Tyler Cowen on Immigration

Very good:

In other words, immigrants may be competing more with offshored workers than with other laborers in America. ...

We see the job-creating benefits of trade and immigration every day, even if we don’t always recognize them. As other papers by Professor Peri have shown, low-skilled immigrants usually fill gaps in American labor markets and generally enhance domestic business prospects rather than destroy jobs; this occurs because of an important phenomenon, the presence of what are known as “complementary” workers, namely those who add value to the work of others. An immigrant will often take a job as a construction worker, a drywall installer or a taxi driver, for example, while a native-born worker may end up being promoted to supervisor. And as immigrants succeed here, they help the United States develop strong business and social networks with the rest of the world, making it easier for us to do business with India, Brazil and most other countries, again creating more jobs.

[I]t’s not all about one group of people taking jobs from another. Job creation and destruction are so intertwined that, over all, the authors find no statistically verifiable connection between offshoring and net creation of American jobs. ...

When it comes to immigration, positive-sum thinking is too often absent in public discourse these days. Debates on immigration and labor markets reflect some common human cognitive failings — namely, that we are quicker to vilify groups of different “others” than we are to blame impersonal forces.

The current skepticism has deadlocked prospects for immigration reform, even though no one is particularly happy with the status quo. Against that trend, we should be looking to immigration as a creative force in our economic favor. Allowing in more immigrants, skilled and unskilled, wouldn’t just create jobs. It could increase tax revenue, help finance Social Security, bring new home buyers and improve the business environment.

And yet many do not see it that way. This is not just an American problem. Migrant workers are also viewed suspiciously (at best) in developed Europe, are treated miserably in the Middle East, and are largely prohibited in China.

I wish this sort of economic argument would be persuasive, but in the end I don't think it's enough. I think people view society largely in terms of identity and ownership, and they don't want to lose control of that even if it would benefit them materially. I wish I was wrong about that. I don't think I am.

Why Greece Won't Default (Yet)

Yglesias:

Thanks to the Euro, none of that’s possible and it’s not at all clear to me what the endgame here really is. For understandable reasons, German (and Austrian, Dutch, etc.) taxpayers don’t want to bail out the government of Greece. And also for understandable reasons, German policymakers prefer the European Central Bank to run a monetary policy that’s appropriate for Germany rather than one that’s appropriate for Greece. So Greece is stuck on a path to default.

This is all right, but it stops where the interesting analysis begins. If Greece defaults, who will it affect? Well, it will hurt the owners of Greek debt, as well as the owners of debt of other troubled Eurozone countries. Who owns that debt? Banks in Germany and France, mostly:

German and French banks carry a combined $119 billion in exposure to Greek borrowers alone and more than $900 billion to Greece and other countries on the euro-zone's vulnerable periphery: Portugal, Ireland and Spain.

Together, France and Germany's banking sectors account for roughly half of all European banks' exposure to those countries. Nearly half of the outstanding debt is with Spain, according to data from the Bank for International Settlements. The data include government bonds, corporate debt and loans to individuals.

So the integrity of the French and German banking sectors are vulnerable to a Greek default. Of course, the integrity of the U.S. and U.K. banking sectors are at risk to the collapse of French and German banks. The question is whether these countries want to bail out their banking sectors directly after a Greek default, or bail out Greece before a default. So far they have chosen the latter, just as the U.S. did following the Latin American debt crisis in the 1980s. If banks are able to reduce their exposure to a debt default, we might see that change. Until then, we likely won't.

Mea Culpa (Kinda Sorta)

Somehow I missed this from Brad DeLong when it was first posted:

Now I do not think that the United States should pressure China--much--to more rapidly appreciate the yuan. The United States ought to help China become richer as fast as possible--and allowing them to run an undervalued currency and a big export surplus for a while is a good way to do that. The United States, as the hegemon of the world economy, ought to be able to manage the level of its own and of global demand without pushing for demand-shifting policies. A little pressure on China to figure out how to shift more rapidly to internal demand-driven growth is good for them and good for us. But too much pressure--I don't think so.

This amounts to a fairly strong, if unattributed, rebuke of the Krugman view. Since I publicly doubted whether he'd do it, I suppose DeLong's partial denunciation deserves a partial apology from me. So there it is. I still wish he'd take Krugman on directly when he goes all neo-con on China, but this is a good step.

Much Ado About China

Dan Drezner hits the road to hawk his new book at ZomBcon, but drops a challenge on his way out the door:

Question to readers: if you had to engineer the U.S. strategy in the Pacific Rim, what would you do to deal with a rising China? In your answer, be sure to acknowledge the risks and costs, as well as the benefits of your strategy.

Well, I'm at least as (un)qualified as everyone else writing on the subject, so why not?

1. Don't freak out. This is very important. Do not give credence to anything that Thomas Friedman heard in a cab in Beijing. Do not assume that China intends to be an evil empire. Do not assume that China has a masterplan at all. Do not assume that even if China had a masterplan that it would be able to carry it out. Do not assume that the U.S. has entered its autumn while China is beginning to bloom. As Jon Western writes:

[M]y broader objection to this discussion and to the broader debate on relative decline, power transition, and the "rise of China and India," is the failure to understand or examine the complexities and challenges that both China and India face. No one can dispute the extraordinary economic transitions and growth rates realized by China and India over the past twenty-five years. But most of the political discourse on power transition (and the lament of American decline) seems to assume linear trends over the next twenty-five to fifty years. ...

With all due respect to the challenges facing the United States, both China and India face far greater obstacles in terms of internal political challenges and vulnerabilities, in terms of the relative disparities in the distribution of wealth, in terms of dealing with abject poverty, in terms of rural to urban migration and the subsequent social and cultural dislocations, as well as in terms of environmental degradation and resource scarcity. Given these challenges, I'm not sure I see China's rise as inevitable -- we may see it, but we may not.

2. Remember the security dilemma. The traditional realist security security dilemma, yes, but also the economic security dilemma. Unless proven otherwise, our first interpretation of China's economic policies should be that they are intended to appease China's domestic audience, not global domination. Right now China's internal audience demands employment-boosting policies, and they are willing to suppress consumption and make really lousy investment decisions to get that. As Brad DeLong writes:

Look. China has 900 million rural dwellers who are still living at a standard of living not that far above subsistence. The pressure to migrate from the countryside to the coastal cities is enormous. China needs to grow at more than 8% per year in order to avoid mass unemployment in the coastal cities. And mass unemployment in the coastal cities is likely to be followed by political collapse and turmoil on a gigantic scale.

Part of growing at 8% per year is to continue to rapidly expand exports to the North Atlantic core of the world economy. But in order to expand exports Chinese-produced goods must look like good values. And if demand for dollar-denominated assets falls and the value of the dollar falls, Chinese-produced goods will no longer look like good values. We [China] know very well that when we unwind these purchases of dollar-denominated assets a generation from now the financial rate of return on our investments will be lousy. But in the meantime we get something much more important to us--export growth, full employment in Shanghai, and societal stability.

Right now it does not appear that China is interested in expending the resources necessary to become a global leader. And it likely will not for quite some time, even if recent growth rates persist.

3. Remember recent history. This isn't the first that Americans have gone all ZOMG! when another country's economy started growing. There was similar hysteria over 1950s-USSR, 1980s-Japan, 1990s-Russia, and others. Recent history suggests that underdeveloped economies will have periods of rapid growth, but this will not result in the overtaking of the U.S. in any worrisome timeframe. To this point, rumors of America's decline have been greatly exaggerated. As Kevin Drum notes:

[I]n relative terms America has declined since World War II. How could it not? There's simply no possible world in which a single country could retain the kind of power and influence that America held over a shattered world in 1945. As other countries rebuilt and grew, the inevitable consequence was that their power would grow relatively faster than ours.

