The Moorish Wanderer

Tax Cut Design versus Deficit Spending

Posted in Dismal Economics, Flash News, Moroccan Politics & Economics, Morocco by Zouhair ABH on December 13, 2012

The following is a small model designed to simulate the effect of a tax cut targeted on middle classes. The idea is to review the respective effects of each tax cut category (on VAT, Income, etc…) and weigh it on versus an increase in government expenditure. Over the (very) long run, both policies are fundamentally the same, but one needs to keep in mind government expenditure is potentially infinite, while taxes are constrained by the existing resources.

The idea is to compare the effect of a government expenditure increase versus tax cuts on growth and the subsequent created welfare. And the results are clear-cut: tax cuts stimulate GDP a lot more than increased expenditure. On average, a 1% tax cut would deliver on average of .85% in additional growth, while a 1% deficit would contribute only .06% to growth. Investment tax credit (fiscal incentives to investment) contribute a lot more to growth – a 2.16% additional growth for a 1% increase in investment tax credit. These results are compared for a 1% change in government budgetary policy, and then extended over a couple of quarters.

The argument behind this can be summed up in the following ‘policy transition functions’:

y = 1.91 + .028 k_{t-1} - .038 r_{t-1} + .7 z_{t-1} - .006 \tau_{k_{t-1}} \pm .029 def - .0047 \tau_{w_t} - .041 \tau_c + .003 \tau_k + .028 \tau_i + 2.55 \epsilon_t


g = .076 + .004 k_{t-1} + 1.29 r_{t-1} - .026 z_{t-1} + .19 \tau_{k_{t-1}} \pm def+.16 \tau_{w_t} + 1.37 \tau_{c_t} - .0005 \tau_{k_t} - .47 \tau_{i_t} - .0972 \epsilon_t

It is worth pointing out these policy transition functions are not the product of usual computations, i.e. these are not structural models estimated afterwards, but they are rather the end result of a more complex set of equations and assumptions. They (among other policy functions) provide policy recommendations that can be further expanded to account for specific fiscal policies, my particular insterest for instance, tax breaks and cuts for the middle class, has some useful applications.

It shows for instance that unfunded government expenditure (deficit-spending) contributes weakly to GDP growth, not as much as a single or aggregate tax cut, or indeed one tax credit scheme. This is not to say any spending-based stimulus is useless: there is evidence of counter-cyclical budgetary policy -detrended budget and output are negatively correlated- but it is not as persistent as output, and cannot provide optimal cycle smoothing: ‘unpredictable elements’, the technological shocks captured by z_t and \epsilon_t exhibits excessive diturbances deficit spending cannot bridge when these are negative exogenous shocks (a factor of 22:1 against deficit spending). On the other hand, a relatively modest increase in investment tax credit (which acts as a tax cut) can immediately make up for a negative shock and deliver a .19% boost to GDP growth, ceteris paribus. Obviously, there are some repercussions as to a fiscal policy geared toward investment tax credit, as it results in lower domestic consumption, regardless of any accrued consumption tax cut.

I am posting the code I have used to generate those results (applicable via the Dynare Matlab/Add-in) and will elaborate on this in the next couple of posts. I am very excited about these results because they have confirmed some of the policy recommendations conveyed in the Capdéma Budget Draft, with quantitative interpretations to specific policies. It also confirms some measure of fiscal consolidation and debt-deflation are needed not only to maintain the 2016 3% deficit ceiling, but also put growth back on track.

