Friday, 30 November 2012

Graph(s) of the week: adapting to technology

The Economist produced a great video this week in which it analyzes the US daily newspapers subscriptions and circulation.

What's most interesting here is the analysis behind the recent success of the New York Times (NYT) and the Wall Street Journal (WSJ) and the downfall of USA today and LA Times. The reason in the divergence between these two groups of daily newspapers is in the adjustment of their demand to online subscribers. (see graphs below)

New York Times print and online circulation. Source: The Economist
Wall Street Journal print and online circulation. Source: The Economist
 USA Today and LA Times print and online circulation. Source: The Economist
This is a perfect example of an adaptation to the new technological environment. The technological change in people's behavioral patterns was recognized firstly as a threat to the newspaper industry but after a while it was embraced and adjusted to. Advertising online couldn't be the only source of income. They needed more online subscribers. 

This is also another good example of how it takes an exogenous shock like the crisis and the consequential loss of revenues for a company to realize that it needs to change. It was only after the crisis that NYT and WSJ changed their business model and saw an upsurge of their online subscribers (NYT actually has more online than print readers). This is an upcoming future trend that these companies need to adapt to in order to survive. If USA Today and the LA Times fail to do so, they will find themselves perishing.

Going back to an earlier text on technology and unemployment, this is what the aggregate demand shock implied in most professions. It was a signal that the business model needs to change and adapt. 

As the new generation of readers emerges there will be more and more people who are used to only reading news online. Even books are switching to new technologies like Kindle and it's a matter of time in a not so distant future where online readers will completely take over print readers (of both books and papers, but especially papers).

I'm mixture between the categories, as I read most of the news and commentaries online, but when it comes to books and academic papers I like to read them in print, since I like to write a lot of comments on them as I read. I've been told that things like Kindle have the option of inserting comments, but I still prefer the old-fashioned way. Maybe in 50 years (or less) future generations will find this kind of behaviour weird.

Thursday, 29 November 2012

CPS: "Seeking a dynamic recovery"

I started writing for the Centre for Policy Studies, an independent free market think tank, co-founded in 1974 by none other than Margaret Thatcher, and Sir Keith Joseph. This is where the "Conservative revolution [of the 80-ies] began". 

Here's a quote from Lady Thatcher about the CPS:
"I do think we have accomplished the revival of the philosophy and principles of a free society, and the acceptance of it. And that is absolutely the thing that I live for. History will accord a very great place to Keith Joseph in that accomplishment. A tremendous place because he was imbued by this passion too. We set up the Centre for Policy Studies, and it has propagated those ideas, and they have been accepted."
Margaret Thatcher, 1979

My first text for them, entitled Seeking a Dynamic Recovery, was mostly on ideas on how to ignite a dynamic recovery in Western Europe. It focuses on innovation, investments and trade as the essential principles for surpassing the productivity shock and achieving a higher level of wealth. 

Here's an excerpt from the text
"The situation in which the Western economies found themselves isn’t an isolated historical event. These situations happen quite often. The biggest difference is in the response to the shocks, or better yet, how the shocks are recognized. In the case of Sweden in 1992, Germany in 2003, or Estonia and Latvia in 2009, the faults of an old system were recognized and reformed. Whether this was an inflexible labour market, an inefficient tax system, burdensome regulations, or all three combined, the response was timely and efficient, and the results were a more sustainable growth model. 
In terms of current fiscal consolidation attempts it is important that all the reforms be mutually supported by medium term budget plans which will send credible signals to attract investors.
But this is harder to accept in many European countries where its citizens got used to a comfortable social safety net which has altered their incentives of creating value and generating wealth. Electoral pressures make the necessary reforms all the harder to do, but even the voters realize that the system must be reformed. Drastic times require drastic measures. The focus on austerity was a wrong approach primarily because it was done the wrong way (favouring increased taxation and minimal spending cuts), and more importantly, institutional reforms which were supposed to reinforce the government cuts weren’t implemented. 
Structural reforms to promote competitiveness, medium-term fiscal consolidation and a strong pro-business environment will enable the economy to pick up the momentum it needs to regain confidence and start growing again. No single policy aimed at short-term boosts will be of much help. Only a broad set of policies aimed at institutional reforms - like the ones done in the aforementioned countries - will signal greater confidence among businesses, consumers and the banks to innovate and invest in new ventures. Only then the true process of deleveraging can commence and new patterns of specialisation will emerge."
Read the full text here.

Tuesday, 27 November 2012

Reinhart and Rogoff on the crisis and the recovery

Carmen Reinhart and Kenneth Rogoff, Harvard professors and the authors of the brilliant "This Time is Different", did an interview for Barron's  last week on the causes of the crisis and the slow recovery from it. (In a post from November last year I summarized some of their main points.)

Read the whole interview, it's very interesting. In a majority of their arguments I agree with them, some of them I have used repeatedly on the blog. For example: 
"No two crises are identical. Policies differ, and political systems differ. But the common thread is this sustained buildup in a period of really bold optimism, often predicated on the expectation that if asset prices have gone up today, they are going to go up tomorrow and, therefore, we can borrow fairly indiscriminately without a problem. What was also very illuminating was that the U.S. wasn't alone. You saw Ireland, Spain, Portugal, Greece, and the U.K. with a very similar pattern of debt buildup. In all these cases, the U.S. included, they were fueled not just by borrowing domestically, but by borrowing from the rest of the world. All these countries have been running current-account deficits."
A desire to eliminate risk incentivised borrowing from abroad and high CA deficits that were used  to finance (both private and government) consumption rather than investment. This is the main point of my Eurozone crisis analysis and the central criticism of pre-crisis regulatory decisions and omissions.

