Category Archives: Economics and demography

Sunshine: at the IMF, of all places

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So, here we are, after a 2010 of economic horrors. There is extensive debate as to whether the standard tools of economics are even valid – as Daniel Davies points out, even Paul Krugman now self-identifies as a heterodox economist – while on the other side, the discipline is coping with the financial crisis experience by clapping louder and imposing ideological censorship. But is anyone at least trying to do something original with the standard toolkit? The DSGE model may be one of John Quiggin’s zombies (buy now for Christmas and support Australian professors’ lifestyles – what’s not to love?), but zombies are notoriously resilient. (Head shots! as a well-known advocate of conservative austerity once said.)

The answer on this occasion is yes, at least as far as Michael Kumhof and Romain Ranciére, go. In a new paper, they present a DSGE model with the following parameters: the top 5% of the income distribution value wealth more than everyone else, for whatever reason, and specifically, they want AAA-rated assets. Further, these are intermediated through the financial sector. Then, they run a simulation of the macro-economy assuming that there is a negative shock to the bargaining power of labour resulting in a shift in the income distribution.

The simulation results were that the financial sector balloons in size, that total private debt in the economy expands hugely, and that credit acts as a substitute for rising average wages in the short run. Eventually, the model produced a massive financial crisis and a brutal recession, followed by a blow-out of the government budget.

Your keen and agile minds will not have missed that flat real wages, an increased share of national income going to the top 5%, enormous growth in the financial sector, and a credit-financed consumer boom are exactly what happened to the macroeconomy in the last 30 years. Also, it would appear that the economic situation has developed not necessarily to our advantage, to borrow the Emperor Hirohito’s remark on Japan’s surrender to the Allies.

So, what should we do about it? Kumhof and Ranciére have something to say about that as well. Specifically, they ran the model for several different scenarios representing different paths out of the crisis. They considered a scenario in which the government took the pain, accepting a large government deficit in order to minimise the impact of the crisis on the real economy. This had the advantage of reducing the fall in GDP, and therefore allowing growth to reduce households’ leverage. They also considered the option of just suffering, which actually increased leverage as incomes fell and the stock of debt remained.

Then they considered two more positive responses to the crisis. One was a debt restructuring, or to be brutal about it, widespread default and bankruptcy. This had the advantage that it does, indeed, reduce the leverage burden and does so cheaply. It also implies the end of the big banks, as they point out that a bank rescue doesn’t constitute a restructuring, just a transfer of debt from the private sector to the public sector. In a policy context, we could caricature this option as “stimulus plus cramdown”.

The other was to shift the labour share of income upwards. They found that this achieved a faster, bigger, and more lasting reduction in leverage and a reduced probability of crises. In their own words:

The main difference to Figure 14 however is observed following period 30, where under a loan restructuring leverage and default probability resume an upward trajectory for several additional decades, while under the bargaining power solution both immediately go onto a declining path. By year 50 leverage is around 20 percentage points lower under the bargaining power solution than under the loan restructuring solution. For long-run sustainability a permanent flow adjustment, giving workers the means to repay their obligations over time, is therefore much more successful than a stock adjustment, unless the latter is extremely large….But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy.

They also argue that the inequality-finance-lending transmission mechanism might also explain the global imbalances, with the emergence of a globalised rich elite driving the demand for AAA-rated assets, the growth of the financial sector, and the emergence of persistent large capital account surpluses and trade deficits. (We already know that imbalances in the balance of payments are intermediated through the financial sector.) However, they haven’t extended the model to include the international dimension yet, although it’s on their agenda for further research.

I’ve waited for this moment, 752 words on, to mention the key detail: this cell of dangerous subversive Bolsheviks is embedded in the International Monetary Fund, and their poisonous hate-writings were published as an IMF Working Paper. Perhaps DSK really has had an influence on the institution? In other optimistic news, both IFO and the German Chambers of Commerce expect significantly stronger internal demand next year and a smaller trade surplus, while Daimler Benz’s CEO is promising that this year’s profit share payments will be “attractive”.

