7 Year Old Politics

Henry Farrell goes after me over this post, and says he'd rather be an unsophisticated 6 year old than... whatever I am. Dan Nexon seconds the motion. Really Farrell's making a much bigger point about IPE and is using me as an illustrative case. He's written about this before.

This puts me in a weird position. I tossed off that post, mostly because I was short of time and because Krugman perpetually annoys me. The point of the post was intended to be that Krugman's constant moralizing doesn't get us anywhere, not even as far as the most basic view of democratic politics. The point was not that the most basic view is the right one. I tried to caveat a bit ("first approximation", "doesn't always work"), but that obviously didn't get across. So I guess Farrell's response is just desserts for being lazy. I'll try to flesh out what I meant better in this post. While I don't want to run away from what I wrote, much less what I intended to convey, I also don't want to get the shit kicked out of me for something I don't really think. So this will be at least as long as Farrell's post, and much longer than Nexon's.

As (I think) Farrell knows, I agree with many of his points about IPE in general. I agree that IPE does a very poor job of explaining preference aggregation, and a pretty poor job of preference formation (although, ideally, we could just import at least some of that from comparative politics). In fact, I'd extend it: I think IPE has a generally poor view of the political space, and like other subfields of political science is too reductionist. I agree that IPE does not have a very good sense of how interest groups and elites influence policy in democracies. I agree that we should pay more attention to subfields that examine these questions in detail. As he says, IPE generally infers preferences from economic theory, then applies some crude form of the median voter theorem (if that) to explain outcomes*. IPE generally assumes (implicitly) that voters are fully informed, and actually care about whatever issue we happen to be studying.

This is lazy even when it's not entirely wrong, and a big part of my dissertation is dedicated to more rigorously exploring how interest groups shape policy in a global context. So, as a jumping-off point, I don't mind him taking me to the rails. Except. He's writing this in defense of Krugman's purely elite-driven take. Here's what Krugman says:

The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.

Here's what Farrell says:

On many important policy issues, the public has no preferences whatsoever. On others, it has preferences that largely maps onto partisan identifications rather than actual interests, and that reflect claims made by political elites (e.g. global warming). On others yet, the public has a set of contradictory preferences that politicians can pick and choose from. In some broad sense, public opinion does provide a brake on elite policy making – but the boundaries are both relatively loose and weakly defined. Policy elites can get away with a hell of a lot if they want to.

These are two very different statements. On the issues we're talking about -- tax cuts, Iraq war, prescription drugs covered by Medicare, housing policy -- the public did have pretty clearly identifiable preferences about policy, and those happen to map onto policy debates (and resulting legislation) fairly well**. As I linked in the prior post (via Drezner), a majority of the public supported the Bush tax cuts and the Iraq war. The former represented the biggest policy proposal of Bush's 2000 campaign, the latter represented the biggest policy proposal of his 2004 campaign. He won both of them. (Okay, only kind of won in 2000.) Moreover, the public's representatives in the House and Senate voted for both policies.

Now we could believe that public preferences had nothing to do with the Bush tax cuts becoming law and the Iraq war being prosecuted. But then how to explain how a number of other policies supported by the same elites but not the public during the same period -- Social Security privatization, immigration reform, invading Iran -- did not become law or practice? If we're to discard polls and the votes of representatives, how else are we going to get at the public's preferences to know whether they're relevant?

That's not to say that elites don't have a huge role in shaping public opinion, crafting the specific nuances of policy, or even that they have quite a lot of flexibility to shape policy to their own ends. Of course they do. Legislation is written by elected elites, who are influenced by unelected elites and interest groups within their states/districts. One casual glance at trade law is enough to convince anyone of that. Medicare Part D gets closer to Farrell's last sentence. The public supported coverage of prescription drugs by Medicare. It seems likely to me that the public did not have strong preferences over precisely how that happened, other than that they would prefer not to have to pay higher taxes. So what we got was an unfunded bill that catered strongly to the interests of the drug industry. Similarly, the public supported tax cuts. The particulars of the Bush tax cuts met that demand, but in a way that also privileged powerful interest groups and likely Republican voters (see the cartoon in the Bartels paper Farrell links to). There is nothing in the Hacker/Pierson or Bartels studies that Farrell cites that disputes this interpretation***.

