Monday, January 31, 2005

Write to me

I now have an e-mail address:

The Fiscal Mess and the Housing Bubble

So, how does the US fix its fiscal mess (supposing that it wants to fix the fiscal mess)? Here is what the OECD recommended in a survey last year.
Restraining both discretionary and mandatory spending, while necessary, is unlikely to be sufficient to restore the budget to balance over the longer term. To the extent that revenues have to be raised, this should be done primarily by broadening the tax base rather than by reversing recent reductions in marginal tax rates. Considering the low aggregate tax burden compared to other member countries, statutory and marginal effective tax rates remain rather high, reflecting the heavy reliance on income taxes, in particular at the federal level.

To broaden the tax base of the personal income tax, the deductibility of mortgage interest (regardless of the use of the loan) and of charitable donations should be phased out, as should the unlimited exclusion of employer health insurance plan premia. As to the corporate income tax, base-broadening efforts should focus on exemptions that reduce revenues and create inefficiencies, such as sectoral tax shelters. In any case, there is significant scope to improve revenue yield by better enforcement.

If the yield from broadening existing income tax bases is ultimately insufficient, a further move to a consumption based tax system through the introduction of a nationwide value added tax (VAT) should be considered. While introducing a VAT would be complicated in the US context, in which most states rely heavily on sales taxes for their revenues, such a step would be an efficient approach to raising revenues and might also help to boost household and national saving. Restraining both discretionary and mandatory spending, while necessary, is unlikely to be sufficient to restore the budget to balance over the longer term. To the extent that revenues have to be raised, this should be done primarily by broadening the tax base rather than by reversing recent reductions in marginal tax rates. Considering the low aggregate tax burden compared to other member countries, statutory and marginal effective tax rates remain rather high, reflecting the heavy reliance on income taxes, in particular at the federal level.
Pretty dramatic... When I first read this, I simply discarded the possibilities as politically impossible, but now I see that the Wall Street Journal is advocating the elimination of mortgage deductibility (thanks to Jane Halt).

Now, I wonder what would happen to government revenues if interest payments suddenly became less affordable, and the housing bubble burst... Looks like plan B would have to be enacted. Hello VAT.

Sunday, January 30, 2005

Cafe Hayek: Dogs at the Margin

Cafe Hayek knows dogs know economics.

...natural selection gave dogs an (unconscious) understanding of the margin.

If historically for wolves (and dogs) water was more readily available than food, as seems plausible, then there was less to be gained by a dog being genetically programmed to threaten physical violence if another dog shared his water than there was to be gained from threatening violence if another dog tried to share his food. Put differently, each available unit of food was worth more to wolves and early dogs than was each available, comparably sized unit of water. Hence, dogs’ genes are evolved to prompt them to be willing to spend more – risking life and limb by threatening violence – to protect a food source than they are programmed to spend to protect an equally sized source of water.
This is true. I know from experience.

A Lesson from (1930s) Japan

How Strong is the Pressure to Keep Spending?

Suppose an economic policymaker decides that a policy of fiscal stimulus, easy money, and devaluation of the currency is necessary in order to keep demand afloat. If there is plenty of excess capacity in the economy, and wage pressure is light for one reason or another, this type of effort could be successful at reflating demand without generating too much inflation.

But how does the policymaker know when enough is enough? When does reflationary policy become inflationary? At present, the member of the Fed's open market committee seem to disagree about whether the economy is close to, at, or above potential, and hence the scope for continuation of loose policy without inflationary consequences.

From the December minutes:
A few participants also noted that uncertainty about the extent of resource slack in the economy was considerable and that it was quite possible that the economy could soon be operating close to potential, particularly if labor force participation rates did not turn up much while employment continued to register gains. The increase over the last few months in five-year measures of inflation compensation derived from Treasury nominal and inflation-indexed securities might be a warning sign that expectations were not as well anchored as they had been over the summer.
So the Fed seems like it believes the time has come to remove some stimulus and indeed is (timidly) doing so.

But, will the US treasury follow in its footsteps? There is a lesson from Japan in the 1930’s that shows just how difficult it is to get an economy off junk once politicians have noticed how effective stimulus is for staying popular. Japan’s policy during the great depression years was one of stimulus and devaluation. Japan was actually very successful at keeping unemployment low during those years, though of course at the cost of making its trading partners quite upset at the beggar-thy-neighbor policies. In short, though, the stimulative monetary and fiscal policies were effective at reactivating demand and production without inflationary consequences because the economy, like most of the world, had plenty of slack capacity (and commodity prices had plunged).

From W. Arthur Lewis’ account of the world economy during the inter-war years we learn what happened next:

By the beginning 1936 the Finance Minister responsible for this policy (Takahashi Korekiyo) had come to the conclusion that full employment had been reached, that further deficit expenditure would now start an inflation, and that expenditure should now be curtailed. But the militarists were now too firmly established to be denied. He was murdered. His successor continued the military expenditures, and wages and prices started to move swiftly upwards. Then, in 1937, came the attack on China, and the adoption of a full war economy.
The US is being quite successful with its reflationary policy, forcing the rest of the world to accommodate to its loose policy or suffer from exchange rate appreciation. Eventually (who knows how soon) full employment will be reached, and the stimulus will need to be taken away in order to avoid inflation. I wonder whether politicians will be eager to do so.

Materials add up ... way up

Sure, low interest rates, psychology, and the Chinese central bank are the main reasons behind booming house prices, but don't forget the fact that commodity prices are going through the roof, thanks to... well, low interest rates, abundant world-wide credit, and the weak dollar.

This LAT article does a good job showing how it all adds up.

A painting contractor by trade, Don Dellino knows a lot more about residential remodeling than your average homeowner. But even he was startled by the recent run-up in construction costs due in large part to soaring prices of building materials. Dellino and his wife are expanding their two-bedroom Manhattan Beach home into a 3,900-square-foot Italian-style villa.

"One bid for the roof was $14,000 higher if I decided to use copper flashing," said Dellino, who opted for the less expensive — if less attractive — galvanized metal. Despite his cost-cutting, however, Dellino's home makeover will wind up costing about $450,000, significantly higher than his own original estimate of $300,000.

101 Dumbest Moments in Business


India Fact of the Day

The entire Nehru-Gandhi family -- Cha-chaji, Indira, Rajiv, Sonia, Sanjay, Rahul, Prianka – collectively haver fewer educational qualifications than [an average person] does. If I am not mistaken, they don't have one solitary single college degree among the whole lot of them.

Via Deeshaa/a>

Saturday, January 29, 2005

Beautiful Horizons: They're Not Brazilians, Mr. Rohter

This Beautiful Horizons post shows more of Larry Rohter's rotten journalism.

He gets the facts wrong almost every time, twisting whatever he can in an effort to get a story that people will notice. Good thing Brazilians are optimists...

It's sad, what a poor journalist he is.

Inflation? Part 2

There was quite a buzz last week about the 4Q GDP report. The headline number, 3.1% annualized, was lower than many people were expecting, in part because inventory accumulation was lower than expected, but more importantly because net trade took of 1.73 percentage points from the headline rate.

There are many different ways of looking at this number. Some will tell you that it was weak and focus on the headline figure, and others will instead emphasize that domestic demand is still humming along quite nicely, with consumption rising 4.6%, and investment almost 10%.

The truth is that those consumption and investment number are pretty strong indeed. What's to blame? I would highlight extremely loose monetary and fiscal policy, which is stimulating demand quite vigorously still, despite the Fed's timid rate hikes.

Luckily, this dramatic demand is meeting plenty of supply from abroad at current prices. (actually, import prices are rising at about 10% per year, but this could be a lot worse) The reason supply is available for so cheap is that, as brad setser has been emphasizing and explaining in his blog, Asian (and some other) central banks have been piling up US dollars in order to keep their currencies cheap.

Most people who think about these issues (for a some good sources see my previous link on the US current account) agree that the dollar is going to fall significantly. You can think of the dollars' plunge as a massive supply shock. Things that used to be available in infinite amounts at current prices suddenly cost much more.

This would not be inflationary if the policy mix (monetary and fiscal policy) were tightened in order to keep demand in check. However, I somehow doubt that will happen. The White House loves to spend and hates to tax, and the Fed is way too chummy with the administration.

To me, the most likely result of all this is inflation, as policymakers will choose to accommodate the pressures stemming from the supply shock I've described above rather than be blamed for causing a recession.