It better be…

Other people’s money

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USA Financial Crisis Inquiry Commission, “primer” issued by the Republican party defectors from the project –

If the bank uses deposits to fund poorly performing projects, depositors can become concerned that eventually their bank is going to fail and they will not get their deposits back. If a bank lends too much of its deposits to finance long-term projects, depositors might begin to worry that they will not be able to withdraw their money according to their needs. Therefore, banks hold enough cash on hand, or “liquidity,” to be able to honor withdrawal requests and offer confidence to depositors that their money will be there when they want it. If depositors lose confidence in their bank, the only rational thing to do is to withdraw their money and move it to a safer place. With each depositor withdrawal, the bank becomes more leveraged, the mismatch between its assets and liabilities becomes more pronounced, and liquidity on hand is further diminished.

With the credentials that one assumes qualified them to be on the commission in the first place, you’d hope to do better than what you’d get from putting “bank run” into The Google.  But do you?

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DSK on QE2

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IMF Managing Director Dominique Strauss-Kahn gave an interesting interview to Stern magazine.  The transcript on the IMF website seems more comprehensive than the story based on the interview in Stern.   DSK covered a lot of ground but his comments on the US Fed quantitative easing were especially interesting.  In addition to offering the standard pro-QE2 position that what’s good for the US economy is good for the world, he had this exchange –
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An Unusual But Interesting Argument Which May Help To Understand Why QE2 Is Now Almost Inevitable

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For reasons which aren’t worth going into now, I’m reading through a recent report by Deutsche Bank Global Markets Research entitled “From The Golden To The Grey Age” this afternoon. The report (all 100 pages of it, many thanks to researchers Jim Reid and Nick Burns who produced the thing) looks at the extent to which a variety of macro indicators – like GDP growth, inflation rate, equity yields, etc – may have been influenced by demographic forces over the last 100 years or so. It is certainly one of the most systematic reports of its kind I have seen, and well worth losing a Saturday afternoon to read. Continue reading →

sunshinewatch

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More sunshine. Bloomberg:

So-called warning strikes by steelworkers at ThyssenKrupp AG and Salzgitter AG that began yesterday will “definitely” continue unless employers meet demands for 6 percent more pay, Helga Schwitzer, an IG Metall board member responsible for wage negotiations said in a Sept. 21 interview in Frankfurt.

While exports give Germany a “very strong leg to stand on,” increases are justified because the recovery is at risk without consumer spending, Schwitzer said. “If you’re only standing on one leg, you start to limp,” she said. “The second leg, domestic spending, has to be strengthened.” ..

“We could use a level of redistribution in this wage round, but we shouldn’t overdo it,” Andreas Scheuerle, an economist at Dekabank in Frankfurt, said by phone. “Pay increases would mean a win for the domestic economy, but it would come at the cost of exports.” ..

The government should use its trade surplus, the European Union’s biggest, to “foster domestic demand and ease reliance on exports that are contributing a huge trade imbalance on the euro-zone’s periphery,” said Juergen Kroeger, a director in the EU Commission’s Economic and Financial Affairs department.

“Why aren’t we paying people higher wages in this country?” he said Sept. 13 in Berlin. “That might be a start.”

Premature evaluation – The Spirit Level

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Richard Wilkinson and Kate Pickett’s The Spirit Level is a vigorous polemic for social democracy, something we’re probably in need of as the neo-liberals recover from the 2008 experience.

Unlike most such, this one is based on data – specifically, a whole battery of socioeconomic indicators that turn out to be strongly correlated with income inequality. In fact, the paperback comes with a handy table of the R-squareds and p-values of all the indicators used, which range across life expectancy, imprisonment per capita, patents issued per capita and much else. Everywhere, it seems, more egalitarian societies tend to do better.

