Differing Views on China

Obama and Geithner want structural adjustment of the Chinese economy and some upwards movement on the value of the RMB relative to the dollar.

Scott Sumner wants to see the RMB devalue against the dollar. Not a typical viewpoint (at least among non-economists), but he has some very good reasons.

In the first scenario, China stops funding the U.S. debt by buying Treasury bills. In the second, they continue that practice. For a very good article discussing the choice Beijing must make, see this piece by David Leonhardt.

On the (Ir)relevance of IR Scholarship to Policy Makers

In April, Joseph Nye initiated a discussion about the policy relevance of contemporary international relations research. Dan Drezner pushed the discussion further, inviting academics to weigh in. (Will posted the blogging heads version last week). The central questions are two: why does contemporary IR scholarship have so little impact on policy? What, if anything, should or could be done about this lack of influence? Answers focus on the incentives that scholars face within the academy, with some focus on the supposed methodization of IR scholarship.

Yet to be articulated is the recognition that given what IR strives to do as a social science, any advice we might offer to policy makers must be either redundant or wrong. This is probably overstated, but let me defend it before I qualify it.

As a social science, IR strives to explain the choices that politicians make. The models we develop therefore either accurately explain governments' policy choices or they are wrong. IR models that accurately explain the decisions that governments make offer no insights to the politicians whose behavior they model. In fact, the more our models become grounded in empirical observation, that is, the more they summarize how politicians typically behave, the less useful they become to the politicians whose behavior they summarize. On the other hand, when politicians make choices that our models do not explain, our models must be wrong; after all, our models purport to explain politicians’ choices. Consequently, the only policy-relevant advice that IR can offer must be either redundant or wrong.

This problem is compounded by the incentive problem. Contemporary IR models assume that politicians respond rationally to incentives. What this means concretely will obviously depend upon context. Yet, the notion that a politician would adopt a fundamentally different policy than the one currently in place after learning about a piece of IR scholarship assumes that policy choice is predominantly a matter of intellectual persuasion. Thus, what we assume to be true in our models (politicians respond to incentives) is inconsistent with what must be true in order for our models to influence governments’ policy choices (politicians respond to intellectual persuasion). This implies that contemporary IR models can influence policy only if they fundamentally mischaracterize the nature of political decision making.

Contemporary IR’s lack of policy influence is therefore the inevitable consequence of the field’s effort to become more scientific given what we seek to explain. Although economics has powerfully influenced our quest for rigor, the belief that policy influence is the natural consequence of this endeavor suggests that we have lost sight of how IR differs from economics. Economics as a social science (along with sociology and perhaps psychology) tells politicians how to use policy to change social outcomes. IR as a social science explains why governments adopt some policies rather than others. The better we are at explaining the choices that governments make, the fewer novel insights we can offer to policy makers.

The subtext of the broader discussion seems to suggest that we should lament this. I don't see why. We give up the opportunity to offer poorly-conceived policy advice in favor of gaining systematic knowledge. We could benefit by being more self-consciousness about the consequences of the choices we make. In particular, because our commitment to social science necessarily renders us less useful as policy advisers, we must invent new justifications for the project in which we are engaged. That, however, must be the topic of another post.

Bad News for Microfinance Proponents

The results of the first randomized trial of the effects of microfinance are in [pdf], and the conclusion is mixed:

On balance our results show significant and not insubstantial impact on both how many new businesses get started and the profitability of new businesses. We also do see some impact on the purchase of durables, and especially business durables. However there is no impact on average consumption, though as we will argue later, there may well be a delayed positive effect on consumption. Nor is there any discernible effect on any of the human development outcomes, though, once again, it is possible that things will be different in the long run.

Basically, microfinance is good for those who are already have businesses but need some cash to make investments that boost productivity. It may make it possible for some others to start their own businesses, but the evidence for this is indirect. Its effect on "human development" indicators like health, education, or women's empowerment is basically nil, although the study only looks at short-term effects. In short, the effusive language often used by microfinance proponents may have to be toned down a good bit. Pointer from the World Bank's PSD blog, which notes:

As the authors note, the impact of microfinance in education, health, etc. may not appear for quite some time. In normal times, we would just wait another year or so and take another survey. However, the financial crisis means these are not normal times. If, in a year or two, a new set of results appears to indicate no impact on human development, the randomistas could claim this as a failure of microfinance. In turn, the microfinance proponents will claim that the financial crisis invalidates the findings, arguing that the ROI for small-scale entrepreneurs was abnormally low due to the crisis. Unfortunately, we'll simply have no way to know for sure who's right.

Back in February, erstwhile co-blogger Sarah had a post on the effects on microfinance of the global economic downturn. It is here.