But what's remarkable, really, is how little America has declined. We are perpetually astounded that our military might doesn't guarantee us instant victory anywhere we go and that other countries are routinely able to make trouble for us, but that says more about our national psyche than about our actual global influence or military power. If anything, our ability to project power may be greater today than it's ever been, and it's certainly greater relative to other countries than it was 50 years ago. Economically, our share of GDP fell surprisingly little in the postwar era, from 28% to about 22%, and has stayed very nearly flat since 1980. And political idiocy aside, our ability to lead the world in a rebound from a world historical financial crash has actually been pretty impressive.

The crisis has also caused all potential challengers to U.S. hegemony to turn inward. Germany and France are trying to somehow resolve the mess that is the E.U., the U.K. is intentionally contracting via austerity, China is acting like a bratty child rather than a mature power, and... that's it. Russia is still a mess, Japan hasn't recovered from a 15-year economic slump, India is still finding its footing, and there really aren't any other contenders.

4. Know your role. Right now the job of the U.S. is to act like a hegemon. It is to stabilize the global economy by keeping markets open and preventing tit-for-tat behavior. It is to not act selfishly by beggaring its neighbors. It is to strengthen and support institutions that foster cooperation rather than discord. It is to provide liquidity to the international system, and provide a market for distress goods. If there are going to be devaluations against the dollar, rather than fight them try to coordinate them so that exchange rates are somewhat stable. Some of these may slow the U.S.' internal recovery by a bit, but not as much as allowing the international system to collapse around it will. We want this to be more like the 1980s and less like the 1930s.

5. Build and maintain coalitions. The U.S. needs to reassure a skeptical international system that it is willing to do what is necessary to maintain a global recovery. That means it needs to credibly signal that intention to other countries. It needs to stress that it is in the interests of the United States to help emerging markets develop, and then follow up that rhetoric with actions. It needs to get stalled trade agreements moving. It needs to push -- hard -- for the elimination of agricultural subsidies in the U.S. and E.U. in order to get Doha going again. It needs to make short-run commitments to domestic growth (that is welcoming towards imports) and medium-run commitments to fiscal rectitude. It needs to build closer relationships in the Pacific Rim and elsewhere, but not for the purpose of frightening China. Rather, it should do it in a way that encourages further Chinese integration into the global economy.

Admittedly, much of this is difficult and likely cannot happen overnight. But China's recent belligerence towards Japan, South Korea, internal dissidents, and other groups has already drawn many of those countries closer to the U.S. If America can welcome that development without putting China too much on the defensive, then it could lead to better cooperation in the future.

I didn't spend too much time discussing potential costs and benefits of each of these, for two reasons. First, they are very hard to assess with any precision. Two, this post is already long enough. But my inclination is to say that none of these are especially costly, while the downside risk of neglecting them is great indeed. Just as TARP has ended up costing very little (or nothing) for the benefit it provided, any short-run expenditures in the service of the stability of the international economic system will be well worth it. Some of these have already been done, or are already being done, but I do fear that the Obama administration has been so focused on domestic issues that they've put some important international issues on the back-burner. That cannot go on too much longer.

Structure and Experimentation in the International System

Jeffrey Frankel says that we can learn from policy experiments in smaller countries:

Two decades ago, many people thought that the lesson of the 1980’s was that Japan’s variant of capitalism was the best model, and that other countries around the world should and would follow it. The Japanese model quickly lost its luster in the 1990’s.

A decade ago, many thought that the lesson of the 1990’s was that the United States’ variant of capitalism was the best model, and that other countries should and would follow. The American model lost its attractiveness in the 2000’s.

So, where should countries look now, in 2010, for models of economic success to emulate?

Perhaps they should look to the periphery of the world economy. Many small countries there have experimented with policies and institutions that could usefully be adopted by others. ...

[A] country does not have to be large to serve as a model for others.

Small countries tend to be open to trade. Often, they are open to new ideas – and freer than large countries to experiment. The results of such experiments – even those that fail – include useful lessons for all of us.

Perhaps. But small countries have a big advantage when it comes to experimentation: they are small. If Estonia or Mauritius (two of his examples) try out some new policy, it doesn't affect the global economy at all. If the U.S. even considers trying to adjust the composition of the maturity of its debt (QE2), the global economy goes crazy. If the U.S. pursues typical monetary policy -- holding interest rates low to combat deflation by counteracting a dropping velocity of money -- other major countries freak out about "currency manipulation".

There are structural factors in international politics that give states advantages over others in some areas but not in others. The position of the U.S. as the leading state provides benefits for the U.S., but it also prevents the sort of policy experimentation that has worked so well for Chile. Or China, for that matter. And Chile and China would not be able to experiment if the stability of the system was not maintained by others.

Nye Does TED

Via the Duck, Joseph Nye gives a TED talk:

The Global Financial System as a Network

We have been hard at work striving to apply some network concepts to the international financial system. Among other things, we managed to figure out (and by we I really mean Will) how to use R to visualize weighted network data. The two pictures here, which depict cross-border equity assets (stock) in 1980 and 2001, is one result of this effort. The 18 countries account for about 80 percent of global financial transactions (exclusive of government/central bank official reserve transactions). The thickness of the red and black reflect the absolute value of the assets placed by country A in country B. We need to add arrows here to make the direction clearer. Suffice it to say that the thick black lines linking to the US represent equity assets placed in the US market. Red lines emanating from the US represent US equity assets in the foreign market. Notice that these ties are substantially thicker in 2001 than they are in 1980, indicating the growth of cross-border equity investment since 1980.

Node size reflects the relative importance of that market in the global financial system. I was not surprised by the stability of the US position between 1980 and 2001; I was surprised by the dramatic change in the UK position. We are working to determine when, exactly, this huge growth in the importance of the London market occurred. Post 1987 I would guess. I am a bit surprised at how little change there is otherwise. In a period that we think of as financial globalization and redistribution of economic power, these figures suggest that more capital flowed across borders, but it went basically to the same place in 2001 that it went in 1980--to the US.

More of this to come in the future.

I should note that we generated these figures using the tnet R package developed by Tore Opsahl. Thank you, Tore, for making this available. The underlying data come from Kubelec, Chris and Sa, Filipa G., The Geographical Composition of National External Balance Sheets: 1980-2005 (March 23, 2010). Bank of England Working Paper No. 384. Available at SSRN: http://ssrn.com/abstract=1577143.

Fiscal Stimulus and The Unholy Trilemma

A new NBER working paper (earlier ungated version here) presents a more nuanced view of the effectiveness of fiscal stimulus:

How Big (Small?) are Fiscal Multipliers?

Ethan Ilzetzki, Enrique G. Mendoza, Carlos A. Végh

We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.

In other words, maintaining an open economy with flexible exchange rates prevents a country from using fiscal policy to stimulate during downturns. Note that under their definition (total trade = 60% of GDP), the U.S. is far from being an open economy. As such, the authors find that the post-1980 multiplier in the U.S. is 0.3 - 0.4. Additionally, when debt-to-GDP is greater than 50%, fiscal multipliers are nil or negative.

