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- Some trade-related news: follow-up
- RIP Peter Kenen
- This Looks Important: The Inefficient Markets Hypo...
- Update on L'Affaire Loomis
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- Some trade-related news
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- The Loomis Affair
- Diversity of What, Emmanuel?
- There Is No Technocracy: Bank of Japan Edition
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- New Multilateral Trade Agreements?
- Albert Hirschman, RIP
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- If you incentivize it, will they come?
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- Can I Have Some Politics With My Investment Incent...
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Monday, December 31, 2012
Tuesday, December 25, 2012
Monday, December 24, 2012
The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real WorldI think Munger gets it wrong when he writes:
Roger E.A. Farmer, Carine Nourry, Alain Venditti
NBER Working Paper No. 18647
Issued in December 2012
Existing literature continues to be unable to offer a convincing explanation for the volatility of the stochastic discount factor in real world data. Our work provides such an explanation. We do not rely on frictions, market incompleteness or transactions costs of any kind. Instead, we modify a simple stochastic representative agent model by allowing for birth and death and by allowing for heterogeneity in agents' discount factors. We show that these two minor and realistic changes to the timeless Arrow-Debreu paradigm are sufficient to invalidate the implication that competitive financial markets efficiently allocate risk. Our work demonstrates that financial markets, by their very nature, cannot be Pareto efficient, except by chance. Although individuals in our model are rational; markets are not.
An objection to the ability of markets to get the rate of time discount "correct." My question: as compared to what? Compared to legislators with a two year time horizon (okay, six in the Senate, right after an election)? Why don't people make fun of the "efficient governments" hypothesis? The libertarian argument is not that markets are perfect, it's that politicians are even more short-sighted.Again, having only read the abstract, I don't see this as saying that the actors aren't discounting correctly, but that they are discounting differently. This paper is still making pretty strong assumptions -- complete markets and no transaction costs -- but simply showing that with heterogenous agents financial markets are not Pareto-optimal. This is a big deal! It is also in line with things Steve Randy Waldman has been writing about for awhile (e.g.).
I don't think it implies quite what Munger thinks it implies; inefficient/irrational markets could still be more efficient or more rational than politicians. In fact, I imagine that the model would show that the market with a larger number of actors performs better than it would if it were controlled by a smaller number of actors, e.g. a government. But maybe not. I'll have to read it first.
Via Dan Nexon. While I see Nexon's point that we are dealing with mealy-mouthed university administrators, I must completely disagree with his ("modest") level of satisfaction. This represents no victory at all because this new statement from URI officials, like the first one, completely misses the point. This is not about First Amendment rights. Nobody was saying that Loomis should be thrown into the deepest darkest dungeon never to be heard from again. They were saying that he should be fired or otherwise professionally damaged for an emotional -- and politically motivated -- response to a mass killing.
The relevant standard here is academic freedom, not First Amendment rights. The University of Rhode Island subscribes to the 1940 "Statement of Principles on Academic Freedom and Tenure" issued by the American Association of University Professors. This Statement indicates that Loomis deserves the full support of the University of Rhode Island even if he was speaking under the banner of the University. (Which he always is, implicitly, contra the views of the CT commenters.) Instead of espousing that principle, which is fundamental to the mission of public universities, the University has repudiated it by saying that Loomis deserves no greater protection than those who have written to the University on this matter, whether in solidarity with or opposition to Loomis.
Loomis does not need the University to protect him from the threats of violence he has received; he has the FBI and the Rhode Island police for that. Loomis does not need the University to protect him from those who would suppress his speech; he has the U.S. Constitution for that. Loomis needs the University to protect him from professional damage as the result of a campaign of sabotage in response to his expression of a political nature. The University has failed to do that. Therefore the University has failed.
This new statement from URI is no better than the first. It simultaneously misses the point and refuses to honor its obligations to its faculty. A better statement would have read, in toto:
"The University of Rhode Island does not comment on the statements of individual faculty members, but it steadfastly defends the principles of academic freedom which are an essential component of the University's commitment to 'fostering a collective and individual propensity for inquiry' so that students may 'communicate, understand, and engage productively with people very different from themselves', including those with different beliefs and values."
