Wednesday, February 27, 2013

Austerity, Eurocrats, and Italy

A good post by Krugman here.

Remember the time, not long ago, when the European media uniformly praised the eurocrat and Davos and ECB insider, Mario Monti? He was supposed to “save” Italy. Now he lost the election to MM. Berlusconi and Grillo and this probably will bring down M. Draghi’s ECB “kick-the-can”policy.

For an interesting assessment of the assets and characteristics that make an Italian exit from the euro possible see Ambrose Evans-Pritchard here.

So we are heading back towards the pre-summer situation.

Did you say that the euro was “the biggest macroeconomic mistake since the 1930s”? 

Tuesday, February 26, 2013

Easy-Money-and-Easy-Fiscal Policy Mix

In a remarkable new article John Makin, an acute observer and analyst of macroeconomic trends and problems, explains how “currency wars” (the “quantitative easing” policies adopted by most large economies, with the exception of the Eurozone) combined with restrictive (conservative) fiscal tightening, amount to a negative sum game: by definition not all large economies can depreciate their currencies at the same time, and the combined “austerity” policies depress the aggregate level of activity worldwide.

A solution could be found in the new Japanese economic policy of EMEF (easy-money-easy-fiscal policy) combining easy money now and temporarily easier fiscal policy, leaving the balancing of the budget task to future, more prosperous times.    


“The easy-money-tighter-fiscal policy (EMTF) mix being pursued globally in 2012–13 with increasing intensity is the classic policy mix for a weaker currency. Easy money pushes down interest rates and spills cash abroad in search of higher returns, pushing down the value of the easy-money currency. Tighter fiscal policy reduces growth and weakens demand, including demand for imports, and so the demand for foreign currency is reduced and the easier-money currency weakens. Easier money—in the United States, for example—increases the supply of dollars in global financial markets, while tighter fiscal policy reduces the US demand for foreign currency in global financial markets. This is a clear recipe for a weaker dollar.”

In this context, as the author notes, the governments that still pursue tighter fiscal policy while refusing to weaken their currency are doubly penalized and that is the case of all the Eurozone economies but Germany.

“Governments under the political strain of enacting meaningful tax increases and spending cuts often find their efforts unrewarded because almost all countries are pursuing EMTF, leaving almost no room for government efforts to succeed in sustaining growth while fiscal consolidation is underway. It becomes very tempting for a country like Spain to protest any weakening of the dollar or yen, which by definition strengthens the euro. France has been pushed into a recession by the austerity imposed by deficit reduction and trapped inside the euro system of fixed exchange rates that mandates an overvalued currency for all but Germany. For these reasons, France is among the loudest objectors to Japan’s recent aggressive and successful efforts to push down its currency.”

“France’s dilemma is being felt even more intensely in Spain and Italy, where political backlash is building. The outcome of Italy’s February 24–25 elections may include a thumbs down on the austerity programs Italy has been forced to follow. Greece, meanwhile, has become the poster child for the “pain and political backlash” club of countries trapped inside the eurozone with a politically and economically toxic combination of an overvalued currency, higher taxes, and reduced government spending. The eurozone entered a recession in the fourth quarter of 2012, its “reward” for pursuing deficit reduction with a still-overvalued currency for most of its members.”

“Japan’s new government—under Prime Minister Shinzo Abe, who was elected in December 2012—is pursuing a modified EMTF formula that is essentially an easy-money-easy-fiscal policy (EMEF). “Abenomics” is a two-pronged approach to getting Japan out of deflation, which is a currency-strengthening disaster in a world of widespread EMTF. If every country’s currency but Japan’s is weakening, then the yen becomes very overvalued.”

“… policymakers need to remember and recognize that the aftermath of a global financial crisis like the one that occurred in 2007–08 is never easy. Wealth losses and resulting consolidation and debt reduction by the private sector make for weak recoveries and stubborn unemployment.
EMEF provides temporary relief, but it ultimately must turn into EMTF as budget deficits and debt quantities get too high. Added to this is the complication surrounding the fact that the world’s third-largest economy, Japan, has entered the EMEF stage late, complicating efforts in the rest of the world to transition to the EMTF phase. With patience and a clear understanding of the fact that the world economy still faces a difficult period of recovery from the global financial crisis, it should be possible to reach a sustainable path to global recovery by 2015. 
The trick is not to let the challenges underway result in counterproductive measures that delay progress toward that sustainable recovery.”