TIPS seem like a good idea

Wall Street, the IMF, and the Argentine crisis

Ben Muse has a post about a new book by WP reporter Paul Blustein, whose previous book, "The Chastening" is a marvellous account of the financial turmoil of the late '90s.

This time, Blustein takes on the Argentine crisis, and it looks like he wrote the book that I would have liked to write (I suppose I shouldn't speak too soon... I haven't read it). I witnessed how Wall Street painted a distorted picture of what was a clearly unsustainable situation in order to keep pushing bonds.

Blustein comments that "For people who believe in the power of globalization to raise living standards in the developing world — and I count myself among them — the story of the most spectacular national bust of recent times is a sobering drama of immense significance for us all."

I couldn't agree more.

Here is the link to his book.

Inflation? Part 1

Companies have lots of cash on their balance sheets these days ($600 billion for the S&P 500), the result of excellent profit growth (19% in 2004, compared to an average of 6.5%).

It is quite surprising that companies would keep all that cash around, especially when interest rates are so low. Why not invest in a project with a positive real rate of return?

It turns out that, instead of choosing to invest in new capacity, many companies are instead choosing to invest in existing assets through mergers and acquisitions.

Industry consolidation is improving pricing power, and this is yet another factor that reminds me of situations where inflation has come about.

Friday, January 28, 2005

Keep 100m distance or you will be shot

Baghdad Girl: "Life in Baghdad these days" is a recent post on the blog of a 13 year old girl that lives in Baghdad. Mostly it's about kittens, but she also comments on other things. Here is a quote:
even the Americans solders have no security, they have a sign on there vehicles saying "keep 100m distance or you will be shot", imagine you are driving in a crowded road and an American patrol want to use this road, where will you go and how to keep the 100m distance, this is the reason that all our roads are almost in stand still state.

via the Guardian blog.

Thursday, January 27, 2005

Dynamist Blog: Competition's Fruits

To be fair, the NYT also has very good economics reporting (when it's not Larry Rother). Virginia Postrel writes about what happened in Canada when tariffs were removed and a free trade agreement was signed. Yes, jobs were lost. Yes, a lot. But there were plenty of gains. Society has to decide what it wants, and these choices are hard, but it's horrible when people have to make those choices without the adequate information.

This link is to her blog post.

More sloppy NYT reporting on Latin America

The NYT has an article on Chile’s pension system that I found quite disappointing. Many people are commenting on it or otherwise pointing it out, few critically. Here is crooked timer and Brad Delong, for example. It seems that Larry Rohter either doesn’t have a capacity to think critically and analytically, or he is being dishonest in the evidence that he offers in order to paint the privatization as a failure. Frankly, one doesn’t have to resort to clearly biased inference from superficial and anecdotal evidence presented in an unfair way in order to avoid seeming like one is in favor of President Bush’s plan to privatize social security.

Here are a few examples of his really sloppy reporting:

For all the program's success in economic terms, the government continues to direct billions of dollars to a safety net for those whose contributions were not large enough to ensure even a minimum pension approaching $140 a month. Many others - because they earned much of their income in the underground economy, are self-employed, or work only seasonally - remain outside the system altogether. Combined, those groups constitute roughly half the Chilean labor force. Only half of workers are captured by the system.
I think these are unfair criticisms, because both of these facts would also be true under a pay-as-you go system. Some people would need to be subsidized because they did not contribute enough to the system because they were not formally employed throughout their careers. It is also true that people in the informal sector would not receive pensions under a payg system. Indeed, no Latin American country’s system pays pensions to people who are in the informal sector.

Dagoberto Sáez, for example, is a 66-year-old laboratory technician here who plans, because of a recent heart attack, to retire in March. He earns just under $950 a month; his pension fund has told him that his nearly 24 years of contributions will finance a 20-year annuity paying only $315 a month.
This is also a very unfair statement. This person retired early, so it is unclear what kind of tax treatment his pension had, or mention that Saez should have been given a government debt in recognition of his contributions before the system was privatized. Perhaps his pension would be significantly higher after taking this into account.

Most importantly, though, Rohter does not consider the alternative. If Chile had not privatized its pension fund system, it would probably be where Colombia or Brazil are right now. Those pension systems are really shaky, and are causing a real economic burden to the nations. In particular, they contribute to the fiscal imbalances that keep sovereign risk and real interest rates high, thus clamping down growth.

Wednesday, January 26, 2005

Has Triffin's time come?

Robert Triffin was a famous Yale economist who became famous for, among other things, his assertion that the dollar's role as a reserve currency was headed for doom.

His logic was roughly as follows: as an international currency, demand for dollars will grow roughly at the rate of world trade. This additional demand for dollars would allow the US to run current account deficits beyond its capacity to export. Eventually, however, there would be a day of reckoning. If the US were to avoid its day of reckoning and remain an international currency, it would have to engage in deflationary policies (restricting demand through austere economic policy). Otherwise, there would eventually be an overhang of dollar balances accumulated in the rest of the world. Foreigners (and residents) would lose their faith in the dollar's value, and its role as a reserve currency would come to an end.

Sounds familiar... The problem with Triffin, though, is that he was well ahead of his time. He was right to say that the Bretton Woods system didn't have much of a chance, but he called for the end of the dollar standard way too soon.

Here is (the beginning of) an article he published in Foreign Affairs back in 1979. To quote Triffin,

All Americans are alarmed at the shrinking value of the dollar in their neighborhood supermarkets - by close to one-half in the last ten years. With the President's announcement in early November ordering a series of dramatic actions to shore up the value of the dollar abroad, more and more Americans have also become conscious of the dollar's declining value in terms of major foreign currencies over the same period - by more than one-half against the West German mark and the Japanese yen, and by nearly two-thirds vis-à-vis the Swiss franc. But I suspect that no more than one American out of 10,000 realizes that these - and other - developments are rapidly undermining what President de Gaulle used to call our "exorbitant privilege" of being able to settle with our own dollar IOUs the growing excess of our expenditures abroad over our receipts from abroad (on capital as well as on current account).

This blog should be interesting over the next few days - The World Economic Forum Weblog

From Davos, the top post right now comments that "The absence of major US leaders (Bush, Cheney, Powell, anyone!) from the WEF this year is glaring. "

via Davos Newbies

The European Income Gap

Via Mahalanobis comes an interesting post on the European economies.

They point out, for example, that "in 2002, GDP per capita, expressed in terms of purchasing power standards, in the EU25's 254 NUTS-2 regions ranged from 32% of the EU25 average in the region of Lubelskie in Poland, to 315% of the average in Inner London in the UK."

That reminds me that there is still a lot of potential growth in the European periphery... and that the relative price level of the periphery needs to rise. This can happen the good way (inflation in Poland, for example) or the painful way (deflation in Germany).

Here is the link.

IMF Hint to China: Revalue

The IMF posted a paper on its website today that discusses the Chinese exchange rate. It goes through the arguments in favor and against exchange rate liberalization, capital account liberalization, and touches upon the issues of sequencing. In the end, (surprise!) it comes out (weakly, in my opinion) in favor of exchange rate liberalization as soon as possible, even ahead of capital account liberalization.

There were some interesting observations along the way. For example, here they discuss the vulnerability of the financial system, and dismiss concerns.
...the banking system is unlikely to be subject to substantial stress simply as a result of greater exchange rate flexibility. Domestic banks do not have a large net exposure to currency risk, and exchange rate flexibility by itself is unlikely to create strong incentives (or channels) to take deposits out of the Chinese banking system.

The current overall exposure of the corporate sector and banks in China to foreign exchange risks appears to be low; however, there are some indications that the degree of exposure has been on the rise in recent years. As shown in Table 1, in 2003, banks’ net foreign assets accounted for 3 percent of broad money and 6 percent of GDP, and foreign currency lending constituted about 5 percent of domestic credit and 9 percent of GDP.