Political Incentives and the Israel/Palestine Situation

Matthew Yglesias asks a question about the American government's willingness to pressure Israel into ceasing settlements in Palestinian territory:

Unfortunately for us, we’re not in one of those periods of time when Israel has a government that’s probably actually not that sympathetic to the settlers but faces domestic political difficulties in cracking down on them. If that were the case, then strong words from the United States might be enough to force change in Israeli policy. But the current government is a coalition between the right and the far-right, and gives every indication of being extremely committed to settlement expansion. This, naturally, raises the question of what American policymakers are prepared to actually do about the fact that the world’s largest recipient of American aid seems to have so little interest in our perspective on crucial regional issues.

"Our perspective" is in fact a reference to Yglesias' perspective, which happens to be roughly in line with Obama's perspective. But it is not necessarily the perspective of the public at large, who tend to side with the Israeli government come hell or high-water. Politicians want to stay in office, and the best way to do that is to get the public on your side. In this case, that means taking a hard-line approach against the Palestinians:

[T]he thrust of US policy in the region derives almost entirely from domestic politics, and especially the activities of the ‘Israel Lobby’. Other special-interest groups have managed to skew foreign policy, but no lobby has managed to divert it as far from what the national interest would suggest, while simultaneously convincing Americans that US interests and those of the other country – in this case, Israel – are essentially identical.

Now, I don't entirely agree with the 'Israel Lobby' argument advanced by Mearsheimer and Walt, but the broader point is impossible to deny: the broad public sides with Israel over the Palestinians for a variety of reasons. This is evident in both political parties and in every national election. Indeed, last week 76 U.S. Senators sent a letter to Obama urging him to "support Israel" without conditions but to demand a host of concessions from Palestine before affirming its right to a state. (Interestingly, the Jerusalem Post article linked above omits the senators' affirmation of the Palestinians' right to a state if they achieve certain pre-conditions; this AFP story keeps the relevant passage in. The letter itself is here [pdf].) This is actually a very different line than the one Obama is taking -- a much harder line towards Palestine -- which shows that even a very popular president will have difficulty galvanizing Congressional support for any policy that is even remotely critical of Israel.

The lesson is that legislators respond to incentives just like anyone else, and the incentives are all aligned in such a way as to practically guarantee universal support for Israel in the Congress, because that is what the electorate wishes to see. So the Congressional movement that Yglesias wishes to see is very unlikely to actually happen.

Handicapping the Upcoming E.U. Parliament Elections

Via A Fistful of Euros, here is a handy primer from FiveThirtyEight. Forecasting is much more difficult in this case than in the last U.S. election:

As a result, quantitative evaluation and projection of the outcome of the elections is quite a challenge. Rather than only developing a projection model, such as FiveThirtyEight was able to do with the 2008 election cycle in the US, inter-party and intra-party dynamics in 27 countries must be analyzed. With around 250 parties running for seats in the EP, and 8 coalition parties vying for power in the Parliament, complications are many.

But maybe more interesting is the detachment many Europeans feel towards the process:

Another dynamic that shapes the EP elections is the dramatic lack of interest from most Europeans in the election. One British friend of mine, when I asked if he would be voting in the elections, insisted the UK did not have any MEPs, as they had not changed to the Euro from the British Pound. Recent Eurobarometer polling indicates that only 29% of EU citizens could identify the correct year for the next wave of EP elections, ranging from just 14% in the UK to 56% in Luxembourg. Even though more than 70% of respondents felt that “the EU is indispensible in meeting global challenges” and “what brings citizens together is more important than what separates,” just 34% of citizens planned to vote in this round of EP elections.

Similar melancholy over the elections were expressed by two E.U. citizens in my living room yesterday while watching the Champion's League final. But for those who are interested, FiveThirtyEight promises much more coverage over the next month as the election comes and goes. (Voting occurs at different times in different countries, but most E.U. citizens (some 80%) will vote from June 4-7.) FiveThirtyEight was indispensable during the American election season, so if they are able to do half as well for the European elections they will prove to be a valuable resource.

Social Science Smackdown Week!

There have been an awful lot of high-profile battles going on in the blogosphere lately. And I'm not talking about the typical blogger-vs.-blogger spats. I'm talking about big-shot social science Ph.D.s going at it hammer-and-tongs over issues directly related to public policy. A breakdown:

-- Richard Posner vs. Alan Greenspan on whether Greenspan deserves some blame for the economic crisis, with commentary by Megan McArdle (she calls this round for Posner).

-- Scott Sumner vs. Brad DeLong and Paul Krugman on the utility of models of asset-price bubbles. Of course, Sumner has been fighting with Krugman practically non-stop since joining the blogosphere.

-- A real-live bet (for money!) between Bryan Caplan and John Quiggin over U.S. vs. E.U. unemployment rates over the next decade. I previously covered this here.

-- William Easterly vs. Jeffrey Sachs, and Dani Rodrik, and Paul Collier, all on different aspects of development policy. Plus a bonus: Dambisa Moyo goes after Sachs, too! It's usually not nice to gang up, but then again, Sachs started it.

