Nobel Laureate Finn Kydland: a Lesson on Fiscal policy

Finn Kydland, Nobel Laureate in Economics, committed himself to convincing the audience that the difference between a growing economy and a stagnant one is forward looking.  Forward looking fiscal policy underlines the difference between Italy, Spain and Portugal’s infamously sluggish economies and Canada, USA and Australia’s.

In an unusual breakdown of the familiar GDP equation, GDP = Z, F (K, L) – representing the relationship between growth and technology, capital and labour – Kydland dismantles the winning and the losing strategies of the last few decades. “It turns out, “he says, “even the optimal policies would be time inconsistent.” Kydland proposes that governments’ intentions to do good in the long-term are often too weak to withstand temptation to stray off course. As such, decisions should involve an awareness that future governments will fail to complete the task.

governments’ intentions to do good in the long-term are often too weak to withstand temptation

He commended the establishment of independent Central Banks to insulate monetary policy (interest rates and inflation) from the short-lived nature of governments. He suggested it is imperative to similarly isolate fiscal aspects in order to create consistent policies. By fiscal policy, we consider the manipulation of taxes and spending to incentivise or discourage certain movements in the economy.

The Nobel Laureate is certainly a supporter of globalisation; indeed, he emphasises how countries which used fiscal policy to exploit global trade have fared better than others. Kydland’s discussion presented a view on a core debate of contemporary economics. It is now a familiar notion that low corporate tax-rates bring investment, business and employment in a way that cannot be matched by other policies. Yet, the cost can be dire in terms of the sorts of services the government can henceforth offer citizens from tax revenue.

countries which used fiscal policy to exploit global trade have fared better than others

The professor was of course weary of the misguided picture of national welfare that GDP and Labour productivity can portray. Nonetheless, he points to several cases that in his view, succeeded in establishing forward looking fiscal policy and seize the global current. A primary example he presented was Ireland’s setting of low corporate tax-rates in 1990 for the next two decades, thus committing future governments to a consistent fiscal policy which would reap the benefits of globalisation.

 Areas to look forward on

1. Traded vs. Non-traded goods: Since the 1980’s the market share of traded goods has declined compared to non-traded goods. Since output per hour worked in the traded sector has increased significantly more than that in the non-traded sector over the past three decades, more attention to the traded sector could boost productivity.
2. Financial crisis responses: He emphasised the striking divergence in Mexican and Chilean GDP after their 1980’s crisis, attributing Chilean success, in part, to their forward thinking in calculating which banks would be most profitable in the long-term. Chileans determined to bail out only the few most profitable, re-privatising them after only a few years.

For Professor Kydland, the Economist’s current job is to keep an eye on a more distant future in order to allocate resources efficiently.