Michael Spence’s The Next Convergence

On this blog, your correspondent writes book reports. Not book reviews – because that would imply a polished and systematic criticism, going back to the book, etc. But just book reports, that recall (1) the basic thesis and (2) the interesting ideas that stood out and are worth highlighting. They may not be super rigorous or entertaining, but they will be useful exercises for the writer and perhaps informative for readers.

This week’s reading was Michael Spence’s The Next Convergence. Spence is an economics laureate who made his name in microeconomic theory, especially his work on signaling. After that, he moved into academic administration for a while, and then into the global-development-conference circuit. From those experiences, he’s emerged with broader and more accessible thoughts which he has assembled in this, his first non-technical book.

The Next Convergence is basically just one of those “what’s going on in the economy right now” books, with a special focus on the emerging economics and what they need to do in order to/how they will become fully developed affluent nations (that’s the titular “next convergence”).  Most of it won’t be news to the economically literate public, but it’s a nice review anyways.

Here are the basics:

  • Spence explains standard economic consensus about the prerequisites for for economic development in poor countries. The basic idea is that fast catch-up growth ought to happen when borders are open to trade and technology. The dispersion of technology allows developing countries to immediately bear the fruits (in terms of productivity gains) of what developed nations have sown. Global trade allows poorer countries to find a niche in specialization, and to produce and sell a lot more than their domestic economies are ready to consume. So, once the right balls get rolling, we should expect poor nations to grow quickly. Spence is optimistic about this process and predicts that midway through this century, 75% of the world will live in a developed nation.
  • There’s a lot to be optimistic about for the 21st century, but the obvious haunting specter is global climate change. Spence advocates allowing emerging economies privileges in delaying cuts in their carbon emissions — it’s only fair, he argues, to make catch-up growth possible — but stronger international institutions that would be capable of enforcing worldwide tradeable carbon permits.
  • The other big thing that has to change is major global imbalance w.r.t trade and savings/investment. It has a lot of causes, one of which is China’s commitment to an investment-based growth model. Spence predicts a long, long delevering for the United States, so shifting China to a demand-driven economic model is needed quick to avoid a long global recession. Reducing its massive savings imbalances will also require structural reform within China.
  • It will be really interesting to watch 21st century India and China happen geopolitically, because, we often half-forget in all our excitement, they are fundamentally still impoverished nations that are only weighty in total by virtue of their massive populations. Seeing how they do in international leadership will put to the test our theories about what factors determine geopolitical influence beyond GDP.
  • The E.U. needs more fiscal union to match its monetary union.
  • Communication technologies, especially the mobile internet, are a big deal and a force for good. They’re one of the major factors accelerating growth in Africa (i.e., easier to find out about prices in various markets). They’ll also inspire a lot of political reform, as people can now more easily see how other people live, become aware of injustices and other countries’ ways of doing things, etc. And heck, they just make life better and more convenient in the developed world — academics who spent most of their time in the past pinning down data sets can now get raw information with a few Google searches and give the rest of their time to actual analysis.

And here are some of the ideas that stood out as really really interesting:

  • Spence points out that, as your correspondent likes to belabor, the truth is a lot more complicated than the endlessly repeated claim that “The financial crisis showed just how screwed up markets can be, so we need more financial regulation now.” The basic problem with this is that crises are, pretty much by definition, risks that the market didn’t see coming. And the thing is, regulators use the exact same models to measure systemic risk as market participants do, because both employ the latest macroeconomics. So the logical extension of this point seems to be that the next crisis won’t be averted by changing the structure of our regulation — it has to come from better (truer) economics. (It also invites an avenue for future research: To see if the kinds of extra regulation being proposed in the 90s and 2000s/being removed in the 80s — if effected/if prevented from being removed — actually would have prevented the crisis, given that fact. There’s a strong possibility the answer is ‘no.’)
  • China faces the very real prospect of a “middle-income trap,” and it’s weird that people assume that China will just sort of cruise through it, because, historically, most quickly-developing nations did not escape that trap. A middle-income trap happens when a country can no longer rely on the low-hanging fruit of growth driven by the export of labor intensive products, as made possible by low labor costs. Once incomes rise sufficiently, this model obviously no longer works. To keep progressing, the country needs to transition into a modern, services-based economy, which involves political leaders making the difficult choice to allow some export industries to die, and getting domestic production and consumption to match up at a high level. It’s really, really hard to pull off — South Korea’s one of the only recent success stories, and its political leadership had a hell of a time making it happen. And there’s little telling what will happen when incomes rise in China sufficient to undermine the competitiveness of exports.
  • Spence does a fine job articulating the benefits versus costs of a managed exchange rate for emerging markets. The basic virtue of a manged exchange rate is that it allows an emerging market to partially insulate itself from panics and crises in the developed world’s financial markets: I.e., if Americans suddenly become more risk averse and suddenly withdraw capital from Emergistan, Emergistan can prevent its currency from being suddenly devalued (prompting a vicious cycle) by selling the dollars it acquired in the process of managing the exchange rate. So, when handled credibly, managed exchange rates can give fragile industries in emerging markets a lot more certainty, by eliminating currency risks that — due to the low sophistication of their financial markets — they have trouble otherwise hedging. That’s a big boon to growth.
  • But there’s a trade-off here that has to do with the middle-income trap: As long as countries manage their exchange rates, there will always be political pressure on the central bank to keep the currency weak enough to keep its export industries competitive. This can become a serious problem when it’s time for the country to move through and beyond the middle income zone.
  • Finally, international economics involves a lot of what Spence calls “adding-up problems” (i.e. prisoner’s dilemmas on an international scale)  some of which are, interestingly, exacerbated by globalization. The most interesting case of this is that, in the wake of the financial crisis, European countries weren’t generally able to enact a stimulus plan like those enacted in the U.S. and China. Why? Well, since Europe is so economically interlocked, any one country would benefit if all the other European countries around it enacted a stimulus that boosted demand for its products; and any one country would be hurt if it alone enacted stimulus, because most of this debt-funded, stimulus-driven demand would leak over into the surrounding countries. So each country had an incentive to ‘free ride’ on the stimulus of all the others and little stimulus happened. The U.S. and China, because they are fiscally sovereign, didn’t have this problem (this obviously is part of the reason Spence thinks the Eurozone needs more fiscal unity to match its monetary).