(For detailed description of the proposed model, have a look at Ljungqvist & Sargent’s “Recursive Macroeconomic Theory”)

// endogeneous variables: debt, government budget,
// consumption capital, output, labour, investment, wages, interest rates and technological change
var b g c k y h x w r z;
// taxes and deficit are considered to be exogenous
 varexo def tauw tauc tauk taui e;

parameters zig, alpha,delta,beta,theta,rho,sigmaw,sigmac,sigmak,sigmai,sigmad;

alpha = .335966;
 theta = 1/3;
 delta = .02909;
 beta = .9895569177;
 rho = .2742;
 zig = .0037;
 sigmaw =.007;
 sigmac =.0671;
 sigmak =.219;
 sigmai =.209;
 sigmad =.005671;

// The model depicts optimality conditions for all agents
// Simple FOC

 z = rho*z(-1)+e;
 y = c+g+x;
 y = exp(z)*k^alpha*h^(1-alpha);
 k = (1-delta)*k(-1)+(1+taui)*x;
 w =(1-tauw)*(1-alpha)*y/k(-1);
 r =(1-tauk(-1)+delta)*alpha*y/k(-1);
 (1-alpha)*y/c = theta*h/((1-theta)*(1-h));

 y = 0.7976304742;
 k = 9.7353698337;
 c = 0.5367196072;
 h = 0.3079168146;
 x = 0.2832019085;
 b = .51;
 z = 0;
 e = 0;
 g = .192;
 def = .03;
 tauk =0;
 tauc =0;
 tauw =0;
 taui =0;


 var e; stderr zig;
 var tauw; stderr sigmaw;
 var tauc; stderr sigmac;
 var tauk; stderr sigmak;
 var taui; stderr sigmai;
 var def; stderr sigmad;
 var tauw, tauc = 0;
 var tauw, taui = 0;
 var tauw, tauk = 0;
 var tauw, def = 0;
 var tauk, def = 0;
 var tauc, def = 0;
 var taui, def = 0;

stoch_simul(order=1, periods=224, hp_filter=1600,nograph);

Growth and Technological Change

Posted in Dismal Economics, Morocco, Read & Heard by Zouhair ABH on November 16, 2012

Capital accumulation exhibits significantly low levels of growth compared to output growth, and remarkably enough, TFP.

For all its simplistic setting, the 1957 Solow paper provides enough of a case to support the following claim: accumulation of physical capital per capita does not create growth. And as far as the domestic economy goes, this is what comes out:

   Y  |   H   |   K  | TFP
1.40% | 0.07% | 0.22% | 0.83%
      | 5.12% | 15.68%| 59.38%

(Quarterly growth. Y: Output, H: Labour, K: Capital, TFP: Solow Residual)

Over the past half a century, capital accumulation accounted for only 15.7% of the average GDP growth in the Moroccan economy, three times as much as demographic growth (actually, growth in the labour force) but most of the observed growth (in real terms) comes from TFP, Total Factor Productivity, or commonly known as ‘The Solow Residual’.

TFP accounts for almost 60% of the long-run average GDP growth. It does a lot more than that: it is more aligned with GDP growth, more correlated, and most importantly, a 1% increase in the Solow residual accounts for .96% in output growth, even as 1% in Capital growth accounts for only .08% in output What can the policy-maker learn from this very simple yet robust model? First, that accelerated accumulation of capital is unlikely to get output to grow faster. In the universe of our government’s commitment to get the 5.5% growth over their legislature, they need to generate a mind-boggling 23% increase in gross capital formation – i.e. an annual additional investment of 9.42 Bn dirhams above the current trend.

Impulse response graph to a 1%, one-period increase in productivity. Capital (k) decreases 4.43% the first period, and recovers only 60% of its initial return 5 years after the shock. Investment (x) on the other hand, increases substantially, even if it does not exhibit comparable strong persistence.

The findings are easy to sum up: what drives most of economic growth is not physical capital accumulation, but rather those things policy makers in Morocco care little about: research & development, labour and capital efficiency (a sad story I can recall from a lecturer in my Alma Mater, about a project of diesel-powered desalt water plant in Laayun, a wasteful process the Moroccan officials were reportedly proud of) and most important of all, institutional changes. These of course do not refer exclusively to political reforms, it encompasses labour market regulation and rigidities, rule of law and enforcement of contracts.

What is the real effect of this ‘technological change?’ first, a 1% sustained increase in innovation (such as it is) over 4 periods (or one year) results in boosting investment productivity 4.24%, with spillover effects going up to 3.2% on average over a 5-year period. Just think of it: this is sustained investment over just the first year in office. In budget terms, this means a relatively low investment of 50 Million dirhams in efficiency programs can increase investment efficiency by 4.24%, hence contributing an additional 12.5 Bn dirhams a year, a net contribution to growth by 360 basis points in one year – that is, an additional 3 Bn in added value, jobs and economic activity.

