Thursday, July 30, 2009

End of the recession? Erratum

The figure on the preceding post represents the Aruoba-Dieblod-Scotti Business Conditions Index computed for the US economy at the Philadelphia Fed.

Its underlying economic indicators (weekly initial jobless claims; monthly payroll employment, industrial production, personal income less transfer payments, manufacturing and trade sales; and quarterly real GDP) blend high- and low- frequency information and stock and flow data.

According to this index the recession began in the last quarter of 2007, and it could be finished apparently by early 2010, barring a “W” episode that could prolong it a bit.

The text under the graph was intended to present the same index in perspective, first from 2000 to present, and then from 1960 to present. Both graphs are available on Econbrowser or from the Philadelphia Fed here .

Hat tip to Econbrowser and apologies to the readers for the mistaken post.

1965 1970 1975 1980 1985 1990 1995 2000 2005
Aruoba-Diebold-Scotti Business Conditions Index (3/1/1960-7/18/2009)
Business Conditions
Note: We construct the ADS Index using the latest data available as of July 23, 2009. This includes (1) initial jobless claims through the week ending July 18, 2009,
(2) payroll employment through June 2009, (3) industrial production through June 2009, (4) real personal income through May 2009, (5) real manufacturing and trade sales
through April 2009, and (6) real GDP through the first quarter of 2009. Gray shading indicates historical NBER-designated recessions. Yellow shading indicates the most recent
recession, designated by the NBER to have started in December 2007 but not yet (as of the date of creation of the figure) designated by the NBER to have ended.

Big Cities or the Virtual Megalopolis?

Should young, creative people move to New York to chase their “big break” as they used to? Is New York still worth the trip when recession hits cultural activities especially hard? Wherever creative people physically reside today, they are increasingly moving online. In economics, the competitive advantage of large, first rate universities, over smaller and less well known ones has been dwindling.

While monetary rewards on the Internet are still scarce, it is true, the cost of living in the virtual world is cheap and, more important, the opportunities for attention are plentiful.

But there is a catch: the Internet is tougher than New York; fewer people make it here, and no one there seems to make it for long.

A great paper written by Bill Wasik, a senior editor at Harper’s, for the New York Times (“Bright Lights, Big Internet”, July 29, 2009) here .

Wednesday, July 29, 2009

Can the West Save Africa ?

That’s the (big) question William Easterly (New York University) tries to answer in his recent survey of the literature (Journal of Economic Literature, June 2009). Here is his summary:

“In the new millennium, the Western aid effort toward Africa has surged due to writings by well-known economists, a celebrity mass advocacy campaign, and decisions by Western leaders to make Africa a major policy priority. This survey contrasts the predominant “transformational” approach (West comprehensively saves Africa) to occasional swings to a “marginal” approach (West takes one small step at a time to help individual Africans). Evaluation of “one step at a time” initiatives is generally easier than that of transformational ones either through controlled experiments (although these have been oversold) or simple case studies where it is easier to attribute outcomes to actions.
We see two themes emerge from the literature survey: (1) escalation – as each successive Western transformational effort has yielded disappointing results (as judged at least by stylized facts, since again the econometrics are shaky), the response has been to try an even more ambitious effort, and (2) the cycle of ideas – rather than a progressive testing and discarding of faded ideas, we see a cycle in aid ideas in many areas in Africa, with ideas going out of fashion only to come back again later after some lapse long enough to forget the previous disappointing experience. Both escalation and cyclicality of ideas are symptomatic of the lack of learning that seems to be characteristic of the “transformational” approach. In contrast, the “marginal” approach had some successes in improving the well-being of individual Africans, such as the dramatic fall in mortality.”

Meanwhile, I would add, Africans themselves are transforming their societies piecemeal, the result being highly visible even to the casual visitor, either in the sustained urbanization trend which also has positive sides despite the obvious costs and difficulties that it raises, or in the effervescence of artistic creation leading to the formation of entirely new industries (movies, painting, performing arts and music) that are connected to international markets and not limited to local, traditional folklore.

In spite of the failure of the African food production relative to the green revolution in Asia (Easterly’s figure 10), income per capita has resumed an upward trend since 2000, after three decades (1970-2000) of stagnation (Figure 1).

Small steps, both external and internal, may at last lead to some sustainable progress.

