Should price reform proceed gradually or in a"big bang?"

Should countries such as Poland or the USSR move toward more flexible prices gradually or in a"big bang?"Why is it that governments committed to eventual price flexibility so often seem to be unable to let go of"temporary"controls? Why, after price increases early in a program of price controls, does output often rise at the same time that shortages seem to increase? Theauthor argues that intertemporal speculation, hoarding, and the political economy of price control help explain these puzzles. The interaction between shortages and the political vulnerability of reformist governments to early perceptions of failure is a strong argument against gradualism in the decontrol of prices.Markets and Market Access,Access to Markets,Environmental Economics&Policies,Consumption,Economic Theory&Research

Cash debt buybacksand the insurance value of reserves

Bulow and Rogoff showed in 1988 that auction based purchases of debt could not be an effective way to capture the secondary market discount, since the purchase pushes up the secondary market afterward. The author of this report points out another problem with cash debt buy backs - one that arises because terms of trade contingent instruments do not exist in international capital markets, and because of the differences in risk aversion that one may plausibly assume to exist between commercial creditors and the developing countries that are their debtor clients. Under such circumstances, secondary market prices fail to reflect the insurance value reserves have to debtors but not to creditors - since, after all, the secondary market reflects mostly intrabank transactions. As a result, the country buying back debt with reserves clearly ends up worse off, even if it succeeds in capturing the full secondary market discount prevailing before the buyback - because the buyback reduces the insurance possibilities open to the country.Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research,Strategic Debt Management,Financial Intermediation

Trade reform, policy uncertainty, and the current account

Rapid trade liberalization is often followed by a surge of imports and a deterioration in the current account. The macroeconomic counterpart of this is a decline in private savings. This paper discusses the impact of policy uncertainty on private savings. The author uses the Ordinal Certainty Equivalence approach to establish that trade policy uncertainty by itself will further reduce savings if: (a) there is a positive risk aversion; and (b) the intertemporal substitution elasticity exceeds 1. The result shows that, with positive risk aversion, policy uncertainty will in fact reinforce the negative savings impact of an anticipated policy reversal, especially when that negative impact is strong. This suggests that with high risk aversion and high intertemporal substitution, a rapid trade reform that is not fully credible may depress private savings significantly, with attendant negative impact on the current account.Environmental Economics&Policies,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Insurance&Risk Mitigation,Financial Intermediation,Economic Theory&Research

Tariffs, Employment and the Current Account: Real Wage Resistance and the Macroeconomics of Protectionism

Using a standard complete specialization model of a small open economy within a rigorous intertemporal optimization framework with contract- based wage rigidity, we show that permanent tariffs may lead to a current account deterioration and a fall in employment, contradicting most of the literature of macro-economic effects of import tariffs. I show that this will always be the case if the economy is small enough. The crucial factor in this complete reversal of standard results is the impact of tariffs on domestic real product wages via wage indexation. Temporary tariffs will have less of a negative impact on the CA or potentially even a positive impact, because they increase the consumption rate of interest (the terms at which future consumption can be traded for current consumption) and so increase private savings. Extensions towards incorporating a more general production structure, investment and the use of tariff revenues to provide wage subsidies are presented.

Evaluating the asset based minimum tax on corporations : an option pricing approach

In many countries, well-meant ad hoc tax incentives proliferate over time, creating an opaque corporate tax structure and many unanticipated tax loopholes. Tax authorities in several countries have considered and sometimes introduced minimum corporate taxes. Liability under such a tax is sometimes linked to profits but more often to assets, as these are harder to manipulate. The authors refer to such a tax as a minimum asset tax (MAT). They suggest an approach based on option pricing, which is designed to incorporate the impact of rate-of-return uncertainty on the burden a MAT will impose. The authors use their methodology to assess a recent Brazilian MAT proposal using sectoral data on corporate income tax revenue and asset value. The MAT, with its simple tax code and marginal impact on the marginal effective tax rate (MERT), is an appealing short cut to comprehensive tax reform - and the revenue effects in Brazil could be substantial. Two common assumptions turned out not to be true: 1) the MAT does not reduce sectoral distortions. The standard deviation of the MERT is higher with MAT than without; and 2) high-risk firms tend to be high-rate-of-return firms, which reduces MAT's impact.Public Sector Economics&Finance,Environmental Economics&Policies,Economic Theory&Research,Banks&Banking Reform,International Terrorism&Counterterrorism

