Economics

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  • Macro policy and the recovery

    Learned helplessness

    Jun 4th 2011, 3:23 by G.I. | WASHINGTON

    BACK in the 1990s and early 2000s, American policymakers would castigate their Japanese counterparts for inertia in the face of unfolding economic tragedy. Why wouldn’t they at least try some of the tools available to them, they would demand in frustration. In 1998, Ben Bernanke, then an academic, called it a case of “self-induced paralysis.” He observed, “Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”

    Americans traditionally had an abiding faith in the power of enlightened activism. If an asteroid were headed for earth, they would argue for pre-emptive and aggressive fiscal and monetary policy to neutralize the impact. Plainly some economic events, like asteroids, would overwhelm even the most astutely applied policy tools; Japan’s collapsed property bubble would be one. Yet it was comforting to know that the Americans at least would try. And for three years they did, via the fiscal stimulus, the financial market interventions, and the Fed’s aggressive conventional and unconventional stimulus.

    Yet as the economic outlook has suddenly darkened in recent weeks I detect an unfamiliar mood among policy makers: policy fatigue, a sort of learned helplessness. Officials acknowledge that we are replaying the events of one year ago when a promising springtime expansion petered out over the summer, but this time they have no faith that additional fiscal and monetary stimulus, of the type applied last year, is either possible or even beneficial.

    Austan Goolsbee, chairman of the White House Council of Economic Advisers, responded to Friday’s dreary payroll report by reciting the Administration’s programme of supply-side initiatives. And as for stimulating demand? “We will continue to work with Congress to responsibly reduce the deficit and live within our means.” Everyone in Washington is terrified that bond yields will rise if we don’t raise the debt ceiling while barely aware of the grim message sent by the fact that yields are steadily falling.

    I can understand the fiscal immobility. There is a case (though I don’t see anyone making it) that some fiscal drag now is the price of avoiding a fiscal crisis later. Moreover, even if the Obama Administration were inclined to activism, it could not get it past Congress.

    The Fed is more of a puzzle. I’m used to hearing the hawks claim the Fed has done all it can, as Richard Fisher of the Dallas Fed did again this week. I’m less used to detecting it from the rest of the Fed as I now do. My current colleague, R.A., quotes my former colleague, Jon Hilsenrath of the Wall Street Journal, on Mr Bernanke’s assertion at his inaugural press conference, that the bar for more quantitative easing after QE2 finishes is high. “The tradeoffs are getting less attractive at this point,” Mr Bernanke said, citing the risk of higher inflation and higher inflation expectations.

    Fed officials are loathe to admit it, but political blowback, of the kind that QE2 ignited overseas and on Capitol Hill (not to mention from some corners inside the Fed) may be the biggest tradeoff.

    Mr Bernanke has to care about politics. After all, monetary policy is to some extent a confidence game: a stimulative policy works in part because people think it will. If instead people only think it will drive up commodity prices and inflation while doing nothing to boost demand, then it won’t work – no matter what the economics says.

    Yet most of the rise in commodity prices that is often blamed on QE2 can be explained by excessively loose monetary policy in the emerging market economies, and that is being corrected. Inflation expectations have come down sharply. QE2 did help at the margin; I don’t see why QE3 wouldn’t as well.

    It may prove unneeded. The base case is still that the current soft patch is temporary. Gasoline prices don’t have to drop to boost consumer purchasing power, they only have to stop rising, which they have. China seems headed for soft landing which, by deflating commodities, would be the best thing that could happen to America and the global economy right now. While America’s job creation was weak in May, wages rose, a positive for income. With a lag, growth should resume in coming months.

    Still, I was recently reminded by someone who lived through Japan’s lost decade that America is qualitatively, if not quantitatively, following the same script. That means we will often think robust, above-trend growth has begun, only to see it snuffed out by the inexorable post-bubble deleveraging. Japan offers another sobering lesson: its policy flexibility was heavily circumscribed by politics. Bail-outs, deficits and quantitative easing were no more popular in Japan than in America today. Japanese officials are far too polite to say “I told you so.” But they could.

    Update: I was inspired to call this post "learned helplessness" by a conversation with a source a few months back about private inaction in the face of uncertainty. Paul Krugman reminds me he used the term a week ago in the context of policy makers. He expands on the point here.

     

  • America's jobless recovery

    Not again

    Jun 3rd 2011, 13:33 by R.A. | WASHINGTON

    AMERICAN labour markets are faltering, and the script looks distressingly familiar. In the spring of 2010, a strong American economic recovery finally seemed imminent. In the three months to May of last year, private employers added over 400,000 workers and the future looked brighter still. But a crisis in Europe shook market confidence. As investors fled to safety, firms grew nervous and hiring slowed. Only in the fall of last year—not long after the Federal Reserve announced a new round of stimulative asset purchases—did activity pick up.

    And in 2011? In the three months to April, private employers added over 700,000 jobs, and conditions again seemed to be improving. But the global economy has suffered one disruptive shock after another. Bad weather dragged down activity early in the year and political instability in North Africa and the Middle East boosted oil prices. A devastating disaster in Japan seems to have had a bigger impact on the Japanese economy, and on global trade, than was initially expected. Big emerging markets—primary sources of global growth in recent years—have been working to slow their economies to tamp down rapid inflation. And Europe's crisis continues to worsen.

    Amid these headwinds, American growth has disappointed, falling short of the 4% annual rates projected early in the year. And labour market trouble followed. This morning, the Bureau of Labour Statistics released a dismal economic report. After producing job gains averaging 220,000 per month in the three months to April, the economy added just 54,000 in May, below expectations. The private sector did a bit better, adding 83,000 jobs, but that was well off the healthy rate of hiring enjoyed earlier in the year. The unemployment rate rose to 9.1%, from 9.0% in April.

    It's not too difficult to spot the sources of economic weakness in the details of the report. Manufacturing employment fell by 5,000 jobs in May after rising steadily in previous months, a testament to the worsening outlook for exports in a weakening global economy. Retail trade employment growth also tumbled, as nervous consumers trimmed spending. America's job woes have also been self-inflicted. Private firms have added over 1.7m jobs in the past 12 months, but the government has shed nearly half a million over the same period (not counting the loss of temporary Census jobs last year). Local governments alone have cut 446,000 positions since September of 2008. Some of those government jobs losses reflect a sensible rationalisation of workforces. Too many of them reflect the damaging effect of pro-cyclical budget cutting due to balanced-budget rules in cash-strapped states. More federal aid to states might have dampened the reductions, easing the drag on national growth.

    Budget issues at the federal level may also be contributing to the slowdown. Unexpectedly large federal budget cuts are chipping away at quarterly growth rates with less of a cushion than previously imagined. The 0.5 percentage point drag due to slashed spending seems less problematic when the economy is expected to expand at 4%—as was once hoped for the first half of 2011—than when it's growing at less than 2%, as America's did in the first quarter, and as forecasters are increasingly predicting for the second quarter.

    The ongoing debt-ceiling battle is an additional source of uncertainty. Legislators continue to bicker over how and how much to trim from the federal budget in exchange for an agreement to raise the nation's statutory limit on borrowing. Failure to raise the ceiling by August will trigger default. Just yesterday Moody's, a ratings agency, threatened to downgrade America's debt rating if a deal on the ceiling weren't reached by next month.

    For now, market appetite for American debt is undiminished. Lagging global growth prospects and increased uncertainty are driving a flight to perceived safety, pushing down Treasury yields. Falling yields provide an awkward backdrop to American budget negotiations, in which legislators warn that bond traders may sour on American credit at any moment. They're also a testament to the importance of the integrity of American debt. With financial markets feeling shaky, any disturbance to the trustworthiness of the safe asset of last resort could prove highly destabilising to the global financial system and the economy.

    In a global economy this volatile, the American economy is going to have a rocky month here and there. But American government officials are doing themselves no favours. Federal Reserve officials are overly concerned with inflation given the outlook for slowing global growth. Now is no time for policy tightening. And elected representatives in Washington are playing with fire. By cutting too much spending in the short-term and turning the debt-ceiling fight into a political battle, Congress risks making a large unforced error. The economy is simply too vulnerable at the moment for politicians to make those kinds of mistakes.