Are all of these ideas correct? Well, Spence is the Nobel laureate, so your correspondent defers to him for now.

Final judgment: The book is half-recommended for readers who want a catch-up on these basics. But be warned – it is poorly written, and poorly edited. English is surely Spence’s second language, behind mathematics. It may be the slowest non-technical reading you’ve ever done.

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Labor Markets for Grownups

In the ongoing discussion of the Eurozone collapse, we keep hearing statistics about the extraordinarily high levels of youth unemployment in the PIIGs (Portugal, Ireland, Italy and Greece). France also has very high levels of youth unemployment, and Europe, in general, consistently has higher unemployment than the United States, despite the fact that may European countries arguably have higher overall levels of human capital. That is (in English): even though the U.S. is less successful in educating its entire population, U.S. companies can still find more employment for more of the population, especially the young (yes, even now).

It’s relatively uncontroversial among economists of all political stripes that one of the main reason for this is that European labor markets are less liquid – i.e., French law makes it more difficult to fire employees, so employers are much more circumspect about hiring people in the first pace. Since any kid with a good resume could turn out to be great or could turn out to be a slacker lemon, you’ll be less inclined to hire if it will be extremely costly to get rid of him in the latter case. (Spain tried to get around this problem by giving companies more freedom to fire “interns”—this has led to a two-tiered employment system, with many young people living in serial, monogamous, but non-committal employment relationships, getting let go from each company as soon as the government’s time limit for classifying someone as an intern runs up.)

Economists all agree that that is a cost. But some—debating as economists ostensibly do, solely with descriptive models and empirical evidence—point out that the European model has benefits which may be worth the cost. If you know you can’t get rid of your employees and they are less likely to leave, you may be more inclined to invest in them—giving them better and more extensive training, helping them continue education, sincerely caring for their health, etc. And the knowledge that it’s hard for your employer to fire you can give you greater security and certainty about the future, and consequent happiness, if you’re into that.

So it’s hard to scientifically say which model has better consequences (full disclosure: my view is that  liquid labor markets combined with reliable social insurance is the best policy overall). Economists think that this debate is just one instance of the ubiquitous dilemma between efficiency and moral goods like equity/security.

But here’s my non-empirical, non-economic, non-consequentialist, sanctimonious thought: It’s really sad and bad, deontologically speaking, to be “into that,” meaning the idea that employers can’t fire their employees.

Employers only want to fire employees who aren’t worth their paychecks—i.e., whose costs outweigh their benefits. Maybe this accounting language sounds cruel in the context of real people’s real jobs. But the alternative is worse: It is the idea that we have a right to demand succor from private employers without having a reciprocal obligation to be equally useful. And that strikes me as perverse. I could not bear to work for an employer who did not find me useful, did not want me, and were restrained from firing me only because the law made it prohibitively difficult—I would be too ashamed and humiliated to show my face in the office if I were regarded as a drag. And the kind of person who doesn’t feel that is, in two harsh words, contemptible and pathetic—not really a grownup. A society that legally enshrines and subsidizes those characteristics strikes me as one that will produce less grownup citizens. (I also think it’s hugely morally problematic for the government to forcibly prevent private business owners from shifting resources from failing employees to eager prospective employees who might better help the business achieve the goal for which it was incorporated.)

(N.B.: This is not an argument against things like disability insurance. Disability insurance is just the logical way of pooling the uncontrollable and rare but potentially devastating risk we all face. There is a difference between a policy designed to bear huge, unpredictable risks and one whose effect is to subsidize controllable and consistent failure.)

The Morality of Economic Growth: Fun Rant + Grave Thoughts

In his last post, your correspondent wrote:

…one of my main tasks as an emissary from humanities people to economics people and (in this case) vice versa is to explain to the former that, no, growth, really does matter…

Serendipitously, your correspondent was invited to a lunch seminar yesterday, given by Professor Benjamim Friedman of the Kennedy School, on his book, “The Moral Consequences of Economic Growth,” and he dragged along his skeptical, perennial-humanities-student roommate.

Your correspondent worried that this would be one of those vomit-inducing seminars in which people repeat the phrase “self-interest rightly understood” a dozen times, or remind us that Adam Smith’s first book was on moral philosophy, and conclude that QED virtue is commerce. The reason such seminars induce vomit is that, while the views expressed at them are mostly correct, they’re also by now old, boring, and obvious, while the people who advocate them imagine just the opposite. And the only people in the world more infuriating than the conventionally-opinionated are the semi-conventionally opinionated who cast themselves as transgressively unconventional. (Rant Fin.)

But Friedman’s argument was more interesting and novel.

On “morals and markets” question, fans of the latter typically advance two kinds of arguments, one about extrinsic goods (results) and the other about intrinsic goods:

1. Economic growth, by definition, means more stuff to buy. People need and like stuff. Markets have proven to be the most effective way of maximizing stuff produced, so they are good, QED.

2. Market behavior is itself intrinsically virtuous behavior, and markets inculcate virtue. This is because markets are just big sets of consensual transactions. Consensual transactions are based upon, and reinforce the idea, of, respect for individual autonomy and rights. Markets teach us to think about others’ attitudes and wants and needs, and reward our industry in meeting them (because, simply, a seller must persuade the buyer that her product is worth buying).

Friedman’s case, is that historical growth causes greater personal morality: In periods of high economic growth, people have usually become more welcoming of immigrants, less resentful and suspicious of outsiders, more willing to give, less inclined to bigotry. In periods of economic contraction, people become just the opposite. The most vivid example of this is the fact that the Nazis won only 2% of the German vote in 1928, before the onset of the great depression aided Hitler’s sudden ascent. Friedman draws on enough historical data and examples for a pretty good prima facie case for causation.

The basic explanation for this is that when we feel that we are doing better than we were in the past and that our future is secure, we feel less threatened and become more willing to cooperate with others. We become less interested in protecting what we have, and more hopeful about ventures and partnerships that can make us even better off.  And there’s a feedback loop here: As growth increases, we become more optimistic about the future, which makes us more willing to cooperate, which itself boosts growth. (For a basic review of Friedman’s thesis, see The Economist; for a smart criticism, see Will Wilkinson.)