These indicators seem relatively innocuous when compared with those of other countries. Their recent evolution, however, points to a trend that bears watching closely: during 2001-03, banks’ foreign currency loans to domestic residents have increased by over 60 percent, net foreign currency liabilities are up by nearly 50 percent, and total short-term external debt (which is denominated in foreign currencies) has risen by over 50 percent. These are trends that are likely to continue with China’s increasing global integration and the opening of the financial system as part of the terms of World Trade Organization (WTO) accession. (italics mine)
They admit, however, that there could have been excessive lending in the recent Chinese boom...
...rapid growth of bank credit has contributed to a surge in investment growth, leading to the possible buildup of excess capacity and associated nonperforming loans in several sectors of the economy, as well as potential problems of more generalized overheating.
...and are not concerned about the impact on Chinese exports of an exchange rate appreciation (conversely, this has implications for the US trade balance).
...the direct impact on exports of a moderate appreciation of the exchange rate is likely to be considerably muted by the high import content of China’s exports, as well as China’s strong productivity growth and low labor costs. Indeed, during the period 1999- 2002, China’s total exports (in value terms) rose by 37 percent despite a 7 percent real effective appreciation... An appreciation of the renminbi, while raising the cost of processing and assembly in China, would also lower the cost of imported intermediate inputs. Hence, an appreciation of the renminbi may not put much of a dent in China’s external competitiveness.
Finally, here is an interesting observation: they assume that the PBOC has been investing toward the long end of the curve. Hmm...I wonder what will happen to US interest rates when the Chinese bid for treasuries goes away.
The sterilization of capital inflows has been facilitated by the fact that domestic interest rates related to the main sterilization instrument (central bank bills) have been lower than interest rates on medium and long-term industrial country treasury bonds, which is where much of China’s reserves are presumed to be held. Thus, the traditional net costs of sterilization are absent in this case.

Tuesday, January 25, 2005

Bush and FDR

Cafe Hayek links to an interesting comparison between Bush and FDR. It's quite surprising that the administration can hide its big government tendencies behind such a tiny fig leaf of conservatism.

How is the Negotiating Power of the US Doing?

Michael Lind notes that, not only is the US adopting unilateral policies toward the rest of the world, but the rest of the world is leaving the US out of the loop. Find it in today's FT opinions (subscription required).

Here is the clincher...

Ironically, the US, having won the cold war, is adopting the strategy that led the Soviet Union to lose it: hoping that raw military power will be sufficient to intimidate other great powers alienated by its belligerence. To compound the irony, these other great powers are drafting the blueprints for new international institutions and alliances. That is what the US did during and after the second world war.
The US wrote the rules of the post-war era, and so stacked the deck in its favor. At the end of WWII, the US was a creditor, and it forced the rest of the world to make significant concessions regarding exchange rate flexibility (the US advocated fixed rates back then) and the amount of financial support that the US was required to give to the other members of the IMF. (In the end, the actual US contribution was a small fraction of what Keynes and the Europeans wanted.)

Now the US is a net debtor, and it needs its political influence more than ever. If the US loses relevance in international institutions (major treaties, organizations, etc) I doubt that it will be able to continue writing the rules. The more the "soft power" of the US is eroded, the more difficult it will be to convince China and Japan (along with Russia, the Middle East, and many more) to keep financing the current account gap.

The Holy Grail of development might not exist

Here is an interesting article on economic development by Charles Kenny, at the world bank. He notes that there are quite a few exceptions to the rule that “laissez-faire is the recipe for growth.”

Can you name the eight countries in the world that managed to more than quadruple their per capita GDP between 1929 and 1988? They are Japan, Taiwan, South Korea, Italy, Norway, Finland, Bulgaria — and the USSR.

Then again,

There are also a number of counter-examples, which suggest government intervention is hardly a universal catalyst for growth. ‘One size fits all’ theories do not fit the facts of economic experience and — so far — economists have had little to offer beyond such theories.
But, to be fair, contradictions across, and even within Development economists are quite common, thus reflecting the nature of the field...
The level of the confusion in which development economists find themselves on the topic of the causes of economic growth is suggested by two articles published in The Economist, both written by Columbia University economist Jeffrey Sachs.

In the first, published in June 1996, Sachs argued that had African policymakers merely followed an agenda of open markets, African countries would have grown even faster than the countries of East Asia.

But in the second article, published in June 1997, Sachs argued that even if they had the policies right, Africa would have grown 2.3% per year slower than East Asia — because of poor soil, geographic isolation and a bad climate.
Who'd have guessed. Jeffrey Sachs is a flip-flopper.

Monday, January 24, 2005

Dollar's Steep Slide Adding to Tensions U.S. Faces Abroad

The The NYT comments on the political economy of exchange rate determination.

It is an important lesson of the 1920's and 1930's that failure to coordinate international economic policies during times when great adjustments need to be made in the relative consumption power of different nations can lead to great political friction.

I hope global policymakers remember this lesson from history. The last time, the consequences were quite nasty.

Very Useful Page

The New Yorker Archives: Complete Coverage of Iraq

Defend the American Dream Act of 2004

The Economic Times of India reports on a US bill with interesting economic implications. There is a proposal in congress to further modify the US H1-B visa scheme that is meant to provide employers with incentives to hire US residents and citizens.

According to the proposal, "...employers need to attest that they had looked for American workers before hiring an H-1B visa holder." Perhaps more interestingly, it also attempts to ensure that H1-B holders will not be hired at salaries lower than those of comparable US workers.

So the government wants to introduce some rigidity into the labor market. No surprise.

Who wins, and who loses? Here are my first guesses:

Winners: the least productive US workers who compete with H1-B visa workers. they just saw the likelihood that they will be laid off decline significantly.

Losers: US productivity and competitiveness, the US unemployed, US economic growth, the workers that will be laid off from firms that can no longer compete in the global marketplace because they are no longer competitive, foreign workers who are willing to provide superior services for competitive wages, foreign countries that receive remittances...

Who's Propping up the US Housing Bubble?

It looks like the dollar's slide is being noticed not only by exporters, but by owners of US assets. Here is an example from Canada's National Post.

"The precarious combination of a weaker dollar and still low interest rates is making foreign investment in real estate a bargain," Laura Stone Mortimer, managing economist with U.S.-based Torto Wheaton, said in a research note.

She said total acquisitions by foreign investors were more than US$14-billion in 2004, up from $9.5-billion in 2003.

"German funds are the largest, most notable group of foreign investors currently active in U.S. commercial real estate," she said, adding players from the United Kingdom, Australia and other European countries were also entering the market.

The point is not that the dollar has weakened enough to make US assets attractive enough so that the current pace of current account deficit accumulation is sustainable, but rather that there are important stabilizers in place that make the dollar's slide a lot smoother than people think. While I agree that the dollar is a one-way street, those looking for an Argentine-style crash will be disappointed.

Sunday, January 23, 2005

Technological Tranfer at Work

Here is an example of technological transfer: Toyota sets up a manufacturing plant in Mexico. Except things aren't exactly the same...

Except for the Mexican flag flying outside the plant and the signs in Spanish inside, the plant here, painted a gleaming white, looks like most other Toyota manufacturing facilities. But there are notable differences between this plant and a Toyota factory in, say, Kentucky.

One is the relative lack of automation. Production volumes are too low to justify the expense of automating the entire assembly line, said Robert Ried, the plant's vice president for administration.

So in one part of the plant, truck beds are built from metal parts stamped at a Toyota facility in Long Beach and a bed structure made at another factory in Tijuana. Elsewhere in the plant, workers put together truck frames and passenger cabs with parts shipped from throughout the United States and Mexico.

For the final assembly, laborers fit the pieces into jigs mounted on wheeled carriers, weld and bolt them together and roll them down the assembly line. Interior wiring harnesses are installed at one station, seats and instrument panels at several others.

This factory stands out in another way: Many of the people working here came from electronic assembly jobs at maquiladoras, the foreign-owned factories that dot the border with the United States.

"Teamwork, personal responsibility and looking out for the other guy, all things Toyota's system values, are not what the maquiladoras have been all about," said Gordon Hanson, an economist at UC San Diego's Center for U.S.-Mexican Studies. "The challenge Toyota faces is to get the workers to adapt to its ways."
Cultural issues are quite a challenge for getting the job done...

At first, Rodriguez indicated through an interpreter, the challenge of his job was as much cultural as physical.

Mexican culture emphasizes self-reliance while Toyota stresses cooperation, and "I would conceal problems and try to fix them myself, without help," he said. "But now I have learned to communicate. And I have learned that there is never a dumb question."
And sometimes, it is good to be flexible.

when workers found it hard to push their heavy carts full of parts over an electrical conduit, they didn't complain; they scrounged up hammers and chisels and laboriously chipped a trough across the concrete floor. The electrical cable dropped into the channel, and moving the parts across the floor became easier and faster.