  • America's recovery

    Watching the Fed

    Jun 2nd 2011, 14:18 by R.A. | WASHINGTON

    I WOULD not have guessed that we'd be replaying last year's script here in 2011, but the similarities to the recovery and policy dynamic this year and last are striking. Last year, early signs of a strong recovery fizzled amid external shocks, and a long waiting game ensued as writers watched for hints of a Fed response while the economy slowly deteriorated. This year, early signs of a strong recovery seem to be fizzling amid external shocks, and writers are beginning to wonder whether the Fed will respond again.

    There are a couple of key differences, however. One is that the American recovery is better established this year than it was last year. The labour market, while still very slack, has been improving steadily. The economy has several more quarters of expansion under its belt. And while there is the hint of a negative trend in the economic data, it's not nearly as pronounced as was the case last summer. The Fed tries to avoid reacting to temporary blips, and there are reasons to expect a second-half turnaround.

    The other key difference is the inflation environment. While core inflation in America is dormant and long-run inflation expectations actually fell from April to May, a rise in commodity prices pushed up headline inflation figures early in the year, leading some economists to call for tightening. At the New York Fed, Gauti Eggertsson says the Fed won't repeat the mistakes of 1937:

    What we call “the Mistake of 1937” was, in broad terms, a decision by the Fed and the administration to implement a series of contractionary policies that choked off the recovery of 1933-37 and brought on the recession of 1937-38, one of the worst on record. What is particularly noteworthy is that the inflation fears that triggered the Mistake of 1937 were largely driven by a rally in commodity prices. These circumstances invite direct comparison with our own time, when a substantial recent rise in commodity prices (which now seems to be abating somewhat) stoked inflation fears and led some commentators to call for an increase in the federal funds rate.

    The question for the contemporary reader is this: If we could transport a modern-day economist back to 1937, would he or she have made the same mistake? My suggested answer—admittedly somewhat hopeful—is no. I base this view on the fact that most economists today distinguish between the temporary movements in the consumer price index that stem from volatility in commodity prices and the movements that reflect fundamental inflation pressures. Hence a modern economist most likely would have identified the price rise in 1936 and 1937 as a temporary upswing in commodity prices that did not signal a significant increase in overall inflation.

    Well, maybe, maybe not. So what might the Fed do? Jon Hilsenrath recalls Ben Bernanke's statements at his April press conference:

    Fed Chairman Ben Bernanke signaled in April that the hurdle to more "quantitative easing," as it is known, is very high and Fed officials have done nothing to indicate that Mr. Bernanke's guidance has changed as economic data has worsened in recent weeks.

    In an April news conference, Mr. Bernanke said the tradeoffs that would come with additional purchases were becoming unappealing. "It's not clear we can get substantial improvements in [employment] without some additional inflation risk," he said.

    Mr Bernanke said at the time that the trade-offs to additional easing are less attractive than they previously were, and so new purchases were unlikely. But he also said that the trade-offs would shift if economic deterioration resumed. And if inflation expectations resume a sustained fall, then the balance of forces may move strongly in favour of additional action.

    My sense is that the Fed will do nothing until it becomes more clear that the slowing trend is real. And my guess is that the downward trend will prove temporary, such that the Fed won't need to act. The other thing to remember is that the Fed takes a "stock" approach to easing, which means it is the size of the balance sheet rather than the pace of purchases that matters. So long as the Fed is reinvesting the proceeds from maturing securities its balance sheet isn't shrinking and policy isn't tightening. Of course, "not tightening" may not be good enough. But in my view the Fed has paused. It's watching the data, and the cycle of easing hasn't obviously ended.

  • Environmental economics

    Taxing the bad stuff

    Jun 2nd 2011, 12:51 by R.A. | WASHINGTON

    ALSO at Ezra Klein's place, Brad Plumer writes an excellent post summarising a new IMF paper on environmental taxation. It includes this telling graph:

    Among OECD members, America does the worst at raising revenue through taxes designed to discourage pollution. I suspect that a big part of this is due to America's remarkably low petrol tax, but that in itself is worth noting. Ideally, one would like to tax bad things rather than good things, and pollution is a bad thing. In a country that dislikes income taxes and frets over its deficit, a bigger role for environmental taxes, including a carbon tax, seems like a no-brainer. Unfortunately, America's politicians have failed to come up with an effective way to sell the idea.

  • Trade and wages

    Apple, China, and the class war

    Jun 2nd 2011, 12:35 by R.A. | WASHINGTON

    OVER at Ezra Klein's blog, Karl Smith has been doing some very interesting blogging on the compositional effects of the recession in America. He concludes a post documenting the dramatic decline in manufacturing employment over the past decade by writing:

    The lesson is that it seems unlikely this trend was caused solely by the financial crisis or housing collapse. The job loss that began in 1999 has continued at a greater or lesser pace ever since. More likely this is the result of globalization.

    It’s anathema in many economics circles to speak ill of international trade. Indeed, I am not even willing to go that far. What I am saying is that the story of this recession is a part of the larger story of globalization and its effects on the U.S. labor market.

    He elaborates here:

    Suppose that I have a factory with 1,000 workers who produce $1 million worth of goods. Now, suppose I restructure my factory so that I outsource half the work to China or India. I keep my 500 most skilled employees and have them focus on the most value-intensive work.

    My new reorganized factory produces $1.5 million in output, of which $500,000 comes from outsourced workers. The value added by my factory is still $1.5 million – $500,000 or $1 million. However, since I have 500 workers, average worker productivity has doubled.

    If you were to simply read the statistics, you might say, well, trade contributed somewhat to those 500 job losses, but it looks like the real driver was an increase in worker productivity. Yet, it is trade that facilitated that increase in worker productivity. It was trade that allowed me to fire a bunch of my regular line staff and keep my engineers and highly skilled machine operators.

    Mr Smith suggests that in the long run, this may well be for the best, but in the short run there are significant dislocations that cause real economic pain. Is this how the economy functions in the real world? A new paper in the Journal of International Commerce and Economics says that, yes, it is:

    Globalization skeptics argue that the benefits of globalization, such as lower consumer prices, are outweighed by job losses, lower earnings for U.S. workers, and a potential loss of technology to foreign rivals. To shed light on the jobs issue, we analyze the iPod, which is manufactured offshore using mostly foreign-made components. In terms of headcount, we estimate that, in 2006, the iPod supported nearly twice as many jobs offshore as in the United States. Yet the total wages paid in the United States amounted to more than twice as much as those paid overseas. Driving this result is the fact that Apple keeps most of its research and development (R&D) and corporate support functions in the United States, providing thousands of high-paid professional and engineering jobs that can be attributed to the success of the iPod. This case provides evidence that innovation by a U.S. company at the head of a global value chain can benefit both the company and U.S. workers.

    This will be cold comfort to many American workers, for a couple of reasons. First, Chinese officials are very interested in moving up the value chain and developing their R&D and support service capabilities. These sectors are already blossoming, albeit with a focus on domestic industry. It won't be long, however, before they're able to compete internationally. And second, wage gains that accrue to top engineers and financiers in Silicon Valley and New York City mean very little to the median income earner in Cleveland or Phoenix.

    When pressed for responses to this dynamic, economists tend to argue for measures designed to help American workers prosper in the marketplace. That means an emphasis on training and education, infrastructure investment, and improvement of the regulatory climate. Those are all good things to do, but they're unlikely to make much of a dent in what is obviously a significant shift in the pattern of global production and employment. And so we shouldn't be surprised to see growing interest in greater government support for industry and protectionism (Donald Trump may be a buffoon, but "slap tariffs on China" is a popular policy in America). Against those options, one Chinese solution—provide a lot of direct public service employment for displaced workers—doesn't seem that terrible an idea.

  • American government debt

    Mining the safe harbour

    Jun 1st 2011, 15:34 by R.A. | WASHINGTON

    ONE of the nice things about taking a couple of weeks off blogging is that it allows you to take a slightly longer perspective. Markets swung up and down while I was gone, but are now roughly where they were when I left. Still, over the past few weeks a trend seems to have emerged: American economic activity appears to be disappointing in the second quarter, much as it did in the first. Today's data points continue the chain of frustrating numbers. ADP reported an increase in private employment of just 38,000 in May, well below the April figure and economist expectations. And the ISM report for May provided yet another sign that manufacturing growth is slowing.

