The Moorish Wanderer

From Hero to Zero: 7% – 5.5% – 5% … 4%?

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on May 27, 2012

Who cares really… Forecast in growth is usually a very tricky business, but it is interesting in assessing the government’s own projections of how the Moroccan economy will fare in the next couple of years.

For instance, by my account, the government’s claim to create enough growth for 2016, an average of 5.5% as a matter of fact. 2012 is off to a bad start, since the best estimates are 3-4%, which leaves them with a higher target – about 5.8% to 6.1% to meet by the end of their legislation. By Bank Al Maghrib‘s own projections, that means the economy has to perform 5.5% for the next couple of years. But then again, these are basic results: growth figures are computed as geometric means, with 1+\hat{y_t}=\sqrt[5]{\prod 1+y_t}

the lower the initial value, the higher the next growth figures will have to make up for it – that’s how averages work. But then again, I do not expect the government to delve into explaining the method by which they get their figures. So if the Moroccan economy does not perform very close to 5 or 5.5% every year, then they would lose their bet, and with it some of their spending commitment will be halved or shelved.

Potential Real GDP (computed with respect to demographic growth)

A quick word perhaps on projected growth: there is more to it than just delivering a 5.5% five years straight. for the last 20 years, the potential output growth for the economy has turned around 5% (4.98% to be precise) in real terms. To promise 5.5% on average over the next 5 years means they are expecting an expansionary cycles, which does not seem to be doable at this moment: ever since 1992, the potential GDP growth has been very steady, and the volatility of cycles have decreased by a third when compared to the 50-years trend, and has been hovering around 5.02% and 4.95%, regardless of economic performances (and these were not top notch during the 1990s with the benefit of hindsight)

An IMF report points out:
Growth has been lackluster and volatile, especially since the 1990s. The most recent years show some encouraging signs […] However, the performance of the economy still needs to improve to catch up with the recent trends of GDP […]

Let us look back to the RBC computations described in the Big Picture Series: I have recomputed the parameters in question, and introduced the changes below. It is worth pointing out that these changes, while not very significant, are solely based on how one deals with the labour aggregate; the standard modus operandi is to compute total hours worked by the potential working population; since I have based most of my computations on DeJong & Dave, this is the most proper way to proceed:

Title:              	Nonfarm Business Sector: Hours of All Persons
Series ID:          	HOANBS
Source:             	U.S. Department of Labor: Bureau of Labor Statistics
Release:            	Productivity and Costs
Seasonal Adjustment:	Seasonally Adjusted
Frequency:          	Quarterly
Units:              	Index 1992=100
Date Range:         	1947-01-01 to 2004-10-01
Last Updated:       	2005-03-03 8:36 AM CT

But since no such data exist for Morocco, I had to make do with the available material, and settle for the standard 2080 hours per productive worker.

1/ we first list the parameters of interest as follows:

\alpha Capital Share: 0.335966

\beta Households’ discount rate: 0.934257

\delta Capital annual depreciation rate: 2.909%

\epsilon_{z_t} White noise of structural shocks N(0,0.01019)

\upsilon_{bp_t} White noise of balance of payments N(0, 0.08656)

\tau cross-persistence between the balance of payments and structural shocks: 0.599035

\rho persistence of AR(1) process: 0.371501

\phi time share allocated to work, 8 hours per day: 1/3

2/ model specification

* Household utility function, defined such: U(c_t,h_t)=\sum_{t=0}^{\infty}\beta^t\left[\theta \log c_t +(1-\theta) \log (1-h_t)\right]

* Output production: y_t=\exp(z_t)k_t^\alpha h_t^{1- \alpha}

* Structural shock process: z_t = \rho z_{t-1} + \tau bp_{t-1} + \epsilon_{z}

* Balance of payments process: bp_t = \rho bp_{t-1} + \tau z_{t-1} + \upsilon_{bp}

* Capital accumulation: k_{t+1} = (1 - \delta) k_{t-1} + i_t

* Investment dynamics: i_t = \exp (bp_t) \frac{y_t}{c_t} the definition combines a measure of domestic savings (\frac{y_t}{c_t}) and inflows of Capital.

* National Accounting Identity: y_t = \exp (bp_t) g_t + c_t + i_t government expenditure factors in foreign shocks as well, so as to capture other constraints a government in a closed economy doesn’t usually face.