Tuesday, July 28, 2009

More taxes and less health care

Martin Feldstein presents some good criticism of the Obama health care plan in yesterday’s Washington Post here . Major tax increases on middle income earners are to be expected, as well as bureaucratic rationing of health care for all, if the plan is implemented.

Readers of this blog know that already, but they also know that the impact of increased tax will cost dearly in lost growth as Edward Prescott has convincingly demonstrated (see my paper – in French – “Comment gagner plus?” published in the spring issue of Commentaire and available for download on my home page,

Efficient markets in a nutshell

The best summary of what efficient markets theory really means is to be found in a post by James Kwak, The Baseline scenario, “What Is the Efficient Market Hypothesis” (, on July 20, 2009). It is well worth reading and saves a lot of time, compared to an equations filled textbook in finance.

Sunday, July 26, 2009

A Weak Recovery in the US

Writes David Altig, senior vice president and research director at the Atlanta Fed, on July 24:

“The chart plots the four-quarter growth rate of gross domestic product (GDP) from the trough of a recession against the depth of the corresponding contraction, as measured by the cumulative loss of GDP over the course of the downturn. (…)

The points within the red circle represent all previous postwar recessions. They show that the deeper the recession the faster the recovery. (…)

The points within the blue circle are based on forecasts of GDP growth from the third quarter of this year through the third quarter of 2010, from the Blue Chip Economic Indicators (which report survey results from “America’s leading business economists”).”

He also quotes Atlanta Fed President Dennis Lockart, for saying:

“The recovery will be weak because the economy must make structural adjustments before the healthiest possible rate of growth can be achieved.”

Should the US break down the dollar ?

"Look at the US where a single currency is shared by 50 states", was a common objection to economists criticizing the creation of the euro, several years ago. Now the years’ old European debate about the single currency (instead of several national ones) has crossed the Atlantic. In his blog “Macro and Other Market Musings” David Beckworth, an assistant professor of economics at Texas State University, here, ponders the question.

His conclusion:
“I find some evidence that the rustbelt and energybelt may have benefited from having their own currency over the period 1983-2008. What I do not show -- as is the case with most OCA studies – is the (1) added transaction costs and (2) potential political economy problems that would emerge had these regions formed their own currency unions.”

And he refers the reader to his paper here.

Computations made in Europe prior to the creation of the euro did show that the transaction costs reductions were to be rather small. Regarding the political economy “problems” he mentions, readers of this blog (see my post “Why Europe Then?”, June 13) would say that the multicurrency economy would improve the lot of the consumer by reducing the collusive advantage of large firms and tax seeking states: international cartels are much easier to manage when the exchange rates are fixed, and even more so when they are “definitively” fixed.

Monday, July 20, 2009

The health care debate

American economists, following the path of European ones for once, are being trapped in the public insurance of health care dilemma: if the state provides universal insurance coverage, then health care spending is going to increase, and since that insurance (being public in that scheme) has to be tax financed, the overall amount of taxes (mostly on labor) is going to increase too, slowing down economic growth.

As a consequence future governments will try – just like their European counterpart -- to ration health care spending because higher labor taxes are bad for growth and not because more health care is bad for people. But this is not an optimum for an aging and richer population. And the trend will prove difficult to resist, since administrative rationing is inefficient, as European experience abundantly demonstrates.

The solution: health care insurance should be made compulsory but privately purchased by households. Low income households, and only they, should then be helped and subsidized by public funded vouchers. This limited financing would reduce the overall amount of taxes levied on labor (compared to the current scheme) and their growth-reducing impact.

The bottom line: health care spending could then increase as much as people wish, economic growth would not be slowed by permanently increasing labor taxes, and low income households would benefit from the same health care coverage than high income ones.

Friday, July 17, 2009

Roubini’s Dilemma

In the RGE Monitor (July 16), Chairman Nouriel Roubini (also Professor, New York University, Stern School of Business) a leading and acute observer and forecaster of the economy explains why a “double-dip W–shaped” recession is a real risk toward the end of 2010, even though he expects – as he consistently did – the end of 2009 to mark a pause in the current contraction. This great recession would then have lasted 24 months and thus “been three times longer than the previous two and five times deeper –in terms of cumulative GDP contraction – than the previous two.”

