Politics of Hard Times - Macroeconomic Imbalances Edition

Yesterday morning I attended a panel at the annual American Political Science Association meeting on the macroeconomic and global responses to the financial crisis. Organized by Jeff Frieden of Harvard, the purpose of this panel was to discuss ways to revitalize theory building around the political economy of adjustment. Speakers included former chief IMF economist Raghuram Rajan , former Mexican president Ernesto Zedillo, and UNC professor Layna Mosley (MA thesis advisor to Will, Alex, and me). Overall, I found the discussion fascinating, although I wish that there had been more discussion about whether current conceptual and methodological tools are adequate for this task. Here's a quick run down of some main themes that emerged:

1) Current explanations of the Great Recession tend either to be mainly a macroeconomic imbalance story (without much political economy) OR a political story about regulatory failure due to rent seeking at the domestic political level. IPE scholars need to spend more time thinking about the political economy behind macro imbalances, and the complex interests and institutions that lead to variation in national economic policies. The question hear is why do some structurally important states become borrowers and why do others become lenders? Why do some governments adjust in time to structural imbalances and why don't others?

2) What are the political and economic consequences of an international political economy characterized by some states running persistent current account deficits while others run persistent current account surpluses? Rajan is particularly worried that an increased focus on export-oriented growth is creating a vicious cycle in which countries that would normally be in the best position to stimulate counter-cyclical AD can't because of enduring weakness in the domestic market. If I'm not mistaken, this point speaks to a running debate between Will and Thomas. (Perhaps someone wants to weigh in?)

3) How does growing inequality affect the politics of adjustment? Discussion on inequality focused mostly on the US and stems from Rajan's argument in his recent book, Fault Lines: How Hidden Fractures Still Threaten the World Economy. Rajan argues that technological changes are decreasing the wage advantages traditionally afforded by a college education, and that this effect is particularly important in thinking about inequality more around the 80/20 divide (I have no data on this - I'm assume this is in his book which I'm planning on reading after taking my Methods Comp). For him, the story here is that politicians have dealt with this growing inequality in the most politically expedient way - extending credit to those down the bottom of the distribution. Of course, the point here is that dealing with inequality this way leads to asset bubbles as we saw this time around. (This is the response to Will's post yesterday about performance pay and wage inequality. Rajan's take on this would be that democratic governments have to deal with inequality some way (even if some of rising inequality is merit based, as the 2007 NBER working paper suggests), and the problem is that the quick fix for elected officials is to pursue policies that do not change underlying structural inequality but also lead to increased demand for imports and financial instability.)

4) How has the Great Recession changed the way we study how governments choose to engage markets? This is Layna's main question and speaks to questions about how governments manage their debt, the role of official entities that hold sovereign debt on the rates states must pay to borrow, and whether the idea that advanced industrial countries have "room to move" still holds.

5) What are the prospects for macroeconomic policy coordination and global governance of capital markets when governments are dealing with the domestic politics of adjustment? Zedillo is particularly pessimistic about the future of economic interactions, especially between the US, the Eurozone, and China. Audience member Dan Drezner voiced concern about the politics of fiscal policy as more politically insulated monetary policy tools become less effective at managing downturns.

From my perspective, the take-away from this panel was that we just don't have a robust understand of the political implications of an international political economy with such deep structural macroeconomic imbalances. In order for IPE gain some explanatory purchase over the question panel members raised, we really have to re-conceptualize how to study IPE as a complex dynamic system. It is too easy to revert to a domestic political explanation. What states can do is constrained both by domestic and international politics and economics.

US Unemployment Rate Higher than Europe's?

It is expected that when the April international unemployment numbers are released, the United States will have a higher jobless rate than Europe. The United States' rate is already on par with European averages, a factoid that would have surprised many just a few months ago. 

For many years, unemployment in the United States was lower than in Western Europe, a fact often cited by people who argued that the flexibility inherent in the American system — it is easier to both hire and fire workers than in many European countries — produced more jobs.

In April, the rate in the United States rose to 8.9 percent. When the European figures are compiled, it seems likely that the American rate will be higher for the first time since Eurostat began compiling the numbers in 1993.

For men, the unemployment rate in the United States surpassed that of the 15 original European Union countries in December. By March, it was 9.5 percent in the United States, compared with just 7.5 percent for women. The figures for men and women in the 15 European countries, however, are close together, at 8.4 percent and 8.5 percent.

