Reflections from Europe | SEPTEMBER 4, 2006
The Yakoubovich Syndrome, or Lies, Damn Lies and Economic Policy
Injecting purchasing power by ratcheting up wages to revive a sluggish economy, soaking the rich to help the poor, and giving aid to 'developing' countries to reduce the flows of illegal immigration to the developed world, are false promises that sound nice enough to be believed.
Back in 1970, I spent a few days in Israel. One object of the visit was to find out a little about economic prospects and policies. Inflation was accelerating. I was being briefed by two intimidatingly bright bankers. Talk came round to a highly visible bankruptcy of a well-known business man—let us call him Yakoubovich. I expressed disbelief that anyone can go bust in an inflationary environment by piling up debt.
'Normally', I was told, 'it would not occur. But if you knew Yakoubovich, you would see how it can happen all the same.' And they told me a number of anecdotes about the gentleman in question to illustrate the point. One of them, I found, teaches a great lesson about economic policy and much else besides.
Yakoubovich is sunning himself in a deckchair by the pool in the gardens of a Jerusalem hotel. In the pool, children are splashing each other, shrieking, jumping in and out and making a nuisance of themselves. Yakoubovich calls out to them:
'Children, run round to the dining room, they are handing out cookies and sweets!'
The children run off and calm reigns around the pool. In a little while, Yakoubovich gets up, wraps himself in his bathrobe and shuffles off.
'Yakoubovich, where are you off to?'
'I am going to the dining room, they are distributing cookies and sweets.'
In the Yakoubovich syndrome, someone—typically, a political or financial operator—tells a lie or makes a fraudulent promise that is meant to earn him support. A significant part of his public is gullible and believes the lie. Seeing this, the perpetrator then comes to believe it himself and tries to act on it. The end is disappointment for all.
A characteristic promise setting off the Yakoubovich syndrome is to 'give purchasing power to the masses.' The setting is one where the economy is sluggish, crawling along below its potential. The space between the actual and the potential performance is, so to speak, wasted. If actual production were to rise to its potential, untold billions could be distributed to worthy recipients, the wants of the needy could be met and projects serving the public interest could be promoted.
A beguiling promise is then made to bring about this rise in output by 'giving' people the purchasing power to buy it. In his mighty effort to pull the Brazilian economy up by its bootstraps, President Kubitschek (1956-61) simply ordered all wages and salaries in the country to be doubled. Needless to say, prices doubled with wages and production did not. Today, politicians in and out of government try to boost purchasing power by legislating higher minimum wages, more generous unemployment and retirement pay, and by inciting labor unions to make aggressive wage claims and bullying industry to meet the claims. The implicit argument is that if industry paid higher wages, demand for its products would increase and allow the higher wages to be paid. However, if wage costs increase all round, it is prices that will increase, not output. Demand would then just suffice to purchase the old, unchanged level of output, but not a higher one. If this were not the case, it would be because the old level of output was not in equilibrium and would have increased anyway of its own accord. The idea that higher costs amount to greater purchasing power springs from confusing demand and output at current prices with demand and output in real terms.
Unlike the 'purchasing power' promise that boils down to conjuring up something out of nothing, another Yakoubovich lie that promises to squeeze the rich to help the poor, does involve real resources and is not devoid of all logic. But it is fraudulent in misrepresenting the resources involved. The only part of the income of the rich that can be taken from them and safely given to be consumed by the poor without upsetting the saving-investment balance of the economy, is the amount by which the rich reduce their consumption as a result of the higher tax meant to 'squeeze' them. If they maintain their consumption and cut their investment instead, the poor can consume more only at the expense of fewer resources being devoted to investment. The actual result of the higher tax will no doubt be a reduction in both consumption and investment by the rich, with investment being cut more—not a result that would help the poor beyond the shortest of short runs.
A corruption-laden form of the Yakoubovich syndrome is the advocacy of development aid. A small minority in the economics profession is acting as part-time consultant either to donors on matters of development aid, or to the governments of the countries asking for such aid. Some quite prominent economists do this as a full-time business, even forming their own corporations to carry it on. We can only guess whether a particular 'development economist' is really convinced that aid will not be stolen or wasted and debt forgiveness will not result in the piling up of new debt. Many are no doubt genuinely convinced. But all are interested in aid flows being maintained and increased. Almost inevitably, for the simple reason that few people feel comfortable in pleading day in, day out something they know to be a lie, the interest in aid will in due course generate a belief that aid is in fact a good thing
Both the recipient governments and the donors must be persuaded that the charade of submissions and project appraisals, leading to transfers of vast sums, will in fact yield the cookies and sweets of economic development. In convincing them, development economists convince themselves, too, and are more inclined to act on their wishes than on the evidence provided by the often sad or sordid history of development aid.
One special twist in this reciprocal make-believe calls for attention. Europe is getting seriously alarmed by the rising streams of illegal immigrants entering it by landing in Spain, Italy and Greece and moving northwards. Underdeveloped countries and their advocates now argue that if they were helped to grow out of poverty, their peoples would be content to stay at home and the threat of illegal immigration would ease or cease. The idea is plausible over a time span of several decades, but implausible within our lifetime. Pumping in aid, notably into education, would induce some thousands to stay at home but make hundreds of thousands all the more eager to leave and reach more civilised shores.