This historical thesis is backed up by some evidence from social psychology experiments which have found, for example, that when you prime people to feel more pessimistic about their future, they are more likely to exhibit “in-group bias.” Put another way: If your life is getting better, you’re less likely to be a prick/racist. With modern data analysis, we could do some really interesting research on whether, say, a bearish stock market correlates with more in-group bias, resentment, or general nastiness, as measured by, say, aggregate word choice on Twitter.

***

But this takes your correspondent back to a conversation he had with his roommate in which the latter asked “Does/Why does growth really matter?” The latter excerpted the very famous speech in which Robert Kennedy concludes that GNP “measures everything, in short, except that which makes life worthwhile.”

Kennedy was, very plainly, incorrect. Productive enterprise makes life worthwhile, as do travel, education, cool clothes, fun video games, technologies that connect us to loved ones, tickets to the opera, etc., all of which are in GNP. Some ‘negatives’ are in fact encompassed in GNP (i.e., increased production of munitions for a war or new prisons would ‘help’ GNP in the short run). But those are very much the minority, and nobody actually proposes actively building new prisons just to boost GNP. The wonderful things that are not encompassed in GDP — i.e., loving relationships, friendly conversations with strangers — are important, but they are outside the scope of government policy, and so not really relevant to what GNP intends to be used for.

But the roommate asked your correspondent some tough follow-up questions:

(1) Are people with $100,000 a year in income actually happier than those with $60,000 a year? Or those with $1 million a year happier than those with $350,000 a year? Or even, is a person with $10,000 a year in a society with a per capita income of $2,000 less happy than a person with $250,000 a year in a country with a per capita income of $50,000 a year?

(2) In dragging the third world — take India as an example — out of poverty through globalization, and placing the whole world in Western business attire, are we sure that we are not sacrificing some sort of ineffable spiritual values?

(3) Isn’t growth an imperfect metric, since it doesn’t tell us anything about the distribution of the gains?

Your correspondent admits that we cannot say with certainty that the answer to any of these questions is ‘no.’

But here are some things we can say with confidence:

(1) If two countries have equal wealth, but one grows at 2-3% per year, and the other does not grow, the former country will be roughly twice as wealthy within just one generation. That’s a big deal. Even if the gains are not, at first, evenly distributed, the sheer amount of wealth will make it much, much easier for the latter country to solve any problems of poverty through redistributive policies. (Even the gains that go to the top have good effects: Wealthy people, with excess money and leisure, are always the major fosters of great art and culture.)

(2) Poor people in India themselves say that they would like to be much wealthier — as wealthy as we are in the United States. Maybe we privileged, upper-middle class Americans long for some prelapsarian fantasy we see in third-world poverty, and don’t think the affluence in which we have ever been surrounded is all that great — but the global poor beg to differ. It is the worst kind of elitism and presumption for the rich to say the poor, “No, actually, our wealth isn’t worth having — trust us — stay the way you are.” And insofar as we say that India’s continued fast growth is unimportant, that is what we are saying. (And, incidentally regarding the prelapsarian fantasy: There may well be unmeasuarable, ‘spiritual’ goods in life. But the metrics of spiritual harmony/disharmony that we can measure — i.e., murder rates, etc. — all improve as people leave the ‘Eden’ of tribal poverty and become bourgeois moderns.)

Your correspondent thinks that wealth isn’t everything, but it is pretty excellent. The things that it permits — travel, cultivation of arts, independence — are awesome. But even those who are less worldly, corrupted, and greedy than your correspondent should care a lot about growth for those two reasons.

How I think about Japan

In the popular imagination, the story of post-war Japan is one of extremes. Its rapid economic growth through the 60s, 70s, and 80s — which turned it into the first non-Western developed country, and made America tremble with fear that they would eat our lunch —  was a miracle. But then, it experienced an enormous, spectacular real-estate and asset bubble, which, when it popped, caused an unmitigated economic disaster.

Overall, this narrative is overdone and overstated. But let me hedge a bit: I’m in an unusual position here, because, typically, one of my main tasks as an emissary from humanities people to economics people and (in this case) vice versa is to explain to the former that, no, actually, economic growth really does matter. And, depending on how you calculate it, after the bubble burst, Japan more or less experienced a “lost decade” or almost two, with negative growth at times and negligible growth over all. This has significantly compressed the basic job opportunities for Japanese young people, and completely knocked the country off of its prior path. Becoming (as it was on pace to become) by far the most affluent society in human history would have allowed Japan to leave enormous, indelible marks on culture and the international order — 21st century Tokyo could have been the equivalent of 1920s Paris and London combined, and we would all be watching Japanese TV. Japan’s actual marks in the past two decades have been rather more muted.

But all that said, Japan’s initial catch-up growth was hardly a miracle, and life in Japan today is hardly a disaster — the average Japanese has a very high quality of life, which it would be unwise to pooh-pooh.

To see economics textbooks and commentators refer to the Japanese ‘miracle’ is curious, because according to their very own economic models — the very basic ones we learn in Econ 101 — it is exactly what we should expect of any poor country that has the basics down, namely (1) stability and (2) a semi-enlightened political leadership. Very simply, if a country is (1) stable (i.e., with rule of law, lack of coups, an independent central bank, etc.), (2) decently well-educated, and (3) poor, then multinational firms and international investors should pour capital into it, because with the right technologies it can, due to its workers’ low wages, produce anything its workers have the education to produce at a below-market cost. The influx of capital makes the country much more productive, which quickly raises its GDP and hence incomes. So poor but non-dysfunctional countries should quickly catch up to rich ones. And, indeed, once these countries have caught up, we might expect them to continue on ahead, because old, long-ago developed countries have a lot of technologically-outdated infrastructure lying around, while the newly-developed country’s infrastructure will be based on newly-developed technology, etc. There are slight complications — such as, perhaps, the need for some early protectionist policies to nurture industrialization in its infancy, to get the process going. But that’s the basic idea. (See Krugman on this here.)

So why the ‘miracle’ moniker? Well, Japan was the first to make it really work, though the Asian tigers quickly followed. And the really basic economic prediction — that poor countries should catch up pretty quickly as long as capital and manufactured goods can move across borders — didn’t come so much true in Africa, all of Latin America, or MENA. The fact that it hasn’t, and that Japan’s story is not the norm, is a testament to (1) the general dysfunction of politics and (2) abiding sources of social division and instability (e.g., tribal strife in MENA countries with colonial-era-drawn borders, and humanity’s general deep iniquity) that simple economic models don’t really factor in.

