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

and

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”)

</pre>
// 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

model;
 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);
 w=b+c;
 r =(1-tauk(-1)+delta)*alpha*y/k(-1);
 (1-alpha)*y/c = theta*h/((1-theta)*(1-h));
 g+def+(1+r(-1))*b=b(+1)+tauk(-1)*(r-delta)*k(-1)+tauw*w+tauc*c-taui*x;
 c(+1)=c*beta*(alpha*y(+1)/k+1-delta);
 end;

endval;
 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;
 end;

steady;

shocks;
 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;
 end;

stoch_simul(order=1, periods=224, hp_filter=1600,nograph);
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“There’s Your Turn” – “You’ve Missed It, You Idiot”

Posted in Ancient Times, Happy Times, Dismal Economics, Morocco, Read & Heard by Zouhair ABH on November 23, 2012

From Robin William’s One Man Show “Weapons of Self-Destruction”

At the risk of stating the obvious, Morocco is very sensitive to exogenous and foreign (imported) shocks, as it is a small and open economy (75.9% of its GDP goes to foreign trade) And from my ivory tower I foresee a bad course of action, captured in one essential aggregate of growth in Morocco: household consumption is too volatile, too high to actually benefit from its openness to foreign trade – and some government policies come to mind in order to explain these discrepancies: the Subsidy fund harms growth.

de-trended quarterly foreign trade and technological growth – the combined effect of both exogenous aggregates produce interest results

Morocco observes domestic and foreign shocks; these are weakly negatively correlated, as shown on the graph. It is obvious foreign shocks exhibit larger magnitudes – the changes due to oil prices, exports and imports for instance are very large and quite volatile. Mainstream economics tells us large shocks should compel households to be more prudent about their consumption habits: if you are expecting oil prices to vary significantly, you might want to think twice before getting to work on your car – but on the other hand, because the government provides a comfortable cushion that keeps fuel prices low, whatever happens overseas is of little concern to you. Speaking of which, there is going to be a long-term effect of the government’s decision to lift some of the subsidies on oil derivatives: HCP’s estimates were an average decline of 1.13% in household consumption:

[…] Le pouvoir d’achat des ménages serait en dégradation et leur consommation connaîtrait en conséquence une baisse passant de 0.98% en 2012 à 1.53% en 2013, pour se stabiliser aux alentours de 0.97% en 2016-2017.[…]

mine is somewhat more pessimistic, close to 1.37%. Same goes for GDP impact, though HCP estimates an average .61% in lost GDP, close enough to my forecast of .69%:

[…] Au total, le produit intérieur brut (PIB) devrait enregistrer un manque à gagner de 0.39% en 2012, de 0,74% en 2013-2014 et 0.69% en 2017. […]

But let us get back to the issue of Morocco as a small, open economy: an earlier post showed growth in Morocco is mainly driven by technological change, though I have restricted the results to domestic shocks:

The addition of foreign shocks (imported technological change) only confirms my initial assumption: total technological change account for 73% of observed growth since 1995, including a 13.6% contribution from foreign trade, almost on par with physical capital accumulation.

Technical Note:

I have attached impulse-response graphs for both Domestic and Foreign Shocks; graphs are read as the percentage of aggregate variation from steady-state following a one-period, 1% exogenous shock.

16 – 12… Why Not 7?

Posted in Flash News, Intikhabates-Elections, Moroccan ‘Current’ News, Morocco, Read & Heard by Zouhair ABH on November 15, 2012

503 days since our new (in)glorious constitution has been voted overwhelmingly, and no word as yet as to the dozen of bills essential to make it work have been presented before parliament. Our elected representatives have not the foggiest about what perhaps may be the most important pieces of legislation since 1997 (Bill n° 47-96).

It is sad that for two major decisions, the first in January 2010, and the second in another speech in July 2011, the legislative process did not follow suit. Regionalization is just as important as the constitution itself. Either Morocco chooses to devolve as much power as possible to local and regional bodies, or the same old mistrust and latent hostility will prevail between the citizens and their elected representatives, local or national, all of which is at the expense of democracy, and only encourages Moroccans to seek other sources of unelected, crypto-autocratic power.

The Regionalization commission set up after the Royal speech three years ago came up with a rather peculiar proposal for 12 regions – since I am no expert in all the aspects involved in their offer for that particular proposal, I should refrain from commenting on it; Although, I must point out regional GDP is likely to be more dispersed and more unequal – in fact, save for Casablanca-Settat and Rabat-Salé-Kenitra, a 1% increase in regional density per capita in the new setting actually decreases regional GDP per Capita by 3% (the newly redrawn Southern regions are actually worse off) a pure economic analysis means these redrawn regions will only increase dispersion in population density and wealth per capita – even as provincial output is relatively well distributed – most provinces add up 116.5 Million dirhams to their GDP when their local population increases 1%. But this is only possible if the aggregate regions even growth out, instead of concentrating high-growth sources and leave hinterlands to fend for themselves.

