Tuesday, August 24, 2010

Long-term Perspective on the Stock Market

An interesting analysis in Econbrowser relying on Robert Shiller’s database.

Government as a Special Interest Group

Is the current form of democracy doomed?

Only 21% of American voters believe that the federal government enjoys the consent of the governed. A new Rasmussen Reports national telephone survey finds that seventy-one percent (71%) of all voters now view the federal government as a special interest group, and 70% believe that the government and big business typically work together in ways that hurt consumers and investors.

However, 63% of the Political Class think the government has the consent of the governed, but only six percent (6%) of those with Mainstream views agree.

In his new book, In Search of Self-Governance, Scott Rasmussen observes that “the gap between Americans who want to govern themselves and the politicians who want to rule over them may be as big today as the gap between the colonies and England during the 18th century.”

I would be curious to know the results of similar polls organized in European countries.

Read the post in the Rasmussen Reports.

Hat tip: Roger Congleton via Tyler Cowen.

Thursday, August 19, 2010

Tensions Rise in Greece

On the basis of simple macroeconomic theory it was widely understood (and especially on this blog here, here, here, and here) that a severe austerity policy could not succeed and would bring Greece on the edge of chaos. Only the Eurocracy members and the European political class (mostly the same) thought otherwise.

Now the Spiegel Online reports that: “The austerity measures that were supposed to fix Greece’s problems are dragging down the country’s economy. Stores are closing, tax revenues are falling and unemployment has hit an unbelievable 70 percent in some places. Frustrated workers are threatening to strike back.”

Nikos Meletis, a shipbuilder they quote, concludes:
“Things are starting to simmer here. And at some point they’re going to explode.”

Read the whole paper here.

Crisis ahead.

Democracy and Growth

Dani Rodrik debunks the myth of superior authoritarian growth in an article published by Project Syndicate.


“When we look at systematic historical evidence, instead of individual cases, we find that authoritarianism buys little in terms of economic growth. For every authoritarian country that has managed to grow rapidly, there are several that have floundered. For every Lee Kuan Yew of Singapore, there are many like Mobutu Sese Seko of the Congo.

Democracies not only out-perform dictatorships when it comes to long-term economic growth, but also outdo them in several other important respects. They provide much greater economic stability, measured by the ups and downs of the business cycle. They are better at adjusting to external economic shocks (such as terms-of-trade declines or sudden stops in capital inflows). They generate more investment in human capital – health and education. And they produce more equitable societies.”

The punch line:

“This (Erdogan’s administration) turn towards authoritarianism bodes ill for the Turkish economy, despite its strong fundamentals. It will have corrosive effects on the quality of policymaking, as well as undermine Turkey’s claim to global economic standing.
For the true up-and-coming economic superpowers, we should turn instead to countries like Brazil, India, and South Africa, which have already accomplished their democratic transitions and are unlikely to regress. None of these countries is without problems, of course. Brazil has yet to recover fully its economic dynamism and find a path to rapid growth. India’s democracy can be maddening in its resistance to economic change. And South Africa suffers from a shockingly high level of unemployment.
Yet these challenges are nothing compared to the momentous tasks of institutional transformation that await authoritarian countries. Don’t be surprised if Brazil leaves Turkey in the dust, South Africa eventually surpasses Russia, and India outdoes China.”

I would like to add that this analysis and the corresponding forecast are completely in line with my “decline of hierarchies” (and thus of authoritarian regimes) thesis. In the current information era, decentralized decisions -- and thus democratic organizations -- are much more efficient than centralized ones.
The coming years will provide the test.

Read the paper here .

Monday, August 16, 2010

Criticizing the Notion of a Debt “Threshold”

John Irons and Josh Bivens are skeptical of the Reinhart and Rogoff conclusion that there exists a well-defined threshold (90%, in their estimation) of government debt relative to gross domestic product (GDP) above which economic growth is hindered. Read their paper here .


“While nobody would dispute that financial crises caused by excessive debt have inflicted large economic costs on many countries through time, these crises have generally not afflicted modern economies—like the United States’—that can borrow in their own currency and that have independent monetary and exchange rate policies. A review of the academic literature on sovereign debt defaults (Manasse and Roubini 2005) finds that it is exposure to currency risk that dominates the probability of debt default or financial crisis. This same review sets out a classification system to sort countries into those safe from debt crises versus those who are not safe—and the simple ratio of public debt to GDP is not found to be a useful predictor variable for this.