But here's the key point: the policy space that elites use to manipulate for their own ends does not exist without the broad support of mass publics****. Or, as Farrell says, "It is fair to say that the Medicare changes began in a shift in partisan patterns of competition over issues. However, it surely didn’t end there." No argument from me. That, however, is not what Krugman argues. He claims that the public had nothing to do with it at all. That this is purely a top-down disaster. This view is disputed by the Campbell and Morgan quote that Farrell reproduces:

More generally, gaining the support of powerful interest groups was essential in passing a reform that was likely to garner little Democratic support and was viewed skeptically by more conservative Republicans.

Right, but this was only important because the public wanted Medicare to cover prescription drugs in the first place. If they hadn't, a bill that both Republicans and Democrats were ambivalent about is unlikely to have become law. To gain passage, and thus satisfy the public demand, it became necessary to craft a bill in such a way as to get the necessary support from powerful interest groups. But that doesn't negate the public's interest in reform along the broad lines that reform occurred. A very similar process occurred during the PPACA ("Obamacare") deliberations.

Near the end Farrell writes:

One can certainly make a reasonable case that electoral politics plays a more important role than Krugman acknowledges. But one cannot make a good case that policies of the kind that Winecoff describes are a simple reflection of public preferences.

This where Farrell is misreading me. (And, I think, Drezner.) We're not saying that the public was perfectly represented, much less "reflected". Indeed, I think such a statement is all but meaningless. Drezner has written a book about how interest groups dominate regulation of the economy, particularly in highly-technical areas in which the public is unlikely to have much information or strong preferences. We're both very interested in how power and influence is filtered through political institutions/interactions. I'm just saying, contra Krugman, that mass publics are part of that equation. After linking to a bunch of surveys showing that the public broadly supported the policies Krugman says they had nothing to do with, I wrote in my post, "This [reference to public opinion] might not work all the time, but as a first approximation this sort of thinking holds up fairly well". Or, at least, to entirely excuse the public from the outcomes of policy you should first have to show that they didn't create the political space for those policies to be enacted. Krugman can't do that. That's the point.

(As for housing policy, I'd refer Farrell (and anyone else interested) to the CPE/IPE research done by Seabrooke and Schwartz (also here and this special issue of Comparative European Politics). Ragu Rajan has argued that the rise of credit was encouraged by policymakers to offset stagnating median wages. Oatley has an argument that "what we're experiencing right now" is a result of a number of macro policies, operating within an international context, that both elites and the public broadly supported, culminating in disaster. I think, though I've done no research to back it up, that home ownership was encouraged by major public policies -- including the mortgage interest deduction and Fannie/Freddie -- supported through a host public policies by administrations and majority Congresses from both major parties across several decades, and that the most recent housing crisis is only the most recent, not the only. In many cases, bipartisan elite opinion is/was that these policies distort the economy and should be abandoned. Which mass publics wanted less access to credit and higher interest rates? Sure, finance liked it also, but they weren't the only ones. I.e., We got the housing finance we got because the public wanted credit, the politicians wanted votes, and the financiers wanted profits. NOTE: I slightly modified this parenthetical after initial posting to improve clarity and fix typos.)

*Usually IPE just pumps POLITY into a regression and mumbles something about transparency or checks and balances and then moves on.

**As for "On other [issues], [the public] has preferences that largely maps onto partisan identifications rather than actual interests"... Who's lazily inferring interests now? Why can't partisan identification be an interest?

***The dearly departed George Rabinowitz used to befuddle his Intro to American Politics students every year by assigning Showdown at Gucci Gulch, a journalistic account of the passage of the 1986 tax reform act. It does a great job of explaining how the pressure for tax reform was generated by the mass public, but how the vagaries of getting it passed heavily involved elites and interest groups.

****For one thing, saying "elites did it" doesn't actually tell us anything at all. There are elites on both sides of every issue. Krugman himself is an elite now, as he was during all of the 2000s, and yet he disagreed with most major policies enacted during that period. Which elites get to control policy is decided, among other things, by the publics.

Finance, Trade, and Growth Through History

New NBER paper:

Historical Evidence on the Finance-Trade-Growth Nexus
Michael D. Bordo, Peter L. Rousseau
NBER Working Paper No. 17024
Issued in May 2011

We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.

When all the debate over whether financial innovation added any value to society was going on, and folks like Volcker were saying that there was no evidence that it did, I always wondered what the evidence was. I've always thought that countries with deep, liquid financial markets had better economic performance than those that did not. I've always thought that financial innovation helped to create deep, liquid financial markets. Not sure this paper will settle that question, but it's worth a look.

There Will Be Politics

UPDATE: Henry Farrell and Dan Nexon have taken their shots at me, at least partly deserved, but I didn't say the things I said. A more fleshed out version of my thought is here.