(one small digression perhaps: I was looking at a pre-1870 Germany map to illustrate my point; the present Bundeslaenders vs the fractured old Holy Roman Empire.Quite an illustrative example as to how historical particularism can be dealt with in devolution schemes)

a 7-regions scheme makes it actually easier to determine the regional weightings for the subsequent electoral reforms

Here is a proposal for a much more reduced-form (and arguably, fairer) regional breakdown that would perhaps serve local democracy, and representation at the federal (or national) level. 7 Regions, with relatively homogeneous cultural and historical roots, not to mention some measure of economic fairness – the proposed scheme reduces regional GDP dispersion by 31% compared to the scheme put forward by the Royal Commission. It also serves as a spring-board for another project many have lost interest in: Electoral reform for strong parliamentary majorities – and thus, stronger elected government.

The Roof is On Fire, Keep Calm and Carry On

The season of Budget Bill is upon us. and from what I can surmise, the planning staff at the Finances ministry is dead set on using the 5.5% growth for 2012-2016, and the target for reducing budget deficit to 3% of GDP by 2016 is maintained nonetheless.

I posted a short blog on how unreallistic these figures are, in the face of gloomy global, conjecture (even more gloomy as the IMF cut its global growth projection last week) pressure on Morocco’s foreign exchange reserves and the urge to cut the subsidies.

year|   Deficit  | Deficit| Deficit 
    |(Bn dirhams)| % GDP  |Reduction
----+------------+--------+---------
2012|   -49,6    |  -6,1% |  +4.9
2013|   -45,1    |  -5,3% |  +4.7
2014|   -40,7    |  -4,5% |  +4.2
2015|   -35,8    |  -3,7% |  +5.1
2016|   -29,9    |  -2,9% |  +5.8

The short communiqué on the MINEFI website points out projected growth for 2012 is 4.5% (close to IMF’s 4.3% prediction 3 months ago) and 4.8% deficit. There is a small difference between that figure and the 5.3% budget deficit for 2013 mentioned in the IMF report – which means there is margin for the government in its intent to implement this dramatic deficit reduction plan; It is dramatic, because a deficit-cutting plan from 6.1% to 4.8% means there are 11.03Bn net cuts in the budget – which in turns means larger revenues and/or expenses adjustments.

And here is the clincher: There are going to be 24,000 new openings in public service payroll – and since most of these are going into relatively high-paying jobs – in fact, they are most likely to be centered around the median entry public service salary (about 7,000 a month) 2Bn in additional expenses.

So there it is: a tax increase is unavoidable -in fact, desirable, provided discretionary loopholes are closed, though it is not certain Mr Benkirane has the guts to take on the special interests benefitting from the status-quo, and so are the cuts to subsidies.

PS: IMF seems to have considerably upgraded Morocco’s outlook on GDP growth to… 5.5% (up from the previous 4.3%) strange.

 

Standard and Poor’s, Hatchet Man?

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

So it it true then. In itself, the outlook switch to ‘Negative’ is not such a bad piece of news, although it gives reason to worry about the future. If anything, I would have expected S&P to be a bit more Johnny on the Spot.

 

Let us first read the actual words S&P used to explain its outlook update (because it is only an outlook update, not a downgrade, mind you)

– We are affirming our investment-grade long- and short-term foreign and local currency sovereign credit ratings on Morocco at ‘BBB-/A-3’ and ‘BBB/A-2’, respectively.
– We expect economic reforms, and particularly petroleum subsidy cuts, to diminish Morocco’s external and fiscal deficits.
– We are revising the outlook to negative from stable. This reflects our view that the Moroccan authorities are finding it more challenging to reduce the vulnerabilities created by the twin deficits in the context of a difficult external environment, while maintaining Morocco’s traditional political and social stability.
– The negative outlook reflects our view that we could lower the ratings if the fiscal and current account deficits do not narrow significantly, if social pressures escalate and impair reform progress, or if economic performance is materially harmed by a weakening external economic environment.

S&P worries are just as justified as those of, the IMF when the PLL was extended to Morocco: the current account and budget deficit have significantly deteriorated during year, and as a result fiscal consolidation is to be expected.

The report is quite interesting in fact: beyond the inevitable media tension over the outlook update (and all the ensuing misunderstandings) S&P’s assessment is fascinating as to how the current government can or will deal with these issues. First off, they seem to challenge the Moroccan position as to the promises made before the IMF:

The total subsidy bill was equivalent to a substantial 6% of GDP in 2011. The government began to reduce untargeted fuel subsidies in mid-2012, but will need to take more steps to restore Morocco’s traditional fiscal stability.  While the government has expressed its intent to press ahead with further subsidy reform, we believe this will be politically contentious and could undermine social cohesion, leading to further delays. We also note that, to date, no concrete timetable for reforms has been laid out.

Does it mean we should kiss goodbye to the 2016 target of less than 3% deficit to GDP? The report does not say. It is painfully clear however the efforts on behalf of our government to trim the Compensation Fund do not look credible, precisely because they refused to communicate any precise timetable as to how the subsidies will be cut. It seems IMF has been for once overly optimistic as to Morocco’s future economic performance.

