International Political Economy at the University of North Carolina

There Is No Great Stagnation, Only Great Integration

2012-01-28T18:34:00.001-05:00

There are a lot of ways to think about what's happened to the flattening of median American income growth. One of the most interesting is Cowen's stagnation hypothesis, which attributes the lack of wage growth to not generating enough job-creating innovation. I like some parts of that hypothesis -- although I prefer to look at changes to political systems and developments in the global economy -- but there have been other things going on as well. One of them is this:

I want to focus on the period ending around 2000. If you go from the early-1970s trough to the late-1990s peak, the U.S. added about 9 percentage points of its labor to the workforce in about 30 years. At current population levels, that's about 30 million people. Even if you go from 1970 peak to the 2000s average, it's about 15 million people or so. Often these would be members of disadvantaged groups, such as women and minorities, whose wage potential would be lower than that of white males that were already in the workforce, so we're adding a bunch of relatively low salaries to our statistics over that stretch.

Looked at that way, it's almost impressive that median wages have been flat. If there had actually been stagnation, median wages would have gone down as more people got added to the labor force at low wages.

Or, instead of looking at median individual wages, we could look at median household wages:

As you can see, until the 2000s we had pretty strong growth that was actually accelerating over time. This doesn't consider everything -- more two-worker households means greater expenses for child care, etc. -- but we generally think employment is good for its own sake. It yields psychological benefits, allows greater flexibility for satisfying preferences and tastes, etc. In terms of social justice, excluding fewer women and minorities from pursuing the good life is also a good thing.

If we're thinking about trends in the U.S. economy over the past few decades we might consider it good news that we've been able to integrate more people into the workforce and that household incomes have increased. That's not stagnation. That's improvement.

This only gets us up to the 2000s, and it doesn't tell us anything about the future, but it's a component of the U.S.'s postwar economic history that doesn't get talked about enough.

It's A System, Not a Dyad

2012-01-25T08:15:00.000-05:00

There's a lot of discussion of China's rise and it's implications for the U.S. Michael Beckley published an article in International Security arguing that China's rise over the past two decades has been dramatically overstated. Phil Arena and Eric Voeten criticize Beckley's thinking -- although not conclusively, I don't think -- while Dan Drezner argues that things is looking up for the U.S., Roubini and Pettis argue that things is looking down for China, Chang (again) says China is gonna collapse, while Liu and Chen think China will democratize. Joffe thinks that the U.S. still has time to act to prevent its slide into "Just Another Country" status, while Subramanian thinks that China has already surpassed the U.S. and Rodrik demurs.

That's a lot of different views being espoused by a lot of different people, most of who are pretty smart, all from the past month or two (and most from the past week!). And while I could quibble with a lot of individual points being made by most of them, I'd like to instead shift the focus a little bit. All of these discussions have either been monadic -- focused on internal aspects of either the U.S. or China -- or dyadic -- the relationship between the two and/or the relative gap between them. While these examinations have their uses, in terms of importance for geopolitics we should think of the systemic as well as the monadic and dyadic.

Similar discussions were being had in the 1980s. Back then it wasn't China's rise that threatened the U.S.'s position, but the advance of Japan and other rapidly-industrializing countries. In response to the prognosticators of the day, Susan Strange wrote a series of articles (e.g. here and here) arguing that many folks were missing the point. In response to those complaining that the U.S. was losing its manufacturing base Strange wrote (second link, p. 5), "Is it more desirable that Americans should wear blue collars and mind the machines or that they should wear white collars and design, direct, and finance the whole operation?" To ask that question is to answer it, but then why has everyone lost their breath over the disclosure that Apple products are assembled in outside of the United States? As Strange noted, what it's important is controlling the information and collecting the profit. In fact, the spread of influence of American corporations outside of the U.S. borders and into other countries actually strengthened American power, according to Strange. Think of it as more fingers in more pies.

Rather than focusing on short-term trends in simple metrics like GDP, Strange was concerned with the "structural power" rather than "relational power". Structural power contained four metrics: the ability to exercise control over others' security; control the system of production and trade; determine the structure of global finance and credit; have the most influence over the global stock of knowledge.

Regarding the first, a forthcoming paper in Conflict Management and Peace Science by Cranmer, Desmarais, and Menninga (all UNC folks) analyzes "Complex Dependencies in the Alliance Network" and confirms what one Chinese official recently said (from memory; can't find the reference now), that China has "only one ally" and it's the one that no one would want: North Korea. The United States, by contrast, has robust ties to nearly every major power in the world and is a central member of NATO, perhaps the strongest defense relationship in the history of the world. (In the Cranmer et al paper, see Figure 4.) In terms of traditional capabilities the U.S. far out-paces everyone else too, but it's the structural relationships that really give the U.S. significant influence.

Regarding production and trade, a recent study looking at networks of corporate ownership found a highly-skewed distribution: 147 firms control nearly 40% of corporations worldwide. Of the top 50 firms in terms of "corporate control", nearly half (24/50) are U.S. firms; exactly one is from China, and it's the last on the list (#50). China is the world's largest exporter, but that is an indication of its dependence on the rest of the world for growth rather than the opposite. And remember that U.S. equities have out-performed China's during the past few years. Is China an important global actor in terms of production and trade? Yes of course. Have they become as embedded into knowledge and production as the U.S.? Not yet.

In terms of the structure of global finance and credit, I have a paper (with Thomas, Sarah, and Andy Pennock) that deals with some of this, currently in the revise and resubmit stage. We've blogged about this before too, so I'll refer you to those rather than re-write the whole thing. (Some other relevant past posts are here.) The gist is that China has surprisingly little presence in the global financial system -- as in, almost none at all -- while the structural position of the U.S. is unparalleled. That's one lesson from Eichengreen's Exorbitant Privilege as well, applied to the monetary/currency systems.

Regarding the fourth of Strange criteria -- control of the global stock of knowledge -- it is true that China has been churning out many more students than the U.S. in STEM majors, and that the quality of Chinese education has improved dramatically, but China remains well behind more developed economies in terms of innovation: Of the 100 most innovative firms in a recent study, 40% are in the U.S.; none are in China. In terms of military technology, the U.S. has a lead of decades on China, and continues to dramatically out-spend China in military R&D. That, coupled with the embeddedness of the U.S. within the global security system, provides a huge structural advantage over China.

I could go on, but this should be enough to give you the gist. It's not enough to just look at recent trends in GDP growth rates and conclude that China will eclipse the U.S. within the next decade. The U.S. has spent decades deeply integrating itself into the global economy, financial system, security apparatus, and knowledge networks. Those positions will likely privilege the U.S. for the foreseeable future. It seems likely that China recognizes this, which is why it hasn't begun challenging the U.S. on any significant dimension yet.

SOTU Bingo

2012-01-24T16:19:00.003-05:00

Jon Kropko -- UNC poli sci PhD, now at a postdoc at Columbia -- puts together bingo sheets every year for the State of the Union address. Here ya go, but be forewarned: it usually doesn't take all that long for someone to line 'em up, so it pays to be familiar with your layout ahead of time.

(The link is to a pdf containing 30 sheets, with randomized placements of key words likely to be spoken by Obama tonight. Instructions for making your own sheets can be found at Jon's web site.)

Paradigms in Political Science

2012-01-22T10:12:00.000-05:00

It may not be easy to see (click here for a bigger image, and here for some discussion at TMC), but the above graph shows the probability that a political scientist will think that the eurozone will split up versus stay together. The group in the top left are IPE scholars, the middle are International Org scholars, and the bottom are comparativists who study Europe. I'm not a big fan of this graphing style, as it seems to obscure nearly as much information as it illuminates, but it's fairly easy to see that IPE folks are the most convinced that at least one country will leave the euro. More than half of us. Meanwhile, only about 37% of IO folks and 30% of Europeanists think a country will exit the common currency.

I find this interesting for a lot of reasons, but mostly because I think provides a pretty stark reminder that political scientists think very differently about politics. This could break down along paradigmatic lines -- the authors of the report note that constructivists tend to be comparativists, while realists tend to be in IR. I still think that a materialist conception of politics carries me farthest down the road I wish to be on, so I think it is fairly likely that a country will drop the euro if things continue to deteriorate.

I've had many conversations with Europeanists on this point. All of them are enamored of the EU. For them the collapse of the EU is unthinkable. I can't understand why. It's not as if fixed exchange rate regimes -- and political unions -- haven't collapsed before, particularly when subjected to this level of stress. That said, they certainly know more about Europe and the European identity than I do, and they take it very seriously.

I don't really have an answer here. I hope that conditions in the EU improve enough that we don't have to test these paradigms this time. A confederal Europe is good for the world, on net, particularly if they can figure out how to manage the broader economy in ways that don't lead to periodic crises. But I have my doubts about that.

Interests, Ideas, and MIT Economists

2012-01-21T14:55:00.002-05:00

Over at Bloomberg, Rich Miller and Jennifer Ryan have an article that should make constructivists smile:

At MIT, [Mervyn] King, 63, and then-professor Ben S. Bernanke, 58, had adjoining offices in 1983, spending the early days of their academic careers in an environment where economics was viewed as a tool to set policy. Earlier, Bernanke and European Central Bank President Mario Draghi, 64, earned their doctorates from the university in the late 1970s, Draghi with a thesis entitled “Essays on Economic Theory and Applications.”

[Stanley] Fischer, 68, advised Bernanke’s thesis on “Long-Term Commitments, Dynamic Optimization and the Business Cycle,” and taught Draghi. Greek Prime Minister and former ECB vice president Lucas Papademos and Olivier Blanchard, now chief economist for the International Monetary Fund in Washington, earned their doctorates from MIT at about the same time.

Other monetary policy makers who have passed through MIT’s doors include Athanasios Orphanides, head of the Central Bank of Cyprus, Duvvuri Subbarao, governor of the Reserve Bank of India and Charles Bean, King’s deputy in the U.K.

This almost immediately brought to mind Jeffrey Chwieroth's 2007 article -- expanded in his book Capital Ideas -- "Neoliberal Economists and Capital Account Liberalization in Emerging Markets" (ungated). Chwieroth analyzed the behavior of IMF staffers and argued that their policy recommendations was highly influence by where they received their postgraduate education: economists that came from "neoliberal" economics departments advocated for neoliberal policies.

When I first read the paper I focused a lot on what constituted a "neoliberal" economics department. It seemed a bit arbitrary. Chwieroth's list of neoliberal departments included eight important schools: Cal-Berkeley, Brown, Carnegie Mellon, Chicago, Harvard, Hebrew (Jerusalem), Johns Hopkins, NYU, Northwestern, Penn, Princeton, Stanford, Wisconsin, and Yale. These came from a previous article by Chwieroth, in which he presents a methodology for linking abstract concepts to empirical identities.

I don't know what is an appropriate test of the validity of this methodology, but a list that includes both Chicago and Berkeley as normatively similar raises an eyebrow. As does one that includes Harvard and Princeton but not MIT. This certainly cuts against the "saltwater vs. freshwater" story that folks like Krugman tell. (Krugman was also at MIT during this period.) Perhaps Chwieroth's classification works for the specific issue he's considering -- capital account liberalization -- and not more generally.

In any case, the Bloomberg piece also made me recall Krugman's talk of the "Dark Age of Macroeconomics", in which freshwater economists have forgotten everything they were supposed to know about how the economy works. Krugman complains about the belief in "confidence fairies" and "expansionary austerity", and about how "wise men" who are setting policy are making such significant mistakes that we are doomed to at least one lost decade and maybe more.

As the article points out, in an impressive number of cases these policymakers are saltwater economists, from MIT, who think of economics in the same way that Krugman does and received the same education from the same people at roughly the same time as he did. What does this tell us?

It could be that everyone in the world except for Krugman is an idiot, or it could be that everyone in the world but Krugman is a vicious liar. Or it could be that policymakers are highly constrained by the fact that economic issues are highly contentious. Particularly in democracies, political interests and ideas are often much more important than economic training or even ideology. In the end, it matters much less that some central bankers went to MIT in the 1970s than that the interests of the median Greek are divergent from the interests of the median German.

And if that's true, then why does everyone spend so much time talking to economists about political dynamics?

(Terrible, No Good) GOTD

2012-01-18T08:31:00.000-05:00

This, apparently, was Bloomberg's "Chart of the Day" (via, and HT to Leigh Caldwell on Twitter). In case you can't tell, the orange line is the U.S.'s legal debt ceiling, the white line is the spot price of gold.

It is a very bad, no good, terrible, very bad graph. Misleading at best. Can you tell why?

Here's a clue, but it won't work until tomorrow.

Why Theories of Regulation Are Inadequate

2012-01-17T14:37:00.001-05:00

Here are some assumptions shared by the most prominent theories of regulatory politics*:

1.a. Strict regulations in one country will generally hurt the competitiveness of firms in that country.

1.b. Unless those regulations confer rents to domestic firms.

2. Because banks are a concentrated, influential interest group, this means that states will generally not unilaterally regulate. Therefore, new regulations must come in the form of a credible international standard -- generally originated by a powerful state with agenda-setting power -- that ensures that foreign competitors will have to abide by the same restrictions.

3. States attempt to use their power and influence to affect the parameters of regulations in ways that benefit their firms. This may involve an international redistribution of rents, from firms in a less-powerful country to firms in a more-powerful country. Such a redistribution may, but does not have to, fall along the Pareto frontier.

Now let's look at some news from the past month:

-- Philipp Hildebrand, head of the Swiss central bank, is enforcing stricter capital standards for Swiss firms than those required in the international Basel III agreement.

-- Japan and Canada are asking U.S. regulators to not regulate U.S. firms more strictly.

-- Joe Nocera -- no lackey for the financial sector -- joins JP MorganChase CEO Jamie Dimon in protesting that the number of new regulations is potentially destabilizing and will lead to arbitrage opportunities for the type of large firms they are supposed to curtail, while agreeing with Dimon that simple rules like capital standards should be strengthened.

None of these would be expected by the dominant theories in the literature, despite the fact that none of these dynamics are especially new. In 2006, more than 40% of the governments surveyed by World Bank researchers reported that their capital regulations were stricter than the Basel requirements. There were similar responses in two previous surveys, conducted in 1999 and 2003. Only a handful (I believe it was three or four) of countries reported that their regulations were weaker than the Basel minima, despite the fact that accession to the Basel accords has not been mandatory outside of the G-10 (and later the EU). That means that, if existing theory is to be believed, 40% of the world's governments were putting their firms at a competitive disadvantage by having stronger regulations than the international standard. That means that, if existing theory is to be believed, nearly 100% of governments responding to the World Bank survey were refusing to take an opportunity to give their firms a competitive advantage by staying out of Basel**.

These empirical patterns suggest that we need to do more hard thinking about what regulations actually do and how they impact markets. Once we have a better understanding of these, we might be able to get a better sense of how interest groups form preferences over regulatory policy and how comparative and international political processes work.

I have some ideas along these lines, but this is getting long enough already. If you're interested stay tuned; I'll be posting somewhat regularly on this topic over the next year.

*I'm most familiar with theories specifically applied to financial regulation, but I believe these hold true more generally. The two main categories of regulatory theory in the political science and economic literatures are joint-gains functionalism and rent-seeking public choice. Despite having different conclusions about the outcomes of regulatory policies, they share many fundamental assumptions about the ways that regulations work and different interest groups' attitudes over regulations.

**There is certainly some "mock" compliance, where states claim to be in compliance but are not. Since Basel has no monitoring or enforcement mechanism other than market discipline, this may happen quite a bit. Indeed, Andrew Walter extensively documented some examples in East Asia. Still, the World Bank surveys have been public for years, and the researchers actively encourage people to report discrepancies between de facto and de jure policies. To my knowledge few revisions have been necessary.

Economists Are Not Doctors

2012-01-16T08:56:00.000-05:00

So says Ryan Avent, reporting from the annual meeting of the American Economics Association:

THE annual meeting of the American Economic Association (AEA) functions a bit like a large, rumbustious diagnosis session. The world economy is rolled in on a gurney, prodded and poked, and declared to be suffering from a host of conditions. Yet the awareness that economists are not doctors has been rather slow to creep into the profession. Doctors may order a treatment (even the wrong one) and feel reasonably confident it will be administered. Economists cannot. The crisis in the euro zone is an acute case. Ideas for fixing the problem are plentiful. But the best economic policies may never see the light of day because of the brittle and baffling world of European politics.

I would say it's even worse than that. For doctors, there is a clear separation between patient and disease. With economies every "treatment" harms a patient even as it helps another. A policy that benefits debtors over creditors is... benefiting debtors over creditors. There may be instances in which policies are Pareto-improving, but they are rarer than economists (or political scientists, for that matter) care to admit. Even if we find a policy that will move us to the Pareto frontier, there is still the matter of where along the curve we're going to end up.

This is not an optimization problem.

Academic Publishers Are Evil

2012-01-16T07:17:00.000-05:00

Yeah, nothing new. There seems to have been a recent uptick in people getting angry about it. This rant in particular was pretty satisfying. And while there are some positive trends towards increasing access to research -- e.g. JSTOR is moving towards open access -- in general the barriers to dissemination of research are silly.

Because I have access to university facilities, usually I find things like journal access to be more of an annoyance than anything. I have to log onto the university's library's web page, navigate through five or six screens, enter passwords a few times, and then I get the article. That's annoying, but at the end of the day I get access to almost everything for free.

Almost everything. I currently want to read an article in the newest issue of Political Science Quarterly, but my university's library only has online access for PSQ issues that are at least six months old. So I can't read this article. And I can't find an ungated version anywhere else. I guess I could go to the physical library and try to navigate the hundreds of journals on the racks, but by the time I find it (assuming I do), check it out, and get back to my office I will have spent half an hour or more of my time, which is probably about as long as it would take me to read the article. Plus I won't be able to keep an electronic copy to reference in the future unless I scan it.

In this case making their material difficult to read is bad for the author and publisher as well, because I likely would have blogged the article. That's (a very small amount of) free publicity, now lost. I might have assigned it to my class, as I'm looking for one more current reading to add to the syllabus on this topic. But not if my students can't find it. And -- not that they really care -- I can't imagine ever submitting any of my own work to a journal where I know that no one will be able to read it until it's lost currency.

Perhaps the intention of the policy is to motivate me to pay for a subscription to PSQ. Instead it's motivated me to ignore it entirely. It's not like I don't have other things to read.

Baking Banking Instability into the European Cake

2012-01-14T13:52:00.002-05:00

Apologies for the long absence. The past few weeks have been extraordinarily busy on several fronts. I think I'll be able to get this place back into fighting shape pretty quickly.

The decision of S&P to downgrade more or less the whole of Europe has made a lot of headlines, but I'm not sure how much it matters. The plan for Europe before that happened isn't much affected by the downgrade: the ECB prints money and gives it to the banks, accepting EMU sovereign debt as collateral. The banks use the funds to buy sovereign debt. The banks get financing for sure, and if all goes well so do the governments. As far as I can tell, for regulatory purposes all OECD sovereign debt still counts as "risk-less" -- meaning that banks are not forced to hold any capital against it -- under the Basel accords, so there is a regulatory incentive for banks to buy some of this stuff.

There's something absurd about all of this... every step in the chain is an attempt to hear no evil by sticking fingers in one's ear. But if the eurozone is going to survive the European banking system has to stand upright and be able to finance governments. That requires ECB support.

JP MorganChase CEO Jamie Dimon, who often says things in public that are more revealing than he perhaps realizes, recently claimed to believe that there is no banking problem in Europe:

“It eliminates bank liquidity or funding problems for at least the next year, that’s a pretty powerful statement,” Dimon said today after his company reported a drop in fourth-quarter net income. “That was the biggest single risk of an uncontrollable surprise right there, so if that’s taken off the table, that’s a good thing.” ...

“Europe is trying mightily to solve its problems. I still think the likely outcome is they will muddle through,” Dimon said. “The longer you wait, the higher you run the risk of something disorderly that you can’t really control. I think the ECB took off the worst outcome, i.e. a bank failure.”

Dimon might be right about Europe being able to muddle through, although I still have my doubts. He might even be right that a bank failure is the "worst outcome" in Europe, although I can think of some worse outcomes. But what he doesn't say, indeed what no one has much talked about, are the negative effects this will likely have in the European banking sector if the plan works.

The problem that the new ECB policy is supposed to resolve is this: banks won't lend to needy European governments except at punitive rates. Why? Because those governments are highly likely to default. This is exactly what we want a responsible, healthy banking sector to do.* What we don't want is what we're now hoping to get, which is to say that we don't want a banking sector whose investment behavior is skewed by political institutions pursuing dubious policy goals. We don't want a banking sector that has an expectation of future support if their investments go bad, and we don't want a banking sector that cannot discipline either itself or those to whom it lends.**

We don't, in short, want a situation in which government interventions make Jamie Dimon smile. (Or interventions that make him rich.)

Is this road less bad than the one Europe was on previously? In short run, surely. In the medium-to-long run it's hard to say. Perhaps we think that once the crisis is resolved the ECB can make a credible future commitment to be more standoffish towards the European banking sector. Perhaps we think that we can rein in banks and national governments in other ways, via strict capital standards for the banks and "Hard Keynesianism" for the governments. But I have little confidence that those things are likely. They cut against almost every identifiable political current.

The only way it works is if this crisis really scares everybody so much that a significant (and durable) shift is made in the regulatory and fiscal infrastructure of Europe. While not impossible, I remain highly skeptical that that will happen. I believe it's more likely that policymakers will conclude that the institutions in place are pretty resilient already -- "How else could we have pulled through this crisis?" -- particularly when coupled with a more activist ECB that will support the banking sector when needed. I believe the banks will conclude that the ECB is their friend, and will therefore count on support when needed, particularly if the cause of the trouble are the member nations of the EMU. That is a recipe for a lot of future financial instability.

The ECB cannot, and should not, be in the business of resolving Europe's political problems. Forcing it into that role is likely to make things worse in the long run.

*The "we" here being an imagined societal consensus in possession of the general will, which reflects more-or-less center-left neoliberal technocratic principles. Yes, I know this "we" does not exist in nature.

**I have a paper, currently R&R, that argues that when banks expect preferential policies from governments they act less prudently. Simple argument, I know, but it's not in the literature yet. I find statistical support. I'll post it if/when it gets accepted somewhere; if someone wants it sooner e-mail me.

We Won An Award!

2011-12-31T02:17:00.001-05:00

Well, not "we". Thomas did. And not an "award" per se, in that there's no cash or statue or anything. But Thomas was just given a prestigious "Albie", named in memory of the great Albert Hirschman (whether A. H. would approve or not), by Dan Drezner, for his article "The Reductionist Gamble". In Drezner's words:

The Albies are awarded to the best writing in global political economy for the past calendar year. The writing can be in a book, journal article, think tank report, or blog post -- the key is that the article makes you reconsider the way the world works.

Thomas's article was listed second in the "no particular order" list, but it was the only article published in a top academic journal on his list -- there was a think tank paper and a UP book as well -- so in terms of importance for the discipline of IPE it in some sense stands alone. Last year, I believe, no academic IPE pieces made Drezner's list.