Lastly, given that the market for U.S. treasuries is the most liquid and transparent market in the financial world, interest rates in this market should be a barometer of investors’ expectations about the prospect of the U.S. government being unable to service its debt. Today, in- terest rates in these markets are at historic lows, reflecting the very large demand by global investors who want to hold U.S. debt. In short, we seem very far from facing a financial crisis triggered by the unwillingness of these investors to hold U.S. debt (for more on why these low interest rates are a normal part of a recessionary economy, see Bivens (2010) and Irons (2010)).[1]

[1] Bivens, Josh. 2010. “Budget deficits and interest rates.” Briefing Paper #262. Washington, D.C.: Economic Policy Institute.

Irons, John. 2010. “No crisis in confidence—Evidence shows U.S. creditors still think U.S. debt remains safest in world.” Issue Brief #276. Washington, D.C.: Economic Policy Institute.

An African Century?

Rajiv Sethi disagrees with Bill Easterly’s post on Aid Watch, “Was the poverty of Africa determined in 1000 BC?” regarding the role of History in determining present African growth.

« A large role for history is still likely to sit uncomfortably with modern development practitioners, because you can’t change your history. (…)

Twenty years ago nobody would have predicted that China and India would be the big drivers of growth and political superpowers they have become. And there is no reason to believe the countries of Africa cannot make similar leaps in the decades to come.... just as people have spoken of an American century and an Asian century, I believe we can now speak of an African century...

I believe the new African growth will come from five sources;

a faster pace of economic integration in Africa's internal market, and between your market and those of other continents, facilitated by investment in infrastructure

a broader based export-led growth, founded on new products and services

investment in the private sector from African and foreign sources in firms that create jobs and wealth

the up-skilling of the workforce, including through the acceleration of education provision, IT infrastructure and uptake and finally through

more effective governance to ensure that effective states can discharge their task of creating growth and reducing poverty

Each of these five priorities will be difficult to achieve. But we should remember the value of the prize. Because if we can agree (that there is) a new model of post-crisis growth then Africa - already a 1.6 trillion economy - will continue to grow even faster than the rest of the world. This is not my assessment, but that of the world's leading companies and analysts. For example a report just published by the McKinsey Global Institute claims that Africa's consumer spending could reach 1.4 trillion dollars by 2020 - a 60% increase on 2008. In other words in ten years African consumer spending will be as big as the whole African economy is today.

It is those sorts of projections which mean people are now rightly talking not just of East Asian tigers, but of African lions. »

Rajiv Sethi finds a similar line of analysis presented by a Managing Director of the World Bank, Ngozi Okonjo-Iweala, in an article “What’s the Big Idea? Africa as the next “BRIC” “, suggesting to “reposition Africa as the fifth BRIC, i.e. a destination for investment, not just aid.


« What trillion dollar economy has grown faster than Brazil and India between 2000 and 2010 in nominal dollar terms and is projected by the IMF to grow faster than Brazil between 2010 and 2015? The answer may surprise you: it is Sub-Saharan Africa... At a time when Asian equity and debt markets are saturated and no longer offer substantial returns, SSA could be poised to provide the best global risk-return profile. »

Many investors, and obviously Chinese enterprises investing in Africa, seem to agree …

Sunday, August 15, 2010

Do China’s low wages explain job destruction in high wages countries?

Here is a crystal clear explanation from Scott Sumner (The Money Illusion):

« Suppose someone argued that rich country workers can’t compete with low wage countries like China. The counterargument would be that Germany has led the world in exports for most of the past decade, and they have some of the highest wages in the world. Bangladesh has a much bigger population, but puny exports. The counter-counterargument is that Germany’s high wages are caused by their high productivity, and that high wages are still a disadvantage in trade, holding other things constant. In the end, the debate is sterile unless we understand all of the underlying fundamentals, in which case wages are superfluous.

Here’s better analogy. Massachusetts saw a big loss in jobs in industries like shoes and textiles during the 1980s. Was the job loss due to high wages? If so, then why didn’t Massachusetts see a higher unemployment rate? Economists would use the good old comparative advantage model. The booming high tech, health care, and finance sectors created lots of high paying jobs. This raised the cost of living here, and drove out the low paying jobs. Thus our low wage jobs weren’t stolen by cheaper labor in Mexico or China, they were literally pushed out (or crowded out) by higher paying jobs in other industries. That’s creative destruction.

