Nothing Useful Will Happen in the Climate Summit in Cancun, Alas

From November 29 to December 10 Cancun, Quintana Roo is the site for the United Nations Framework Convention on Climate Change. Unfortunately, there is no reason to expect any sort of significant agreement outlining specific steps to be taken to slow or reverse human-caused climate change. The incentives to do so don't exist. Global pollution is a problem that national governments are not well-suited to address.

Consider a very simple example. There is a factory that emits soot that negatively affects a community. What options do the citizens of the community have? Although the Coase Theorem shows that there are conditions (rather strict ones) under which the private parties can reach an agreement to resolve the problem, generally the only practical option is to seek redress from the local government. The government could adopt a law limiting the pollution or impose a tax on the pollution. A correctly specified tax would reduce the pollution to the socially efficient level. Now suppose that the community is on the frontier and the factory is across the border in another country. Why should the government of the jurisdiction in which the factory is located seek to reduce pollution if it has little effect on its own citizens? Almost certainly it will do nothing because restricting the pollution would harm its own citizens by reducing production, hence employment, in the factory.

On a much bigger scale, climate change presents the same sort of problem. Presently, the only (obviously) affected nations are a few small island countries in danger of disappearing due to rising sea levels. The apparent negative consequences for the biggest emitters of global warming gases; the United States, China, and Russia; are small thus these countries (and others) have little incentive to reduce the emission of such gases. Until the (expected) costs of climate change rise sufficiently to affect these countries as well, nothing will happen.

According to the NY Times (As Glaciers Melt, Science Seeks Data on Rising Seas, November 22, 2010) many scientists expect sea levels to rise three feet by 2100. If so, nobody will have any meetings in Cancun at the next turn of the century because the hotel zone-convention area will be underwater.

Taxes-In Praise of Mexico

Let me note at the outset that taxes are distressingly high in Mexico.  There is a value-added tax (VAT) of 16% on most goods; food is excluded for example. The VAT rate is a bit less at the international borders. Mexico also imposes a hefty income tax on those from whom it can easily extract the tax; people who work in the formal sector such as government bureaucrats, employees in large corporations, and university professors, of course, among others. Tax avoidance is one reason the informal economy is so large in Mexico. Indirectly, the federal government taxes all Mexicans by taking a portion of the revenue from oil sales rather than redistributing those funds to the nominal owners of the oil, the citizens of Mexico. Naturally there are a multitude of other taxes, somewhat less important as sources for federal government revenue.

Instead, the subject of this blog is tax reporting. Around this time of year I start thinking about my income taxes in the U.S. I earn a tiny bit of interest and dividends in the U.S. but the bulk of my income is from my salary in Mexico. The US does not tax my salary, it is below the limit allowed for foreign earnings, but I do have to report the earnings to the IRS and the state of Montana where I am a legal resident. This reporting requirement always generates the same sort of angst I had prior to April 15 when I lived in the US. I would (almost) rather be waterboarded. Preparing my US tax forms still requires a ridiculous amount of  time gathering documents and filling out forms.

In addition, I have to file a tax report in Mexico. But, the process far less complicated. In Mexico I complete an online form that is submitted electronically to the Secretaria de Hacienda (the government ministry responsible for collecting taxes). Including my name, the form requires entering information in, perhaps, eight or ten spaces. Very few deductions are allowed thus greatly simplifying the process. After submission, I receive an e-mail confirming the receipt of my tax return. Refunds are deposited electronically in my bank account. If I owe taxes a trip to a local bank is required where I pay and the funds are deposited in the appropriate government account. In all, perhaps 2 hours work if I don't owe anything and an additional hour if I have to go to the bank.

Thank you Mexico for not making tax reporting the nightmare that it is in my own country.

I wish that members of the U.S. Congress and the Administration would quit quibbling about the extension of the 'Bush tax cuts' and start talking seriously about total reform of the system. The flat tax proposal developed by Robert Hall and Alvin Rabushka would be a good place to start. If the Tea Party proposed such a reform, I suspect it would gain millions of converts, me included.

More on Property Rights

In contrast to Mexico, the United States is generally regarded as having strong property rights. The current home foreclosure mess in the US introduces a huge element of doubt into property rights. How and when it will be resolved is uncertain at the moment. There is a reasonable chance that the U.S. economy will suffer another recession in 2011 as a result of problems in the financial sector.