Here is the 2010 dilemma:

“I see a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years (…) the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector, and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and public debt accumulation. (…)

on one side, early exit from monetary and fiscal easing would tip the economy into a new recession as the recovery is anemic and deflationary pressures are dominant. On the other side, maintaining large budget deficits and continued monetization of such deficits would eventually increase long term interest rates (because of concerns about medium term fiscal sustainability and because of an increase in expected inflation) and thus would lead to a crowding out of private demand.”

Thus “the exit strategy for monetary and fiscal policy easing will be daunting.”

The task will prove even more difficult in Europe, where the eurozone currency has been consistently overvalued while national activity trends are markedly diverse.

Tuesday, July 14, 2009

Crisis not over

According to Tim Lee, the founder of financial economic consultancy pi Economics, (in yesterday’s Financial Times) national savings rates remain too low in most countries that had real estate bubbles, including the US, Eastern Europe, Spain and Turkey. The recourse to external finance (the current account deficit) has been reduced but not because of any increased savings: it results from investment collapse.

While “one can argue that real estate prices have fallen enough, particularly in the US (…) the total market value of US residential property remains high relative to disposable incomes (and) the total of outstanding mortgages has barely declined. It does not seem possible for the housing market crisis to be resolved without a significant decline in mortgages outstanding, which means substantial further credit losses.”

There are then three possibilities: one is that governments and central banks could be creating a new bubble, but this appears unlikely with negative savings rates and poor economic background. A second possibility is inflation that would reduce global indebtedness, but across most of the world, bank credit and money supply have been growing only slowly.

Then if we do not yet have inflation and we cannot have a new bubble there must be more deleveraging and unwinding of the past global credit bubble. This means a very weak global economy with falling stock markets and commodity prices, and falling government bond yields, weak carry trade recipient currencies (e.g. the Australian dollar) and strong funding currencies (mainly the yen and US dollar).

“In short, a troubling return to the markets that we suffered for most of last year.”

This dismal prospect is compatible with the forecast of a “W” recession suggested by many economists, and also with the Michael Mandel hypothesis (in Business Week) about the end of the information technology boom that I referred to in a previous post (“Is the innovation wave ‘passé’?” this blog, June 7, 2009) . With a slower trend of growth, recessions tend to last longer and be more severe, as was well known to the “classical” students of business cycles of the mid-XXth century such as Burns or Schumpeter.

US Government spending spike and falling receipts

The complete analysis is on the blog Econompicdata ( Courtesy Rebecca (News N Economics).

Sunday, July 12, 2009

China and Iran

Do the upheaval and fighting of Uighurs in the Chinese province of Xinjiang have something to do with the contested polls in Iran? The answer is definitely yes. It is the same deep decentralizing momentum which is at work in both popular demands: Regional and maybe ethnic autonomy against internal colonization rule in one case, and democratic control of the theocratic and military power in the other case.

China’s leaders have brilliantly succeeded in opening their economy to market rules and decentralized initiatives, keeping for themselves the whole of political power control. However, when information is more openly diffused (despite all the attempts at internet rationing),there is no reason why the demand for civil and political rights should not develop at the same time. For an analysis of this demand for rights – both economic and political -- and its link with the abundance of information, see my Second XXth Century (Hoover Press) and the paper co-authored with Xavier de Vanssay, “The Global Freedom Boom”, available both on my homepage and on SSRN (

The increasing per capita income just makes things “worse” in the sense that rights – or “freedom” in general – are more likely “superior” goods, and their demand will thus increase with economic growth. That’s why, as Mancur Olson once observed, growth in general is socially and politically destabilizing.

It follows that one should expect more difficult times to come both in Iran and in China and more destabilization of their centralized power governments.

Wednesday, July 8, 2009

Narrow Banking and John Kay

In the July 7 issue of the Financial Times, John Kay provides an easy excuse for bank managers. They are the best and the brightest he says:

“The bank executives pilloried by the UK’s Treasury select committee of MPs were all exceptional people. (…) Our banks were not run by idiots. They were run by able men who were out of their depth. If their aspirations were beyond their capacity it is because they were probably beyond anyone’s capacity.”

Thus we should not search for Supermen or Superwomen to run our banks but we “would be wiser to look for a simpler world, more resilient to human error and the inevitable misjudgments.”

Agreed. But the “best and the brightest” should have helped on the way by putting into place better control mechanisms of the agency problem in the large organizations that they were supposed to manage responsibly. Instead of that, they paid themselves huge sums of money to take absurd risks that they pretended to understand and to master.

