Trust and reputation effects in the conduct of fiscal policy

opinion August 31, 2012 00:00

By Kiertisak Toh

During my visit to Thailand in late December and early this year, I had glimpses of the aftermath of Thailand's biggest and most extensive floods in recent memory, and the enormous challenges on the road ahead still to be addressed.


These challenges are in the context of a fragile global economic environment and a general reluctance to embrace expansionary fiscal policy in developed countries, especially in the euro-zone economies and the US. Both are significant export markets for Thailand as well as sources of investment and capital flows. Instead, there are austerity refrains in the euro zone economies; in the US the political impossibility for any meaningful fiscal stimulus. The euro mess has become increasingly worrisome. Despite expansionary austerity policies, growth in the euro-zone economies has turned negative.
The devastating floods happened two months after the government of Prime Minister Yingluck Shinawatra began. In late 2011, the newly formed government put in place a stimulus package to support a combination of emergency relief, reconstruction and populist projects. The administration has just completed its first year in the office. In the coming weeks it will review, among other things, its achievements in its management of the macro-economy, including the implementation of the economic stimulus programme. The full performance report of the administration’s first year in office is expected to be submitted to Parliament in late September, just prior to the beginning of fiscal year 2013, on October 1.
How has the administration managed the economy? How effective is the fiscal stimulus? What are some of the issues and challenges ahead?
In late April, following its Article IV consultation mission, the IMF concluded that the Thai economy was on its way to a strong rebound from last year’s floods. The economy was projected to grow at 5.5 per cent for 2012 and 7.5 per cent for 2013.
Last week, the National Economic and Social Development Board of Thailand released its revised overall growth projections downward slightly to the range of 5.5 to 6 per cent, but halved the export growth forecast from 15.1 per cent to 7.3 per cent, pointing out the delay in post-flood industrial recovery and the slowdown of the world economy, especially in Europe, the US and China, as the major causes. It also indicated that the private sector grew by nearly 12 per cent with household consumption increased by 5.3 per cent, not enough to offset the fall in exports. Data also revealed a slowdown in the agricultural sector, from 3.4 per cent in the first quarter to 1.3 per cent in the second quarter.
While the Thai administration will tout its achievements in macro-economic management, critics and the opposition will raise issues related to fiscal discipline, budgeting efficiency and public financial mismanagement. Critics suggest populist polices such as the rice-price subsidy scheme for farmers, undermine fiscal discipline, are too costly and raise questions about the distribution of benefits that are going disproportionately to millers and traders, and encourage rent-seeking behaviour. Critics also point out non-transparent procurement procedures, ineffective budgeting and financial mismanagement of flood-control infrastructure projects resulting in delays or underfunding of certain projects.
Adding to these implementation concerns was the admission by the finance minister and deputy prime minister, Kitiratt Na-Ranong, last week that the government sometimes exaggerates the country’s economic performance. He admitted: “The finance minister needs to lie sometimes to create good feelings. The world knows this as a ‘white lie’. The goal is to create confidence … [to benefit] the country’s economy as a whole.”
The typical way to measure the likely impact of fiscal policy is through the use of estimated multipliers – the change in output in response to changes in particular government expenditures or taxes. These estimates tend to vary widely from negative to slightly positive to greater than one; the larger the multiplier the greater the impact. These multipliers are sensitive to other factors, such as the state of the economy – for example, the degree of excess capacity, the level of public debt – and whether other macro-economic policies, such as monetary and exchange rate policies, are accommodative. In addition, recent research findings also suggest the importance of trust, credibility and reputation effects for the conduct of fiscal policy. Social scientists consider these essential ingredients for building the social capital that can be critical in public policy.
Unfortunately, the finance minister’s statement does not inspire trust or develop positive reputation effects. Thailand’s fiscal stimulus seems to have respectable results so far in terms of growth, even though earlier projections have not been met because of export performance. This is understandable given the worsening global economic environment.
Discussion in the coming weeks should focus on improving transparency in budgeting, public financial management and assessing the cost-benefit of populist policies given their risks toward undermining fiscal discipline and encouraging rent-seeking behaviour. And when it came to lies, remember Mark Twain’s advice – “lies, damn lies and statistics” – even with good intentions.
Dr Kiertisak Toh is a former senior foreign service officer with the US Agency for International Development. He is currently a member of the economics faculty at Radford University, Virginia, and a senior fellow at Duke Centre for International Development, Sanford School of Public Policy, Duke University, North Carolina.