Still, Japan’s success is simply what we should have expected from a society that had been politically modernizing since the late 19th century, that enjoyed stability under the long government of the LDP, that was homogenous and hence socially stable, that had a population that had successfully taken to public education, that enjoyed peace and international security under the U.S.’s post-war watch, and that was poorer than the major economic powers.

Then, Japan’s asset and real-estate bubble was indeed extreme and spectacular, and so was its bust — but, frankly, occasional financial crises are a fact of modern economic life.

Since then, Japan has remained an affluent, developed, modern, slow-growth economy. From 2000 to 2010, its economy grew 17%. That’s not great, but it’s not horrible either. A strong yen means that Japan’s manufacturing export sector suffers — but that’s not so bad, because, at its income level, it really should be a modern, services-based economy. The flip side of the strong yen is that Japanese can enjoy travel and imported goods on the cheap. Under purchasing power parity, Japan has a per-capita income that trails just barely behind the U.K. and France, according to the IMF. And there’s virtually no crime or any other form of public obnoxiousness. The Japanese can enjoy a treasured and ancient culture, lifetime employment, and really fun, advanced, cities. Tokyo residents can eat at, I am told, more Michelin 4-star restaurants than anyone else in the world.

Should we feel totally assuaged? No. The story so far is okay, but Japan has big problems in its future. There are three huge, obvious ones: (1) enormous sovereign debt, (2) an aging population, and (3) a shrinking population. Japanese senior citizens will become increasingly expensive for the government to care for; and there is a shortage of new, young, taxpaying workers to provide the funding needed for that. So as the Japanese debt grows, investors could become nervous about Japan’s ability to repay its debt, and demand higher yields on the country’s bonds or short them. This could make it prohibitively expensive for Japan to borrow, prompting a fiscal crisis and political instability that could trigger a financial crisis. Japan, could, in short, be the next Greece.

And this is why, yes, growth, really does matter. Japan has no option but to grow its way out of that scenario.

Today, Japan is growing slowly partly just because it is now a developed, relatively contented country. But there are other drags on its growth that Japan can change. Some of these have to do with technical financial economics (i.e., Japanese banks are arguably still unwilling to write off some of the bad loans they made before the bubble burst, which prevents them from lending to new, hopeful ventures), and others with economic policy. Restoring vibrant economic growth, if it is at all possible, will require: (1) more monetary stimulus from the Bank of Japan (which actually looks, unexpectedly, to be happening!), (2) entitlement reform to bring down the country’s enormous debt (which looks unlikely, given the country’s weak political leadership, and that it is increasingly beholden to older voters), (3) labor market reforms that would trade off some of Japan’s famed job security for a more dynamic, liquid market (questionably likely), (4) a greater openness to immigration, both high-skilled and low-skilled (the former is sort of likely, the latter appears, unfortunately, to be totally out of the question), (5) corporate governance reform that gives shareholders more power to demand higher profits from the firms they own (which has been in slow progress since the Koizumi premiership).

Japan missed its chance to be the future. But it can still be a lovely home for its citizens if it makes these reforms now rather than later.

Irrational, Exuberant Regulators

The econ blogosphere is passing around this graph, a statistical analysis of the frequency of laughter at Federal Open Market Committee meetings (based, simply, upon the frequency with which “[laughter]” appears in the text of the minutes):

This is, of course, not a scientific proof of anything. But it can serve as a funny illustration of a point I want to harp on as I continue to write about brain science and economics for the next year and a half. We very frequently read in popular magazines and newspapers that modern behavioral economics, by shedding light on individuals’ irrationality, demonstrates that we need more regulation. I don’t doubt that this is true in certain cases; and I do support many of the innovative regulatory “nudges” that behavioral economists like Cass Sunstein have proposed (i.e., making the default options on various things, like state forms related to organ donation or employment forms related to savings plans, the more broadly socially beneficial ones).

But what this graph hints at is that regulators and technocrats are also biased and irrational — in this case, the members of the FOMC appear to be as caught up in the “irrational exuberance” of the bull market and ever-rising real estate prices as AIG ever was. Indeed, since regulators are humans, our default assumption should be that any broad cognitive bias, such as infectious irrational exuberance, should affect them as much as speculators. So it is never enough to say, “Individuals are irrational, therefore we need more regulation, QED.” To make a strong case for more regulation, you need to have a good reason to be able to predict that, “In this case, taking account of the biases, blind spots, conflicts of interest, and irrationalities of both the marketplace and our proposed regulators, we can show that our proposed regulation on the whole will lead to a better outcome.” I fear that journalists, who don’t have time to make that case in full and who, instead, just dash off that familiar line, leave their readers with an inappropriately vague and optimistic view of how greater regulation can help.

 

Four Objections to ‘Free Currency’

Over the weekend I had a conversation with a brilliant mathematician and ueber-libertarian, which turned (as conversations with brilliant ueber-libertarians usually do) to the subject of free currency.

In brief, many libertarians want to be rid of our current “monetary authoritarianism,” i.e. the government’s monopolistic control, via the Treasury and Federal Reserve, of the currency and money supply. (Technically the government doesn’t fully control—just influences—the money supply, as banks and individuals can reduce the money supply by choosing to hold more reserves and cash.) They would prefer, instead, ‘free currency,’ i.e., a system in which private banks and institutions could issue their own bills, which would not be backed by the full faith and credit and power of the federal government, but, rather, by the credibility of the private issuing institutions themselves.

Now, this idea isn’t actually as crazy as laypeople initially assume. To understand why, we need to think about the fundamental nature of money. U.S. paper dollars have no value in themselves, i.e., for consumption, but are useful only as a store of value, which value is a function of our shared faith in the issuer of dollars, the federal government. Another way to think about this is that currency is a super- or infinitely-liquid asset. But there are other highly liquid assets issued by private institutions, which function so much like money that they are said to circulate in the ‘money market.’ These include short-term corporate bonds. Their value depends on and varies with the faith bondholders have that the issuing corporation is solvent, willing and able to redeem the obligation. Thanks to financial innovation and some oversight, the markets for these bonds are actually extremely efficient and reliable, and chances are much of the ‘money’ you have in your bank account or mutual fund is actually ownership of these bonds. But you don’t need to worry about it disappearing, because highly sophisticated analysts aggressively police the credibility of bond issuers, and bond issuers have a huge incentive to deserve it. (And, paper currency itself, of course, historically traces to checks issued by private banks which promised to redeem them with gold.)

