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Fed rate hike: Is market economy a myth?

By XN Iraki | December 27th 2015 at 00:00:00 GMT +0300

The recent US Federal Reserve Bank (Fed) interest rate hike by 0.25 per cent was breaking news globally.

But in the contrary, even if our Central Bank raises its rate by five per cent, it would never attract global headlines. In the aftermath of this rate hike, economic analysts went into overdrive analysing the possible consequences of this rate hike, the first in USA nearly a decade.

Why should a decision thousands of kilometres away be of interests to so many people. Are economic decisions more like wind that knows no borders?

First, despite devolution, and very much like the US, the Kenya national government (I was told it was formerly called central government) is in charge of the fiscal and monetary policies. Fiscal policies are about taxation and government spending and their effect on the economy.

High taxes rates slow down the economy, while Government pending can stimulate the economy to growth and forestall depressions. Remember John Maynard Keynes and Economic stimulus package in Kenya when Uhuru was the finance minister?

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Monetary policies are about interest rates and money supply. A high interest normally slows down growth (but not always), reduce inflation and prop up the value of the currency. Functions such as setting up such policies are rarely devolved anywhere; it would mean having different currencies and tax systems, which would be expensive and confusing.

Even the European Union (EU), followed the American example and set up the European Central Bank to harmonize the monetary policies across EU. They also got a single currency, the euro. We used to have a single currency in East Africa once upon a time and other common services like port and harbours and even an airline. I got a few East African shillings, some dating as early as 1922.

These services were later devolved to separate states. In Kenya we are still devolving the services, while talking about East African community. Does anyone see the contradiction? Even education was an East African affair, with university of East Africa, with campus in Dar es Salaam, Kampala and Nairobi. Even exams were East African!

Enough digression; why should a decision so far away be felt across the globe? Some argue that the reaction of the global economies to Fed decisions shows the extent and reach of the American power. That is partly true. We use the US dollar as the reserve currency and even culturally, US defines lots of our beliefs and pseudo beliefs through the media. My students do not even know if the Chinese president is married but they all can name Obama’s wife-in a chorus. That is the power of the media.

The wide use of the US dollar means that any change in its value will affect a lot of countries. Once the Fed raised its rate, more money will find its way to the US market, investors and speculators are like wind, they know no borders. The demand for the US dollar will raise its value, and lower the value of other currencies like the Kenyan shilling.

Weaker currencies would mean inflation in some countries and countries would counter that by raising their own interest rates and the consequences thereof. Luckily, our currency seems to have had the worst and not much depreciation is expected. Now you can see why the Fed rate hike was closely watched, is closely watched.

But wait a minute. Is Fed rate hiking not a government decision? After all, the members of Fed, just as members of our Central Bank are appointed by the politicians. Recall politicians interviewing the current CBK governor and the questions they raised?

If the politicians either directly or indirectly have such an effect on the economy, are we right in arguing that the market economy is a myth? Adam Smith wrote about the invisible hand of the market. Did he foresee the visible hand of the governments?

Few can deny that the Government plays a great role in an economy despite all the preaching on the virtues of the market economy by high priests of social sciences-economists. Politicians perhaps know that, the reason they fight so hard to get power.

To the ordinary man, political power is about being driven in conveys, addressing political parties and occasional traditional dancers entertaining you.

I have always wondered why traditional dancers entertain our politicians in the 21st century. I never saw Native Americans at any time dancing for the US presidents. Yet their attire and dances closely resemble ours. When I watched a Choctaw dance in Mississippi, one dancer was quick to notice my Masai belt and picked me to participate in their dance.

But political power go beyond ceremonies, it has a sweet economic component. Noted how Kenyan politicians are focusing more on economic issues from Eurobond to SGR.

Think of your daily economic activities and how politics get into them. First the Government registers your business and gives you a license; that is already a control and reduces the number of competitors in any market or sector.

That means we are likely to pay higher prices than we should for goods and services. If you ask any county government how many salons or kiosks would give customers the best prices, he will most likely say he does not know. What tax rate would give KRA the highest revenue? The answer is probably unknown.

How many universities would give our students the best fees for the best education? Most industries have a regulator, read government visible hand. We have CBK to regulate banks and recently froze licensing of more banks, which means the current banks can make more money, more easily.

We have NEMA to regulate environmental matters, which means you can’t pollute as much as you want and in the process reduce your costs. Education has a regulator, and so has medical services. We have communications authority and the list can go on.

Professional associations go beyond the Government regulation and set their own regulations. That is why we have more law schools and medical schools in Kenya but the services offered by these professions aren’t getting cheaper as expected, through the laws of supply and demand. Surveyors, accountants and lawyers are even asking the competition authority of Kenya to exempt them from competition laws.

Some observers note that with devolution, we shall have more government in our lives, in the economy. Recall the new laws in the county government of Mombasa over the port? Political leaders by their nature want to control as much as they can, particularly sources of revenues. Noted how the debate on revenue sharing between the counties and the national government never dies and is heading to the referendum?

The big question for politicians and economists is determining the optimal level of government involvement in the economy that yields the best returns for the citizens. That is question is hard to answer, you cannot do an experiment to find out, you either learn from other developed countries or through trial and error- just like on constitutional matters.

It could be argued that the collective wisdom of the market keeps the Government excesses in check. The judiciary is moderating the visible hand too. I’m seeing more economic oriented cases in our courts.

The distilled truth is that the visible hand of the Government plays more roles in the economy than hoi polloi (general public) realise. With international connections, you are even affected by governments beyond the one you elected. Supranational institutions like World Trade Organisation (WTO) affects the economy through trade agreements (government again!).

The visibility of the Government in the economy is the reason you need to vote wisely every five years, or in by elections so that we have leaders who understand the Gordian knot that ties the economy and politics.

The market economy may not be a myth and cannot escape the visible hand of the State. Next time pay attention to government policies through sessional papers, budgets and nowadays, State of the nation address (we copied that from US).

The visible hand of government and the invisible hand of the market will continue working together in the foreseeable future-just like the two hands of a human being or is it homo sapien. Striking the balance between two hands will keep taxing our creativity and ingenuity.

—The writer is senior lecturer, University of Nairobi. [email protected]

US Federal Reserve Bank economy
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