-- Robin Hanson vs. Andrew Gelman on the signaling motivations of the approaches conservatives and libertarians take to public policy, with a cameo by Tyler Cowen whose contribution was one pithy line: "don't forget the villains also".

Whew! I must say, I've tried to pick a few fights in recent days but nobody ever notices me (except dear Emmanuel, who is always willing to argue in favor of the proposition that I am either silly or stupid). But for fun, here's my scorecard on the above arguments:

1. Posner vs. Greenspan is a draw; Greenspan certainly bears some responsibility for the consequences of his actions, however it is hard to imagine anybody else in the same position doing much better (as evidenced by the fact that Greenspan had few critics until last Fall). I also think that Posner over-states his case.

2. Sumner vs. Krugman/DeLong goes to Sumner; even if Krugman and DeLong succeed in fitting past data onto a model, its utility going forward is probably close to nil.

3. I'd take Caplan's side over Quiggin's in their bet, but I think it'll be very close. Caplan's first proposal was pretty obviously skewed in his favor, which is why Quiggin forced a compromise. The new terms strike me as fair and much more interesting.

4. Easterly vs. Sachs goes to Easterly; Easterly vs. Rodrik is probably a draw; Easterly vs. Collier goes to Collier.

5. Hanson vs. Gelman goes to Gelman.

Props

Inspired by North Korea's most recent nuclear test, Dan Drezner offers a list of his favorite IR articles and books on the role that the reputations of states play in international relations. This isn't usually IPE fare (although several of the his favorites are IPE texts), but one thing about his list immediately stood out: an article by Mark Crescenzi, Associate Professor of Political Science here at UNC, made the list along such luminaries as Thomas Schelling, Daryl Press, Philip Zelikow, and some dude named Machiavelli. The list is here, and Dr. Crescenzi's article may be found at JSTOR here (I do not know of an ungated version). I can second Drezner's recommendation: it's a very good article.

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.

Mo' Money, Less Problems

KPC just posted the above picture, taken from research by Justin Wolfers. The picture shows the correlation between the U.N.'s Human Development Index (HDI) and per capita income. The correlation is .95, meaning that the two things are almost perfectly correlated. In the social sciences, relationships this strong are exceedingly rare.

HDI is an attempt to compare development outcomes across countries in a more nuanced way than simply looking at GDP numbers. So it includes things like educational enrollment, life expectancy (at birth), and adult literacy as well as per capita GDP. The thing is, those things are all highly correlated with per capita GDP. So even though the intention is to give a more nuanced view of quality of life than simply comparing income levels across countries, what we end up seeing is that income levels are the primary determinant of quality of life.

This shouldn't be too surprising. After all, if you have more money you can buy better health care (and thus live longer) and afford to send your children to school (thus boosting literacy and educational enrollment). However, simply comparing incomes across countries is often thought of as being a crass way of measuring quality of life. After all, money can't buy love or happiness, right? And if we spend our lives selfishly chasing money than we are surely missing other things.

That may be true, but it doesn't show up in cross-national studies. Wolfers has also done other work on the relationship between income and happiness (discussed here briefly; the actual research is here). This work (with Betsy Stevenson) re-examines the "Easterlin Paradox" that has caused much debate in the social sciences for decades. The Easterlin Paradox states that citizens of countries with more economic growth are not happier than citizens of countries with less economic growth, as was commonly assumed by economists. The inference was often made that there is no relationship between income and happiness. But the Stevenson/Wolfers research indicates that this isn't true, and the Easterlin Paradox doesn't actually hold: higher levels of GDP are strongly related with higher levels of subjective happiness.

This new research all points in the same direction: higher economic development leads to better objective and subjective outcomes. People in richer countries live longer, more enriching, happier, more fulfilled lives. So if we want to improve peoples' quality of life, then we need to improve their economic opportunities. And if we don't do that, we will have a difficult time improving outcomes.

Quote of the weekend.

I posted a link a couple of days ago to Barry Eichengreen's recent article "The Last Temptation of Risk" in The National Interest. But I thought I'd isolate a key bloc of paragraphs for our readers, in case you hadn't had the time to read the piece or clicked on the link and decided it was far too long, especially on a nice early summer weekend to read: 

WITH THE pressure of social conformity being so powerful, are we economists doomed to repeat past mistakes? Will we forever follow the latest intellectual fad and fashion, swinging wildly—much like investors whose behavior we seek to model—from irrational exuberance to excessive despair about the operation of markets? Isn’t our outlook simply too erratic and advice therefore too unreliable to be trusted as a guide for policy?

Maybe so. But amid the pervading sense of gloom and doom, there is at least one reason for hope. The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost.

But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.

The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty.

Not surprisingly, the best students have responded. The top young economists are, increasingly, empirically oriented. They are concerned not with theoretical flights of fancy but with the facts on the ground. To the extent that their work is rooted concretely in observation of the real world, it is less likely to sway with the latest fad and fashion. Or so one hopes.

The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy.

In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.