    There are one-off factors contributing to the slowdown, the Japanese earthquake and subsequent economic slowdown chief among them, but it's hard to avoid the conclusion that America is joining in the broad global economic deceleration which appears to be underway. Emerging markets have been tightening rapidly to tame inflation, and the effects are now apparent. Chinese industrial figures are showing an easing in activity, and India's economic growth slowed sharply in the first quarter. All signs in Europe point to deceleration, threatening to exacerbate the euro zone's crisis. Things should—should—turnaround as the year progresses. Moderating commodity prices will be good for growth, the Japanese economy should rebound, and America's housing market looks poised for a second-half recovery. But fiscal and monetary tightening, or new shocks, could prevent this.

    One thing seems clear: America's government is making its economic road harder than it needs to be. Debt problems loom, but there is no immediate fiscal crisis and no need for drastic short-term cuts. When debt issues came up during my trip to China, officials had a consistent message: China is a patient investor. It wants America to take steps toward fiscal sustainability, but it's happy to have this happen over a 5- to 10-year period. By cutting drastically now, America is undermining its economy for no good reason.

    Treasury yields tell the tale; they continue to tumble. The yield on the 10-year Treasury fell below 3% on today's bad economic news. Treasury yields have fallen on reduced American economic prospects, but they've also moved down as part of a broad flight to safety. Trouble in Europe and a slowdown in Asia have made the safe haven of American government debt more attractive. Which makes the tussle over America's debt ceiling look even more unnecessarily dangerous. The other consistent message from Chinese officials on debt matters was that any failure to make good on American obligations would be catastrophic. Even a very short disruption in payments, of a week or two, would be totally unacceptable.

    Neither Chinese leaders or markets think a disruption is likely. Today's downward move in Treasuries followed on the heels of the failure in Congress last night of a "clean" (that is, without tacked on spending cuts) increase in the debt ceiling. And Congress will almost certainly lift the debt limit. But the decline in Treasury yields indicates the nature of the fire with which legislators are playing. If Congress called into question the safety of the one safe asset for which markets have an almost unlimited appetite, all hell would break loose.

  • China's economy

    How real is China's growth?

    Jun 1st 2011, 14:39 by R.A. | WASHINGTON

    I'M NOW back from China, and I'm going to resist the temptation to draw grand, sweeping conclusions based on two weeks jaunting around the country. I will tell you some of my impressions, however. And I'll start with the primary question on my mind as I left to visit China: how real is its economic growth?

    I came away from China a bit less worried about property issues than I'd been going in. Don't get me wrong, China is building an enormous amount of new housing, and quite a lot of that new housing is standing empty, even as prices rise. But this isn't necessarily the problem many people suspect, for a few reasons. For one thing, the flow of new demand for housing seems sure. Millions of Chinese remain underhoused while real incomes are soaring. In some cases, the Chinese government is coordinating the construction of several years' worth of demand for new homes all at once, justifiably confident that new units will ultimately be occupied. In other cases, Chinese workers are buying up new units as investment vehicles—but are using savings, rather than debt, to fund the purchases. It's not impossible, or even that unlikely, that prices in the main cities may fall, but it would be wrong to assume that China's property markets operate in the way American markets do and share the same vulnerabilities.

    Tightening restrictions on household purchases, and tightening credit, designed to rein in booming private construction, may produce a squeeze in some segments of the real estate market, leading to pain for some on the development and transactional side of the market. But a slowdown in private construction is unlikely to gut the broader economy, thanks to a massive government push for affordable housing construction that will keep workers and suppliers busy. And the government has the will and the ability to make sure any broader loan troubles are contained. I won't begin to argue that there aren't huge inefficiencies and costs to this system, but it doesn't look like the kind of structure that's likely to collapse, bringing the economy down with it. It's clear where the risk ultimately lies—with the government—and it's clear that the government can handle it.

    What little I saw of China's manufacturing sector reinforced my sense that it's an impressive and productive part of the economy. China's manufacturing also spans the value-added chain. In the large coastal cities, deindustrialisation is already a reality; labour-intensive factories have already left for cheaper markets, leaving high-tech manufacturing and a growing service sector behind. In the poorer west, by contrast, the scope for movement up the value chain remains significant. Much of what rapid growth China has left will be powered, in no small, part, by the convergence of western provinces toward coastal development levels, and this process is well underway.

  • Immigration

    More labour, less family

    May 31st 2011, 15:01 by A.S. | NEW YORK

    I KNOW a man who came to America alone as a teenager with no money or contacts. Within ten years he had a PhD and high-paying job. Then the financial crisis hit and he lost his job. He had an H1-B visa at the time which meant that if he did not find another job fast he’d have to leave the country. It was a tense few months for him. For a while it looked like he might be deported. In the mean time his sister, who was not nearly as well educated, got a green card (which ensures permanent residence independent of employment) because she was a political refugee. And because she had a green card she was able to secure one for my friend's mother, who had not finished elementary school.

    According to the latest OECD Migration Outlook, America received 1,107,000 permanent immigrants in 2008. About 73% of them came for family re-unification, which often means they are unskilled. About 15% came as refugees, and only 7% were labour migrants, meaning they came for work. There were also 340,700 temporary migrants who came on student visas. So much family and refugee migration makes sense for humanitarian reasons, but does it make sense economically? The American economy would benefit from more skilled workers, so why do they make up such a small fraction of migrant flows?

    Most OECD countries take more family than labour migrants. But in America labour migrants make-up an exceptionally small share. In Australia and Britain, labour migrants make up more than a quarter of annual flows. The low fraction of labour migrants in America is due to the few work visas available. Most labour migrants must have an American employer sponsor them. Most skilled workers initially come as temporary migrants under an H1-B visa. The H1-B is also how many foreign students stay and work after finishing their studies. After a few years, if your employer sponsors you, this can be converted into permanent residency. There are only 65,000 available H1-B visas each year, plus another 20,000 for advanced degree holders (that totals about one tenth the number of visas granted for family reunification).

    It may seem counter-productive to want more labour migrants when unemployment is high, but immigrantion can actually be a source of job creation. Research from the Kauffman Foundation has found that more than half of all Silicon Valley start-ups had at least one foreign-born founder. Jennifer Hunt, an economist, has found that immigrants, who come as either students or on a H1-B, are more likely than natives to file a patent and commercialise their innovation. But you need an employer sponsor for an H1-B. So you when you migrate on this visa it’s hard, at least initially, to be self employed. While there’s evidence that this an exceptionally entrepreneurial population, America limits its numbers and designs visas to discourage entrepreneurship.

    The question for immigration policy reform should be how America can attract immigrants who will contribute most to economic growth. There are good reasons for the absolute number of family and humanitarian migrants. It is important to keep in mind that low-skill migrants also make a significant contribution the American economy (and also tend to be entrepreneurial). But it seems odd that America makes it so hard for skilled migrants to come for work. Expanding the number of H1-Bs would be a good start. But it should also consider policies, already in place in Britain and Australia, which allow skilled migrants and students to come and work in America based on their skills and achievements.

  • Inequality in China

    O brother, where art thou?

    May 30th 2011, 11:25 by S.C. | HONG KONG

    CHINA has enjoyed (and suffered) more than its fair share of social mobility in recent decades. Between 1981 and 2005, over 600m Chinese moved out of poverty, according to Shaohua Chen and Martin Ravallion of the World Bank. Some Chinese of modest means became fabulously rich. But not all social mobility was upwards. From 1949 to the end of the 1960s, China's communists uprooted landlords, expropriated capitalists, and banished bourgeois intellectuals to the hinterlands. Through collectivisation, socialisation and rustication, they dismantled the traditional mechanisms (land, capital, schooling) by which the well-to-do pass on their advantages to their offspring.