The last way to think about this is that, in fact, today we do have competing currencies – that is, the different currencies of different countries (or, since the advent of the Euro, different ‘monetary unions.’) Right now, a Eurozone employer pays his employee in Euros, and an American employer pays his employees in dollars; but each employee can travel to the other’s country and buy the other’s employer’s goods, because each can buy the other’s currency at a value set by the foreign exchange market. Efficient forex markets set the exchange rate of each currency such that the two bundles of currency that trade for the same value can buy the value of the same bundle of goods in either country. (I.e. If 2 dollars and 1 euros both buy one gallon of oil in the U.S. and the Eurozone respectively, but you could ‘buy’ 1 euro for only 1 dollar, then financial intermediaries would have an incentive to sell their dollars in exchange for euros, to buy up oil at a cheap ‘dollar’ price, and resell it in the U.S. for 50 cents plus profit; this process will itself drive up the ‘price’ of euros, continuing until it takes 2 dollars to purchase 1 euro.) And, because we have efficient forex markets, you can travel anywhere in the world with a Visa card and an American bank account and get the local currency from an ATM without getting ripped off.

Now, suppose we let corporations and banks move from just issuing money-like ‘commercial paper,’ and let them issue their own currencies, and relieved the Treasury of that duty. In principle, these banks would simply function much like sovereign nations’ central banks function today. Employer A pays employee A with Bank A’s currency, while Employer B pays Employee B with Bank B’s currency; and then a currency exchange market, with many traders who aggressively seek arbitrage opportunities, discovers the efficient exchange rates among the currencies. Given modern information technology, in a free-currency world, you could have a bank account that stored purely private moneys, and you could still walk into any store and swipe your bank card, secure in the faith that, if your own bank is credible, and the currency markets are as efficient as traders have an incentive to make them, you won’t get ripped off — just as today, you can swipe your Visa card at foreign shops without much worry.

Now, one obvious difference between banks and governments is that governments have armies, and this is a major source of governments’ credibility – i.e., when they face a solvency crisis, they can simply confiscate assets via taxation. Private institutions don’t have that power, and so have less ability to maintain widespread faith in the currency (which is also, incidentally, why corporate bonds sell at a risk premium above Treasuries, even when the issuing corporations are more intelligent and conscientious than the U.S. government). But for free-currency advocates, this is precisely the advantage of getting rid of ‘monetary authoritarianism.’ Today, we all must use and accept U.S. dollars, regardless of the bad behavior, inflationary policies, etc., of the U.S. government, because we are forced to. But in a free-currency world, we would choose which banks’ currencies we wanted to use, according to the banks’ reliability, our aversion to inflation, etc. If we are committed to long-term savings, and averse to the risks of financial markets, we could simply choose a bank that reliably promises never to let its currency inflate, and store its currency under mattresses, protecting our savings against inflation, without bearing the risks of a mutual fund. And as dynamic currency markets developed, currency traders would have an incentive to monitor the credibility of issuing banks, so they could short-sell the currencies of banks that are alienating customers or risking their solvency – and this itself would debase those bank’s currency value, giving every bank a huge incentive to be good and reliable. And governments would have to work harder to live within their means, because they would lose the ‘stealth taxation’ that comes from printing more money and inflating the currency.

So I really mean that the idea is not as crazy as it sounds. Indeed, the currency libertarians have a point that most all of our economic interactions in life are mediated by markets, and so the presumption of proof must be on those who advocate a government monopoly on this one particular asset – money.

So allow me to presume to make that proof. I have four basic, preliminary objections to free currency:

First, money may be a natural monopoly. It is, curiously enough, sort of like Facebook: The value of currency to any individual currency-holder comes from the value that others place on that currency. The more people use a particular currency, the more sought after that currency should become, the more people will use that currency, and so forth. Which means that free currency markets should exhibit ‘snowball effects/virtuous cycles,’ etc, leading to monopoly. Even if Bank B has a slightly better currency policy, if Bank A’s currency dominates the market, I will stick with Bank A for security and it will be ‘locked in’ to its advantage. More than I fear a few extra basis points of inflation, I just want reliability – lack of hassle and certainty that it will be accepted. If money is a natural monopoly, we should expect it to be exploited. The natural response to this market failure is democratic accountability through government control.

Second, if I’m wrong, and money is not a natural monopoly, a free currency world is one in which there will be many different currencies vigorously competing for users. I think this competition has obvious theoretical virtues, but this complexity also has two kinds of dangers. Competing currencies could have the same broad effects as inflation. The main reason why high and unpredictable inflation saps economic growth is that it discourages the formation of economic contracts by creating uncertainty about the value of money in the future. In the same way, competing currencies could increase each market participant’s uncertainty and equivocation in small ways that, over the aggregate, clog the economy. Since it is very hard to predict the likely solvency of any private institution in, say, 30 years (in the same way that most everyone assumes the U.S. government will still be around then — and that if it’s not, their business ventures won’t be either), private currencies without recourse to the “full faith and credit” of the global superpower could discourage long-term contracts, hence long-term investments. Increasing complexity also gives the financially savvy more opportunities to take advantage of the financially naïve. Most of the population is doubtfully capable of understanding exchange rates, inflation, etc. A devious employer could contract with a naïve employee on a long-term basis, to pay him in a currency that has an announced policy of high inflation. Or he could promise to beat another employer’s offer of 100 Bank A notes per day, with an offer of 120 Bank B notes per day, secure in the assumption that the employee will not understand what it means that the exchange rate is 2 Bank B notes per Bank A note (or the employer could, even, make him work for 60 Bank B notes, by telling him that Bank B notes are worth twice as much—“See? 2 to 1.”).