The solution could have led to disciplinary action in many auto plants; carving up factory floors without permission might be frowned on. But Ried and other managers applauded.

Saturday, January 22, 2005

The Emperor Has No Clothes

The policy mix might be changing

There is a rumor in Washington - thus far unconfirmed - that Mr. Greenspan warned the White House in mid-December that it would have to take more credible steps than it has so far to meet its goal of cutting the deficit in half by 2009.

If true, the unspoken but inescapable threat would be clear: if the Fed wasn't satisfied, Mr. Greenspan could signal his lack of confidence in Mr. Bush's fiscal plan. Investors would be shaken and Mr. Bush's credibility would be damaged.

This could get interesting...

The Hermit Nuclear Kingdom

The most secretive, strange, totalitarian place on earth.

- many North Koreans would welcome a war in hopes that it might end their miseries

- entire families sometimes executed if one member gets drunk and slights the Dear Leader

- More remarkable, it turns out, Kim's father was a Christian.

Friday, January 21, 2005

Is it Technology or Institutions?

Oliver Williamson quotes Hayek in his Economic Institutions of Capitalism:

How easy it is for an inefficient manager to dissipate the differentials on which profitability rests and that it is possible, with the same technical facilities, to produce with a great variety of costs, are among the commonplaces of business experience which do not seem to be equally familiar to the study of the economist.

It is easy to get carried away when thinking about technological transfer and growth in the developing world. The same technologies for car production, for example, exist pretty much all over the world, and yet the incentives to produce are different, and therefore so is the efficiency. Unfortunately, it is not as easy to import things like trust as it is to import a computer, or even a freshly minted (or experienced) MBA.

The Panglossean Bond Market

Floyd Norris writes in today’s NYT.

In the world bond market, all is sweetness and light. Companies with bad credit do not have to pay very much to borrow, and they have no trouble meeting their obligations. So lenders also do well.


Thursday, January 20, 2005

China's Middle Class

From Xinhua

"We set the number according to the World Bank's criteria of the medium level of international GDP per capita, ranging from US$3,470 to US$8,000, and transferred it after currency exchange, purchasing power conversion and GDP per capital to average income conversion," Cheng said.

"The proportion of middle class in China will expand to 45 percent in 2020 from 5 percent today."

So, according to these numbers, there are 65 million Chinese who earn that much and, if China's population grows as fast as the UN thinks it will, the "middle class" will expand to 720 million by 2020. Then again, I wonder if the "middle class" will be measured in dollars in 2020.

Some more facts about China's labor force and population.

Keynes the Austrian

There's a silly debate going on about who's a closet Austrian. First, Tyler Cowen accused Brad Delong of being an Austrian, essentially because he thinks the current account deficit is a problem.
Personally, I think the litmus test for Austrians is whether they think that improperly set interest rates will inevitably lead to inflation, and while I am sympathetic to that idea, I don't consider myself an Austrian. On that note, I would defend Delong from the accusation on the grounds that he doesn't think monetary policy should be tightened.

But then again, just about anyone could be accused of being an Austrian. Keynes had many ideas that Austrians tend to espouse. For example, an aversion to index numbers.

Llewellyn Rockwell makes the point rather starkly: "If Austrians had their way, the government would never collect another economic statistic. Such data is used primarily to plan the economy."

It turns out that Keynes thought along similar lines. From his General theory:

...the proper place for such things as net real output and the general level of prices lies within the field of historical and statistical description, and their purpose should be to satisfy historical or social curiosity, a purpose for which perfect precision — such as our causal analysis requires, whether or not our knowledge of the actual values of the relevant quantities is complete or exact — is neither usual nor necessary. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth — a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of a quantitative analysis. Keynes was a closet Austrian.

Fewer Businesses Worldwide Default

The default rate of companies worldwide halved last year according to Moody's.

The 39 companies that failed to make timely payments on $16.6 billion in bonds, was down from 80 companies with $34.2 billion of debt in 2003. Overall, 0.7% of companies with rated debt defaulted, compared with 1.7% a year earlier.
This is a reflection of easy money. In fact, real interest rates are negative at the short end, and about 1% at the long end. With free money to be had, it's no wonder nobody defaults. This includes, by the way, the developing world, who not only can refinance at these bargain-basement rates, but also pay back in depreciated dollars!

Import Substitution

L.A. Location Shoots Jump Sharply, in large part due to the weaker dollar. Not only are small manufacturers getting more export orders, but hollywood is bringing its projects closer to home.

The Entertainment Industry Development Corp. issued permits for 52,707 location production days — one day representing a single day of work on a single project — for a 19% increase over 2003.

In recent years, Canada, Australia, Ireland and other countries have succeeded in luring movie work, capitalizing on the strength of the U.S. dollar, which made their currencies attractive, and on government-offered incentives.

Now, "with the decline in the value of the dollar it makes more sense to stay home," said Jack Kyser, chief economist with the Los Angeles County Economic Development Corp. "The cost savings is no longer there."
I wonder, though, if this is going to make it any easier to sell US entertainment overseas. In order to do that, not only must the industry be competitive (clearly it is), but there must also be good protection of intellectual property laws.

Wednesday, January 19, 2005

China's power sector

Foreign firms are leaving China, complaining about the execution of contracts.

At the same time, the BBC reports that China has suspended 26 power projects for environmental reasons, despite the great need for energy.

This could be the binding constraint on Chinese economic growth. Not feeding 1.3 billion people, but rather letting them plug things in.

Tuesday, January 18, 2005

God's Blog

God's Blog is the most authoritative blog there is. Unfortunately, there aren't any posts about currencies or the stock market. Stay tuned...

How to Stabilize the Dollar

Barry Eichengreen has written a nice piece that argues a new "plaza accord" will not help to stabilize the dollar. Through recent history , intervention in the currency markets has not been effective unless supported by policies that go with the grain of the intervention (he focuses on the 1980's, but intervention attempts during the 1970's also show the same thing). He also lists what true "coordinated intervention" would look like. Fat chance...
...if the U.S. takes steps to address its budget deficit, the rest of the world needs to support global demand. In Europe, where the ever-higher euro will soon be putting downward pressure on inflation, there is room for the ECB to cut interest rates. In Asian countries with low debts and deficits, there is room for cutting taxes. Korea’s deficit, for example, is only 1 per cent of GDP. Its government has already committed to applying a small dose of fiscal stimulus, but it could go further. Japan, with much larger debts and deficits, is preparing to raising taxes. While it will have to undertake fiscal consolidation eventually, it should put those measures on hold for now. Asia can also take some of the pressure off Europe by allowing its currencies to rise against the dollar, but doing so will slow its economies, making strong fiscal expansion all the more important.

So here we have the outlines of a grand bargain: fiscal consolidation in the U.S., fiscal expansion in Asia, and monetary stimulus in Europe. Everyone will be better off with this adjustment in the policy mix. Budgetary adjustment in the U.S. will strengthen the dollar and put the U.S. back on a sustainable fiscal path. Monetary stimulus by the ECB will cap the rise in the euro and encourage the investment that Europe needs. And looser fiscal policy in Asia will sustain global growth and help the continent to recover from its tsunami.

Unfortunately, none of the three regions seems ready to do its part. The ECB is still preoccupied by the nonexistent specter of inflation when the real risk in Europe is deflation due to the falling prices of imports not just from China but now from America as well. It is engaged in a death struggle with national governments, refusing to cut interest rates until the latter first rein in their excessive deficits. And with the collapse of the Stability and Growth Pact and the breakdown of fiscal discipline in France and Germany, no end to this gridlock is in sight.

What if the consequences of default were more drastic?

This is what happened to the Dominican Republic in 1905, when it defaulted. It surely is a good thing that the world doesn't work this way any more, but then again, it might reduce borrowing costs...
Financial difficulties prevented Santo Domingo from paying its debts…On February 4, 1905, a protocol was drawn up between the two governments by which the United States was to act as bankrupt’s receiver for Santo Domingo, taking over all customhouses, administering its finances, and settling the claims of foreign and domestic creditors. Of the revenues which the United States should collect, 55 percent were to be used for paying bondholders and the remainder was to be turned over to the Dominican government for administrative expenses. The Senate at Washington refused to ratify this drastic protocol, but President Roosevelt entered into an “executive agreement” with the president of the Dominican Republic which achieved the same results. Under the agreement the customs collectors were to be American and to have the support of American warships.

