On the value of “basic science” in economics and other disciplines

A few months ago, Larry Summers was reported to have made some comments regarding rules of thumb he used to distinguish between useful and not-so-useful economic papers when he was working in government:

He had a fairly clear categorisation for which ones were likely to be useful: read virtually all the ones that used the words leverage, liquidity, and deflation, he said, and virtually none that used the words optimising, choice-theoretic or neoclassical (presumably in the titles or abstracts).

However, while this sounds kind of harsh, he made sure to temper his criticism by saying that some seemingly useless things of apparently limited applicability might turn out to be useful in years to come (microfoundations for macroeconomics, perhaps?).

This last caveat is one I’ve frequently encountered in two contexts: From people who want to defend basic (natural) science, and from people who want to defend some discipline in economics that is just plain wacky. The argument is the same: It might turn out to be useful in the future.

Though true in the strict sense (I can’t rule out possible value coming from this research), the argument is frequently a “cheat”: I suspect that the person supporting basic science (or abstract economic theorizing) believes that this is nice and valuable intrinsically no matter what the usefulness of the results may turn out to be. But since this is a tough pitch to sell to the general public (especially for the economist), they try to say that “well, this could actually turn out to be valued highly by you even if you don’t care about the intrinsic value.” And yes, there are clear cases of (truly) useful things that came out of (seemingly) pointless and abstract theorizing. Here’s an example from the US Department of Energy:

The discovery that all matter comes in discrete bundles was at the core of forefront research on quantum mechanics in the 1920s. This knowledge did not originally appear to have much connection to the way things were built or used in daily life. In time, however, the understanding of quantum mechanics allowed us to build devices such as the transistor and the laser. Our present-day electronic world, with computers, communications networks, medical technology, and space-age materials would be utterly impossible without the quantum revolution in the understanding of matter that occurred seven decades ago. But the payoff took time, and no one envisioned the enormous economic and social outcome at the time of the original research.

However, it seems wrong (especially of an economist) to just transfer this argument from basic science (whether mathematics or theoretical physics or whatever) to economics. The reason is simple: Take two types of research. One (“applied research”?) is practical and will with high probability lead to valuable insights (in  terms of practical usefulness, economic value, material benefits to humanity or whatever). The other one (“basic research”?) is highly abstract and divorced from empirical applications and will with high probability fail to lead to such valuable insights. However, with both of them there is uncertainty, and we can imagine some probability distribution over “insight-value” that these could generate. It seems to me that unless we have reason to believe that the tail of the “basic science” distribution is fatter – i.e., unless the probability of making truly mind-blowing important progress  is higher for basic than for applied science – then we should always go for the applied in so far as the pragmatic value of the insights is what we want. The expected value would be higher, and the probability of an insight of any given value would be higher with the applied research. In other words, we need a “fat-tail” argument – an argument that the distributions will differ for observations lying far away from the mean. Since discussing differences in the tails of various distributions in another context was part of what made Summers resign as President of Harvard, this is a point I think he would get easily.

My point is just that I can see the possibility of this fat-tail argument in terms of certain types of basic science, but that does not mean it is present in economics. In physics there could be some argument such as “the higher the granularity and precision with which we can understand and manipulate the world around us, the more opportunities are open to us for manipulating it to our benefit,” and this can be supported by examples from experience. In mathematics there could be an argument that “the more analytical tools for a broader array of problems, the more mathematics will be able to power up other disciplines and improve their reach and value”. However, I am at a loss to see what more sophisticated representative agent-modelling in DSGE models or rational addiction models will give us. To me, such work seems more like Tolkienesque fantasy about alternate worlds. And if such fantasy about alternate probably-not-even-conceivably-realistic worlds can be useful – then the question is: Which ones are most likely to be useful, and how do we tell? Why representative agents deciding with optimal control theory? Why the (apparent) bias towards non-regulation and free markets?

Also – if such modeling divorced from evidence “could potentially” turn out to be useful – surely it could also “potentially” turn out to be harmful? For instance, if it misled (at times influential) economists into thinking that the world is simpler than it is and that it is imperative that we implement policies derived from such rational choice fan-fiction. An anecdote that may provide a possible example: Brooksley Born apparently, according to some, pushed hard for the regulation of a booming, wild-west-frontier derivatives market. In this she was stopped by President Clinton’s Working Group on Financial Markets. Alan Greenspan claimed that regulation could lead to financial turmoil, and at one point the very same Larry Summers we started with called her and said that

“You’re going to cause the worst financial crisis since the end of World War II.”… [Summers then said he had] 13 bankers in his office who informed him of this.

