Economics for our time
BusinessMirror Online, November 19, 2007

HE'S been called the "the most important economist of our time" and "the best economist in the world today." He has also been an adviser for the United Nations, International Monetary Fund, World Bank, European Commission, the Federal Reserve Board, the US Treasury and the government of Canada.

Thus, it was only fitting that Canadian-born economist Robert A. Mundell, winner of the 1999 Nobel prize in economics for his theoretical work in the 1960s on monetary and fiscal policy in open economies and now a professor at Columbia University in New York, would be asked to deliver the first of a series of lectures here organized by the International Peace Foundation dubbed "Bridges: Dialogues Toward a Culture of Peace."

In remarks to media on Thursday after his lecture on "Economic development by fitting globalization into the national-development strategy," Mundell said the Philippines can implement a fixed exchange-rate system to achieve a more stable economy "anytime it is prepared for it." But he cited several conditions: "You have to have a balanced budget and enough foreign reserves, and if government officials agree with it and have decided on what the exchange rate is going to be.

Mundell explained that having a fixed exchange rate means a process in which the central bank fixes the price of foreign exchange and allows the money supply to move in a direction that keeps the balance of payments in equilibrium. For countries with rates of inflation that do not go beyond 5 percent a year, a fixed exchange rate could be the best monetary rule that the central bank can adopt. That would make the Philippines theoretically eligible if only inflation were considered, since the country's inflation rate has been within 2.2 percent to 3.9 percent, with the Bangko Sentral ng Pilipinas projecting full-year inflation this year to be between 3 percent and 4 percent.
"Equilibrium under a fixed exchange rate means that the country's money supply is directed by its balance of payments. When the balance is in surplus, the money supply expands and that increases expenditure in goods and securities and that corrects its surplus," he said.

Mundell's views are particularly relevant for the country in light of improved economic conditions, including a better-than-expected GDP growth rate this year and the sharp increase in the value of the peso in relation to the US dollar. The strengthening of the peso is hurting not only our exporters, but also the OFWs who now complain that they must send more dollars than before to their families back home, and are urging government to intervene to stop the peso's strong showing.

Mundell's reputation as one of the foremost experts in international economics is secured by a prodigious amount of written works. In the 1960s, he originated the concept of the "optimal currency area," which framed the debate that led to the creation of a single currency, the euro, for Western Europe. He also demonstrated that with a floating currency and free capital flows, fiscal policy cannot affect overall demand because changes in government spending trigger changes in interest rates, exchange rates and trade flows that are exactly offsetting.

He was a pioneer of the theory of the monetary and fiscal-policy mix, the theory of inflation and interest and growth, the monetary approach to the balance of payments, and the cofounder of supply-side economics.

In an earlier book, Mundell said: "I believe that exchange-rate volatility is a major threat to prosperity in the world today. It is volatility of exchange rates that causes unnecessary volatility in capital markets. Whenever the exchange rate overshoots, it affects the real value of taxes, the value of all financial assets, the domestic price level and, eventually, wage rates. An unstable exchange rate means unstable financial markets, and a stable exchange rate means more stable financial markets."

But Filipino economists and economic managers can learn more from Mundell than monetary and fiscal policy. In the preface to his book Man and Economics: The Science of Choice, cited by Fortune magazine as "both a readable introduction to economics and a work in which a trained economist can find insights, formulations and perspectives he has never encountered before," Mundell asserts: "Economics is the science of choice. It began with Aristotle but got mixed up with ethics in the Middle Ages. Adam Smith separated it from ethics, and Walras mathematized it. Alfred Marshall tried to narrow it, and Keynes made it fashionable. Robbins widened it, and Samuelson dynamized it, but modern science made it statistical and tried to confine it again."

He continues: "But the science won't stay put. It keeps cropping up all over the place. There is an economics of money and trade, of production and consumption, of distribution and development. There is also an economics of welfare, manners, language, industry, music and art. There is an economics of war and an economics of power. There is even an economics of love.

"Economics seems to apply to every nook and cranny of human experience. It is an aspect of all conscious action. Whenever decisions are made, the law of economy is called into play. Whenever alternatives exist, life takes on an economic aspect. It has always been so. But how can it be?

"It can be because economics is more than just the most developed of the sciences of control. It is a way of looking at things, an ordering principle, a complete part of everything. It is a system of thought, a life game, an element of pure knowledge."

Seen from this perspective, therefore, economics becomes less of an arcane science or an esoteric academic discipline that only scholars and technocrats can fathom, but something that's grounded in everyday reality, and can therefore be appreciated and understood by everyone. That's an important distinction; those who live under conditions of wretched poverty may not be familiar with interest rates and debt-to-equity ratios, but they do know that it is government's responsibility to help them improve their lives, and that they can hope for more than mere survival.