Interests, Ideas, and MIT Economists

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

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

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

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

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

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

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

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

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

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

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

Why Theories of Regulation Are Inadequate

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

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

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

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

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

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

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

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

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

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

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

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

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

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

New Research

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

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

NBER Working Paper No. 17577 

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

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

Testing the Global Financial Transparency Regime
J. C. Sharman 

International Studies Quarterly Vol. 55 No. 4 

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

The IPE work on exchange rate regimes continues to improve.

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

International Studies Quarterly Vol. 55 No. 4

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

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

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

International Studies Quarterly Vol. 55 No. 4 

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

There Is No Technocracy QOTD

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

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

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

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

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

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

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

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

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

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

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

Interests and Cognitive Dissonance

In my mind, one of the biggest challenges facing IPE research is how to accurately model the link between interest formation and interest aggregation. (SBD said something about this in conversation the other day, and i've been mulling it over since.) Quite often in IPE we infer interests from economic models. E.g., the scarce factor/sector of production should prefer trade protectionism, while the abundant factor/sector should prefer openness. Or we infer "government" preferences based on the partisan composition of the ruling coalition or executive. I think we all know that these are shortcuts that can't be justified in all circumstances, but as a first cut these types of assumptions often make sense.

But sociologist Fabio Rojas has some newish research (with Michael Heaney) arguing that political mobilization is highly dependent on contextual factors, even if political preferences remain constant. They produce the above graph showing that Democrats stopped showing up to anti-war rallies after Obama became president, and conclude:

Social movements and parties rely on each other. Movements benefit when partisans appear because they can bolster their numbers. Parties use movements as platform for partisan grievances. But there’s a drawback, electoral victories mean that the rank and file will stop showing up.

People don't want to mobilize against their own side.

Some have been perplexed by the Obama administration's foreign policies. Not only has he not reversed some of the Bush administration's detainee policies as he promised he would during the campaign, but he's escalated in Afghanistan and Yemen, and now gotten involved in Libya. This research suggests that one of the reasons he's taken these actions is because he is not constrained by partisans from either party: Democrats will tend to stand by their man, and Republicans tend to favor (or not oppose) military action in general. As the researchers say:

“What’s left in the antiwar movement today is the hardcore,” Heaney said in the interview, “the people who are more or less professional activists. It’s just a small group of people that’s left.”

In other words, this is not the median Democratic voter, much less the median voter in the general population.

This research was just picked up by ABC News, and for good reason. It suggests that we may need to complicate our inference-based models of interest formation and aggregation. It also suggests that if we do, we have an opportunity to get a handle on many substantive questions of interest.

For Richer or Poorer

Kevin Drum, summarizing research by Larry Bartels:

Using data from voting records in the early 90s, it shows that the responsiveness of senators to the views of the poor and working class is....zero. Or maybe even negative. And that's true for both parties. The middle class does better — again, with both parties — and high earners do better still. In fact, they do spectacularly better among Republican senators. And this disparity has almost certainly gotten even worse over the past two decades.

I haven't read the paper yet, so I don't know what the caveats are. But if this sort of result holds up it calls a lot of political economy models into question. I may comment more if I find time later in the week (I'm studying for comps, so blogging time is limited).

Interests and Issue Salience

I strongly believe that politics is a competition between interest groups. The problem for political scientists is identifying which interests are most salient. Steven Landsburg sums up in a sentence:

If you’re a gay Jewish small business owner, to which brand of parochialism are you now in thrall? Please advise.

Is it possible to develop accurate models of mass trade politics when trade is just not a salient issue for most voters? How about exchange rates, or capital account openness? Is it better in some cases to eschew models of mass politics in favor of models of elite competition? If so, when? These are questions that I wish IPE would spend more time thinking about.