Thursday, December 1, 2011

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

. Thursday, December 1, 2011

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

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

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

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

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

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

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

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

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

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

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

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


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




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