Under pressure from street protests by members of farmers' and fishermen's associations, the government announced a week ago that it is suspending implementation of the three-tiered risk-control mechanism for the associations' credit units. This move is truly and deeply regrettable because it distorts many aspects of economic incentives and doesn't bode well for Taiwan's future economic development.
The problem has been blamed on the shortcomings of the three-tiered risk-control mechanism, such as sloppy decisions, bad communication and insufficient incentives. These shortcomings, however, are not sufficient reason for the policy change.
The credit units in many of the farmers' and fishermen's associations are sitting on a disproportionate amount of non-performing loans (NPLs) and would already have folded were it not for their dependence on the government's insurance and bail-out mechanisms. Although these mechanisms have the positive effect of preventing bank runs, they also amply reward pernicious behavior and work against incentives. The more problems an institution has, the more likely that institution will rely on these two mechanisms.
The Ministry of Finance is planning to restrict the operation of credit units with excessive amounts of NPLs. This would be the same as punishing harmful behavior and could offset the anti-incentive effects of the two mechanisms, which would be a step in the right direction.
I'm not clear on what the ideal reform would be in the minds of the critics, or what their superior strategy would be, but it cannot be claimed that the second-best option -- the three-tiered risk-control mechanism -- is inferior to the superior strategy and then use that as a reason for going with an inferior option, which would be to maintain the status quo. Deferring policies will cause existing distortions to gobble up economic resources, which in itself is a frightening result.
It is unavoidable that many commendable policies will affect income distribution. Even though the positive effects of a policy by far exceed the cost, these effects are difficult to assess because they are widely distributed among the public, while the cost is concentrated in a minority of victims. The voices of the victims will be louder than those of the beneficiaries and this is what distorts perception of the policies.
Income distribution resulting from these policies clearly diminishes the benefits to specific groups, which will be fuming with rage. Anything but the toughest policies will be insufficient to stop these groups. Blind belief in communication as the solution to all problems will be the same as underestimating their intelligence or overestimating their moral posture. That the government has abruptly applied the brakes under pressure by threats from special interest groups tells the demonstrators that their demonstrations are effective, and leaves the groups that do not demonstrate to continue to suffer in silence. This is a distortion of behavioral incentives and will obstruct the implementation of future reforms.
This unplanned halt to the government's financial reform policy will not only fail to amend existing distortions, but the pressure created by demands from vested interests will lead to new ones in other areas. In the eyes of those hopeful for reform, reforms have stopped progressing and even retreated. This is a heartless blow. Investors used to have a bullish faith in the economic situation. Vain attempts at using language and pretty words to cover up this mistake will be the same as shrinking the beef on the plate and replacing it with sculpted vegetables. It will only be met with scorn by the affected parties.
Lai Ping-yan is associate professor in the Department of Economics at Ming Chuan University.
Translated by Perry Svensson
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