UPDATE: Dan Nexon further explains his position. I respond in comments.
Saturday, December 22, 2012
But it’s not just the United States and Japan. Name a country with three elements—a stable political system, a credible central bank to call its own, and a free flow of capital across its borders—and it has, right now, extraordinarily low interest rates. That’s true for Canada and Australia (10 year yields of 1.85 percent and 3.36 percent), of Switzerland and Sweden (0.55 percent and 1.6 percent). Britain, certainly (1.94 percent), but even some countries that don’t technically fit our classification because they lack their own central bank (Germany at 1.42 percent and France at 1.99 percent. That would be the same France that The Economist, in a cover story last month, called “the ticking time bomb at the heart of Europe.”).
So what is going on? Interest rates are, essentially, the relative price of money today versus its value in the future. And investors are saying that they don’t need very much compensation to delay their spending for the future, as long as they can feel secure that they will get their money back and that the money they get back will be worth roughly what they put in.
To put it a different way, around the world there are all sorts of savers—pension funds, wealthy individuals in emerging nations, governments that want to ensure they have reserves put aside in case there were to be a run on their currency—for whom the goal is not so much to get a big yield on their savings, but rather to ensure that they will get their money back when they need it.I may have more to say about this over the coming weeks as I'm writing a book chapter related to the topic, but for now let me just mention that this isn't only about the domestic factors that Irwin describes. It is also related to broader developments in the global economy in recent decades. The only development model which has sustained success is export biased: emerging economies export resources and consumer goods to developed countries. Second, the opening up of global trade has increased reliance on comparative advantage, thus benefiting the owners of the abundant factor of production. Third, the decline in capital controls have allowed financial flows to increase markedly. These three factors have led to a world where trade flows constitute 60% of global GDP, international financial balance sheets are 150% of global GDP ($100 trillion), and income inequality has increased markedly.
But it also means that the global economy is fundamentally imbalanced: developing countries must run persistent current account surpluses, while developed countries must run persistent current account deficits. These must be offset by financial transactions: developed countries essentially hand over IOUs to developing countries. And this process must be indefinite; or, rather, they must continue until the whole world has reached roughly equivalent levels of development, until a new political system makes the export-biased development model impossible (restrictions on trade and/or capital movement), or until the imbalances reach a tipping point and a crisis ensues.
The question is what deficit governments should do in this environment. Irwin suggests that they should take advantage of cheap finance to make domestic investments in infrastructure and education. Another option is to try to reduce the probability of a future (domestic) crisis by balancing the books. In the 1990s they largely chose the latter, which ended up leading to crises in the developing world as imbalances unwound. In the 2000s they chose the latter, which ended up leading to crises in the developed world as imbalances fueled asset price bubbles in real estate and sovereign debt.
The story of the 2010s will be how these imbalances are managed.
Friday, December 21, 2012
Don’t forget the Farm Bill -- With all the talk about the fiscal cliff, some big trade-related legislation has taken a back seat. In particular, this includes the U.S. Farm Bill, which (among other things) provides subsidies and insurance for farmers. The current provisions are scheduled to expire at the end of 2012, as new versions must be passed every five years. As of now, no agreement has been reached, causing some concern among farmers (see here). Potential sources of conflict abound . . . conflicts between two of our favorite snack food providers (see here), and between U.S. farmers and the WTO (see here). [By the way, there have been rumblings about Farm Bill provisions being included in a fiscal cliff resolution package . . . if one is reached, of course]
Thursday, December 20, 2012
For more context, the Kirshner government wrested control of YPL from Spanish energy giant Repsol this past May. In the ensuing fall out, Repsol sued the Argentine government in a U.S. court, President Obama revoked Argentina's preferential trade privileges, and Repsol filed arbitration paperwork at ICSID earlier this month. No one is too confident that Repsol is going to recoup any of its $10 billion investment, especially since Argentina probably hasn't paid out a single arbitorial award. Spain is also threatening to sanction Argentina and Repsol has publically stated it will seek damages from any corporation that subsequently enters production and exploration agreements with YPL.