    Some of those mechanisms may now be back in operation, however. Inequality in China has, of course, risen sharply in the past 30 years. A few scholars are now documenting its transmission from one generation to the next. In a 2010 paper, for example, Yingqiang Zhang of Beijing Jiaotong University and Tor Eriksson of Aarhus University, Business and Social Sciences, in Denmark looked at the offspring of thousands of households included in a longitudinal survey of nine provinces from 1989 to 2006. The offspring experienced diverging fortunes over the years, roughly in line with national trends. This rising inequality might not be worrying if it reflected an increasingly dynamic, meritocratic society, rewarding greater effort or ability. But the authors estimate that 63% of this inequality in outcomes was due to inequality of opportunity.

    Inequality of opportunity is not easy to measure, or even to define. Economists tend to worry when some people are barred from making their full contribution to society, while other people reap disproportionate rewards, taking more from the national product than they add to it. That is not just unfair; it is inefficient.

    Philosophers go further. They feel people should be rewarded or punished only for the things they can choose, such as effort, and not for circumstances outside their control. Those circumstances include obvious inherited privileges, such as wealth and social connections. But the definition can extend further, to include many things we normally associate with merit, such as talent. We do not, after all, get to choose our talents, so why should we be rewarded for them, beyond perhaps what is necessary to make us put those talents to good use?

    In their 2010 paper, Messrs Zhang and Eriksson take account of a number of circumstances beyond the individual's control, including the income, education and employer of a person's parents; as well as that person's place of birth and gender. They find that having richer parents helped a person's prospects (a 10% increment in parental income was reflected in a 4.5% income boost for their offspring) and having parents who were employed by the state helped a lot. Parental education, on the other hand, was no help whatsoever. In these provinces, where your parent works matters more than where he went to school.

    Not every parental influence can be observed, distinguished and measured, however. So in a recent working paper, the two authors look at an alternative indicator: namely, the correlation between one brother's income and another's. This fraternal comparison is a good "omnibus" measure of the weight of family and community influence, according to Mr Eriksson. Two children brought up by the same people, under the same roof, in the same neighbourhood, will share many of the same circumstances of birth and background. If these things matter greatly in a society, they will govern the life chances of both brothers, resulting in a tight correlation in their incomes. If, on the other hand, family background matters little, the fraternal correlation will be low.

    In a 2000 paper co-authored by Mr Eriksson, he and his colleagues found that the correlation was much higher in the US (0.43) than in the Nordic countries (0.14 to 0.26). In China, the correlation is higher still: 0.57. To put that in context, the authors argue that knowing what a person's brother earns gives you a a better guide to a Chinese person's income than economists are normally able to obtain from knowing how many years of schooling and work experience a person has under his belt. 

    There is, however, one big obstacle to calculating brother correlations in China. Thanks to the one-child policy, few young, urban Chinese have siblings. The author's estimate of 0.57, therefore, applies only to rural China. In China's cities, inequality of opportunity takes a rather different form: the second-born are denied the opportunity to exist.

  • The Swedish view of the euro crisis

    Get on with it

    May 28th 2011, 15:00 by J.K. | LONDON

    ALL the rancour and distress of the euro crisis seems a world away from Mölle, an idyllic hamlet on the west coast of Sweden. The euro's woes were nonetheless the main talking point among those gathered in the town this month for the annual meeting of the Swedish Network for European Studies in Economics and Business (or SNEE, for short). Now in its 13th year, SNEE’s event brings academics and policymakers from Sweden and beyond—but mostly from Sweden—to discuss European integration.

    I moderated a discussion on Europe's fiscal mess. Aside from some minor disagreements among the panellists, the overall impression was that a solution is simple: restructure wobbly debt and write-down dud loans without delay. This is, more or less, the approach that Sweden took following banking crises in the early 1990s. Bo Lundgren, a key Swedish minister during the 1990s debacle, said that his greatest hope for Europe's financial regulators was that they simply "learn lessons". He himself has been busy dispensing these lessons in one financial capital after another in his guise as "Mr Fix-It".

    Throughout the conference, Nordic views on honesty, transparency and fairness made for an open, if somewhat unrealistic, debate on Europe's current problems. When other explanations for the fiscal indiscipline in the euro area's periphery seemed insufficient, someone would inevitably suggest that innate cultural factors were to blame. Half-joking, a proposal was mooted for improving Europe's monetary union by splitting it into a Protestant North and a Catholic South (or cold and hot countries, as a more secular-minded attendee suggested).

    In the interests of fair play, the participants also criticised Germany's surpluses as stringently as the periphery's deficits. Excessive prudence is as dangerous as gross recklessness when it comes to correcting imbalances, it was suggested. There was vague talk of official punishments for countries that save too much. 

    And the Swedes were not above self-criticism. Leif Pagrotsky, an MP, said that the idea of the "Swedish model" of crisis resolution is now more powerful than the plan's actual details (flawed, in his opinion). Lars Oxelheim, SNEE's chairman and a professor at Lund University, has also published a paper doubting the Swedish model's applicability to the current crisis.

    Despite these caveats, the Swedish model still seems more encouraging than anything now being discussed for Europe's ailing economies. A report on "The Nordic Way", passed to me by the head of a think tank (and discussed recently by Bagehot) sums it up nicely: "A swift and resolute reform strategy may yield better results than a wishy-washy, drawn-out one." Given recent experience, "may" seems like the Swedes merely trying to be polite.

  • Stanley Fischer and the IMF

    Fisching for a job

    May 27th 2011, 8:23 by S.C. | HONG KONG

    PERHAPS he read this week's leader. Stanley Fischer--governor of Israel's central bank, former number two at the IMF, and one of the biggest names in macroeconomics--is thinking about running for the top job at the Fund. That, at least, is what a person "familiar with his thinking" has told Bob Davis of the Wall Street Journal.

    Mr Fischer considers himself a "compromise" candidate, says this unnamed person with a view inside his head. But surely that gets it backwards. He's the kind of candidate that might emerge if the hiring process were blissfully free of the political compromises that now weigh so heavily upon it.

    His record is not spotless, of course. He was a leading figure at the Fund from 1994 to 2001 during the most traumatic period in its history, fighting fires in Thailand, Indonesia and South Korea, which then spread to Brazil. The IMF's high-interest-rate defence of Asia's currencies remains controversial. Its fiscal prescriptions for South Korea were initially too tight, a mistake which it hastily reversed. And if those difficult choices offended the easy-money types, the IMF's last "Hail-Mary" loan to Argentina, in the same month Mr Fischer left, offended the fiscal conservatives. (It was "the greatest mistake the Fund made in my ten years there," according to Michael Mussa.)

    On the other hand, Mr Fischer has many obvious strengths: intellectual heft, deep experience and the respect and affection of just about everyone who has worked with him. He also has some quieter virtues: this is a man, after all, who just won a 70% pay hike at the Bank of Israel for his successor. He felt the higher pay was necessary to attract good future candidates for the job, but thought it would be bad form if he himself accepted it.

    And of course, for graduate students of a certain generation, there's the added pleasure of seeing the "Blanchard and Fischer" team reunited: the lecturers on macroeconomics recast as macroeconomic leaders.

     

  • Europe and the IMF

    En Garde

    May 26th 2011, 23:58 by P.B. | LONDON

    IN THIS week's edition, The Economist argues that a euro-zone finance minister should not lead the IMF. Many of the guest contributors to Economics By Invitation share that view. So let me add my own voice to the chorus.

    By all accounts (including our own) Christine Lagarde is a highly capable international lawyer and canny political operator, well-respected throughout Europe and America. But she is also the French Minister of Finance, and that fact alone should rule her out of the IMF job.

    Given the IMF's entanglement in the euro crisis, Ms Lagarde faces far greater conflicts of interest (real or perceived) than alternative, non-European candidates. What’s best for France or Sarkozy’s reelection campaign may not be what’s best for the IMF as a whole. Her appointment would raise unnecessary questions about the IMF's decisions.

    Of course, until last week the IMF was led by Dominique Strauss-Kahn (DSK), a man getting ready to run for the French presidency. He won praise from many quarters for his management of the Fund. But that should not disguise the fact that he suffered from a very real conflict of interest that opened the IMF to potential criticism.