Third, whether or not money is a natural monopoly, free currency would destroy the possibility of countercyclical monetary policy. Mainstream economics holds that, though artificially low interest rates set by the Fed do play a role, business cycles fundamentally derive from human psychology—i.e. virtuous cycles of increasing optimism and irrational exuberance, followed by vicious cycles of increasing pessimism, decreasing investment, decreasing output, decreasing income, decreasing demand, which increases pessimism even more, etc. Insofar as this is true, government has a counter-cyclical role to play in markets. When the business cycle turns down, higher inflation helps stop people from hording their money (see “the paradox of thrift”), to allow real wages to fall to a market-clearing, full-employment inducing level, and to fool people into thinking they’re making more than they are, to restore optimism. Private currency-issuers would not have, it seems to me, no incentive to provide counter-cyclical inflations. If anything, they might engage in competitive deflation – i.e., in times of economic distress, people flee to safety, and the bank that made the surest promise not to devalue its currency by issuing any more would attract the highest demand.

Finally, it’s not broke, let’s not fix it: Since the late 70s, inflation has been stable and low in the United States, and the value of low inflation has been broadly accepted by economists and central bankers throughout the world. The Federal Reserve appears to be the least incompetent component of the Federal Government (libertarians in particular should appreciate that monetary activism is the surest way to preempt ineffective fiscal stimulus). We are at no risk of hyper-inflation. The United States enjoys substantial economic advantages from the faith foreigners place in our currency, backed by our government’s full faith and credit. Free currency is a fun thought experiment—one that helps illuminate the underlying nature of money and markets—but a serious effort to implement it almost surely wouldn’t be worth the costs.

Lunch, the Coalitional Nature of Ideology, etc.

Yesterday, urged on by my roommate, I went to a “community” organic lunch at the Harvard Divinity School. All of the food and ingredients were ueber-organic, grown by local farmers, prepared on site, etc.. Obviously, some of the people there were a little bit silly, but, ideological ecumenicist that I am, I suppressed all ungood thoughts and listened closely.

And, I’m glad I did. And older woman, a gardener, was refreshingly lucid:  She argued (following, I presume, Michael Pollan, who made the same point in The Omnivore’s Dilemma) that we humans adapted over our long evolutionary history to ingest and digest foods which were not protected by pesticides. There’s a strong likelihood that there are chemicals, micronutrients, etc., that we have not yet discovered or cannot synthetically reproduce, which plants produce in response to the natural threat of pests and disease, and which we are evolutionarily adapted to make use of.  That’s a strong case for organic.

Her case for local foods was that, logically, we should expect local food grown on long-standing farms which recycle their own seeds to be more nutritional than alternatives. These long-local foods have had the advantage of evolving to flourish in the local climate and its idiosyncratic weather conditions and patterns. She went so far as to say that local foods “know when there is a nor’easter coming.” This comes off as new-agey, but insofar as she means that genetic material is a kind of information, hence a kind of knowledge, and plants have, through thousands of generations of piecemeal variations and selections, encoded a sensitivity to weather conditions that correlate with coming nor’easters, then she is correct.

The very simplest way to put the case that she and Michael Pollan make for organic, local food is that evolution is smarter than modern science, and, accordingly, we should expect the former to make better produce than the latter. We have a limited ability to healthfully depart from the diet that our ancestors ingested over our evolutionary history, because we co-evolved with that food — we are designed for it. (Notably, it’s very hard to get rigorous empirical evidence about the health benefits or local/organic — way too many confounding variables — but I think the logic checks out.)

The interesting thing about this is that she was making an argument about food that (1) libertarians and (2) conservatives, respectively, make about markets and culture. That is, (1) market libertarians claim that the piecemeal, evolutionary adjustments of the marketplace produce an economic order that is more conducive to human flourishing than anything any technocratic board of Economic Decisionmakers could impose — i.e., markets are smarter than social science. And (2) cultural conservatives claim that the organic process by which communities develop and sustain systems of mores is more intelligent, and, hence, more conducive to human flourishing, than the mores we can come up with just by thinking about it — i.e., culture is smarter than moral philosophy. (Indeed, I remember my confusion as a college freshman, when, I first heard the word ‘organic’ used in the context of political theory, and wondered what Edmund Burke had to do with Michael Pollan.)

My point is not to endorse. There are obvious problems: (1) there exist well-known market failures; (2) many traditional cultural mores in many places, such as, say, the stigmatization of homosexuals, are not the products of communities discovering through piecemeal experimentation which mores most enhance their flourishing, but of emotional hatreds, ignorance, non-empirical theology, political power plays (as in the Catholic church forbidding the priesthood to marry, originally in order to prevent the division of its properties).

The basic point is that the logic for all three ideologies is consistent. So here’s an important, fundamental question for you, gentle reader: Which is smarter in general — evolution or contemporary science? Organic processes or social science?

If your answer is ‘the former,’ this should make you a little more inclined toward organic foodie-ness, market libertarianism, and cultural conservatism. If the answer is the latter, you should be a political leftist who loves agribiz. OBVIOUSLY this is a massive oversimplification. But an extraterrestrial who knew nothing about the world’s cultural politics, upon considering the question from the perspective of “evolutionary processes vs. modern knowledge processes,” would expect to see that alignment on the controversies in food, economics, and culture.

So why don’t we see it? The obvious fact — the obvious fact which makes your humble correspondent and wannabe policy intellectual very sad/disillusioned about mankind — is that no person’s bundle of perspectives on Contentious Issues, his ideology,  is purely logical, i.e., the consistent and dispassionate extension of a single set of first principles and basic concepts. Rather it is much more the case that our bundles of perspectives are the often-contradictory products of the groups of people we identify and associate with.

Conservatives, who, by the logic by which they justify their cultural positions, really ought to be organic foodies, are, to put it mildly, generally not, because, by and large, they regard organic foodies as the sort of silly, square-glasses types one finds in Cambridge, Massachusetts, and other politically liberal latte towns. Conservatives who reject organic food aren’t so much thinking about the logic of organic food itself as about the sorts of people they identify with it. (Nota bene: Here I am separating the personal-choice question of “Should I eat organic food?” from the political question of “should we subsidize organic farming and remake as much farming as possible in its image?”, in which case I think conservatives who, e.g, don’t want millions of people in poor countries to starve, are on firmer ground.) The reader can surely think of ways in which this same sort of process works on other groups as well.

