Sunday Afternoon Video

I'm back from a trip, and should get into the flow again, but to tide you over here's a cool video of Timur Kuran and Douglass North talking about institutions and political economy in 2000.



Via Teppo Felin.

The Decline

Consider the never-ending narrative of American decline. My historical knowledge isn't super-deep, but I know for certain that that drum has been kicked at least since Sputnik ('50s), continuing through the Vietnam War ('60s), the closing of the gold window and the oil embargo/stagflation ('70s), the rise of Japan ('80s), European integration ('90s), and now the rise of the BRICs, especially China. During this entire period critics of the U.S. have focused on its sclerotic political system and messy "laissez-faire" capitalism (ha!), which was clearly inferior to the svelte technocratic industrial policies of the USSR OPEC Japan NICs E.U. China. The U.S. is becoming more and more irrelevant, I keep hearing. The quick rebound of China, Brazil, and Germany is proof that the world is decoupling from the U.S. The world is becoming more multipolar, the U.S. needs to learn how to shift into obsolescence and be just another state among states.

And yet when the U.S. announces that it is going to reduce some of the maturity of its sovereign debt in order to boost domestic demand -- an equivalent action to normal monetary policy operations, except on 5-year T-bills rather than shorter maturities, at a time when markets expect deflation (see graph above) -- the world goes ballistic. Huh? If the U.S. was as vulnerable as folks make it out to be, and the rest as powerful and resilient, this shouldn't even register. Instead the Chinese complain about "currency manipulation" as if QE2 wasn't a demand-side domestic monetary policy. Brazil complains about capital inflows creating bubbles, and institutes capital controls to counteract them, as if protecting local capital owners and commodity exporters in one of the most inegalitarian countries on earth had nothing to do with it. Japan enacts its own QE, and South Korea is pushing for, er, something to deal with exchange rates at the upcoming G20 meeting it hosts. The entire industrialized world is concerned that a relatively small program in the U.S. is going to threaten their entire economies.

(Either that or they're using it as cover to justify policies that they wish to enact anyway. I actually think this is more likely, since they can always continue to devalue against the dollar without retribution if they wish, and anything that boosts American demand is good for Chinese, Japanese, Brazilian, and South Korean exporters. But I don't know that for certain; maybe these leaders really are freaked out.)

Of course all of this follows a financial crisis that originated in the U.S. but was not contained within it. Forgive me for thinking that at this point the importance of the U.S. to the global economy almost cannot be overstated. At this point I wouldn't be terribly surprised if the replacement of Bretton Woods II is a variant of Bretton Woods I. The U.S. needs to recognize its place in the world, and act like a hegemon should. There's not chance the G-20 is capable of doing it.

So far I think we've done a reasonably good job -- the trading system has remained intact, warnings of competitive currency depreciations have been all smoke and no fire, countercyclical lending has gotten to states (like Greece) that have needed it, international institutions have held together remarkably well -- but we can do even better. Now is the time to finish the Korea FTA and give fast-track negotiating authority to Obama. Doha isn't going anywhere right now, but in a few years time there could be a window for movement, and it would be good to have the tracks laid ahead of time. Now is the time to let other countries devalue against the dollar if they need to, while still pursuing policies that will boost domestic demand, including demand for imports. Yes that hurt employment in tradable sectors, but mostly in the sort of less-skilled manufacturing that will not yield new jobs anyway. In the meantime, it will boost employment in importing sectors, and provide low-cost goods for struggling households. I wish it were possible to push for immigration reform too, since it's the time for that as well, but I'm pretty sure the sort of immigration reform we'd be likely to see right now isn't the sort I'd support.

Now is emphatically not the time to "get tough" with other countries that also pursue policies in their domestic interest, even if they have some short-run negative consequences for the U.S. There is a lot of low-hanging positive-sum fruit hanging out there. There's no need to take an axe to the trunk.

After all, if the Federal Reserve can't get the U.S. economy moving, the Bank of Japan won't be able to either.

The U.S. should not set policy out of fear of decline.

Why do governments buy companies when they could just steal them?

The WSJ reports Venezuela is negotiating to purchase a majority stake in French company Casino Guichard-Perrachon SA's local subsidiary, Cativen. Casino offered to sell a few weeks after Venezuela seized Casino's local grocery chain. So, the obvious (but ignored by the WSJ) question is why would Venezuela pay for a company it can seize?