In fact, the accrued effect of  a one-year investment produce a marginal effect of almost one percentage point of GDP growth. And it is only right GDP grows thanks to technological change – because these resources when allocated to capital accumulation have a much lower return (one observes in the second graph capital accumulation declines by similar amounts (4.43% the first period). I argue this provides good evidence that accumulated investment for its own sake (which is about anything when it comes to some of the ongoing Grand Design workshops)

One last thing; since the mid-1970s, a particular component I have not described here accounted for the remaining 20% in real growth: even the impact of foreign trade (or perhaps just foreign productivity spillover effects) generates more growth than capital accumulation.

Technical note:

See Cooley & Prescott for the model used to generate the IRF graphs. Steady-state values have been used to calibrate the deep parameters.

Stimulus v. Austerity in Morocco

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on September 29, 2012

@Capdema is set on releasing a ‘white-paper’ of sorts, a Budget proposal for the next decade if you will. This project, with which I was closely associated, provides the blueprints for fiscal consolidation, as well as a set of bold policy proposals on both sides of the balance sheet.

An acquaintance reviewed the document, and one of the many observations they have made caught my attention: the Budget proposal basically takes the side of fiscal consolidation (austerity, if you will) as a sort of ‘There is No Alternative’ policy decision. Maybe it is; Perhaps some mechanisms embedded in the proposal seemed too harsh and too controversial for an otherwise consensus-seeking mindset in Morocco, prevalent among policy-makers and pundits alike.

But then again, this is the beauty of policy-making: choices are made depending on ideologies, or perhaps, according to each one’s Weltschauung. A traditional left-winger in Morocco (including the vast majority of my own PSU) though it makes sense to get value for money from government expenditure, would find it hard to support policies designed to contain the size and cost of the civil service payroll. They would cheer the introduction of a de facto wealth tax on the rich, yet express scepticism to the idea of tax cuts to corporations. Strangely enough, the voices of pro-fiscal consolidation in Morocco are very far and between, and I mean, voices that advocate specifics in terms of deficit and debt reduction for instance.

I would like to discuss two aspects of that fiscal consolidation government and pundits alike want to see happening, yet fail to make it happen in terms of government policies: Subsidies and Tax exemptions.

Ceteris Paribus, the Compensation Fund accounted for less than a third of the Budget Deficit in 1979-2007, but then since 2008, it has been on par.

The Compensation Fund has long been a pain in the neck: it is inefficient, it showers the richest households and big corporations with government subsidies, and a small fraction of these actually reach the targeted populations (let us put these at the conservative estimate of the bottom 20% income households) But for the past 30 years (say between 1980 and 2007) the aggregate crowding-out effect of this fund has been relatively low compared to GDP – less than 1.61% of GDP, yet for the past 4 years, the system has proven to be unsustainable; the current narrative about the ‘Compensation Problem’ shifts the blame to international markets and the upward pressure on commodities’ prices. Actually, the increased reliance on domestic consumption to sustain growth over the past 5 years means richer households would consume more of these subsidized goods, hence putting pressure on the compensation fund to require more funding from the Budget.

Tax exemptions in themselves cost about as much as the Budget deficit – about 33 Bn in 2012, but they stir government policies in the targeted sectors for different tax credits, exemptions and moratoriums. But, it is quite difficult to argue a reasonable case for some of these, unless political calculations are considered as well. The agricultural sector is pampered beyond reason (there are tax exemptions as well as direct subsidies) with official talking points arguing the very existence of the generous moratorium is of social value. It is as though the 120-odd Bn dirhams are evenly distributed among Moroccan farmers, when it really is not, and the figure speak for it.