Germany is not turning on itself

I’ve recently read some interesting but somewhat shocking article, recommended by FT alphaville, in The Globe and Mail (Canada): “Germany’s season of angst: why a prosperous nation is turning on itself”. Fortunately, the author Doug Saunders is wrong.

Describing Germany’s booming economy, he writes:

These are, by several measures, the most successful people in the world. Yet it is very hard to find anyone here who is happy about this state of affairs.

And from my personal anecdotal evidence, he is right. When I talk to my fellow Germans about the economic situation, I have the same impression. But why is that? Doug’s interpretation, that Germany is afraid of change, involvement with the outside world, immigration or technological progress may be fitting with an earlier image of Germany. But I find other explanation much more plausible.

For starters, Germans fear the consequences of the Euro crisis in part because some politicians, academics and the media deliberately nurture fear. From “defending the Euro” to Prof Sinn’s exaggerated Target-2 arguments, from claims of high inflation to a Lehman-moment, the Germans are being told that the economic risks for them are huge and imminent, which is only partly correct (if at all). Interesting enough, the political risks – that the German taxpayers will become the major creditors of the periphery thanks to fear-induced bailouts (money and friendship…) – is discussed much less often.

But more importantly, Germans have lived through 15 years (!) of near-stagnation or mind-bogglingly high unemployment or both. That shapes your expectations in two important ways.

First, Germany knows how difficult it is to integrate and reform an economically (much more) devastated country of roughly the size of Greece. In fact, they have just been through it. So not only are they jolly well fed up with paying for something like that: after cumulated net public transfers of €1400bn (it’s not a typo), there are still €6bn in net transfers going to Eastern Germany. Per month. (The brain drain from former Eastern Germany was heavy, so how much “Western” Germany really payed is debatable.) At the same time, many Germans feel obliged to help European friends according to a recent poll:

A new survey finds that 60 percent of Germans believe their country has to help Greece in the eurozone debt crisis — like it or not.

Anyone caught in this tension will stray to extremes at times (like the person that Doug interviewed). The trigger may be when the Greek press retaliates with Nazi-jargon to German tabloids’ disgraceful headlines. Or when German politicians – supported by part of the German press – keep talking about “rescuing Greece” instead of being honest about what is actually being rescued: German investors and banks.

Second, after a decade-and-a-half-long economic struggle, Germans simply cannot believe that those times have finally passed for good, which is fully understandable for a country in whose national psyche security comes first. And no, Doug, the German boom is neither built on the birth of the Euro nor on “a deliberate strategy to keep labour costs low and productivity high”. It is built on Germany having re(!)-gained its competitiveness (warning: shameless cross-linking) and an ECB that will have to conduct too loose monetary policy for Germany in the years to come.

Doug’s other examples, immigration and a new protest movement, as well as nuclear power and the Libya war, have multiple roots that are too complex to discuss in a single post. He might have a point here, but there are more sympathetic and equally plausible explanations. For instance, the success of a populist and alarmist book by Thilo Sarrazin about the alleged decline of Germany is a late response of the German public to problems that have been piling up largely unaddressed over the last 30 years. In this context, Doug much too easily dismisses the internationally underappreciated contrast to Italy, Netherlands, France or even Sweden (!), not to mention Austria, that no right-wing populist party has made it into the federal parliament during the last 20 years, despite an unmatched economic malaise and a proportional election system.

Germany is not turning on itself. Germans just have a hard time dealing with and making sense of the current economic situation – and who could blame them? But if you give it some time, you will see that the 2006 & 2010 World Cup euphoria was not just a break from a national state of angst.

The Pressure is Building in Iceland

I am happy to be back here at AFOE with a guest post. For those of you don’t know me my name is Claus Vistesen and I write regularly from my personal blog Alpha.Sources. In my writings I usually stay within the comfortable world of the dismal science and this post is no exception. Today’s topic is Iceland and the probability that she will be the first real macroeconomic fallout (if any) of the much debated credit market turmoil which has gripped financial markets since August 2007. Since I posted this over at my own blog many others have been moving in with interesting observations on Iceland. Most notably I would like to draw your attention to one of Brad Setser’s recent posts in which he constrasts the Icelandic situation with the US ditto.