Standard political theories of foreign direct investment rest on a central insight from obsolescing bargaining (OBM) - FDI is limited by the political risk that firms face when they sink investment in a foreign jurisdiction, thus becoming "captive" to a potentially predatory state that faces incentives to promise contract sanctity ex ante and then renege on these promises ex post. From this perspective, no multinational should want to invest in Argentina - the risk of expropriation is just too high. Tools designed to mitigate the problems associated with time inconsistency of preferences just are not working in the Argentinian case (i.e. - Argentina is not compensating firms for contract breach, despite rulings against it). Yet, my weekly update from the Economist Intelligence Unit includes a discussion about how large oil multinationals are rushing to invest in Patagonia's shale deposits. Multiple oil giants are in contract negotiations with the Argentine government to undertake production sharing agreements with the newly nationalized YPL. And, they are doing this despite Repsol's threat to go after these private corporations for damages associated with nationalization.
So, what is the standard OBM missing? Of course, firms have to care about many things besides political risk. Economic factors are the primary drivers of investment decisions; political considerations are largely secondary. In this context, big countries with large domestic markets and with rich endowments of lucrative natural resources typically can get away with a lot of things small countries without energy reserves cannot. This economic/geographic argument underpins Rachel Wellhausen's recent post on the permissive environment for Argentina's nationalistic investment policies. And, understanding the economic factors that provide governments' more bargaining power vis-a-vie investors certainly explains much of the deviation away from what OBM-based theories predict.
But, I think there is something else we need to consider - how firm and investment characteristics modify OBM dynamics. Some of my current research considers how firms are heterogenous in both the amount of political risk they will accept and how they define political risk. What do I mean by this? First, firm characteristics matter for how risk acceptant they will be. Some of the most interesting current work on FDI focuses on explaining these systematic variations. Daniel Blake argues multinationals view their subsidiaries as a portfolio of potential revenue streams, and within this holistic management conception, MNEs might be willing to sustain losses in one location as part of a larger strategy of gaining market share. Ben Graham argues that firms can learn how to manage political risk, and that some firms are uniquely positioned to manage such risks and therefore may specialize in locating in high risk countries. Together, both of these arguments fit nicely with EIU’s assertion that large oil companies are willing to take large bets in Argentina’s shale fields despite threats of nationalization. Indeed, such threats may benefit large energy multinationals because small firms are less able to manage these risks, depressing acquisition prices. This is an important point because it indicates that certain multinational firms will actually benefit from nationalistic policies!
While a bit further afield from the Argentine case, I also argue firms vary in how exposed they are to the threat of government interference. Firms that enter countries through privatization of utilities and infrastructure as well as firms that engage in resource extraction on government land are more vulnerable to government interference than are manufacturing firms. Right now, I'm working on a project that shows that bilateral investment treaties (treaties specifically designed to overcome OBM problems) have differential effects on different modes of entry for FDI. The point here is that BITs may help attract FDI for privatization much more than FDI for private sector M&As or greenfield investment. Since there is some evidence that mode of entry matters for contributions to economic growth, this insight has important investment and development policy implications.
I speak for no one else on this blog, much less the Department of Political Science or UNC, when I say that I support this statement in support of Erik Loomis.*
I support Loomis mostly because I have a sense of humor, but also because I believe that the Michelle Malkins of the world should not be able to dictate to anyone what is in good taste, and I believe a flagship public University should not acquiesce to blatantly partisan mock outrage over a trivial non-issue.
I disagree with Loomis' ideas, rhetoric, and methods much more often than I agree with them. I cannot ever remember a time that I've been enriched by reading him. But that's well besides the point. If losing one's job was the penalty for every improvised (clearly exaggerated) jibe then not a single one of Loomis' accusers would be employed.
I signed the CT statement. I hope others will as well.
*I do hope everyone associated with this blog and the broader UNC community agrees with me, and expect that they do/will, but I cannot speak for them.
Tuesday, December 18, 2012
"Its very rare for monetary policy to be the focus of an election. We campaigned on the need to beat deflation, and our argument has won strong support. I hope the Bank of Japan accepts the results and takes an appropriate decision," he said.Political economists have not done a very good job of analyzing the political role of central banks and other "technocratic" institutions. We've spent most of our time looking for central bank independence how that conditions inflation outcomes, with a bias in favor of low inflation. But central bankers respond to the political environment in which they operate, have preferences of their own, and should therefore be treated as political actors.