In my opinion this article should be on every IPE syllabus from the advanced undergrad level on up.

The link Drezner provided to the article is gated; an ungated pdf is here. The logical extension of that article is to forge a new IPE paradigm. Or, as I believe, to try to re-unify the open economy politics paradigm with the "complex interdependence" focus from IPE's early days, using more rigorous empirical tools. I think that's the track that Thomas is currently pursuing in his work, and it's the primary epistemological motivation for my dissertation as well.

So, congrats Thomas!

There Is No Such Thing As a Free Market

2011-12-29T16:13:00.001-05:00

Matt Yglesias starts with a cute little point about trade politics -- the Marvel corporation has defined the X-Men as mutants rather than humans so as to exploit the difference in tariffs between human dolls and non-human "toys" -- but then, I think, misses an opportunity to explain something more significant about how the world works:

It's remarkable, incidentally, the extent to which the politics of "trade deals" have gotten away from the fundamental issues of free trade as seen in an economics textbook. What we have here is a federal 12% sales tax on dolls, but only if the dolls are made in foreign countries, and a different -- arbitrarily lower -- 6.8% federal sales tax on toys, but again only if the toys are made in foreign countries. There's no good reason to have special higher sales taxes on toys made in foreign countries, and there's certainly no good reason to tax dolls and non-doll toys at different rates. It's nuts and it could and should be addressed by a unilateral acts of congress. The amount of revenue that would be lost to the federal government by repealing these taxes would be tiny, and it's trivial to think of better ways to raise the money. And yet this core -- and quite simple -- trade policy issue is a world away from the incredible complexity of the trade deals of the past decade.

This goes back to what I was driving at in my old post arguing that "The Problem with Economics Is the Economists". The standard welfare case for trade assumes that through specialization in comparative advantage each country can consume more via trade than they can via autarky. That's where economics stops, unless they go on to mutter about something about "distributional consequences blah blah politics blah". In other words, economics books don't spend much time noticing that those employed in the sector/factor that does not have a comparative advantage all get put out of business.

In reality the distributional consequences drive everything. The length and specificity of trade agreements is mind-boggling. The "schedules" of tariffs from the last completed WTO negotiating round (the Uruguay round) is over 30,000 pages, and it's full of thousands of cases like the dolls/toys distinction Yglesias is describing. Each one has a highly-motivated domestic interest group behind it, who will fight to keep in each and every provision that benefits them even tangentially. As there is generally no countervailing force, Congress will listen to whoever is talking to them.

The reason why Congress does not, and will not, step in to change these rules is because there is no political reason why they should. Maybe it's "nuts" and maybe it isn't, but there is some group in this country for whom each of the rules represents the difference between profit and loss. For example, if Marvel can sell X-Men as "toys" rather than "dolls", then they get an immediate competitive advantage over DC Comics, who has to factor in the higher tariff rate when it produces Batman dolls. So Marvel will lobby Congress not to change the tariff schedule. Because, as Yglesias notes, the issue is really pretty trivial for almost everyone in the country (except for Marvel) the likelihood of it being changed is pretty low.

Issues which are generally of very high salience to a small group and low salience to a larger group are high susceptible to capture by the small group. There's a ton of political economy research developing this point (Mancur Olson made a prominent career out of it), but it doesn't seem to have captured the public's mind. Or the mind of many economists.

Here is what it means: there is no such thing as a free market, anywhere or in anything. The reason why is because of politics. To the extent that economics ignores this, economics is irrelevant.

Who Wants to Be a President?

2011-12-28T13:24:00.001-05:00

Never heard of this happening before:

Moldova risks a prolonged political stalemate that may further slow down reforms in one of Europe's poorest nations as the only candidate for president said on Wednesday he was pulling out of this month's election.

The withdrawal of parliament speaker Marian Lupu means the presidential election, which takes place in parliament rather than by popular vote, might be delayed if no other candidate steps in. The vote is currently scheduled for January 15.

Ex-Soviet Moldova has been without a president for over two years as no group in parliament has been able to muster the necessary 61 votes out of 101.

I know nearly nothing about Moldova so I have no idea what's motivating this. The article suggests that the Parliament is sufficiently fractured that no candidate will get 61 votes, and if a candidate fails to do so then the Parliament is dissolved and a new special election is held. Right now Lupu is acting president, so not running for president might actually mean that he can remain president longer than he otherwise would. Interesting.

Political Survival in Syria

2011-12-20T21:08:00.003-05:00

I've got my issues with selectorate theory, but I think this take from BdM & Smith on Assad is pretty right.

The IMF Isn't Technocratic Either

2011-12-20T13:30:00.000-05:00

The title of a recent post at The New Republic is "How the IMF Got It's Keynesian Groove Back". I don't want to pick on author, Jared Vary, too much as he appears to be an intern at TNR, but I see this line of reasoning proffered from more credentialed folks all the time and it drives me crazy. It basically goes like this: originally, the IMF was a fairly kind, generous, technocratic "Keynesian" institution, which was corrupted over time by a "Chicago school" ideology that made crises worse rather than better by insisting on harsh austerity. After the IMF botched up 1990s crises, they started to return to their postwar Keynesian roots.

This type of narrative relies on a view of the IMF that is, I think, inherently flawed. IMF actions have varied along with the geopolitical issues of the time. More specifically, it has always taken actions that the major Western powers, particularly the U.S., wanted. (The U.S. is the only single country with an effective veto, since it has always controlled over 15% of the voting rights and actions must be approved with an 85% majority.) These preferences were not consistent across countries or time, and there is no reason to expect that they would be. During the Bretton Woods period, the IMF was used to used to balance the fixed exchange rate system that embedded the U.S. at the center of the international economic system. In the 1970s and 1980s, the IMF was used as a sort of bailout device for commercial banks in the U.S. and Europe, which owned too much emerging market debt. Harsh conditionality was tied to these loans because the purpose of them was to help the banks, not the indebted countries. In the 1990s the IMF behaved differently depending on the geopolitical context. Loans to countries undergoing post-communist traditions had fewer conditionalities attached to them than loans to East Asian countries or the Latin American countries in the 1980s.

The above paragraph draws from a fairly long string of research on these questions. While the ideational view has some support from folks like Chwieroth, materialist explanations of the IMF's behavior are more prevalent in the literature. Strom Thacker wrote about the "high politics" of IMF lending, and showed how countries that "move toward the political space of the U.S." -- for example by voting with the U.S. in the U.N. -- have a greater chance of receiving loans. Oatley and Yackee extend this further, showing that countries with a lot of indebtedness to U.S. financial firms receive larger IMF loans, as do countries that are allied with the U.S. Randall Stone finds that conditionality is enforced less on countries that are important to the U.S., and can offer the U.S. something valuable in return. Finally, Grigore Pop-Eleches argues that the size of IMF loans and type of conditionalities attached to them varies according to geopolitical, rather than economic, concerns. Indebted Latin American countries in the 1980s had more strings attached than transitioning Eastern European countries, because the major Western powers had an interest in a smooth transition away from communism towards capitalism, and towards greater integration of the European continent.

The point of all of this is to say keep reiterating that there is no technocracy. Institutions like the IMF are inherently political, and act accordingly. The constituent members of these institutions are also political, and will use the institution to suit their ends when they are capable of doing so. Often this will involve issue-linkages and quid pro quo arrangements, so it may not always be transparent, but that doesn't mean it isn't happening.

Update: See also this previous post from Thomas.

Hitchens and Iraq

2011-12-19T10:52:00.000-05:00

Two events this week -- the withdrawal of U.S. troops from Iraq and the death of Christopher Hitchens -- have brought to mind something that has always bothered me in conversations about the Iraq war: the fact that the "pro-war" side is often made to answer for the crimes of the other side. In the case of Hitchens, a general criticism is that he never changed his mind on Iraq despite the fact that hundreds of thousands of Iraqi civilians were killed, maimed, or forced to flee the country. Quite often he is accused of having blood on his hands. Here's one good example.

There are, in my mind, two possible answers to this. The first is to turn the logic on its head. If it is true that removing Hussein from power unleashed a "quagmire" in Iraq that could only be resolved when the power vacuum had been filled, then this was inevitable. Hussein was not going to live forever, and there would likely have been a protracted power struggle involving mass amounts of civilians deaths whenever he passed on. In which case the presence of large numbers of American troops may have had something of a pacifying effect; as bad as Iraq was, it wasn't Rwanda or Sudan. It may be true that the presence of foreign occupiers was what was driving the violence, but there are good reasons to think that that is not the case. There were different strong factions within the country, from the Kurds to the Sadrists to the Baathists and others, with fundamentally different interests and a strong desire to control the mechanism of the state to improve their own standing. There were a number of regional powers that would have been happy to encourage violence and instability in Iraq both as a method of proxy warfare and to prevent a strong Iraq from materializing and threatening their interests in the future. It simply is not clear that there was any realistic counterfactual scenario in which there was not large-scale bloodshed in Iraq.

And could you imagine how Hussein would have responded to an Arab Spring in his country?

The second is to flip the logic entirely. The groups most responsible for the violence in Iraq are the groups that Hitchens wanted to fight. The people Hitchens wanted to defend from these groups were the civilians being victimized by them. The level of violence that occurred in Iraq following the invasion can thus taken as vindication for Hitchens: these groups will use violence against civilians or governments whenever it is tactically advantageous to do so, and therefore they should be obliterated. Carrying that out will have costs, but failing to do so will have even greater costs, and for a longer period of time.

Many of the other criticisms of Hitchens' support for the war -- "blood for oil", "imperialism", your typical warmed-over '60s Marxist rhetoric -- have also turned out to be vapid. (Although I do recall Hitchens making the argument that if we were going to fight for any materialist reason, securing the supplies of energy that fuel the global economy was a pretty good one.) And as Nick Cohen once wrote of anti-war protests in London, it was pretty odd to see a bunch of leftists marching in opposition of a war against a fascist regime. It is true that the Bush administration made many excruciating mistakes, such as not getting the electricity back on quickly, or protecting the National Museum. Probably the biggest one was appoint Bremer as Viceroy, and then letting him screw up everything he possibly could. But these were actually less inevitable than the counterfactual that the internal politics of Iraq would have remained peaceful in the absence of invasion. And now there is some real hope that a stable state that is responsive to its citizens will emerge. That would have been exceptionally unlikely in any other state of the world.

Perhaps these reasons are not sufficient for supporting the war in retrospect. But too many people are too glib about it now. It's not enough to simply say it was a "mistake" and let it go at that.

(Do Not) RIP, Kim Jong Il

2011-12-18T22:30:00.003-05:00

And another one. Be interesting to see how this plays out.

(Video above has some strong language.)

Update: Havel on Kim Jon Il, from 2004. (Via half of Twitter.)

RIP, Vaclav Havel

2011-12-18T22:20:00.003-05:00

He was one of my favorite figures of the 20th century. His advice to dissidents living under oppression was to live as if you were free. His essay "The Power of the Powerless" is a landmark achievement in 20th century normative political thought. Here is one good brief remembrance.

It is perhaps fitting that he died in such proximity to Christopher Hitchens, who was one of Havel's biggest fans. The two were acquainted I believe, and both belonged to what now appears to be the only revolutionary opposition movement to have truly emerged from 20th century geopolitics: an opposition to socialist totalitarianism. To that end they were on the same side in the Balkans and in Iraq. Hitchens appreciated Havel for his literary ability -- and not just Havel; Hitchens once wrote that he most admired Obama for his book about his father -- and his understanding of how language is itself political.

It is a shame that Hitchens was not able to write an appreciation of Havel. (Just as it is a shame that he will not be able to write the obituaries of folks like Kissinger and Ratzinger.) But there are plenty of others. Havel's life was well-lived.

RIP.

Update: Drezner has a good post on Havel and Hitchens.

RIP, Christopher Hitchens

2011-12-16T00:42:00.002-05:00

There Is No Technocracy QOTD

2011-12-13T14:11:00.002-05:00

From Daniel Davies, talking about the new EU deal:

The ‘technocrats’ (which is apparently what they want to be called, although frankly I am seeing a lot of ideology and not much technical ability) want to reorganise the whole of Europe on neoliberal lines.

Insta-Classic

2011-12-12T02:34:00.001-05:00

Andrew Gelman:

If some dude scratched my car, I wouldn’t be so quick to jump to the conclusion that he’s a rapist.

But would you think he was an atheist?

Context.

Apologies for the light posting. Hopefully we'll be back to normal soon.

Arbitrage Opportunity of the Day

2011-12-07T12:47:00.001-05:00

Tyler Cowen points to a discussion of the possibility of physicists discovering the Higgs Boson Particle, and notes that InTrade has the odds of discovery prior to Jan. 1, 2014 as 88%. Which is true. But InTrade also has the odds of discovery prior to Jan. 1, 2015 as 60%. (The market for discovery prior to Jan. 1, 2016 appears to not be trading.) This makes no sense. It's illegal for folks in the U.S. to use sites like InTrade, but readers in foreign countries have a chance to make some money.

(There Can Be No) Flight to Safety Uh-Oh GOTD

2011-12-06T16:15:00.001-05:00

Yikes. Clear here for bigger image. Discussion here, including this:

Historically, a Triffin Dilemma — and that’s kinda what this is — leads to funky innovations in the shadow banking system and all the complications that such innovations bring. Will the whispers of new kinds of financial alchemy get louder?

You can see in the chart that before the crisis, US Treasuries were an important but minority amount of the world’s stock of safe haven assets. Treasuries are now the vast majority of such assets. But this is because of the extraordinary decline in the other kinds of assets and because of quantitative easing by the Fed, not because the outstanding stock of Treasuries has increased by so much.

Perhaps the outstanding stock of Treasuries should increase.

Via Counterparties.

sdjfhklsdfjhslkhdks

2011-12-02T05:47:00.000-05:00

3QuarksDaily is hosting a contest for best blog writing in politics and social sciences, to be judged by Stephen Walt. Nominations are open until end-of-day on December 3. In a characteristic fit of pugnaciousness, I'm very tempted to self-nominate one my posts blasting Walt. Like this one. Or this one. Or this one. Of course, we've run many other very good posts here that have nothing to do with Walt, and it'd be an honor if you kind folks nominated us for consideration.

The Arab Spring and the Global Economy, or, The Geopolitics of NGDP Targeting

2011-12-01T16:36:00.001-05:00

Matt Yglesias has a post on the difficulties with getting Egypt's economy going post-revolution:

To give a broad overview of Egypt's problems, the countries of the developing world are now falling into roughly three groups. First, you have India and China who are driving global economic growth and whose rising middle classes and need for production inputs are increasing global demand for all kinds of primary commodities. Second, you have countries -- including much of Africa and Latin America -- who are growing rapidly by exporting primary commodities at new higher prices. Third, you have countries that aren't commodity exporters and that are growing slower than China/India so average people's incomes can't keep up with rising commodity prices. ...

The self-sufficiency stuff indicates that Freedom and Justice has correctly identified Egypt's main problem as increasingly unfavorable terms of trade in a resource-constrained world. But is self-sufficiency a realistic strategy? It might be if Egypt's food gap is caused by decades of corrupt mismanagement leading to devastatingly low agricultural yields. But on a per hectare basis, Egypt's cereal farming is already extraordinarily productive.

Egypt's problem, obviously, is that the country is mostly a giant desert. Giant desert + long narrow strip of incredibly fertile land = cradle of civilization, but it's not a great long-term growth strategy.

This reminded me to write a post that I've been intending to put down for awhile, and that concerns the dilemma facing small open economies that import a lot of basic necessities. Put simply, it runs like this: there remains no viable development model that does not involve somewhat-open engagement with the global economy. This is a new phenomenon in global economic history. In prior periods you could expand growth by expanding your empire. Post-WWII, overt imperialism of the sort that dominated geopolitics before became impossible. Developing countries, many of which were former colonies, believed that their terms of trade were disadvantageous from the perspective of development, so they tried policies that protected local producers from the global market. This generally failed pretty much everywhere it was tried, and the countries that shifted from import-substituting industrialization towards export-led industrialization performed very well in the last half of the twentieth century.

But these countries generally had political systems that rewarded development. Many of them were democratic, or if they were autocratic the rulers were at least dedicated to development and felt that their political futures were tied to increased economic growth. Kleptocratic autocracies, on the other hand, actually had incentives to not develop. Instead, political survival was dependent on maintaining elite support, which was more easily done by distributing rents. So these countries didn't develop, and their terms of trade didn't improve, even if their economies were relatively open.

What happens when you are a small open economy? You are susceptible to movements in global asset prices. What drives global asset prices? A number of things, but one of them is movements in the global monetary system. What institution has the greatest effect on movements in the global monetary system? The U.S. Federal Reserve. So if you are a small open economy, what the Fed does has an impact on your real standards of living. What has the Fed been doing?

Here's a timeline of Fed actions during the crisis. That fist tick up is related to the Fed's first round of quantitative easing, which began in January, 2009. The second round of quantitative easing was announced on November 3, 2010, but had been expected for some time (from at least October 1, when NY Fed President Dudley called for QE2). Commodity prices spiked again, and the Arab Spring began literally a few months after.

In other words, there's a fairly strong case to be made that nominal GDP (NGDP) targeting -- backed by large purchases of financial assets by the Fed -- of the sort favored by Scott Sumner and other "market monetarists" (or whatever they're being called) has the potential to export instability to the rest of the world. This isn't just economic instability; it can lead to political instability. In Libya, it could have led to mass slaughter or even genocide and eventually necessitated U.S./NATO military intervention. Thinking in these terms offers a different perspective than other accounts of the role of the Fed, but also of the revolutions in the Middle East and North Africa. Here are just a few important potential implications:

1. This can help us explain why the Arab Spring happened when it did. Mubarak, Ghadafi, and other Arab autocrats had been in power for decades... why did the revolutions all happen at the same time? Why now? Many have focused on path dependence and contagion effects, but there's another answer: there was a huge external shock to their political economies, which originated with Fed actions.

2. This should give us some pause when advocating for policies that will boost U.S. demand in the short run. The out-sized influence of the U.S. on the global economy, particularly in the realm of the monetary system, means that any decision we make will have far-reaching ripple effects. We could find ourselves in an environment where the political dynamics in the U.S. provide incentives for policymakers to goose the U.S. economy, which then in turn sends other parts of the world reeling. The Federal Reserve should keep this in mind, as should pundits and others who call for rapid extreme easing until NGDP growth returns to trend. To a large extent, the U.S. Fed controls the global monetary system, particularly for small, open, developing, resource-dependent economies. It can use that power for good or ill. It needs to be aware of the effects of its actions.

3. Academics and pundits must stop thinking in a closed-economy context when we live in an open-economy world. We can't only consider the impact of policy choices within the U.S., since what happens in the U.S. drives what happens everywhere else.

(Note: I was first made away of this line of thinking by another IPE scholar, who has been working on a more rigorous analysis. If I hear any more about that I'll pass it along.)

Political Economy in Fiction QOTD

2011-11-30T22:35:00.001-05:00

L. Frank Baum's book The Wonderful Wizard of Oz, which appeared in 1900, is widely recognized to be a parable for the Populist campaign of William Jennings Bryan, who twice ran for president on the Free Silver platform -- vowing to replace the gold standard with a bimetallic system that would allow the free creation of silver money alongside gold. ... According to the Populist reading, the Wicked Witches of the East and West represent the East and West Coast bankers (promoters of and benefactors from the tight money supply), the Scarecrow represented the farmers (who didn't have the brains to avoid the debt trap), the Tin Woodsman was the industrial proletariat (who didn't have the heart to act in solidarity with the farmers), the Cowardly Lion represented the political class (who didn't have the courage to intervene). ... "Oz" is of course the standard abbreviation for "ounce." (52)

That comes from David Graber's book Debt: The First 5,000 Years, an anthropological take on the evolution of the role of money and credit in the economy. Via Daniel Little who has an interesting take on the book and also adds this:

(This is roughly as startling to me as an interpretation of Star Wars as an extended allegory on Reaganism (intervention in Nicaragua, scary military officers in the background, etc.). This doesn't quite work, though, since Star Wars appeared in 1977, three years before Reagan's first election as president.)

Kindleberger Smiles

2011-11-30T13:30:00.001-05:00

The banks announced that they would reduce by roughly half the cost of an existing program under which banks in foreign countries can borrow dollars from their own central banks, which in turn get those dollars from the Fed. The banks also said that loans will be available until February 2013, extending a previous endpoint of August 2012.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the banks said in a statement. The participants in addition to the Fed were the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Canada and the Swiss National Bank.

More here. The title refers to the previous post.

More US Debt Needed?

2011-11-28T06:59:00.000-05:00

So says David Andolfatto (via Mark Thoma):

I believe that the decline in real rates on U.S. treasuries reflects a steady change in how agents and agencies around the world want to structure their wealth portfolios. There has been a massive substitution away from many asset classes into U.S. treasuries; and it is this fundamental market force that is driving real interest rates lower.

The phenomenon began in the early 1990s, with the collapse of the Japanese stock market. Then Mexico in 1994, the Asian crisis 1997-98, Russia in 1998, and Brazil in 1999; see Bernanke (2005). Investors became rationally pessimistic about the returns to investing in these countries, as well as similar countries that had not yet experienced crisis. The natural effect of this would be capital outflows from these countries into relative safe havens, like the United States.

The basic thesis here is very much related to what Ricardo Caballero calls a "global asset shortage."

I wrote about this over a year ago, in response to a similar argument by Brad DeLong. You can read that post for more details, but the gist is that Kindleberger argued that in a crisis a hegemon is needed to stabilize the international system by providing five public goods: a market for distress (unsalable) goods, lender of last resort and provider of liquidity into the global financial system, a stable system of exchange rates, macroeconomic coordination, and countercyclical lending.

But what if there's a 6th? What if the hegemon should also create large amounts of highly-rated financial assets that firms can keep on their books without worrying about default?

In a sense, such a role is already encapsulated in Kindleberger's five. It would, in a sense, provide a market for distress goods, which in this case is speculative finance. If these assets are heavily-traded enough an increase in their supply could also constitute a form of liquidity. And they could be used to fund a program of countercyclical lending, by borrowing funds from skittish investors and channeling them to needy borrowers.

As Mark Blyth and Matthias Matthijs argue in a recent issue of Foreign Affairs, Germany is either incapable or unwilling to play this role in Europe. (I'd argue both.) In which case the U.S. should step in and be more aggressive. The Federal Reserve has taken some steps in that direction, opening up swap lines with most major central banks worldwide, and lending directly to foreign banks. But many of those programs have ended. It's not clear that the Fed is doing much to stabilize Europe now. Meanwhile, the federal government has no appetite for such a role.

Put all this together and it's hard to escape the belief that things are going to get worse before they get better. The U.S. may be relatively insulated from a European collapse, but that doesn't mean we're perfectly insulated. And plenty of other places are much more exposed. As the systems level, then, unless the U.S. steps up instability is likely to worsen.

Is Job Creation Really Impossible?