Now let’s consider the role of wages. Although they weren’t the root cause, it is true that high wages were a sort of transmission mechanism between the high tech boom and the loss of low wage jobs. So why do I object to people saying high wages drove out those older industries? Because wages change for many different reasons. They might change because the shoe industry became highly unionized and drove up wages, despite weakness in other areas of the economy. Or they might change because of the creative destruction process I just described—a high tech boom pushing up the overall wage rate around here. It makes a big difference which factor is behind the wage change. You haven’t really described the reason why shoe-making jobs left the state unless you can explain why wages rose. »

The whole post is about interest rates, and why they are not a reliable indicator of monetary policy. But I found this comparison with the various underlying factors of wage competition especially interesting. Read the complete post here .

Wednesday, August 11, 2010

It’s the European Economy, Stupid!

Here are a few excerpts from today’s released Roubini’s Q3 2010 Geostrategy Note:

“Something other than leaves will fall in Europe this autumn. American attention, no doubt, will focus on Barack Obama’s date with an angry electorate this November. Yet across the pond, governments of the right, left and center in Europe appear ready to crumble, their positions eroded by a wave of austerity and high unemployment and government debt, plus a smattering of nasty corruption scandals.


In Germany, one of the costs of bailing out the Greeks earlier this year appears to be the career of Chancellor Angela Merkel. It’s too early to write her off, but voters sharply rebuked her Christian Democrat-led coalition in local elections in July, depriving her government of control of the upper house of parliament. Since the election, Merkel’s own poll numbers have slipped, and trouble has emerged inside her coalition.


In Italy last week, Prime Minister Silvio Berlusconi lost his parliamentary majority due to the defection of a 30-strong faction from his People of Freedom party over a junior minister accused of corruption. Berlusconi, who has been in power since 2008 (after leading in 1994-95 and 2001-06), probably will face a vote of confidence in September. As of right now, new elections in Italy seem more likely than not.


In France, meanwhile, another mercurial continental leader, President Nicolas Sarkozy, finds himself embroiled in a campaign finance scandal that could threaten his job. (…)

In this Critical Issue, we address the potential implications for the implementation of Sarkozy's highly unpopular austerity package.


In Spain, the European country staring most intently into the economic abyss, Prime Minister Jose Luis Rodriguez Zapatero’s coalition is dependent on two nationalist parties that know they have him in a spot. Ahead of the Catalan regional elections in October and November, both the Catalan Party and the Basque Nationalist Party want concessions on regional autonomy that the rank-and-file of Zapatero’s Socialist Party oppose. The Catalan nationalists also want to see more and deeper reforms of labor laws and social programs and could be tempted by a coalition with Zapatero’s rival, People’s Party leader Mariano Rajoy, who now trumps Zapatero in opinion polls.”

And even Britain’s recently elected government is threatened, since:

… “the election that ended 12 years of Labour rule in April brought to power not the Tories but rather a Tory-Liberal Democrat coalition, an uncomfortable and somewhat unprecedented situation for the British. The deals each side cut have a one-year shelf life—basically, until the referendum on electoral reforms that the Lib Dems insisted on can be held next May. After that, watch how quickly the coalition unravels.”

Previous evidence regarding the determining impact of economic conditions on the political market is vindicated, again. Accordingly, politicians of all stripe would be well advised to carefully weigh what their next economic policy move will be.

Where Does the Laffer Curve Bend?

An interesting inquiry among economists by Dylan Matthews, for the Washington Post. Left leaning economists tend to answer with higher estimates of the revenue maximizing tax rate than conservatives do.

Greg Mankiw rightly points to the difference between the short-run tax rate elasticity of government revenues and the long-run value. The latter should be smaller since demand and supply elasticities are higher in the long-run

But to me the best answer is Martin Feldstein’s:

"Why look for the rate that maximizes revenue? As the tax rate rises, the "deadweight loss" (real loss to the economy) rises, so as the rate gets close to maximizing revenue the loss to the economy exceeds the gain in revenue.... I dislike budget deficits as much as anyone else. But would I really want to give up say $1 billion of GDP in order to reduce the deficit by $100 million? No. National income is a goal in itself. That is what drives consumption and our standard of living."