    Under DSK, for example, the IMF made an unprecedented commitment to preserving the very existence of the eurozone. Whereas traditionally it supported countries facing a balance of payments crisis, the IMF has now extended loans to countries with a reserve currency, the euro, in order to prevent that monetary union from breaking up. Nearly two thirds of the IMF’s outstanding loans are tied up in European nations, a profound change from its recent history as a lender to poorer countries. And it has made a seemingly open-ended implicit agreement to provide a third of any EU bailout.

    Time will tell whether underpinning the eurozone was the right decision, but the very fact that it served DSK’s political ambitions, positioning him as the saviour of the euro, highlights the inappropriateness of mixing national politics with international technocracy.

    DSK also used his IMF position to push for greater European centralisation, including tax harmonisation, and to advocate more stimulus spending. These positions may or may not sit well with the IMF's intellectual traditions, but they are certainly positions a French Socialist presidential candidate would want to support. 

    The IMF, along with the ECB, has also strongly opposed calls for restructuring Greece's debts--at least before mid-2013, when the EU's loans to Greece take on more senior status, shielding them from the indignity of default or delay. Any restructuring would, of course, be tremendously unpopular in France. The mid-2013 target date, by contrast, comes conveniently after France’s presidential elections. 

    So, although there is no pure, meritocratic way of choosing an IMF chief – how does one even assess ‘aptitude to run a unique international monetary body created in 1945’? –  some candidates are more compromised than others. It’s unrealistic to expect that Ms Lagarde, a youthful 55, will leave her past and future political career behind her after joining the IMF, or that any other similarly qualified European choice would. 

    At least DSK was appointed before the euro-crisis. Now that the IMF is in the business of bailing out Europe, it shouldn’t be run by a European.

  • America's recovery

    Special factors or new trend?

    May 26th 2011, 18:29 by G.I. | WASHINGTON

    LAST fall I figured the American economy would outperform the pessimistic consensus of 2.5% in 2011. Yes, the recovery would be weak, as it typically is after a financial crisis, but it would nonetheless be a recovery: GDP would grow faster than potential, around 2.5%. The catalyst would be a moderation in deleveraging: consumers would be saving enough out of current income to both pay down debt and spend more.

    Deleveraging has, indeed, slowed. Consumer credit has begun growing again, though mortgage credit has not. The saving rate has stabilised at between 5% and 6% of disposable income.

    And yet, growth has not picked up. The latest disappointment came this morning as the Bureau of Economic Analysis left its estimate of first quarter growth at an annualised 1.8%, throwing cold water over the street’s consensus of 2.2%. The BEA revised down first quarter personal consumption growth to 2.2% from 2.7%, as it concluded that consumers were spending more because of higher prices for energy, not a larger volume of purchases.

    I could, in the noble tradition of forecasting, stick to my original view and chalk the first quarter disappointment up to special factors (ie, bad weather and a one-off hike in energy prices). Goldman Sachs today lowered its forecast for global growth this year to 4.3% from 4.8%, and for the United States by an identical half percentage point, to 2.6% from 3.1%, as it raised its oil price forecast by $20 a barrel.

    Unfortunately, the second quarter isn’t looking much better. Macroeconomic Advisers yesterday lowered its tracking estimate of second quarter growth to 2.8% because of weak durable goods. Just two weeks ago, it was 3.5%. This is starting to look eerily like the erosion in estimates that transpired over the course of the first quarter. Optimists like me had assumed the gap between weak GDP and robust high frequency data, such as stock prices and jobless claims, would be resolved in favour of the latter. In fact, the opposite is happening. Stocks have been grinding lower and today we learned that jobless claims rose 10,000 last week to 424,000, the seventh week above 400,000.

    The second quarter weakness is also being blamed on a special factor, namely the hit to automobile production because of supply interruptions in Japan. But at some point a stream of special factors starts to look like a trend, and that trend, as my chart above shows, has been the same for two years now: an economy making almost no progress in closing the output gap. GDP has grown an average of 2.8% in the two years since the recession ended (assuming 2.8% in the current quarter). The unemployment rate has come down anyway, more due to a puzzling lack of labour force growth than to above-potential output growth.

    I eyeballed my trendline; you can do it more scientifically by computing, then extrapolating, trend growth or by using moving averages. The fit and output gap varies but the underlying story is the same. Looking back at the experiences of Scandinavia and east Asia after their crises, I shouldn’t have been surprised, or disappointed (as these charts from the IMF show). But so far, I am.

    The Federal Reserve knows what’s going on and while it isn’t about to embark on QE3, the date it starts tightening is almost certainly being pushed out. Fiscal policy has me more worried. Republicans and the administration seem bent on $1 trillion of spending cuts over the next decade. If backloaded, fine. What I worry is that since big entitlements are off the table, this will be front-loaded onto discretionary spending, further burdening the recovery. And of course, failure to raise the debt ceiling at all would force an immediate contraction in federal spending equal to 9% of GDP.

    I still think as energy prices stabilise and job growth remains intact, consumption and growth will pick up. But that's starting to look more like an aspiration than a forecast.

    UPDATE: I should have pointed to Mark Thoma's post here looking at actual GDP vs. trend back to 1870.

  • The politics of Medicare

    Medicare has a lemons problem

    May 25th 2011, 21:53 by G.I. | WASHINGTON

    THERE are many problems with Paul Ryan’s budget and his plans for Medicare, but for Democrats, one is paramount: it is unpopular. His proposal initially put Democrats on the back foot, but within days they took heart as press commentary and polls turned negative. Mr Ryan’s plan, they concluded, was an electoral gift. That culminated in the upset victory by Kathy Hochul, a Democrat, in a predominantly Republican New York district in a special congressional election rightly seen as a referendum on RyanCare.

    At the Peterson Foundation’s fiscal summit this morning, Mr Ryan complained that Democrats "are shamelessly demagoguing and distorting" his budget. It’s hard not to smile. As James Kwak thoughtfully reminds us with some choice press releases from Mitch McConnell, this is precisely how Republicans captured the elderly vote in last November’s midterms. Old folks, they said, would have their care rationed, and treatment decisions left to a cruel committee of unelected bureaucrats (the Independent Payment Advisory Board, which they have vowed to repeal).

    Mr Ryan’s critics, however, should curb their schadenfreude. As Bill Clinton noted at the Peterson summit, the election results were "an inevitable consequence of the fact the Republicans ran to left of Democrats in the [mid-term] election… I'm afraid Democrats will draw the conclusion that because the Republicans’ proposal is not the best one we shouldn’t do anything."

    Or, as Brad DeLong put it:

    [T]he political lesson of the past two years is now that you win elections by denouncing the other party's plans to control Medicare spending in the long run—whether those plans are smart like the Affordable Care Act or profoundly stupid like the replacement of Medicare by RyanCare for the aged—sitting back, and waiting for the voters to reward you.

    I don’t fully agree with Mr DeLong. There is nothing profoundly stupid, in principle, with either vouchers (or premium support, as Mr Ryan calls it) for Medicare or block grants for Medicaid; as Alice Rivlin notes, the term premium support was coined by two Democratic economists, Henry Aaron and Robert Reischauer, and Mr Clinton converted welfare to block grants with good results. Whether either is in fact a viable alternative to the present structure depends crucially on how much money the block grants and vouchers are worth. Mr Ryan is too flinty on both. Republicans could have deflected some of this criticism by presenting the plan as the starting point for debate. Instead, by marrying it to unbending opposition to higher taxes, they turned the budget into a contest of wills rather than a negotiation.

    Neither the Affordable Care Act (ACA), nor Mr Obama’s response to the Ryan budget, represent a long term deficit reduction plan. The ACA has only a slight impact on the Congressional Budget Office’s projections of long-term federal health spending and Mr Obama hasn't even released the detailed projections underlying his budget speech.

    Politically, it may not matter: Republicans may eventually abandon RyanCare because of its sheer unpopularity without Democrats having to come up with something better. But the country will not be better off for it.

    We have a lemons problem here. In George Akerlof’s original formulation, markets break down when one party to a transaction knows more than the other. The seller of a used car knows whether or not his car is a lemon; the buyer does not. The buyer is aware of this information asymmetry and assumes he will be sold a lemon, and will thus only pay a lemon price. And since the seller can only get a lemon price, he will only sell a lemon. (HT to Tom Gallagher of Scowcroft Group who gave me the idea for this analogy.)