I am sure that most of AFOE’s readers are aware that Iceland, to a somewhat greater extent than the rest of us, are subject to the forces of nature. Being severed by the mid-Atlantic ridge which is a constructive tectonic plate margin cutting across the Atlantic ocean is consequently not for the faint of hearts. In modern times the skirmishes of Surtsey 1963 and Heimaey 1973 are omnious cases in point. As far as I am informed the tectonic activity in Iceland is relatively subdued at the moment but that, as we shall see, does not mean Iceland is not faced with a potential eruption. This time only, Iceland is subject to the equally potent forces of global financial markets rather than the whims of mother nature. In many ways, the sudden return by Iceland to the spotlight is not surprising. As early as in the Spring of 2006 we discussed whether Iceland were among the first in line to suffer a blowout on the back of an abyss deep current account deficit driven by a housing and consumer credit boom and a subsequent vulnerable currency. Over at my own blog I have, since the credit turmoil began, been looking wearily towards the Eastern European edifice for the first potential macroeconomic fallout in the context of what we could call emerging economies. I still am but given the most recent events it could indeed seem as if Iceland is about to beat the collective of the CEE and Baltic countries to it. At the heart of the debacle in Iceland lies the same kind of imbalance as we are currently observing in the US as well as other countries around the globe. A large current account deficit coupled with high inflation at a time when the housing bubble and consumer credit boom is about to come to a very abrupt standstill are all ingredients which we should be well aware of at this point. As can be expected this has also taken its toll on the financial sector which has played a seminal role in the recent Icelandic expansion. In this way, Iceland’s three largest banks (Kaupting, Glitnir, and Landsbanki) have all seen their credit rating being scythed by the rating agencies recently. In one of their recent much appreciated daily digests Eurointelligence reports how credit default swaps have risen to alarming levels even if we should note that the three big Icelandic banks have branches in mainland Europe allowing them to potentially knock down the ECB’s door for liquidity.

(…) the FT reports that credit default swaps for Icelandic banks have risen to extreme levels, for example to 912bps for Kaupthing. The article also makes the piont that Iceland’s three top banks, Kaupthing, Landsbanki and Glitnir, have branches in mainland Europe, which means they can tap the ECB for funding.

The rather precarious situation of the Icelandic economy recently prompted the central bank into pulling a reverse Bernanke as it was decided at an emergency meeting to raise the main refi rate by a healthy 1.25% bringing it to 15% in total. The immediate impetus for the move were indeed the global financial turmoil and by derivative the fact that the Icelandic krone had, in the past weeks, taken a flogging which would make the buck look like Cassius Clay in his prime. In the original post over at Alpha.Sources I field a chart which provides a sniff of the situation at hand as it shows the nominal exchange rate of the EUR/ISK as an index with 2.1.2006=100. As can be observed the recent weeks’ turmoil have more than halved the nominal value of Iceland’s currency vs the Euro. Yesterday the FT furthermore reported how the central bank and the government would move in tandem to shore up short term market liquidity, in part, by issuing €80m worth of short-term bonds. Whether this will work as a remedy to hold off the immediate crisis is basically impossible to tell. At the moment the only thing we can really do is to sit back and look where it will pop first. In the short term Iceland, with its floating currency, obviously seems more inclined to go to the pillory than many Eastern European countries who have pegged their currency to the Euro. We should however, in this context, never let our glance stray away from Hungary who recently was ‘forced’ to lift its trading band on the Forint. Over at the Hungary Economy Watch Edward and me are following the situation closely. We could also, I think, ask with some validity whether it is really such an advantage for many of the Eastern European countries to have married themselves with the Euro in the sense that this was done in first place on the expectation of future membership of the EMU. At this point this consequently seems all but a fool’s hope for most of the countries in question I would argue.

I don’t think it would be timely at this point to downplay the potential fallout facing Iceland and as Macro Man aptly noted a while back; you cannot spell risk without ‘ISK.’ As always in these kind of situation the main risk is that markets call the authorities to the poker table in which case the central bank’s reserves are certain to be drained faster than many investment banks’ balance sheets are currently being re-furnished. Given the size of the Icelandic economy such a move would likely be nasty, brutish and short. I don’t know whether all those loans in Iceland are denominated in Euros which would clearly represent a substantial degree of translation risk but even without this issue the situation is still getting increasingly more precarious. Obviously, not all view it this way and we would be well advised to pay attention to the following as quoted from the FT …

Richard Portes, president of the Centre for Economic Policy Research, and the author of a respected report on Iceland’s economy last year, has urged investors to pay more attention to the data. He points out overheating is being tackled, with economic growth slowing, hitting 2.9 per cent in 2007 and zero this year. He adds that Iceland’s current account deficit – the source of many of the concerns about the economy – has narrowed from 26 per cent of GDP in 2006 to 16 per cent in 2007. He has also made clear that Iceland’s banks are sound by international standards, with deposit ratios in line with international norms, high capital adequacy ratios by European standards and credible funding profiles. Finnur Oddsson, managing director of the Icelandic Chamber of Commerce, said: “The global turmoil is certainly hurting the financial sector, but the danger of things toppling over here is greatly exaggerated.”