Briefly, many who purchased homes in the real estate boom are behind in their payments. Lenders have foreclosed on many of these properties. During the second quarter of 2010, nonperforming loans, those more than 90 days past due, were 5.36% of total loans according to data from the Federal Reserve Bank of St. Louis (the graph is available at http://research.stlouisfed.org/fred2/graph/?s[1][id]=NPTLTL ) Mortgages currently account for a large share, but not all, of past due loans. Rates over 5% are extraordinarily high. Prior to 2009, the highest rate, 4.01%, occurred in 1991. Between 1995 and 2007 the rate averaged slightly more than 1%.

Until recently, the process of foreclosure has been relatively straightforward. A borrower does not pay, the lender sends (often nasty) notices, legal steps are taken and the lender takes over the property. Banks and other lenders typically do not want to own houses, so they usually try to sell the foreclosed properties. But, in part due to the shear volume of foreclosed properties, it seems that banks and other lenders did not always comply with the exact legal requirements for foreclosure. Thus, some affected property-owners have gone to court. The details of these problems have been well-documented in the NY Times and other publications so I will not bother to recount them. A complicating factor is that many mortgages were packaged into securities which were then sold. Simply determining who owns a particular mortgage could be problematic.

As usual, the involved parties have different perspectives. Lenders have tended to minimize the difficulties as minor, little more than their failures to 'dot all the i's' in the relevant documents. On the other hand, consumer groups and lawyers whose clients' properties are in foreclosure suggest that the errors are serious. Ultimately, state supreme courts will resolve these issues. It is possible that the resolutions will differ significantly across states. Most interesting will be how the states that have seen the biggest collapses of the housing markets; those such as California, Florida, and Nevada; deal with the problems.

How could this affect the US economy? At best, a tempest in a teapot as my grandmother might have said. If so, the economy of the United States will start to grow more rapidly, probably starting in the second half of 2011. At worst, lenders will be more reluctant to lend than would otherwise be the case during an expansion and the economy returns to recession. Probably something in between these two extremes is most likely, so I expect that U.S. economic growth will remain tepid over the next year.

... and in Mexico and Belize? Another recession in the US would have negative impacts on Mexico. The United States is the destination for approximately 80% of Mexican exports. The recent US recession led to a reduction of more than 6% in Mexico's gross domestic product, much of the reduction occurred in the export sector. A double whammy of U.S. recession and the AH1N1 strain of the flu made the 2008-2009 tourist season dismal in Quintana Roo. Although the 2010-2011 period will probably be better than the year before, I expect a relatively slow winter season for tourism in the Caribbean this year. Tourism in Belize also suffers when the US is in recession. The over-valued Belize dollar will continue to suppress tourism in Belize.

In short, the foreclosure situation is a Gordian knot. Resolving the problem will be (to paraphrase Hobbes) nasty, brutish, but definitely not short.

Property Rights and Public Security

I had planned an entry on the foreclosure mess and property rights in the United States, but I will save that topic until next week and instead write about a specific instance of weak property rights in Mexico. Unfortunately, the story I will recount seems to be a common one in Quintana Roo and, probably, other parts of Mexico.

There are at least two important economic functions of the legal system. First, the system must protect life and property. Second, the system must provide a means of resolving disputes in a timely, relatively low-cost fashion according to the law, not personal preferences of those in authority. A legal system that satisfies these two requirements is one characterized by strong property rights. One can argue that such a system is desirable because it is fair or just. But apart from these arguments, economies with strong property rights generally grow faster and have higher levels of income. Individuals and businesses are more likely to invest if they do not fear expropriation of their property by the government or the cronies of those in power.

Sadly, today (26 October, 2010) I witnessed firsthand the weakness of property rights in Quintana Roo. My brother-in-law is owner of two taxis. His name is on the titles so there is no question of ownership. Some time ago he rented each of these taxis to individuals. Contracts were signed in which the individuals promised to pay a fixed amount periodically for the rentals. All the legal formalities were followed. Both stopped making payments shortly after getting the taxis. More than a year ago he filed the necessary documents with the appropriate authorities, the judicial police, to recover the taxis. The police knew who had his property and that the taxis were still being operated as taxis in Chetumal, yet nothing happened. His property had been stolen.