How did that happen during a worldwide recession? First, it appears that the safety nets in many Western European economies made it easier for people to keep their jobs as the economy declined. In Germany, programs allow companies to get government help in paying workers, for example, keeping them employed. If the recession becomes severe enough and long enough, of course, it could turn out those programs do not so much avoid the pain as defer it.

In the United States, there has been more movement of workers from depressed areas to places where the employment outlook is brighter. But the housing crisis appears to be hampering such movement because some workers own homes that are worth far less than the amount they owe on their mortgages.

Among the 15 European Union countries, the national unemployment rates range from 2.8 percent in the Netherlands to 17.4 percent in Spain. That is a wider spread than the ones among American states, where the rates range from 4.2 percent in North Dakota to 12.6 percent in Michigan.

So I guess I'll add to the speculation. Another reason may be the extent and quality of European re-training programs and their ability to get workers back into the labor force after shorter adjustment periods. A vast chunk of the increase in American unemployment has come from financials, insurance, housing and retail (as well as unemployed graduate students argh!). Europe may simply have been less exposed to the problems in financials and housing. 

The rigidity of European labor markets also play a role; it is harder to lay off workers in Europe, thus causing a higher level of stickiness in labor markets. As the downturn drags on, we can expect larger increases in European unemployment levels. The United States sheds jobs at a quicker pace (because of relatively less sticky labor markets), with most lay-offs concentrated towards the beginning of a recession. Europe may simply be dragging on the labor market adjustment period with their generous social insurance programs and rigid labor markets. 

So the United States' unemployment rate could rise above Europe's in the short-run, but may be surpassed by Europe's as the downturn continues and as the (predicted) expansion begins. We may simply be observing a wider band for American unemployment rates over time, and a smaller band for the average European rate. 

The Break-Up of Chimerica

Niall Ferguson, with all kinds of good stuff:

We are living through a challenge to a phenomenon Moritz Schularick and I have christened “Chimerica.”1 In this view, the most important thing to understand about the world economy over the past decade has been the relationship between China and America. If you think of it as one economy called Chimerica, that relationship accounts for around 13 percent of the world’s land surface, a quarter of its population, about a third of its gross domestic product, and somewhere over half of the global economic growth of the past six years.

For a time, it was a symbiotic relationship that seemed like a marriage made in heaven. Put simply, one half did the saving, the other half the spending. Comparing net national savings as a proportion of Gross National Income, American savings declined from above 5 percent in the mid 1990s to virtually zero by 2005, while Chinese savings surged from below 30 percent to nearly 45 percent. This divergence in saving patterns allowed a tremendous explosion of debt in the United States, for one effect of the Asian “savings glut” was to make it much cheaper for households to borrow money than would otherwise have been the case.

Of course that "arrangement" is unraveling, as the Great Adjustment progresses. There is more:

Among the other developed economies, both the Eurozone and Japan are already officially in recession, ahead of the United States. The European situation is especially precarious because, contrary to popular belief, European banks are in worse shape than their American counterparts. Average bank leverage in the United States is around 12:1. In Germany the figure is 52:1. Short-term bank liabilities are equivalent to 15 percent of U.S. GDP; the British figure is 156 percent. Indeed, the United Kingdom runs a real risk of being Greater Iceland—an economy crushed by a super-sized financial sector.

Emerging markets, too, have been hammered harder by the crisis than the “decoupling” thesis promised. In the year to the end of October 2008, the U.S. stock market declined by 34 percent. But Brazil’s was down 54 percent, China’s 58 percent, India’s 64 percent and Russia’s 66 percent. When Goldman Sachs christened these four countries the BRICs, they little realized that their equity markets would one day be dropping like bricks. These figures are scarcely good advertisements for the more regulated, state-led economic models favored in Beijing and Moscow.

The financial crisis is especially bad news for energy exporters: not only belligerent Russia, whose leaders yearn for a reconstituted Soviet empire, but also those other thorns in the side of the United States, Iran and Venezuela. Any oil price below $94 a barrel is bad news for Venezuela’s fragile finances; any price below $55 spells trouble for Iran.