2011-11-22T14:43:00.001-05:00

This is a strong conclusion to a good post from Krugman:

My point, then, is that this claim — and the lionization of high earners as people who make a vast contribution to society [via job creation] — is not, in fact, something that comes out of the free-market economic principles these people claim to believe in. Even if you believe that the top 1% or better yet the top 0.1% are actually earning the money they make, what they contribute is what they get, and they deserve no special solicitude.

Here are his assumptions earlier in the post: "Yet textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period." The upshot being that the entire idea of a "job creator" is misguided. All of the value that factors of production add to the economy is recouped by those factors of production, and none "trickles down" to anyone else.

Correct me if I'm wrong, but doesn't the relevant "textbook economics" assume not only a competitive market but also constant returns to scale and no spillover effects? How often do we think all three of these things hold? Doesn't a Keynesian view of the world explicitly claim that in a depression there are often scale returns to be captured, as well as positive spillover effects from investment? How else could the Obama administration (like all administrations) claim that it has "saved or created" so many thousands of jobs via fiscal policy?

I Would Not Have Guessed This China-US FOTD

2011-11-21T23:36:00.001-05:00

Another way to gauge China's problem is that its gross domestic product (GDP) quintupled over the decade through 2010, while its stock market doubled - so that market capitalization has fallen sharply relative to GDP.

Via. I don't agree with everything else in the article, but this is another data point indicating that the rise of China may not yet be as impressive as many have thought.

Also this (which I would have guessed): "U.S. Leadership Approval Ratings Top China's in Asia". (ht: Phil Arena.)

Short Note on the Importance of History and Governance

2011-11-20T01:05:00.001-05:00

This post by Yglesias, linked by a lot of folks, has a lot of good in it. But it's missing one thing: a conception of politics. Why is it that San Franciscans transfer so much money to Kentuckians? After all, California could surely use the cash to shore up local balance sheets. The answer is because Kentuckians (and Mississippians and Georgians and Iowans and Alabamans and etc.) get to elect the government that ultimately controls San Franciscans. And this privilege was gained -- well lost, technically, but such are the ironies of history* -- as the result of a brutal civil war.

If we're thinking in terms of parallels, Europe has had the civil wars. They just haven't had a winner. So they don't have a federal government, so they don't have a legitimate method of transfers, so they have fiscals crises in their periphery.

*Some well-regarded conservative -- I believe it's Walter Williams, tho I can't recall with certainty -- is often quoted as saying that the best thing that happened to Africans was the Atlantic slave trade, because despite its ills the children and grandchildren of slaves grew up in America rather than colonial or post-colonial Africa. Even given the abominable record of the US w/r/t minorities, this view contends that the lot of Africans is better here than there. Perhaps this is another irony of history. Perhaps it's completely specious. Whether one thinks that claim contains truth or not, it would be hard to argue that the American South did not benefit, in the long run, by losing their bid for independence. Without it, they could not rely on the transfers from rich San Franciscans to poor Alabamans.

Why Is the US Doing So Well?

2011-11-19T10:35:00.000-05:00

So asks Ezra Klein:

Not in absolute terms, of course. Unemployment remains high. Growth remains anemic. Markets remain shaky. But Europe has been doing something very close to imploding for months now. So just as our financial crisis sent Europe into a tailspin three years ago, you might expect that the possibility of a partial or complete break-up of the Eurozone would have American businesses taking a chainsaw to their workforces and households stuffing their paychecks under the mattress in the expectation that 2012 will be a lot like 2009. And yet none of that is happening.

He then runs down some data and has some quotes from macroeconomists. I think the answer is given by this interactive graph from the BBC. In short, Europe is much more highly exposed to weakness in the US (Above picture) than the US is exposed to weakness from Europe. Click on a few of those European countries; almost none of them expose the US. The ones that do -- mostly the UK -- are in decent enough shape. Even the biggest exposures, from France and Germany, are much smaller than exposures of European countries to the US, and of course the US has a much larger economy and banking system than any one of those countries.

Thomas, Sarah, Andy, and I have some joint research that we've posted about before that visualizes the same data in a different way. Ours includes more countries as well as cross-time developments, shown in an animation. (We posted it nine months ago, so the BBC is way behind.) The point is the same: the world is much more susceptible to contagion emanating from the US than the US is to contagion from the rest of the world. This includes even Europe.

In other words, it's not enough to simply say that interlinkages in the global economy are important, and conclude from that developments in the EU will automatically determine the US's economic performance. The patterns of interdependence are even more important, and these give us reasons to be optimistic that the US may be relatively okay even if Europe goes belly-up.

The World is Hierarchical

2011-11-19T09:26:00.001-05:00

Will links to a WAPO piece on the apparent US resilience to EU difficulties. As Ezra summarizes, "Nevertheless, the fact remains that the American economy has been curiously resilient over the past few months. Things are getting better when you could imagine them getting worse."

This isn't curious; this is how the global economy functions. Financial and economic shocks that originate in the United States have global consequences, while shocks that originate in other parts of the system have consequences that are primarily local.* Empirical research conducted over the past ten years finds clear and consistent evidence of this asymmetry Consider the asymmetric impact of news—unexpected economic outcomes--on asset prices. When US economic performance is stronger than expected or if US monetary policy tightens unexpectedly, interest rates rise in the UK and euro areas and the dollar appreciates. Stronger-than-expected US growth raises foreign equity prices during US recessions, and reduces them during expansions. In contrast, foreign economic news has little impact on markets in the US and elsewhere. German economic news has little impact on euro-dollar exchange rate; euro-area news has little impact on US bond yields. British news has no impact on US equity prices.

Similar asymmetries characterize spillovers through financial linkages. Changes in American interest rates affect interest rates in Australia, Canada, and the euro area. US equity market movements affect equity prices in overseas markets. Yet, US interest rates, exchange rates, and equity prices are affected modestly if at all by foreign developments. For instance, one study finds that the share of euro area variance in equity and bond prices accounted for by US market developments is three times as large as the impact of euro market movements impact on US bond and equity prices. Others find robust evidence that real interest rates in the United States affect real interest rates in the euro area but no evidence that euro rates affect rates in the US.

There is a broader point, here. Although we typically realize that the global economy is defined by connectedness, we pay little attention to the structure of connectedness. And even when we give some thought to this structure, we rarely consider how the structure shapes performance. We seem willing to accept Friedman's claim that the world is flat. Well, the world isn't flat. The world is hierarchical. This hierarchical structure shapes performance in ways that are important and remain under-appreciated. We need to pay it greater attention.

*For an entry to this research, see Bayoumi, Tamim, and Andrew Swiston. 2010. "TheTies that Bind: Measuring International Bond Spillovers Using Inflation-IndexedBond Yields." IMF Staff Papers57 (2):366–406. (An ungated pre-pub version here).

Weekend Links

2011-11-19T05:56:00.000-05:00

-- A long, excellent interview with Patrick Thaddeus Jackson at Theory Talks (a generally excellent site; it's easy to lose hours in there), concerning IR and the philosophy of science. I haven't yet had the chance to read PTJ's newest book, but it's in the pile and I look forward to it.

-- The Economist enlists Larry Summers and Donald Kohn in a role-play, asking them to deal with the imminent collapse of a major bank using the new tools provided by Dodd-Frank.

-- Matthias Matthijs and Mark Blyth read Kindleberger in Berlin. I hope to have more to say about this later.

-- Is it surprising that the US's financial troubles had a larger effect on Europe than Europe's financial troubles have had on the US? Not to me, as regular readers would expect.

-- Weber, "Science as a Vocation". I find it somewhat odd that "Politics as a Vocation" ends up on many social science syllabi while "Science" does not, given that social scientists want to be scientists not politicians. Or maybe my experience has been unique.

-- "The Women's Petition Against Coffee, 1674". One of my favorite historical documents, brought to memory by this article on rising global coffee pries.

-- The Piedmont (which includes my town) has a local currency, in operation since 2002. I've never seen it used.

Review: Exorbitant Privilege

2011-11-18T18:25:00.001-05:00

I read Barry Eichengreen's Exorbitant Privilege last night, whose subject is found in the subtitle "the Rise and Fall of the Dollar and the Future of the International Monetary System". From this, one might expect the bulk of the book to be a current discussion of the imminent fall of the dollar as the world's reserve currency, as well as predictions regarding what sort of system will replace it. This expectation is not well met.

As always, Eichengreen does best when he sticks to a narrative of economic history. There are two predominant strands here: chapters two and three, tracing the origins of the US as an international currency, from before the Revolutionary War until the collapse of the Bretton Woods system of fixed exchange rates in the 1970s; and chapter four, which recounts the series of economic and monetary integration regimes in Europe that culminated in the introduction of the European monetary union in 1999. Those two histories make up roughly the first two-thirds of this short book, the rest of which is dedicated to a discussion of the subprime crisis and other contemporary events.

The problem with the book is that there is no conceptual frame shaping Eichengreen's discussion. From the subtitle and many of the chapter titles (the euro's "Rivalry" with the dollar; the greenback's "Monopoly No More"; the specter of a "Dollar Crash") you might expect Eichengreen to be pessimistic about the future role of the dollar in the international monetary system. In the introduction Eichengreen sets the book up in this way, arguing on page 6 that "The conventional wisdom about the historical processes resulting in the current state of affairs – that incumbency is an overwhelming advantage in the competition for reserve currency status – is wrong". But the core of the book actually makes the opposite case: the role of the dollar as the pre-eminent global currency is likely to remain for the foreseeable future, both because of the attributes of the US as the world's largest economy, and because of the deficiencies of the only conceivable challengers.

Concerning the latter, Eichengreen spends the majority of the time on the EU. He also discusses Japan (no desire for the yen to be a reserve currency), China (no capability for the yuan to be without major reforms which would likely be destabilizing), other currencies like the Brazilian real and Indian rupee (not big enough, or global enough, economies or financial systems), and the IMF "special drawing rights" (SDRs, which among other criticisms are only used as accounting devices, and are not accepted by any private actors as a medium of exchange), but dismisses them in short order. He dedicates a long chapter to European postwar monetary history, some of which may be interesting to those approaching this subject for the first time, but all of which has been dealt with in more detail, and with more theoretical and empirical care, elsewhere.

Without making too much of a case, Eichengreen seems to suggest that the subprime crisis may be a catalyst for a shift in the global monetary architecture. His discussion of the crisis is not strong, either as a standalone discussion or as a means of linking it to the potential for a change in the global reserve currency. For example, near the beginning of this chapter he claims "At the root of the crisis lay financial irregularities unchecked by adequate regulation" (p. 98). At this point most observers acknowledge that this was the manifestation of the crisis, perhaps even the proximate cause, but not the root cause. Eichengreen seems to understand this a bit later on, when he discussions macroeconomic imbalances in the global system, the global savings glut, the US domestic political economy that led to low national savings and persistent budget deficits, loose Fed policy and the "Greenspan put", etc. All of these are deeper causes than the inability of banks or regulators to judge the extent of risk embedded in asset-backed securities, which, in this context, appear to be more leaf than root.

The end of Eichengreen's discussion of the crisis leads him to marvel that the strength of the dollar was reinforced as a result of the crisis, not weakened. This may also surprise a reader not already aware of this phenomenon, since all of the book until that point has set the stage for a rapid move away from the dollar following a crisis, similar in speed and precedent to the rise of the dollar in the immediate aftermath of World War I. The rest of the book is dedicated to a discussion of why that is unlikely to happen.

As a part of that explication Eichengreen reverses what he wrote earlier about the incumbency advantage. In the first chapter he wrote that arguing that the status quo is durable precisely because it is the status quo is "wrong". But later, on pages 124-126, he argues that the "advantage of incumbency" is "not to be dismissed". Then he hedges again, writing of China on p. 146:

That said, Chinese policymakers are serious about transforming Shanghai into an international financial center by 2020. Doing so will require deeper and more liquid markets. It will require liberalizing the access of foreign investors to those markets, which in turn imply other changes in the country's tried-and-true growth model. Liberalizing the access of foreign investors to China's financial markets will in turn require a more flexible exchange rate to accommodate a larger volume of capital inflows and outflows. While these are not changes that can occur overnight, it is worth recalling how the United States moved in less than 10 ears from a position where the dollar played no international role to one where it was the leading international currency. There is precedent, in other words, for the schedule that the Chinese authorities aspire to meet.

This should lead us to a comparison of the the world in the 2010s to that of the 1910s, and the relative positions of the US and China within those worlds. In the earlier period the largest economy (the US) was not the issuer of the global reserve currency as it is now. Despite that, it took at least one World War, and the subsequent collapse of the global economy during the interwar period, for the dollar to supplant the pound sterling. To reach undisputed dollar pre-eminence took another World War. The rapid shift in the dollar was therefore a consequence of the rapid shifts in the organization of global security and economic apparatus. As bad as the subprime crisis has been, it has not been anywhere near that scale.

Perhaps because Eichengreen does not have a clear conceptual framework with which to make sense of his history, his views about the future are wishy-washy: the "fall of the dollar" mentioned in the subtitle is not inevitable, nor even likely; then again, the rise of the dollar was rapid, and China's economic rise is rapid, so who knows?

A better approach, I think, would be to try to understand monetary dynamics in a network context. Eichengreen considers this briefly, in footnote 50 on page 151, only to dismiss it just as briefly. This is a shame. If he better understood network dynamics he might not write things like this, from page 8:

There may have been only one country with sufficiently deep financial markets in the second half of the twentieth century, but not because this exclusivity is an intrinsic feature of the global financial system.

But what if it is? What if the distribution of financial liquidity is power-law distributed? What if this introduces scale-free dynamics into the global financial network? This would imply that there is only room for one reserve currency at a time, and that currency is likely to remain in place until there is such a large shock that the network itself is destroyed, at which point a new network is constructed with a new currency at the center of it.

Such a shock occurred from 1914-1945. It has not occurred since, which is why the dollar's pre-eminence has survived less-major shocks like the collapse of Bretton Woods, the rise of emerging market economies, the monetary unification of Europe, the end of the Cold War, and the subprime crisis. Such a history might lead us to expect more stasis than change in the coming years, barring a systemic collapse on a level not seen since the interwar period.

Eichengreen does not spend much time in this short book on theoretical explanations for the nature of the global monetary system, instead choosing to trace several historical developments. This is fine, but it leaves us with more description than explanation, and so teaches us little about what to expect from the future.

On Crises

2011-11-16T21:16:00.001-05:00

Was on a panel this evening with Karl Smith and a couple other UNC folks that focused on the EU debt crisis. The event was hosted by the UNC economics club (I think). I am happy to report that we solved the crisis, or at least figured out what to do to prevent the next one.

Karl's contributions got me wondering about some things, so I wandered over to Modeled Behavior to get a better sense of his point of view. He is rather critical of the ECB, by the way, because he thinks it should be playing a LOR role and is very annoyed that it refuses to do so. He seemed unsure about whether the ECB's refusal is sincere (willing to blow up the system to avoid higher inflation in the short run and moral hazard problem in the long run) or strategic (credible commitment to no LOR in order to force reform in the PIIGS, then step in as LOR). I tried to convince him it was sincere. He seemed to remain hopeful that it was strategic. Obviously, if it is strategic, the ECB would want us to think it sincere, so it makes sense that we are unsure.

As I was scrolling through Modeled Behavior, however, I got distracted by this quote from Larry Summers that I had not seen before:

“In four years of reflection and rather intense involvement with this financial crisis, not a single aspect of dynamic stochastic general equilibrium has seemed worth even a passing thought,” Summers said, adding: “I think the profession is not entirely innocent.” Still, Summers said, the complaint that economists should have seen the crisis coming represents “a confusion” on the part of critics. Identifying financial bubbles and knowing when they will burst, he claimed, “is to ask more of the profession than it can reasonably expect to discover.”

Karl comments:

The problem here is that we have had hundreds of years of market evolution under a capitalist system where bubbles can and did occur. No solution has emerged. This is despite the fact that evolutionary systems can evolve solutions to problems that no one understands or indeed is even aware exist. This tells me that there is at least a reasonable chance that bubbles are the result not of mistaken expectations but of some combination of market and government failure. Its not crazy to suggest that we will be able to see this.

All of this makes me wonder: how many hundreds of years must elapse before we conclude that "bubbles" and the resulting market corrections are a part of the underlying distribution of asset price movements? It seems that everyone who looks (from Benoit Mandelbrot on) finds that (asset) price movements are power law distributed; most are rather small, some are extremely large (see also Didier Sornette). Thus, large market corrections are not market failures, because they are an expected outcome of typical market behavior. We don't need to develop special explanations for them because they result from the same processes that cause smaller movements. We can't see this because there isn't anything to see. The dynamic process is what Per Bak dubbed "self organized criticality": a steady input drives the system to a critical state, and in this critical state the system generates outputs of varying magnitude. Consequently, most of the time markets don't crash. Sometimes they do. End of story.

There is an associated story here that I have been puzzling over for a while: humanity's need to make sense of big events in concrete and personal terms. Those damn bankers and their crazy complex mortgage backed securities. Those crazy corrupt Greeks. That Allen Greenspan with his low interest rates. Thus we substitute description for explanation and don't seem to care much about (or even recognize) the distinction. We also seem to have this compelling need to figure out who is to blame (in fact, the last question on the list at this evening's panel was precisely that--who is to blame for the EU debt crisis?). Explanations based on the underlying distribution fail entirely to satisfy us (though we do seem to accept them when it comes to earthquakes).

I don't know if this reflects some cognitive bias (as individuals we only believe what we can observe) or some social science thing (social scientists prefer actor-centered explanations) or some manifestation of how negative shocks enter into the political system, shape legislative hearings, and thus enter the public consciousness through media reports of the political reaction which can only be about concrete things like Greenspan and greedy bankers. Or maybe it is a product of our belief that we should be able to control our world and the reluctance to accept that sometimes we cannot separate things we want (financial systems) from things we don't want (market crashes).

Because I don't really have a conclusion, let me exit on the following. Rather than waste time trying to explain something that doesn't need explanation, we could focus on how to respond to these events when they occur. Given that we will confront them because we cannot prevent them, what can we do to minimize their negative consequences for the financial sector and real economies? California and Japan employ earthquake resistant construction techniques rather than try to prevent large earthquakes. Maybe that strategy could be usefully applied to thinking about financial crises.

Which I think brings me back to Karl's point about the utter failure of the ECB to respond effectively to the EU crisis. The system needs someone to be LOR; if the ECB refuses to play this role, perhaps the Federal Reserve must.

New Research

2011-11-16T16:01:00.001-05:00

Gold Sterilization and the Recession of 1937-38

Douglas A. Irwin

NBER Working Paper No. 17595

The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks. This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates.

The Determinants and Long-term Projections of Saving Rates in Developing Asia

Charles Yuji Horioka, Akiko Terada-Hagiwara

NBER Working Paper No. 17581

In this paper, we present data on trends over time in domestic saving rates in twelve economies in developing Asia during the 1966-2007 period and analyze the determinants of these trends. We find that domestic saving rates in developing Asia have, in general, been high and rising but that there have been substantial differences from economy to economy and that the main determinants of these trends appear to have been the age structure of the population (especially the aged dependency ratio), income levels, and the level of financial sector development. We then project future trends in domestic saving rates in developing Asia for the 2011-2030 period based on our estimation results and find that the domestic saving rate in developing Asia as a whole will remain roughly constant during the next two decades despite rapid population aging in some economies in developing Asia because population aging will occur much later in other economies and because the negative impact of population aging on the domestic saving rate will be largely offset by the positive impact of higher income levels.

Governance and Prison Gangs

David Skarbek

American Political Science Review, Vol. 105.

How can people who lack access to effective government institutions establish property rights and facilitate exchange? The illegal narcotics trade in Los Angeles has flourished despite its inability to rely on state-based formal institutions of governance. An alternative system of governance has emerged from an unexpected source—behind bars. The Mexican Mafia prison gang can extort drug dealers on the street because they wield substantial control over inmates in the county jail system and because drug dealers anticipate future incarceration. The gang's ability to extract resources creates incentives for them to provide governance institutions that mitigate market failures among Hispanic drug-dealing street gangs, including enforcing deals, protecting property rights, and adjudicating disputes. Evidence collected from federal indictments and other legal documents related to the Mexican Mafia prison gang and numerous street gangs supports this claim.

Unpacking the Black Box of Causality: Learning about Causal Mechanisms from Experimental and Observational Studies

Kosuke Imai, Luke Keele, Dustin Tingley, and Teppei Yamamoto

American Political Science Review, Vol. 105.

Identifying causal mechanisms is a fundamental goal of social science. Researchers seek to study not only whether one variable affects another but also how such a causal relationship arises. Yet commonly used statistical methods for identifying causal mechanisms rely upon untestable assumptions and are often inappropriate even under those assumptions. Randomizing treatment and intermediate variables is also insufficient. Despite these difficulties, the study of causal mechanisms is too important to abandon. We make three contributions to improve research on causal mechanisms. First, we present a minimum set of assumptions required under standard designs of experimental and observational studies and develop a general algorithm for estimating causal mediation effects. Second, we provide a method for assessing the sensitivity of conclusions to potential violations of a key assumption. Third, we offer alternative research designs for identifying causal mechanisms under weaker assumptions. The proposed approach is illustrated using media framing experiments and incumbency advantage studies.

Is This Really True? QOTD

2011-11-15T22:56:00.001-05:00

From an article on the multidisciplinary influence of Kahneman and Tversky:

Political scientists use prospect theory to model foreign-policy decision making. Some international-relations scholars argue that cognitive biases favor hawkish policies, making wars more likely to begin and more difficult to end. (Kahneman shares that view.)

That's the only part of the article discussion IR (no hypen needed) or other political science. I'll admit that I don't follow the FP decision-making lit very closely, but this doesn't ring true to me. Yes, the classic Kahneman/Tversky prospect theory article was on my Intro to IR Theory first-year syllabus, but it was tucked into the "Other Approaches" week at the end of the semester. I have to say that I've come across few major IR articles that have explicitly adopted a behavioralist frame.

Perhaps others can fill in the gaps in my education. I welcome comment.

The GSG Redux

2011-11-15T05:25:00.001-05:00

Matt Yglesias has a concise post on one of my favorite topics, the Global Savings Glut. It is short, so let me provide the core argument here.

Remember the “global savings glut” of the mid-aughts? This was Ben Bernanke’s explanation for the large U.S. current account deficit as of 2005. It’s also an important part of the backdrop for the housing boom and the financial crisis. What happened is that in the late-1990s, many East Asian countries suffered from a classic financial panic. The international investment community, once bullish on places like Thailand and South Korea, suddenly turned pessimistic. Currencies collapsed, and borrowers were left awash in debt. The IMF stepped in to prevent the global financial system from falling apart, but in exchange for liquidity assistance, it imposed tough austerity conditions on the states in need of rescue.

He then notes that the ECB and German policymakers have embraced this logic.