Intertemporal substitution, risk aversion, and private savings in Mexico

The decline in private savings since 1982 is arguably the most important problem in high debt countries. A reversal of the trend is essential if growth is to be restored. Three factors predominate : 1) the extent of intertemporal substitution; 2) attitudes toward risk; and 3) private/public savings interaction. These factors lie at the core of the authors'research. They test the issue of debt neutrality - whether future taxes are recognized as an offset for the value of any government debt held - and the response of private savings to real interest rates and uncertainty. The authors estimated two configurations of a joint portfolio-choice/savings model. First, they included equity, domestic bonds, and flight capital. In the second configuration they eliminated flight capital. The authors conclusions include the following : i) the intertemporal approach to consumption is supported by the data; ii) the results imply rejection of the traditional, expected utility approach; iii) risk aversion is significant but lower than many have argued from analysis of static versions of the capital asset pricing model; iv) results on the intertemporal substitution elasticity are much weaker; and v) domestic government bonds probably are considered as part of private wealth, although significantly less than one for one, thus rejecting debt neutrality.Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation,Inequality

Ownership and corporate control in Poland : why state firms defied the odds

Survey results in Poland indicate that hard budgets and import comeption can spur state firms to adjust even when privatization lags behind. As they examine the underpinning of Polish reform, the authors address the key question of why managers instigated such adjustment. They examine how corporate ownership and control influence the behavior of state firms, as illuminated by the following survey findings and conclusions: (a) Contrary to expectations, state firms took painful adjustment measures. Enterprise managers firmly believed that privatization was coming. This belief led them to manage better, not worse; a private sector based economy means a market for managers and a premium on skilled management. (b) The excess wage tax (the much criticized"Popiwek"scheme) did restrain wage-setting behavior, judging from the wage-setting equations presented by the authors. (c) Essential to the good performance of state industries is an end to open-ended subsidies. Subsidies, rather than helping firms adjust, give them incentives to continue their past behavior and destroy any mechanism of control other claim-holders might have. (d) Commercial banks, the Polish experience shows, can be made to exercise governance over state firms. Without effective takeover mechanisms, withholding funds is their most powerful instrument. That instrument is made powerless if firms, pressured to adjust by banks, can turn to the government themselves. Banks themselves started to respond appropriately- and to play a powerful role in discipline enterprises - only after their own governance and control/incentive mechanisms had been reformed as part of the banking reforms of the fourth quarter of 1991.Economic Theory&Research,Municipal Financial Management,Environmental Economics&Policies,Public Sector Economics&Finance,Banks&Banking Reform

Pricing average price options for the 1990 Mexican and Venezuelan recapture clauses

This paper derived closed form solutions for the pricing of options on average prices and recapture clauses. On this basis, the values of recapture clauses in the Mexico and Venezuela agreements under alternative assumptions regarding the state variable underlying the clauses are estimated. The paper shows that the sensitivity of the values of the recapture clauses with respect to the stochastic process of the underlying variable is different than expected. The more"stationary"the process driving the underlying variable becomes, the more valuable the recapture clause becomes. The reason is that the effect of an increasing variance on the value of the recapture clauses is analytically unclear since in the two agreements the clauses are"collars", bounded above and below. Only in the empirical application does it show that increasing the variance reduces the value of the collar.Markets and Market Access,Access to Markets,Economic Theory&Research,Banks&Banking Reform,Environmental Economics&Policies