Of course, international institutions could pay a role. Several multinationals are currently pursuing international arbitration to dispute what they deem unfair payouts, and Venezuela needs new FDI. Negotiating a buyout may be a way for Venezuela to reestablish a pro-investment reputation (though, given Chavez's domestic agenda, investors probably need a bit more than news of a fair buyout to make them more willing to invest in the country). But, if Venezuela is trying to reestablish its reputation, it probably wouldn't have seized Casino's grocery chain in the first place.

Perhaps there's a domestic interest group story at work here. I wouldn't be surprised if influential constituents of Chavez's have some sort of stake in a negotiated buyout.

The recent Venezuelan example highlights a failure of IPE scholarship in explaining political determinants of FDI and investment expropriation. Most of this literature (my MA thesis-in-progress included) focuses on institutional solutions to incomplete contracting problems associated with foreign investing. But, this framework for analysis often forgets that domestic constituents often have real interests in protecting the investments of certain foreign firms. The Casino-Venezuela case is particularly interesting because Venezuela has consistently refused to be constrained by international investment treaties in recent years. Yet, at least some firms can get some sort of compensation for expropriation even in an environment devoid of institutional constraints.

Institutions often matter, but there's another layer to the story.

There Is No Resource Curse

So says Adam Martin, guest-blogging at Aid Watch:

New research argues that empirical work on the Curse suffers from two interrelated problems. First, it uses dependence (the share of GDP from that resource) and calls it abundance (the stock of a resource in the ground). But dependence in turn depends on institutional quality—if you have sound institutions, natural resources take their place along other industries. If not, natural resources will by default constitute a large share of GDP because poor institutions stifle an advanced division of labor. When you look at cross-sectional data using dependence as a proxy for abundance, it will look like natural resources compromise institutional quality.

That reliance on cross-sectional data is the second major problem. The Curse story does not claim that Nigeria is Britain plus oil, but rather that Nigeria is less democratic than Nigeria would be in the absence of oil. One way to get around this problem is to test whether oil makes country X less democratic using panel data with fixed country effects. That’s fancy econometric speak for taking into account other factors that might make country X more or less democratic—its history, institutions, culture, etc. Fixed effects also allow testing a corollary of the Curse known as the “First Law of Petropolitics”: as oil prices go up, oil-rich autocrats crack down on democracy even more.

Martin highlights, and links to, some of that new research at the link.

There are still fundamental questions at play: if poor institutions are to blame (as alleged by some of that new research and much old research too), that still doesn't tell us why some places have poorer institutional development than others. IR theory offers a few potential explanations:

1. Structural factors make conflict more likely in some places than others. Sometimes this leads to actual conflict, other times the potential for conflict retards the development of a more institutionalized, liberal social order that can encourage more division of labor. Either way, the kinds of institutions that can facilitate development never take root, so development is perpetually stunted.

2. The notion of dependence immediately raises the specter of "dependency theory," according to which LDCs become dependent on their natural resources. Not on the resources themselves, but rather on the technology needed to procure and commoditize those resources. This technology comes from richer states, in whose interests it is to keep LDCs in a downtrodden state and thus keep profiting from them. So LDCs cannot improve their status by participating in the global economy until they are somewhat self-sufficient. These theories were much in vogue in the mid-20th century, but fell out of favor following the rapid development of export-biased economies in Asia and elsewhere and the continued stagnation of isolated economies.

3. Good, old-fashioned, power politics. Those who have it tend to keep it by taking control of lucrative industries, using the proceeds to enrich and insulate themselves from political competition.

Emmanuel recently discussed some of these issues in the context of Nigeria. My take? There is still a lot of work to be done in understanding institutional development and if/how the international community can encourage it.

Happy Thanksgiving

A few years back, after being saved from death by a medical procedure, Daniel Dennett gave thanks for goodness:

Yes, I did have an epiphany. I saw with greater clarity than ever before in my life that when I say "Thank goodness!" this is not merely a euphemism for "Thank God!" (We atheists don't believe that there is any God to thank.) I really do mean thank goodness! There is a lot of goodness in this world, and more goodness every day, and this fantastic human-made fabric of excellence is genuinely responsible for the fact that I am alive today. It is a worthy recipient of the gratitude I feel today, and I want to celebrate that fact here and now.