But I digress. The central question remains: do we go for Stimulus or Fiscal Consolidation? As a matter of fact, the two options are not mutually exclusive: a fiscal reform can be nested in an ambitious spending program, but for policy evaluation purposes the picture is blurred a bit. Yet let us consider the Stimulus option as fairly as possible. The bottom line is simple enough to make it government policy: push output growth as close as possible to 6.5% for a short period of time. But that’s about it: it is the very nature of a stimulus package to be short-lived – or perhaps the lefty punditocracy is referring to the Welfare State?

How would one go for a Stimulus in Morocco? We are already spending good money in public investments (Budget and State-managed companies put in 188Bn in investments for 2012) so perhaps we might consider some scheme to boost consumption; the Compensation Fund is already taking care of it, but not as efficiently as one might have hoped it to be, so a reform has to be included into the stimulus. The tricky part is to get other policy measures alongside the Compensation Reform, because it will harm growth and household consumption, and the latest HCP figures on that matter provide evidence to that effect. As for massive recruitment in the civil service, it will not do good, especially when the new civil service labour force is ill-suited to their selected job: is it enough to get more teachers and nurses, when quality is in higher demand?

So tax cuts are the way to go, specifically on distortionary taxes, like VAT and/or Income tax, which means there are 81Bn to be cut, with perhaps a targeted 31Bn worth of various taxes and duties on imports; on the other side of the balance sheet, potentially 50Bn, the Compensation Fund have to be cut one way or the other. Let us suppose this tax cuts-based stimulus wants to go back to direct fiscal pressure observed in the early 1990s, which means there are 2.07% worth of tax cuts to be enacted, 17Bn that is. This means 2,554dhs worth of tax cuts on average to Moroccan households, and that contributes a full percentage point to output in 2012, close to 4% GDP. The remaining .8% (to get to potential output) can be scrapped somewhere, surely, but it cannot go beyond 2014.

Unfortunately, I cannot go on about what a Stimulus-based budget policy can do, but it seems to me the exogenous factors from Morocco’s commercial partners are best matched with structural reforms, and these are better served in an austerity-based government program.

Deficits and Cycles in Morocco

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on September 12, 2012

No one needs to be hardcore Keynesian to understand why governments – and Morocco is no exception to that- prefer to go deficit-spending when the economy is in recession, especially when it is a serious one. Indeed, Robert Lucas (a big name from the University of Chicago) quipped:

I guess everyone is a Keynesian in a foxhole.

(TIME, Oct. 23, 2008)

And Morocco has been -and continues to be- a Keynesian-style economy. Unfortunately, it indulges a lot more into Zombie Keynesianism, fiscal and expenditure policies are indeed supposedly designed to stimulate domestic demand, but they do not reach the majority of our citizens (just think of household consumption distribution in Morocco: a third of its aggregate total is controlled by 10% richest households) the same can be said of public investment, although the argument is not as clear-cut as one might think it is.

relatively strong negative correlation might lead to think deficits are there to smooth economic fluctuations (captured by GDP growth volatility)

Look at the graph: deficit as a percentage of GDP opposite GDP growth over the period 1960-2011. correlation seems strong enough to sustain the assumption deficits are there to alleviate deficit. However, beware of confusing correlation with causality; we can also produce equally good evidence that deficits are the ones responsible for GDP volatility.

There is also the question of how much historical volatility is linked to deficits. The choice of 3-years deviation of GDP growth was purely arbitrary, and if anything, the strongest correlation between deficit and volatility in GDP is observed for 6-years periods, and immediate correlation between GDP growth (as it is) and deficit in percentage of GDP is equally significant. Finally, there is relatively weak evidence deficits limit somehow fluctuations in the economy (less than two years). This result seem to be in line with usual assumptions in taking 5-years averages to smooth things over.

We therefore have a glimpse to the double effect of deficits: in the shorter run as well as the longer run, deficits are negatively correlated to GDP volatility and growth.

Why do we care about standard deviation in GDP growth? For many reasons, chiefly because of government targets and growth itself; large deviation in GDP from one year to the other reflects badly on average growth – think about the 5.5% average growth projected for 2012-2016 and the impact of large ups-and-downs in GDP growth; as it stands, 2014-2016 needs to deliver consecutive growth figures close to 6.75% each year.