It appears that, once again, governments face a tradeoff between maintaining an open economy and being able to effectively moderate downturns using countercyclical policy tools. More specifically, the effect of monetary vs. fiscal stimulus appears to be moderated by exchange rate policy. Under fixed exchange rates, either capital mobility or monetary independence must be sacrificed. Under floating exchange rates monetary independence may be kept, but there's less room to maneuver on the fiscal side. That can leave a country in trouble if it runs up against the zero lower bound.

We may have to further complicate the Unholy Trilemma. In any case, this is a reminder that policy choices can have far-reaching effects.

The EU as a Deficit Economy

Emmanuel notes in a comment on my Global Imbalances post that perhaps the EU's net external balance is the better focus than the current account of a particular EU country like Portugal. This is probably true. Moreover, once we look at the EU as a whole we see additional evidence about why Geithner's proposal misses the point.

If we net out the individual EU members to produce an overall EU current account position, we see that the EU has a current account deficit. Hmm, that piece of information doesn't really help Geithner convince Angela Merkel of the need for a smaller German surplus, now does it?

And as Will points out, the distributional consequences of adjustment create incentive for Merkel and Co. to emphasize the EU-as-a-whole where, obviously, the contribution to global balancing must come through reducing the EU current account deficit rather than producing a smaller German surplus. In fact, perhaps the EU needs a bigger German surplus in order to bring the EU as a whole into balance?

Balancing Act

Just to piggy-back off of Dr. Oatley's post below. Geithner wants to cap current account surpluses or deficits at 4% of GDP. What effect would that have? Well, U.S. GDP is roughly $14tn. 4% of that is $560bn. In other words, a persistent 4% deficit in the current account is still quite large. Large enough that during most periods the U.S. was well within that boundary, though not during the mid-2000s. As the picture above shows, only in the last few years has the U.S.'s balance of payments been that sharply out of balance. (Note: that is nominal yearly data.)

What's interesting to me about the G20 kicking around these types of proposals are the distributional implications:

Representatives of the world’s largest economies, meeting in South Korea, reached tentative agreement early Saturday on the need to rein in trade imbalances, as part of an American-brokered compromise on calming exchange-rate tensions that have threatened to disrupt the uneven global recovery.

The Obama administration on Friday urged the other economic powers that make up the Group of 20 to agree to curb persistent surpluses and deficits that could contribute to the next financial crisis.

The proposal, which included a numerical limit, was backed by South Korea and quickly drew support from Britain, Canada and Australia. But it met with resistance from Germany and ambivalence from Japan, both major export countries. China, whose currency battle with the United States has threatened to derail the process of global economic cooperation, did not formally weigh in.

So after a marathon negotiating session that stretched into the predawn hours Saturday, the G-20 representatives agreed on the goal of “reducing excessive imbalances” — without a specified limit — and called on the International Monetary Fund to examine the causes of “persistently large imbalances.” The draft statement, to be ratified later Saturday, will also call on countries to “refrain from competitive devaluation” of their currencies, officials said. ...

Four countries have current-account surpluses exceeding 4 percent: Saudi Arabia (6.7 percent), Germany (6.1 percent), China (4.7 percent) and Russia (4.7 percent.) But under the American proposal, countries like Russia and Saudi Arabia that are “structurally large exporters of raw materials” would be exempt from the 4 percent limit, so the pressure would have fallen on China and Germany.

Two G-20 countries have current-account deficits larger than 4 percent: Turkey (5.2 percent) and South Africa (4.3 percent). The United States is next, at 3.2 percent.

A lot of stuff in here. First note that, once again, the expansion of the G7 to the G20 seems to have made it practically impossible to reach meaningful agreements with actionable language. How to reduce these imbalances? Umm... How much should they be reduced? No hard limit. What is the consequence of not reducing imbalances? None that I can see.

Of course the most important thing is who is reducing imbalances. As Dr. Oatley noted, it doesn't matter what countries like Turkey and South Africa do. Nor Russia or Saudi Arabia. It only matters what the U.S., China, and Germany do. The U.S. is under the proposed 4% limit, so is it any surprise that that is the level Geithner picked? It's the number that directly targets China and Germany, and to a lesser-extent Japan. The U.S. is trying to make China, Germany, and Japan pay for international macroeconomic adjustment. No wonder that those countries immediately rejected a firm requirement.

Meanwhile, Justin Fox notes that Keynes proposed something very similar during the Bretton Woods discussions:

Not impossible-to-enforce targets, but a system with incentives built in that would have made big trade imbalances unattractive to both sides. There’s that little matter of creating a new global currency and getting everybody to accept it, but this was at the tail end of World War II. If the U.S. had decreed that the International Clearing Union was a go, the International Clearing Union would have been a go. But at the time, the U.S. ran big trade surpluses and assumed it would do so forever. Its delegates at the Bretton Woods meetings were vehemently opposed. So the idea went nowhere.

Imagine that! Powerful governments decided not to pursue actions that went against their domestic interests. Who could have foreseen it?

The same dynamics are still at play even if some of the roles have reversed, so asking the IMF to investigate causes is a waste of time. China, Germany, and Japan have strong domestic political incentives to pursue policies that generate large current account surpluses. Their political survival depends on continued economic growth, and their economies are so structured that growth has to come largely from exports. The IMF will surely highlight the policies that lead to these outcomes, including exchange rate machinations, but it won't matter because they won't address the underlying political processes that generate the policies in the first place. Even if leaders wanted to bite the bullet and reverse these policies, their domestic constituents wouldn't allow it.

If the U.S. wants to address this issue, it's going to take much more than a vaguely-worded G20 communique. It will have to build a large constituency of other large economies. It will have to find a way to appease Germany and Japan while isolating China. It will have to massively boost domestic savings. And it will have to push a binding agreement through the IMF or WTO. That's a very tall order right now, and I don't see how they can pull it off. As the NYT article linked above notes:

Desmond Lachman, a former I.M.F. official now at the American Enterprise Institute in Washington, praised Mr. Geithner’s message. “It’s a constructive and imaginative proposal and it broadens the discussion away from an exclusive focus on currency to the wider set of policies needed to bring balance about,” he said. “But if you don’t have the Germans and the Chinese, this isn’t going to go very far.”

He added: “They want the U.S. to reduce its deficits, but they don’t want to reduce their surpluses.”

And vice versa.

Global Imbalances

Timothy Geithner proposed (in anticipation of the G-20 meeting in South Korea) that governments agree to limit the magnitude of their current account imbalances to 4 percent of GDP. Emmanuel thinks this is unlikely to be accepted. I would like to suggest that Geithner's proposal misses the point entirely.

The figure above plots current account deficits and surpluses (for 2008) expressed as a percentage of the total global imbalance. Notice that ten countries account for three-quarters of the total global current account deficit, and one country alone accounts for 44 percent (in 2006 the US share was 68 percent; still wonder why we had a global crisis?). The remaining 90 countries with deficits make up the balance. The global deficit, therefore, is really concentrated in a single country.

The surplus is less concentrated. The ten largest surpluses account for a combined total of 58% and the largest single surplus equals about one-quarter of the total. The other 42% is accounted for by the other 30 countries with surpluses. The global surplus, therefore, is less obviously the consequence of decisions in a single country than is the global deficit.

Asking governments to embrace a current account imbalance no larger than 4 percent of GDP misses the point, therefore, because it suggests that all imbalances are equally problematic for global stability. These simple statistics indicate quite clearly that all deficits are not of equal importance. Asking Portugal to limit its imbalance to 4% of GDP may be good for the Portugese economy and its overseas investors. For the world economy, however, reducing Portugal's deficit from 5 to 4 percent of GDP is irrelevant. And Portugal has the tenth largest deficit. Does anyone really believe that restricting Romania (0.1% of the total) to a current account deficit of 4% of GDP will have any impact on global imbalances?