    This is precisely where the Medicare debate is headed. Both parties have, somewhere inside them, a serious proposal to reform Medicare. If they thought they could be elected by offering such a plan, they would do so. But any serious attempt to reform Medicare is going to be unpopular because it will cost the elderly something, and the elderly are on the way to becoming 30% of the voting population. Thus, the opposing party is inevitably going to use such a proposal to kill the other at the next election without advancing an alternative. And since both parties know this, the only Medicare plans they offer voters will be lemons.

  • The IMF and emerging economies

    BRICmanship

    May 25th 2011, 6:57 by S.C. | HONG KONG

    I must confess to feeling a bit disappointed with the BRICs this morning. Here I was thinking they were poised to run the world and it turns out they can’t even stop the French running the IMF. At this point, it’s no good them railing against unwritten conventions. It’s time to start rallying behind a flesh-and-blood candidate.

    Agustin Carstens has been nominated by Mexico, of course. But he can’t even count on the support of the Brazilians, according to an official familiar with the negotiations cited by Bloomberg. The same agency quotes India’s representative on the IMF’s executive board, Arvind Virmani. He would prefer a candidate from an emerging economy. But if he were advising friends he would tell them they were running for second place. That’s the spirit!

    The BRICs and other prominent emerging economies may feel they don’t want the IMF job badly enough to turn this into a real contest. To win a proper fight they would have to paper over some big internal rivalries and annoy some powerful European partners and allies. (The United States probably isn’t that bothered either way.) By the same token, losing a geunine contest would be humiliating for them and possibly damaging for the institution, if the visible lack of consensus undermined the legitimacy of the new boss. Worse to have fought and lost, they must think, than never to have fought at all.

    That’s all probably true. But not showing up has its own costs. In particular the BRICS are beginning to look a little feeble. They look as though they have valid complaints but no viable solutions. As global powers, they're all hat, no cattle; all wood, no bears; all soda, no scotch; all broth, and no noodle.

    For the past few years, they’ve been in the rather comfortable position of heirs apparent. But they've been largely spared the gruelling spadework of multilateral statesmanship, which includes building coalitions, expending political capital for an indirect benefit, and figuring out what they want to do with the global institutions and circles of power in which they’ve always felt marginalised. In his Bloomberg interview, Mr Carstens makes a similar point: as well as more representation in the institution, the emerging economies should take more responsibility.

    If the emerging economies rally round a candidate of their own, they may not prevail. But as Mr Virmani puts it, “there is still perhaps merit in saying that 'we tried'".

  • Greece's debt crisis

    The A-Team, Greece and mud volcanoes

    May 24th 2011, 13:23 by A.P. | LONDON

    The climax of every episode of “The A-Team” followed an unchanging formula. Our heroes are trapped in a building with no chance of escape. Things look bleak until they discover an oxyacetylene torch, some sheets of metal, a screwdriver and a car engine. They build a vehicle and ram their way to freedom.

    There was a mild A-Team echo at an Economist conference I co-chaired in Greece last week. Session after session considered the problems facing the Greek economy. Government ministers gamely listed their achievements to date and batted aside suggestions of restructuring. But the immensity of the task still ahead loomed over the discussions.

    And then, in the penultimate session of the event, a metaphorical blowtorch appeared. A group of geology professors took to the stage to give a series of lengthy and  impassioned presentations about Greece’s untapped offshore oil reserves. Suddenly, the talk was of mineral wealth that would solve Greece’s debt crisis at a stroke.

    The presence of mud volcanoes in the Mediterranean, said one speaker, had signalled oil reserves for other countries. Greece has mud volcanoes, ergo Greece has oil. One slide teasingly showed potential revenues of €300 billion, against the country’s outstanding debt of €340 billion. The speakers slammed the government for failing to pursue exploration. The audience applauded wildly. Given a choice between grinding structural reform and living like the Saudis, who could blame them?

    The A-Team ending is missing, however. Disputes with Turkey muddy Greece’s territorial claims. Your blogger is in no position to comment on the science, but the interest of foreign oil firms would be a far better indicator of accessible oil reserves than conference presentations. In an earlier session, Yiannis Maniatis, Greece’s deputy minister of the environment, energy and climate change, told the audience not to believe claims that oil wealth could solve the country’s sovereign-debt crisis. Or, as Mr T would put it, stop your jibber-jabber.

  • US manufacturing jobs

    Song two

    May 24th 2011, 12:47 by S.C. | HONG KONG

    IN THE past year American manufacturers have added almost 200,000 jobs to the payrolls (197,000 from April 2010 to April 2011 to be precise). That's a "terrific increase," writes Mark Doms, chief economist of the Department of Commerce, in his preview of tomorrow's durable-goods report. It didn't sound all that terrific to me, until I checked the numbers. It turns out that no administration has been able to make that claim since President Clinton's in the summer of 1998. The closest we got during the Bush years was the 12 months to October 2004, when American manufacturers added zero workers (see chart below).

    Just to be clear: the chart shows the year-on-year change in manufacturing employment, not the level. (A straightfoward chart of the number of people employed in manufacturing looks like this.) It may be that manufacturing layoffs overshot during the Great Recession and that after a brief recovery, employment will resume its decade-long downward trend. Or perhaps the Great Recession hastened the workforce's descent to rock-bottom (reached in December 2009 at 11.5m workers*), and things can only improve from there.

    Where have these new jobs been added, exactly? The chart below from Mr Doms and his team shows the job gains and losses in different parts of manufacturing. Housing-related industries, such as furniture, continue to shed workers. But two export-orientated industries--machinery and transportation equipment--added 80,000 jobs between them. And almost 100,000 were added in the metals industry, counting both the primary sector (steel mills, aluminium smelters, etc) and fabricated metals (cans, coating, forging, and so on). It is, writes Mr Doms, "a welcome reminder of the importance of American heavy metal".

    *CORRECTION: I notice I put my decimal point in the wrong place in the original post. The text has now been corrected. Perhaps the whole post should be retitled Song 0.2

  • Short-termism

    Sir Richard on Sir Ralph

    May 24th 2011, 11:15 by S.C. | HONG KONG

    IN YESTERDAY'S FT, Richard Lambert, its former editor, heralded the industrial achievements of his fellow Knight Bachelor, Sir Ralph Robins. Under Sir Ralph's patient guidance, Rolls Royce resisted the tyranny of short-termism to survive as one of Britain's last bastions of engineering excellence. Sir Ralph often complained about the myopia of the City of London:

    What do you want,” Sir Ralph would ask. “A world-leading company in a dozen years’ time, or a bigger pay-out today?

    Now that myopia can be measured. Mr Lambert cites "The Short Long", a paper published this month by Andrew Haldane and Richard Davies of the Bank of England. It documents the British and American stockmarkets' tendency to feel the morrow only dimly, discounting future earnings more heavily than is rational. A pay-out in a dozen years' time, for example, was undervalued by almost 54% by the markets over the period 1995-2004 (which largely overlaps with Sir Ralph's tenure as chairman). In the industrials sector, it was undervalued by more than 60%.

    If Rolls Royce is an example of a company that resisted myopia, Cadbury is a company that succumbed to it, according to Mr Lambert. Note the preposition he chooses in describing the company's sale last year to a well-known American food giant:

    Shareholders might well have decided to take a small but certain gain from a hostile takeover today rather than wait for the uncertain returns tomorrow from all that new investment. That’s just what happened to Cadbury when it was taken out by Kraft last year.

  • China's economy

    Flash! Ah-Ahh!

    May 24th 2011, 4:13 by S.C. | HONG KONG

    AS BUTTONWOOD has already noted, HSBC yesterday published its "flash" (ie, preliminary) purchasing managers' index for Chinese manufacturing (compiled by Markit). The PMI reading fell to 51.1, its lowest since July 2010. The release contributed to stockmarket declines in Japan, Australia, South Korea and Hong Kong as well as mainland China itself. The Shanghai Composite fell again today, for the fourth session in a row.