Paul Krugman thinks that democratic politics does not exist:

Well, what I’ve been hearing with growing frequency from members of the policy elite — self-appointed wise men, officials, and pundits in good standing — is the claim that it’s mostly the public’s fault. The idea is that we got into this mess because voters wanted something for nothing, and weak-minded politicians catered to the electorate’s foolishness.

So this seems like a good time to point out that this blame-the-public view isn’t just self-serving, it’s dead wrong.

The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.

If Greenspan's "with notably rare exceptions" deserves internet infamy, and it does, then surely Krugman's less notable exceptions should too. As Drezner notes, Krugman's examples -- the Bush tax cuts and the Iraq war, mainly -- were supported by majorities of the population. Bush campaigned on a platform of tax cuts too, so it's not as if he tricked the public once elected.

What interests me about this isn't that Krugman is playing fast and loose with his factual claims, or even stacking the deck in a blatantly partisan way. That's par for his course. It's that he thinks that a simple political explanation is just not feasible. Instead, some moral lesson is needed. If something bad happens, it must be because bad people are doing it. This is the political sophistication of a six year old. The specific bad people in this case -- "self-appointed wise men, officials, and pundits in good standing" -- are less interesting than his usual coterie of sado-masochists, mythical creatures, and conspirators, but at least this time Krugman manages to indict a category of people that includes himself.

Occam's Razor can help us here. If there are tax cuts, maybe it's because people wanted tax cuts. If there is Medicare Part D, maybe it's because people wanted Medicare Part D. If there is a housing bubble, maybe it's because public policy was skewed in ways that home ownership attractive, because that's what people want*. This might not work all the time, but as a first approximation this sort of thinking holds up fairly well. In the examples Krugman gives, it's batting 1.000**. Saying that democratic polities have problems with time inconsistency and preference aggregation isn't exactly a new insight.

Krugman closes with this:

But the larger answer, I’d argue, is that by making up stories about our current predicament that absolve the people who put us here there, we cut off any chance to learn from the crisis. We need to place the blame where it belongs, to chasten our policy elites. Otherwise, they’ll do even more damage in the years ahead.

Amen, I suppose, but there's plenty of blame to go around. We all played a role in this crisis. Not an equal role of course, but a part nonetheless. Might as well own up to it.

*Mortgage interest tax deductions, subsidized subprime (and prime) loans, lower capital requirements for MBS, etc.

**Drezner wonders about public support for financial deregulation. I challenge Krugman to name the deregulatory act that led to the financial crisis. If he can't, and he hasn't, then his example fails and Drezner doesn't have to worry about it.

Euro Intrigue

Now this is interesting. Apparently some folks in Europe are questioning the Der Spiegel reporting that I linked to over the weekend. There are accusations that the German report was unsourced, unsubstantiated, and possibly designed to scare markets enough to kick off a self-fulfilling prophecy. This continues a recent pattern that included Nouriel Roubini as the proverbial canary in the coal mine. See, e.g., this report from Parisian periodical LIBÉRATION:

Washington, 17 April. A session held by The Institute of International Finance — which brings together banks, investors, monetary and financial institutions — was marked by major rumours. Their source, American economist Nouriel Roubini — the man that rose to fame when he successfully predicted the subprimes crisis who is also the President of RGE, an analysis firm that provides (expensive) advice to investors — was at pains to convince everyone that an imminent restructuring of Greek debt was on the way. ...

It took several days to calm the ensuing storm on the capital markets. On Friday 6 May, the same process began all over again when the website of the German weekly Der Spiegel "revealed" that a ”secret meeting” of Eurozone finance ministers was to take place on the same day in Luxembourg. On the agenda, discussions of “Greece’s request” to exit the euro. No sources were cited, but that did not prevent press agencies from taking up the story, or a subsequent slide in the euro. ...

But who stands to gain from the crime? Investors who are currently holding anti-Athens positions. Especially those who have bought Greek credit default swaps (CDS), who will lose their investment if default does not happen. Or those who are indebted in Greece or who have withdrawn money from the country, who have every interest in a return to the drachma. The rumour mill is set to keep on turning.

And Tyler Cowen points to this longer discussion of the weekend's "news". The gist:

It is my considered opinion that Der Spiegel, in consultation with certain circles within the German government (in particular the Finance Ministry) was trying to send a message to the German Chancellor but also the Greek Prime Minister. And what is this message? That there are far worse things than a debt restructure, the worst being a step-by-step dismantling of the euro that will begin once a country like Greece is forced into an impossible situation. And that continuing to live in denial, and to peddle blatant lies about the sustainability of the present course will no longer be tolerated.