The IMF qua IMF seems to have decided that this was a mistake, and under Dominique Strauss-Kahn and now Christine Lagarde has largely been pushing a non-austere agenda. But Angela Merkel, European Commissioner Olli Rehn, and the European Central Bank seem to be re-inventing the late-’90s IMF prescription for economic recovery. They’re afraid of creating a situation in which poor economic management isn’t adequately punished, so they’re determined to make sure that troubled European states enact unpopular austerity packages

He concludes that if this succeeds, it has two implications for the global financial system:
1. Increased demand globally for safe dollar-denominated assets.
2. Therefore, larger US budget deficits or new financial engineering to meet the demand.

Lots to react to here, so let me focus on three things. First, the biggest saver in East Asia post 1997 is China. China's savings were precautionary rather than a direct response to IMF austerity.

Second, Italy isn't China. And neither are Greece, Spain, Portugal, and Ireland. By which I mean that China is an authoritarian state that intervenes directly to extract resources without being constrained by broadly inclusive political institutions. Italy is a parliamentary democracy with a multi-party system. It has struggled with fiscal policy since the late 1960s, largely because of its multi-party parliamentary system. Ditto for Greece, Portugal, and Spain though obviously the timing is a bit different. Hence, no switch that the Italians (or the others) can turn on to become a high savings society.

Finally, it is precisely because there is no switch that would transform Club Med into high savings societies that current sovereign debt problems were anticipated twenty years ago (see convergence criteria) and pose severe challenges to the viability of the EU as a monetary union.

So, although Yglesias point is correct in theory, the likelihood that this problem arises in practice, assuming revolutionary movements overthrow current democratic regimes in southern Europe, is rather limited because democracies are rather different than autocracies.

Global Political Economy QOTD

2011-11-15T02:37:00.001-05:00

Yglesias:

Whatever else [austerity] does, it should certainly succeed in persuading European governments that stockpiling foreign exchange isn’t just for Asians anymore. If the world succeeds in coming out through the other side of this crisis, you should expect to see even more countries joining the perpetual surplus brigades leading to even more demand for safe dollar denominated financial assets. That, in turn, means either big U.S. budget deficits or else some bold new innovations in financial engineering to meet the demand.

The rest of the post is well worth reading. I'm not sure this is the right way to think about the next 10 years, but it's certainly one way to do it. And it's a scary way to do it, since we don't seem to be good at channeling the global savings glut into productive uses.

Eurozone Crisis FOTD

2011-11-13T19:00:00.001-05:00

Will Slovenia be the first eurozone country to default? It's in big trouble, as Slovenian economist Luka Gubo writes to Mish:

1. Slovenian debt to GDP ratio has doubled since 2009 (one of highest growing on the planet)

2. Our banking system is on the brink of collapse. Biggest bank (Nova Ljubljanska Banka - NLB) is owned by the government and almost all the money it has lent is sub-prime (much worse than in US up to 2007/08) or it was lent politically to chosen people who now can't pay the debt back. NLB has 15% bad loans (payments being late more than 90-day) and the number is getting higher.

3. Our housing market is frozen. Prices are not falling because no one is buying or selling. Most of the construction companies are bankrupt and they owe lots of money to banks. (percentage of loans that payments are late in construction sector is mind boggling 25%! - and is even growing!)

4. Government has recapitalized NLB with 250 million €. It will probably do it again with 400 million. I have calculated that if the bank was for sale it would be sold for no more than 400 million €! So taxpayers have already 250M and will pay another 400M for what? For saving some banker's ass because of his bad decisions? (And they call the bank "Slovenian silver"!)

5. There is no interest in Slovenia to leave EU. Moreover, it may be better for incompetent bureaucrats from EU to run the monetary system because things would be much worse if run by incompetent Slovenian bureaucrats.

6. Slovenian banks will need to borrow at least 5 billion € in 2012 and get about 1 billion € of fresh capital. Do you know someone who will give them the money? I truly hope it will not be the taxpayer.

7. When the banks start selling real estate, the market will collapse 20-30% in a year or two. That will further deteriorate bank balance sheets and the problems will be much worse.

8. Our labor market is totally inflexible and unemployment rate is getting higher (currently at 11.5%).

So if someone says to you that Slovenia is healthy just tell him the facts. Slovenia is not healthy. It has a brain-tumor that is getting worse.

Keep It Simple

2011-11-11T17:48:00.001-05:00

Hey! Megan McArdle! Maybe the OECD governments that negotiated the Basel accords assigned a zero risk-weight for OECD sovereign debt because they wanted to incentive banks to buy their debt at low interest rates. And maybe banks complied because they assumed that they'd get bailed out by somebody if those bets ever went bad.

It wasn't about mistakes made while "risk engineering". It was simple political economy.

Moral Hazard FOTD

2011-11-11T07:37:00.000-05:00

Banks that took bailout money acted more riskily.

Ran Duchin and Denis Sosyura of the University of Michigan looked at the U.S.’ Capital Purchase Program. ...

Duchin and Sosyua looked at a sample of 529 public firms that were eligible for CPP and slotted them into categories based on whether they applied, whether they were approved and whether they ultimately took the money. They controlled for non-random selection (via measures of the banks’ financial condition, performance, size and crisis exposure); for changes in national and regional economic conditions; and finally for potential distinctions in credit demand.

They then viewed the banks’ CPP participation status in comparison with their subsequent risk appetite as demonstrated by (1) their consumer mortgage credit approvals or denials (viewed on a risk-profile controlled, application-by-application basis); (2) their participation in syndicated corporate loans for riskier credits and; (3) the risk profile of their investment asset portfolios. What did they find? ...

Moving from this granular level to a bank-wide basis, the authors found that the CPP banks increased asset risk (using ROA & earnings volatility as proxies) while decreasing their leverage (perhaps because they knew that regulators would be keeping an eye on this metric in addition to the capitalization ratio.)

Here's the paper. This part of the abstract is very important:

Our difference-in-difference analysis indicates that after the bailout, bailed banks approve riskier loans and shift investment portfolios toward riskier securities. However, this shift in risk occurs mostly within the same asset class and, therefore, has little effect on the closely-monitored capitalization levels. Consequently, bailed banks appear safer according to the capitalization requirements, but show a significant increase in market-based measures of risk. Overall, our evidence suggests that banks’ response to capital requirements may erode their efficacy in risk regulation.

So of course global -- and many domestic -- regulations focus on capital and leverage ratios.

Lira Lessons from Argentina

2011-11-10T14:43:00.002-05:00

The Economist's 'J.O.' on what it would mean to leave the euro:

Creating a new currency is not that difficult. A determined country could simply pass a law saying that all financial dealings should henceforth be conducted in the new lira (or drachma, or escudo, or whatever). Colleagues who have covered Argentina tell of how, in August 2001, the province of Buenos Aires issued $90m of IOUs to employees as part of their pay packets. These bills, known as patacones, were soon widely accepted in exchange for goods and services. McDonalds even offered a special “Patacombo” menu in exchange for a $5 denomination IOU. Argentina broke its "irrevocable" currency peg to the US dollar a few months later.

That's not how I read the history. How I read the history is that McDonalds was one of the only companies that would take patacones, and even then only if you had exact change. Other companies hoarded pesos (or USD) and moved them out of the country if they were able. Withdrawals of pesos from banks was strictly limited under corralito so patacones had some use, but there was a general shortage of goods and services in the economy so no currencies (besides the USD) could truly be said to be "widely accepted". As I read the history, the workers who suddenly found themselves paid in patacones surrounded government buildings in Buenos Aires in protest and demanded they be paid in pesos. The use of patacones, while perhaps the only option for a provincial government that couldn't pay its debts any other way, was a disaster and the currency was only in substantial use for a short time.

It's possible I've got my history wrong, and J.O. certainly is not arguing that issuing a new currency is painless. But I don't think it's quite as simple as (s)he says.

We Are Not in the 1930s

2011-11-09T20:21:00.001-05:00

It's easy to draw parallels between these days and the 1930s, especially for an IPE scholar. Drezner does it here, I've done it before, and so has practically anybody with any sense of the international or temporal dimensions of political economy. Here's DeLong:

I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria--that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II. Well, right now guess what? The time is 1931, and we are Austria. The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve Needs to do so now.

Is this 1931? Here's a partial list of similarities: an system of prosperous globalization is threatening to unravel as Europe's fixed exchange rate regime crumbles; macroeconomic imbalances presage a significant financial crisis; European governments respond to large fiscal burdens by attempting to devalue internally through austerity rather than devaluing externally through the exchange rate; movements towards trade protectionism and beggar-thy-neighbor policies (outside of Europe); etc.

But I don't think we're in the 1930s. I think the world is different now than it was then in a number of important ways, and that leaves me more optimistic than I otherwise might be.

First, I think the international economic system has been transformed from the way it was during the interwar period in a number of key areas. Unlike then, international politics is now highly institutionalized. We have a series of durable trade relationships that have been legally formalized, but which provide flexibility for national governments to address pressing short-run concerns. We have a credible international organization that monitors trade and provides a mechanism for dispute adjudication. Europe has a common trade market that is likely to remain even if the monetary union dissolves. A collapse in world trade -- and thus global output -- equivalent to that in the 1930s thus seems highly unlikely.

Perhaps more importantly, the present international monetary system is not dedicated to the orthodoxy of currency values fixed to a specific quantity of a sparkly metal. This has allowed central banks, especially the central bank of the global reserve currency, to inject liquidity into the global financial system at key points over the past few years. Even the ECB, which has rightly come under criticism for not doing enough to manage the crisis despite having no legal authority to take the necessary measures, has pursued a far more expansionary policy than it would if it were trying to maintain a gold standard. Indeed it has almost certainly already acted beyond the parameters set out for it under the Lisbon Treaty. In at least some key respects, the US Fed has followed Kindleberger's advice and acted as the World's Central Bank, a role left unfulfilled in the 1930s. While the monetary authorities may not have been expansionary enough, they have done much more than anyone did during the 1930s.

Countries within the eurozone, while not bound by "Golden Fetters", are certainly bound by Euro Shackles. This load is may be too great to bear for some, but there is little doubt that at the regional level this yoke is easier and the burden lighter than the gold standard restraint of the 1930s.

There are other reasons to expect better results than the 1930s. Unlike then, Europe is not the central pivot point in the global economy. Major exporters such as China are not financially exposed to Europe, and have stockpiled foreign exchange reserves sufficiently large to keep their economy moving forward, even if the pace slows somewhat. Even the US is not exposed to European financial markets in sufficiently large way likely to be exceptionally destabilizing, especially when compared to Europe's exposure to the US in 2008 or the US's exposure to Europe in the 1930s. While contagion is a real concern, it's not much of a concern in a European crisis as it was during the US crisis. If you don't live in Europe, that is.

Finally, unlike the 1930s, nearly all of the world's major economies are consolidated democracies. While this can place some unfortunate, even tragic, constraints on short-term policymaking, in the medium run geopolitical and economic stability is likely to benefit from democratic solidarity. Factor in close security ties and the sort of security dilemmas (including economic security dilemmas) that were operating in the 1930s just don't seem to apply today.

None of which is meant to imply that the current troubles are not serious. I remain concerned that the coordinating institutions that now exist do not have sufficient authority to operate effectively. The biggest problem in Europe over the past two years has not been macroeconomic fundamentals, or a currency zone that is not optimal, or even a central bank -- solely concerned with price stability -- that fiddles while Rome burns. The biggest problem is the deficit in governance by which the Euro-level coordinating institutions cannot act without unanimous approval of member states, many of which have preferences that are diametrically opposed. At the global level the problem is both better and worse. Better because the shackles are much looser than in Europe; worse because the coordinating mechanisms are weaker than in Europe. The only game in Governance Town seems to be the G-20, which has been... underwhelming in their policy responses since 2008. The IMF seems to be caught in limbo over the euro-crisis. But in the 1930s there wasn't even a G-20. There wasn't an IMF. There wasn't a central bank at the center of the monetary system willing to take the globally-minded actions that the Fed has taken. There wasn't a US Treasury Security like Geithner who, for all his faults, can never be accused of underestimating the downside risk of financial contagion.

It's difficult to draw perfect parallels to the current situation in Europe. But if I had to pick one, it would be closer to Latin America in the 1980-1990s than Europe in the 1930s. I expect the harshest effects to remain at the regional level. The US, Japan, China, Brazil, India, and other major economies will be affected, but not severely.

The next few years, like the last few years, will be a test of the resiliency of the global economic and political architecture. So far we've done fairly well all things considered. Hopefully that will continue.

Handicapping the Eurozone

2011-11-09T18:25:00.006-05:00

Intrade has a break-up prior to Dec 31, 2011 at 7.4%. A break-up prior to Dec 31, 2012? 52.5%

Global Imbalances FOTD

2011-11-09T16:13:00.000-05:00

By “Northern European,” I mean the 6 countries on the list above that lie between Switzerland and Norway. They have a $455 billion [current account] surplus, as compared to China’s $303 billion.

More here.

New Research

2011-11-08T16:10:00.000-05:00

Are these results surprising? Not to me. And given the high barriers to entry for bargaining, we should expect to see regulations benefit large firms with a history of lobbying activity.

The Dynamics of Firm Lobbying
William R. Kerr, William F. Lincoln, Prachi Mishra

NBER Working Paper No. 17577

We study the determinants of the dynamics of firm lobbying behavior using a panel data set covering 1998-2006. Our data exhibit three striking facts: (i) few firms lobby, (ii) lobbying status is strongly associated with firm size, and (iii) lobbying status is highly persistent over time. Estimating a model of a firm's decision to engage in lobbying, we find significant evidence that up-front costs associated with entering the political process help explain all three facts. We then exploit a natural experiment in the expiration in legislation surrounding the H-1B visa cap for high-skilled immigrant workers to study how these costs affect firms' responses to policy changes. We find that companies primarily adjusted on the intensive margin: the firms that began to lobby for immigration were those who were sensitive to H-1B policy changes and who were already advocating for other issues, rather than firms that became involved in lobbying anew. For a firm already lobbying, the response is determined by the importance of the issue to the firm's business rather than the scale of the firm's prior lobbying efforts. These results support the existence of significant barriers to entry in the lobbying process.

This next one seems very inventive, in a "create your own science" kind of way. Has anyone else done anything like it?

Testing the Global Financial Transparency Regime
J. C. Sharman

International Studies Quarterly Vol. 55 No. 4

How can we tell whether rules that apply in theory actually do so in practice? Realists argue that the gap between what formal rules proscribe and their effectiveness may be particularly wide at the international level. Furthermore, dominant states may impose costly standards on others that they themselves choose not to implement. To test these propositions, the article assesses the effectiveness of international soft law standards prohibiting anonymous participation in the global financial system by seeking to break these standards. The findings indicate that the prohibition on anonymous corporations is relatively ineffective and is flouted much more in G7 countries than in tax havens. The article contributes to and extends the work of realist scholars in international political economy, both in their skepticism of formal rules and focus on the effects of power. Evidence is drawn from the author’s solicitations and purchases of anonymous shell companies from 45 corporate service providers in 22 countries.

The IPE work on exchange rate regimes continues to improve.

Fear of Floating and de Facto Exchange Rate Pegs with Multiple Key Currencies Thomas Plümper and Eric Neumayer

International Studies Quarterly Vol. 55 No. 4

This paper adopts and develops the “fear of floating” theory to explain the decision to implement a de facto peg, the choice of anchor currency among multiple key currencies, and the role of central bank independence for these choices. We argue that since exchange rate depreciations are passed-through into higher prices of imported goods, avoiding the import of inflation provides an important motive to de facto peg the exchange rate in import-dependent countries. This study shows that the choice of anchor currency is determined by the degree of dependence of the potentially pegging country on imports from the key currency country and on imports from the key currency area, consisting of all countries which have already pegged to this key currency. The fear of floating approach also predicts that countries with more independent central banks are more likely to de facto peg their exchange rate since independent central banks are more averse to inflation than governments and can de facto peg a country’s exchange rate independently of the government.

And, lastly, an extension of Kydd's 2003 by UNC's Mark Crescenzi and co-authors:

A Supply Side Theory of Mediation
Mark J.C. Crescenzi, Kelly M. Kadera, Sara McLaughlin Mitchell, and Clayton L. Thyne

International Studies Quarterly Vol. 55 No. 4

We develop and test a theory of the supply side of third-party conflict management. Building on Kydd’s (2003) model of mediation, which shows that bias enhances mediator credibility, we offer three complementary mechanisms that may enable mediator credibility. First, democratic mediators face costs for deception in the conflict management process. Second, a vibrant global democratic community supports the norms of unbiased and nonviolent conflict management, again increasing the costs of deception for potential mediators. Third, as disputants’ ties to international organizations increase, the mediator’s costs for dishonesty in the conflict management process rise because these institutions provide more frequent and accurate information about the disputants’ capabilities and resolve. These factors, along with sources of bias, increase the availability of credible mediators and their efforts to manage interstate conflicts. Empirical analyses of data on contentious issues from 1816 to 2001 lend mixed support for our arguments. Third-party conflict management occurs more frequently and is more successful if a potential mediator is a democracy, as the average global democracy level increases, and as the disputants’ number of shared International Organization (IO) memberships rises. We also find that powerful states serve as mediators more often and are typically successful. Other factors such as trade ties, alliances, issue salience, and distance influence decisions to mediate and mediation success. Taken together, our study provides evidence in support of Kydd’s bias argument while offering several mechanisms for unbiased mediators to become credible and successful mediators.

Making a Mystery Where None Exists

2011-11-07T21:06:00.001-05:00

Ryan Avent, at Free Exchange:

It is remarkable to me how readily old, successful professionals dismiss the labour-market difficulties of young adults as the product of their poorly-chosen majors and general lack of ambition, and on what flimsy evidence they're prepared to base these views. There are now 3.3m unemployed workers between the ages of 25 and 34. That's more than twice the level in 2007. There are over 2m unemployed college graduates of all ages; nearly three times the level of 2007. There are many millions more that are underemployed—unwillingly working less than full-time or unwillingly working in a job outside their field which pays less than jobs in their field. As far as I know, the distribution of college majors didn't swing dramatically from quantitative fields to art history over the past half decade.

Meanwhile, the Wall Street Journal provides us with a handy interactive graphic examining unemployment rates by major according to the 2010 Census. Coming in toward the top of the list and ahead of "art history and criticism" are the sorts of degrees you'd expect, like those falling into "miscellaneous fine arts", but also "computer administration management and security", "engineering and industrial management", "international business", "electrical and mechanic repairs and technologies", "materials engineering and materials science", "genetics", "neuroscience", "biochemical sciences", and "computer engineering". I bet those graduates are all trying to break into puppetry!

Avent is correct that this recession has driven up unemployment among college graduates, but their rates of unemployment remain roughly half the national average, better than half the average of those with just high school degrees, and better than one-third of the average of those without a high school degree. (Those with postgraduate degrees are in even better shape.) Those with freshly-minted bachelor's degrees but little experience and few professional connections aren't doing as well those with many years in the professional world, as one would expect, but it still seems clear that having an advanced degree greatly enhances your ability to remain employed.

I agree that the WSJ's graphic is handy, but I see different things in it than Avent does. Here are the top professions by median wages (click for larger):

And here are those by lowest unemployment rate (click for larger):

There's a lot of quant degrees on both lists. The rest are mainly high-skill services. No humanities, no puppitry, no arts of any kind. (I'd guess that the low rates of unemployment -- albeit with fairly low wages -- in teaching and student counseling are related to the strength of those unions in the public sector, but I can't do any better than guess. And I'd wager that some of the surprisingly high rates of unemployment in some technical fields are related to educations that are out of date, but again that's just a guess.) Compare these charts to the data in this recent post by Alex Tabarrok and it seems pretty hard to deny that many students are not achieving degrees that give them an advantage in labor markets.

"You Can't Just Change the Rules Cuz You Don't Like the Outcome"

2011-11-04T21:14:00.000-04:00

Terrific Office last night. After Andy gets scolded by Robert California for his mistake-prone staff, Dwight creates a doomsday machine (he calls it "an accountability booster"): if the staff make five mistakes in a day, an email that incriminates them all and recommends that the branch be closed gets sent automatically to Robert California. They all get fired and the Scranton branch closes. Of course, they spend more time trying to figure out whether it's just a scare tactic and on how to turn it off than they do working hard to avoid mistakes. Consequently, they trigger the five-mistake threshold.

Today I learn that legislators are considering how to prevent the automatic cuts in defense spending that are scheduled to take effect when the bipartisan Panel that is supposed to find some way to reduce the size of the budget deficit fails to reach such an agreement. Of course, the automatic cuts were never supposed to occur. Instead, the threat of the automatic cuts was supposed to be sufficient to force the Panel to make the adjustments necessary to avoid them. In other words, the automatic cuts are a doomsday machine. But, of course, Congress is getting scared that the Panel will fail, thereby triggering unwanted large cuts in defense spending. "Shut down the machine! Shut it down!" they now scream (watch the clip). David Camp (R-Mich) recently begged Doug Elmendorf of the CBO to reassure him that nothing prevented Congress from "changing the mechanism for automatic cuts." Elmendorf reassured Camp, "Any Congress can reverse the actions of a previous Congress."

To restate Elmendorf's point: Congress can't commit itself. Most members recognize this. As Representative K. Michael Conaway, Republican of Texas and a member of the House Armed Services Committee, noted, "If the joint select committee does not do what it needs to do, most of us will move heaven and earth to find an alternative that prevents a sequester from happening.” So, the threat of automatic cuts isn't credible. And because the threat isn't credible, the Panel isn't really under much pressure to find some way to cut the deficit by $1.2 trillion. As a result, maybe we shouldn't really expect the Panel to find a way to cut $1.2 trillion from the deficit because they bear no short run cost for failing to do so. Oh wait, the Times says they'll be embarrassed.

Spoiler alert: In the end, Dwight shuts down his doomsday machine. Turns out that even Dwight has time inconsistent preferences. His desire to be liked by the staff over-rides his desire to force the staff to improve by holding them accountable. The problem, of course, is that because Dwight shuts down the machine the staff will continue to screw up, and thus move inexorably closer to losing their jobs anyway. Maybe there's a lesson in there somewhere for Congress.

The Rents Are Too Damn High QOTD

2011-11-03T06:47:00.000-04:00

From a long, excellent post by Ashwin Parameswaran at Macroeconomic Resilience. Please read the whole thing, as I expect it will be discussed a lot in the blogosphere over the next few days:

It is not the absence of rents but the continuous threat to the survival of the incumbent rent-earner that defines a truly vibrant capitalist economy.

This, in a nutshell, encapsulates much of the disagreement between Marx and Schumpeter: the former saw this threat as decreasing over time, while the latter saw it increasing. Perhaps one way to read the post-WWII economy is that Schumpeter is right over longer time horizons, but that the process is prone to fits and starts. In the shorter run Marx may well have the better hand.

Parameswaran goes on to link this to the Great Stagnation, theories of unemployment, Minsky, Keynesian/post-Keynesian macro, and much else besides. I'll be pondering this post for a long time.

There Is No Technocracy QOTD

2011-11-02T16:47:00.000-04:00

Felix Salmon nails it in a post titled "All bank regulators are captured":

The fact of the matter, however, is that all regulators are captured by banks. Or, to be a little more precise, all legislatures are captured by banks, and all regulators do what the government tells them to do.