What we have here is analogous to the debate we are having in the context of Eastern Europe and whether the landing will be hard or soft? Definitions as always are important here but it is obvious for anyone with a basic understanding of macroeconomics that having a floating currency also yields to potential of actually correcting the external balance without resorting to deflation something which the Baltics et al. may soon realize. Obviously, the flipside as should be clear from the oveview presented above is that the correction is too swift thus bending the stick so far that it ultimately break. Moreover, and as we are seeing in Hungary the traditional correction by which an undervalued currency boosts exports is not likely to cut it if inflation stays high (i.e. eroding the competitiveness) and the income flows on the current account pulls the balance further down as a result of an overweight of foreign owned domestic assets relative to domestic investors’ foreign assets. Whether this applies to Iceland is dubious. More than anecdotal evidence suggests that Icelandic investors and money men have been active in particularly Scandinavian asset markets. Moreover, and if you accept the fact that Hungary’s and indeed the whole Eastern European situation has something to do with the fact that these countries have moved (still moving actually) through the demographic transition far quicker than the traditional economic development process has been able to keep up I think we have a good basis for analysis. This thus leads me to the point I should perhaps have started with, namely a long term and structural assessment of the Icelandic economy. You should not worry though as I have all my bases covered. It would thus serve us well to go back to May 2007 and have a look at my colleague Edward Hugh’s piece on Iceland posted at Global Economy Matters. In this note, Edward indicates why any worry about Iceland in the long term and from a structural point of view seems to be largely unfounded even if of course the imbalances themselves run the risk of causing an abrupt crisis. In fact, Edward lifts a quote from the Economist Intelligence Unit where the specific risk from financial markets and potential spillover effects into the currency with a subsequent wage-inflation spiral to follow are mentioned. This would then be where we are situated now but allow me still to quote Edward in his final remarks …

So is this really so bad as it seems? Well let’s revisit an argument Claus advances in his recent French post, which is that if some countries with high median ages are now structurally tied to dependence of exports for growth (and sustainability in their public finance), then logically other countries (with somewhat lower median ages) are going to need to run ongoing trade deficits. Claus was referring to France in its ongoing relationship with Germany, but the argument could easily be extended to Iceland and points further afield. Iceland still has a median age of around 34 years, which makes it a very young country in developed economy terms. So if we can apply Modigliani’s Life Cycle Hypothesis to populations in the case of the elderly economies (Japan, Germany, Italy, Finland etc), why shouldn’t we apply the same notion to the relatively more juvenile economies, who can with some greater realism accumulate liabilities now which can be paid off later, as the population ages and domestic saving increases? I know this as all somewhat politically incorrect, but I do worry just exactly what would be the impact on overall economic welfare of all the younger median age societies bringing their economies into trade balance, since the level of ongoing global growth would obviously be lower, and I am not really convinced that this would be especially desireable as an end result.

I certainly have no idea whether Iceland is about to go but given the recent events investors would be wise to keep an eye out. Moreover, any longterm structural bullishness on Iceland clearly need to take the proverbial part as wing man in what is about to unfold since at the moment it is all about animal spirits as Keynes famoulsy articulated it. To end, after all, on an analytical note I would argue that the underlying external position of Iceland seems to be in a better shape than the ones we are seeing in Eastern Europe but that does not mean that any rapid adjustment won’t be tough since the size of Iceland’s economy virtually gurantees that it would be a swift kill for risk averse international investors and punters alike.

Bad Parallels

John Quiggin writes about the banking crisis:

Suppose Bank A owes a trillion dollars to bank B which in turn owes a trillion to C which in turn owes a trillion to D which owes a trillion to A. Now suppose that A gets into liquidity trouble and can’t pay. Then B is similarly in trouble and so in turn are C and D. If D could cancel the debt to A and forgive C who would in turn forgive B and so on to A, all would be well. But in the normal course of business you can’t do that. The fact that it’s zero sum doesn’t help. You need either wholesale resort to bankruptcy, or outside intervention.

It has strong parallels with John Maynard Keynes’ description of the financial consequences of the first world war. Basically, he said, everyone had ended up by owing everyone else a lot of money. Rather than the UK running a trade deficit with the rest of the world (and a services surplus), and a trade surplus with the empire, it had been running a surplus with its allies and a deficit with the empire’s civilian economy and the rest of the world.