Today, he found one of the taxis parked in downtown Chetumal and informed the judicial police, as well as my wife and me. The driver fled. Although there was a key in the taxi, an alarm installed by the thief prevented starting the motor. The police stated that my brother-in-law should call a tow truck and have the taxi towed to the police impound lot. While my brother-in-law was on the phone trying to contact a tow truck operator, the judicial police received a call from one of their superiors ordering them to leave the taxi parked on the street and vacate the scene. Other than to inform my brother-in-law of the order they had received, the police offered no explanation. About a minute after their departure, the thief showed up with 3 other men and tried to take the taxi but were not allowed to do so. Shortly thereafter, the state police arrived and, also acting under orders, let the thief take the taxi despite my brother-in-law's protest.

So, what does this story the protection of private property in Quintana Roo and elsewhere in Mexico? The moral I draw from this tale is that anyone with influence can subvert the rule of law. The ominous implication is that such a system of weak guarantees of property rights depresses investment and citizen confidence in the law. Why invest if the legal system does not protect your property, as happened to my brother-in-law? Why support a system where the police are viewed as tools of those in power? Weak property rights and public insecurity are probably not the only reasons for Mexico's rather dismal macroeconomic performance since 1981 but they surely must rank high on the list of the most important reasons for slow economic growth.

Government Finances-Belize

In my last post (dealing with the Belize dollar) I wrote about government mismanagement of the Belize economy. In this post, I continue with the theme of government mismanagement in Belize.

First, a few basics. Governments, like people and businesses, have budget constraints. Governments have three general ways of financing their spending; taxes, borrowing, and creating money. I include revenue from the sale of government assets and user charges in the category of taxes. For example, a significant portion of oil revenues generated by the state oil company pays for federal government spending in Mexico. Any spending in excess of revenue must be paid for with borrowing and/or money creation. Apparently, Belize has done both. The problem with the regular creation of money to finance spending is the inflationary impact on the economy. As stated in the previous post, official figures have shown relatively low rates of inflation; although I remain skeptical of these figures.

By one common standard, the government deficits in Belize have not been outrageously large. As a percentage of GDP, deficits have been between 1.9% and 8.8% of GDP since 2002, with a small surplus amounting to 1.1% of GDP in 2008. The surplus was not the result of increased tax collections or spending cuts but appears to be the result of a one-time grant or perhaps sale of an asset. The largest deficits, as fractions of GDP, were in 2003-2005; the Belize government has done better in recent years although it may be reverting to its former habits as the 2009 deficit is 4.1% of GDP, the highest share since 2005. By comparison, the European Union allows its member states to have deficits of up to 3% of GDP; but the EU, seemingly, does little to enforce this limit.

But, by another standard the government's deficits are disturbingly large. Since 2002 annual deficits have averaged 16% of total government revenue. This average includes 2003, when the deficit was 38.6% of total revenue, and 2004, with a deficit of 30.1% of total revenue. Deficits have been relatively smaller since 2006, averaging 6% of total revenue; but still quite high. This decline as a percent of total revenue may have occurred because the country arranged a restructuring of its external debt in 2007 and interest payments to debt holders are smaller. However, in 2009 the deficit increased to 10% of total revenue. Whether the government has returned to old habits, spending well more than its income, or whether the high deficit in 2009 is a temporary result of the world wide recession remains to be seen.

There are good reasons to be skeptical of any apparent change in government fiscal behavior in Belize. As argued in the previous post, the fixed exchange rate appears unsustainable over the long run and the official price indexes appear to understate inflation. Financial markets and Belize's creditors would regard fudging the inflation statistics, if indeed that is happening, as a worrisome sign. Maintaining an overvalued, fixed exchange rate hurts Belizean export industries such as agricultural products and toursim. Indeed, tourism in Belize is appears expensive compared to Mexico or Costa Rica, another country that has, like Belize, emphasized the small-scale ecotourism industry. The overvalued exchange rate does keep import prices relatively low, so the persistence of the fixed rate undoubtedly has more to do with politics and voter support than economics. The government's fiscal mismanagement combined with an overvalued currency and, perhaps, deliberate under-reporting of inflation rates suggest that the Belize economy is headed for the same sort of nasty financial crisis which has plagued Greece, most recently, and other countries during the last 30 years.