The only imbalance that matters for global stability is the US imbalance. The US imbalance is problematic because when as much as 70 percent of the total global imbalance is concentrated in a single economy, an economic crisis in that economy has dramatic negative global consequences. You can't fix that problem by imposing a 4% of GDP limit. During the Reagan imbalance, for example, the US deficit equaled 58% of the total global imbalance but never rose much above 4% of GDP). What the G-20 ought to agree is that no country's current account imbalance shall account for more than 10 percent of the total global imbalance.

Of course, we don't need a global rule to make that happen. We just need to adjust.

TARP Still Making Money

Bloomberg:

The government has earned $25.2 billion on its investment of $309 billion in banks and insurance companies, an 8.2 percent return over two years, according to data compiled by Bloomberg. That beat U.S. Treasuries, high-yield savings accounts, money- market funds and certificates of deposit. ...

The $25 billion TARP return could fund the SEC for more than 20 years, based on the agency’s proposed 2011 fiscal year budget. It could pay for all farm subsidies in the U.S. for more than two years.

I've been beating this drum for awhile now, but it's worth returning to every now and then. We didn't lose hundreds of billions saving the banking sector. We bought depressed assets at low prices. Now that the assets are appreciating in value, we're making money.

Aid Incentives Matter (?)

Here’s the simple version: If people give you money because of A, then you don’t do anything to stop A. Even better, make A bigger so you get more money. ...

What’s interesting in Polman’s book is the way that warlords and crooked politicians [in the developing world] are actively making poor people worse off, to raise their profile and increase the flow of “do something!” money funneled through the Angelina-Bono-Geldof-Sachs pipeline.

That's David Zetland at William Easterly's place, building off of his short Public Choice piece (pdf). More discussion is here. The Jolie/Bono/Geldof/Sachs money is then appropriated by warlords and crooked politicians of course rather than going to the needy. Thus the needy stay needy, so they get more aid, which is also stolen by warlords, etc. It can be a vicious cycle.

The argument is that aid actually encourages oppression from autocrats, because they get more aid the more destitute and brutalized the populace is. More research is clearly needed on the question, but the I think the hypothesis is plausible. It reminded of this Acemoglu/Robinson paper (pdf), which I don't think is very convincing but points towards a similar dynamic whereby leaders actively harm their populations in order to secure positions of power.

I don't think we know enough yet to judge how prevalent this phenomenon is, but apparently Linda Polman makes the case in a new book that it's common enough to take seriously. I haven't read the book so I can't comment on it, but there is a logic here that is hard to dismiss out of hand.

Aniversario Feliz

It's the 50th anniversary of the U.S. embargo of Cuba. I think Greg Weeks says it best:

There just isn't any intellectual defense of the embargo anymore. It is not the cause of Cuba's economic woes--Fidel Castro himself has said the economic model is broken--though it has made the lives of the average Cuban more difficult. It has not led to the ouster of the Castro regime. It represents limitation of the freedoms of U.S. citizens. It creates global sympathy for a small country perpetually bullied by Goliath.

None of these outcomes are good for the Cuban people, for U.S. national security or for the U.S. economy.

We're About to Get a Huge Natural Experiment of Austerity in the Developed World

Cameron goes for it:

Britain's Treasury chief George Osborne said Wednesday the country's government will make the largest cuts to public spending since World War II — slashing benefits and public sector jobs in a five-year austerity plan.

Osborne confirmed he had ordered 83 billion pounds ($130 billion) in spending cuts through 2015, which he claims are necessary along with tax increases to wipe out a spending deficit that reached 156 billion pounds last year.

As many as 500,000 public sector jobs will be lost, welfare payments sharply reduced and dozens of scheduled government programs halted. He said that even Queen Elizabeth II would take a hit, cutting her royal household budget by 14 percent over four years under the plans.

"It is a hard road, but it leads to a better future," Osborne told lawmakers in a long anticipated statement to outline the coalition government's long-term economic plans.

Not much reaction on the FTSE, and not much movement on gilts either.. Perhaps markets had already priced this in.

China's Tantrum

What in samhell is China thinking?

China, which has been blocking shipments of crucial minerals to Japan for the last month, has now quietly halted shipments of those materials to the United States and Europe, three industry officials said on Tuesday.

The Chinese action, involving rare earth minerals that are crucial to manufacturing many advanced products, seems certain to further intensify already rising trade and currency tensions with the West. Until recently, China typically sought quick and quiet accommodations on trade issues. But the interruption in rare earth supplies is the latest sign from Beijing that Chinese leaders are willing to use their growing economic muscle.

Willing to use their economic muscle? Perhaps... but if so that muscle is about as big as my pectorals. (Read: practically non-existent.) "Rare earth minerals" aren't all that rare (there are large deposits in California, Brazil, India, and many other places, and the minerals can also be gleaned from recycled electronics), and China's going to lose when this hits the WTO. This is at most a minor annoyance to the U.S., Europe, and Japan, but it makes China look like a spoilt child who's refusing to eat his vegetables.

Unlike Krugman, I don't think the answer is to argue with the child. Better to let him sit at his place until the veggies are eaten. In other words, if China wants to be a major power in global politics, it needs to learn what that entails. Lashing out like a four year-old isn't how it's done. (Neither is responding in kind, as Krugman evidently wants.)

I assume that this move is an attempt to signal to some domestic audience, but I don't know enough about China's internal politics to know what that intention might be. I'd appreciate any pointers in that direction. In the meantime, this is further evidence that China is simply not as mature of a global power as many think.

Hegemony and Currency Wars

Apologies for the lack of posts lately. Real work has gotten in the way.

Over the past few weeks I've been thinking about the Fed's actions over the past few years. At the height of the crisis the Fed moved to shore up the integrity of the banking sector and immediately lowered the funds rate to practically 0%. It also engaged in a first round of quantitative easing -- by increasing the size of its balance sheet -- and qualitative easing -- by increasing the riskiness of its balance sheet. Most observers agree that these actions prevented the Great Decession from becoming another Great Depression.

Since early-2009, the recession has worsened but the Fed has mostly kept policy stable. This has led to complaints from many ideological corners; Scott Sumner and Paul Krugman don't agree on much, but they do agree that the Fed isn't doing enough. Some have expressed bemusement that "Helicopter Ben" Bernanke, student of the Great Depression, hasn't done more to prevent the worsening of the recession. After all, he famously said of the Fed's role in abetting the Depression:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton [Friedman] and Anna [Schwartz]: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

So why has he let the U.S. economy stagnate? Why has he let other countries devalue their currencies with no U.S. response? Why hasn't he learned from history?

Perhaps he has. I have no reason to think this is true, but perhaps Bernanke is influenced by another scholar of the Depression - Charles Kindleberger. Kindleberger argued that the Great Depression became a cataclysmic international event because of the unwillingness of the U.S. and inability of the U.K. to supply public goods to stabilize the international system. Those public goods include maintenance of a system of stable exchange rates and open markets:

"As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all," Kindleberger writes. "With tariff retaliation and competitive depreciation, mutual losses were certain."

In other words, perhaps Bernanke is acting as the world's central banker. If Bernanke believes that a U.S.-led currency war would have adverse consequences for the global economy, then perhaps he is willing to prolong the U.S. recovery in order to prevent a large global downturn. Such a deterioration of the global economy would also affect the negatively affect the U.S. of course. So while, ceteris paribus, a dollar devaluation would help the U.S., ceteris is not paribus. A U.S. devaluation would prompt a series of actions in Frankfurt, Tokyo, and Beijing. The resulting exchange rate instability would spook financial markets and hamper trade. Cries for protectionism would grow louder, and the net effect would be sharply negative.