The menace behind his words did not have to be spelled out. He has already threatened to change the Bank of Japan’s governing law if it refuses to comply.
Via Scott Sumner, who also notes:
In 2001 Argentine fans of the “currency board” learned that their policy regime was not as impregnable as they’d assumed. And in 1933 American supporters of the gold standard found that even the world’s largest monetary gold stock couldn’t prevent a devaluation under duress. The reason was the same in both cases—voters get the last word.On the 1930s see Beth Simmons, who persuasively argues that differences in political regimes conditioned choice of policies during the Depression. On Argentina I like Paul Blustein's account, which is journalism (not social science) but there's more real social science in it than many academic books.
Friday, December 14, 2012
Quick follow-up on the previous post. Simon Lester at the Int'l Law & Economic Policy Blog points to an interesting recent survey of the "best" and "worst" government agencies to work for. Of the small agencies, USTR had the lowest job satisifaction score. From the original Washington Post article:
"The Office of the U.S. Trade Representative ranks as the worst small agency, at 32.7 percent. Former employees said its sense of mission was eroded by an ambivalent attitude toward free trade early in the Obama administration and during the economic crisis. Views of the agency’s leaders plummeted 18.9 percentage points over 2011." (emphasis added)
Article is here:
Tuesday, December 11, 2012
Albert Hirschman has passed away. One of the century's greatest minds is no more.
— Dani Rodrik (@rodrikdani) December 11, 2012
Monday, December 10, 2012
As a follow-up to the below post please see this good discussion at Alphaville. Also note that the entire conversation remains at the local (i.e. national) level, which I think is a major mistake.
I may or may not have further thoughts later.
Sunday, December 9, 2012
I think we’d better start paying attention to those implications.What implications?
[I]t makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.
I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.As it happens, I've been writing about this for quite some time. It was the focal point of my criticism of Tyler Cowen's "Great Stagnation" hypothesis (e.g. 1, 2, 3, and others), which I said was a "Great Redistribution". Basically the question I'd like to answer is why mean and median incomes have diverged, as pictured in the graph above. A "Great Stagnation" hypothesis seeks only to explain the flattening of median income growth. But we haven't had a Great Stagnation, since mean income growth has continued, at least until the Great Recession.
A Great Redistribution view, on the other hand, says that the structure of the global economy has changed over the past 40 years in ways that benefit (US) capital and hurt most of (US) labor. Specifically, the rise of a low-skill labor force in the former global South has competed away wage gains from low-skill American workers, while the rise of a medium-skill industrialized labor force in places like the NICs has competed away wage gains from medium-skill American workers. Additionally, the rise of mechanized labor (via robotics, which prompted Krugman's post) shifts income from labor to capital. Take a look at this chart:
Wages are converging globally, and since the US had disproportionately high wages this is hurting American labor in relative terms. At the same time, the global market has expanded dramatically. This increases the return to high-skill American labor as well as the owners of capital, who can now sell their production to much larger markets. This is particularly the case for goods and services which are reproducible at essentially zero marginal cost: think intellectual property and entertainment. Since the "high skill labor" and "owners of capital" groups are not mutually exclusive, this shows up in the data as both a) increasing wage inequality, and b) increasing returns to capital.
This is the simplest story in the world... basically just stating comparative advantage, at a mix of sectoral and factoral levels. The fact that it's so novel -- even to someone with a Nobel Prize in international macroeconomics! -- is a point of evidence that our intellectual class is way too focused on explaining everything locally. The Great Redistribution view has plenty of implications for political economy at global and local levels, but it is essentially a rejection of many public choice arguments, which tend to emphasize capture of political institutions by bankers or other oligarchs as the fundamental driving force in recent trends in the American economy.
I'm not sure what Krugman means by "uncomfortable implications". It could mean that the fact that the economy is working the way the way it's supposed to is an inconvenient truth for those who think that our political economy is being wrecked by those who prefer public choice explanations. But I doubt Krugman means that. It could mean that the "Golden Age" of American labor that Krugman loves so much -- the 1950s-1960s -- was a historical anomaly, the result of specific contingent circumstances that are not likely to be replicated ever again (and would be tragic if they were, given that that arose because of two devastating world wars and a Great Depression). But I doubt Krugman means that either. It could mean that the technocratic neoliberal vision is a fraud, and that the politics of distribution is likely to dominate capitalist political economies for the foreseeable future.
