attributed to institutional factors, which are the most important preconditions to sustained growth according to the works of Douglas North, Oliver Williamson, Paul Romer and others. Institutional economics added the managerial dimension and the impact of transaction costs to economic theories, unveiling the missing link in the transformation of inputs into output and explaining the success or failure of any business or economic strategy. At the macroeconomic level, it is widely agreed today that the success of public management depends on the institutional quality, which reduces uncertainties and transaction costs stemming from the opportunism of policymakers, improves markets efficiency and leads to a sustained growth.

Institutional quality is measured by governance indicators. The World Bank developed six governance indicators: Political stability and absence of violence, Rule of Law, Government effectiveness, Regulatory quality, Control of Corruption, Voice and Accountability. (The definition and the measurement methodology of these indicators as well as yearly country data can be found at the following address https://info.worldbank.org/governance/wgi/).

More recently, New institutional economics assert the importance of political stability as the primary determinant of an economy’s institutional quality. By political stability, one must understand that it is the perception of economic actors that counts. For instance, under an autocratic regime or a dictatorship stability is forced, thus, false. Additionally, the threat of violence and not necessarily violent eruptions entails uncertainty. An unequal division of power, in polarized political systems for instance, favors opportunism, compromise the independence of the judiciary, which results in a poor enforcement of the law. In turn, the absence of the rule of law affects the credibility of the ruling public authorities at the bureaucratic level and favors corruption. Thus, the “impersonalization” of governance or getting rid of human characteristics, especially opportunism, requires a real democracy where everyone is equal before the law. Before achieving a real democracy there is no hope for the rule of law neither for the end of corruption nor for the implementation of efficient economic reforms.

Adopting fiscal and monetary policy rules ensures an impersonal nature of governance, since the role of officials will be limited to the application of the rules rather than discretionary measures serving personal interests. A rule-based approach improves transparency and boosts a culture of accountability. Furthermore, the development of such rules, which would guide all further fiscal and monetary measures, necessitates experienced highly skilled experts in the relevant fields.

From an institutional perspective, fiscal policy should follow some form of the Golden Rule of government spending stipulating that public current expenditures need to be funded by the existing taxes, while the government can only borrow to finance investment projects. The direct and indirect economic and social returns from investment projects would outweigh the costs allowing for the reimbursement of the debt and benefiting future generations. The form and implementation (maybe a constitutional law) of a golden-rule-based approach reduces discretionary spending policies while including mandatory spending for social programs like social security, health, retirement and more importantly financial inclusion schemes etc.. The adoption of such an approach in many countries (Switzerland, Germany, the European Union) proved to be successful in decreasing the budget deficits.

Monetary policy needs to follow a rule also, such as the European Central Bank rule based on the equation of exchange and targeting inflation, or the Federal Reserve rule based on the Taylor rule and targeting unemployment and inflation. With rules, discretionary monetary policy is no longer possible. Thus, with the implementation of a rule, people’s expectations on prices are stable, so would the markets be. With less uncertainty, businesses would be increasingly motivated to invest.

Many forms of the fiscal and monetary rules are proposed in the literature. Experts are to formulate the appropriate ones adapted to the Lebanese economy. However, the efficiency of the rules stems from their proper implementation by public sector officials, those who would not succumb to any political pressures to protect their own interests rather than the public interest.

Unfortunately, the nexus political-economic interests built by the ruling system throughout the thirty years following the end of the civil war is hard to break. The size of the public sector with a government employment rate that is the highest in the world, only because politicians need to secure votes during the elections, the size of the national debt held by commercial banks, some of which are owned by politicians themselves, the connections between politicians and public works contractors, the nomination of the judiciary by politicians and a number of other examples have generated a strong cobweb of corruption and waste.

The formation of the new government, which we had hoped would bring to power new independent and expert ministers, has failed so far in restoring the confidence between citizens and their rulers or between the international community and Lebanon. Economic recovery and support from the international community are conditional on the implementation of sound reforms to end corruption and waste. In view of the quotas allocated to the old ruling parties in the formation of the new government, the independence of new ministers have been called into question. Furthermore, the level of expertise required to save us from ruin – with all due respect to the diplomas of the new ministers – or worse, the mismatch between the existing skills and those required within a particular ministry to solve specific issues, raise doubt on their technical abilities allowing a quick recovery. We do have some experienced highly skilled experts for restructuring the debt for instance!

Thus, it is time to aim right. Only through the voice of the Lebanese in early parliamentary elections would we able to move towards a real democracy, which would guarantee the rule of law, the efficiency of public governance and the control of corruption. It is our responsibility to vote for a true change!

My opinion on concrete measures is to follow…

Nicole Ballouz Baker

مصلحة الأساتذة الجامعيين في حزب القوات اللبنانيّة

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