This observation is rather more impressive than quite a bit of the book – there’s too much back-of-a-fag-packet neuroscience of the sort that actual neuroscientists run a mile to avoid about mirror neurons and such, as well as a fair bit of 1970s-ish romanticisation of the supposedly ideal status of hunter-gatherer societies. Steven Pinker’s work on the history of violence hasn’t landed here; in places it’s almost nostalgically sweet.

The data, however, speaks for itself. It’s true that quite a few of the charts derive a lot of their correlation from a few outliers, but the outliers invariably point to the same results – specifically the United States, which reliably turns out to have truly awful results for many, many tests – and also very high inequality. Similarly, there are a whole string of statistics that are driven by a group of post-Soviet states that turn out to be dramatically unhappy, conflicted, violent, unhealthy, etc for their level of income; of course, these societies underwent a historic explosion of inequality.

Many of the results have been checked by carrying out the same analyses with the 51 US states, which gives rise to the same conclusion and another crop of interesting outliers. The states of the Deep South are reliably terrible. They are highly unequal, and they get the effects – but they are far off to the top right of the trendline. In a sense, their marginal productivity in terms of inequality is unusually high – for every extra point on the Gini coefficient, they manage to produce a sharply higher degree of suffering than the national average.

On the other hand, there’s the importance of being urban. The more metropolitan the state, the less it suffers from the impact of inequality – New York has the social problems of the average, despite being very unequal. And there’s the Alaskan question.

The Alaskan question? Many people on the left are keen on the idea of a citizens’ basic income, and oddly enough, there is one territory with one in this study. Alaska, famously, distributes its oil revenues equally among the citizenry, and is therefore the most equal society in the United States. However, it also succeeds in being reliably among the worst on every other measure you can think of. Clearly, the statecraft of Sarah Palin must have some impact, but it’s equally clear that it can’t be the whole explanation.

Unless there is some huge missing factor that invalidates the whole data set, we have to consider that this particular basic income experiment has failed to deliver the benefits of equality. Alaska is, of course, a very special and atypical place – but it’s not that different to, say, Norway, another sparsely populated, mountainous, northern territory bordering on Russia whose economy is heavily influenced by oil and gas, forestry, fishing, and metals and whose government decided to take a radical approach to the oil revenues, and where a lot of people own guns. And Norway is both very egalitarian and reliably in the very top of all the metrics in The Spirit Level.

Perhaps the answer is precisely that the Alaskan basic income is free money? Despite all the stuff about mirror neurons, etc, etc, it seems that the trade secret of equality is – equality. It takes a long time for Wilkinson and Pickett to get to this, but the difference between handing out oil windfalls and real egalitarianism is that only one of them is founded on a different balance of power between classes. A lasting reduction of income inequality must be founded in a lasting reduction in the inequality of political power – otherwise it may not last, and it may not even have much effect.

Another interesting point is that changes in relative economic success among nations seem to have little effect on human happiness or security. Obviously, a total crash will do it. But once a certain threshold level of per-capita GDP is passed, Wilkinson and Pickett argue, pushing into the G8 doesn’t change much. They therefore argue that economic growth is useless. However, they then note that a whole range of their metrics, like life expectancy, do seem to go up a percentage point or two a year in the rich nations anyway. Which sounds a lot like growth.

It might be more accurate to say that growth relative to other industrialised states is not particularly important within the normal range of variation, although in absolute terms it is. However, the chart in question is quite heavily driven by the US outlier – which suggests that the costs of enough inequality will essentially swallow all your economic growth.

Eventually, the upshot of TSL is that the world, and especially China, needs trade unions.

On The Shoulders Of Giants – How Spain Is Destined To Follow In Germany’s Footsteps

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The current generation of policymakers seem to be like Captains of large ocean liners, out there on the high seas, bereft of either compass or adequate charts, trying hard to calm there worried passengers by telling them nothing is amiss. But the charts are there, if only they would look at them, and in the present Spanish case, unlike the old refrain, the future is ours to see, and it has a name: Germany.

