Tax sops don't work always: Kydland

What 2004 Nobel prize winner for economics Finn E Kydland told Finance Minister P Chidambaram when he met him on Wednesday became clear during a talk the laureate delivered at Ficci on Thursday -- tax incentives did not always spur investment and credibility of the long-term policy was the key.

Kydland, who won the Nobel for his joint work with Edward C Prescott on the impact of technology shocks in explaining business cycles, is in India for the foundation ceremony in Chennai of the Great Lakes Institute of Management, set up by Professor Bala Balachandran of the Kellogg Graduate School.

Kydland, who studied with Balachandran, will be the honorary director of the GLIM's research arm in India. In a nutshell, Kydland's work shows monetary policy has little impact in creating business "booms" or busts, and that these are best explained by shocks which could increase productivity driven by technology or even by a sharp hike in oil prices.

In an interview to Business Standard, Kydland said if stories he had heard about red tape in India (like the number of days it took to set up or close business units) were correct, then it meant that government policy was not allowing productivity-induced technology shocks from taking place.

"I've been told by people I've met over the last few days, however, that such stories are not true!" Kydland added. One of the persons he met was President APJ Abdul Kalam, who gave him a power point presentation on the progress India has made.

Kydland said while his model's predictions had come very close to what had happened in Argentina during the downturn of the 1980s, it had predicted significantly higher capital investment than what had actually taken place in the 1990s.

That was because while the whole world thought President Carlos Menem had done a great job stabilising the economy, the investors didn't.

There are enough data to show, Kydland said, that investors don't respond to tax breaks in general -- if a tax break is introduced for a short, pre-specified period, investors do respond though. He said the experience of Ireland and other countries, however, showed that long-term policy stability was more important.

The other aspect of the Kydland-Prescott work is that frequent changes in central bank policies seldom work as people make space for such changes in their behaviour functions.

Interestingly, Kydland did not share the world's pessimism about the dollar and the twin US deficits.

"I have a student who's compared the US and Japanese deficits and examined this in relationship to the age profile of their populations -- it showed increasing US deficits were to be expected in the 1990s and early 2000s, but it will soon turn around."