Faced with that scenario, perhaps Bernanke has opted instead to try to stabilize markets and defuse an explosive global political economy by allowing other countries to beggar the U.S. some in the short run. Again, I don't know if this is the case, but it seems more persuasive to me than "Bernanke doesn't understand the monetarist lessons from the Depression".

It should be noted that Barry Eichengreen disagrees with Kindleberger about devaluations. Eichengreen argues that while competitive devaluations in the 1930s did beggar neighbors in the short run, they also constituted a large international monetary stimulus that helped pull the global economy out of the depression (after several years). More recently, Eichengreen has argued that this process is best done through multilateral policy coordination so as to avoid swings in exchange rates. Unfortunately this sort of coordination is basically impossible right now. The Prisoner's Dilemma that incentivizes beggar-thy-neighbor devaluations also incentivizes defection from a coordinated monetary policy.

Given that, perhaps Bernanke has chosen to follow Kindleberger's advice: provide as much liquidity as he can, work to maintain an open trading system and relatively-stable exchange rates, and allow other countries to devalue without U.S. reprisal. Perhaps that will cost the U.S. in the short run, but it can benefit the global economy over the longer run.

If the Debt Cannot Be Sustained, It Won't Be

Martin Feldstein has a plan for reducing the U.S.'s sovereign debt, in the form of an NBER working paper. I tend to be a believer in Herb Stein's Law on such matters.

That is all.

QOTD

From Angus:

Holy crap, people. Has China gotten so far ahead of us that they've made a cow that fits in a suitcase? Like the giraffe in the DirectTV commercial? Thomas Friedman will have a heart attack when he hears about this!

I COLed (Chortled Out Loud).

Rosling Talks to TED (Again)

Hans Rosling's TED talks are always fun, and we've hyped them repeatedly here. Well, he's got a new one on the Millennium Development Goals.



Via Aid Watch.

Trivia Time (E.U. Currency Arbitrage Edition)

Q. What does this quote refer to:

“A hundred years have passed,” the article noted, and “we Italians still have to put up with the same old filth.”

Is it:

a. Caricatures of Italians as mafioso in American pop culture.

b. Poor inspection of canned tomatos by the Italian government leading to an outbreak of salmonella.

c. Swiss xenophobia.

d. Corruption in the Italian parliament.

If you answered "c.", congratulations. Apparently a far-right Swiss party has been running explicitly racist ads that portray (Italian) rats nibbling on Swiss cheese. The rats represent legal Italian immigrants who work in Switzerland, which borders Italy to the north. It seems that this stems in part from the fact that Switzerland has ratified labor accords with the E.U., but has no adopted the Euro:

The global financial crisis has accentuated tensions here, especially since border workers began moving from jobs in sectors like construction, factory work or domestic help to jobs in areas that the Swiss hold sacred, like banking. ...

In the past, Mr. Rusconi said, “you had to beg Swiss graduates” to work in advanced service sectors like banking, insurance or financial services. “Now you have qualified people speaking four languages who are unemployed” because of competition from equally qualified Italians, who work for less money because exchange rates favor the Swiss currency. Claudio Pozzetti, a representative of the Italian trade union C.G.I.L. for border workers said this claim was untrue.

“And we have to fork out unemployment insurance to these young Swiss, so the damage is twice as great,” Mr. Rusconi said.

Nice little bit of currency arbitrage for Italian workers: Italians work for Swiss francs (which have recently strengthened relative to the Euro, prompting attempted devaluation), convert those to Euros, and pocket the difference. Swiss workers face increased competition, which flattens wages and increases unemployment. Swiss employers save money by hiring Italians. Add it up and you get vicious racism from the largest party in the Swiss Federal Assembly. Great.

You know Europe's in bad shape when even meek Switzerland is all messed up.

UPDATE: A commenter reminds me that the SPP has a tradition of being vicious racists, which I knew but had somehow forgotten about. Previous installments have especially focused on Muslims. Remember the minaret ban? See here and here and here for previous examples.

Pounding Away at the Deregulation Zombie

My last post has generated some discussion both here and at Seeking Alpha. Nobody agrees with me, and some have seemingly misunderstood my point. Here is what I said:

I don't think it's true that the financial system would be more stable absent all (or almost all) regulation, as Boettke and Horwitz argue. But to acknowledge that is not to imply that the system we have had at all resembles a deregulated system, nor that failures can't occur despite a heavy regulatory structure. The recent financial crisis spread throughout all kinds of countries: some heavily-regulated states had crises, while others didn't. We need to acknowledge that it's not as simple as "regulation safe, deregulation risky".

Here's what I did not say:

We should deregulate everything. That would make the system more stable.

In previous posts I've argued that the pre-crash U.S. banking/financial system cannot reasonably be considered as "deregulated" as it was one of the most regulated industries in the country, and was more-heavily regulated in the U.S. than in almost any other industrialized country. For example:

Reagan actually strengthened the financial regulatory structure after the Latin American debt crisis (Basel I), as did Dubya after the Enron collapse (Sarbanes-Oxley). The only major deregulation of the past three decades occurred during Clinton's second term (repeal of Glass-Steagall), and mostly what it did was allow American banks to trade on their own behalf... just as European banks had always been allowed to do.

The pushback comes along two general lines:

1. ::Fingers in ears:: NONONONONONONO! Reagan/Bush = free market fundamentalism. Therefore, they just must have deregulated everything, and this just must have caused the crisis. I will not believe anything to the contrary, ever, because I don't want to. (Extreme version at Seeking Alpha: accusing me of graduating from the "Joseph Goebbels School of Propoganda [sic]". No, seriously.)

That is not the more nuanced critique. This is:

2. There was "de facto deregulation" or a "deregulatory spirit" among regulators prior to the crash, despite the de jure tightening of regulations in some areas. This was pushed by one or two of the Seeking Alpha commenters, but mostly by Larry in comments here. The basic idea is that over the past few decades traditional banking functions (like mortgage lending) have increasingly been performed by non-depository institutions that were subject to much less oversight. At the same, banks and other financial institutions began using less-regulated or non-regulated financial instruments like derivatives, and nobody in government acted to bring these into the regulatory orbit.

There is a lot of truth to this, and it is perfectly compatible with the view I presented. I wrote that the regulatory code got stricter from 1980-2005. #2 argues that this may be, but it's only part of the story. If financial activity shifted to less-regulated institutions, then we could simultaneously say that the activities of financial institutions may have been less-regulated overall, even while the regulatory code was tightened. None of this implies, however, that it is the result of deregulation. In fact, the opposite is likely true if the "shadow banking system" grew in response to new regulations.

Did this happen? I honestly don't know. The financial industry in 1985 looked quite a lot different than it does today. True, there were no Countrywides issuing mortgages to everyone in the country, but there were a bunch of Savings and Loans doing similar things. Securitization wasn't as common in the 1980s, but securitization was done most by the GSEs operating under a public mandate and with a government guarantee, so it's a bit difficult to blame "deregulation" for that[fn1]. True, derivatives weren't as common in the 1980s and they were never required to be traded on exchanges, but does anyone really believe that that would have prevented a financial crisis when home prices fell by 40% nationwide? Remember that securitization was created to increase the liquidity in the system, just as credit default swaps were created to hedge against default risk. (It doesn't work too well as a hedging device if the counterparty can't pay up, but it's hard to base your investment strategy on the assumption that AIG is going to go bankrupt.)