Second, volatility in growth means higher uncertainty. Last year, Morocco created in 2008 some 72.6Bn dirhams worth of goods and services. But the next year, only 43Bn where created, and the next years after, an average of 36Bn. These differences in expected additional GDP – about 30 Bn from one year to the other that could have benefited to many businesses and individuals, but did not, because GDP growth fluctuated a lot (not as much as the  10-year average).

Let us take a leaf from serious academia from the World Bank about the matter:

This paper examines the relation between fiscal deficits and growth for a panel of 45 developing countries. Based on a consistent treatment of the government budget constraint, it finds evidence of a threshold effect at a level of the deficit around 1.5% of GDP.

While there appears to be a growth payoff to reducing deficits to this level, this effect disappears or reverses itself for further fiscal contraction. The magnitude of this payoff, but not its general character, necessarily depends on how changes in the deficit are financed […] and on how the change in the deficit is accommodated elsewhere in the budget.

Now, this paper (from 2005) shows the optimal level for budget deficit is 1.5% for emerging economies, even as Morocco tends to flaunt the 3% target as an article of faith. A 1.5% deficit today means the government needs to cut about 38.7Bn from its deficit, or enact a net cut of 21.8Bn in the 2012 Budget – a 6.3% reduction in the Budget size. But then again, the figure of 1.5% GDP is not absolute: there are other parameters to take into account, which makes the ‘optimal’ deficit for Morocco a bit higher, and more manageable; in fact, 3% deficit GDP falls within the 95% confidence interval for the estimated, optimal 1.5% deficit. With a 3% deficit target, the Government needs to cut the deficit some 24Bn dirhams, or enact net spending cuts of 14Bn (on the basis of a maximum tax increase of 14.6Bn)

All in all, the past 40 years have been a period of relentless deficit spending policies, that ultimately culminated with the 1970s (8% over the period 1970-1981). Even the Structural Adjustment programs did not do that well; while they did indeed reduce the budget deficit considerably with respect to the spendthrift years of the 70s, the deficit between 1983 and 1992 averaged 6%, while the deficit between 1999 and 2010 was cut in half, close to 2.9%, with two surplus consecutive years.

In many respects, Budget deficits in Morocco are not deficit-spending per say. The ‘Rapport du Cinquantenaire‘ correctly pointed out in this graph that investment lags behind current expenditure (pay-wage and stationary, for instant). The deficit has a lot more to do with weak fiscal structure, that prefers to tax easy aggregates (consumption mainly, and it companies are actually the ones collecting the money) instead of taking on special interests (the supplementary report to the Budget bill estimates 33Bn in tax exemptions and breaks are embedded in the 2012 Budget) and broadening the tax base.

The Economic Chronicles of the Kingdom, 1955-2011 Part.3

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on July 21, 2012

This post could have been titled ‘Morocco v The Rest Of The World’. and can be summarized in two sentences:

Morocco’s RGDP Per Capita grew 6.18% yearly in current terms. Average Global RGDP Per Capita, 5.35% between 1955 to 2009

in 1955, Morocco’s GDP ranked in the bottom 12% out of 72 countries.

in 2009, Morocco’s GDP ranked in the bottom 32% out of 190 countries.

This is good news: it can be argued that Morocco’s catching up to the global mean is real and tangible, and that is has done well over half a century by lifting itself up from poverty to average, the performance has to be put in perspective: the distribution of global GDP has changed dramatically: it has grown more unequal, and the seemingly bimodal shape of the density estimate in the graph belies the large number of countries left behind the curve, literally. The “bimodal shape” refers to the two humps observed in the light-grayish curve of Real GDP Per Capita for 2009, one close to 6 – 8, which refers to a Real GDP Per Capita of $1,200 and $1,500, and a wealthier hump of $13,000 to $17,000. Morocco’s performance puts it in the vicinity of the upper bound of the first hump, with about half as much, in current terms.