It's no secret that investors will try to move markets in ways that are advantageous to them, nor that political elites will try to turn public opinion through the media. But in this case basically everyone agrees that Greece is insolvent, and that some form of restructuring is all but inevitable. That doesn't mean that the terms of that restructuring, nor the political implications for the eurozone, are assured. These might be examples of certain investors, government officials, or policy entrepreneurs to influence the timing of the restructuring, as well as the political response to it. That's interesting. I don't know quite what to make of it yet, but I'll be paying attention in the coming weeks and months. As always, whatever is decided there will be winners and losers.

Is This It?

Der Spiegel says Greece is about to restructure its debt and leave the eurozone:

Greece's economic problems are massive, with protests against the government being held almost daily. Now Prime Minister George Papandreou apparently feels he has no other option: SPIEGEL ONLINE has obtained information from German government sources knowledgeable of the situation in Athens indicating that Papandreou's government is considering abandoning the euro and reintroducing its own currency.

Alarmed by Athens' intentions, the European Commission has called a crisis meeting in Luxembourg on Friday night. In addition to Greece's possible exit from the currency union, a speedy restructuring of the country's debt also features on the agenda. One year after the Greek crisis broke out, the development represents a potentially existential turning point for the European monetary union -- regardless which variant is ultimately decided upon for dealing with Greece's massive troubles.

And here's one political dynamic:

The European Central Bank (ECB) would also feel the effects. The Frankfurt-based institution would be forced to "write down a significant portion of its claims as irrecoverable." In addition to its exposure to the banks, the ECB also owns large amounts of Greek state bonds, which it has purchased in recent months. Officials at the Finance Ministry estimate the total to be worth at least €40 billion ($58 billion) "Given its 27 percent share of ECB capital, Germany would bear the majority of the losses," the paper reads.

In short, a Greek withdrawal from the euro zone and an ensuing national default would be expensive for euro-zone countries and their taxpayers. Together with the International Monetary Fund, the EU member states have already pledged €110 billion ($159.5 billion) in aid to Athens -- half of which has already been paid out.

"Should the country become insolvent," the paper reads, "euro-zone countries would have to renounce a portion of their claims."

In other words, now that Greece has gotten funds from the EFSF there is domestic political pressure from citizens in the Eurocore to keep them in the monetary union, if only to get their money back. Interesting.

I've blogged a lot about this recently; in the past week or so I've written about it here, here, here, and here. Near the end of the most recent of those I summarized some IPE research on fiscal crises, fixed exchange rates, and propensity to devalue/default and concluded:

Greece? Not as highly financialized, a less stable government that is unable to make credible commitments to much of anything. Not as small or dependent on trade as Iceland and Ireland, although the difference might not be meaningful. Capital flight has already happened. A long history of profligacy, and a citizenry that didn't pay taxes in the best times. Internal devaluation is likely impossible even if it were desirable. Looks like a devaluation to me.

Not exactly a novel prediction, but one supported by prior research and not just a gut feeling.

The link above is via Ryan Avent, who says:

Even as it does this, it runs a deficit, which means that absent access to capital markets (and it will lack access to markets for the forseeable future) it must continue with austerity. Fearing a potentially ugly restructuring, some depositors have been pulling money from Greek banks, threatening the system with dissollution.

As ugly as this path appears, is departure from the euro zone really going to be better? Much of this pain is unavoidable. A massive devaluation would help Greece's economy, but the short-term impact of a Greek departure is unclear and could be highly destabilising. Over the long-term, it's not certain that Greece is better off outside the euro zone.

This is pretty close to my "there will be austerity" argument that Steve Randy Waldman discussed. Avent suggests that it may be a negotiating tactic, and I've made a similar case before: so long as Europeriphery debt is held by weak financial institutions in the Eurocore, the periphery actually has quite a bit of leverage.

If this is the beginning of a new bargaining round, it opens the window for a "Hard Keynesian" agreement similar to what Farrell and Quiggin propose. The timing for a broad negotiation seems about right: Portugal just had to tap into the EFSF fund for the first time, and pressures on Spain mount. There are many difficulties in getting such an agreement through -- I believe it requires the approval of the legislatures in every EU country, which doesn't seem likely -- but if it were ever going to happen, now is probably the time.

