Nothing New on Trade

On the one hand, that title is a good thing. Many expected a global economic downturn to lead to trade wars. Many others expected asymmetric shocks to the global economy, in which exporting countries were perceived to be poaching jobs from importing countries, to have the same effect. But I recently finished Paul Blustein's excellent account of the Doha decade Misadventures of the Most-Favored Nations and a big theme is the battle of interests between the developed North -- especially the US and EU -- and the rest -- especially India, Japan, Brazil, and China. The book's narrative ended a few years ago, but little has changed:

India is unlikely to yield to a fresh effort by the developed countries to push for greater concessions by the larger emerging economies to salvage the World Trade Organisation's Doha Round of global trade talks. ...

With the US leading the chorus to demand further concessions from countries like India, China and Brazil, which will have to eliminate tariffs on some products for the round to progress, the talks have been stalled.

We haven't blogged a lot about trade here lately, but that's mainly because not a whole lot has gone on. The international trading system appears to be locked into the status quo for the time being. Interests are still far apart, and the gains from further coordination are not especially high. So the Doha agenda remains stalled.

EU Fiscal Union Is Highly Unlikely, con

Edward Hugh reports that the Germans are laying down the gauntlet on the Greeks:

Only yesterday, German Finance Minsister Wolfgang Schaeuble informed members of the parliamentary budget committee that Greece is now perched on a "knife's edge". This follows hints from other leading German politicians (including Angela Merkel herself) that a Greek euro exit is no longer the unthinkable taboo topic which it had been to date.  

As if all of this wasn't clear enough, the Dutch Prime Minister Mark Rutte suggested yesterday in an FT article that expulsion from the Euro Area should be available as a disciplinary measure of last resort.

For detail on why things are coming to head now, see the link. The gist is that the "voluntary haircut" component of the most recent Greek bailout isn't working the way it was intended, and neither Greece nor Germany (and other Euro creditors) are especially interested in yielding to the other at this juncture. They may continue to muddle through as they have previously, but hopes that the recent bailout-plus-haircut approach is going to be sufficient have been weakened.

Banks Too Weak for Basel III?

It looks like many might be, especially in Europe:

Banking regulators are preparing to relax the new rules requiring banks to hold more liquid assets to be prepared for a new funding crisis, writes the Financial Times. ... 

A new report by JPMorgan estimates that 28 European banks showed a liquidity deficit of 493 billion euro billion at the end of last year. 

Only seven of the 28 banks tested comply with the  new standards, French banks being among the least prepared. In fact, JPMorgan analysts concluded that the requirements of liquidity for the banks must hold sufficient assets, easily sold to meet a 30-day-long funding crisis, will affect most sectors, and will cost about 12% of the average European banks earnings of 2012.

We've written a lot about the competitive nature of Basel III, and especially how American banks tend to have higher capital and liquidity ratios than many of their European counterparts. Basel III was really hard on European (and Japanese) banks, and it looks like many of them won't be able to meet their obligations in a timely manner, especially if the European debt situation deteriorates. And, of course, if European banks are allowed to defect from their Basel obligations then pressure will be placed on the US and other governments to allow their banks to do the same.

This is worth keeping an eye on.

EU Fiscal Union Is Highly Unlikely

Phil Arena was fishing for a post from me on Europe in response to this:

Europe appears to be inching closer to a more centralized fiscal union that would eventually turn the euro zone into something resembling a United States of Europe.

Today we have news that a German court has ruled that Merkel's actions to bailout other European countries were not illegal -- good news for Merkel -- but that any new funding must be approved by the German legislature -- very bad news for Merkel. And yet even Merkel does not approve of the sort of measures that would create a "more centralized fiscal union" in Europe. Her joint statement with Sarkozy on August 16 repudiated eurobonds, as well as an extension for the European bailout mechanism, the EFSF. Meanwhile voters in Finland (and other countries) are starting to assert themselves by demanding increased collateral from Euroborrowers before they approve of new funding. Any one of the 17 EMU members can veto any agreement, and it looks increasingly likely that one or more of them will. And not just the creditors... the debtors are angry too. (Most recently Italian workers went on strike to protest a new austerity package, following similar protests in Greece, Portugal, and Spain.) The EU banking crisis looks like it's spreading, placing even greater burdens on public sector balance sheets and economic growth rates.

Meanwhile, where is the constituency for a greater fiscal union? Perhaps Sarkozy wants that, but Merkel does not. Voters in the Eurocore do not, and it's not even clear that voters in the Europeriphery do either, at least if that comes with supranational authority to set budgets and intervene into macroeconomic policymaking. Which it surely would.

So I just don't see how a fiscal union is politically possible. And I don't even see why it's desirable. Or more precisely, I don't see who would desire it. So I don't see it happening.

Is US Politics Really More Partisan Than Ever?