Meanwhile, the bedrock of all regulatory regimes -- capital requirements and accounting standards -- were both stricter in 2007 than they were in 1980, for banks at least. If you don't trust simple counts of new regulations as evidence of this, or the enactment of the first two Basels and Sarbanes-Oxley, then you can still infer it from history. The fact that financial activity shifted away from the more-regulated banks to the less-regulated "shadow banking system" is itself evidence that the regulatory code had gotten stricter overall. Why? If regulatory arbitrage has become more profitable because the regulatory burden is heavier, then we should expect to see more of it. Which we did. Why else would a "shadow banking system" exist except to escape regulations?

The upshot is that the financial industry changed quite a lot in the past 30 years, and so did the regulatory structure. There were some deregulations, but many more new regulations (four times as many, according to Horwitz and Boettke). There were two major international regulatory agreements during that period, both of which tightened regulatory regimes. Some financial activities remained less-regulated than others, but that had always been the case. Non-regulation is not the same thing as deregulation. Blaming Summers, or Rubin, or Bush, or Reagan for not doing what nobody else had ever done is nothing more than scapegoating.

Whatever else we can conclude from this, we can say with certainty that the "30 years of deregulation by free market fundamentalists caused the financial crisis" narrative is at least too simplistic, if not outright false. We can say with certainty that financial markets, among the most-heavily regulated markets in the world, did not in any way approach laissez-faire. Anyone who is arguing either of those points (e.g. Charles Ferguson) is either ill-informed or mendacious.

[fn1] And, contrary to CW, W. Bush tried repeatedly to regulate the GSEs more tightly and was rebuffed by Congress. Many Republicans were part of that effort, but the biggest obstacles were noted laissez-faire fundamentalists Chris Dodd and Barney Frank. Larry Summers, for the record, wanted to regulate the GSEs more strictly in 1999, as did Alan Greenspan by at least 2004. It is true of course that both pushed hard against regulating derivatives. As with everything else, it's just not as simple as Summers/Greenspan = deregulation. It depends on the case.

Policy Preferences over Capital Controls

Sebastian Mallaby has a new op-ed in the Financial Times about the difficulty of reversing financial globalization. While that may be true, Mallaby makes some pretty crazy claims on the path to this conclusion.

First, Mallaby suggests that a growing preference for increased capital restrictions among policy makers in US and Europe signals an end to consensus among the richest economies that capital mobility creates growth. By comparing the policy response (and rhetoric) of today to the response to the Asian and Latin American crises of previous decades, Mallaby points out that while the IMF, the US, and the EU pushed capital account openness before, they are now more willing to entertain the idea that capital account openness might be too risky. But, in the past the US and Europe weren't the states having difficultly financing their current account deficits. It makes sense that the US and Europe will now be more open to some measures of capital account restraints since they may want to keep investment from going abroad. And, this policy preference may well be temporary - when macro imbalances are corrected, the US and Europe may be perfectly willing to support unfettered capital account openness once more.

Second, in talking about US animosity towards China, Mallaby offers this policy advice:

Equally, proposals to prevent Chinese capital from flowing into the western economies have a clear appeal. China's peg, and the associated capital exports, distort the world economy; and years of patient diplomacy have failed to resolve the problem. Retaliating against China via trade sanctions would be reckless, since doing so would spread the existing currency war into the trade realm. So why not apply a more proportionate sanction? China already prevents foreigners from buying its bonds, so what is wrong with preventing China from buying US Treasuries? (emphasis added)

Wait, what? The last thing the US wants to do is to cut off a major buyer of its debt!

Rather than characterizing the return of capital controls as an indication that policymakers are moving towards a new consensus on the perils of globalized finance, it may be far more helpful to think about the conditions under which governments will advocate barriers to financial flows.

Finally, while the incentives for making it difficult for domestic capital to exit are pretty straightforward, it is less clear what drives governments to erect barriers to foreign sources of investment. Mallaby mentions Brazil's new tax on foreigners holding domestic securities. What drives these policy choices? Might it be that emerging economies may want to limit the rate of capital inflows since inward investment can easily overwhelm a small economy? If so, would that preclude advanced industrial economies from enacting such barriers?

Just How Laissez-Faire Was the Financial Sector?

I just want to tie up some loose ends on Charles Ferguson and the argument that the recent financial crisis was the end product of several decades of financial deregulation. I've already pushed back against this here and here, now Will Wilkinson piles on:

As economists Peter Boettke and Steven Horwitz have pointed out in a lucid short paper on the causes of the "Great Recession", between 1980 and 2009, four new regulatory policies were imposed on the financial sector for each regulatory policy lifted. It's simply inaccurate to describe this period as an era of deregulation. It was, on the whole, a period of decidedly increasing regulation.

Boettke and Horwitz's paper is here (pdf). As actual laissez-faire Austrian economists, unlike Summers and other neo-Keynesians that Ferguson goes after, they point out that:

We do not live in a free market. We live in a mixed economy. The mixture varies by industry. Technology is primarily free. Financial Services is primarily government. It is not surprising that the most government regulated and controlled segment of the economy, financial services, experienced the biggest problems.

Jeffrey Friedman has made similar points (pdf). This is more or less true. Even the biggest deregulation over this period -- the repeal of Glass-Steagall -- simply allowed U.S. banks to act more like Continental European banks always had. Is it really Ferguson's position that the financial crisis occurred because the U.S. moved towards a more European system?

I don't think it's true that the financial system would be more stable absent all (or almost all) regulation, as Boettke and Horwitz argue. But to acknowledge that is not to imply that the system we have had at all resembles a deregulated system, nor that failures can't occur despite a heavy regulatory structure. The recent financial crisis spread throughout all kinds of countries: some heavily-regulated states had crises, while others didn't. We need to acknowledge that it's not as simple as "regulation safe, deregulation risky".

Good Research = ...

Fabio Rojas describes his attitude towards social science research:

Here’s how I evaluate research importance in social science. Averages, of course:

1. Great problem, great solution.
2. Great problem, partial/boring solution.
3. Decent problem, great solution.
4. Great problem, empirical/descriptive work.
5. Decent problem, partial/boring solution.
6. Decent problem, empirical/descriptive work.
7. Small problem, any solution.
8. Bizarre/highly technical approaches to any problem.
9. Definitional/taxonomic/philosophical writings on any problem.
10. History of social thought.

Sounds about right, but all of those categories are more-or-less in the eye of the beholder, yes?

The Merits and Demerits of Relative Decline

Matt Yglesias comments on all the worry about America's decline (put into perspective succintly by Kevin Drum here):

Something to note here is that relative [American] decline would almost certainly be a good thing. America’s share of world population is pretty small, so far and away the most likely scenario for American relative decline would be “catch up” growth in large poor countries such as China, India, Brazil, Indonesia, Pakistan, Bangladesh, and Nigeria. And I hope it happens! A lot of third world countries adopted staggering bad policies in the postwar era. That bolstered America’s relative standing in the world, but it was a human tragedy. Besides which, even if faster growth in those places leads to relative decline in American dominance, it would almost certainly boost our living standards in absolute terms. Healthier, better-educated, freer, richer, more productive people in all those other countries would invent marvelous things, produce great works of art, etc. and we’d all win.

What Yglesias is saying here is that there are two ways for American prestige to decline in relative terms: 1. the numerator (American affluence) can decrease; 2. the denominator (global affluence) can increase. Both would lead to a smaller quotient, but #1 would be bad for global well-being while #2 would be good for it.