From Scott Nearing and Joseph Freeman, Dollar Diplomacy, New York, 1925

Tuesday, January 11, 2005

I'll be away until next Tuesday

See y'all.

Argentina's Recovery as Market Failure

International macroeconomists don’t think about market failure enough, and that is why I found this book particularly refreshing.

Tirole looks at international capital markets through the lens of corporate finance, and concludes that most of the problems of international finance are the result of market failure. Market failures, in turn, happen because some players in the game do not fully internalize the overall costs of their actions. Thus, for example, there is moral hazard involved when a government has an incentive to promise a certain thing in order to secure international financing, but then renege afterward.

I wonder if Argentina’s economic success might be a symptom of an externality. Argentina has broken its promises to pay and there needs to be a mechanism of punishment to discourage such behavior. If this mechanism is effective, sovereign borrowing in general will become cheaper because there will be less risk of default. However, while it is in the interest of all lenders (and foreign investors in general) to punish Argentina, an individual lender could make a killing. Those few foreigners who bought real-estate following the crisis know about this.

This brings up the issue of pledgeable capital. One of the main problems of sovereign borrowers, according to Tirole, is that they lack the ability to pledge assets against their borrowing because foreign investors can’t come in and take over, say, Buenos Aires, in the event of default. In the absence of pledgeable capital, sovereign borrowers must undergo costly exercises to increase confidence, like accumulating foreign reserves. Granted, accumulating reserves isn’t so expensive these days.

But then again, I keep having to remind myself that Argentina is a net lender to the rest of the world, and not a net borrower. Indeed foreign investors are not financing Argentina’s growth, but rather the other way around. Argentina’s economic success is mostly a function of its current account surplus, and its current account surplus is a function of loose US monetary policy (weak dollar, low interest rates), the recovery in Brazil, and high commodity prices. Things would look considerably different if Argentina needed to access foreign savings right now, and world interest rates were higher.

You can read a favorable review of Tirole’s book here and a less favorable one here.

European Productivity is Much Better than you Think

Speaking of French economists... Olivier Blanchard has some interesting ideas about Europe.

It is fashionable to bash Europe for its rigidities and its unrealistically generous welfare states, but there is another side to this story. While the rigidities and the unsustainable promises are real, and it is true that Europe’s income per capita is stuck at around 70% of the US in PPP terms,

“Over the last 30 years, productivity growth has been much higher in Europe than in the United States. And productivity levels are roughly similar today in the EU and in the United States.

The main difference is that Europe has used some of the increase in productivity to increase leisure rather than income — while the United States has done the opposite...

The stability of the U.S.-EU gap in relative income on a per capita basis comes from the decline in hours worked. To be specific, in the United States, over the period 1970 to 2000, GDP per hour increased by 38%. Hours worked per person also increased, by 26%. Thus, GDP per person increased by 64%.

In France, over the same period, GDP per hour increased by 83%. But hours worked per person decreased by 23% — so GDP per capita only increased by 60%...

Viewed in that light, the performance of France — and of the European Union in general — does not look so bad. The EU had a much higher productivity growth rate than the United States. And the EU countries chose to allocate part of those gains to increased income — and part to increased leisure.

You can also find a presentation titled “economic survey of Europe” here.

Monday, January 10, 2005

Does India Need a Shining Mindset?

Here is an interesting thought from the IMF’s director of research: Does convergence require the right mindset?

A mindset is defined as follows:

there are times in the life of nations when they feel confident that they can take on the world, that they are capable of meeting any challenge, achieving any dream. If properly channeled, such a spirit can be an enormous aid to growth. In fact, some sociologists argue that such a spirit, a national "atma vishwas" so to speak, is critical to the kind of explosive growth that we saw in Japan in the 1950s and 1960s, in Korea in the 1970s, and in China today.1 It is the spirit that moved South Korea from having a per capita income on par with India's to the ranks of the OECD in just four decades, the spirit that built a sleek futuristic city in Pudong, Shanghai out of an area that was largely farmland just a decade ago, and the spirit that is currently building the New Delhi Metro to world standards and on time. It is the spirit that asks "why not?" instead of "why".

One reason such a mindset is important is that it creates an intolerance for laziness, for shoddy products, for open corruption, and for the usual excuses—when people have a strong conviction that they can achieve the possibilities of the future, it makes them less tolerant of impediments in their way to it. It also makes generations willing to sacrifice their present, even working themselves to death—a phenomenon that in Japanese has its own special word, "karoshi"—for the opportunities they can see they are creating for their children.
But, does India have the right mindset for development?

On the IMF's trade restrictiveness index, India has a score of 8, which places it amongst the most restrictive countries. India's GDP accounted for 1.6 percent of world GDP in 2003 but its trade accounted for only .94 percent of world trade.2 And it holds the dubious record of instigating the maximum number of anti-dumping cases under the WTO in the period between 1995 and 2003.3 India's capital account is still closed. It still place restrictions on foreign entry and participation in various areas of the economy, even those that have little implication for national defense. And it still is extremely wary of advice that may be associated with a foreign hand.
What retards the formation of the right mindset?
One [factor] is the politician, aided or abetted by the bureaucrat. Not only are foreigners much harder to control but also they do not vote, so they are an appealing lot to discriminate against. But India is not special in this regard—whether it be Nordic politicians resisting the takeover of their banks by other European banks or French politicians creating national champions or US politicians complaining about outsourcing—politicians the world over, with a few notable exceptions find it convenient to rail against openness.

But politicians do not act in a vacuum. They are particularly effective when they cater to strong constituencies. With large corporations becoming more open-minded, sotospeak, could it be the people who are against competition?

And, if India doesn’t yet have the right mindset, what can help her get it?
Two factors have been particularly important, I believe, in helping us break out of this vicious cycle where the lack of competition bred corporate indifference towards the efficient provision of factors like power and finance, which in turn reinforced resistance towards liberalization. First, companies like Infosys, TCS, and Wipro showed that it was possible for Indian firms to compete effectively on the world stage and that the profits from doing so were enormous. Second, creeping liberalization, initiated by crisis but then gaining a momentum of its own, forced competition on the rest. When challenged to improve productivity, Indian firms found that despite the inefficiencies of the system, there were unique sources of Indian comparative advantage, even in manufacturing.

Chinese Can Now Withdraw Cash Abroad

Holders of cards issued by Chinese banks can now withdraw cash overseas. Slowly but steadily, the Chinese capital account is opening up, and it's anyones guess in which direction currency will flow. Brad Setser has some strong opinions on the subject, and I agree with him.

Incidentally, I've noticed that the US is not on the approved Chinese tourism list (Cuba is).

Allawi group slips cash to reporters

This wouldn't happen in a real democracy, would it?

The electoral group headed by Iyad Allawi, the interim Iraqi prime minister, on Monday handed out cash to journalists to ensure coverage of its press conferences in a throwback to Ba'athist-era patronage ahead of parliamentary elections on January 30.

After a meeting held by Mr Allawi's campaign alliance in west Baghdad, reporters, most of whom were from the Arabic-language press, were invited upstairs where each was offered a "gift" of a $100 bill contained in an envelope.

Who Should Enforce Intellectual Property Rights?

India has improved patent protection in the pharmaceutical industry. This raises all sorts of interesting issues in development. It is fairly well accepted that patent rights are an important factor in innovation because they stimulate spending on R&D. That said, how much protecting property rights will help spur innovation also has to do with the relative costs of coming up with an invention. In a country like the US, where the capital stock (both human and physical) stock for coming up with new drugs is very large, the cost of innovating is probably lower than in a country like, say, Brazil, where the pharmaceutical industry is not quite as developed.

Brazil might be better off if it does not respect property rights, as its technological capabilities favor copying existing inventions at a relatively low cost rather than coming up with its own inventions at a very high cost. Furthermore, the benefits of extending cheap medication to the population could very well outweigh the potential gains to national income that would come from innovation.

But what about a country like India, where the pharma and biotech industries are not quite nascent, but not quite developed? I don’t have the answer to this question, but it seems like the lack of respect for intellectual property rights has worked pretty well for India thus far, and it also seems like it has worked for China.

This brings to mind the idea that there could be differences in the type of economic model that works for catching up to the developed world versus remaining at the frontier of growth. While strict enforcement of international property rights might be in the interest of the US, it might not be in the interest of India or China... This means that it is up to the countries on the technological frontier to make the appropriate incentives for developing countries to respect intellectual property rights.