In any case, as an example of this Krugman talks about "re-shoring", the process of bringing manufacturing production back to the United States. Krugman suggests that this will have no major effect on employment or the income accruing to labor, because much of this production is done using robots. I think he's right that the direct effects on labor and wages will not be much. The indirect effect could be much higher, however. Why? Because in order to have robots build things, you first have to have factories. Humans have to build those. And you have to have roads to transport the goods. Humans have to build those too. And you have to have shops where the goods can be sold. Humans have to work in those shops. The desire for human labor that is complementary to robot labor can support wage gains for the median worker. That may not be enough to overwhelm the relative redistribution from the median worker to the top 10%, but it can help the absolute numbers.
American labor can benefit in another way: by receiving more non-cash compensation. The trend in the US is to provide more years of subsidized non-work at the beginning and end of life -- longer periods of education, longer retirements as lifespans increase -- and more non-cash benefits -- subsidized health care and education -- in a somewhat egalitarian way. These programs are overwhelmingly funded by the top 10% of wage earners, who are the high-skilled workers and the owners of capital*. To the extent that goods are increasingly created by non-human labor they free up people to do other things, some of which will not be market work. We'll call that "unemployment" or "underemployment" but if we generate sufficient national income to guarantee minimum standards of living at a level that ensures human dignity it will function as quasi-early retirement.
At the same time, quality of life continues to increase rapidly as the marginal cost of entertainment, education, and other goods approaches zero as a result of advances in information technology. This gain is felt by the median member of society as much as the richest person in society, and is more valuable for those with more available time. In terms of maximizing valuable leisure and minimizing alienating labor the typical citizen might be doing better, maybe even much better, than she otherwise would even while the data continue to show that she is doing much worse.
If this is an equilibrium it will have some negative consequences, for sure. Among them will be a reduction in social mobility and an increasingly bitter political economy. But Keynes dreamed of a world in which the gains from capitalism were distributed in a way that allowed people to work less, and some people are still dreaming of it. Marx too: his criticism of capitalism was not just that it generated inequality, but that it created alienation as labor became routinized. Marx didn't care about social mobility... he cared about human dignity. So maybe the left should welcome our new robot overlords (and their capitalist owners) for bringing the vision of Keynes and Marx closer to reality. Instead of slaving away in factories we can all post kittens to Tumblr and write stimulating blog posts. Yeah, maybe it looks like inequality, but it could end up being Utopia.
*The US tax code is already pretty progressive, and is likely to get much more progressive over the coming years, beginning with whatever deal comes out of the fiscal cliff negotiations. At the same time, the US benefit system is one of the least progressive, but I expect this to change over the coming decades for political economy reasons. Ultimately it will be up to the democratic system to manage these structural shifts.
Saturday, December 8, 2012
Rubio, you see, wants the Federal Reserve to stabilize three things:
1. The path of the price level,
2. The value of the dollar, and
3.The level of interest rates.
But you cannot do this. cannot stabilize the path of the price level and the exchange rate and nominal interest rates. Were we to confirm The One Who Is to chair the Fed, she could not do it.
If you stabilize the exchange rate--i.e., set up a gold standard and join it--interest rates and the price level will do their thing.
If you stabilize the nominal interest rate, you will find yourself in either an inflationary or deflationary spiral.
And if you stabilize the path of the price level, you will have to do some serious leaning against the wind with interest rates, and that will set the currency bouncing around.This is true of the proverbial "small open economy" that macroeconomists generally model, and is therefore true for most actually-existing counties. But it is not necessarily true of the United States. Why? Because of the fact that in a world with n countries there are n-1 exchange rates. Whichever country controls the base currency has quite a bit more policy flexibility than all the others.