The enormous losses that they inflicted upon unsuspecting shareholders constitute another obvious example of the “pretence of knowledge” that Hayek denounced among other hubris driven managers of other very large hierarchies, the politicians in charge of governments in our corporatist economies.

John Kay is right, however, to state the problem in terms of structures: since even the best managers will probably make mistakes in pursuing their self-interest, we should limit the magnitude of the probable losses that will be inflicted on society by limiting the size of their businesses and by making their activities more transparent. Just like individual portfolio holders diversify their risks and avoid investing massively in concentrated assets, societies at large should avoid that just one corporation, or a few of them, can mismanage amounts of a magnitude that may jeopardize the whole economy. Large banks should be broken into smaller and more specialized ones.

Curtailing the personal financial power of the best and the brightest who ran the oversized institutions that they build, and still manage them to that day, is the least that we can do as a way of insuring ourselves against a similar future disaster.

MPDRAAI ! (Malkiel)

“MPDRAAI” stands for “Market Prices Do Reflect All Available Information”. Burton Malkiel, the famous author of A Random Walk Down Wall Street (1973) is an unreconstructed efficient market hypothesis aficionado.

In an interview published on July 7 in BARRON’S, here , he explains that market efficiency means that there is no easy arbitrage opportunity (what others define as “the no easy money condition”) in the real economy. If you find one, pick it up fast because those opportunities aren’t going to be there for long. There are just too many smart people out there looking for arbitrage opportunities.

Many people believe, especially today, that stock markets fail to reflect all the available information and are ruled by fads and mistakes, neglecting the fact that the available information is changing all the time and reveals itself in precisely those large movements in prices that many observers believe "irrational". It’s easy to make such a claim. But if true you should be able to profit from such a situation. Can you?

Says Malkiel:
“If you think that the market doesn’t reflect important information, that means that you ought to know the information, you ought to be able to trade on that information, and you ought to be able to beat a simple index.”

Otherwise, I would add, you just believe that some important information has been neglected, but you don’t know that it has been, really. So your claim is not proven, unverifiable, most probably unfounded.

And Malkiel goes on:
“What I come down again and again is OK, if you think that, why do you persistently underperform the index? Look, stock prices are not always right, and there are a lot of people who say, “Well, I knew it.” Well, if you knew that in advance, you ought to be able to beat the index. The only market that I fond is inefficient is the local A-share market in China. In a market dominated by individual gamblers, it turns out that professionals can and do outperform. But I believe the stocks of Chinese companies traded in Hong Kong and New York are efficiently priced.”

Thanks to Greg Mankiw for signaling the interview on his blog today.

Recolonization vs. State Sovereignty ?

The Boston Review (July/August 2009 issue) includes a forum on global poverty and intervention: Development in dangerous places , centered on the Paul Collier’s thesis.

In The Bottom Billion and in his new book Wars, Guns, and Votes he claims that about a billion human beings, living in a group of about 60 small, impoverished, post-colonial countries that “came unnatural into the world” but were created artificially by colonial rulers – and mostly in Africa - have no chance of getting out of the poverty trap if internationally unaided.

“With neither the social unity needed for cooperation, nor the size to reap the benefits of larger scale, they are structurally unable to provide the public goods – such as security – that are critical for decent quality of life and imperative for economic development. (…) unless the international community, at least for a time, supplies basic public goods that go beyond the typical aid agenda.”

“It is a troubling thesis. I have come to it reluctantly, and the international community has shied away from it, as have the societies of the bottom billion themselves”, he adds.

These countries are too large, and heterogeneous, to be nations and too small to be efficient states. Indeed these small “unnatural” states that were created by departing colonial powers fail to provide security and accountability. Where sub-national identities predominate, it is more difficult for people to cooperate in providing public goods.

In medieval Europe, local rulers who ran such tiny proto-states competed over time in a Darwinian struggle that led to the building of larger and more efficient states, but the process took several centuries of incessant external and civil wars.

These “bottom billion” countries are mostly too small to be viable states and are rife with civil wars, the costs of which are enormous. And given the reluctance of these countries to pool sovereignty within neighborhoods, the only alternative is a phase of international assistance in the provision of vital public goods, security and accountability.

Read the complete article here, and the criticisms of William Easterly Easterly here .

Interesting comments by Larry Diamond, Stephen D. Krasner and others are published in the same forum.