These new World Bank papers suggest that the protection of intellectual property rights in poor countries could be an entirely different ballgame from the protection of intellectual property rights in rich countries. In particular, poor countries could need different types of protection than rich countries. “The challenge facing developing countries is to unpackage knowledge from indigenous products and repackage it for commercial markets.” An example of this would be “Congolese artisans who sold distinctive toys in the US market, assisted by an alternative trading organization specializing in marketing developing countries’ IP”

Furthermore, “Countries that sharply strengthen their IPR regime are unlikely to experience sudden boosts in inward FDI. They would be better advised to improve overall investment climate and business infrastructure.”

Sunday, January 09, 2005

Something Different is Happening

The latest survey of Latin America's economies from the UN's Economic Commission for Latin America begins with an interesting observation:

One of the distinguishing characteristics of the current recovery that makes it stand out from other events in the region’s economic history is that, for the second year in a row, GDP growth has been coupled with a surplus on the balance-of-payments current account; moreover, both of these aggregates are on the rise. In the past, when GDP was growing, the current account was deteriorating, and when the current account was improving based on positive trade balances, this was because imports had contracted owing to slack domestic demand in the countries of the region. A strengthening current account has been combined with GDP growth of over 2% for the region as a whole in only three of the last 20 years; the other two cases were 1987 and 2000, but the increase in economic activity has been sharper in 2004 than it was in either of those two years. (italics mine)
One has to wonder: is it a coincidence that all of Latin America's economies (with the exception of a few Central American countries) found religion at the same time and suddenly became export powerhouses, or is something else going on?

The irony is that, given the fact that monetary policy is so loose in the US (or that the real interest rate in dollars is very low, which might not be the same thing) if Latin America's economies needed to finance large current account deficits, they probably could do so very easily. After all, the world's capital allocators, whether portfolio of fixed, need to find places where the real rate of return is not negative, as it is in the US. A depreciating dollar makes emerging markets investing even more attractive.

The stars are aligned for Latin America's economies to prosper thanks to this external windfall. Of course, the period of free money won't last forever, though. Policymakers should keep this in mind. My guess, though, is that economic success in coming months will be seen as a validation of existing economic policies, rather than a result of pure luck.

The report goes on to note something that should be obvious: that a current account surplus means that the region is a net saver. In other words, that Latin America is exporting capital.
A second distinctive trait which is related to the first is that the sharp increase in GDP has occurred at a time when the region is registering capital outflows, which means that the net capital flow being received by the region is much smaller than it was in 2003. Decreases of this scale have never before been seen in conjunction with an increase in GDP growth. Furthermore, this situation has been accompanied by a downward trend in sovereign risk premiums, which are now approaching record lows. Thus, the net outflow of capital has coincided with strengthening demand for regional financial assets.
Latin America a net saver? Something strange must be going on. I would explain this phenomenon in a positive way, by stressing very competitive exchange rates, along with an improvement in the terms of trade that is not expected to be permanent. Therefore, Latin America is saving its windfall gains, something that has not happened in a long time.

However, La Jornada of Mexico takes a very different viewpoint on the phenomenon. According to the paper, Latin America's net resource transfer is essentially the result of foreign investors milking the productive resources of the region. How frustrating. If Latin America is a net borrower, then foreign capital is exploiting the region. If Latin America is a net saver, then foreign capital is exploiting the region. Make up your mind...

Argentina's Economic Experiment, Part 2

The Colombian weekly Semana (spanish)Semana picked up on last week's New York Times article on Argentina, endorsing "not listening to the IMF" as the recipe for economic success.

Much as I thought, this article is being used all over the world as proof that countries don't have to keep current on foreign debt, and in general don't have to follow conventional wisdom when it comes to economic policy. It must feel nice to have ammunition to use against the arrogance of US trained economists, but I wonder if those people who are getting excited about default realize that Argentina didn't start growing when it stopped paying its foreign debt. Indeed Argentina's GDP is only now getting back to where it was before default, and is still below the levels it reached in the 1990's. Moreover, Argentina's deepest recession in history came the year after its default.

I also wonder whether these newspapers and magazines will write articles in favor of the Washington Consensus if Argentina falls into recession in the next few years. The point is that, if the IMF's advice isn't any good (mostly agree) it doesn't mean that the opposite of the IMF's advice is good. Indeed the opposite of the IMF's advice has been tried before, and it didn't work very well.

Unfortunately, it will probably take another crisis and many years before people realize this.

Saturday, January 08, 2005

Get Out of Jail Free

Stanley Fischer was quoted yesterday in Brazil's leading newspaper, Valor. "The saying says that 'Brazil is the country of the future, and always will be,' but I think that Brazil is already having that future." He was being kind, I suppose, given that his employer, Citigroup, wants to be much bigger in Brazil.

Fischer congratulated the Lula administration on its macroeconomic management, and led the audience to believe that Brazil's recent good fortune was its own making. I wonder, however, if he would say the same thing about Argentina, which is also recovering (in fact growing faster than Brazil) despite the fact that the Argentine government's economic policies have been atrocious at best.

Indeed across the globe, it appears that developing country governments can do whatever they want with economic management, and markets will not punish them. Just think of it. Russia's President Putin has nationalized a large proportion of the country's energy industry and, while the stock market fell, there were no other economic repercussions.

So, Argentina can snub foreign investors, the IMF, and impose a tax on exports, India can consider tapping into its foreign reserves in order to build infrastructure, and so on, and none of these countries witness a run on the currency, or even the slightest pressure on interest rates.

Something else must be going on here. We must be in a new environment, where capital flows don't respond negatively to economic aberrations. Why could this be? Could it be because the country that prints the world's reserve currency is also running its economy in an irresponsible manner? Yes. The US twin deficits (and the stock of foreign debt) are a get out of jail free card for irresponsible economic policymakers across the world.

Turkey and the EU

Turkey is set to begin talks to become a member of the EU. This is an easy issue on which to have an opinion if you’re an outsider like me, but it has been very interesting to see what the involved parties have to say.

Needless to say, I have little sympathy for those who argue that the reason Turkey should not be admitted into the EU is that there is a fundamental cultural difference. Herve Morin of France, a member of Parliament from the Union for French Democracy party, said to the Washington Post “The integration of Turkey is the breakdown of the European project…We don't have a common history, culture or vision. The European identity is built on a common history, a Judeo-Christian culture, a culture of human rights and the enlightenment ideas."

This argument has been rightly compared to the old saying that “Africa begins at the Pyrenees.”

Along this line of thought, this Sunday Telegraph opinion piece is very reminiscent of Samuel Huntington’s senile delusions. Turkish citizens are not showing signs of wanting to integrate into the prevailing culture, it argues. “Young Swedes and Germans of Turkish extraction usually marry back into their ancestral homelands, bringing their brides home to Europe to reinforce the creation of an Anatolia in exile.” This reluctance threatens to heighten divisive, nationalist, and racist politics, which could throw Europe into cultural and political chaos, not to mention violence. For good measure, the author throws in that Turkey cannot be a successful democracy. If the military steps back from power, as is demanded by the EU, Turkey might become a fundamentalist state. If that doesn’t do it, then the author considers that “some deranged Euro-fantasists in Brussels see Ankara's armed forces not as the shield of Turkish secularism, but as potentially the main military arm of an EU superstate. This is not just drivel; it is extremely dangerous drivel.” Hmmm… no comment.

Perhaps the most appealing opinion I’ve seen on the subject was posted on A Fistful of Euros. They remind those who argue that Turkey is not culturally fit to join that:
if admitted, Turkey will not be the first EU member state that once despised the liberal market economy, failed spectacularly to honour human rights, persecuted its minorities and was separated from other European nations (at least, those it hadn’t conquered) by a deep cultural chasm. Indeed, Turkey would be far from the worst example of such countries, at least one of which was found fit for membership not very long after the persecutions etc. were stopped (and, unlike in Turkey’s case, stopped by outsiders).

The Great Current Account Debate

This post will be a work in progress.

These are, in my opinion, some of the most interesting recent contributions to the ongoing debate over the US current account deficit. At least, they are the papers that have helped me to understand the most. Most of them focus on, or at least heavily emphasize, the dramatic increase in the global capital market integration. For example, according to Lane and Milesi-Ferreti, during the past 20 years “The growth in international financial interdependence is striking: during this period, aggregate assets and liabilities tripled as a share of GDP, FDI assets and liabilities increased four-fold, portfolio equity assets and liabilities six-fold, and debt assets and liabilities 2 ½ times.”