What does it mean? The U.S. is actually remarkably well-positioned to ride out this storm compared almost every other country; whether developed or emerging, more or less regulated, net importer or exporter. Remember that when you hear that
The American Century is over, or capitalism is dead, or any other similar sentiment.

How Low Will It Go?!

The price of oil tumbled further today, settling at $43.67, it's lowest close in nearly four years.

So the question is, how much lower will it go?

Airlines, Recession and Going Bust

So far this year, about 30 airlines have gone bust around the world, including ATA, Aloha, Skybus, Sterling, and Frontier Airlines, all relatively small airlines with mostly regional coverage. However, these small carriers declaring bankruptcy does not bode well for an aviation industry staring down a global recession, tight credit, and decreasing demand. These bankruptcies have produced ripple effects throughout the aviation sector and have left tens of thousands of travelers stranded in airports around the world. Will we continue to see more bankruptcies? Will we see consolidation in the airline industry much like we've started to see in the banking industry?

Last month, Willie Walsh, CEO of British Airways predicted that by the end of this year, 30 more airlines will declare bankruptcy as a result of the current economic climate, causing more headaches and stranding more passengers worldwide. Furthermore, analysts are predicting consolidation within the aviation industry in order to take advantage of economies of scale. 

Today, the Justice Department approved the merger between Delta Airlines and Northwest Airlines, after a six-month investigation as to the impact of the merger on consumers. This deal will create the largest airline in the world. Also today, Lufthansa, the German carrier, came to terms to purchase BMI, the British airline, and is also seeking to purchase major stakes in Austrian Airlines and Alitalia. Major carriers like British Airways, Air France-KLM, and Virgin are also positioning themselves to buyout smaller carriers and expand their networks.

However, most analysts are overlooking one important obstacle to airline consolidation, especially on a global scale. The main obstacle to airline industry consolidation globally is that it is illegal, and has been since 1938, for foreigners to own US based air carriers. The United States caps foreign ownership of domestic carriers at 25%, thus ensuring that the only consolidation in the US market can come from within. We will most likely see less consolidation than most are predicting, and the consolidation that we do see, will be a wave of "intra-market" mergers, especially within the US and the EU.

Because the sources of continued financing and merger are limited to "intra-market" transactions, especially in the US but also in Europe, our wave of consolidation may be much smaller in scope and not sufficient enough to ensure that the airline industry continues to function at its current capacity. In the short run, as a result of tighter credit, decreased consumption of aviation industry services and a global recession, we may see further bankruptcies and more headaches for travelers because airlines will not be allowed to merge across borders and take advantage of economies of scale. In the long run, none of this matters b/c we're all either dead or won't need airlines. (Hopefully someone invents Star Trek style teleportation!)

Americans are saving?!

What?! Since when do Americans save? Well, according to the latest figures, the personal savings rate in the United States was up to almost 3% for the second quarter of '08, the highest its been in at least five years, and is predicted to at the very least stay at this level for a while. This is an interesting development. 

This news bodes well for the American economy in the long run, as "domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time. A growing domestic savings pool could also reduce America's need to borrow money overseas - which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year."

However, in the short run, "saving more means spending less - which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday's steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Given that two-thirds of economic activity is consumer spending, today's thrift [may] exacerbate a general downturn and [may] weaken the impact of the massive interventions the government has made in the financial markets."

This development has consequences for the predicted (or actual, depending on your definition of the term) recession and recovery.  If Americans aren't willing to go out and do what they do best (shop and eat) and instead stuff their money under the mattress, it is a signal that the American economy may be in for a longer and deeper recession than originally predicted. Furthermore, the recovery from the Great Financial Crisis of 2008 (catchy huh?!) and its ensuing recession may take longer than we thought it would. (We may be sitting here in the 3rd and 4th quarter of 2010, still awaiting the recovery to begin.) 

So I say unto you America, shop, baby, shop!

Financial Contagion?

Iceland is near bankruptcy. Credit crisis hits Canada. Belgium, France, Luxembourg intervening to save bank after bank. The Euro falls to 14 month low as credit crisis spreads throughout Europe. Asian equity markets continue their deep slide.

$700 billion bailout. 50 basis point emergency global coordinated rate cut. Banking deposit guarantees. Governments taking equity stakes in banks (yes, including here in the US). 

Is there any further action that can stem the spread? Can the government do anything? Is this too little too late? Is a global recession inevitable?