Matt Yglesias writes: 

Historically, the United States has been dominated by an ideology of non-partisanship driven by precisely the suspicion that the interests of a party or faction are not those of the country. And for most of America’s history, when parties were largely non-ideological, this made a ton of sense. A non-ideological party, after all, is basically just an interlocking web of patronage networks and party machines. If a Democrat is in the White House, then Tammany Hall gets to reward its supporters by handing out federal jobs in New York City. The machine couldn’t care less what the president thinks about “the issues” (unless the issue is civil service reform) it just wants a president who recognizes his affiliation with the machine.

Karl Smith agrees, and is working on spinning this line of thinking into a broader argument about republican democracy's role in the future of governance.

But I think this is completely wrong. This isn't my area of expertise -- I've tried to enlist one of my grad student colleagues for a guest-post, but he's busy so that can't happen until next week -- but my understanding of the relevant political science literature is that there is a sweet spot during which American politics is less-partisan*. That sweet spot was immediately following WWII, basically the Truman and Eisenhower administrations. Before that the parties were divided by the New Deal and intervention/isolationism in Europe. After that the parties were divided by race and social reform. The current party alignment isn't much different from the early 1970s, when the religious right aligned with the GOP, southern Democrats switched to the GOP, and liberal northern Republicans switched to the Democratic party.

But more fundamentally it's just really hard for me to buy an argument that rests on the assumption that the current political environment is more nasty or divisive than it's ever been. Given the history of political competition and instability in this country -- literally from its moment of inception -- today's political environment doesn't seem out of the norm. In fact, things might be more civil now than at most points in US history.

In any case, US politics has always been about competing interests. Whether those are transformed into ideology more or less now than before is thus not all that interesting of a question to me. It's asking about the window-dressing, not the structure of the building.

*I'm not sure partisanship is the best proxy for "ideological parties", but I think that's what Yglesias and Smith are really driving at anyway.

UPDATE: Michael Flynn has a great post (better than mine) looking at the same dynamics I'm concerned with but focusing on foreign policy. And as Phil Arena points out in comments here, Brendan Nyhan (and others) have covered this ground much better than I can. Here's one good example.

(Nearly) Daily Reminder That Everything Is Screwy

Treasuries now more expensive than they've ever been:

Treasury 10-year note yields fell to an all-time low today as concern the euro area’s debt crisis will cripple financial institutions underpinned demand for the safest assets. A government report Sept. 2 showed no jobs were added in August, reinforcing concern the U.S. economy has slowed which may prompt additional stimulus by the Fed.

System Dynamics Remain Important

(click here for animation)

Via TC, a data point that reinforces some research that the IPE@UNC crew has been conducting:

MFIs in Europe have drained their bank accounts at European banks by about €700 billion over the past year and half, which at current exchange rates is approximately $1 trillion. It seems that much of that money has recently found its way into the bank accounts that European MFIs keep in US banks. And conversely, it seems likely that the large inflow of cash deposits held at US banks this year is largely from European banks.

Putting it all together yields a compelling story: European banks are shifting their cash assets out of European banks and putting much of them into US banks. This has happened at a significant rate, with a net transatlantic flow from European to US banks that probably totals close to half a trillion dollars in just six months.

Given all of the trouble in the US banking sector over the past four years, and given the recent S&P shot, why would foreign funds continue to flow into the US rather than, say, emerging economies that continue to grow at high rates? This sort of behavior is not expected by most political science, economics, or finance research or by many in the pundit and investing classes.

One answer may be found by examining the network dynamics embedded in the international banking system, one representation of which is above. (This graphs in-degree, which are bank holdings from country i to country j. Tie strength is the amount of holdings, node size is cumulative in-degree from all countries in the network.) The international banking network is highly unequal, with the US as the most central node in the system. Highly unequal networks have different dynamics than other networks, one of which is a "preferential attachment" rule for organizing links between nodes. The rule states that, because of network externalities, nodes that attract a lot of links will tend to attract even more links in the future. Thus, the structure of the network is stable and self-reinforcing.

The US has attracted by far the most foreign bank holdings throughout the entire data series, and the intensity of these links has increased (in nominal terms) over time. That process hesitated briefly at the height of the financial crisis before resuming. So given the structure of the network and the dynamics that that structure implies, increased flows into the US -- especially during times of trouble like those currently plaguing Europe -- is exactly what we should expect. If we didn't continue to see this behavior that's when we would need to start looking for major changes to the organization of the global economy.

The Great Crash 2008, Part One

In "Cause and Consequences", the last chapter of The Great Crash 1929, JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash that led to a prolonged slump. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the first.