    In the face of all this consternation, can I humbly point out that a reading of 51.1 is consistent with growth of 13% in Chinese industrial production and 9% in Chinese GDP. Settle down people.

    Since late 2009, once it became clear China had pulled through the global financial crisis, I've despaired of keeping track of the pendulum swings of sentiment towards the country. I never know whether people want the economy to grow faster or slower. In the spring of 2010 people were worried about a property bubble, suggesting things were a bit hot. But when the government imposed curbs on mortgage borrowing and speculative homebuying in April of that year, people quickly began to fear a hard landing. Likewise in the past few months, China-watchers have documented the government's struggles to rein in its banks. But now that it seems to be succeeding, people are once again raising the alarm about a severe slowdown. 

    It is as if China-watchers are possessed by the 70-year old Harrod-Domar model of growth, in which the economy is always poised on a knife-edge. If growth is faster than warranted, the overheated economy will only get hotter. If growth is slower, demand will fall ever further short of capacity.

  • Economic metaphors

    Life is elsewhere

    May 24th 2011, 0:01 by S.M. | SINGAPORE

    IN MILAN KUNDERA's "The Unbearable Lightness of Being", the character Tomas falls in love with a woman after imagining her as a child in a bulrush basket. "Tomas did not realise at the time that metaphors are dangerous," Mr Kundera tells us, "A single metaphor can give birth to love."

    Economists are not immune to this danger. Many of them fell in love with their ideas through the metaphors that sustained them, as historian Daniel Rodgers suggests in his new book, "Age of Fracture"--a survey of intellectual trends since the 1970s. The chapter on economics recounts how social scientists become enamoured with economic thought experiments detached from history, institutions or power. The result has been a widening gap between what economists told us and what actually happened. 

    At the time, however, the movement persuaded many people. In law and economics, Richard Posner asked rhetorically whether justice was not merely what was economically efficient. He relied on the "Coase theorem", which argued that initial allocations of wealth don't matter to efficiency as long as markets allow people to trade their stakes. Within economics itself, Robert Lucas re-imagined human beings as lightning calculators of discounted value and time. In so doing, he sought to discredit Keynesian efforts to control economic activity. Like many other economics textbooks, early editions of Paul Samuelson's tome argued that explaining "fluctuations of national income" was the first task of economics. The problem was then described with institution-thick data. But by 1982, the book's structure was reversed, first teaching microeconomics along with abstract models of perfect competition. In philosophy, John Rawls' veil of ignorance situated individuals outside the context of any particular community and asked them to calculate their advantage in the context of uncertainty.

    Economics has always used metaphors abstracted from society—the "invisible hand" comes to mind. But Mr Rodgers points out that the 19th century political economists were more realistic about society than today's model-builders. For Adam Smith and David Ricardo, the basic three factors of production—land, labour, and capital—corresponded to three great "classes of community": landowners, capital investors, and labourers. This very schema suggests a socially contextualised understanding of markets. Economists largely stuck by this intuitive understanding of economics until even the 1940s, when Robert Solow was still talking about a "socially imbedded" understanding of markets, with different "kinds of goods, kinds of industries, kinds of labour." Even Samuelson's textbook in the 1960s retained separate chapters on agricultural and labour economics, "deemed different enough from markets in the abstract to require their own analytically distinctive treatment," as Mr Rodgers points out.

    Of course, recent trends have tended away from market metaphors. In the late 1990s, behavioural economics, which studies the limits of rationality, began to emerge. A new institutional economics, focused on firm structures and information imperfections, also began to grow.  Recent economic convulsions will only intensify these departures. Social and institutional contexts do not seem optional in explaining, for instance, why Washington regulators so often side with the financial institutions they police.  They also seem necessary to explain nearly any facet of Chinese monetary policy, which seems predicated on a dense network of institutional and political relationships. In effect, the sharp pinch of necessity continues to remind economics of the importance of history, institutions, and power. 

    One lesson of the 1970s is that economics does respond to economic crises. Unpersuasive economists get discredited, irrelevant economic models lose prestige, and ideas that were once on the periphery become hotly debated.  Without this, economics risks losing "mindshare and influence to others—from business schools and public-policy programs to political science, psychology, and sociology departments."  In other words, winning new loves will require new metaphors.

  • Writing worth reading about

    Econobrowsing

    May 23rd 2011, 23:44 by S.C. | HONG KONG

    I'D LIKE to think I was a serious reader. But in truth, I'm a serious browser. I am not one of those people who always has a novel on the go. That's partly because I dip in and out of non-fiction, but also because my reading about books gets in the way of my reading of books. NYRoB, LRB, TLS, The New Yorker, aldaily.com--there are so many ways to read about the books you are going to read...if only you could stop reading about them.

    So it was with some trepidation that I followed Tyler Cowen's recommendation to visit The Browser, which he says is "better than I ever expected a web site to be."

    In the interests of disclosure, I should point out right away that the site was founded by Robert Cottrell, a former colleague at The Economist. Before he left, Mr Cottrell invented many of our blogs. If it were not for him, I probably wouldn't have to be blogging now.

    I visited The Browser to read an interview with Tim Harford, author of The Undercover Economist, the Logic of Life and the forthcoming Adapt. Mr Harford was asked to recommend five books about economics. He chose several that are about economics without knowing it. You can read about them here. (I thought his first and last picks were the most thought provoking.)

    The Browser's interest in economics aroused my curiosity about the economics of sites like The Browser--in particular, the economics of attention, as Richard Lanham has called it. Attention is a scarce resource. In several industries it is the scarce resource. The allocation of attention is therefore among the more interesting economic problems of our time.

    How does The Browser help solve that problem? I must confess I'm not really looking for additional things to read. I suspect I'm not alone. I probably already own more books than I'm ever going to get through in my life. All of them are good; many are "indispensable" classics I've so far got by without. I would describe all of them as "worth reading". And yet if you think about it, some of them can't be. if I can't get through all of them, then reading any one of them means not reading another. There must, then, be some books in my pile that are great and yet not worth reading, because they'll crowd out another book that's greater. The opportunity cost of a book is partly determined by the value of other, alternative books. Or to put it simply, would one not be better off reading Wodehouse?

    What I'd like to know about The Browser is this: will it add to my pile of unread books or reduce it? According to its website, the site now earns revenue only from Amazon commissions. So to make money it has to add to my bookshelf. But in the near future it hopes to generate money by building on its "skills, reputation and readership".

    One of its skills is curation. That's become a bit of a buzzword in the content-provision business. But there's one neglected aspect of curation that I find enormously appealing: museum curators put things on display, of course, but they also leave a lot of stuff in the storerooms. The Browser's curation could do something similar. Instead of trying to add to my reading list, it could try to shorten it or at least hone it. Instead of working on the extensive margin, it could work on the intensive one.

    It could offer recommendations like: If you read only five books on classical Chinese poetry, these should be the ones. If you read only three, these are the two to drop. If you've read this, you don't need to read that. If you were intending to buy this well known book, try this lesser known, but better, book instead. Now that I would love to read.

  • Standard & Poor's lowers its credit outlook for Italy

    Negativo

    May 23rd 2011, 12:37 by J.P.P. | LONDON

    THE abject performance of the rating agencies in the run up to what Australians call the GFC (that's the Great Financial Crisis, not a hitherto undiscovered Roald Dahl masterpiece) has not diminished the attention that markets pay to their pronouncements. Italy's stockmarket is sharply down today after S&P changed its credit-rating outlook on Italy from stable to negative. Confusingly this doesn't mean the agency has changed its view on Italy's short or long-dated paper, to which it still ascribes fairly favourable ratings. The change in the outlook is more of a call on Italy's direction of travel. And while the timing of the move makes little sense—S&P justifies it with reference to Italy's domestic politics, which did not suddenly alter between Friday and Monday—the bearish call does.

    Italy does not have a debt problem in the same way that other troubled European economies do. Its public finances have been run well in recent times and thus the country enjoys the confidence of markets. It also has the advantage of size: Italian treasuries are the third-largest bond market in the world (after American and Japanese government debt). If investors want exposure to euro-denominated sovereign debt they cannot ignore Italy.