This is all just a roundabout way of saying that our politics today and everything else that has a political valence — and this makes me very sad — is lamentably little about “what I think and why I think it” and lamentably a lot about “who I am and whom I affiliate with.”

Executive Summary — 😦

Ideas as Economic Inputs

I finally got around to reading through Paul Krugman’s Pop Internationalism, which is a collection of his essays and speeches in the 90s that attempted to explain standard trade theory to the public. The essays are readable, and Krugman is reliable here — he won his quasi-Nobel prize for trade theory. He’s actually quite fun as he pillories common misconceptions (and the standout misconceivers who promulgate them).

Consider, as a stylized version of common trade misconception, the claim that, “emerging markets’ low wages and cooperative governments will attract huge capital inflows, which will allow them to industrialize and run huge trade surpluses, taking investment capital from and hurting real incomes in developed economies — as developed countries’ manufacturing sectors become less productive, the job losses will be enormous.” These sorts of claims (1) make a basic error in accounting identities — it is simply impossible to attract net capital inflows and run a trade surplus; (2) get productivity precisely backwards — the more productive manufacturing becomes the more you should expect job losses in that industry, since by definition productivity gains decrease amount of labor required to produce the output that meets demand; (3) ignore pretty much everything else in basic trade theory, such as the fact that, as has been known since Ricardo’s time, each country is best off when it specializes in the enterprises in which it enjoys a comparative advantage, and that American consumers broadly benefit from being able to purchase the goods they want from cheaper foreign manufacturers, which also frees up their income to pay for goods produced by American worker in which America has an actual comparative advantage; and (4) ignore the empirical realities of international trade, such as the fact that, for all Tom Friedman’s columns, it’s actually not economically overwhelming (18% of GDP in 2009 — lower when Krugman was writing and NAFTA was controversial), and so the vast majority of changes in any country’s welfare are attributable to (in the long run) productivity growth and (in the short run) aggregate demand within the domestic economy itself.

Krugman today is known as a cranky stimulus advocate, but he’s apolitical on trade theory, and at times subversively right wing — he writes, for example, that ostensible concerns over labor practices and ‘fair compensation’ in emerging markets are very often a veil for efforts to shut those emerging economies’ exports out of global markets, in ways that hurt poor countries’ chances of developing, while aiding incumbent interest groups such as, e.g., the developed world’s trade unions. He pretty effortlessly dressed down objections to NAFTA (though he also noted, correctly it seems in retrospect, that others had over-claimed for its benefits). He explains the standard economic perspective that rising income inequality is explained by increased specialization, increasing technological complexity, and the rise of ‘tournament economies’ thanks to improved communication technologies (I’ll save the full explanation for a later blog post), rather than just dreaded ‘tax cuts on the wealthy.’

But, now that I’ve submitted my book report, I’ll tell you the thing I found really interesting (as opposed to just a nice rehash of Things Economists Know but Some People Don’t): One point he makes about the Mexico’s impressive growth in 1994 is that a lot of the growth was attributable to a new consensus in development economic theory. That is to say, after the success of the NICs, the global economic commentariat had largely started to agree in the early 90s, in contrast to the preceding decades, that the formula for economic development was (1) opening up to trade and (2) sound, hard money. Now, crucially, both (1) policy makers and (2) investors largely base their decisions off of the conventional wisdom in economics. In Mexico’s case this meant that, starting in the early 90s, Mexico’s policy shakers moved the country toward open trade and hard money, and investors decided that, because Mexico was moving toward open trade and hard money, it was a good bet. So in 1994, capital flowed in to Mexico, boosting its GDP in the act.

Now, in a way, this inflow of investment was a confirmation of the theory that openness to trade and hard money were the key to development. But it’s a peculiar kind of confirmation, because among the key inputs into Mexico’s success were the very volatile assets known as beliefs, and, most importantly, the mutually reinforcing coincidence of the policy-makers’ and investors’ beliefs. Krugman warned, presciently, that the great danger to the Mexican economy was that, rather than its real assets being harmed, some other country’s problems might change development theory itself, which would set off a vicious cycle. In 1995, he was pretty much proved correct, as crises in other emerging markets set off capital outflows, which devastated Mexican GDP, which ‘confirmed’ the belief that motivated the capital outflows, etc.

Which is one of the marvelous and mind-blowing things about social science, particularly the queen of the social sciences, economics: Each person’s ideas, including her ideas about others’ social behavior — her own private social science, as it were — becomes the basis for her behavior, and hence for the social behavior that social science itself is supposed to explain. Economic theory is itself an input into the economy, and so a complete economic theory must be recursive.

Two thumbs up.

How to think about the Russian protests

I want to lay out a few facts that I fear get lost in all the chatter and media-driven excitement about the protests currently underway in Russia.

Yes, United Russia did cheat in the parliamentary elections in December. The distribution of different polling stations’ reports of their vote tallies had several statistical irregularities, such as abnormal upticks on ‘round’ percentages (i.e. 65%, 70%, 75%) of votes for United Russia.

But, no, United Russia did not steal the elections: even accounting for the liberal estimates of how many votes were falsified, United Russia would still be the dominant party. And westerners who hope for a more democratic, liberal Russia, need to explain and take account of that.

Yes, the blatant protests against United Russia, including signs on the streets of Moscow that read, “Mubarak, Qaddafi, Putin,” are unprecedented; and, yes, they are pushing the taboos against criticizing Putin in ways that have some vague similarities to the new willingness to criticize the Communist Party of the Soviet Union prior to Glasnost.

But, no, Putin is not going anywhere anytime soon. The government is mildly kleptocratic, and the FSB (successor to the KGB) occasionally punishes political enemies. But Russia never was North Korea – it’s far closer to the democratic West than to North Korea. And so these protests really aren’t quite as revolutionary and transgressive as most Western media outlets like to pretend.

In fact, Putin has been, and remains, wildly popular in Russia. The protesters we see on the streets of Moscow are part of a narrow slice of the population — educated, urban, middle class — and they do not reflect the majority even of that slice. Even if Russia’s presidential election in March is free and fair and democratic, Putin will be reelected by an enormous margin, to the happiness of most of the Russian populace. How, we westerners wonder, is he so popular?