The financially weaker allies had all turned to the next one up the chain for funds; Greece and Romania turned to Russia and Italy and they turned to France, which turned to the UK, which eventually turned to the US. As Europe was running a massive trade deficit with the rest of the world, the dollar claims everyone else accumulated could only be spent with the US; the adjustment path was meant to be that the British empire would spend the accumulated sterling claims buying things from the UK, and that the other allies would pay up. Netting out the numbers, Keynes concluded that the remaining dollar debt was manageable.

But the Russian revolution kiboshed this; if the Russians didn’t pay (and neither did some others), the French couldn’t pay, which meant the British couldn’t pay either. The solution the government offered was to make the Germans pay; Keynes pointed out that as nobody had any forex, there was no-one in a position to buy German exports, so they couldn’t pay either. Further, holding US dollars meant that Australia, say, could go and buy capital goods from the US instead. In a sense, the eventual solution was that Germany didn’t pay, but borrowed a ton of money from the US to finance its imports, paying with exports to the US; a Marshall Plan in one country, at least until the credit crunch meant it couldn’t roll over short-term paper.

Short-term commercial paper? Where have we heard that recently? Oh yes, at companies like IKB, Northern Rock, Citigroup, Morgan Stanley…substitute subprime mortgages for Russian bonds, SIVs and CDOs for France and Italy, and the UK for the major investment banks, and it’s quite eerie. But who are the Americans in this scenario?

Et in Formentera ego; or, où sont les flaons d’antan?

We’ve just returned from two weeks on Formentera, the smallest and southernmost of the inhabited illes Balears. We try to spend some time on the island at least once every two or three years; for it is an unspoilt place, a place time has left behind, a place untouched by the imperatives of vulgar economics.

No, that’s bollocks, of course. It is no such thing, nor could it be. Continue reading

Fertility in Europe

According to the Economist last week “Reports of Europe’s death are somewhat exaggerated“. I can only whole-heartedly agree. I think though, it only fair to add, that reports of Europe’s impending old age are almost certainly not, indeed generally it might be felt that the significance of this phenomenon were rather underestimated, than overstated.

Let me explain.

As the Economist article itself points out, here in Europe a good deal more attention has been being focused on the potential impact of climatic change (which is in and of itself undoubtedly an important topic), whilst, and in contrast, comparatively little coverage is being given to our need to develop a population policy:

though every rich country has a climate-change policy, few have a population one (there are historical reasons for that). And just as everyone whinges about the weather, but does nothing about it, so everyone in Europe complains, but does nothing, about population.

Again I tend to agree. Part of the difficulty comes, I think, from our undoubted tendency to try – as the Economist also notes – to simplify what are undoubtedly complex topics. This simplification processes can in itself produce rather sudden and noticeable shifts in opinion, as we have recently seen in some quarters in the case of climate change. What was previously thought by some to be benign, now is thought to be not quite so benign, and in the process a new global consensus emerges, even if comparatively little seems to have changed in the way of available evidence.

And so it will probably be with demography. In part, if this does turn out to be the case the Economist itself may turn out to be one of the guilty parties, since interesting and useful as this article is, it does most definitely fall into the complacent – things aren’t so bad as was feared – camp.

The article makes 6 main points:

i) “This article will argue that pessimism is no longer justified. It would be too much to say Europe’s population is bouncing back. But its long-term decline is starting to bottom out, and is even rising in a few places.

ii) A long list of US observers – ranging from American observers from Walter Laqueur, an academic, to Mark Steyn, a conservative polemicist – who have been arguing that “Europe is fast becoming a barren, ageing, enfeebled place” are wrong.

iii) That changes in population are not – in and of themselves – either a good or a bad thing in economic terms, since “there is no short-term correlation between population change and wealth” and “Japan and South Korea have even lower fertility than Europe”.

iv) Europe is simply not in decline. “Rather…. it no longer makes sense to talk about Europe as a single demographic unit at all” since “There are two Europes.”

v) Some “very-low-fertility countries can fall into a trap”. (This is a reference to a hypothesis which has been advanced by the Austrian demographer Wolfgang Lutz and his collaborators at the Vienna Institute of demography, although strangely, even while the Economist author uses adjusted data from the VID for the article, Lutz himself doesn’t appear to warrant a mention. I have posted on this hypothesis extensively both on Afoe and elsewhere, and a list of posts can be found here)

vi) “16 European countries, with a total population of 234m, now have fertility rates of 1.8 or more…..They are rare examples of bucking the trend that, as countries get richer, their birth rates fall. Why? There are no obvious answers.”

Of these (iv) (with qualifications see below) and (v) seem to be arguably very much to the point, (vi) is undoubtedly true, (iii) is highly questionable (in substance, though not in the rather constrained form in which the argument is presented, again see below), (ii) is undoubtedly the case, due to the simplistic way in which the argument is often put, and (i) is really not only deeply questionable, but fall foul of exactly the same kind of oversimplification process which the article’s author would want us to reject from Europe’s US critics. A case of double standards?