Galbraith's first reason given for why the stock market collapse plunged the real economy into deep depression is the large amount of income inequality. Galbraith writes:

This highly unequal income distribution meant that the economy was dependent on a high level of investment or a high level of luxury consumer spending or both. The rich cannot buy great quantities of bread. ... Both investment and luxury spending are subject, inevitably, to more erratic influences and to wider fluctuations that the bread and rent outlays of the $25-a-week workman. This high-bracket spending and investment was especially susceptible, one may assume, to the crushing news from the stock market in October of 1929.

It's well-established that US income inequality increased dramatically over the two decades prior to the 2008 crash. Here's a snapshot of the share of national income going to the top 10% of income earners from the famous Piketty/Saez historical study of the American income distribution (labelled and discussed by Krugman here)



The graph ends a few years before 2008 but the trend didn't reverse in that time. What I like about Galbraith's explanation of the role of income inequality in the Great Depression is that there is a plausible causal story: with increased inequality the economy becomes more dependent on the fortunes of the high-bracket folks to maintain demand and investment; a shock to their finances via a financial crash thus hurts more than it otherwise would. This can link up with demand-side and structural explanations of the sclerotic US recovery. Too often discussions of contemporary income inequality lacks such a mechanism, and are much more normatively framed and politically charged. That's fine, but it doesn't really help us understand how income distribution affects the broader economy.

The question is whether Gailbaith's causal story matches the present. Let's look at some data on private investment. We know that there was a slump in housing, so let's check that first:




It drops off a cliff, but notice that that begins in late-2005. This is in line with the usual story that the housing collapse preceded and perhaps caused the financial collapse by deteriorating the value of the underlying assets on which securities were backed. For Galbraith's story to be true, we'd need to see investment drop off after the financial collapse destroyed the wealth of those at the top of the income distribution. And we do:



Note that in percentage terms, the dropoff post-2008 is more severe than what occurred during the 2001 recession. My back of the envelope estimate is that investment at the trough post-2001 was ~ 88% of the pre-2001 peak; In 2008 it was 78%. Moreover, investment fell more steeply more quickly post-2008 than post-2001. But it also rebounded in a sharper V-pattern than in 2001. If Galbraith's logic held, we might expect to see the opposite: a deeper, longer investment drought. Sometime like an 'L'- or 'U'-shaped pattern of recovery.

Let's look at some consumption data:



Here we see a much bigger dropoff post-2008 than post-2001, and it persists for much longer. While we've gotten back to pre-2008 levels, we haven't yet caught back up to trend. But is this slack enough to explain the persistent malaise in labor and financial markets? And is the slack in spending and investment attributable to income inequality rather than high unemployment? Is high unemployment attributable to income inequality? There's no obvious mechanism that explains it. At least not that I can think of.

It may be that increased inequality was a symptom of structural shifts in the global economy that pre-dated the crash. An effect rather than a cause. Post-crash inequality becomes a cause of ongoing economic weakness. However as a first explanation for the Lesser Depression I'd look elsewhere.

In any case, the major political battles in the US since the financial crisis have been on issues related to income distribution: health care, financial regulation, and progressive taxation vs. expenditure austerity. Maybe we could add classic Phillips-curve battles over unemployment/inflation tradeoffs.* This suggests that the cleavages in the economy break down along at least some of these lines. But this could be a consequence of the weak economy rather than a cause of it, especially since the political scene has shifted from fire-fighting to deficit-cutting.

*Krugman and others argue that right now there isn't much of a tradeoff and I tend to agree, but neither the political leadership of the GOP nor most pundits seem to believe him.

This Is Embarrassing

Mearsheimer, in August 1990: Europe will revert to "untamed anarchy" and "Hobbes' war of all against all" in the post-Cold War era.

Oops.

ht: Phil Arena 

Universities Are Not (Only) About Education

Angus writes:

College football is a mess, with Ohio State and The U providing the latest "scandals" and with the pattern of conference jumping we've seen lately.

I think it's time to split big time football from academics. Dissolve the NCAA. Pay the players. Don't even force them to be students if they don't want to be students. Treat college football like an age 21 and under pro league. The schools rent out their facilities, names, supporters, etc. and the football program is separate from the school itself, just like the food service program.

I've long viewed college football, and college athletics in general, as a sort of "loss leader" for the university. A prominent sports program raises the university's status. Saying that it doesn't do much for the university's core mission only makes sense if you think the core mission is efficiently allocate resources towards the best educational environment possible.

But it clearly isn't. Universities exist for a host of reasons, most related to status and social networking rather than actual education. Which is why so many people are willing to pay huge premia to go to 4-year universities for basic classes rather than 2-year colleges, even though the class quality will usually be comparable or even better at the 2-year schools (b/c of smaller class sizes, professional teachers rather than researchers teaching those classes, same texts and curricula, etc.). And why many people are willing to pay even higher premia to go to flagship 4-year colleges rather than Eastern Small Town State, even though the actual education will be very similar.

So having high-profile sports programs does serve universities' core mission: it raises the university's status, and that attracts students and other sources of funding.