The United States is still that country, despite not having a formal exchange rate peg since the end of Bretton Woods. Other countries still conduct monetary policy with a view towards impacting exchange rates vis-a-vis the US dollar. So long as those countries are stabilizing (nominal) exchange rates, the US central bank can conduct monetary policy with an eye towards stabilizing the path of the price level and interest rates. Absent shocks on the real side, these are the same thing.
This is not what Rubio is saying... DeLong is right about that. What Rubio actually wants -- "The Federal Reserve Board should publish and follow a clear monetary rule – to provide greater stability about prices and what the value of a dollar will be over time" -- is a new way to criticize the Fed. But on its face this is not so crazy. It is what Scott Sumner wants: a stated 5% nominal GDP growth target. Others want some form of a Taylor Rule. The Fed itself actually has stated a goal of 2% long-run inflation. To the extent that the effectiveness of monetary policy depends on expectations, wanting a clearly-articulated policy is perfectly sensible.
Thursday, December 6, 2012
Wednesday, December 5, 2012
*Oatley, Thomas. 2010. “Real Exchange Rates and Trade Protectionism.”
Business and Politics 12 (2): 1-17.
*In fact, because of this clear opposition at the tippy-top, the Senate's vote on this legislation was often considered to be "symbolic."
Monday, December 3, 2012
On Sunday, The New York Times unveiled the first of a three part "investigation" of investment incentives in the United States. The story has generated a lot of media chatter, and caught my attention because I actual study investment incentives, albeit within the context of developing non-democratic regimes. I plan to write a series of posts directly engaging with the Times reporting, and I want to start with a short post laying a critical framework.
The report finds that states and local governments in the U.S. provide, on average, a combined $80 billion in investment incentives each year. The author, Louise Story, frames the issue as a tradeoff between incentives and broad-based government spending; investment incentives amount to a transfer from workers to businesses. Today, the second part in the series focused on Texas's incentive program (it's the biggest in the country), and blames its excess on the close relationship between a tax incentive consultant G. Brint Bryan and basically every elected official in the state of Texas. Tomorrow's installment will focus on incentives for the entertainment industry.
As someone who studies this stuff, I'm glad it's receiving national attention. The New York Times released a database cateloging the investment incentives, which I along with many others will be glad to use for our own research purposes. Yet, there are some real weaknesses with Story's analysis. And, while she mentions economists who have concluded incentives are inefficient, she never once sources good work in political science about the political motivations for providing incentive packages.
The closest Story gets to a political explanation for incentive programs comes when she mentions academic research that concludes incentives are inefficient:
Indeed, there is actually a decent amount of work in political science devoted to understanding incentive programs and policies toward foreign investment. Nate Jensen has a really neat working paper along with several other authors in which they use experimental data to show that U.S. voters reward governors who offer firms incentive packages and punish those who don't. Sonal Pandya finds workers, and in particular skilled workers, are more inclined to support efforts to attract foreign investment. At a global level, the lack of an institution governing investment policies is routinely pointed to as the source for recurring prisoners' dilemma-type dynamics. Politicians provide incentives because the localities with which they are competing for investment provide them and because their constituents reward them for doing so. You don't need a story about corruption to understand the dynamics perpetuating incentive programs.
I mention this because I don't think the corruption meme is helpful. What drives the high value of investment incentives in the US is fiscal federalism. If the Federal government had authority over taxation and investment incentives, states wouldn't be able to use the tax code to compete against each other. This is a distinction that is lost in the New York Times report. Story finds it bizarre that, amid a national discussion about austerity and government debt there hasn't been a sustained discussion about investment incentives. Well, investment incentives happen at the state and local level, so it's unsurprising that dicussions about the national budget don't normally veer off in this direction. Moreover, investment incentives, for the most part, do not generate budgetary outlays - a point Story obscures in her reporting. Of the $80 billion in incentives offered each year, $70 billion are in the form of income and sales tax exemptions or reductions. Sure, this $70 billion can be considered lost revenue, but it doesn't amount to spending and it is also difficult to determine exactly how much tax incentives cost because firms often argue that they would not make an investment without the incentive. When governments do provide incentives that require budgetary outlays, mostly in the form of loans, a national discussion often ensues (remember Solyndra?).
In all that, I have hardly touched the global conditions that affect policies toward investment. I'll discuss that further in a follow-up post.