In countries like Canada and India, there’s a very small number of strong, well-capitalized banks with a vested interest in maximizing barriers to entry. So they’re happy with very tough standards. In Europe, national banking systems are also concentrated, so in theory they could go the same way. But European banks are more likely to have cross-border and global ambitions, and in any case as a matter of contingent fact they’re not very well capitalized. So they get the regulation they want — which allows them to grow fast without having to raise lots of expensive new equity capital.

And then there’s the US, which is pretty much unique among major economies in having thousands of pretty vibrant small banks. Those small banks have a lot of political clout in Congress, and they hated Basel II, because they’re not nearly sophisticated enough to take advantage of it. So they essentially bullied Congress into keeping the old Basel I standards, for fear that otherwise they would be at a massive competitive disadvantage with respect to the big US banks like JP Morgan Chase. Congress obliged, and used the FDIC as its chosen mechanism for blocking the adoption of Basel II in the US.

Does that make the FDIC particularly virtuous? No: it makes the FDIC just as beholden to the banks as any European regulator. Look at the banks’ contributions to the FDIC insurance fund, for instance: they fell to zero, for no good reason, just because the banks didn’t like making those payments.

Cross-national differences in regulations are not due to one country's regulators being somehow wiser than the rest. It has to do with different organizations of domestic interests within (and across) countries. These lead to different policy outcomes.

Paul Krugman does not in a post titled "Crats, Maybe, But Not Much Techno":

But it’s more than that: these alleged technocrats have in fact systematically ignored both textbook macroeconomics and the lessons of history in favor of fantasies. The European Central Bank has placed its faith in the confidence fairy, while imagining that it can run policy in a way that has never worked in several centuries of central bank experience. Meanwhile, the European policy elite has simply wished away the clear evidence that the euro zone needs to make an adjustment that is virtually impossible unless inflation targets are raised.

The point is that I know technocrats, and these people aren’t — they’re faith healers who are making stuff up to suit their prejudices.

I contend that Paul Krugman does not know technocrats. He knows people who have different priorities than those he dislikes in the government and punditocracy. He claims that his side are the true technocrats -- untainted by avarice or bias -- because that gives them a moral authority that they would not otherwise have. But Krugman's preferred "technocrats" are just those who prioritize labor over capital, to use a short-hand, while those he decries have the opposite preference. As Salmon notes, capital generally wins, but in varying ways that reflect their varying preferences in disparate places.

"Textbook macroeconomics" presupposes a political system that is dedicated to the pursuit of utilitarian aims, a "socially optimal" mix of outcomes. But there is no universally agreed upon social optimum. There are only different, competing interest groups with different, competing preferences. Rousseau was wrong about this. There is no General Will, only the Sum of Private Wills. Some interests are narrower than others, as OWS has figured out, but that's really the only difference.

The Euro Bailout, Explained

2011-10-31T12:35:00.003-04:00

Xtranormal has gotten passe, but it still has its uses. I thought this was a pretty good run-down of the new plan for the eurozone. I'm still very pessimistic.

Fly the Flag

2011-10-29T02:27:00.000-04:00

I am very happy right now.

The Argentinian Euro Deal

2011-10-28T16:11:00.001-04:00

Markets seemed to like it yesterday, not so much today. You can find news and discussion of the plan everywhere. I liked Salmon's takes here and here.

Like many others I'm skeptical that it will work. Interestingly enough I'm currently reading Paul Blustein's very good And the Money Kept Rolling In (and Out) about the IMF's relationship with Argentina around the turn of the millenium. The parallels between Argentina and Greece are striking -- I'm not the first to notice this -- but the parallels between the IMF and EU actions are also notable. Let's run down some of them.

1. At the time Argentina was on a convertibility system with the peso was pegged one-to-one to the US dollar. This is functionally very similar to the European common currency, where "Greek" euros are pegged one-to-one with "German" euros. Both systems were adopted for similar reasons: national authorities were not able to credibly commit to stable monetary policy, which led to a lot of economic volatility, investment risk, and concomitant slow growth. In both cases macroeconomic adjustment is impossible through the exchange rate, which leaves internal devaluation (i.e. austerity) and/or debt default as the only remaining options.

2. Both policies worked well for about a decade. Because of that, the Argentine and Greek governments were able to borrow at low interest rates. And because of that, governments were fairly casual about fiscal probity. While public deficits were not extreme, they were politically entrenched. When growth began to slow lower tax revenues led to a growing debt burden. Interest rate spreads widened as investors began to believe that both economies would not be able to grow fast enough to manage their debt. This, of course, can become a self-fulfilling prophecy. Both governments were voted out of office, both new governments instituted fiscal reforms. In both cases these were insufficient to close the budget gap. In both cases the cost of incurring new debt, or of servicing old debt, became prohibitive.

3. In Argentina, the IMF began disbursing relatively small amounts of money in the hope that external financing would reassure bond markets. In other words, the IMF hoped that it was a liquidity crunch, not a solvency crisis. In that situation a tie-over loan can buy time for the economy to get some growth back. The EU did the same thing with the introduction of the EFSF. But the underlying economic numbers didn't improve, and bond markets continued to believe that issue was over solvency, not liquidity.

4. Politics intervenes. In Argentina, the US (and other key IMF members) were hesitant to offer additional financing as they had done during the Tequila Crisis. In particular, John Taylor -- then at the Treasury Department -- didn't want to throw US funds into the pot. Neither did Glenn Hubbard of the CEA or Paul O'Neill, the Treasury Secretary. In Europe, many members were reticent to commit more funds. In both cases policymakers tried to figure out how to leverage already-appropriated funds to have a greater effect, but nobody bought it in either case. (Ken Rogoff, at the IMF during the Argentina crisis, quipped "After one strips out all the window dressing, there is no way to make $6 billion of liquidity worth more than $6 billion in liquidity. But there are many creative ways to make it less.")

5. Then come the "voluntary" private sector bailouts, coupled with additional public funds. These are intended to do a few things: extend the timeframe that indebted countries have to consolidate fiscally, reestablish growth, force the private sector to bear some of the costs of bailouts, and thus prevent default in a politically palatable way. In both cases the initial market reaction was positive, but in Argentina the effect was short-lived and I expect that to be the case with Greece as well. Barry Eichengreen described the Argentina situation thus: "The realization had dawned that the IMF package offered no magic formula for getting growth going again. And without growth, it is hard to see how political support for paying the foreign debt can be sustained." This sounds a lot like Greece, no?

6. A corollary of the private sector haircuts, as well as extended financing from international institutions, is that the country actually becomes more indebted rather than less. This happens in two ways. The private sector demands some form of compensation in exchange for voluntarily altering the terms of their debt contracts; and the new financing from international institutions also tacks onto the principle. Additionally, it's more difficult to default on IMF/EFSF loans than private sector loans. Given that the optimistic scenario is that this deal will reduce Greece's debt load to 120% of GDP, and the fact that the fundamental problems -- low growth + high debt in a fixed-currency system -- have not been resolved, there is little reason to be optimistic about the outcome.

Ultimately Argentina's internal adjustment plans were undermined by domestic politics. Voters simply got sick of extreme austerity and revolted. That meant a debt default and the abandonment of the convertibility system. It's hard not to imagine a similar scenario playing out in Greece in the coming months.

Even if it doesn't, there's still Spain and Italy looming over the horizon.

UNC Everywhere

2011-10-28T14:38:00.000-04:00

Layna Mosley, one of our IR profs, has a very good op-ed in the NY Times that summarizes some of her recent research on the effect of international trade on labor rights.* Many would be surprised by the results of this work. Gist:

There is, however, a more general way in which trade agreements — and the economic ties they generate — benefit workers in developing nations. As Colombia and Panama expand their trade relationships with the United States, workers stand to gain more than just the job creation and higher wages that often come with expanded trade. Research I conducted over the last several years with the political scientists Brian Greenhill and Aseem Prakash suggests that trade with developed nations helps developing countries expand labor rights themselves.

Why? International trade gives producers incentives to meet the standards of their export markets. When developing nations export more to countries with better labor standards, their labor rights laws and practices tend to improve. Our findings, which are based on newly collected measures of labor rights around the world, demonstrate a “California effect” on workers’ rights, in which exporting nations are influenced by the labor rights conditions that prevail in their main trading partners.

Read the whole thing.

*I guess Layna didn't want to get shown-up by her husband, UNC Prof Andy Reynolds, who recently had an op-ed on Libya in the News and Observer.

Links

2011-10-26T09:45:00.000-04:00

Some of these I may blog properly later, but time is scarce these days.

-- Ikenberry responds to Walt.

-- Good discussion of Herbert Simon and complex social systems.

-- Bernanke on how central banking has changed post-crisis, including on the interplay between regulatory and monetary policies.

-- Problems with Basel III implementation. This is what Jamie Dimon is referring to when he says Basel is "anti-American".

-- Vladislav Surkov, "Putin's Rasputin".

-- Interactive description of the eurozone crisis, as a series of weighted, directed networks. (ht Alex)

-- US attacks China's "Great Firewall" at WTO.

-- Ambrose Evans-Pritchard says world power is swinging back to the US. I hadn't realized it had gone.

The Government Does Not Own 100% of Everything

2011-10-25T18:30:00.000-04:00

If I am reading this right, then Suzanne Mettler believes that any tax rate lower than 100% is "indirect social policy":

Conversely, many of our mostly costly forms of social provision today camouflage government’s role as a provider of social benefits. They do this by channeling benefits through the tax code, as does the Home Mortgage Interest Deduction, for example, and/or through subsidies to private organizations, such as employer-provided health insurance benefits, for which recipients are not required to pay taxes. These latter, indirect policies are the ones I call the “submerged state.” It is easy for citizens to miss government’s role in these policies, and to assume that only the market at is at work.

Now as it happens I am against deductions and all other loopholes as a matter of course. But I do not define "things not taxed" as the government acting as "provider of social benefits". Mettler, it seems, does:

The difference between the direct and indirect social welfare policies, however, is illusory. From an accounting perspective, they are the same thing: both impose costs on federal spending and add to federal deficits.

This is only true if you start from the assumption that 100% of national income belongs to the government, which then distributes according to a mix of "indirect" tax breaks and "direct" spending programs. I.e., it's only true if you believe that there is an implicit 100% tax rate, from which the government deducts differing percentages based on a number of criteria. In that case a tax deduction and a spending program are the same thing.

But if you start from the assumption that 100% of national income does not belong to the government then this makes no sense at all. If I buy a house and the government does not tax a small portion of the amount I pay for it -- I still pay taxes on the purchase of the home... I just get to deduct the interest -- I am hardly "getting" anything from the government. I'm just not having something taken away.

And in that case the only thing that adds to federal deficits are spending increases. Think of a scenario: there is a tax rate of 0%, and no federal spending. The government decides to pass a child tax credit equal to 5% per child. Does this add to the federal deficit? No, because 5% of 0% is 0%. Under this scenario the child tax credit is meaningless. Now suppose the government was to keep taxes the same but spend 5% on the child. The deficit goes up.

More:

In most cases, tax breaks distribute resources by permitting people to pay less in taxes, rather than by paying out dollars or providing services. That aspect of their design makes it easy to construe them as tax cuts rather than as social provision. But this, too, is a false distinction. “Social tax expenditures” assist people with particular circumstances, granting them resources to which others are not entitled. This is in stark contrast to across-the-board tax cuts to all Americans.

That's true. People without children cannot claim child tax credits. And the child tax credit is a politically-motivated tax exclusion designed to encourage better care for children (or, perhaps, having more of them). But it is qualitatively not the same as a spending program that is also intended to benefit children. The latter redistributes income from some people to other people. The former does not. The latter increases the budget deficit. The ~~latter~~ former does not. See? It's a very important distinction.

Note also that according to Mettler's definition a progressive tax code is a government "social provision" because the tax does not apply equally to everyone.

You could make the same argument about some of the other programs Mettler discusses. The GI Bill could be considered part of the compensation contract that the military makes with service members. I know my siblings in the military (there are currently five of them) think of it that way. Many wouldn't join the military just for the salary; the fact that part or all of their college education is included in the package is what tips the scales.

If you look at the famous table that Mettler produced in her paper, the programs that people tend not think of as government programs are things in which there is no redistribution happening. All of them are tax credits (except for student loans, which are paid back usually with interest). The things that people do think are government programs are the things in which there is redistribution happening. Mettler recognizes this:

In short, the fact that citizens often fail to recognize these policies as government social provision is attributable not to some fault of citizens, but rather to the characteristics of the policies themselves.

Precisely. And the characteristic of the policy is what is important. A policy of not taxing 100% of income is not a government intervention. It is the absence of a government intervention. A policy of not taxing mortgage interest is similarly a lack of taxing mortgage interest. People have different attitudes about whether these are "social provisions" from the government because they have different definitions of what constitutes a social provision from the government. Remember the outcry when Obama started talking about "tax expenditures" a few months back? That's because people immediately recognized what he was talking about: he wanted to raise taxes and redistribute the proceeds to others. So the phenomenon Mettler is describing is at least partially about semantics, not just cognitive dissonance.

I do not write this to disparage Mettler's research program, which I find very interesting and valuable. And the phenomenon she describes certainly happens sometimes. But I see the tendency to use the accounting that Mettler uses, which presupposes that 100% of national income belongs to the government, from a lot of political scientists. I've never understood it. It goes against all of the common principles pertaining to the nature and role of liberal government in a democratic society.

Military Spending and the Value of Lives

2011-10-21T17:48:00.001-04:00

John Quiggin has a post at Crooked Timber that asks us to think about opportunity costs when considering how allocate resources from the public purse. The title is, I think, not only needlessly provocative -- "Has the U.S. Defense Department Killed One Million Americans Since 2001?" -- but also clearly wrong. If anyone can be considered guilty of that offense it would be the Congress and Presidents Bush and Obama rather than DoD, but setting that aside he makes a valid point:

I’ve spent the day at a workshop on benefit-cost analysis where a lot of discussion is on valuing policies that reduce risks to life of various kinds. US policy, for better or worse, is focused on the idea of Value of a Statistical Life. Typically a policy that reduces risks of death will be approved if the cost per life saved is below $5million, and not otherwise. (There are similar numbers applied to publicly funded health care services, prescription drugs and so on, usually per year of life saved).

The numbers are quite striking. The ‘peacetime’ defense budget is around $500 billion a year, and the various wars of choice have cost around $250 billion a year for the last decade (very round numbers here). Allocated to domestic risk reduction, that money would save 150 000 American lives a year.

So, since 9/11, US defense spending has been chosen in preference to measures that would have saved 1.5 million American lives. That’s not a hypothetical number – it’s 1.5 million people who are now dead but who could have been saved. I think its fair to say that those people were killed by the Defense Department, or, more precisely, by the allocation of scarce life-saving resources to that Department.

As happens on the best of days at CT, many of the comments are well worth reading. Leigh Caldwell made a few good points: 1) the marginal cost curve is not only not flat, it likely slopes upwards pretty quickly (so the nth life saved is much more expensive than the n-50,000th life saved); 2) to the extent that defense spending represents a global public good at all it likely saves some lives, and perhaps quite a large number. 'soru' notes:

US casualties in WWII were approximately half a million. Baseline assumption of planners, calibrated from the first half of the 20C, is that there is 40% chance of a conflict on that scale in any given decade.

So reducing that to a negligible chance saves ~200,000 US lives per decade, which is in the right order of magnitude. So by the time you account for the possibility of a worse (or just less successful) conflict, and the points mentioned above about the incidental benefits of defence spending, increasing marginal costs of other measures and so on, it starts to make sense on its own terms.

Others referenced deterrence spending by India and Pakistan, and other scenarios whereby military spending may have conflict sufficiently costly that it does not occur when it otherwise might have. When we teach Poli 150 -- Intro to International Politics -- we generally say that all military spending is inefficient in that it does not generate prosperity, but is nevertheless necessary to protect the prosperity that has been generated by other means. The implication is that, while military spending would be wasteful in a world with no threats, there exist threats and so some military spending is not wasteful. I think everyone involved in the discussion agrees that the US is currently spending too much on the military, but I also believe that cutting spending by something like 90% (or, as Quiggin mentions, 100%) would probably have some nasty knock-on effects.

As soru says, we're talking in probabilities here, and the differences don't have to be all that large for large amounts of military spending to be rational on its own terms. Moreover, you want to over-insure against tail risks with extremely negative potential consequences. Obviously counterfactuals are hard, but it is pretty clearly the case that spending zero percent of national income on defense would embolden others to attack, and spending one hundred percent of national income on defense is not only overkill but defeats the whole point of defense spending. So there is a margin where spending more on defense will "save lives" via deterrence, and there is some margin where increased spending will have a very small or null effect, and could thus profitably be diverted to other uses. The question then should be: where is the relevant margin?

I asked Phil Arena to write a post on what he thought were the best models addressing the question. He cited Slantchev (as I thought he might):

This is doing no justice to Slantchev's arguments, but to grossly oversimplify matters, he essentially argues that states can typically prevent war if they are willing to encourage sufficiently large costs.

Military preeminence is a stated intention of American military spending, at least partially for this reason. Phil also referenced some of his own work in progress:

However, as I demonstrate in a working paper (a new version of which I will be posting sometime next month), there might be reason to expect that the effect of military spending on the probability of war depends in part on the baseline distribution of capabilities. I identify results where the challenger risks war with the defender if and only if the defender engages in costly military buildups, yet the defender is nonetheless willing to adopt such a strategy. And for that matter, defense spending by would-be aggressors may similarly either embolden them or allow them to extract such large concessions even when playing it safe that the overall risk of war will go down. Put simply, I think there is very good reason to assume that the relationship between defense spending and the probability of war is non-monotonic.

Which is precisely the relationship I described above. We're in Laffer-curve territory here, so it's no use belaboring the point. But it isn't difficult to see how a lot of US military spending -- perhaps even more than we now do -- could be cost-effective in the way that Quiggin describes if it were deployed with the intention of saving as many lives as possible. Tens of thousands of people die in horrible civil conflicts every year, most of which the US does not intervene in. Some of the US' interventions likely have saved many lives at relatively low cost (eg Kosovo and Libya) although the counterfactuals are, as always, very difficult.

But as Phil notes, the goal of most military spending is not saving lives at cost-effective margins. (This gets back to where Quiggin's wrong to point the finger at DoD rather than the legislature and executive.) Thus, criticizing DoD for not maximizing lives-saved is like criticizing the Yankees for not winning the Super Bowl: the DoD is playing a different game. Hell, the legislative and executive branches are playing a different game.

Quiggin should be criticizing the government for playing baseball rather than football. But if the government is guilty of massively misallocating resources in the same way over long time horizons then, as Phil hints, doesn't it make more sense to work towards reducing the ability of the government to misallocate resources rather than trying to force it to do something that it is clearly not well-constructed for? That's what I take away from Quiggin's post: shrink the government. If you don't, it'll spend the money on things that increases the capabilities of the government. I'm pretty sure this is not what Quiggin believes, but since this post isn't coupled with any theory of politics that allows the transference of military funds to other programs that do improve public health, it's hard to take his post any other way.

One last point: Phil notes that IR has a very poor understanding of the way that the systems work, as opposed to bilateral crisis bargaining. In other words, it isn't necessarily reasonable to infer from a model of a dyadic interaction to the broader system. I think this is especially true when talking about a superpower.

Will the Dollar Remain the Global Reserve Currency?

2011-10-19T18:22:00.001-04:00

Jeffrey Frankel summarizes some of his recent research on how some currencies become internationalized, and speculates on the implications of his work (and that of others like Eichengreen) for the rise of the renminbi as an international currency. He highlights two previous occasions change in reserve currencies: the shift from the pound sterling to the dollar in the 1930s-1940s, and the rise of the yen and German mark during the 1970s-1980s. (He mentions the rise of the euro since 1999, but the euro mostly just replaced the mark.) Frankel suggests that shifts in global reserve currencies come about when the following conditions are met:

1. A large volume of trade in the rising country.

2. Creditor status for the rising country.

3. Perceptions that the currency of the rising country will maintain its value.

4. Deep, liquid, open financial markets in the rising country.

China definitely meets the first two criteria, probably meets the third, and definitely does not yet meet the fourth although it has taken some baby steps in that direction over the past few years. But I'd add another criterion to the four above: a reserve currency becomes a reserve currency when it's already a reserve currency. In other words, the attractiveness of a currency is partly about the national characteristics that Frankel describes and partly about network externalities. The usefulness of a reserve currency is largely a function of who else uses it as a medium of exchange. If lots of other folks use it, it makes sense for you to use it too. If few others use it, there's not much point in your using it. Therefore, currency usage is determined by a preferential attachment decision rule: currencies that attract a lot of usage by foreign entities tend to attract even more usage; currencies that attract little usage tend to continue to attract little usage.*

For this reason, the reserve status of a currency tends to be pretty durable. As long as the currency network remains intact, central nodes tend to remain central nodes and peripheral nodes tend to remain peripheral nodes. It generally takes a major crisis for the network to disintegrate, thus it generally takes a major crisis for a displacement to take place even if Frankel's four conditions are otherwise met. The shift from the pound sterling (under the gold standard) to the dollar required several world wars and a global depression. These extreme events obliterated the network that had emerged during the "first age of globalization"(large pdf), and allowed the formation of the post-war reserve system based on the dollar.

In other words, I believe Frankel's criteria are necessary for a shift in global reserve currency, but are not sufficient. Previous systemic changes required major crises. There have been few of these; in the past half-century perhaps only a partial one: the dollar's status weakened a bit with the collapse of the Bretton Woods system of exchange rates pegged to the dollar, which was in turn pegged to gold. This led to the emergence of the German mark and Japanese yen as important currencies, though clearly still subordinate to the dollar. The dollar's centrality remained through the "Bretton Woods II" system, in which industrializing economies exported capital to industrialized countries (particularly the United States) to facilitate growth and employment through exportation.

This monetary system actually reinforced the central role of the dollar in the international monetary system, but eventually culminated in the subprime crisis. Was this shock large enough to further the process of reserve diversification by disrupting the currency network? There are reasons to think so. The initial financial shock was probably the largest in history, and it emanated from the country at the center of the system: the United States. In hierarchal complex networks, major systemic change generally requires a large attack on the central nodes. For these reasons many expected -- and some hoped -- that the subprime crisis would lead to a reorganization of the international monetary system and the rise of a new reserve currency. Some hoped that the Chinese yuan would increase in global importance, others that special drawing rights at the IMF -- which are comprised of a basket of currencies -- would emerge as a central international reserve asset. Still others anticipated a greater role for the euro; while the European debt crisis now makes this look exceedingly unlikely, it never had much of a chance as Kathleen McNamara wrote in a 2008 article in RIPE.