* Government dynamics: it is assumed the government funds itself by levying taxes on capital and labour, with no room for deficit. this assumption is dictated to by the reality of given data and not pure ideology: the time series on public debt are incomplete and do not go as far as the late 1950s. The government announces a sequence of taxes \left\{tax_k , tax_h \right\}

Taxes: g_t = tax_k.\alpha.\exp z_{t-1} \left[\frac{k_t}{h_t}\right]^{\alpha-1} + tax_h.(1-\alpha).\exp z_{t-1} \left[\frac{k_t}{h_t}\right]^{\alpha}

Substitution rates of taxes: \frac{tax_h}{tax_k}=\frac{h_t}{k_t} \left(\frac{1-\alpha}{\alpha}\right)

3/ Results:

the assumption behind a utilitarian rate of substitution precludes any activist policy; the idea is to figure out first how an optimal funding for government expenditure in an RBC setting, then consider other settings where taxes are selected according to a specific decision rule.

  V   | St.Dev | sj/sy|Cor(j,y)|
------+--------+------+--------+     
  Y   |0.060230|   1  |    1   |
------+--------+------+--------+       
  C   |0.042792|0.7105| 0.9636 |
------+--------+------+--------+
  K   |0.380672|6.3203| 0.8090 |
------+--------+------+--------+       
  I   |0.020965|0.3481| 0.8727 |
------+--------+------+--------+        
  H   |0.004720|0.0784|-0.5595 |
------+--------+------+--------+        
 tax_h|0.003165|0.0525| 0.4948 |
------+--------+------+--------+        
 tax_k|0.076674|1.2730| 0.3870 |
------+--------+------+--------+
  G   |0.009470|0.1572| 0.2632 |
------+------------------------+

the model is significantly less volatile than the data, but ultimately fields good prediction when the cycle is close to the trend.

(we can already say the tax sequence is not based on utilitarian principles, since volatility on tax_k is higher than total government expenditure, and a lot closer to that of empirical government aggregates – this means taxes on capital are either too distortionary, or that government decision rules are based on unknown parameters.

in terms of cycle projection, while issues of equity premium puzzle arise – the comparison between RBC-generated data and empirical cycles for investment and capital, broader results are in line with model predictions, in particular when the cycle is close to the trend; aside from the expected low volatility, deviations are mainly due to exogeneous shocks, which allows for some predictions without too much tampering with the broad aggregates’ identities.

At this point, the model predicts very narrow results for the next quarters in 2011, but it remains very ellusive: the graph below points out to the variations with respect to the potential GDP growth per capita – about 3,94%, or 4,98% in aggregates terms.

Growth will not go beyond 5% for the next half a decade; there are no particular exogeneous shocks to expect that might lift productivity up and thus push the boundary of potential growth. There are however many shocks to expect that might slow down growth: foreign demand for Moroccan exports is likely to weaken, and the need for imported goods – whose relative price is quite high- will grow and handicap the economy. This means growth projects are wider on the lower side than they are on the upper one; a growth target for 5%, the baseline scenario might very well look overly optimistic, let alone an average of 5.5% over the 2012-2016 period.

On the other hand, the model by itself predicts a higher boundary of 4.98% – the potential trend that is – and provides ample room for lower projections, in the region of 4%. For Q2-2012, the model forecasts between 3.951% and 3.936% per capita growth; this means, in real terms, the economy will grow between 4.05% and 4.03%; but based on historical volatility, it is likely to be closer to 4%. From then on, the model predicts only one quarter above the 4.98% trend and from 2012 to 2016, average real GDP growth per capita does not rise beyond an average of 4.02%, and could go down as low as 3.8% (within a 95% confidence interval, that is)

Pushing the Boundaries of Potential Growth

Posted in Dismal Economics, Moroccan Politics & Economics, Morocco, Read & Heard, Tiny bit of Politics by Zouhair ABH on September 13, 2011

An interactive reader pointed out to me a few days ago that the proposed regression in an earlier post about potential growth. The remark focused precisely on the estimated TPF: .16. No way productivity and technical progress would record such a high number, especially for Morocco.

Model shows constant returns to scale, as well as robust indicators

But the model is not wrong, quite de contrary: the measured logarithmic GDP is real GDP growth, with 1981 as base year. Because the domestic economy was in deep recession during the 1980s -due to the conjugated effect of debt crisis and contracting GDP- any growth observed with respect to that base year is not adulterated by yearly fluctuations; This modus operandi fits the long-term framework for estimating labour and capital contribution to growth, as well as the estimation of potential GDP. Because the global economy has recorded a phenomenal increase in productivity and technical progress, the residual of 0.16 is logical and expected; as a matter of fact, at least 95% of estimated values are positive, which vindicates the robustness of this model. And so, it is safe to say that on average, over the last 30 years, TPF have contributed 0.16 bps to real GDP growth. We can do better, and we must do better, because, as Prof. Akesbi pointed out, our average growth rate – as well as potential growth- are too low to catch up with emerging economies.