The Problem with Economics Is the Economists

Brad DeLong continues his trend of being unhappy with modern macroeconomics:

The most interesting moment at a recent conference held in Bretton Woods, New Hampshire – site of the 1945 conference that created today’s global economic architecture – came when Financial Times columnist Martin Wolf quizzed former United States Treasury Secretary Larry Summers, President Barack Obama’s ex-assistant for economic policy. "[Doesn’t] what has happened in the past few years,” Wolf asked, “simply suggest that [academic] economists did not understand what was going on?”

Here is the most interesting part of Summers’ long answer: “There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger.” That may sound obscure to a non-economist, but it was a devastating indictment. ...

Asked to name where to turn to understand what was going on in 2008, Summers cited three dead men, a book written 33 years ago, and another written the century before last.

It's a good piece, and Krugman assents, so let's turn the mic over to Kindleberger to find out why he thought macroeconomics suffered, during his 1985 AEA Presidential address:

In a recent paper, unpublished I believe, George Stigler discussed "the imperialism of economics," which, he claims, is invading and colonizing political science-through public choice theory and the economic theory of democracy-law, and perhaps especially sociology, where our soon-to-be president-elect, Gary Becker (1981), has extended the reach of economics into questions of the family, marriage, procreation, crime, and other subjects usually dealt with by the sociologist. "Imperialism" suggests super- and subordination, with economics on top, and raises the question whether as a profession we are not flirting with vainglory.

My interest has long been in trade, and I observe that economics imports from, as well as exports to, its sister social sciences. In public choice, we can perhaps explain after the event whose interest was served by a particular decision, but we need political science to be able to forecast which interest is likely to be served, whether that of the executive, the legislature, the bureaucracy, some pressure group-and which pressure group or, in the odd instance, the voters. Individuals act in their own interest, let us grant, but a more general motive of emulation may be drawn from sociology as Adam Smith was aware in the Wealth of Nations (1776, p. 717), as well as in The Theory of Moral Sentiments (1759 (1808), I, p. 113). I want today to borrow one or two ideas from political philosophy, and to conduct a conversation with a new, impressive, and growing breed of political scientists working on international economic questions...

In reading recent books on macroeconomic policy by leading governmental economists under both Democratic and Republican administrations, the late Arthur Okun (1981) and Herbert Stein (1984), I have been struck by how little attention the authors paid to international repercussion.

What Kindleberger is saying is that we can't examine the macroeconomy as if it were a machine that occasionally needs a tuneup. It's not. It's the product of political interactions that are designed to benefit some groups over others, and it takes place in an international context. To the extent that modern economics is a big utility-maximization problem, as if reaching the Pareto-frontier was the goal of public policy, modern economics is irrelevant. What Kindleberger is saying, then, is that ceteris is generally not paribus. Pretending that it is corrupts your whole analysis. Or, to put it into econometrics terms, ignoring international context and political systems creates a huge omitted variable bias in economics.

In a sense, I view my role (and that of other IPE people) in the intellectual universe as explaining to economists why their theories are either wrong or irrelevant. Showing how the variables they omit are causally significant. Unlike Krugman, it isn't surprising to me, or probably anyone in IPE, that the ECB is pursuing contractionary monetary policy when unemployment in Spain is 21%. The ECB isn't interested in the least in Spanish unemployment. It's interested in protecting finance in the European core. I don't need to subscribe to a pop psychology of masochism -- "pain caucus" -- to explain why we didn't get a bigger stimulus package. I don't need to vilify bankers to explain why we massively skewed public policy in ways that led to the financial crisis.

Economists sometimes mention politics, usually in reference to why their pet models don't work, but they rarely consider that pragmatic study of the economy outside of the political and social context it exists in makes little sense. The original political economists -- Hume, Mill, Marx -- understood this, as did the more recent political economists that Summers recommended to Wolf -- Minsky and Kindleberger. What Summers is really saying to Wolf is that the only interesting or useful economists are political economists. The interesting question is not whether Keynesian mechanics are better than Austrian mechanics, or whether saltwater fish is more nutritious than freshwater fish. The interesting question is who is driving the vehicle, and where they're taking it. Trying to locate the precise fiscal multiplier in a liquidity trap is thus like arranging your living room for party with no invited guests: an interesting exercise, perhaps, but really what's the point?

Similarly, it's silly to study a national macroeconomy outside of its international context. I'm not just talking about trade and foreign investment as substantive topics; I'm talking about how all domestic economic policies are conditioned by international circumstances. To ignore them is to discard major explanatory variables. Again, the early political economists realized this... it was the primary concern of Smith, Ricardo, Marx, and others. Kindleberger realized it. Some contemporary economists do -- including Krugman on his best days and DeLong most of the time, Eichengreen is obviously great -- but many do not.