That is, most countries now own a lot more assets overseas than they used to, and conversely foreigners own a lot more assets in most countries than before. This increase in asset cross-ownership adds an important factor to the typical current account story, because after all, current accounts are meant to measure the change in net foreign liabilities of a country.

Maurice Obstfeld: External Adjustment

This paper is 100% intuition, and Obstfeld does a great job at bringing some fairly esoteric models down to earth. He explains why the next wave of research in balance of payments analysis will have to take into account not just trade flows, but asset valuations.

Kenneth Rogoff and Maurice Obstfeld, The Unsustainable Current Account Position Revisited

This paper deals more directly with the current account deficit. Rogoff and Obstfeld show that the dollar has to fall, and fall a lot, in order to close the current account deficit. They also show that, despite the fact that dollar depreciation erodes the value of net foreign liabilities, in the end it’s the trade flows that have to adjust.

Philip R. Lane and Gian Maria Milesi-Ferretti: Financial Globalization and Exchange Rates

This paper has some interesting analysis of data on net foreign liabilities of developing and developed countries. They show who are the biggest net creditors (Switzerland) and debtors (Iceland, New Zealand) in the developed world, and they also consider the developing economies.

Cédric Tille: The Impact of Exchange Rate Movements on U.S. Foreign Debt

This is a great primer on the way in which exchange rates affect the external assets and liabilities of the US. A must read for anyone who wants to say anything about the US current account deficit.

Pierre-Olivier Gourinchas and Helene Rey: International Financial Adjustment

This paper has some interesting empirical results. They show that net foreign assets contain information about the future of the exchange rate. In particular, “deviations from trend of the ratio of net exports to net foreign assets contain information about future portfolio returns and, possibly, future exchange rate changes.”

Haloscan commenting and trackback have been added to this blog.

Friday, January 07, 2005

India's Thirst for Oil Makes for Interesting Geopolitics

India sealed a 25-yr LNG supply pact with Iran this week, just months after China signed a similar deal.

It isn't likely that the economic and political ties between the "Axis of Evil" country and China or India will end here. And so, the world gets more complicated every day.


(miles x velocity = price level x production)

The Economist has an interesting editorial this week. Apparently the outstanding stock of miles held by the public is so large that “At current rates of redemption, even if no more miles were issued, it would take 25 years to use up the stock” Airlines are printing too much money in order to entice people to fly with them, and this has created a huge liability for the airlines. Miles will have to be watered down in the future. Moral of the story? Go on vacation.

Were it to exist, the IMF (the International Mileage Fund) would by now repeatedly have warned that these growing external liabilities are unsustainable in exactly the same way that America cannot keep borrowing from the rest of the world. If the new global currency was left entirely to the market, the value of frequent-flyer miles would plummet in order to match the demand for and supply of free flights—just as the dollar would be weaker if Asian central banks stopped intervening. Frequent-flyer miles are no better as a reserve currency than the greenback.

Thursday, January 06, 2005

Mathematical Social Sciences: An Oxymoron?

This series of lectures by Donald Saari sound intimidating, but are actually very easy to understand. In particular I recommend the first one, where Saari explains how voting schemes are subject to the "aggregation paradox" so that most times the result of an election reflects the counting method more than the voters' preferences!

Barriers to Competition

A new paper notes that Latin American countries are the only western countries that are not catching up to the US. The emphasis is on western here. Latin America is placed in a peer group along with Europe, Australia, and New Zealand. We are supposed to believe that Latin American culture is, for the purposes of economic development, not distinguishable from the rest of the "western"cultures. That way, it can be said that "...since the Europeans who populated these regions established Western religion, language, and culture, then it should have been feasible for [the Latin American countries] to replicate the successful economies of the West.

The growth performance of Latin America is shown to be pitiful.

...all the other poor Western countries have had significant catch-up over the last 50 years. The average European country in this group increased from 40 percent of U.S. income in 1950 to 67 percent in 2000. In contrast, Latin America lost ground, falling from 28 percentof the U.S. level in 1950 to 22 percent in 2000.
The paper is also successful in showing that Latin America's growth failure is not the result of insufficient capital accumulation (even including human capital), but rather the result of unexplained total factor productivity. That is, Latin America has lagged behind the rest of its "peers" because it has used its capital inefficiently.

Why has this happened? Lack of competition, say the authors. Latin American countries have set up protectionist barriers that have sheltered domestic producers, and high barriers to entry that have sheltered incumbent firms. The most striking evidence is anecdotal. The Venezuelan oil industry was nationalized in the mid-1970s, and this was the result:

By 1985 productivity had fallen over 70 percent from its 1970 peak, and was at its 1955 level. Output fell 53 percent between its peak in 1970 and 1985, and was also at its 1955 level. It is striking that the large output loss was accompanied by an increase in employment, which suggests that the local managers were not nearly as efficient at running the operation as the foreign managers. Moreover, this output loss is not the result of OPEC policies; many OPEC members increased their output considerably in the 1970s and 1980s.
In Chile, the Pinochet government protected the national copper company, Codelco, because 10% of its revenues went to the military. After democracy was restored, foreign competition entered the picture and productivity sky-rocketed. After import bans in the computer industry were removed in Brazil, productivity lost one third of its gap with the US, a dramatic achievement given that productivity in the US computer industry was growing at 30%.

I tend to believe the results of this paper, but frankly it's not the empirical exercise that convinces me. The reason I'm convinced is that these guys are preaching to the converted. I believed to begin with. Frankly, their argument that you can lump in the Latin American culture with the Protestant cultures of northern Europe and the US is flimsy. It is probably no coincidence that the "peers" that did manage to catch up to the income of the US were Canada, Australia, and New Zealand. Did they notice that the sample had just been split into the countries that speak Spanish and Portuguese and the countries that speak English?

Regardless, "culture" is a very vague term, and economists who claim to understand it rank up there with the sociologists who try to explain monetary policy. This is a good paper that could have been a great paper if it had not crossed over into this dodgy territory. Why did they have to mention culture to begin with? The anecdotal evidence on productivity is fantastic.

This made me dizzy...

The Infinite Cat Project - Cats watching cats watching cats. Hey! It's a concept!

Wednesday, January 05, 2005

Dependency Theory, Not Again!

Andre Gunder Frank is still around? I remember him from a college sociology class, and I really thought his writing had gone the way of the dinosaur. But I’m quickly realizing I’m wrong, for not only are there still many devoted fans of dependency theory, but Gunder Frank is still writing.

I found his latest at the Asia Times, which occasionally has interesting articles. He writes about US indebtedness, a little late to the game given that almost everyone everywhere has already given their opinion on this theme (you'll hear plenty of mine in later posts, also late to the game). His imagery is quite sensationalist, as he has us imagine what all the debt would look like in cash. “But no worries: Congress just raised the debt ceiling to $8.2 trillion. To help us visualize, $1 trillion tightly packed up in $1,000 bills would match a building 40 stories high”

According to Gunder Frank, the current arrangement between China and the US is one where “especially poor China gives away for nothing at all to rich Uncle Sam hundreds of billions of dollars' worth of real goods produced at home and consumed by Uncle Sam. Then China turns around and trades these same paper dollar bills in for more of Uncle Sam's paper called Treasury Certificate bonds, which are even more worthless, except that they pay a percent of interest.”

Gunder Frank goes on to assert that the US’s imperial traipses of the last decades (beginning with Iraq) have been the result of threats to denominate international trade in Euros. According to that theory, we should have gone to war with Russia last year, as they debated (and are still considering, I’m sure) pricing their oil in Euros.

The sad thing is that he takes a perfectly good story (that the US is over-indebted, that its over-indebtedness is due to its “exorbitant privilege” of printing the world’s reserve currency, and that the dollar will be watered down in order to pay for that debt) and turns it into such a whacky conspiracy theory that all the little nuggets of truth are lost in the huge swamp of exaggeration.

Ecuador's Decaying Institutions

Beautiful Horizons has a wonderful (but terrifying) post highlighting the way in which Ecuador's President is destroying what little is left of the country's institutions. Now he is shamelessly packing the supreme court in cahoots with a corrupt ex-president.

Will Exchange Rate Appreciation Kill the Australian Economy?