Much more concerning is S&P’s pessimistic analysis of future growth: while it is expected exports would benefit from a structural boost (provided by FDIs flowing into Morocco during the past decade) growth is also expected to be weak, with all ensuing political risks. In fact, the report lays out quite explicitly the doomsday scenario:

We expect the progress of political and economic reforms, and the authorities’ ongoing efforts to contain consumer price inflation, to limit popular unrest  to sporadic outbursts. However, if unemployment remains stubbornly high, living costs spike, or political reforms disappoint popular expectations,  there is a risk of sustained and large-scale unrest that could also lead to a downgrade.

This outlook update will most certainly have a negative impact on the expected new dollar-denominated bond issue. Remember the good news on March 2010, when the Moroccan sovereign debt got its Investment-Grade label, a testimony to a decade-long period of fiscal conservatism and discipline. The yields on the 2017 Eurobond have decreased 110bps in less than one month, and spreads to benchmark yields contracted 50bps. If it was not for the global uncertainty triggered by the Arab Spring, the yields would have stayed below 4.5% – is was the coupon attached to the 2010 issue; on the other hand, Moroccan sovereign spreads during the first 6 months in 2011 rose moderately, which means the yield increase is of a systemic nature.

the yield could have stabilized itself below the 4.5% if it was not for the high level of uncertainty during the first half of 2011

The impact of this piece of news can be verified in the next couple of days on the other Eurobond; If its price goes below 99.3 in less than a week, it would not only confirm the sensitiveness of the 2020 Eurobond to country-specific market news, but would also allow to make some predictions as to the expected coupon for the next bond issue, and these point to a figure close to 5.4% than it is to the 4.53% embedded in the Bond issue two years ago.

News can go both ways: there has been indeed a positive impact on Morocco’s foreign debt when it was upgraded to Investment Grade in 2010- and subsequently allowed for a second bond issue at a relatively low 4.53% coupon. Nonetheless, given the pressure on public finances, the government has little choice but to go to international markets for a third bond issue, handicapped with this S&P new assessment.

Note: the S&P report can be read below

FRANKFURT (Standard & Poor’s) Oct. 11, 2012–Standard & Poor’s Ratings Services today affirmed its long- and short-term foreign currency sovereign credit ratings on the Kingdom of Morocco at ‘BBB-/A-3’ and its long- and  short-term local currency ratings at ‘BBB/A-2’. The transfer and  convertibility assessment for Morocco remains ‘BBB+’. At the same time, we  revised our outlook on Morocco to negative from stable.

The ratings on Morocco are supported by its macroeconomic management approach,  which has traditionally focused on achieving stability. This has contributed  to strong economic growth relative to peers, low consumer price inflation,  relatively low external leverage, and moderate government debt levels. The  ratings are constrained by comparatively low prosperity (relative to similarly rated peers) and by social pressures, which we believe have increased since the Arab Spring, but remain much lower than in neighboring countries.

The general government balance had been broadly balanced during the past  decade. However, deficits rose to over 4% of GDP in 2011 and this year as spending, especially on fuel subsidies, has increased and driven the primary  balance deeper into deficit. We expect that cuts in subsidies will see a  primary surplus return in 2013 and the net general government debt peak at an estimated 41% of GDP in 2012.

The total subsidy bill was equivalent to a substantial 6% of GDP in 2011. The government began to reduce untargeted fuel subsidies in mid-2012, but will need to take more steps to restore Morocco’s traditional fiscal stability.
While the government has expressed its intent to press ahead with further  subsidy reform, we believe this will be politically contentious and could  undermine social cohesion, leading to further delays. We also note that, to  date, no concrete timetable for reforms has been laid out. Higher global oil  prices–while currently not expected by Standard & Poor’s–could also impair  progress, as could weak economic performance in European export markets and sources of trade, investment, remittances, and tourists.

Morocco’s external financing needs used to be contained due to low external debt and a current account close to balance or in surplus. Since the onset of the global financial crisis, however, the current account deficit has risen  fast, reaching by our estimate an average of over 7.5% of GDP during 2011-2013, partly fuelled by rising oil prices and a poor harvest in 2012.

Morocco’s narrow net external debt ratio has therefore quickly deteriorated. As recently as the middle of last decade the Moroccan economy was a net creditor, by that measure, of more than 20% of current account receipts (CARs). By contrast, we forecast a net debtor position of 28% in 2012.

Although official foreign exchange reserves have fallen sharply from their peak, we estimate immediate gross external financing needs at a still-moderate 93% of CARs plus usable reserves (in 2012) and expect them to stabilize at around 100% by the middle of the decade (from less than 70% before 2007). Immediate refinancing risks are further mitigated by an IMF precautionary liquidity line equivalent to $6.2 billion.

We also recognize that past FDI (averaging about 2% of GDP during the last decade) will likely improve export performance. Nevertheless, we believe that economic rebalancing over the medium term will remain difficult and may lead to lower GDP growth, which could heighten risks to political and social