Well, let’s take a look at what is actually happening.

In the first place, as the Economist argues (and this is undoubtedly one of the strong points of the article) it is simply not satisfactory to talk about Europe as one single demographic whole. There are several Europe’s, and perhaps not two, but four. The general situation can be rapidly grasped by a quick glance at this map which I have put online here.

In the first place we have those countries – essentially France, the UK, Ireland, the Netherlands and Scandinavia – where fertility is at, or near, population replacement rate. The population path here, if you add in a certain quantity of immigration which the comparatively strong economic dynamic of these countries naturally attracts, would certainly seem to be pretty sustainable, and at least a lot more sustainable than in many other countries. As noted above these countries vary considerably in their welfare and tax systems, so it is hard to identify any specific feature which has contributed to their relative stability. This being said, that isn’t the end of the problem, unfortunately, since demographic processes are not only about fertility, they are also about life expectancy, and increases in the latter, which seem to form part of what Federal Reserve Chairman Ben Bernanke recently referred to as an ongoing demographic transition, a transition which is associated with rising population median ages and which is destined, with or without fertility-related problems, to place growing pressure on the health and pensions systems of all OECD countries.

In the second place, and at, as it were, the opposite extreme, we have the former member States of the Eastern Bloc. I single this group out as a special category since they are arguably still operating under the weight of what could well be termed an “asymmetric demographic shock” since their fertility generally plummeted following the coming down of the Berlin Wall. In addition, prior to the coming down of the wall, the mean age at first birth of mothers was significantly below that which could be found in Western Europe (see this map here for an at a glance appreciation) and below ages which are now considered to be the norm for developed societies with services-oriented economies. As a result these countries face what could be called a continuing “birth dearth” as mean first-birth ages move steadily upwards over – and probably over a good number of years to come – as women systematically put off having children to ever-higher ages.

This postponement process can lead many astray into thinking that the impact the process has on Total Fertility Rates (TFRs) is benign, since eventually TFRs may well recover somewhat (if there is not a trap, again see below), and although this debate gets incredibly technical involving comparisons of Completed Cohort Fertility Rates and TFRs, and the study of an issue which has become known as Quantum vs Tempo, one of the obvious impacts is easy enough to understand: with each passing generation the size of the cohort base from which children can be born is reduced, and substantially so – as a result of the missing births. The structural damage which this does to the shape of the population pyramid is known as the negative momentum effect, and this is one of the mechanisms which has been identified as a factor in any possible low-fertility trap.

In the third place we have the ‘Latin’ cultures of Southern Europe – Spain, Italy, Portugal and Greece – where, by and large, significant birth postponement has already taken place (Portugal is something of an outlier here), but where fertility still stubbornly sticks near to the lowest-low TFR 1.3 zone. I think entering the specifics of these countries is going to have to remain beyond the scope of the present post, but my feeling is that Portugal and Italy are much more stuck in the fly-trap than Greece and Spain are (this remains outside my present scope since the explanation of why I think this is the case rests on a development of the economic dynamics of the trap which Claus Vistesen and I are currently working on, which I briefly outline here, and which I sort of spell out in the case of Italy here. In a nutshell, it depends on whether – as a population – you are still young enough to get a housing boom or not).

Fourthly and lastly we have the case of the German speaking countries, namely Germany and Austria (and a part of Switzerland). The German case is by now reasonably well known. Aggregate fertility was, of course, negatively affected by the fertility “crash” in the former DDR, but as the graph appearing in the middle of this post – and which compares the two constituents independently – reveals, fertility in the West is low in its own right, and has been so for a very long time now.

As the Economist notes:

Germany not only has low fertility now, but has had for more than a generation. This suggests that “exceptionally” low rates can persist for decades. Admittedly, points out Michael Teitelbaum of the Sloan School in New York, Germany may simply be odd demographically.

Now while the German fertility pattern is decidedly odd, perhaps one of the oddest of odd features in the recent childbirth patterns there is omitted from mention in the article, namely the relatively higher numbers of women in German-speaking cultures who remain childless (see this chart where you can see the very rapid and significant rise in childlessness – up towards the 25% mark – among German women since the 1950 cohort) and indeed the proportions of women in these cultures who have considered it normal not to have a child. As can be seen in this chart, in answer to the question asked of women in the 2002 Eurobarometer survey about what their “ideal” number of children would be some 16.6% (in the 18-34 age group) declared “none” to be their ideal number of children in Germany and 12.6% in Austria.