I don't writes this as someone who dislikes economics as a discipline. I studied it in undergrad, and I still like it a lot. I think there's a lot of value in developing models that work in a first-best world, even if we're never in a first-best world. It is nice to know the landscape of the possible, and economic theory can help us understand preference formation, among other things. Economics has given us a lot of tools -- theoretical and methodological -- that can be applied in ways that help us advance our political understanding. But I chose to study IPE (rather than economics) in graduate school because I wanted to know how the world works, not how it could work. I share DeLong's interest in the history of thought in political economy (in fact, much of that interest was sparked by reading his blog while an undergrad), so when I decided to go to grad school I ruled out econ departments almost immediately for the reasons he describes. But I don't think the problem is solely a lack of teaching of economic history; it's that economics cast aside politics with the marginal revolution, and never got it back.

Why the Fed Isn't a Tough Regulator

Felix Salmon asks when the Fed will start caring about banking regulation, and points to this column by Jesse Eisinger. I'm not sure whether the question is serious or facetious, but I have an answer: never. And it's not really the Fed's fault.

What do I mean? As it happens, I wrote my thesis on this question*. The paper jumps off of previous literature that has established that monetary policy and regulatory policy have a natural tension. Monetary policy is counter-cyclical, regulatory policy is pro-cyclical. The principal-agent dynamic that exists when central banks are also bank regulators is such that central banks cannot credibly commit to either let struggling banks fail, or to tighten monetary policy when that might be damaging to banks. As a result, banks know they'll get liquidity support from regulatory central banks when needed, so they act more riskily than they otherwise would. It's a form of moral hazard that is distinct from the typical TBTF hazard, because the mechanism is monetary rather than fiscal, but it operates similarly. And it may be worse: it applies to all banks, not just TBTF banks.

To answer the question, I compare overall bank capitalization ratios across OECD countries and time (1992-2007) using a standard time series cross-sectional econometric model. These countries were all in compliance with the Basel accords by at least 1999, so they all subscribed to some broadly similar regulatory guidelines, and probably as far back as 1992. I use fixed effects to isolate changes within countries (so the stats aren't biased by idiosyncratic variation), and look at two interventions into the time series: the introduction of the Euro in 1999, which removed monetary authority from a number of domestic central banks and gave it to the ECB; and the reorganization of domestic regulatory institutions in five countries, all of which shifted regulatory authority away from their central banks in 1999-2000. I find that where monetary authority and regulatory authority were split, banking systems had higher capital ratios than when they were unified**. The coefficients are substantively large and statistically significant at the usual levels. The results are robust to the inclusion of controls (sorry Phil) and alternative specifications.

The takeaway is that institutional design is important here. If you give one institution conflicting mandates -- one to act counter-cyclically, and one to act pro-cyclically -- then at the relevant margin one of those two has to give. Private sector actors are smart enough to know that, and adjust their behavior accordingly.

*I'll post it soon, but I need finish up a couple of minor edits before sending it off to a journal.

**The only exceptions are the PIGS (actually just Portugal, Greece, and Spain).

UPDATE: This paper from Douglas Diamond and Raghuram Rajan, uploaded to NBER this week (ungated version), appears to be making a similar theoretical argument, although I haven't had time to go through it carefully yet.

ANOTHER UPDATE: The link to my paper is here.

This Is What Adjustment Looks Like (An Ongoing Series)

A dollar decline is what we would expect from a country with a large current account deficit and weak demand-side of the economy. And that's what we're getting. This is a bad thing for consumers, but a good thing for producers (at least exporters), and right now the country needs jobs more than anything. It's bad the US's external creditors, but good for the US's internal debtors (including the sovereign). If the dollar stays low, it will be interesting to see how other countries react. Another round of competitive devaluations? Internal macroeconomic adjustment, leading to a rebalancing?

I don't think this has much to do with QE2; it's exactly what we'd expect from a country in the US's position. But changes in the dollars value will force change on the US's trading partners, which is more or less everyone. It will be interesting to see what choices other countries make.

OBL

Dubya, 6 months after 9/11. I think he's basically right. Symbolically, this may be important. In terms of justice, YMMV but I'm very happy OBL is dead. In the grand scheme of things? I don't think it's especially important. bin Laden had not been an important source of al-Qaida strategy for a long time.

Some random thoughts:

1. Apparently OBL had been living in this compound for 5 years. People have called this a great achievement (finally!) by the CIA. Excuse me? 5 years?