In 1955, discrepancies between countries were not as striking; on the other hand, there were only 72 countries whose individual economic data were recorded. Nonetheless, distribution was very close to a theoretical normal distribution, with average Real GDP Per Capita around $ 476.24 (in current prices) and about 95% of all values between $478.3 and $474.2, what is more, countries in the left hand-side tail, the richest countries are quite rare, if any.

Morocco’s Real GDP Per Capita ranked in 1955 around the bottom 12%, close to the lower decile that is. As usual, going from small A to larger B does not necessarily mean we have scored good. It is true Morocco has grown about an average full percentage point above worldwide trend, but is it enough? Or is it even statistically significant?

where high growth is not enough: world GDP is more likely to stick to its average growth figure, while Morocco has a higher likelihood to dip into negative growth figures.

Growth in Morocco is definitely more volatile: even as its mean is significantly higher, the standard deviation is about twice as large as the average global growth. Indeed, if it was not for the large differences in growth levels, Morocco could have improved its standing in the global percentile. in short, the Moroccan economy hasn’t done enough in terms of β-convergence (the maximum growth rate to catch up to more advanced economies) and has definitely failed to generate enough in terms of σ-convergence (the ability to achieve growth rates without too much volatility through redistributive growth).

It is not too harsh a statement: after all, volatility around growth levels for the past decade has been cut by 15% relative to the 50-years long trend, and 20% when compared to pre-1999 levels. What happened was, the economy did not push stronger in achieving more in reducing volatility. At this stage, the argument that maximum growth doctrine, even if it has been achieved at some level by the Moroccan economy, did not generate the anticipated level of wealth and income per capita. This might explain why even as Morocco has improved its ranking by jumping two full deciles, it is not nearly enough to qualify as a true emerging market with upper-middle income potential; simply put, Morocco was lucky enough to improve its ranking because other countries have messed up their development model – check the lower right hand-side tail to verify: it is no good to boast a 30% bottom when the said 30% are much poorer.

The alternative way to go might reside in a little-known and seldom advocated policy, that is, to achieve the lowest possible volatility over an intermediate or long period of time.

Consider a generic Moroccan economy, where everything runs smoothly with no volatility, i.e. a stable economy with the same growth rate of 5.655% every year from 1961 to 2010, which is the exact average growth of real GDP Per Capita over the same period of time. GDP Per  Capita is expected to grow 16.5 times in 50 years, which means GDP per capita (current US$) would reach $3,871.57 instead of the existing $3,053.53 per capita. The generic economy has run on the same growth rate, the same population, but there is one crucial factor that explains the $818 gain per capita (or the aggregate sum of $ 26.7 Bn, or 213 Bn dirhams) and a notch higher toward the $ 4,036 Upper-Middle Income Countries per World Bank nomenclature. In fact, there is a way to quantify the gains from any policies designed to reduced output per capita volatility. A completely ‘sanitized’ growth brings increases GDP Per Capita by $ 800.

Halving output per capita volatility by 50% means growth gains would amount to $160. This shows growth stability is not an easy target to achieve, and the potential benefits have long-term effects, but it is clear the σ-convergence path has more benefits to the Moroccan economy. Unfortunately, growth volatility in Morocco has been followed by a proportionally larger drop in average output per capita – even as demographic growth dropped too, so this is, up to less than a percentage point, the economy’s entire responsibility.

There is room for the next years to generate an additional $160 per capita if growth volatility is cut in half.

The political argument for a more stable growth is more difficult to make: no political party or organization would advocate moderate growth rate for higher stability. Elected representatives cannot produce electoral manifestos without ambitious growth rates: recall PJD’s pledge to increase GDP Per Capita 40% by 2016, which means they need to achieve an annual growth of 6%, or 7% when demographic growth is taken into account. The unelected officials need to promote a narrative whereby Morocco is a dynamic, Mediterranean Dragon, and potential growth rates of steady 5% do not look terrific when sold to foreign investors.

Come to think of it, this is the actual cost of development policies in Morocco: these should have at least alleviated the effects of volatility. Instead, some have only exacerbated them, to the tune of 213 Bn dirhams of lost development.