I'm with him, as far as it goes. But there's a but: Power Transition/ Hegemonic Stability Theory predicts rising geopolitical instability as the relative position of the leading state declines. Basically the idea is that security dilemmas are mitigated when one state has a preponderance of power, but are exacerbated when other states approach parity (if the rising state is dissatisfied with the international order). Robert Keohane, one of IPE's founding fathers, argued that multilateral institutions might be sufficient to ease those pressures, but that theory has yet to be put to a strong test. The recent record of the major multilateral institutions doesn't leave me with too much hope.

That doesn't mean that we shouldn't strongly encourage the continued development of the rest of the world. We should. But we need to be wary to not fall into the spiraling trap. So when we read people like Fred Bergsten laying the groundwork for a trade war we should run as fast as we can in the opposite direction. (Anyone want to bet that Krugman won't link approvingly to that Bergsten post within 24 hours?)

It's a shame, but it seems that today's international economists don't remember the basic lessons of Charles Kindleberger. Everyone has gone back to Keynes and Minsky in the past few years, but Kindleberger is just as worthy of a re-read. Today's protectionists too often have partial equilibrium (domestic) economic models in mind when what's needed is general equilibrium (international) political economy models. And so they advocate instability when the world desperately needs stability.

Don't listen to them. They preach destruction.

William Easterly Is Shrill!

What else is new, I know, but it's always important to take a longer-run perspective:

So another way of stating China’s rapid growth recipe would be something like the following:

Have a succession of crazy autocrats, political chaos, and war savagely repress one of history’s most inventive peoples, along with not allowing one of the most successful trading diasporas in history to operate in China proper. Then have things calm down a bit and have somewhat less crazy rulers allow more of the people’s energy and creativity to burst out. Presto, the change from EXTREME NEGATIVE to LESS NEGATIVE is called a “growth rate,” and it will be high. Now accept worship from around the world.

More at the link. I hope to have more to say about the "somewhat less crazy" part of this over the next few days. But Easterly's point is that we should not be emphasizing how well China is doing under an autocratic system, but how poorly they have done. Look at these charts, created from Angus Maddison's data and pilfered from here:







The point is that China's economic performance has been so unbelievably poor over the past few centuries, almost against all odds, that any government just to this side of sado-masochistic could expect to produce short-run economic growth. That doesn't mean they are worthy of praise.

Perspective Matters

Good stuff from Dave Hart:

Moreover, that Hayek's predictions failed to materialize is a testament to the degree to which we've internalized many of his arguments in the book. I would argue that the same can be said for Marx. The extremes that both men were railing against no longer exist as credible threats to our society, despite what some will have you believe. In re-reading these texts, their arguments would almost seem quaint were it not for the recognition that the problems were, at the time, very real.

The flip side to all of this is that this particular book has lost much of its relevancy to the problems we are dealing with today, much in the same way that many of Marx's writings are of little use in addressing contemporary issues. That may not please the self-styled radicals at either end of the ideological spectrum, but for the rest of us it is very good news indeed.

I was never impressed with Road to Serfdom, but I suspect it is for this reason. From the perspective of 1942, when the world was terrifying and nearly all economies were commanded and controlled, it probably made a lot more sense. Getting on a high horse and waiving the book in the air in 2010 doesn't.

Meanwhile, Brad DeLong asks how much the market organization of economic life matters, which is what Hayek (and Marx) were really concerned about? Almost a factor of 10, as it turns out.

Lou Dobbs: Hypocrite

Well, whaddya know:

In Lou Dobbs's heyday at CNN, when he commanded more than 800,000 viewers and a reported $6 million a year for "his fearless reporting and commentary," in the words of former CNN president Jonathan Klein, the host became notorious for his angry rants against "illegal aliens." But Dobbs reserved a special venom for the employers who hire them, railing against "the employer who is so shamelessly exploiting the illegal alien and so shamelessly flouting US law" and even proposing, on one April 2006 show, that "illegal employers who hire illegal aliens" should face felony charges.

Since he left CNN last November, after Latino groups mounted a protest campaign against his inflammatory rhetoric, Dobbs has continued to advocate an enforcement-first approach to immigration, emphasizing, as he did in a March 2010 interview on Univision, that "the illegal employer is the central issue in this entire mess!" ...

But with his relentless diatribes against "illegals" and their employers, Dobbs is casting stones from a house—make that an estate—of glass. Based on a yearlong investigation, including interviews with five immigrants who worked without papers on his properties, The Nation and the Investigative Fund at The Nation Institute have found that Dobbs has relied for years on undocumented labor for the upkeep of his multimillion-dollar estates and the horses he keeps for his 22-year-old daughter, Hillary, a champion show jumper.

Revenge is a dish best served with a side of picante sauce.

QOTD

First deputy managing director of the IMF John Lipsky:

“Basel III is microprudential”, said Lipsky, and there’s very much still a need for big-picture cooperation between countries when international financial institutions get into trouble. That said, he was at pains to say that he didn’t want the job: “we’re not supervisors, we’re not regulators, and we do not aspire to be either. We can provide perspective to the standard setters. This will be an agreement among sovereigns.”

At this year's ISA meetings I attended a panel that discussed what sort of new international financial regulatory architecture should emerge from the crisis. The only concrete suggestion (made by Benjamin Cohen) was for the IMF to play a much greater role, the hold-up being that national governments didn't want them to. Well that's true, but as it turns out the IMF doesn't want to either. This is not what the IMF is for, it's not what they're good at, and they recognize that.

Auschwitz, Germany, and 1968

I recently watched the excellent The Baader Meinhof Complex, about the wing of the sixty-eighters in Germany that eventually morphed into the Red Army Faction of domestic and international terrorists. I was originally turned onto the film by this Hitchens review of it. Like him, I highly recommend it, and it's available on Netflix Instant for those who subscribe.

Anyway, I didn't know much about the group before watching the film, and it sent me on one of those down-the-Wikipedia-wormhole jags that sucked up an evening. So I was pleased to find this excellent review in the recent n+1 by Yascha Mounk of Utopia or Auschwitz, a recent Columbia UP book by Hans Kundnani on the sixty-eight generation, its origins, its politics, and how it all went wrong. In a byte:

The violent fringes of the 1968 movement eventually even invoked the name of Auschwitz to justify lethal attacks on Jews. Identifying fascism with capitalism, capitalism with the Federal Republic, the Federal Republic with the US, the US with Israel, and Israel with all Jews, they soon came to think of Jews as the true fascists. This may sound like the tortured logic of your average antisemite, but the RAF started from an unusual premise: it was precisely the concern with the injustices their parents had perpetrated against Jews that led these young Germans to kill more Jews.

This was but one of several pathologies operating in German society at the time. But eventual statesmen like Gerhard Schröder and his foreign minister Joschka Fischer learned from them, and used them to further the rehabilitation of Germany as an important nation-state.

The government, along with other NATO countries, planned to use military force to protect Kosovar Albanians against Serbia. Fundamentalists within the [Green] party were outraged. On their view Germany’s history mandated pacifism. Fischer, by contrast, derived from his own understanding of German history an imperative to stop genocide by whatever means necessary.

“I didn’t just learn ‘Never again war,’” he told activists at a tense party conference, “I also learned, ‘Never again Auschwitz.’” In the end Fischer narrowly prevailed over the fundamentalists in his party. Under his leadership—and in the name of Auschwitz—German planes assisted in bombing Serbia. It was the first offensive mission of the German Army since World War II.