So there are also reasons to be skeptical about a shift away from dollar dominance. Unlike the British in the interwar period, the US has proactively worked to stabilize the international monetary system. The Fed opened currency swap lines with almost every important central bank in the world from 2008-2010, ensuring that the financial system had ample liquidity. For the most part these actions have been successful, and as of year-end 2010 the dollar was as central to the international exchange network as it had been in 1998.** In other words, the US's actions prevented the network from unraveling the way it did during the interwar years.

In addition, there is no other country that is well-positioned to take over. The Chinese yuan is not yet convertible. The Japanese and Swiss economies are not large or dynamic enough. The euro is not stable enough. And that's... about it. So despite major upheavals in recent years, I do not expect major shifts in the international monetary system any time in the near future.

*Credit to Thomas for first making this point to me.

**I took a look at the data in a previous post, from which the picture at the top of this post is taken.

Quibble

2011-10-17T20:14:00.004-04:00

Vikash Yadav supports the Occupy Wall Street, but wants to see more protests directed at international institutions like the Basel Committee on Banking Supervision. Although he doesn't say this, I suspect that he is not aware that the BCBS is nothing more than a talk shop. Its members are the (domestic) central bankers and finance ministers from industrial economies. As such, it doesn't make a whole lot of sense to protest against the administrative staff, which are the only ones actually located in Basel. It makes a lot more sense to protest against the domestic authorities that meet under the auspices of the BCBS to set international regulatory policy. Which is pretty much what the #OWS movement is doing.

We Are the 1%

2011-10-16T16:06:00.001-04:00

I came across the Occupy Prishtina Tumblr the other day. While I find the rapid spread of the #OWS movement across the globe to be interesting, it also got me thinking. Kosovo is the poorest country in Europe. According to the CIA World Factbook, about 15% of its ~~GDP~~ GNP comes from remittances, and another 7.5% comes from aid and foreign donors. Kosovo has 40% unemployment and per capita income is under $3,000/year. And, of course, they are perpetually threatened by their stronger, richer, larger neighbor -- Serbia.

Almost anyone in Kosovo would gladly trade places with almost anyone camping out in Zuccotti Park. This is illustrative of the fact that the "We are the 99%" sentiment very much depends on which sample you are looking at. If you make $39,000/year you are below the US mean and median, and thus firmly within the domestic 99%. But an income of $39,000/year puts you in the top 1% of the global income distribution.* The American middle class may have stagnated in recent decades, but it is still a much better life than that of 99% of the world's population.

Not including my tuition remission, the stipend UNC gives me for teaching is about $15,000/year. I am occasionally able to supplement that by another grand or two through various sources. While that is above the poverty line, I obviously don't lead an extravagant life. And yet I am in the top 8% of the world's income earners, with expectations of doing far better within a year or two.

Of course the top 1% of Americans are even more elite. I'm not trying to diminish that fact, and I know that the "We are the 99%" is a slogan intended to amplify a broader political point. But I'd like to encourage folks to think globally. There are few people in the US whose lives are not within the world's top 10-15%.

*Yes that is PPP-adjusted.

UPDATE: Suzy Khimm and Scott Sumner make similar points. Khimm's numbers are slightly different than mine; I'm not sure why, but the takeaway is the same. I think this portrayal by Sumner drives it home:

Now let’s start down through Dante’s seven circles of Hell:

1. The US is much richer than Mexico. So much so that millions of Mexicans will risk the horrors of human trafficking into the US to get crummy jobs picking tomatoes all day in the hot sun.
2. China in 2011 is still considerably poorer than Mexico. The Chinese take much greater risks to get here.
3. China today is so much richer than China in 1997 that it’s like a different planet. The changes (even in rural areas) are massive.
4. The China of 1997 seemed like paradise compared to the China of the 1970s. Throughout Hessler’s book, people keep talking about how horrible things were during that decade and how prosperous they are now (1997 in Sichuan!)
5. The China of the 1970s was nowhere near as bad as during 1959-61, when 30 million starved to death.
It’s fine to worry about income inequality in the US. I also worry about this issue. But it’s important to keep in mind that there is much more to life than income inequality, and much more to the world than the US. In the grand scheme of things, tinkering with government programs to help the poor, pitiful, beleaguered American middle class isn’t likely to make much difference, at least from a utilitarian perspective. We need to broaden our outlook.

UNC Everywhere

2011-10-14T03:40:00.001-04:00

UNC poli sci Prof Andy Reynolds has an informed op-ed on the challenges facing Libya in the News & Observer.

ht: Layna

What Do Regulations Do?

2011-10-12T08:25:00.000-04:00

I believe I wrote about this year-old post by John Hempton awhile ago, but it's worth revisiting. I like the way he thinks about the effect of financial regulation:

In the UK banks were allowed to lever themselves to a silly extent (similar over-leverage occurs in their life insurance companies). Overleverage as a policy was the defining character of Northern Rock.

Individually it makes sense for banks to lever up. However competition was intense - and collectively it was insane. Northern Rock was levered 60 times or so - but to mortgages that were really thin margin. Their spreads were about 40bps.

What I suspect is happening is all the banks are standing on tippy-toes. It is individually rational - collectively insane because competition kills the benefit of all that extra leverage. Margins in the UK - the most over-levered market on the planet - fell further than anywhere else.

Of course competition was good for borrowers - at least for a while. Lower spreads meant cheaper finance - but not dramatically cheaper. Spreads of 150bps on mortgages levered 15 times is about as profitable as spreads of 40bps levered 60 times. Competition might drive spreads down by 110bps - at the risk to the whole banking system.

In most of the popular discourse and academic literature banks are presumed to be opposed to regulation, because it corrects market inefficiencies by forcing firms to internalize negative externalities*. The public choice school** argues that there are times when this is not the case -- when incumbent firms can use regulatory structures to collect rents -- so there is no reason to start from the assumption that regulations will be welfare-enhancing.

Hempton is proposing something else: thinking of financial markets as creating a prisoner's dilemma for banks. In this case, banks would be better off if they were able to collude. They'd be able to maintain fairly large spreads, and thus profits, without taking on inordinate risk. The "cooperative" outcome is Pareto-optimal (for the banks at least). But it isn't individually rational. If all the other banks are maintaining higher standards, you can capture quite a lot of market share by "defecting" -- levering up, in this example. To do this you will have to accept lower margins, but profits will still increase if you increase volume enough.

Of course what is individually rational for one firm is individually rational for all firms, so just like in a prisoner's dilemma everyone "defects", driving down margins without capturing any more market share. In this scenario, bankers would prefer regulations like minimum capital adequacy and limits on leverage, not because it bestows rents (at least not only for that reason), but because it changes the structure of the strategic interaction. Firms can now attain Pareto-improving outcomes where they can achieve a decent profit at fatter margins without taking on so much risk. So, ceteris paribus, in this situation firms should actually prefer to be regulated so long as everyone else is regulated too.

And, in fact, in the wake of the financial crisis every banker said they supported re-regulation of the financial sector so long as it affected everybody. But here's the kicker: the same dynamic that makes regulation Pareto-improving also makes regulatory avoidance very lucrative. If you can figure out a way to arbitrage the regulation, you can capture more market share at a slightly lower margin, thus boosting profits. In terms of the prisoner's dilemma, you can profit by defecting while everyone else cooperates. The rise of the shadow banking system is best understood in this light.

Meanwhile, I'm not as perplexed as Drezner is by recent developments in domestic and international regulatory regimes. First, Basel III went basically the way previous rounds went. This process isn't as simple as "bank preferences are communicated to national governments, and also includes the preferences of voters and policy elites. Second, the majority of the Dodd-Frank rules haven't been written yet, must less implemented so it's far too soon to say that bankers have "lost" in any meaningful way. Third, there are very real concerns that the EU won't be able to begin enforcing Basel III any time soon, which could potentially affect the competitiveness of US banks (this is what Jamie Dimon was talking about when he called Basel III "anti-American"). Fourth, Dodd-Frank contains dozens of provisions on top of Basel III, some of which could effect international competitiveness (although most won't).

Lastly, I think Drezner is making too much of the fact that the banks aren't getting everything they want. They are still getting quite a lot -- Dodd-Frank implementation is slow, underfunded, and every GOP candidate vows to repeal or otherwise castrate it -- but they never get everything they want. Finance is one of the most heavily-regulated industries in the country. They routinely lose political fights. The influence of bankers on politics is real, but it is quite often over-stated.

*A line of thought that began with Pigou, who wrote more about taxation than regulation, but the fundamental principle is the same.

**Notably Stigler and Peltzman, extended onto the international level by Oatley and Nabors.

All Politics Is Local

2011-10-11T17:16:00.000-04:00

In Poli 150 -- Intro to International Politics -- we are transitioning from studying the politics of the global security apparatus to studying the politics of the global economy. So I was pleased to see a current case with some local flavor described on the front page of the NYT's web site:

There are still a few textile mills in the Carolina piedmont, making futuristic fabrics that cover soldiers’ helmets and the roofs of commercial buildings.

There is also a new threat on the horizon. A proposed free trade agreement with South Korea, which the House and Senate are scheduled to consider this week, would open the American market to a manufacturing powerhouse that has its own high-technology textile industry. ...

“We are very much in favor of global trade, but we’re just not about having agreements that are unfair to the U.S. textile industry,” said Allen E. Gant Jr., chief executive of Glen Raven, a family-owned company that employs 1,500 people in the United States. “The U.S. needs every single job that we can get.” ...

Economists generally argue that free trade agreements benefit all participating countries by creating a larger market for goods and services. But that benefit derives in part from the movement of some activities to the lower-cost countries. In other words, even if the deal is good for the United States as a whole, it is likely to create clear losers.

The North Carolina textile industry was hit pretty hard by NAFTA, and the new FTAs will likely batter the sector further. I like the article -- written by the excellent Binyamin Appelbaum -- because it neatly lays out the politics of the deal: the country as a whole will benefit, but smaller groups will suffer. Those groups have a strong incentive to lobby the government for protection. Sometimes they will be successful, sometimes they won't. The Obama administration renegotiated parts of the pact it inherited from the Bush administration under pressure from autoworkers' unions and other powerful groups. Textile workers evidently don't have the same sway.

The article also goes a long way towards describing preference formation and aggregation. Allen Gant reveals more than he realizes in that short statement. What he's saying is that he supports market exchange except when his firm is the one facing new competition. And he's saying that in this case trade would hurt both capital and labor in the textile industry. This statement illustrates materialist conceptions of trade politics, and supports the view that attitudes over trade fall along sectoral, rather than factoral, lines. It's a nice little article, and I'll be giving it to my students.

The Selectorate in Theory and Practice

2011-10-11T10:17:00.000-04:00

Bueno de Mesquita and Smith continue their guest-posting at the Monkey Cage with this, which basically describes how time inconsistency problems can affect politics. (Michael Lewis recently wrote a case study of this process in California which, for all its faults, is better than his essays on Europe.) Before I get into my criticism, let me say that I value their work on selectorate theory, even though I think it has some problems. I value it for a few reasons: because I think the dynamics they are trying to model (basically a formalization of a strand of public choice econ) are very important for the study of politics even if their theory isn't a finished product, and because they provide a central theoretical paradigm for other scholars to use as a foil for their own research.

Anyway, enough throat-clearing. As this post, and the titles of their books on selectorate theory -- The Logic of Political Survival and The Dictator's Handbook -- make clear, theirs is a theory of comparative politics, not international relations. Nothing wrong with that, but it leaves them susceptible to problems that scholars who primarily operate in one subfield often have when crossing over into another. Specifically, they tend to make assumptions that seem reasonable but are nevertheless highly contentious. This post illustrates one of them. BdM and Smith write:

It is certainly true that bankers and businessmen wrote loans they suspected would not be repaid; they buried debt on the balance sheet; and, in extreme cases, committed outright fraud. These actions, and hundreds of others like them, provide rewards today, accruing costs that must be paid in the future. Why run up so much debt? Easy, paying costs in the future is someone else’s problem. It certainly won’t be the executive’s problem if she does not survive at the top today. Business leaders happily – and smartly – mortgage their firm’s future to ensure that they retain control now. Lavish payments even when performance is poor is the norm, not the exception.

As much as politicians chide business leaders, they too love debt. It lets them buy loyalty now. Repayment is some future leader’s problem. Politicians hate to pay as they go. They love to make expensive promises that they don’t have to fund. For instance, politicians love to pay public sector employees with modest wages and fantastic defined pension benefits. This means less to pay today on their watch and more to pay on someone else’s tomorrow. What could be better!

On the one hand this seems more or less incontestable: politicians would prefer to buy support now and have someone else pay later. As the theorize later in the post, autocracies are more prone towards debt accumulation than democracies. I'm sure this is true in many contexts, and Oatley has some recent research that backs it up, but the example they introduce as illustrative of the broader phenomenon -- the actions of bankers -- gives us reason to question their narrative. Bankers acted the way they did in part because of policies that rewarded this behavior. The financial sector profited enormously from the legal and regulatory structures in the United States and around the world over the past few decades, and there was always an expectation that the government would support them in times of trouble. The Fed made that guarantee via the Greenspan/Bernanke "put", and the fiscal authorities did as well, setting a clear precedent of interventionism through a series of fiscal interventions from 1980s-2000s.

In democracies the "selectorate" -- the group whose support politicians must maintain to stay in office -- is assumed by BdM/Smith to be 50% of the population, or near that number. And yet the most energized political movements on both sides of the ideological spectrum right now, the #OccupyWallStreet and Tea Party groups, both formed in large part in reaction to policies that benefited bankers over the masses. These policies were enacted by both major political parties in two different presidential administrations, and do not benefit 50% of the population. They benefit a very small minority of it, hence the "We are the 99%" slogan of #OWS. In general the economy of the US and other industrialized democracies has become much more unequal over the past several decades, and there has been little or no movement towards redistribution to mitigate the trend. A more progressive tax system would definitely benefit more than 50% of the population, yet the government finds it very difficult to pass a several percentage point marginal tax increase on millionaires.

Not only can selectorate theory not explain this, it would predict the opposite. More generally it would expect the majority of the population in an increasingly-unequal society to favor highly redistributive policies, and it would expect politicians to respond to this demand. BdM/Smith might be on stronger footing if they adopted the Rajan thesis that the government countered stagnating median wages by expanding credit access, but even this would depend on the claim that 50% would prefer more credit to more income. This seems dubious.

It seems more likely, to me, that the idealized account of democracy that selectorate theory provides is incomplete. The strength of selectorate theory is that it can accomodate more complex accounts of preference creation and aggregation relatively painlessly, but the weakness of the BdM/Smith application of selectorate theory is that they seldom take the more complicated steps that are necessary to reach conclusions that match our empirical understanding of the world. That leaves us in a place where selectorate theory is potentially valuable if used with care, but the primary proponents of selectorate theory -- in emphasizing parsimony over accuracy -- end up reaching conclusions that are pretty clearly wrong.

New Research

2011-10-11T06:32:00.000-04:00

On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms Francis X. Diebold, Kamil Yilmaz
NBER Working Paper No. 17490
We propose several connectedness measures built from pieces of variance decompositions, and we argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. We also show that variance decompositions define weighted, directed networks, so that our connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, we track both average and daily time-varying connectedness of major U.S. financial institutions' stock return volatilities in recent years, including during the financial crisis of 2007-2008.

This is important work, and I know that several regulators and central banks (including the Bank of England) are starting to take this sort of modeling -- weighted, directed networks -- very seriously. When you're trying to track sources of systemic weakness you really need to know what the system looks like. The problem isn't just "too big too fail", it's also about which firms are tightly connected to many other firms. These two will often correlate, but not always and not perfectly, so knowing the difference is important.

The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence Roger Farmer
NBER Working Paper No. 17479
This paper argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession. The paper has three parts. First, it provides evidence of a high correlation between the value of the stock market and the unemployment rate in U.S. data since 1929. Second, it compares a new model of the economy developed in recent papers and books by Farmer, with a classical model and with a textbook Keynesian approach. Third, it provides evidence that fiscal stimulus will not permanently restore full employment. In Farmer's model, as in the Keynesian model, employment is demand determined. But aggregate demand depends on wealth, not on income.

I think some of this gets to my confusion about Keynesianism from a few days back. I think the last sentence particularly drives at what I was saying before: if the monetary multiplier is low because of expectations, then how can the fiscal multiplier be high under the same set of expectations? It makes more sense (to me) for behavior to be conditioned by wealth more than income, particularly if the income is temporary. I clearly need to become more familiar with Farmer's work.

And here's a near-complete preprint of Herb Gintis' most recent book, The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences. Via one of Phil Arena's commenters.

Cain's Foreign Policy Statements Aren't About Foreign Policy Either

2011-10-11T03:44:00.003-04:00

At least I hope they aren't:

Cain replied, “I’m ready for the ‘gotcha’ questions and they’re already starting to come. And when they ask me, ‘Who is the president of Ubeki-beki-beki-beki-stan-stan?’ I’m going to say you know, ‘I don’t know. Do you know?’ And then I’m going to say, ‘How’s that going to create one job?’ I want to focus on the top priorities of this country. That’s what leaders do.

“They make sure that the nation is focused on the critical issues with critical solutions,” Cain said. “Knowing who is the head of some of these small insignificant states around the world, I don’t think that is something that is critical to focusing on national security and getting this economy going. When I get ready to go visit that country, I’ll know who it is, but until then, I want to focus on the big issues that we need to solve.”

Via Nathan Hamm, who adds:

I’ll give most people a pass for being ignorant about Central Asia. It doesn’t even surprise me that someone aspiring to be the US President would be ignorant of the region. But to be so epically ill-informed about a supply route that that both the Bush and Obama administrations thought important that runs right through a country he so bluntly calls “small” and “insignificant,” well… that’s just funny. (And not for nothin’ but surely at least one American job has to have been created by GM’s factory in Uzbekistan.)

Smirking aside, I actually think Cain's pretty much correct about this. There is a supply route that runs through Uzbekistan, but it's hardly essential for the US to pursue its geopolitical interests. And while the GM factory may have created a job or two, the total number won't be much higher than that. In any case, that sort of "gotcha" question has no bearing on the presidential race.

Cain is obviously all but irrelevant, but its more worrying is that no major political candidate seems to have much understanding of, or interest in, international political and economic dynamics. Secretary Clinton may be the furthest along the curve, and she has a new article in Foreign Policy that looks like it's dedicated to the topic. I haven't had time to read it in full yet, so perhaps I'll have more to say later. But if it contains sense it will be the exception.

Romney's Foreign Policy Statements Aren't About Foreign Policy

2011-10-10T18:20:00.002-04:00

I don't disagree with any of Drezner's critiques of Romney's white paper, nor with his overall grade. But I think that it's mostly irrelevant. Here's what Drezner says:

Similarly, for someone who says that, the Obama administration is "undermining one’s allies (p. 3)" in contrast to you, who will "reassure our allies (p. 13)", you don't actually talk about America's treaty allies much at all. True, you do talk about expanding America's allies to include India and Indonesia. Mexico gets some face time. Israel gets a lot of face time. On the other hand, NATO is not mentioned once in this entire document. Neither is the European Union. Japan and South Korea get perfunctory treamtment at best. Turkey is a major treaty ally but you treat it like a pariah state. For someone who's claiming that the U.S. will reassure its major allies, you didn't talk about them much at all. This is a really important problem, because Japan and Europe have been crucial allies in a lot of major American initiatives -- and they're getting weaker. Even in discussing new possible allies, I'm kind of gobsmacked that Brazil is never discussed.

Another big problem is that your approach to China is so shot full of contradictions that I don't know where to begin. ...

If the section on China is contradictory, then your discussion of Pakistan is worse. ...

One final point, should you choose to revise this draft strategy -- you need to prioritize the threats you discuss in the paper. You list a bunch of them -- rising authoritarian states, transnational violence, failing states, and rogue states. If you have to prioritize, which threats merit greater attention? This should actually be pretty easy, since you absurdly overhype the threats posed by some of these countries (Venezuela, Cuba and Russia in particular).

But I suspect that these inconsistencies are exactly the message that Romney intended to convey. After all, he's not trying to convince the FP wonkosphere that he's got a consistent grand strategy that would get an exceptional grade in a graduate class. He's trying to convince GOP voters to nominate him for the presidency. And what do those voters want to hear? It seems likely that they want hyped-up threats from Cold War baddies, a blank check for Israel, and mixed feelings on China. I doubt they care much about Brazil, and they take Japan and Europe for granted. And, as Drezner noted previously, they (presumably) want someone who has thought about foreign policy for more than 15 seconds and has some coherent vision for how it should be conducted. Unlike Perry. Romney's tossing them the red meat that he hopes will convince primary voters that he's more serious and knowledgable about foreign policy than his competitors.

In other words, the audience matters. Romney's audience is the contemporary GOP, which is endlessly hawkish but only in some directions. He's signaling to them as hard as he can that he's hawkish in those directions too, but no others. Everything in the document makes sense when viewed in that light, even if it doesn't make sense as actual policy platform.

I'm not trying to knock Drezner at all; his job is to take these kinds of policy statements at face value and evaluate them. He is obviously aware of Romney's motivations. But it's worth remembering the context.

Trade Developments

2011-10-09T12:32:00.000-04:00

Some of this is already old news, but there were some developments on trade over the past week.

-- The US looks set to ratify FTAs with Columbia, South Korea, and Panama. I've been pondering a longer post about the value of FTAs, which I'll try to get to in the future. For now it's just worth noting that these deals are pretty small beer.

-- Russia's going to try to get into the WTO. Again. This is potentially important for Europe (and Russia); not so much for the US.

-- Obama's going after China on violating WTO rules by not reporting subsidies -- 200 of them, apparently -- some of which are probably WTO-illegal. I think this is important. China's trade policies are incredibly distorting, and the global economy needs a rebalancing. Adjustment is occurring, but perhaps not quickly enough. Going through the WTO is much better than risking a trade war by unilaterally imposing tariffs in response to currency manipulation.

-- So, of course, Congress is also risking a trade war by considering unilateral tariffs in response to Chinese currency manipulation.

And some new research:

Why Do Some Countries Get Better WTO Accession Terms Than Others?

Krzysztof J. Pelc

International Organization 65 (4)

The process by which countries accede to the World Trade Organization (WTO) has become the subject of considerable debate. This article takes a closer look at what determines the concessions the institution requires of an entrant. In other words, who gets a good deal, and who does not? I argue that given the institutional design of accession proceedings and the resulting suspension of reciprocity, accession terms are driven by the domestic export interests of existing members. As a result, relatively greater liberalization will be imposed on those entrants that have more valuable market access to offer upon accession, something that appears to be in opposition to expectations during multilateral trade rounds, where market access functions as a bargaining chit. The empirical evidence supports these assertions. Looking at eighteen recent entrants at the six-digit product level, I find that controlling for a host of country-specific variables, as well as the applied protection rates on a given product prior to accession, the more a country has to offer, the more it is required to give. Moreover, I show how more democratic countries, in spite of their greater overall depth of integration, exhibit greater resistance to adjustment in key industries than do nondemocracies. Finally, I demonstrate that wealth exhibits a curvilinear effect. On the one hand, institutionalized norms lead members to exercise observable restraint vis-à-vis the poorest countries. On the other hand, the richest countries have the greatest bargaining expertise, and thus obtain better terms. The outcome, as I show using a semi-parametric analysis, is that middle-income countries end up with the most stringent terms, and have to make the greatest relative adjustments to their trade regimes.