Some good news from the Australian economy points to something I've been suspecting for a while. While exchange rate appreciation might hurt export industries and generate deflationary pressure, there are also positive effects. One of the most important is that it encourages consumption, as a more appreciated exchange rate increases the price of services relative to goods. Most employment in most economies (especially industrialized economies) is tied to the service sector, so the drag from lower competitiveness isn't as big as the boost from greater purchasing power as goods become cheaper, compared to wages in the service sector and to asset prices.

This is why the US economy didn't implode in the 1990's, when the dollar strengthened so dramatically. Now the Euro is staging a come-back, and most observers are calling for "maximum pain". While I don't expect a boom of dot-com proportions (or anything even close), I think people will be surprised at how well the European economy fares despite Euro appreciation.

Australian Dec. Services Index Rises to 2-Yr High (Update1)

Jan. 6 (Bloomberg) -- Australian service industries expanded in December at the fastest pace in two years as demand increased at recreation, property and business services companies and retailers.

The performance of services index, which measures activity for retailers and other service companies, jumped 5.9 points to 65.4 in December, Commonwealth Bank of Australia and the Australian Industry Group said in a report e-mailed to Bloomberg News. A reading greater than 50 indicates the services industry, which accounts for two-thirds of the economy, is expanding.

An increase in the services index, coupled with a report showing December retail spending surged, suggest the Australian economy may rebound from its slowest growth in almost four years. The fifth-largest economy in the Asia-Pacific region expanded 0.3 percent in the three months ended Sept. 30 as exports and home building fell.

Then again, the Korean economy is pointing in the opposite direction. That said, I think there are confounding factors peculiar to the Korean economy here, and the slump is not just a function of the won's exchange rate.

Institutions and Hot Money

What determines the type of financing that a country gets? A new IMF paper attempts to answer the question. Institutions, it claims, account for much of the difference. More proof that the real question in macroeconomics is “what accounts for institutions?”

A widespread view holds that countries that finance themselves through foreign direct investment (FDI) and portfolio equity, rather than bonds and loans, are
less prone to rises. But what determines countries’ external capital structures? In a cross section of emerging markets and developing countries, we find that equity-like liabilities (FDI and, especially, portfolio equity) as a share of countries’ total external liabilities (or as a share of GDP) are positively and significantly associated with indicators of educational attainment, natural resource abundance, and especially, institutional quality. These relationships are robust to attempts to control for possible endogeneity, suggesting that better institutional quality may help improve countries’ capital structures. The results might also provide an explanation for the observed correlation between institutional quality and the frequency of crises.


Economic Heresy

"What do you believe is true even though you cannot prove it?"

This was the question posed to scientists, futurists and other creative thinkers by John Brockman, a literary agent and publisher of Edge, a Web site devoted to science.

Roger SchankPsychologist and computer scientist; author, "Designing World-Class E-Learning"

Irrational choices.

I do not believe that people are capable of rational thought when it comes to making decisions in their own lives. People believe they are behaving rationally and have thought things out, of course, but when major decisions are made - who to marry, where to live, what career to pursue, what college to attend, people's minds simply cannot cope with the complexity. When they try to rationally analyze potential options, their unconscious, emotional thoughts take over and make the choice for them.

More here...

China Targets Lower Money Supply Growth

The only way for China to cut money supply growth, in my opinion, is to stop accumulating foreign reserves at such a dramatic pace. Sterilization doesn’t work, I think, because when the central bank tries to mop up liquidity it does so by exchanging a short-term asset for a long-term asset, but the longer term asset can easily be monetized by the financial institution in question. This whole question may be moot anyway, given China’s government-driven credit rationing system. That said, rationing credit clearly isn’t working either, given that the bank credit targets are routinely violated.

The implication of less foreign exchange intervention is, of course, a weaker dollar. There is a clear dilemma here. If you want to stop money growth, you have to stop intervention. If you want to stop intervention, the exchange rate will appreciate. So you can’t control the money supply and the exchange rate at the same time. This is a well-known idea in economics that many smart people don’t really believe...

China Cuts Money Supply Goal to 15% to Curb Inflation (Update8)

Jan. 5 (Bloomberg) -- China's central bank cut its target for growth in the amount of money circulating in the world's fastest-growing major economy and signaled it may raise borrowing costs to curb inflation.

``The central bank should fully take advantage of the function of interest rates in adjusting the economy,'' Governor Zhou Xiaochuan told a bank meeting yesterday in Nanning, Guangxi province, according to a statement.

The People's Bank of China plans to cap growth in M2, the nation's broadest measure of money supply, at 15 percent this year, compared with a 17 percent target for 2004 and actual growth last year of about 14.5 percent, Zhou said.

Tuesday, January 04, 2005

How do you get the Chinese to consume?

The McKinsey Quarterly (registration required) has an interesting article on the Chinese consumer. They propose a series of tax and other incentives to get young consumers to start consuming more. “Consumers over the age of 45 are probably a lost cause.” The young, the article claims, only need a trigger to start consuming out of their savings, and the government’s efforts thus far have only been temporarily effective.

To sustain rapid economic growth, the Chinese government will have to encourage consumers—especially the 250 million with household incomes of more than $1,000 a year and the 50 million with more than $3,500 a year—to spend more of their hard-earned cash. The good news is that Chinese consumers do have money to spend, having accumulated well over $1 trillion in savings. However, they are showing little sign of losing their caution, with the savings rate climbing to 44 percent of GDP last year, as opposed to 26 percent in Taiwan and 32 percent in South Korea. In big cities, such as Beijing and Shanghai, savings rates are as high as 50 percent, reflecting the consumers' propensity to save a higher proportion of their growing household income.

The Weak Dollar

The Washington Post has a good article this morning on the effects of the weak dollar. Not only is it making it expensive for US tourists abroad, but already the anecdotal evidence of foreigners snapping up goods in the US is coming in.

“...Canadian shoppers have been snapping up goods made cheaper by the decline of
the greenback relative to the Canadian dollar during the past 34 months. The
Canadian dollar cost just under 83 cents yesterday, compared with 62 cents in February 2002. Luring shoppers are reports like one in Canada's National Post, which showed that a trip to malls near Buffalo could save them 20 percent on goose-down coats at Eddie Bauer and 23 percent on leather armchairs at Pottery Barn.

Far more important in economic terms is the reduction in the cost of U.S.-made machines, turbines and aircraft on global markets and the corresponding erosion in the competitiveness of similar goods made overseas. On this score, the dollar's descent has been a boon for the U.S. economy, fueling U.S. exports and prompting some foreign firms to move manufacturing operations to the United States.”

Or, in short, “if it's going to be sold in the States, you try to make it in the States.” This type of anecdotal evidence makes me think that US industrial production is going to remain strong in 2005, despite most predictions of a slowdown.

The article also helps to explain why the trade deficit is falling so slowly, focusing on the fact that people and companies are slow in making decisions such as changing suppliers, etc. As people realize that the dollar’s fall is permanent, and not just a temporary blip, the dollar’s effect will be seen much more clearly on the trade balance.

Of course, this is not to say that the weak dollar is the elixir that solves all problems...

Monday, January 03, 2005

China's Sucking Sound: Maybe not Giant?

Via comes an interesting link to a study from the always interesting McKinsey Quarterly on outsourcing. It turns out that outsourcing isn't always as profitable as one thinks. In many areas, we are reaching the limits of the savings that can be achieved by reducing labor costs.

We found compelling evidence that in a number of cases, offshore manufacturing isn't all it's cracked up to be. One reason is that for many manufacturers, the importance of direct labor is declining rapidly. Since it often accounts for just 7 to 15 percent of the cost of goods sold, hard-goods and high-tech manufacturers often say that wage rates are hardly the most critical determinants of their overall economic performance.

Consider the case of one fashion apparel company based in Los Angeles. Its 1,500 workers, paid at rates well above the minimum wage, make casual wear in an old, multistory downtown brick warehouse. The executives view labor costs, currently 3 percent of the retail price of these goods and heading lower, as a secondary concern to the company. If it were to move its operations offshore, logistics costs might well swallow up any savings from lower wages. Another example: A consumer electronics manufacturer we interviewed has stripped away roughly 60 percent of its labor costs from production and reduced lead times from weeks to days. Even if an offshore competitor drove down its own labor costs close to zero, this manufacturer would still have an insurmountable advantage in logistics—a fact that has emboldened the company to reverse-engineer low-end Chinese goods for manufacture in California.

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