2. It sounds like some of the intel that led to the couriers that led to OBL came from Gitmo detainees. That's unfortunate, because it will be used to validate that wicked policy. Let me be clear: if I had to choose between bin Laden dying naturally in isolation and a systematized policy of extraordinary rendition, indefinite detention, and "enhanced interrogation" torture, I'd choose the former. Every day. Twice on Sunday.

3. Related to #2, I'm very happy that the speech tonight wasn't given by President Giuliani.

4. All the talk is about how this changes our relations with Pakistan. I don't think it changes anything, but then I don't know anything about it.

5. I'm happy the Obama administration isn't desecrating the body, Guevara-style. I'm perplexed as to why they've apparently already dumped it out to sea. Fire up yer conspiracy theories.

6. This is the best account I've read so far about what happened. A lot is still very, very murky.

7. This does not validate the Obama administration. This does not disparage the Bush administration. This does not validate the Bush administration. This is the CIA finally doing it's job.

8. I'm looking forward to Hitchens' Slate column tomorrow. I hope he's healthy enough to rise to the occasion.

This is mostly political spectacle, not IR. So I don't expect to have anything else to say about it.

Some Politics of Some Novels

Awhile back a reader asked Tyler Cowen what was the prototypical left-wing novel, using these criteria:

A conservative friend and I recently discussed Atlas Shrugged, which he said was the ultimate right-wing novel. He challenged me to point him towards a left-wing novel that does for that side of politics what Rand does for the right. I think the book needs to do two things: justify the welfare state and argue the limitations of the invisible hand.

Leave aside for now the definition that a "left-wing" novel is defined as a "Third way" technocratic-utilitarian vision of society, where markets are good but externalities are real, and folks shouldn't be left to die in the street. The rules are: be like Atlas Shrugged in importance/influence, defend the welfare state (on what grounds?), question the invisible hand. That's a pretty strange set, and under most common utilitarian(ish) ethical paradigms including nearly any non-Objectivist Western ethical system, Atlas Shrugged is actually a pretty good example. The book is a nightmare; the Rorschach test is which nightmare you see. Rand imagined a dystopia where the weak and stupid push the strong and innovative out of society through confiscatory politics, leading to societal sclerosis and collapse. Others see a nightmare where less-talented people are dehumanized, where no conception of power or social structure is considered in the terms of production, and where there is no sense that markets require mass coordination among mass publics -- not just a cabal of smart people -- in order to produce the economies of scale that generate wealth. In other words, it comes down to how you view this statement from a young Alan Greenspan, responding to a negative review of Atlas Shrugged in the NYT Book Review: "Parasites who persistently avoid either purpose or reason perish as they should". If you're comfortable calling masses of humans that make up the market for Atlas' innovations "parasites", and if you're comfortable damning them to non-existence, then that puts you on one side*. It's a glorification of the politics that Thucydides decried: the strong do what they can, the weak suffer what they must. It is, in other words, an autocracy of the exceptional.

If you're not on that side, then you might conclude that society, including the capitalists, benefits from some form of a welfare state. Maybe also that the "invisible hand" (which makes no appearance in Atlas Shrugged) trembles a bit. If you're to the left of the Rand/Greenspan side -- which includes everyone this side of Hayek, inclusive, as well as later-period Greenspan -- then the nightmare of Atlas Shrugged is actually a very strong argument in favor of embedding markets within systems of governance, including a robust social safety net. In other words, Atlas Shrugged is not a conservative book at all, and Rand would have recoiled from the notion that it was. (The original questioner puts two signifiers in the first sentence quoted above: "conservative" and "right-wing". The two are not always analogous. This is one of those times.) In fact, there isn't much about Atlas Shrugged that is especially pro-market, in the Smith-Ricardo-Hayek sense. Dagny Taggart might have run her railway company, but she didn't single-handedly build the lines. Rearden may have invented a stronger steel, but he couldn't mass-produce it on his own. Atlas Shrugged is not a paean to markets; it's a paean to innovators. What it misses is that innovators need markets just as markets need innovators.

In some ways, Atlas Shrugged is the flip side of the Marxist coin: similar general theory of production, different normative implication. So I think the question is crap.

Nevertheless I won't want to evade it, but I am going to keep circling for a bit. Andrew Gelman says the answer to the original question is 1984, and I can see why. There's a certain strand of leftism coursing through that book. But ultimately, fundamentally, it is not an anti-market book, because it has little to say about markets. While the invisible hand of markets is mostly neglected, the visible hand of the state is scorned. What markets do exist -- in prole shops and the black markets -- yield nearly the only pleasures in the book.