  • Putin had really  lucky economic timing: He happened to come to power – hand picked by the new Federation’s ailing lush-in-chief – right as Russia was finally recovering from the destabilizing shock of the collapse of the Soviet Union, and, more importantly, just as global energy prices were undergoing an enormous, sustained, and unpredicted boom. This surge in prices was caused mostly by instability in the Middle East, partly attributable to 9/11 and U.S. invasions, and to the growing demand for energy that has attended China’s rise. Russia is one of the world’s great energy superpowers. Depending on your calculation, it has been in previous years either 1st or second in oil production, and it’s also the world leader in natural gas. So, from 2000 to 2008, Russia enjoyed spectacular GDP growth rates attributable to (1) an energy-export boom, and (2) some increase in foreign direct investment attributable to its new relative political instability and market reforms made in the 90s.
  • Most ordinary people don’t understand economics and global trade, and how their own livelihoods are affected by faceless forces beyond the control of any policy maker. To the ordinary Russian, Putin is to be thanked for the near doubling in her standard of living that she enjoyed in just 8 years of his presidency; just as, to the ordinary American voter, the president is single-handedly responsible for the latest quarter’s GDP growth.

Russia’s lucky energy-boom during the aughts, is the single most important reason for Putin’s continued popularity, and it’s also sort of obvious. There are a couple of other things going on as well.

  • We Westerners often forget that the collapse of the Soviet Union, and the instability that followed, was actually a deeply humiliating experience for the average Slavic Russian. Gorbachev, for all his accolades in the West, is a hated man in mainstream Russia. The Russians’ empire had fallen, and that wound to pride stung more than the economic boom ten years later (whose origin, again, they don’t understand) could repair. Russians are motivated by nationalist passions as much as by reasons. Putin is thus proudly held as a strong leader, who “kept Russia together” (to borrow the phrase they endlessly repeat), who increased its geopolitical weight and assertiveness, who exercised control over the “oligarchs,” who had so rapaciously taken advantage of Russia’s hectic and corrupt process of privatization.
  • Putin and United Russia maintain a significant amount of control over the media, most particularly Russian television stations. (Though I hasten to add, once more, that, no, you will not be imprisoned for criticizing Putin in a Russian newspaper.) Today’s protesters are disproportionately members of the tech-savvy, wired urban middle class, and they get their news and commentary from delightfully subversive bloggers. But the average, aging Russia voter gets it from a state-controlled television station.
  • Finally (dare I say it?) I think Putin’s bravado/machismo – not just the macho posturing, but the fact that he actually is a strongman – appeals to something in the Russian character. I’ve always been surprised how, in my interactions with Russians, even the urban/cosmopolitan/educated set seems to be “in to” macho gestures and the people who make them. Less subjectively, it’s undeniable that an American or northern or western European leader who engaged in high-profile judo matches or tiger hunts would be universally ridiculed, and forced to stop – but Putin still finds plenty of time for these and othershirtless photo-ops as well.

The thing that brought about Glasnost was not the failure of any one political leader or the spontaneous outbreak of protests per se, but the no-longer-deniable economic failure of Soviet communism. Russia today is booming, and economic trends look to continue that boom. In a few months, Putin will once again be the de jure president rather than merely the de facto, the protesters will have given up, and Russians as a whole will so enjoy the fruits of economic growth and increasing geopolitical influence that hey will forgive Putin for his occasional spats of tyranny, political terror, and gross theft.

What the Iron Lady missed

First, the film was excessively focused on Thatcher-as-dottering-old-woman-LOL. This (1) occupied so much of the film it crowded out really interesting and important and dramatic political history, (2) was tiresome and pseudo-psychiatric in its presentation of her relationship with he deceased husband, and was (3) pretty tasteless, given Thatcher’s stature and the fact that she is still living. The movie’s portrayal of her dotage was cartoonish, and cruel at that.

On the bright side, Meryl Streep was fantastic; some of the scenes (especially of Streep’s entries first into Westminster Palace and then into Number 10, and then taking prime minister’s questions) were very well done; and it was refreshingly politically incorrect in its portrayal of boorish union behavior.

But the film, unfortunately, left out an iconic British institution: Fleet Street. This almost-sympathetic portrayal of the Iron Lady shouldn’t let us forget one of the most interesting and telling things about her, which was how she how she aroused the complete, utter, and obsessive hatred of the British press, and bien pensants and Socially Respectable people more generally. Their cries against her were self-contradicting, but all agreed, essentially, on what horrid shrew she was. She was an enemy of the poor and the working classes, who had risen above her station — a grocer’s daughter! She was a provincial xenophobe, who wanted to learn from those grotesque Americans! She was an idiot; and frankly elitist, as an Oxford grad! Was there any doubt that her regressive views probably came from her father, who was (did you know?) a grocer?

History has — as is its wont — largely redeemed the Iron Lady, and forced the culture industry to take a more measured view of her. But we shouldn’t forget their erstwhile revulsion (which is a risk, since those who hated her so intensely and obsessively are also those who have the luxury of writing our official histories). Rather, Thatcher should stand as a reminder of how, then, as now, the culture industry — the guardians of Officially Approved Views™ — is a nasty, intellectually narrow, middle-brow tribe, which will lie, slander, violate its own ostensible moral standards, and work itself and its cranky followers into fits, in its brutal attacks against those who violate the Officially Approved Views of which it has appointed itself the enforcer, especially when they seem to be having too much success (and they will feel even more confident in their attacks, when the objects are, say,  female, or originating from a lower social order).

She was without question the most impactful woman leader in modern Western history, but she was not and will not be claimed or celebrated by the clique of academic self-appointed guardians of the term ‘feminist,’ because she associated with the Wrong People and had the Wrong Views. Her life was an astonishing Horatio Alger story, of fearless aspiration and mobility, which really ought be held as an example to less-privileged school children — but it will not be, because, hateful woman that she was, she believed, e.g., that Britain was not obligated to provide miners a living so much as they were obligated to make themselves useful to society. The political narrowness and aggressive ignorance of our narrow clique of journalists, academics, cultural-enforcers, and intellectuals more generally means that Thatcher will never get the credit she is due, and others will. It sucks.

I know that it is considered unattractive and resentful or (worst) conservative to say these things. But I say them anyways because they have the (in my view) compensating advantage of being clearly true.