For those willing and able to examine our present situation with a reasonably open mind, a comparison of the recent history of the Spanish and German economies can prove illuminating, especially since, as I will argue below, there are strong structural homologues to be observed in the evolution of the two.

This post will contain comparatively few words (what a blessing!) since I will try and let the charts themselves tell their own story, in the hope that concepts which seem to be difficult to convey verbally, may be easier to grasp visually. Continue reading →

The Baron Münchhausen Effect

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Karl Friedrich Hieronymus, Freiherr von Münchhausen was a German baron born in Bodenwerder in the eighteenth century. Made famous by the Hollywood director Terrence Gilliam, the baron first came to public attention for his ability to recount outrageously tall tales about his adventures while fighting abroad in the Russian army. Among the astounding feats which legend attributes to him are riding cannonballs and travelling to the Moon. But perhaps his best known marvel is the story of how he managed to escape from a swamp by pulling himself out by his own hair (or by his bootstraps, depending on who tells the story). Which puts me directly in mind of the way some people are now expecting an export-dependent German economy to drag the rest of Europe – and with it the whole global train – up and out of the ditch in which it is currently sunk, simply by exporting to everbody else. Sounds just like one of those tall tales, doesn’t it. A very tall one. Continue reading →

Estonia’s Long Awaited Recovery May Still Be Delayed Yet Awhile

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In a recent FT Op-ed, entitled “Estonia’s recovery defies economists and academics“, columnist John Dizard argued that “the “internal devaluation” policy, which means cuts in nominal costs such as wages and rents, was very hard on the population, but appears to have worked ahead of even the Estonian government’s schedule”.

But as I said to John in a very enjoyable phone conversation I had with him before he wrote the piece (where he was kind enough to descibe me as a “freelance economist”, one who doesn’t have to answer to a boss before expressing an opinion), perhaps we should just hold on a minute before jumping to too many conclusions, since things are still far from clear. So let’s take a look. Continue reading →

Chart Of The Day: How Spain’s Stimulus Money Helps Germany Achieve Record Growth

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Well, here’s a nice way of putting things. Spain did less badly than expected in Q2 2010 as compared with a year ago, since in Q2 2009 it actually did worse than it initially appeard (following a downward revision in the data). Well, that’s one way to improve, push the past backwards.

On a more serious note, the detailed data on the second quarter are now available for Spain, and interesting reading they make. Basically, what little improvement Spain did manage to achieve (0.2 q-o-q, -0.1% y-o-y) came from domestic demand and not exports, while the external trade balance deteriorated. Exactly the opposite to what you want to happen.

As the statistics office (INE) say: “On analysing the two large components of Spanish GDP from the perspective of expenditure, a similar pattern of performance could be observed as in the previous quarter. Thus, on the one hand, the negative contribution of domestic demand to GDP decreased two points and three tenths in this quarter, from –2.8 to –0.5 points. Whereas, in contrast, foreign demand decreased its positive contribution to the aggregate growth one point and one tenth, from 1.5 to 0.4 points”.

In other words, all that deficit spending money is simply getting wasted, and there is no competitiveness correction taking place. In the midst of a huge potential export boom, Spain’s economy is growing thanks to domestic demand, as the trade deficit once more deteriorates.

So one very simple way of putting this, so everyone can understand, is that the Spanish government is running a double digit deficit, and one part of the money spent is going straight out in additional imports which (among other places) come from Germany. That is, Spain is getting itself even more into debt to lend a kindly helping hand to the German economy. In theory, the exact opposite was to happen, and the German expansion was supposed to help Spain’s net exports. But Spanish industry isn’t, well you know..

And just to remind us, here are the respective industrial output charts I published in this post.

So when are people at the EU Commission and the IMF going to finally wake up to reality? This isn’t going to work like this, and Spain needs to adopt concrete measures to restore competitiveness, and not find ever more ingenious ways to kick the can even further down the road. Either that, or we will all live to regret our own inaction one of these fine days.