Similarly, 1984 does nothing to justify the welfare state and is nearly as derisive towards the "proles" as Randians are of the "parasites". Yes, "if there is hope, it lies in the proles", but the takeaway is that there is no hope. The book is often read as anti-Stalinist, and it is, but remember that the imagined 1984 exists in England, not Russia. The warning is about creeping authoritarianism within social democracies. In that way, it's much closer to Hayek than most people realize. (Orwell reviewed The Road to Serfdom, and found not a little value in it. In fact, in many respects Orwell's vision of the future of social democracy is closely related to Hayek's, as Lord Skidelsky examines here)**. So when Winston doesn't even try to mobilize the proles, instead opting to infiltrate the elite, that should tell you something. The proles are too much distracted by pop songs and bad alcohol and pornography to be of any use. And life on the dole in 1984 isn't exactly portrayed as something to be desired. 1984 is one of the greatest criticisms of government ever written, and not just of the Stalinist kind. The left strands are all Trot-libertarian. Orwell was more Bakunin than Bukharin. While not an anarchist, he was not enamored with the statist "egalitarianism" either. So 1984 does not properly qualify as a left-wing book under the definition given, for similar reasons as those that disqualify Atlas Shrugged as a pro-market, conservative book.

Cowen says the answer is Grapes of Wrath, and immediately concedes that it doesn't answer the question. He also points to this list, most of which is disqualified by the criteria given, before concluding:

I would say that the story per se is usually left-wing, in both good and bad ways. It elevates the seen over the unseen, can easily portray a struggle for justice, focuses on the anecdote, and encourages us to judge social institutions by the intentions of the people who work in them, rather than looking at their deeper and longer-term outcomes. Precisely because the story is itself so left-wing, there won't be a definitive example of the left-wing novel. Story-telling encourages context-dependent thinking, although not necessarily in an accurate manner. One notable feature of Atlas Shrugged is how frequently the story-telling stops for a long speech or an extended dialogue, in order to explain some first principles to the reader.

Is the story per se left-wing? For that matter, is a "struggle for justice" left-wing? I hope and think that both answers must be "no", and not because I have any allergy to the descriptor. (These days, given all the essential and hard-won principles that yer archetypical "conservative" sneeringly calls "left-wing" -- equal rights under the law for everyone regardless of creed or personal proclivity, the maintenance of habeas corpus, the most basic rights to privacy and other civil liberties, xenophilia -- how could any considerate person not consider themselves some form of leftist? If those are wrong, then I don't want to be right. Wing, that is.) Many stories do look at the "deeper and longer-term outcomes", and I know Cowen knows this.

There's a bit of bias in Cowen's sentiment, but I see what he's driving at. I'd put it this way: the point of the welfare state is to eliminate the harsh drama that populates good fiction. So a left-wing counterpoint to Atlas Shrugged must either make the negative case against the lack of a welfare state (or equality, or democracy, or etc.) and need for a regulatory structure, or must be focused on other issues, with the social safety net just kind of sitting in the background. For the former, there's plenty of good stuff, from the Grapes of Wrath to Urban Jungle to etc. For the latter there is too, it's just not in the foreground. Almost any "urban" novel includes elements of this, as well as most stories set in educational environments, those including policemen as protagonists, etc. For certain types of "left-wing" you could choose several Vonnegut books. Why not Mark Twain? It would be hard to confuse him as unaware of deep, long-term outcomes of social policy. "The Importance of Being Earnest" is not a novel, but it is a story, and it is anti-conservative. Depending on how you define your terms, the New Testament might qualify.

Or I could just go with Gore Vidal's biographical novels of the United States***.

*And, as a friend commented on Twitter, everyone who proclaims to be on that side imagines themselves mini-Galts. A very un-Randian idea. E.g.: the producer/writer of the failed Atlas Shrugged film has blamed critics for its lack of success, and like Galt has declared himself "on strike". Which means that he won't make parts two and three. In response to the news, society shrugged. But why should a mini-Galt expect the masses to buy in?

**Skidelsky, of course, is Keynes' best biographer. In that capacity he notes that Keynes was also a Hayekian in some important respects. He wrote to Hayek in a letter, responding to The Road to Serfdom, "Morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement, but in a deeply moved agreement." (Quote from same link as above.) The question for Keynes was about where to draw the line. Hayek admitted there must be one, but couldn't say where it should go, which point was the one that tipped over into serfdom. Nevertheless, for this abandonment of purity, Rand called him (Hayek) a "compromiser".

***But I haven't read those.