Have a look at the complete panel answers here .

Hat tip: Tyler Cowen.

Monday, August 9, 2010

Unpalatable Greek Facts

Did the Greek problem vanish, wonders Irwin Stelzer in today’s Wall Street Journal: “Everything’s fine with Greece, Just Ignore Some Facts”. Apparently the eurocracy and the IMF are satisfied with the country’s ability to meet the austerity targets they set for it. But of course, “to reach that conclusion, the only one available to those with a political stake in the durability of the euro, the authorities had to ignore a few nasty facts.”

… “The markets do not deem it sufficiently credit-worthy to be allowed to borrow at tolerable rates. (They) have higher standards than the EC, IMF and ECB, and no political reason to show any tolerance.”

Meanwhile, tax evasion continues unabated, banks’ capital is still declining and their bad loans are rising, and there is no sign of economic recovery since (my comment) the penalty real exchange rate with Germany has not been improved, while the euro is re-appreciating against the dollar.

“Austerity will take about 10% out of GDP … and still leave Greece with unmanageable debt levels and interest obligations.”

A political economy conclusion follows:

“Fortunately for Greece, in the bargaining between the bailed and the bailers, it has the upper hand. The cost to Greece of default is relatively trivial compared to the cost to its creditors, mostly European banks uneager to take large write-downs. And the political cost of having been unable to forestall default by one of its tiniest members is unacceptable to the eurocracy. … So the Greek government just might decide, if necessary, to bow to an angry public and renege on promises of austerity, passing the cost of its pas profligacy on to German and other euroland taxpayers, or to its creditors. Some 95% of Greek debt was issued in Greece, and is subject to sovereign immunity laws, which reduce the options available to unhappy creditors … It would be understandable if they decide that unhappy euro-zone taxpayers or short-changed creditors are lesser evils than angry Greek voters.”

But then, default will become inevitable if the German taxpayer wearies of a perpetual Greek bailout.

Beware, turbulence ahead! And read the paper here.

Sunday, August 8, 2010

Post Depression America in Colors: 1939-1943

Rural and small town American population in the early 1940s. A great photo gallery published in the Denver Post here.

Wednesday, August 4, 2010

Resource Curse or Resource Boon? It All Depends.

Rabah Arezki and Markus Br├╝ckner just finished a working paper for the IMF, titled “Resource Windfalls and Emerging Market Sovereign Bond Spreads: The Role of Political Institutions”.

Excerpt :

« We examine the effect that revenue windfalls from international commodity price shocks have on sovereign bond spreads using panel data for 30 emerging market economies during the period 1997-2007. Our main finding is that positive commodity price shocks lead to a significant reduction in the sovereign bond spread in democracies, but to a significant increase in the spread in autocracies. To explain our finding we show that, consistent with the political economy literature on the resource curse, revenue windfalls from international commodity price shocks significantly increased real per capita GDP growth in democracies, while in autocracies GDP per capita growth decreased. »

Non gated version here .

Monday, August 2, 2010

Unsolved Problems in the Euro Zone Economy

“Titanic-Style Problems for Euro Zone” diagnoses Irwin Stelzer in The Wall Street Journal.

The euro zone economic sentiment, reports the European Commission, hit a 28-month high in July. Little wonder: remember the almost 16% devaluation of the euro relative to the dollar of last spring? German exports have been booming. But while retail sales in France and Germany rose in the second quarter, sales in Italy fell. And while Germany heads towards fuller employment, the unemployment rate in the euro zone as a whole hovers around 10%.

The German export machine, however, is at risk of a slowdown since markets in the periphery of Europe are shrinking, due to austerity policy, as well as Asian markets do, while the July 8% rise of the euro against the dollar adds to the downward pressure.

On top of that, Europe’s banks are in worse shape than the sponsors of the stress tests would have us to believe:

“Barclays estimates that if sovereign debt had been properly considered, 22, not the reported seven banks would have failed the tests, and that the sector needs to raise € 12.6 billion in capital, a lot more than the €3.5 billion estimated by the eurocracy.”

The punch line:

“The basic structural deficiency of the common currency area – a single currency with multiple national fiscal policies – is too often mentioned to warrant expanded treatment here. It might well constitute the largest part of the submerged portion of the iceberg towards which the good ship euroland is headed”.

Read the paper here .