Facts on US Inequality

2011-10-08T17:20:00.003-04:00

I like this post by Derek Thompson on inequality in the US. It's not polemical, instead presenting important facts in the easy-to-understand graphs and charts. Most of it I knew previously, but not this:

When you add it all up, we have a country with steep divisions between rich and poor and a tax code that for all of its problems is progressive (although it has been more progressive in recent year). Here are two more graphs to take you home: the first shows share of income by quintile and the second shows share of federal income taxes by quintile. What you'll see is that income inequality is behind tax burden inequality.

The whole post is worth reading, and the accompanying graphs are enlightening.

Against (Secret) Death Panels

2011-10-06T21:10:00.000-04:00

This is well outside of my normal purview, but since the assassinations of Anwar al-Awlaki and Samir Khan, both American citizens, I've been thinking a good bit -- not for the first time, thank you -- about the wide space between our conception of the checks and balances on the capricious exercise of government power, and the reality of it. People talked about this some during the Bush administration, but I'm now of the opinion that the primary difference between the Bush administration and others in recent history is the former's simple brazenness: Bush would come right and say "I'm the decider", and he'd have his lawyers so obviously butcher the tradition of law to rationalize his policies, and his Vice-President would declare himself a member of neither the executive nor legislative branches and therefore not subject to any oversight from anyone ever, and his ambassador to the UN openly advocated abolishing the UN... Bush just didn't give a damn. He'd practically dare anyone to do anything to slap his wrists. Every other president before or since has at least pretended to uphold the law. Bush said that wasn't necessary, since any action taken by the president was ipso facto permissible.

In other words, the difference between the Bush administration and other administration is that the former was brazen. But that may be the only difference. The Bush administration may have lied to get the US into a war -- or been selective in their disclosure of the known facts, depending on how charitable your interpretation is -- but the Reagan administration lied about the existence of a war. I'm not going to go down the list, but it's now indisputable that every presidential administration since World War II* has used the tools of war at their own discretion, with essentially no accountability. Alright, I know this is no new news.

But this is, to me at least. It seems that the Obama administration convenes a panel of NSC folks who determine who the US will attempt to assassinate. Without legal mandate or any oversight, of course. Here's how Reuters puts it:

There is no public record of the operations or decisions of the panel, which is a subset of the White House's National Security Council, several current and former officials said. Neither is there any law establishing its existence or setting out the rules by which it is supposed to operate.

This is, of course, completely obscene. There may be a case to be made that the president needs the authority to attack high-level targets at short notice, and use lethal force if that's the best or only option. I would hope that decisions involving the use of lethal force would be reviewable by some sort of oversight committee, but I could understand the argument in favor of such a policy. But as far as I can tell the president does not possess that power in any established legal sense. That makes this panel as it exists today no more than the District of Columbia's branch of Murder, Inc. but with the full resources of the United States government at their disposal. Legal immunity too.

I don't see how this is an acceptable state of affairs.

*And possibly before, although my knowledge of American history is murkier before then.

(Via @interfluidity)

New Research

2011-10-05T06:40:00.000-04:00

Political Uncertainty and Risk Premia

Lubos Pastor, Pietro Veronesi

NBER Working Paper No. 17464

We study the pricing of political uncertainty in a general equilibrium model of government policy choice. We find that political uncertainty commands a risk premium whose magnitude is larger in poorer economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated when the economy is weak. In addition, we find that government policies cannot be judged by the stock market response to their announcement. Announcements of deeper reforms tend to elicit less favorable stock market reactions.

Does Short-Term Debt Increase Vulnerability to Crisis? Evidence from the East Asian Financial Crisis

Efraim Benmelech, Eyal Dvir

NBER Working Paper No. 17468

Does short-term debt increase vulnerability to financial crisis, or does short-term debt reflect -- rather than cause -- the incipient crisis? We study the role that short-term debt played in the collapse of the East Asian financial sector in 1997-1998. We alleviate concerns about the endogeneity of short-term debt by using long-term debt obligations that matured during the crisis. We find that debt obligations issued at least three years before the crisis had a negative, albeit sometimes insignificant, effect on the probability of failure. Our results are consistent with the view that short-term debt reflects, rather than causes, distress in financial institutions.

Craziest Thing I Read Today

2011-10-04T22:18:00.001-04:00

Matt Yglesias, who usually is not crazy:

Ben Bernanke isn’t the most important central banker in the world. Jean-Claude Trichet is.

That's... crazy. Europe is certainly important, but the dollar is still the world's reserve currency, and Bernanke manages it. Plus, the Fed is responsible for overseeing the US financial system, which is central to the global financial system in a way no European countries are, separately or taken together. Additionally, the ECB isn't (technically, legally) supposed to have all that much to do with the European financial system; regulatory authority still resides with national governments. Trichet faces constraints that Bernanke doesn't face, which limits his influence, but even if that weren't true he'd be less important.

To illustrate: During the crisis, the Fed routinely provided liquidity support for foreign firms, most of which were in Europe. Has the ECB done anything similar for US firms? During the crisis the Fed opened up swap lines with every major central bank in the world. Did the ECB do anything similar? Not outside of the eurozone, as far as I can tell.

(Side note: Yglesias notes that the EU is a larger economy than the US. Which is true. But Trichet only controls monetary policy in the eurozone, not the entire EU, and eurozone GDP is roughly 75% of US GDP.)

Elementary Questions About Keynesianism

2011-10-04T12:21:00.000-04:00

I think I asked this question back in '09 or early '10, but I didn't get a satisfactory answer so I'll ask it again. I am certain that there is a simple answer to it, but I haven't yet seen it. I know some Keynesian economists occasionally read this blog, so I'm hoping they'll set me straight.

As far as I can tell, the whole Keynesian framework depends on the existence of a liquidity trap. Without it, as Krugman keeps repeating, normal rules of macroeconomics apply: trade is good, monetary policy is effective, etc. But in Depression Economics all that is turned upside down. The rules of the game change because of the constraint imposed by the liquidity trap. Normal macroeconomics doesn't work.

In the Keynesian framework monetary policy is ineffective at the zero lower bound because people (banks, businesses, households) hoard cash. Thus there is a decrease in aggregate demand, economic activity slows, unemployment increases, etc. I get all of that. Here's the leap that I can't make: why isn't that true of fiscal policy as well? If I use monetary policy to give people money and they hoard it, why would they not hoard money if I use fiscal policy to give them cash?* The whole idea of Depression Economics depends on a psychological model of mass peoples -- what Keynes called "Animal Spirits"** -- that would seemingly apply universally to all public policy intended to stimulate demand. I see no reason why businesses or households would respond to cheap/free money from the monetary authorities by not hiring, but respond to cheap/free money from the fiscal authorities by hiring.

In other words, if the monetary multiplier is small because of the hoarding impulse derived from animal spirits, then the fiscal multipler should be no greater and probably smaller, for a few reasons. Cash transfers on the fiscal side only moves the money once, and then it should be hoarded in the same way as cash from monetary policy (which is also moved once). But fiscal policy also incurs new debt, which must be serviced. That imposes real future costs in the form of interest -- which is admittedly quite small or even negative in the present environment -- and fiscal drag from future taxation, both of which can be anticipated. Tack on some waste/corruption/deadweight loss and it's hard to see how fiscal policy would be more effective than monetary policy at the zero lower bound or anywhere else. Even at a high discount rate monetary policy can always be cheaper than fiscal policy, so it should seemingly have a higher multiplier.

I freely admit my ignorance and stupidity in this matter. I understand that economics often makes no sense until someone explains it to you, and my economics education effectively ended with my undergrad major. So I'm asking someone to explain it to me: why do animal spirits negate monetary policy at the zero lower bound but not fiscal policy? I'm guessing it has something to do with financial intermediaries, but then doesn't that require an additional, separate assumption about psychology?

*The closing scene in the HBO adaptation of Sorkin's Too Big to Fail has Poulson muttering to one of his deputies something like "We gave the banks the cash; now they better spend it and get the economy moving". I'm sure that's apocryphal, but the whole point is that they didn't. They hoarded it, as a Keynesian would expect from monetary policy, but not from fiscal policy. Poulson, of course, was most concerned with the fiscal intervention.

**While I'm here, there's something else I don't understand: Why is it that Keynesians smirk at assertions that businesses aren't hiring between of "uncertainty" when their entire underlying model depends on precisely that claim? Partisans on the right surely miss part of the story when they attribute this uncertainty only to Obama's policies -- I agree with Summers when he said that the biggest uncertainty is over the entries on the order books, i.e. aggregate demand -- but the uncertainty that matters is over expected profits. One part of that equation is revenue, the other part is costs including regulatory and tax costs. Decreasing uncertainty over the former (in a positive direction) increases confidence and thus investment, but so does decreasing uncertainty over the latter (in a positive direction). Both sides seem to be right and wrong. Or, rather, incomplete without the other.

PSA

2011-10-04T02:43:00.000-04:00

A bunch of smart people (Downes, Fearon, Nye, others) discuss in print whether/why regime change doesn't "work". Perhaps of interest to some readers. I'll just say that regime change "works" almost every time we attempt it, in that we usually succeed in changing whatever regime we want to change. What doesn't "work" is subsequently establishing a liberal democracy that cow-tows to our every wish.* Which seems like another matter, distinct from "regime change" and requiring its own term. But I don't get to make the rules.

*The wish is seldom defined. Our own democracy never fulfills our own every wish, which I believe is a true statement no matter how you identify "our".

Thoughts on an Article I Haven't Read

2011-10-03T23:07:00.001-04:00

That would be this one, which tells me in the headline and subtitle that North Carolina "grooms its best students to be good teachers". I strongly suspect that this is not true empirically, and I certainly hope it is not. Teaching requires basic competence of the subject material plus the ability to lesson-plan effectively and communicate well. While this is not an easy job relative to many other tasks, it's not on the same level of difficulty of oh, say, developing new medical procedures, inventing new technologies, or devising and testing new theories of human interaction.* Given that, I'd rather our best students focus on the most difficult tasks and/or those with the highest social benefit, while our capable-but-definitely-not-the-best students focus on getting first graders to color inside the lines or getting eighth graders to dissect a frog without vomiting.**

*The inclusion of the latter is me puffing out my chest, in case you couldn't tell.

**Not sure if I have those activities assigned to the proper class because I skipped 8th grade and never dissected a frog, so I assume that's when that happened.

Sunday Links

2011-10-02T10:11:00.000-04:00

-- NYT roundtable on Basel III.

-- Michael Lewis goes to California.

-- Long interview with Daron Acemoglu, on a number of topics.

-- Economist special report on shifting of economic activity from west to east.

-- Opening statement of Firedoglake book salon on Chinn/Frieden's Lost Decades.

-- The attempt to collect and publish in one place accurate data on the graduation and placement rates of poli sci departments. I fully support this, and hope UNC gets on board soon.

The Fed Is Political

2011-09-30T08:17:00.000-04:00

John Thacker, via TC:

Here’s a Hill poll on inflation, and here’s a Gallup poll, and here’s a Rasmussmen poll.

While all differ on the exact numbers, they agree in broad strokes. The median voter is highly worried about inflation. Democrats are worried less about inflation, but still quite a lot. Indpendents are virtually indistinguishable from Republicans in worrying a lot about inflation.

That means that the inflation/hard money bit from the GOP is not an appeal to the base. It’s actually a reach to the center.

Worrying about inflation may be wrong– and I think it is wrong, according to the data– but it’s an attempt to go after the median voter, not play to the base.

We should remember most people are still employed, so inflation erodes the value of their wealth. Perhaps it would benefit the unemployed by stimulating AD, but that's still a minority of the population. The median voter* wants strong RGDP growth, not just NGDP growth.

*Yes, I know that's a simplification. I think it's fine for these purposes.

On Neoliberalism

2011-09-29T20:03:00.000-04:00

Henry Farrell reviews what sounds like a very interesting book, Colin Crouch's The Strange Non-Death of Neoliberalism. Farrell's discussion of the book prompted me to add it to my Amazon wish list. I do, however, have a conceptual quibble. According to Farrell, Crouch defines neoliberalism as the belief that "optimal outcomes will be achieved if the demand and supply for goods and services are allowed to adjust to each other through the price mechanism, without interference by government or other forces". In other words, it's a technical argument that markets allocate resources more efficiently when not interfered with by governments, in general. But then Crouch claims that neoliberalism is really "devoted to the dominance of public life by the giant corporation."

These two are obviously mutually exclusive. The first definition is apolitical, or perhaps anti-political, and is ultimately dedicated to using the tools of technocracy for utilitarian ends. The second is a statement of politics that prefers a statist-corporatist organization of power in society, and there's nothing utilitarian about it. And what I can't get from Farrell's review is whether Crouch is arguing that this is cognitive dissonance -- that neoliberals don't really understand what they're advocating -- or whether the anti-political neoliberal rhetoric is an intentional deceit. Or whether Crouch is confused about this himself.

So here's my quibble: I don't think either of those is the best explanation of the actual intellectual disposition of actual neoliberals. "Neoliberalism" is itself a pretty nebulous concept, which may be part of what Crouch is driving at here. The neoliberals that I have in mind exist on a continuum roughly from Brad DeLong to Greg Mankiw, or essentially the entire discipline of American economics and wonkery, who may disagree on some particulars of which technocratic policy may bring the best outcome but more or less agree on what the best outcome is (within fairly narrow bounds) and the fact that technocratic means are the best way of achieving it. Put another way, I see neoliberals as believing that politics messes up socially optimal policymaking rather than those who believe there is no such thing. As one example, see this recent piece by Peter Orszag.

So I see neoliberals as generally in agreement that markets are good, and therefore that market actors (including corporations) are good, but that under certain conditions markets can generate outcomes that are suboptimal relative to some social ideal. It is in these areas that government is useful. Neoliberals tend to agree that there should be a social safety net (even Hayek and Friedman admitted that much), and that externalities exist and can be quite powerful. They tend to think that in a first-best world markets and governments are two complementary tools that together can enhance utilitarian social outcomes.

In other words, I don't think that neoliberals are actually "devoted to the dominance of public life by the giant corporation". I do think that neoliberals generally believe that corporations produce important social goods so long as they operate in competitive markets, and when they do not -- or when structural factors tend to lead them to generate negative externalities -- they should be regulated. So neoliberals often advocate things like cap-and-trade auctions, oppose industrial policy (which is pro-corporation), and favor laxer restrictions on trade and immigration. To the extent that these policies negatively impact some groups in society, neoliberals generally advocate some sort of social insurance paid for by some sort of progressive taxation scheme.

This is completely distinct from a preference for distributive politics that favors protecting large corporations, or capital in general. In fact, corporatists are often mercantilist and pro-regulation (at least those that provide rents by creating barriers to entry). The only overlap I see is that corporatists and neoliberals both make use of, and attempt to legitimize, markets. But they do so in very different ways, because they think of the "market" differently. Both groups tend to think that markets are often distorted by political processes, but they vary in the normative value they place on that: it's exactly what corporatists want, and it's exactly what neoliberals decry. Corporatists love market failure; neoliberals hate it. In short, corporatists view politics in the same way as socialists, not neoliberals. Corporatists and socialists are on the opposite sides of the distributional battleground, while neoliberals are trying to avoid the combat entirely.

There are times when the neoliberals and corporatists can overlap politically well enough to be on the same side, and this is I think where the confusion sets in. Farrell recounts Crouch's discussion of Thatcher's reforms, with which I'm not familiar enough to discuss. But during the same period in the US we heard a lot about "trickle down" economics, where policies that benefited corporations would in turn benefit the rest of us. Neoliberals and corporatists were generally on the same side in that debate, but for different reasons: neoliberals believed it was true, while corporatists did not (or at least hoped not). And the experience of the US from 1980-2000 provided ammunition for both sides: the American economic experience was pretty good during that period, although it was much, much better for the wealthy than for the rest.

But neoliberals can just as easily oppose corporatists, and quite often do. I think a lot of this gets at what Farrell and Matt Yglesias were arguing about recently, so I was kind of surprised that Farrell didn't link his review to that discussion. Yglesias was arguing for a certain kind of neoliberalism that emphasizes growth plus greater redistribution (relative to the status quo) as being the utilitarian ideal, while Farrell was arguing that that doesn't accurately describe the political landscape so it should be discarded in favor of a more radical politics. Neither was adapting a corporatist line, but they nevertheless disagreed.

The Public Is Not Easily Manipulated

2011-09-27T08:51:00.000-04:00

During the Krugman/Crooked Timber kerfluffle this summer I argued that Krugman's argument that elite pundits and policy wonks ran roughshod over American politics was too simplistic; we also needed to account for voter preferences, especially on big-ticket policy decisions like the Bush tax cuts and the Iraq War. For this I was raked across the coals... after all, isn't public opinion created or manipulated by elites?

Via Chris Blattman, there is some new experimental research in the APSR (ungated) by John Bullock that shows that the effect of elites' cues on public opinion is not dominant:

An enduring concern about democracies is that citizens conform too readily to the policy views of elites in their own parties, even to the point of ignoring other information about the policies in question.

This article presents two experiments that undermine this concern, at least under one important condition. People rarely possess even a modicum of information about policies; but when they do, their attitudes seem to be affected at least as much by that information as by cues from party elites.

The experiments also measure the extent to which people think about policy. Contrary to many accounts, they suggest that party cues do not inhibit such thinking.

This is not cause for unbridled optimism about citizens’ ability to make good decisions, but it is reason to be more sanguine about their ability to use information about policy when they have it.

That doesn't mean that elites can't use public opinion -- especially when it's an ignorant opinion -- to skew policies in ways that suit their own preferences. The selling of the Iraq War might be such a case, when the public was convinced in large numbers that Saddam Hussein was directly or indirectly response for the attacks on 9/11. It may be an example of the mass ignorance that Bullock describes. But as an exception to the general pattern that would have to be demonstrated rather than merely asserted. In general it's just not enough to say that the public is easily manipulated into accepting elite opinion.

Deus ex Machina

2011-09-26T22:29:00.001-04:00

Peter Orszag writes,

"our current legislative gridlock is making it increasingly difficult for lawmakers to tackle the issues that are central to our country’s future—issues like climate change, the hard slog of recovering from a financial slump, and our long-term fiscal gap. It is clear to everyone that a failure to act will lead to undesirable outcomes in these areas...What we need, then, are ways around our politicians."

Seriously?

Shorter Brad DeLong

2011-09-26T11:13:00.000-04:00

"I like it when Ron Suskind uses nefarious tactics to make people I do not like look bad; I do not like it when he uses them to make my friends look bad."

Jacob Weisberg has it right, I think. But then I didn't spend dozens of posts in the middle of the 2000s giving lots of credence to Ron Suskind, so I've really got nothing at stake.

The Great Crash 2008, Part Three

2011-09-26T09:18:00.000-04:00

In the last chapter of The Great Crash 1929, "Cause and Consequences", JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed from the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the third.

The third cause Galbraith gives for the length and depth of the 1930s depression was that there was a bad banking structure. His words:

[M]any of these [banking] practices were made ludicrous only by the depression. Loans which would have been perfectly good were made perfectly foolish by the collapse of the borrower's prices or the markets for his goods or the value of the collateral he had posted. The most responsible bankers -- those who saw that their debtors were victims of circumstances far beyond their control and sought to help -- were often made to look the worst. The banks yielded, as did others, to the blithe, optimistic, and immoral mood of times but probably not more so. ...

However, although the bankers were not unusually foolish in 1929, the banking structure was inherently weak. The weakness was implicit in the large numbers of independent units. When one bank failed, the assets of others were frozen while depositors elsewhere had a pregnant warning to go and ask for their money. Thus one failure led to other failures, and these spread with a domino effect.

The banking structure in 2008 is often characterized as being dominated by the concentration of market share in a few "too big to fail" firms that were able to exploit an implicit government guarantee and thus secure rents. This led these firms to engage in more risk-taking than they would have done absent a guarantee, so the best way to promote future financial stability is to reduce the size of these firms, thus eliminating the implicit government guarantee, thus forcing firms to internalize their risk-taking, thus leading to less risk-taking and more stability. But this was more or less the state of affairs in 1929, according to Galbraith. There were many small firms and no government guarantee. But that led to instability for the opposite reason as 2008: market share was too dispersed throughout the banking sector, with no financial institutions large enough to halt the spread of contagion.

I've blogged similar arguments to Galbraith's before (and before having read the book). A big part of the resolution of the 2008 crisis involved selling illiquid and/or insolvent firms (Bear Stearns, Merrill Lynch, Washington Mutual, Lehman Brothers, Countrywide, etc.). The only possible buyers for firms that large and with that many problems on their balance sheets was to find other large firms that could absorb them, like JP Morgan and Bank of America. This option was mostly not available in 1907 or 1929 but, combined with strong action from the Fed and Treasury, allowed the resolution of the financial crisis much more quickly and comfortably than in those previous crises. Indeed, the actual financial shock in 2008 was worse than in 1929, and possible worse than any in previous history. The fact that since that shock we've merely had a period of slowed growth and a fairly moderate increase in unemployment rather than a Great Depression is perhaps partially attributable to the fact that we dealt with this crisis much better than previous crises.

This line of thinking should give us pause when we consider whether having more small banks rather than fewer large banks would really be a good idea*. One way we might conceptualize this is to think in terms of patterns of financial integration. A financial system in which a relatively small number of firms are central to the system will generally react differently to crises than a system in which the distribution of links is more dispersed. Specifically, according to research on the spread of viruses and other crises through networks, highly-unequal systems are "robust but fragile": they are resilient to shocks in the periphery of the network, but fragile to shocks in the core. In 2008 we had a shock to the core, so the gut reaction is to reduce the importance of the institutions that comprise the core to the broader system. But that may only leave us susceptible to shocks anywhere in the financial system. This, warns Galbraith, is a very real possibility.

That doesn't seem to leave us with many good options. But here we may take some good news from the 2008 crisis: despite being a more severe financial crisis than 1929, the fallout was much less severe. This is obviously due to a number of reasons including the safety net and automatic stabilizers, as well as pretty drastic actions taken by the Fed and other central banks. But the Fed's actions were likely made more effective by the fact that they had to concentrate their efforts towards only a handful of firms at the center of the system. Once those firms were stabilized, the entire system was stabilized. The 1929 Fed didn't have that option.

This "solution" isn't much of one, admittedly. For one thing, it means that we may remain susceptible to types of crises similar to the one in 2008. That's little comfort. Additionally, it maintains the system of rents that these large firms are able to exploit, and that's unfortunate. But there may be ways of using the regulatory code, tax code, or criminal code to eliminate these rents in other ways. It may be possible to use the same tools or others to promote financial stability in other ways. In any case, it isn't obviously clear that a more decentralized financial system would be any more stable. It wasn't in 1929.