While I have considerable doubts over Prof. Akesbi’s claim that Morocco needs to do8% GDP growth to be an emerging country, I certainly agree the Moroccan economy needs to expand without putting strain on its productive factory, or induce inflationary pressures. Not that Moroccan cannot do 8%, but reaching such a target would inevitably trigger inflationary pressures, just like in the mid-1970s: Morocco recorded 10.81% growth in 1976, but was hit back with a 12.6% inflation rate the year after; Of course, the Moroccan economy at the time could not on itself create a Chinese-style growth, something that was swiftly followed by an inflationary spiral fuelled by borrowings and geopolitical conjecture that led in the 1980s to sever crisis and recession.

Since mid-1990s, inflation broke away from GDP growth lag, as output gap has been, on average, negative over the period

An 8% growth bridges only partially the accrued output gap since 1991, and Morocco basically needs to keep up 8% for about a decade to beat potential GDP, an impossible task to perform, even with a halcyon global economic conjecture. It would be better -and smarter- to think of different ways to expand our economy; And as it happens, the “White Heat of Technology” Prime Minister Harold Wilson referred half a decade ago perfectly applies to Morocco: invest in research & development, primary, higher and continuous education, and encourage smaller but more innovative and adventurous businesses to lift us up and expand output for all of us. We start with 0.16 points contribution to growth. The challenge is to go to 1 to 2 full points for growth; It can be done, and it is to the benefit of everybody to do so.

The cost to push potential GDP growth 2 basis points above over a decade is MAD 135Bn, or MAD 132Bn when adjusted for inflation. That means an average R&D spending of MAD 13.3Bn per annum. These spendings are not necessarily public commitment, and private sector can chip in too; But over all, a 13Bn overhaul is double Agriculture and Fishery ministry investment spendings, or 3 times spendings on expanding Education and Research.

But then again, we are in for a different kind of future with our esteemed leaders; the kind of investment for the future engineered higher up is TGV, Tangiers port and other trickling-down economics.Education, Small business and scientific research are not the priority.

Thesis Working Paper n°1

Posted in Dismal Economics, Read & Heard, The Wanderer by Zouhair ABH on December 23, 2010

This year is definitely being bitchy all the way down to early spring. Can it get any worse? (I am masochist, so It’s a bit of wishful thinking)

I’m getting pieces together for the thesis; it’s definitely going into game theory as a theoretical background in describing how a central bank should set the optimal interest rate, and how the fact that rate can be credible when a certain set of conditions are satisfied. I am having an enormous amount of fun in trying to get things going around… In an economic universe, the Central Bank has few objectives to fulfill: “stabilizing inflation around an inflation target and stabilizing the real economy, represented by the output gap“. (Svensson, 1999) the output gap is a reference to the gap between the actual GDP and the optimal GDP, or potential output, and can be roughly computed with the labour and net capital productivity, plus the total productivity factors, which can be proxy for technical innovation (or how to combine factors differently to get a higher output, or the same amount of output for lower level of capital and labour)

Because I claim to be a monetarist, and because I am fully in favour of an independent -but responsible before an elected body of representatives- central bank, I believe this institution is the one adequately geared to influence other players into accepting it as the best level of interest rate they should act upon. The game theory technique is there to prove that it can set a rate and an output target such that all players -that is economic actors- would stand by the targets as credible signals and would yield larger common welfare if they did not.

There is of course a strong assumption going on about the Central Bank’s motives: following institutional backgrounds, banks like the Federal Reserve has a triple objective to fulfill: inflation, growth and employment (Federal Reserve act, Section 2.a) the European Central Bank on the other hand, is mainly focused on inflation, and growth is a purely secondary objective, contrary to the Fed whose 3 objectives are of equal importance; these are even more stressed upon when put in perspective with regard to the kind of relationship their entertain with the political power; There is a wide-range consensus among economists about the virtues of an independent Central Bank, for all of the benefits it brings in terms of credibility, and thus efficiency in monetary policy-making.  As for the Moroccan central bank (Bank Al Maghrib) things are certainly different, but that is another matter.

