The Confidence Question

September 14, 2000 • Commentary
This essay originally appeared in the Sept. 14, 2000, issue of Forbes magazine.

An economist is “someone who sees something happen and wonders whether it would work in theory,” as Ronald Reagan used to say. The old quip contains a lot of truth. Indeed, economists’ obsessive pursuit of theory has led them into a cul‐​de‐​sac, detached from reality.

What’s absent from today’s economic discourse is the concept of consumer and investor confidence in a nation’s government and economy. This wasn’t always the case. As the Cambridge don John Maynard Keynes put it: “The state of confidence, as they term it, is a matter to which practical men pay the closest and most anxious attention.” Another Cambridge economist of his era, Frederick Lavington, identified confidence as a key component of the business cycle. His 1922 The Trade Cycle described the “tendency for confidence to pass into errors of optimism or pessimism,” which triggers booms and busts.

To see how misguided economic theories have laid waste to confidence lately, look at Argentina. Consumers, investors and businessmen are gloomy, fed up with the government’s policies. Foreign direct investment has fallen 66% in the last year. The economy is flat, rising just 0.9% in this year’s first quarter, compared to the first quarter of 1999. There are even dire warnings of debt default.

Argentina suffers from a lack of confidence. The only way to cure it is with a big bang, as Thatcher did in Britain. Cut taxes and government spending to start.

The problem began in December 1999, when Fernando de la Rua became Argentina’s president. His administration’s new economic plan, the brainchild of the IMF, was supposed to lower interest rates and produce a boom. How? By raising taxes, which was meant to reduce the government’s deficit. But added to other built‐​in problems in Argentina’s economic system, the ill‐​conceived plan has produced a mess. Its timing was awful: World interest rates were on the rise. So Argentina’s rates rose with the rest.

How can confidence be reestablished? A big bang is the only way out. That’s what I said in my keynote address at the annual meeting of the Institute of Financial Executives in August at the Bariloche mountain resort. My counsel: Argentina’s unorthodox currency board fixes the dollar at a 1‐​to‐​1 rate. But peso interest rates remain higher than dollar rates. Eliminate the peso and adopt the greenback. This would bring Argentinean interest rates down to U.S. levels, a confidence‐​building headline‐​grabber.

The second leg of the big bang: supply‐​side reforms. The tax code should be simplified and tax rates reduced. Argentina’s unemployment rate has been trending upward since the mid‐​1980s (it’s now 15%) because the tax bite is so large. Deregulate the health care system, labor markets and utilities. This would allow prices and the economy to become more flexible and competitive, as in Hong Kong. Fiscal reforms would constitute the third leg. Government spending has increased by an average of 10% a year since 1991. It must be slashed, and the government must follow New Zealand and produce an annual balance sheet and income statement. This would provide for transparency and thereby rein in corruption.

My proposals were enthusiastically received by the Argentinean financial community, but not by the mainline Argentinean and Wall Street economists. This doesn’t bother me. It reminds me of Margaret Thatcher’s 1981 dash for confidence and growth. To restart the economy, Thatcher instituted a fierce attack on the British deficit, coupled with an expansionary monetary policy. Her moves were immediately condemned by 364 distinguished economists. In a letter to the Times of London, they wrote: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.” Thatcher was quickly vindicated. No sooner had the 364 affixed their signatures than the economy boomed. People had confidence in Britain again.

A big bang would produce similar results in Argentina. Foreign capital would immediately start flowing inward. And with a dollarized monetary regime, it would cause the M3 measure of broad money to soar from its current anemic annual growth rate of about 6% to between 20% and 30%. Economic growth would rapidly match, or surpass, the 7% rate realized in the 1996–97 period.

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