*Keep in mind that a stated goal of regulatory policy at both the domestic and international levels is to reduce the size and number of "systemically important financial institutions". These firms are likely to have higher capital requirements under Basel III, and Obama proposed a special tax for these firms. As far as I can tell these policies have had no effect at all on bank behaviors.

Developments in the DPRK

2011-09-25T20:32:00.001-04:00

I'm fascinated by accounts of North Korea, probably because the Hermit Kingdom is so isolated from the sources of information that I usually access. That may be changing a bit as North Korea tries to ramp up its tourism industry by luring (primarily) the Chinese nouveau-riche above the 38th parallel. Usually portrayals of the DPRK are pretty grim, but these photos from a journalist who went on a cruise have some moments of light and contain a lot of beauty. However the economic news is not so good:

The rationing system, the backbone of the socialist planned economy, has nearly collapsed. Some 4 million people still live on rations — 2.6 million in Pyongyang and 1.2 million soldiers.

But a senior South Korean government official said 20 million North Koreans rely absolutely on the underground economy.

“A North Korean family needs 90,000-100,000 North Korean won for living costs per month, but workers at state-run factories or enterprises earn a mere 2,000-8,000 won,” the source said. “So North Koreans have no choice but to become market traders, cottage industrialists or transport entrepreneurs to make up for shortages.” ...

“Ordinary North Koreans have become so dependent on the private economy that they get 80-90 percent of daily necessities and 60-70 percent of food from the markets,” the security official said.

Obviously the situation is not sustainable in the long term. It will be interesting to see if North Korea begins making gradual Cuba-like reforms after the transition of power from Kim Jong-il to his son Kim Jong-un.

Budget Politics and Power Laws

2011-09-23T14:44:00.002-04:00

How does the United States government balance its budget? The Obama administration and Congress seem attached to the notion that balance is to be achieved via a "Grand Bargain" that delivers multiple trillions of dollars worth of savings all at once. Although a Grand Bargain may be welcome, this isn't how our political system operates.

On the one hand, the system isn't good at making large expenditure reductions. Consider the distribution of expenditure changes since 1945 (see figure to left). The distribution has power law characteristics: lots of small changes in expenditures and very few large changes. Moreover, expenditure reductions (white dots) are more difficult than expenditure increases (black dots). The frequent but small cuts are smaller than the frequent but small increases, and the infrequent but large cuts reduce spending by less than the infrequent but large increases. In short, the system is much better at increasing expenditures than at reducing them. And, typically it cuts expenditures a little bit at a time. Hence, asking for a substantial reduction in expenditures at one go cuts against the fundamental structure of budget politics in the United States.

On the other hand, the system isn't good at increasing taxes sharply. The distribution for legislated tax increases also exhibits power law characteristics (see figure to the right). We see frequent but very small tax increases and very infrequent large tax increases. Moreover, the large tax increases have occurred under pressure of national emergency--mobilization for the Korean War for instance. Hence, asking for a substantial increase in taxes also cuts against the fundamental structure of budget politics in the United States.

Seeking to balance the budget via a grand bargain thus asks the system to do the two things it seems least suited to do: sharply cut expenditures and raise taxes dramatically. Both outcomes seem unlikely given the story these simple statistics illustrate. The more likely way the US will move to a balanced budget is not through a Grand Bargain, but through a path that combines frequent but small reductions in expenditures with frequent but small tax increases.

Sources: The Log-Log Plot on US Domestic Outlays is from page 61 in Jones, Bryan D., Frank R. Baumgartner, Christian Breunig, Christopher Wlezien, Stuart Soroka, Martial Foucault, Abel Francois, Christoffer Green-Pedersen, Chris Koski, Peter John, Peter B. Mortensen, Frederic Varone, and Stefaan Walgrave. 2009. A General Empirical Law of Public Budgets: A Comparative Analysis. American Journal of Political Science 53(4): 855-73.
I generated the Log-Log Plot on Tax Increases from data in Romer, Christina, and David Romer. 2008. A Narrative Analysis of Postwar Tax Changes. Berkeley: University of California, Berkeley. I note that my figure on tax increases is provisional as I input that data a couple years ago and never cleaned it so there may be errors. Thus, I am not certain that the distribution is a power law, butit is the case that large tax increases have been very, very rare.

Understanding

2011-09-23T08:04:00.000-04:00

Angus Deaton has some new research that may help explain why political scientists are all neurotic:

According to Deaton’s analysis, the very act of thinking about politics makes Americans feel less happy and satisfied with their lives — an effect that’s almost as big as being unemployed.

“People appear to dislike politics and politicians so much that prompting them to think about them has a very large downward effect on their assessment of their own lives,” he writes. “The effect of asking the political questions on well-being is only a little less than the effect of someone becoming unemployed, so that to get the same effect on average well-being, three-quarters of the population would have to lose their jobs.”

Welp, that explains a lot. Here's the paper (pdf).

The Fed Is Political

2011-09-22T21:09:00.001-04:00

Today's edition: Mike Konczal tries to rally liberals around the Fed-bashing flag:

For most policymakers and commentators on the left, aggressive monetary policy and inflation has long taken a backseat to fiscal and financial sector issues when it comes to discussing how to return our economy to its full potential. That has allowed the conservative movement and the financial sector to dominate the monetary discussion throughout our current recession—and their focus, as we have seen in recent weeks, is a perpetual fear about imminent hyperinflation. But liberals should be addressing monetary policy head-on, and they should do so by challenging conservatives’ definition of the term “credibility” as it applies to our central bank.

So when can we stop talking about the Fed as if it were an apolitical, technocratic institution?

"Macroeconomic Events Have Macroeconomic Causes"

2011-09-22T21:04:00.000-04:00

That's D^2, saying we need to do better than "the bankers are all bastards" as an explanation of the state we're in. In my view he doesn't talk enough about the political causes of the recession, nor the international dynamics at play, but a good post nonetheless.

Few Links

2011-09-21T08:03:00.000-04:00

-- Cool interactive map of migration patterns.

-- Jeffry Frieden on Europe's "Lehman moment".

-- When hierarchical models are appropriate for time series cross-sectional data.

-- Excellent report on the economic situation, mostly in graphical form. Gist: it's about the banks.

-- Twitter debate between me and Dan Trombly over Hitchens, game theory, Marxism, GWOT, hegemonic stability theory, and other topics.

The Fed Is Political

2011-09-20T21:13:00.001-04:00

Another entry in a continuing series. The top four Republican congressional leaders -- McConnell, Boehner, Kyl, Cantor -- sent this open letter to Bernanke and the Board of Governors. Highlights:

It is our understanding that the Board Members of the Federal Reserve will meet later this week to consider additional monetary stimulus proposals. We write to express our reservations about any such measures. Respectfully, we submit that the board should resist further extraordinary intervention in the U.S. economy, particularly without a clear articulation of the goals of such a policy, direction for success, ample data proving a case for economic action and quantifiable benefits to the American people. ...

We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy. Such steps may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers. To date, we have seen no evidence that further monetary stimulus will create jobs or provide a sustainable path towards economic recovery.

Bold added. Of course the very things they worry about happening if the Fed pursues further easing are exactly the things that would boost growth: a depreciating dollar (which would boost exports) and increased consumer borrowing (which would increase domestic demand).

Advice

2011-09-20T10:54:00.000-04:00

Fabio Rojas:

For example, when I was in graduate school, I often obsessed about work even when I was on vacation. But over the years, I learned to do what I want with whom I want and not to care about what people think. Not caring about what other people think is an important life skill. Just relax as much as you can and enjoy life.

I imagine that gets easier after tenure.

Stagnation and Economic Geography

2011-09-19T22:52:00.000-04:00

Noah Smith considers The Great Stagnation, and comes to similar conclusions as me [1, 2] but from a different starting point:

The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other ("agglomeration"). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial "Core" and a much poorer agricultural "Periphery" that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone's a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive "growth miracles" that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

But here's the thing: in the theory, the "old Core" doesn't keep getting richer. In fact, under some scenarios, it even gets slightly poorer while the "new Core" catches up. For a while, the negative effects of relocation trump the positive effects of progress.

So this could explain why we in the rich world are getting poorer. In the 50s, America was the only industrial "Core" that was not a pile of rubble. But since the 60s, we have seen successive "growth miracles": Japan and Europe in the 60s/70s, then Taiwan/Korea/Singapore in the 80s, then China since then, and now even India. In a New Economic Geography world, we would expect these successive relocations of manufacturing to hold down income growth in the U.S., even if technology was advancing as usual.

Smith calls this the "Great Location". I called it the "Great Redistribution". Smith emphasizes structural economic factors, while I tried to also incorporate political factors. But in general the two stories are congruous and probably complementary. (Arnold Kling has written a fair amount on this too.)

Cowen says in response to Smith that this doesn't tell us everything we want to know because "Median income begins to stagnate in 1973, before this trend is significantly underway". But I'm not sure about that. Is it just a coincidence that the Great Movement began right at the end of the Bretton Woods system? There was a series of perturbations in global markets related to the re-industrialization of Europe and Japan in the 1960s (as Smith notes). And even if the internationalist story can't explain everything, it can arguably explain more than a stagnation hypothesis, which can't account for the fact that average incomes have grown at roughly the same rates post-1973 as pre-1973. What has changed is the divergence between the mean and median of the distribution. This does not imply (to me, at least) a general economic stagnation, but rather a shift in how the economy is organized. Additionally, any account of changes to the US economy over the past 40 years that does not consider international factors is likely to be under-specified.

I had some of this "economic geography" logic in mind when I wrote my posts, but I honestly don't know that literature well enough to say much of anything about it other than the basic story that Smith laid out. That is, I'm sure people have empirically examined these questions in some depth; I just don't know where the consensus lies, if there is one. Clearly it's important enough, since a Nobel Prize was awarded for it. I'm just not sure what the state of that particular literature is.

Anyway, I'm happy to see international dynamics be brought into this discussion.

Fighting Words

2011-09-17T19:16:00.001-04:00

Scott Sumner goes hard after American political science:

Just one more reason why academics should pay no attention to “public opinion” polls. There is no such things as public opinion, there is only election results. No one knows what Americans would believe about Medicare if that sat down with all the government programs and tax revenues in a spreadsheet front of them, and told they had to equate the NPV of all future taxes with the NPV of all future spending. We simply don’t know. And anyone who argues otherwise isn’t thinking deeply enough about the issue.

Sumner calls this post "Thinking like an economist", which reminded me of my past post on the problem with economists.

The UNC political science department is well-known in academic circles for the study of public opinion in American politics, and the consensus view in Hamilton Hall is not that public opinion doesn't matter, much less that there is "no such thing". I very much doubt that Sumner has any familiarity with this literature, but he could start here and here and here. Public opinion matters a lot for policymaking, especially on issues that are salient with voters*. It even matters for the judiciary, even those with extreme job security such as the Supreme Court (see first link). It's not about voters having policy expertise, or what they'd do if they had to match the NPV of spending and revenue. The public does not even have to be coherent to have a major impact on policymaking, and not just via elections.

Let's take an example. Sumner is frequently exasperated by the Federal Reserve. He notes that the economy remains depressed several years after the beginning of the recession. He notes that Ben Bernanke has said that the Fed has plenty of tools to boost nominal GDP even at the zero interest rate bound. He notes that Ben Bernanke did a lot of research on both the Great Depression and Japan's lost decade, and thus understands the situation we're in quite well. The Fed does not face elections and is considered one of the most independent central banks in the world. And yet despite possessing the requisite expertise and policy tools the Fed is nowhere near as activist as Sumner would prefer.

How can we explain this? It could be that the Fed are a bunch of idiots, but Sumner does not believe that to be true at least in Bernanke's case. Or it could be that the Fed has just witnessed a series of events that have made them cautious. The Tea Party has had a major effect on American politics, and one ideological leader of the Tea Party -- Ron Paul -- wants to abolish the Fed and is now chairman of the House committee that oversees the Fed. Paul's book *End the Fed* has 375 reviews on Amazon.com, and nearly all of them give the book four or five stars. A Nobel Prize-winning economist -- Peter Diamond -- was blocked from joining the Fed by this element of the contemporary GOP. The leading candidate for the GOP presidential nomination recently threatened Bernanke with bodily harm and insinuated that he was a traitor. And Bernanke is a fellow Republican who was appointed by a Republican president. He has also been criticized by the left for bank-friendly policies. All of these groups want a monetary policy that is tighter than Sumner's preferred policy, and that is what the Fed has done.

Given all of this, isn't it at least plausible that the Fed feels constrained by public opinion? To my knowledge no studies have focused directly on this question, but as a potential contributing factor to Fed policy choices it seems at least plausible. Even if public opinion doesn't affect the Fed, the finding that it affects the Congress, presidency, and judiciary is very robust. So to be so dismissive is really silly.

*My guess is that the specific issue Sumner is discussing -- the tax penalty for married couples -- is not highly salient for most people. When it is, couples can easily (and cheaply) get legally divorced or remain unmarried as Justin Wolfers and Betsy Stevenson have done.

A Few Links in Lieu of Actual Post

2011-09-15T21:43:00.001-04:00

-- Phil Arena has a great post on selectorate theory as applied by Bueno de Mesquita and Smith in this Foreign Policy article. Gist: if selectorate theory generates useful advice for leaders like Obama, then it isn't much good as theory.

-- John Quiggin on China.

-- Erik Voeten on the UN and a potential General Assembly vote on Palestinian statehood.

-- Hayek: *Monetary Nationalism and International Stability*, from 1937. Haven't finished this yet. Hoping it provides some impetus for a research project or at least a substantive blog post or two.

-- Michael Pettis is a must-read on balance of payments dynamics and currency issues, especially related to China. I've started a post on this, which I hope to finish soon.

The Great Crash 2008, Part Two

2011-09-14T08:05:00.000-04:00

Galbraith's second possible reason for why the 1930s depression was so great was that the corporate structure in the US economy was poor:

The fact was that American enterprise in the twenties had opened its hospitable arms to an exceptional number of promoters, grafters, swindlers, impostors, and frauds. This, in the long history of such activities, was a kind of flood tide of corporate larceny.

The most important corporate weakness was inherent in the vast new structure of holding companies and investment trusts. ... dividends from the operating companies paid the interest on the bonds of the upstream holding companies. The interruption of the dividends meant default on the bonds, bankruptcy, and the collapse of the structure.

There are really two things here. First, Galbraith claims that the 1920s were prone to a widespread prevalence of fraud. Second, that corporations were structured in such a way that a disruption in finance would batter the real economy because financial firms owned many of the most important firms in the real economy. Throughout the book he offers a lot of evidence that fraud and other shenanigans were prevalent in the 1920s, although he does nothing to establish the claim that the 1920s were somehow worse in this regard than decades before or since. He does more throughout the book to show how the corporate structure was organized with productive firms downstream that were owned by financial firms upstream. The two were tightly linked, so that a major perturbation to one sector could have adverse effects on the others.

Some of these charges have been levied about the corporate system in the run-up to the 2008 crash. While I think claims that the financial crisis is a result of fraud or other criminal activity are generally over-stated, and I know of no reason to believe that criminal activity in the financial sector was more prevalent during the 2000s than other periods, there certainly was some of that going on. Perhaps more plausible is the argument that compensation schemes in major financial firms were skewed towards excessive risk-taking and boosting the short-run value of firms, not long-run stability. That may be true as well, although the only piece of research I've seen that directly examines that question finds the opposite (although another study shows that executives of large banks sold their companies stock more than they bought it, perhaps indicating that they didn't have much confidence in their firms' activities).

The second part of Galbraith's claim is more interesting to me, and potentially much more important. Was there was a shift in the underlying structure of the economy that altered the pattern of corporate organization? I don't know of any research showing the specific dynamic that Galbraith describes -- dividends from downstream productive firms paying for activities of upstream financial holding companies -- but something else happened:

From this analysis came two striking figures. The first is a map [above; click for larger version] of links between companies in five key economic sectors: technology, oil, other basic materials, finance linked to real estate and other finance. As of 2003, the sectors are relatively distinct, with real estate isolated. By 2008, they’re a tightly linked jumble, with finance at the center.

I wrote about this research last year:

To me, there are two ways of looking at this. The first is the conclusion reached by Keim, that interdependence on its own can be stabilizing, until it reaches a critical mass, at which point increased interdependence destabilizes the system. Interdependence obviously went up throughout the 2000s. But another way to look at it is to examine the pattern of interdependence, rather than the occurrence of interdependence.

It is clear that the financial sector became much more central to the economy, so the economy as a whole became much more susceptible to trouble in the financial sector. In this way, the U.S. economy appears to display a feature of non-random, hierarchical networks, which is that they are robust to shocks in peripheral parts of the network, but fragile to shocks at the center. In other words, if a shock had hit the peripheral oil sector (as happened, in fact, in the middle part of the decade), the increased interlinkages with finance would make the economy more resilient. But once a shock hit finance, the central sector, everything else was prone to collapse as well.

In other words, the major American industries -- tech, energy, real estate, etc. -- all became very strongly linked to finance. This generated lots of profits during the 2000s, but also left the entire economy more susceptible to a shock to the financial system. So the tightly-linked corporate structure that emerged in the 2000s may indeed have had quite a lot to do with why the financial panic had such a devastating (and persistent) effect on the real economy.

Basel Is Not "Anti-American"

2011-09-13T19:45:00.000-04:00

I see (via Felix Salmon) that JP Morgan executive Jamie Dimon thinks the Basel bank regulations are "anti-American". I have no idea what he means by that, but my working understanding of the Basel regulations is that from a competitiveness standpoint they are generally beneficial to large American firms (like JP Morgan), and generally harmful to European and Asian firms. As Salmon puts it:

I have no idea what Dimon thinks is anti-American about the Basel standards, which are certainly in the interests of the United States. In fact, by all accounts it was the US which was pushing for stricter rules, and had to compromise with the laxer Europeans, whose banks are much less well capitalized right now.US banks, including JP Morgan with its “fortress balance sheet”, are very well placed to navigate through the Basel rules and come out strong and dominant on the other side.

European banks, by contrast, will have to raise a lot of very expensive equity. And UK banks, if the Vickers proposals are adopted, will be much less formidable in the international arena than they are right now, with most of their assets ring-fenced and unavailable for merchant-banking misadventures.

There are two basic ways to think about regulations like the Basel accords. The first way is to think in terms of externalities and welfare: regulations restrict the ability of banks to act riskily, which prevents them from generating negative externalities that spill over into the rest of society during financial crises. Thus, new regulations represent a redistribution away from banks to society at large. I think this is the wrong view.

A better approach, in my opinion, is to think of regulation as altering the competitive landscape in ways that benefit some firms and hurt others, and benefit some in the broader society while hurting others. Large incumbent firms often support new regulations that function as a barrier to entry for potential competitors. Regulations can lock in the market dominance of existing firms. This is what Salmon is talking about when he writes that "US banks are well placed to navigate through the Basel rules and come out strong and dominant on the other side".

So why is Dimon opposed to them? It could be that he doesn't appreciate this dynamic, but that sort of ignorance would wreak havoc on the assumptions used to generate the rent-seeking model of regulation. So let's not go there.

My guess is that Dimon recognizes the advantages of Basel rents but think they are smaller than the benefits to his firm of having lower regulations. That is, since JP Morgan is already at a competitive advantage over many of its competitors, and with the European banking sector apparently on the verge of collapse, he may believe that he doesn't need to collect rents for his firm to be profitable. If that's the situation, then the regulations restrict Dimon's flexibility without providing any significant competitive benefit.

That doesn't mean Basel is "anti-American" of course. For one thing, the Basel system could lock in market dominance for large American firms long into the future. For another, US policy makers hope to create a more stable financial system through Basel, not just secure profits for American firms. Of course Dimon may have a shorter time horizon, in which case the long-run benefits of Basel would be enjoyed by someone other than him, while the costs of initiation and compliance are borne by him and his friends.

Nothing New on Trade

2011-09-09T08:46:00.000-04:00

On the one hand, that title is a good thing. Many expected a global economic downturn to lead to trade wars. Many others expected asymmetric shocks to the global economy, in which exporting countries were perceived to be poaching jobs from importing countries, to have the same effect. But I recently finished Paul Blustein's excellent account of the Doha decade Misadventures of the Most-Favored Nations and a big theme is the battle of interests between the developed North -- especially the US and EU -- and the rest -- especially India, Japan, Brazil, and China. The book's narrative ended a few years ago, but little has changed:

India is unlikely to yield to a fresh effort by the developed countries to push for greater concessions by the larger emerging economies to salvage the World Trade Organisation's Doha Round of global trade talks. ...

With the US leading the chorus to demand further concessions from countries like India, China and Brazil, which will have to eliminate tariffs on some products for the round to progress, the talks have been stalled.

We haven't blogged a lot about trade here lately, but that's mainly because not a whole lot has gone on. The international trading system appears to be locked into the status quo for the time being. Interests are still far apart, and the gains from further coordination are not especially high. So the Doha agenda remains stalled.

EU Fiscal Union Is Highly Unlikely, con

2011-09-08T15:36:00.000-04:00

Edward Hugh reports that the Germans are laying down the gauntlet on the Greeks:

Only yesterday, German Finance Minsister Wolfgang Schaeuble informed members of the parliamentary budget committee that Greece is now perched on a "knife's edge". This follows hints from other leading German politicians (including Angela Merkel herself) that a Greek euro exit is no longer the unthinkable taboo topic which it had been to date.

As if all of this wasn't clear enough, the Dutch Prime Minister Mark Rutte suggested yesterday in an FT article that expulsion from the Euro Area should be available as a disciplinary measure of last resort.

For detail on why things are coming to head now, see the link. The gist is that the "voluntary haircut" component of the most recent Greek bailout isn't working the way it was intended, and neither Greece nor Germany (and other Euro creditors) are especially interested in yielding to the other at this juncture. They may continue to muddle through as they have previously, but hopes that the recent bailout-plus-haircut approach is going to be sufficient have been weakened.

Banks Too Weak for Basel III?

2011-09-08T14:59:00.000-04:00

It looks like many might be, especially in Europe:

Banking regulators are preparing to relax the new rules requiring banks to hold more liquid assets to be prepared for a new funding crisis, writes the Financial Times. ...

A new report by JPMorgan estimates that 28 European banks showed a liquidity deficit of 493 billion euro billion at the end of last year.

Only seven of the 28 banks tested comply with the new standards, French banks being among the least prepared. In fact, JPMorgan analysts concluded that the requirements of liquidity for the banks must hold sufficient assets, easily sold to meet a 30-day-long funding crisis, will affect most sectors, and will cost about 12% of the average European banks earnings of 2012.

We've written a lot about the competitive nature of Basel III, and especially how American banks tend to have higher capital and liquidity ratios than many of their European counterparts. Basel III was really hard on European (and Japanese) banks, and it looks like many of them won't be able to meet their obligations in a timely manner, especially if the European debt situation deteriorates. And, of course, if European banks are allowed to defect from their Basel obligations then pressure will be placed on the US and other governments to allow their banks to do the same.

This is worth keeping an eye on.