To whom, then, do I owe a debt of gratitude? To the cardiologist who has kept me alive and ticking for years, and who swiftly and confidently rejected the original diagnosis of nothing worse than pneumonia. To the surgeons, neurologists, anesthesiologists, and the perfusionist, who kept my systems going for many hours under daunting circumstances. To the dozen or so physician assistants, and to nurses and physical therapists and x-ray technicians and a small army of phlebotomists so deft that you hardly know they are drawing your blood, and the people who brought the meals, kept my room clean, did the mountains of laundry generated by such a messy case, wheel-chaired me to x-ray, and so forth. These people came from Uganda, Kenya, Liberia, Haiti, the Philippines, Croatia, Russia, China, Korea, India—and the United States, of course—and I have never seen more impressive mutual respect, as they helped each other out and checked each other's work. But for all their teamwork, this local gang could not have done their jobs without the huge background of contributions from others. I remember with gratitude my late friend and Tufts colleague, physicist Allan Cormack, who shared the Nobel Prize for his invention of the c-t scanner. Allan—you have posthumously saved yet another life, but who's counting? The world is better for the work you did. Thank goodness. Then there is the whole system of medicine, both the science and the technology, without which the best-intentioned efforts of individuals would be roughly useless. So I am grateful to the editorial boards and referees, past and present, of Science, Nature, Journal of the American Medical Association, Lancet, and all the other institutions of science and medicine that keep churning out improvements, detecting and correcting flaws.

ht to Steven Landsburg, whose excellent new blog in support of his new book The Big Questions is quickly becoming one of my favorites, who adds:

Indeed. And because the supply of thankfulness is not fixed, it will not depreciate the value of Professor Dennett’s sentiment to add a word of thanks not just for goodness but for greed—the greed that inspired generations of inventors and investors, laborers and capitalists, doctors and nurses, technicians and scientists to envision and perfect such a thing as an artificial aorta, to educate themselves in the healing professions, and to show up for work every day. For the most part, they did it to make a buck.

There is more at both links, including a call to arms from Landsburg. But the central point is important, and worth stretching: there is a lot of goodness in the world, and quite a lot of it is motivated by things less noble than altruism: it isn't charity that brought people from all over the world together to save Dennett's life, and the lives of millions of others. So today I give thanks for all the networks and spontaneous orders that allow mutually beneficial relationships to develop between people(s), and I give thanks for institutions that facilitate Pareto-improving interactions. It truly is marvelous, if you stop to think about it.

We Can't Stop Carbon Emissions (redux)

Ryan Avent takes Wilkinson to task for having the audacity to claim that there may be some collective action problems involved in getting the major world powers to credibly commit to reduce their carbon emissions, and in the process unwittingly stumbles onto the principle problem in international relations: in the absence of an over-arching international authority, cooperation among states is very difficult to achieve. Problem is, he has no idea that he's stumbled onto any problem at all. In fact, he denies that there even is a problem:

This seems almost deliberately dense. In particular, it makes no distinction between the world of billions of daily, anonymous transactions and the world in which a handful of great powers attempt to hammer out a diplomatic agreement. Unsurprisingly, it's very difficult to get millions of urban denizens to voluntarily come together to build and fund a road network or transit system in the absence of a coercive mechanism. The benefits are too broadly shared, and the incentive to free ride too great. But the smaller the number of players, the more concentrated the benefits, and the easier it is to find a mutually beneficial agreement. ...

In fact, there are fewer than ten relevant players, and only two really relevant players not already committed to reductions -- the US and China. Given that climate negotiations are part of a repeated game between the two great powers (that is, they're more or less constantly talking about one economic or political issue or another), it seems very likely indeed that an American pre-commitment to emission reductions would facilitate a similar Chinese commitment.

Ignore the rich condescension for a moment, and the irony as well. Avent is poking around at a game-theoretical argument: an over-arching international government isn't necessarily needed, because we only have to get a "handful of great powers" to agree to things, and coordination is easier with a smaller number of players. Well, that should be simple then. But there are all sorts of problems with this.

First, while it might be true that it is easier to coordinate among fewer players, it isn't necessarily true. In many game-theoretic models the number of players is irrelevant: coordination is just as difficult with 2 players as it is with 2,000. In other models, there may be lots of players, but only some have any ability to influence the final decision. In the picture Avent is trying to paint, this is actually the case: despite there being 200-odd states, really all that's necessary is securing the commitments of a relatively small number of those.

But even if Avent were completely correct about this, he's missing something else entirely: the salience of the issue. It's easier to tax millions of people a small amount and build roads with the proceeds than it is for neighbors in a property dispute to resolve the matter without litigation. If Avent's story were complete, this would not be the case. But the history of international relations is filled with instances of disputes between two states that lead to very costly wars or trade disputes. This occurs when the salience of the issue is high, or when the costs of some action are sufficiently high to dissuade a state from taking that action.