    What Italy does have is a growth problem. It has just been through an awful decade in which growth was close to flat in per capita terms. The country therefore seems stuck in a debt trap. To pay off its vast debts (debt to GDP stood at 128% in 2009) it needs to grow. But it's hard to see how Italy can achieve this while it has to spend so much on debt servicing. One way would be to undertake a programme of liberalising reforms. But that isn't going to happen. Incidentally, most Italians are rather comfortable with this situation. A call to imitate Spain's recent protests was met with a shrug of indifference. Some Italians even argue that it's a good thing that their government is weighed down with debt, otherwise it might interfere in their lives even more than it already does.

     

  • The race to replace DSK at the IMF

    Speak softly and...

    May 21st 2011, 14:02 by S.C. | HONG KONG

    NOMINATIONS open today for the next boss of the IMF. Christine Lagarde of France is the clear frontrunner. But if she were to face a rival from outside the West whom might it be? One name tripping off agile tongues is Tharman Shanmugaratnam, the finance minister of Singapore who is now deputy prime minister too. He has a number of things going for him. He knows a bit of economics, having picked up a bachelor's in the subject at the LSE, a master's at Cambridge and an MPA at Harvard's Kennedy School. He served many years at the Monetary Authority of Singapore and was just appointed chair of the committee of ministers (the IMFC) that oversees the IMF.

    You can see his debut press briefing in this webcast, or read the transcript here. He welcomes the IMF's new pragmatism about capital controls (sorry, "macroprudential measures") which he describes as "a major break in the fund's thinking", and he urges it to pay further attention to "spillovers", ie risks that spill over from one country to another, and from the financial system to the macroeconomy (and vice versa).  

    He does not have Christine Lagarde's star power, but I'm told that he is smart, articulate and forceful, and that people in Washington, DC speak of him highly.

    Given the way these things work, it may also help that he doesn't come from any of the big Asian powers, and yet they'll all find him a sympathetic candidate. He is of Tamil ancestry, his wife's ancestry is partly Japanese, and his kids can speak Chinese.

    According to a 2004 profile in the New Paper, a Singapore tabloid, he keeps four canes in a cupboard--one for each of his kids, although he says he's never had to use them. I can think of no better metaphor for Singapore.

    Of course, what those of us interested in his credentials to run the IMF really want to know is something else: what does he do when the kids run out of pocket money?

    (Picture credit: Wikimedia Commons)

  • Reflections on Hanoi III

    Is Vietnam the next China?

    May 20th 2011, 17:53 by S.C. | HONG KONG

    The obvious answer is no. Vietnam's population is less than 7% of China's. It is at best the next Guangdong.

    Nonetheless China veterans who visit its littoral communist neighbour often say it is like China a decade ago. That would make some sense politically. Vietnam introduced its economic reforms (known as doi moi, which is usually translated as "renovation", although the literal translation is apparently "change to something new") at the end of 1986, exactly eight years after China's policy of "reform and opening up" (gaige kaifang) was approved in December 1978. Judged by another reform milestone--WTO accession--Vietnam is even closer behind. It officially joined in January 2007, only a little more than five years after China was admitted in December 2001.

    So much for the politics, what about the economics?

    The simplest gauge of a country's stage of development is per capita GDP. Vietnam's income per head was $1,180 last year. China's roughly matched that amount eight years earlier in 2002. But $1,180 doesn't buy as much today as it did then. According to America's consumer-price index, $1,180 in 2010 was worth about the same as $932 in the year 2000, when China's income per head was $958. So by that reckoning China is ten years ahead.

    The estimates in the Penn World Tables, which try to hold purchasing power constant between countries and over time, suggest something similar. Vietnam is either ten or 13 years behind China, depending on which of two alternative versions of the Chinese figures you choose.

    Another yardstick of development is the "structural transformation" of the economy from agriculture to industry and services. In an earlier post, I suggested that men's thumbnails might serve as one indicator of this transition. But what do the more traditional indicators suggest? Farming, forestry and fisheries accounted for just over a fifth of Vietnam's GDP in 2010. The last time China relied so heavily on agriculture was 17 years ago. Data on agricultural employment (as opposed to agricultural output) aren't as up-to-date, but they also suggest Vietnam is at least 15 years behind.

    But Vietnam's agricultural sector is not limited to residual farming on family plots for domestic consumption. Take rice, for example. It is such a big part of the country's life that the Vietnamese word for the crop--com--can also be used to mean "meal" or even "wife", according to Bill Hayton, author of "Vietnam: Rising Dragon". But com is also now a commodity, of which Vietnam is one of the world's biggest exporters. Vietnam is also a big exporter of catfish, which it famously renamed basa or tra to appease rival fishermen in Mississippi. So the size of its agricultural sector may reflect its comparative advantage and not its stage of development.

    There are alternative measures of progress, including urbanisation and the demographic transition. In 2009 12% of Vietnam's people lived in cities of more than 1m residents. China reached that ratio 11 years earlier. Vietnam in 2009 had 2.1 working-age adults for every dependant, young or old. China had the same dependency ratio eight years earlier.

    So Vietnam does indeed resemble the China of 1997-2002, if your point of comparison is what its people earn, how they earn it, and where--in the villages or in the cities. But where Vietnam least resembles the China of a decade ago is on the demand side of its economy. Consumption accounted for 64% of Vietnam's GDP last year; it has never come close to that ratio in China. Although Vietnam's income per head is 10-13 years behind China's, its consumption per head is only six years behind.

    Vietnam's national demand has long exceeded its supply, resulting in a chronic current-account deficit that reached 5.4% of GDP last year. China hasn't run a (full-year) deficit for 17 years. And it hasn't suffered Vietnamese-style inflation (17.51% in the year to April) since 1995.

    Vietnam's economy may be ten years behind China's. But its spenders are several years ahead of themselves.

  • Exchange rates

    A feel for the markets

    May 20th 2011, 6:56 by S.C. | HONG KONG

    ECONOMISTS are notoriously bad at predicting exchange rates. But perhaps they can do better at predicting exchange-rate predictions. That is the aim of a new paper  ("In Which Exchange Rate Models Do Forecasters Trust?") by three IMF economists, David Hauner, Jaewoo Lee and Hajime Takizawa. They look at the currency forecasts collected by Consensus Economics, which surveys over 250 analysts and economists at banks, research institutes (like Oxford Economics), and big companies (like General Motors). The paper is not interested in how these forecasts perform; it's interested in how they're formed. Which variables do forecasters care about, and which do they ignore?

    For all the talk of deficits and the dollar, current-account balances are not good predictors of predictions. This is perhaps because a big deficit may be either the consequence of a rising currency or the cause of an eventual currency collapse. More surprisingly, forecasters don't seem to pay much attention to interest rates (except insofar as higher nominal rates reflect higher inflation). They therefore disregard the notion of uncovered interest parity, which assumes that if Australian assets offer higher interest rates than American assets, the Aussie dollar must be expected to fall against the American one. This expected depreciation offsets the higher yield. If it did not, then people would pile into the higher-yielding Ozzie dollar until it was so strong, it had nowhere to go but down.  

    So what does grab the attention of forecasters? Inflation and growth, principally. If prices rise faster in one country than another, forecasters expect its currency to fall, offsetting the difference. In making that call, they are relying, implicitly or explicitly, on the doctrine of relative purchasing-power parity. They also expect currencies to rise in fast-growing countries. The forecasters may be assuming that an economic boom will attract inflows of capital, pushing up the exchange rate. Or they may be expecting a Balassa-Samuelson effect, in which fast productivity growth in a country's export industries bids up wages, throwing them out of whack with pay and prices elsewhere in the economy. To restore balance, wages and prices in non-tradeable industries must rise, or the nominal exchange rate must strengthen.

    With their fullest model, the authors can explain about 60% of the variation in the forecasts for 40 currencies (and 76% for a narrower range of 15 currencies). That's pretty good going. By way of comparison, economists can at best explain less than 30% of the variation in currencies themselves, even over the long run, according to a sympathetic review of their efforts. Forecasting currencies may be a mug's game. But forecasting the mugs' forecasts is far easier.

     

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In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts.

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