Another assumption is that other players are interest-rate sensitive: firms are likely to expand or restrain their investment; The assumption looks credible, even though there are occurrences of sub-optimal or indeed irrational decision-making regardless of what the levels of interest rates are. In a dynamic setting, some players, like the unions or households do not change their behaviour overnight, as indeed there is a certain delay (a lag variable that can empirically observed thanks to econometrics) and would therefore blur the bank’s decision;

– Starting/working assumptions:

The Central Bank handles interest rates setting and assigning to the economy a target output (or in most cases, a target output gap) both of which variables are set in a fashion such to maximize common welfare, namely by selecting a pair (r,Y) that yields to the Nash axioms (or at least, to start with, Pareto conditions). These decisions are taken subject to other players’ respective preferences sets. The Central Bank is considered benevolent, and pursues no agenda of its own (that is to say, the Nash pair is the Bank’s own preference).

The aim is to prove that in monetary policy, there exist a Nash pair (r,Y) for which common welfare is maximized, and that Game Theory techniques and findings would help describing mechanisms and strategies that would allow the Central Bank, under specified conditions, to reach this equilibrium set over time. The difference with the ‘regular’ Game Theory setting and the present attempt to model the monetary policy lies in lotteries and risk aversion. The first one is relegated to random events (as perhaps used in econometric study) the second one would be rather about time preferences, as we can assume that agents value time, and would rather reach an agreement sooner rather than later.

Therefore, the starting concepts for this paper are going to be related to bargaining issues: for each Player i there is a function [f(r,Y)] called a utility function, such that one lottery is preferred to another if and only if the expected utility of the first exceeds that of the second.

– Simple Model: We borrow elements from the bargaining model as specified by Osborne & Rubinstein with a simple monetary set: two players, Central Bank (CB) and a Business Firm (BF) in an economy, which have to reach agreement on a specific set (r,Y). Both have their own preferences (CB’s is exogenous to its own condition) We keep the definition 2.1. For the agreements pair (S,d) where S is the set of all feasible pairs (r,Y). Of all Nash axioms (SYM, PAR, IIA & INV) only the symmetry assumption has to be dropped, as CB and BF display different preferences. The feasible set of pairs (r,Y) is divided up between desirable pairs’ sets –to which both players want to yield- and worst outcome possible (WOP) which both players want to avoid at any price. (and is the primary component of bargaining cost)The border between both sub-sets is set by the economy’s own productive capacities (or indeed how far the output gap can be sustained without slipping down into recession) Let us start with the bargaining game of alternating offers, and define monetary policy setting as follow:

1/ CB announces a pair (r,Y) to BF. BF has three ways to go: accept the pair, refuse it or refuse it and submit to CB an alternative pair. If BF accepts or refuses point blank, the game is over, and both parties reach a pair (r,Y) that belongs to the disagreement pair, an outcome both of which are made worse off when reached.

2/ CB, in turns, accepts the pair, refuses it or re-computes another pair (r,Y) and submits to BF.

3/ The game is rolling as long as each players refuse the proposed pair and proposes another.

We have to assume beforehand that CB has access to complete information (a fair assumption as CB uses resources to obtain sufficient information to make an accurate decision- an assumption to be discussed later on) and therefore whatever decision made is necessarily optimal. We can also assume that BF has access to complete information as well, and knows why CB fields its strategy. We also assume both players to adopt an optimal strategy at each point of the bargain, that is, that they are able to order their preferred pairs and play them accordingly at each knot of the game.

This proves that an equilibrium set of pairs (r,Y) can be reached very quickly, as both players know each others’ respective preferences, and if there are resistances from one part or the other, the disagreement –that is, the delay in reaching agreement- does not go further than a couple of periods. In a sequential equilibrium however, ‘We can interpret the equilibrium as follows. The players regard a deviation as a sign of weakness, which they “punish” by playing according to a sequential equilibrium in which the player who did not deviate is better off. Note that there is delay in this equilibrium even though no information is revealed along the equilibrium path.’

This can be used to provide a first-hand punishment deterrent to hurry both CB and BF to reach an equilibrium pair. The time value can be used as well, as indeed the longer both parties reach agreement, the more painful –or indeed the less desirable- the equilibrium pair would be. In real life, that is the case when CB fails to convince other economic players that they will stick to their decision, or that their announcement was not credible. That compels the bank to come after with a much stringent, more constraining announcement, something that could have been avoided if they took their signal seriously in the first place. As mentioned before, the central bank has objectives to stabilize inflation by setting optimal interest rate, and computing optimal (resp. minimal) output (output gap). For the time being, we set up for the output gap, as described in the paper by Gaspar & Smets. Their starting assumption was that both the Central Bank and the private sector (in our case, BF) observe the potential output, an assumption that can be deemed to be realistic, in view of semi-perfect information universe they evolve in.