Finally, even if states could negotiate an agreement, there is no mechanism to prevent them from defecting. States say one thing and do another all the time, especially in violation of multi-lateral agreements like this. This is what Wilkinson was really driving at, and Avent doesn't even seem to consider the possibility. But this is a very, very big problem. In a nutshell, this is what the study of international relations is all about: finding the conditions under which actual cooperation occurs, and not just cheap talk. Turns out, it's harder then one might think, especially if the major powers are in major disagreement as in this case.

Even Avent's own examples speak to this: he says that of the "necessary" handful of countries needed to reach a meaningful agreement, only the U.S. and China have not committed to reducing emissions. Well, perhaps, but an agreement is not the same as an actual change in behavior. Among E.U. states, only the U.K. and Sweden are on track to meet their Kyoto obligations by 2010, and the U.S. has actually had fewer increases in emissions than many countries that ratified the treaty (including Canada and Australia, as well as a half-dozen or so E.U. states). The incentive will always be to defect, because compliance is costly and enforcement is essentially impossible. One simply cannot assume, as Avent does, that these collective action problems magically disappear if a formal agreement is made. In fact, Avent does worse than that by arguing that if the U.S. could only lead the way, China would surely follow. Really? He's never heard of the free-rider problem? When have the Chinese followed the U.S. on anything? China has given absolutely no indication that they will be willing to curb emissions if that means reducing economic growth by any calculable amount. Nor can the Chinese regime halt growth and still remain in power. And without China, the world's largest polluter (and the gap is growing amazingly fast), no overall progress can be made. And this says nothing of India or Brazil or Eastern Europe or Southeast Asia or Africa (if that continent ever starts achieving real growth). Getting real global cooperation on this issue would be the single greatest achievement in the history of international institutions. Which makes it very unlikely that it will happen.

In any case, Avent is arguing in this way to support the Waxman-Markey cap-and-trade legislation currently in the U.S. Congress. Strangely, Avent doesn't even like this bill, calling it "highly imperfect" and "totally inadequate". He also acknowledges that more progressive legislation is politically impossible despite an amazingly popular president who campaigned on this very issue and exceptionally large majorities in both houses of Congress. (Indeed, even this watered-down bill is unlikely to become law.) So Avent finds himself using deeply flawed logic to argue in favor of a wasteful, ineffectual bill that will make some people worse off by imposing a series of costs on them, but will not make anyone better off. He hopes that this bill will create better options in the future, but why? The electorate seems more likely to oppose future actions if present actions are wasteful and ineffective.

This is all odd, because Avent is usually much better than this, and he certainly knows enough economics to know better. So what's going on?

For even more difficulties, please see Tyler Cowen and Jim Manzi, and this previous post by me.

Institutions Matter

UPDATE: Congratulations, Paul Krugman, winner of 2008 Nobel Prize in Economics (okay, The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel).

Paul Krugman lauds Gordon Brown's weekend efforts: "you don’t expect to see Britain playing a leadership role. But the Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own."

Fair enough; yet Krugman offers little explanation for this puzzle beyond his distaste for the Bush administration--"I also wonder how much the Femafication of government under President Bush contributed to Mr. Paulson’s fumble. All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn’t making sense." Yet, just a few column inches above, Krugman notes how Bernanke favored the capital injection approach--surely Ben mentioned this to Paulson?

Perhaps institutions account for the difference. Gordon Brown did not need to testify before the legislative branch, nor did he need to build a majority in the upper and lower houses. Instead, parliamentary government and strong party discipline enabled Gordon Brown to formulate a concise plan and "act quickly on its conclusions." Not so in the U.S., where Paulson must plead for the necessary authority and resources and required two votes in the House to pass a much altered version of the plan he proposed. I am not sure how that institutional process promotes clarity of thought or rapidity of response.

Indeed, Paulson's initial proposal might be seen in this light: more about gaining broad authority to do what was necessary and less about the specific details. Sell the request for authority based on vague details that would sell; once you have the authority use it to do what is needed to stabilize the system (including recapitalization, now in vogue). Hence, the plan was short on details about how to solve the crisis, and explicit about Treasury authority. Yet, Krugman was no big fan of that plan, in part because it gave Treasury so much unchecked authority.

Maybe we can't have our cake and eat it too? If we want clear thought and quick action, we need unfettered executive power. If we want to constrain executive power, we must accept policymaking through a slow process in which outcomes often fail to embody clarity of thought.