Monday, July 6, 2009

The Causes of Serfdom (and Slavery)

In 1970 Evsey Domar wrote a piece titled "The causes of slavery and serfdom: a hypothesis" in the Journal of Economic History. It was mainly an analysis of the Russian "second serfdom" of the XVIth and XVIIth centuries, and the explanation revived an older hypothesis of historians about the causal role of the land/labor ratio.

Domar however was unsatisfied with his theory and further explained that a political factor was at play in the establishment of serfdom (and slavery). Recently Paul Krugman concurred ("Serfs up!" The Unofficial Paul Krugman Home Page, May 8, 2003) and concluded that the puzzle remained unsolved and that serfdom still was a phenomenon in search of an explanation.

I just tried to formulate a general explanation of the occurrence of serfdom in various places and periods, showing that the land/labor ratio, as plausible as it seems as an explanation, is but a small part of the story. As a by-product, I show that the determinants of slavery differ in an important way from those of serfdom, and that freedom depends on the same type of variables, but with opposite signs of course.

My paper is currently available in the Social Science Research Network (SSRN eLibrary), at .

It will also be accessible shortly on my website (

Thursday, July 2, 2009

Easterly & Stiglitz agree to worry

Usually at odds on their appraisal of development policies and state intervention efficiency, William Easterly (a critic) and Joe Stiglitz (a supporter) agree today to warn against the current criticism of markets, widely accused of causing the financial, and then economic, worldwide crisis.

Bill Easterly ironically notes in his blog Aid Watch that Stiglitz, a Nobel Prize winner that has been strongly critical of the World Bank policies and of the “Washington consensus”, now preaches, however belatedly, markets to poor countries and fears that they “will turn away from markets altogether in favor of some heavy-handed state planning and socialism. Stiglitz, who is not usually considered market economics’ best friend, is right to be scared” concludes Easterly.

We are in for “the revival of the Big Markets vs. State Planning Debate” concurs Mark Thoma , himself a notorious critic of free markets and a strong advocate of increased regulation in general.

I believe that all three are wrong and that the big debate is profoundly misguided today. But it does not matter much!

The big debate is misguided because mistakes are committed by men, not by “markets” or by “planning”, and occur both in market economies and in centrally planned ones. The gist of the debate opposing decentralized market economies and centrally planned ones is really about the optimal degree of centralization of decisions in society. This optimal degree depends on the cost of information (as I suggested in The Second XXth Century, in a Coase-Hayek framework) and not on the occurrence of a specific mistake or crisis, and it varies through time and circumstances.

Bad decisions will be made more often in decentralized systems when information is scarce, and will be made more often in centralized ones when information is abundant. Since we are living in a period of very abundant and cheap information, the decentralized system is currently much more efficient, crisis or no crisis. It follows that, if politicians are broadly rational (and I believe that they are, since they have to obtain approval of voters and powerful interest groups), the centralized and planned system will not return in our societies or in emerging economies, that still are information abundant ones. Indeed, in such a technological environment a centralized state management is generally much less efficient than a decentralized market rule.

That’s why the revival of the great debate is profoundly misguided, and that's also why it does not matter much.

Wealth and Technology

Rising inequality is commonly thought to be a major problem of rich economies in the last few decades. It is not due however to an increase of the share of capital versus a decrease of the labor’s share in the overall pie writes Thomas F. Cooley, professor at New York University and dean of the Stern School of Business there. The labor’s share of output has remained remarkably constant at roughly 70% from 1950 to 2008. It is the result of a gilded age for the top 1 % earners, a new group of super-rich, as the above graph from Emmanuel Saez (earner himself of the John Bates Clark award given to the best economist under 40) makes clear.

Contrary to extensive arguments in the literature, this, in turn, is not due, in the main, to tax cuts or extraordinary executive compensation, but according to recent research, to technological change favoring those with the “right” human capital. The spike in the 1920s was due to electrification. Today, it is the result of the information and communication revolution: Let’s think for example about the income and capital value of the owners of Microsoft, Apple or Google … All the others have also benefited from the overall growth (at least in the economies that have been growing but such as the U.S. one, but less so in Europe). Despite that fact, the good fortune of the richest 1% has left many feel impoverished, but in a subjective sense, and relatively, not in income terms.

Here is the paper .

Thanks to Greg Mankiw for signaling it on his blog.