These results do tend to give credence to the idea that some part of the low fertility in Germany is structurally different from low fertility in other members of the “lowest-low” group, in that a more significant part of the childlessness may be due to a free and voluntary decision rather than a result of biological infertility produced by excessive postponement.

But high levels of childlessness are not the only significant characteristic of low fertility in Germany, as can be seen from a glance at this chart, which compares the parity composition of childbirth (ie numbers of children) in six EU countries – Italy, Federal Republic of Germany, the UK, the Netherlands, Finland and France – for the 1935 cohort. If we make a direct comparison between Germany and France we can see that not only does Germany have more women who remain childless, of those who have children, a far lower percentage were having third and fourth children.

If we then take a look at the time-series chart for the percentages of children born out of wedlock to mothers in a number of EU countries which I have at the bottom of this post, we can see that in the case of Germany it is noticeable that the percentage of children born out of wedlock remained low in comparison with the UK, Sweden and France right though the second half of the last century, and that the level had stabilized by the 1990s (at around one-sixth of the birth total): this is an interesting result since marriage and the family are specifically protected by the German Constitution and since we have seen how since unification the number of such births has been halved in the east, where “illegitimacy” was previously massive.

So we may well have a rather perverse situation here, whereby “family” (as opposed to child oriented) policy specifically targeted married couples, and – at least in terms of tax concessions – favoured the father rather than the mum, with the result that – given the significant social transformations which were taking place in family types during the period in question – less children where born. Such at any rate is the opinion of the Max Planck Institute for Demographic Research demographer Jan M. Hoem, as argued in this paper (PDF).

So now lets go to point (iii) in my list from the Economist, namely the idea that population change is economic growth neutral. I would say that this was perhaps the most controversial idea in the whole article. The key point to note here I think, is that it is not population SIZE that matters, but population age structure. Changes in age structure effectively produce – as was mentioned in the context of Ben Bernanke and the Demographic Transition earlier – shifts in median ages, and these shifts in median ages do seem to have significant economic consequences. Basically, if we look – yes, actually look – at those societies whose median age has reached the highest level – around 43 – so far – Germany, Japan, and Italy – we can note straight off that each of these has been experiencing economic problems in recent years which to some extent break away from the traditional pattern. I do not wish to go into this in any great detail here (that will be, I think, another post), but basically it could be argued that these three countries all tend to be suffering from congenitally weak domestic consumer demand, and as a result tend to depend on export lead growth for increases in GDP (increases which in the case of Italy remain exceedingly small, due to the inability to meet the export-lead growth challenge).

I have recently gone into all this in some considerable depth in the German case (and here) so I will simply refer the interested reader to this line of argument. But this kind of economic problem will undoubtedly feed-back into the fertility trap problem (if one exists), and in particular by maintaining downward pressure on the disposable income available to young people, both via the tax squeeze that ageing and the associated higher elderly dependency ratios produces (viz, the 3% VAT rise in Germany) and the downward pressure on wages which is being systematic and relentless in both Germany (see this remarkable Q1 2007 wage data from Eurostat, just 0.1% growth in wage costs y-o-y after the boom year of 2006) and Japan (where again wages continue to fall, and here).

So, in summing up, what can we now make of the Economist’s claims that “pessimism is no longer justified” and that “Europe’s population is bouncing back”? Well, I would say that pessimism is rarely justified, since it tends to produce fatalism. On the other hand realism leads me to want to qualify the Economist’s claims in the following way:

* Europe is only bouncing back in parts, so it is hard to draw any real conclusions, in particular a very large part of Europe still has – as can be seen here – around 70% of its population with TFRs below 1.7, and 1.7 is already significantly below replacement level.

* Demographic changes are not processes which only go to work in the very long term, the short term consequences of changing median ages are already real and present.

* The economic consequences of changing population age structures are not growth neutral, but are real and significant.

* As a consequence of all of this we simply cannot afford to continue to give demographic changes the back seat. Europe needs above all policy – rather than complacency – in the face of these changes, and such policies ought to be just as evident in the minds of our citizens as the recent declarations of good intent about the need to act on climate change.

Circular Logic Watch

The Independent’s John Lichfield, writing about Nicolas Sarkozy:

His ideas are based on two simple but accurate diagnoses of France’s economic decline in the past 30 years.

First, France does not work enough. Young people enter the workforce late; experienced people retire early; the standard working week is now just 35 hours. France works an average of just over 600 hours per inhabitant per year, taking into account all the people not in work; Britain 800 hours. Result: slow growth, low incomes and high unemployment.