Note: All data are from the Central Bank of Belize Statistical Digest, 2009. The dating of the government's budget figures was adjusted to conform with the calendar year, the original budget data are reported for the fiscal year in Belize, April 1 to March 31.

Speculative attacks on the Belize dollar.

Since 1976 Belize has maintained a fixed exchange rate of Bel $2 per US $1. So, I pose the question, how much longer can Belize maintain a fixed exchange rate given the government's mismanagement of the country's macroeconomic situation? Briefly, to sustain a fixed exchange rate a country must be willing to buy or sell its own currency with foreign reserves (in this case the US dollar). This is feasible if the costs of traded goods and services in Belize increase at about the same rate as those in the US, in which case the current account would generally be in balance over time so that only small purchases or sales of Belize dollars would be necessary to avoid pressure on the exchange rate. Official figures suggest that the rate of inflation has been very modest in Belize. As I explain below, there are reasons to be skeptical of the official inflation figures. Note: According to the CIA World Factbook, the US is Belize's most important trading partner, accounting for over 30% of exports and imports in 2009.

But, according to the Central Bank of Belize Statistical Digest 2009, Belize has had annual current account deficits, often large ones, since 1996. Before 1996, the current account was usually in deficit although in a few years there were small surpluses. Essentially, this means there are lots of Belize dollars floating around in the foreign exchange market. It seems unlikely that Belize is such an attractive place for private investors that these Belize dollars are reinvested in the country, at least for such an extended period. Of course the US has been able to maintain large current account deficits precisely because foreign investors have been, and apparently still are, willing to invest in US assets; hence the huge holdings of US government securities by the Chinese government. As Belize is a former colony of Great Britain, perhaps the British government is buying the Belize government's debt thus helping to support the fixed exchange rate?

The price level data reported by the Central Bank of Belize seem to be at odds with the relatively rapid rate of money growth in the country. Briefly, there is a strong correlation between inflation and the rate of money growth so that rapid money growth generally leads to rapid price level growth, i.e. inflation, which the official figures do not reflect. Belize has certainly been creating money; between December 1989 and December 2009 the money supply (M1) has increased at an annual rate of 10.38%. For comparison, the rate of growth of the US M1 money supply has been 3.88% annually over the same period. Consequently, one would expect a higher rate of inflation in Belize than in the U.S., but this is not shown in the official inflation data. How can this be? 

It could happen if price increases are kept artificially low by government decree, that is, there are price controls in the economy. Of course it could also happen if the Belize economy were growing very rapidly (comparable to the Chinese economy in recent years), but this is clearly not the case. If price controls (a bad policy in itself) are not maintaining an officially low rate of inflation, then I suspect the price level data in Belize are understated. Governments such as Argentina and Greece have clearly manipulated (putting it charitably) the economic data they report, it is certainly within the realm of possibility that Belize has done so as well.

Anecdotal evidence also suggests that the price level in Belize is relatively high. Every weekend, many residents of Belize visit the supermarkets of Chetumal to make their purchases. This phenomenon began well before the depreciation of the Mexican peso (fall of 2008) made goods and services bought in Mexico even more of a bargain for Belize shoppers. The CIA World Factbook indicates that Mexico was the source of more than 14% of Belize's imports, second only to the US in terms of imports.

So, what does all this mean. Simply that, if it continues along the path of the last 20 years or so (rapid money growth, fixed exchange rate), prices in Belize will continue to rise more rapidly than those of its major trading partners and competitors (in terms of exports) in world markets. Current account deficits will continue increasing. At some point, speculators will start attacking the Belize dollar. So, I conclude the blog with a partial answer to the question I posed at the beginning of the blog. I don't know how much longer the Belize government can sustain a fixed exchange rate, but the fixed rate regime is clearly unsustainable. If current policies continue (a likely prospect, I think), then a devaluation of the Belize dollar is coming along with all the problems associated with a sudden, large change in the exchange rate.

Nobel Prize

Well, I was wrong about the Nobel prize in economics. Jorgenson will have to wait another year, at least.