It's a fascinating review of what appears to be a fascinating book. I'm looking forward to reading it.

Hatchet Job

Charles Ferguson, the maker of Inside Job, is losing credibility almost by the day. I previously discussed here and here how he's got the history of the U.S. economy, financial crises, and regulation wrong. But those mistakes are at least somewhat academic, if pretty basic. In his anti-Summers companion piece, however, Ferguson reveals that he is simply not a reliable source:

In 2005, at the annual Jackson Hole, Wyo., conference of the world's leading central bankers, the chief economist of the International Monetary Fund, Raghuram Rajan, presented a brilliant paper that constituted the first prominent warning of the coming crisis. Rajan pointed out that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people's money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a "full-blown financial crisis" and a "catastrophic meltdown."

When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a "Luddite," dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector.

Brad DeLong digs up this "attack":

I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject, like Don Kohn, from Alan Greenspan, and someone who finds the basic, slightly Luddite premise of this paper to be largely misguided. I want to use an analogy, not unlike the one Hyun Song Shin did, but to a rather different conclusion.

One can think of the history of transportation over the last two centuries as reflecting a gradual and determined move away from arm’s length transactions. People once supplied their own power. Then, they started carrying on transportation using tools that they owned. Then, they increasingly relied on tools that other people owned that were provided by intermediaries.

In that process, the volume of transportation activity increased very substantially. Over time, people became almost entirely complacent about the safety of the transportation arrangements on which they relied. Large sectors of the economy came to be organized in reliance on the capacity of planes to fly and trains to move. The degree of dependence on individual hubs—like O’Hare Airport—increased substantially. The worst accidents came to be substantially greater conflagrations than they had ever been in an earlier era.

Yet, we all would say almost certainly that something very positive and overwhelmingly positive has taken place through this process. Something that is overwhelmingly positive for individuals is that the number of people who die in transportation-related episodes is substantially smaller than it was in an earlier era.

The best single way to think about the process of financial innovation is as representing a similar process of movement across spaces, spanned not by physical space, but by different states of nature. It seems to me that the overwhelming preponderance of what has taken place has been positive. It is probably true that—as we didn’t use to have transportation safety regulation and we do now—an evolving system does require an evolving regulatory response.

But it seems to me that one needs to be very careful about stressing the negative aspects of the evolution, relative to the positive aspects of the evolution. I was going to make the same point that Don Kohn made about the Japanese financial system and the Scandinavian financial system standing out for the magnitude of damage done and the reliance on vanilla banking, relative to other activities.

Something similar could be said about the history of U.S. business cycles. The history of the business cycles prior to 1970 would place very substantial reliance on problems that came out of the financial sector and the regulation of the financial sector.

I was surprised by the tone of the recommendation around the incentives because it seems that if you take what is the central, most plausible area of concern that is suggested by what takes place in the paper, it is the notion that speculation involves negative feedback over a certain range, then positive feedback once you get outside of that corridor, and that process is very substantially exacerbated by hedge fund phenomena. Indeed, if one looks at the Shleifer-Vishny paper that Mr. Rajan refers to, hedge funds and the behavior induced by hedge funds and hedge fund liquidations are the central example. Yet, hedge funds would be the primary example we have of a financial institution where those who were running it did in fact have, as Raghu Rajan recognized in his comment on Long-Term Capital Management, very substantial wealth that was involved.

While I think the paper is right to warn us of the possibility of positive feedback and the dangers that it can bring about in financial markets, the tendency toward restriction that runs through the tone of the presentation seems to me to be quite problematic. It seems to me to support a wide variety of misguided policy impulses in many countries.

I would say as a final example of what has come out of the discussion for the 1987 crisis is that if those who wish to protect their assets had bought explicit puts rather than portfolio insurance, the situation would have been substantially more stable. That also argues for the benefits of more open and free financial markets, rather than for the concerns they bring.

Summers' critique is not dismissive at all. He deals with Rajan's argument with respect and interest. He acknowledges the strengths of it (as he sees them), and clearly expresses where and why he disagrees.

DeLong says that, despite Ferguson's mischaracterization, Rajan was right and Summers was wrong. If you take a short view (i.e. 2005-2010), Rajan clearly is right and Summers clearly is wrong. But if you take a long view, as Summers is obviously trying to do, it's not so clear. Has the "increased transportation" of finance really hurt the global economy over the past 50 years? 150 years? There have been a multitude of booms and busts during that span, but in the end it's hard to argue that we should entirely forego checking accounts and ATMs and electronic transactions and futures contracts and etc. These innovations have added an enormous amount of value to society, and in general has made the economy much safer and secure than it would otherwise be.

I still want to see Inside Job. But I'll be watching with a more skeptical eye now.

OT: European Stuff

How bad is it in Italy these days? Those who hope for democracy, including those on the left, now largely support a post-fascist who was an ally of Berlusconi's until very recently. A man who once said "Mussolini was the greatest statesman of the century. There are periods in history when freedom isn’t one of the most important values."

Yikes. Yascha Mounk does a number on Gianfranco Fini here, and goes after the rest of the European right (and much of the left) here.

Defining Basel Down

Marc Levinson's article on Basel III at Foreign Affairs is awfully simplistic and doesn't really bother with any of the international politics of it, but at least he gets one part right:

Perhaps Basel III’s biggest problem is that no matter how reasonable the new standards, the Committee on Banking Regulations and Supervision has no power to enforce them. Real reform of the international financial system will depend on turning Basel III into domestic policy. Only national governments can establish and enforce regulations on banks operating in their territory. And only national governments could be held politically accountable for regulatory failures.

I've written about this at some length several times, e.g. here, so there's not much more I can add. But this is a key dimension of Basel, and it's worth highlighting more than once.

A Prediction Sure to Be Wrong

Who else?

Barring a transformation of the Democratic and Republican Parties, there is going to be a serious third party candidate in 2012, with a serious political movement behind him or her — one definitely big enough to impact the election’s outcome.

The most charitable way to interpret this is as literally as possible. After all, Ralph Nader may have tipped the 2000 election to Bush and Ross Perot may have helped Bill Clinton defeat H.W. Bush in 1992. So you could say that those candidates "impacted" the election's outcome, but only by marginally tilting things towards one or other of the two major parties. In neither case has a serious third party emerged to influence public policy or future elections, but it seems that every few elections a third party spoils it for one of the big dogs. I don't think that's what Friedman is talking about, however, because of what Friedman wants this emergent third party to do to American politics:

We need to stop waiting for Superman and start building a superconsensus to do the superhard stuff we must do now. Pretty good is not even close to good enough today.

Besides being High Broderism, just how exactly would further fracturing the political system lead to a "superconsensus"? If two parties are too beholden to their interest groups to enact "optimal" policy by consensus, what makes Friedman think that adding a third group would some how make that easier? Friedman needs to brush up on his Olson.

I've been reading a lot lately about how the political system is broken, and how we're doomed because there are too many veto players and things can't get done and we can't make "tough decisions" and bipartisanship is dead and "special" interest groups have too much influence etc. You know what? That's American politics. That's the way American institutions were designed: to favor incremental changes that required the approval of large groups of different people. That's why changing the system has always taken a very long time. And that's why we have the party system that we have. Perhaps a parliamentary system that encourages the participation of more parties would be better, but that's not what we have. The two-party system is a product of institutional design, and that's not changing in the next 18-24 months.

Finally, how weird is it that just a year ago Friedman was advocating one-party benevolent authoritarianism as the solution to all our problems, and now he's advocating the exact opposite?