Yes, he really did blame high unemployment on the number of people not in work. As it turns out, French people (if Lichfield’s figures are right) work 25 per cent fewer hours than the British, however, that includes the hours of potential work lost to joblessness. Of course, this is quite a valid reason to object to unemployment – it’s literally a waste of time, but this isn’t what he’s getting at. He seems to suggest that if only the others would work harder, they would either generate enough supply-which-creates-its-own-demand to create more jobs, or else they would spend enough extra income to create more aggregate demand and create more jobs.

Current UK unemployment is 5.5 per cent, French 8.4 per cent – so just over a third (34 per cent) greater. All other things being equal, you’d expect the hours gap to change pro-rata with the unemployment gap – that is, if like the Indy, you are stupid enough to contaminate your proposed cause with a measurement of effect. But clearly something is not equal. If the greater quantity of worklessness is too great to explain the lesser quantity of work, the excess must have been cancelled out by something – which can only be that the people in work are working harder.

Economic nonsense about France

Yet again. Here’s what the BBC has to say in its updated-for-the-upcoming-elections online background article about France:

But France’s economy has grown more slowly than any other developed country in the world. In 2006, its 2% growth was the worst in Europe.

Well, sorry to beat a late parrot, but one year does not a trend make: if we look at, say, the 5-years period between 2002 and 2006, the average annual rate of growth of France was a meagre 1.6%*, but that is equal to the euro area average and higher than what the Netherlands (1,4%) and Germany (0,9%) and Italy (0,7%) and Portugal (0,6%) managed over the same period. I’ll spare you the 10-years period (1997-2006) which is even more favorable to France.

But even if we grant the Beeb’s dubious premise that 2006 growth is the ultimate yardstick to measure the strength of an economy (and in that case I have an old “US has grown more slowly than nearly every other developed country in the world” headline from 2001 to sell you), their claim isn’t even true. Or, if it is, we can safely conclude that Italy (1,9% growth in 2006 according to Eurostat) and Portugal (1,3%) are neither European nor developed countries.
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What the hell is an economic government?

So, somebody has a brilliant idea to solve all Europe’s problems. What is it? It’s to set up a European economic government for the EU. It’s not exactly new – several people in the Jospin government thought so, including Dominique Strauss-Kahn. It might have something going for it.

But what is it? The EU already has – already is – an economic government, in that it handles trade negotiations, operates a single set of product standards, interworking arrangements between big networked systems, some social and environmental regulations, and even operates some fiscal rules. If you include the European Central Bank, and why not, it conducts monetary policy.
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Illiterate voters

I should know better than to visit Arts & Letters Daily when I am up to my ears in work. The wealth of reading material found there provides the ideal excuse for procrastination. “Hey, I am doing something intellectual here”. Nevertheless, after having resisted the temptation to go there for a while, I finally succumbed and discovered an interesting blog and an essay on the illiteracy of voters when it comes to basic economic principles. The blog is Cato Unbound and the essay, written by economics professor Bryan Caplan, is called Straight Talk about Economic Illiteracy (pdf, via Mercatus Center). My high school major in economics notwithstanding, please do not laugh, I consider myself to be an economic illiterate and therefore had to read the essay. It was a good call. One quote to wet your appetites as well:

Admittedly, economic illiteracy does not automatically translate into foolish policies. We could imagine that the errors of half the electorate balance out the errors of the other half. In the real world though, we shall see that such coincidences are rare. The public tends to cluster around the same errors – like blaming foreigners for all their woes. Another conceivable way to contain the damage of economic illiteracy would be for citizens to swallow their pride, ignore their own policy views, defer to specialists, and vote based on concrete results. Once again, though, this is rare in the real world. Politicians plainly spend a lot of energy trying to find out what policies voters want, and comparatively little investigating whether voters’ expectations are in error. Indeed, even when politicians brag about their “results”, they usually mean that their proposals became policies, and sidestep the difficult issue of whether those policies worked as advertised.

I do have to add one caveat concerning Bryan Caplan, at least for economic illiterates like myself. Caplan, according to wikipedia, “has been heavily influenced by Ayn Rand, Thomas Szasz, and Thomas Reid”. This influence is notable in the essay, just look for his take on the word “greed”. There may be an ‘agenda’ here. I especially like the before-I-saw-the-light style he adopts. In any case, I am mainly interested in his ideas about voter illiteracy and how he defines that illiteracy in terms of his own economic belief system. Is Caplan right, in general, in saying that voters are economically illiterate? Or is he simply using that angle as a trick to ‘convince’ true illiterates to see his light as well? This is an important, albeit naive, question, since illiterates like me are dependent on information from ‘specialists’, and Caplan ‘is’ an economics professor… To be filed under “forest and trees” and “caveat emptor”?