The whole paper is a must read here.

Friday, February 22, 2013

Tributes to Armen Alchian

 Alchian, a founder both of the theory of property rights and of the economics of organization, economist “extraordinaire”, died at 98.

Here is David’s Henderson’s piece in Econolog, quoting Hayek:

"There are two economists who deserve the Nobel prize because their work is important but won't get it because they didn't do a lot of work: Ronald Coase and Armen Alchian." Unfortunately he was right about Alchian not winning the prize, even though, Henderson writes:

“not only did Armen write a lot but also he wrote unusually well for an economist. As evidence of quantity, consider the fact that Liberty Fund put together 2 hefty volumes of his work that total over 1,500 pages. Most of us would think of that as "a lot."

And here is Shane Greenstein’s post in Digitopoly.

“Armen’s most-cited paper is his work with Harold Demsetz, published in the American Economic Review in 1972.  This paper may be the most influential paper in the economics of organization, catalyzing the development of the field as we know it.  It is the most-cited paper published in the AER in the past 40 years.  (If one takes away finance and econometrics methods papers, it is the most-cited “economics” paper, period.)  It is truly a spectacular piece.  It is a theory not only of firms’ boundaries, but also the firm’s hierarchical and financial structure.”

A paper I put at the center of my own teaching at Sciences Po for many years.

Wednesday, February 13, 2013

Arab Spring or Decentralization

Joseph S. Nye Gets It …
 … in part at least. In a post for Project Syndicate (Feb. 7, 2013), he (re)discovers the analysis I developed in “The Second Twentieth Century” (2000 Grasset, 2006 Hoover Press): the information revolution started in the 1970s, the dramatic decrease in the cost of producing, storing and transmitting information, has a major influence on the decentralization of large hierarchies, including firms and governments. It is now underlying the “Arab Spring” that is really an Arab political revolution.


“The current global revolution is based on rapid technological advances that have dramatically decreased the cost of creating, finding, and transmitting information.” This is my main thesis in the book, expressed in the very same terms.

“As computing power has become cheaper and computers have shrunk to the size of smart phones and other portable devices, the decentralizing effects have been dramatic.”  This is my conclusion and, as I show in the book, the result of the “Coase-Rybczinski theorem”: information-intensive organizations (decentralized, market using processes) develop and centralized ones regress when information gets cheaper.

“The spread of information means that informal networks are undercutting the monopoly of traditional bureaucracy”. Idem. So thank you for reading my book and using it (but an honest quote would have helped).

Nye however dismisses the extreme case of complete decentralization as unlikely to happen and takes it as a proof of the limitation of the analysis:

“While the information revolution could, in principle, reduce large states’ power and increase that of small states and non-state actors, politics and power are more complex than such technological determinism implies.”

That conclusion is trivial but the analysis is false because Nye does not understand basic microeconomic analysis and relies on the simplistic view of a trend-like evolution going to the extremes: it is true indeed in economics that we rarely get a “corner solution”, the extreme case in an all or nothing approach of a phenomenon. Thus we should not expect the information revolution to lead to a complete decentralization of all governments and of all large firms. There exists, somewhere, an optimal solution to the decentralization trend, in which some large hierarchies subsist side by side with smaller ones, including some single-entrepreneur (or artisanal) businesses. But nevertheless a continued fall of the cost of information will push all organizations towards a smaller-size equilibrium.

This has nothing to do with a contrast between a “principle” and “reality”, the latter meaning that “politics and power are more complex than such technological determinism implies” as Nye claims.

It is simply due to the basic economic price mechanism in which a “corner solution” (the extreme case) can only be obtained if the price of one of the objects of choice falls or rises to an extreme. In the present case complete decentralization would occur if the cost of information were to fall to zero, an unlikely event to say the least.

The conclusion is that the analysis of organizations and hierarchies, i.e. of “institutions”, is not a matter of economic “principle” versus political “realism”: it is amenable to sound economic analysis, correctly understood and applied, period.

Friday, February 8, 2013

Contemporary Mercantilism

An excellent post by Peter Boettke in Coordination Problem about the system we are really living in.

His conclusion:
“In short, we have state controlled market economies. We are living the policy reality of mercantilism, while rhetorically emphasizing economic liberalism”.

What is true for the U.S. is even more so for European economies … that so many like to qualify - against all evidence -  as "ultra liberal". 

Read more here.