On the recovery they say the following:
Source: Barron's 
" area where policy really has left a bit to be desired is that both in the U.S. and in Europe, we have embraced forbearance. Delaying debt write-downs and delaying marking to market is not particularly conducive to speeding up deleveraging and recovery. Write-downs are not easy. On the whole, write-offs have been very sluggish. 
Look at Europe. A lot of policies are directed at keeping European banks afloat, and it is crippling the credit system. You could have said the same about the U.S., where a lot of policies are about recapitalizing the financial system. The policy makers were very, very cautious about breaking eggs. The thinking was, "We just have got to hold out for a year, and it is going to be fine."
Big mistake that a lot of policymakers made. I wrote about this persistently back in October and November last year. 

US outlook:
"...over the longer haul, a comprehensive, credible fiscal consolidation is very much needed, because as much as we allude to the level of public debt, the level of private debt, external debt, and so on are even higher. And we also have a lot of unfunded liabilities in our pension scheme, a long-term issue that needs addressing.

But getting back to the earlier point about helping the deleveraging process, we have a credit system that is still working very poorly. It is very difficult for households to refinance. So we are not actually talking about taking on new debt, but re-contracting to get the benefits of lower interest rates."
On monetary policy they claim this is "not the time to be an inflation hawk", primarily because they see the debt deleveraging as the key process that needs to be done faster. I can understand that position, although I would be careful in proposing monetary policy as a long run solution, for reasons I outlined before

They also point out the high long-term costs of persistent deficits and high debt. The deleveraging process is key to both explaining the slow recovery, and to signal when it will be over. In the mean time they call for reforms:  
And then if you didn't just raise taxes or cut taxes but actually fixed the tax system, that would be very important. There are very good ideas out there on how to accomplish that. The baseline is a flat consumption tax of some form with a high deduction. The Simpson-Bowles plan takes the political middle road in trying to reach that. It's a great idea. You can have more revenue and keep incentives and maintain growth. And, lastly, other things, like infrastructure and education spending, are important. This isn't all about austerity versus no austerity. Countries that are successful in dealing with these crises, such as Sweden, sometimes take them as an opportunity to change. We haven't."
This was the point of my VoxEU text - it's not about the austerity debate, it's more about the opportunity and willingness to reform. As they rightly point out, the US, UK and most of the Eurozone failed in precisely that perspective. 

This is one part I don't entirely agree upon - the causes:
"In terms of its onset, it harks back to a lot of the liberalization of the financial systems in the advanced economies that enables a lot more risk-taking. And part of that risk-taking gets reflected in significant private-debt buildup. When we talk about having a debt overhang, it is not just about public debt, but also significant private debt, household debt, bank debt, domestic debt, and external debt. So this buildup began to show itself as an asset-price bubble, importantly in real estate—though that is not unique to this crisis. This is something that culminates with a lot of poor lending decisions, which became a banking crisis."
I agree that there was a mass liberalization of the financial system in the 90-ies, but for me it's the question of misplaced signals sent to the market in several areas, and particularly from regulators to the banks in creating an artificial demand for MBSs, for example: "By steering banks into buying MBSs, they were creating an artificial demand for these securities and henceforth an artificial demand for more mortgages which led banks into lowering their lending standards in order to create more and more AAA-rated MBSs." And all this came from the idea that risks can be eliminated with a good enough securatization. 

Bear in mind that these misplaced signals and artificial demand for mortgages were the causes of the housing market bust and the consequential filling up of balance sheets with what later proved to be toxic assets. These effects only revealed the pre-crisis unsustainable growth model. That's why reforms are important today. 

Anyway, read the interview and read the book if you haven't done so already.

Finally, based on their book's database here's a visual history of all the crisis in one giant poster you can order online

Monday, 26 November 2012

Gains from trade: case studies

Trade was covered only briefly on the blog so far (see here and here), but being such an important subject it deserves more attention. Today I draw on three examples, one positive, two negative, all three emphasizing the importance of trade on economic development, wealth etc.

The first example (the positive one) comes from the Economist's Free Exchange blog and the Wall Street Journal on the story behind the Mexican automobile industry.

After going through Tyler Cowen's "Mexico facts of the day" on how Mexico is today the world's fourth largest exporter of cars (after Germany, Japan and South Korea) hoping to surpass South Korea in a few years, and with a strong interest in conquering the Chinese market after already having a big role in the US car market, an article from March this year in the Economist comparing the automobile manufacturing industries of Brazil and Mexico, explains the recent outburst of Mexico's automobile export success:
"By throwing open its market under the North American Free-Trade Agreement (NAFTA) with the United States and Canada and a host of other bilateral trade accords, Mexico has become a base from which carmakers export to both halves of the Americas, and worldwide. Volkswagen, for example, makes all its Beetles and Jettas there. Although Nissan produces some vehicles at a Renault plant in Brazil, most of those it sells in Latin America come from two plants in Mexico. In all, 2.1m of the 2.6m vehicles produced in Mexico last year were exported."
UPDATE (27/11/2012): The Economist has a special report on Mexico this week. It still has a lot of issues to deal with (breaking up monopolies, internet availability, major institutional reforms), but its expanding trade, rising oil production and booming manufacturing are threatening not only countries in Latin America, but China as well (see this great article on its industrial advantages):

Source: The Economist

In comparison, Brazil is descending into protectionism (I advise you to read the entire article as it describes how two biggest Latin American economies tend to think about trade and industry, through describing their dispute over their 2002 free car trade agreement): 
"In contrast, Brazil's government sees the country's domestic market as an asset to be protected. And it sees imports from China, made even cheaper by the strength of the real, as a threat to its industry. “The regional economy has been threatened by predatory competition that has taken hold around the globe,” said Fernando Pimentel, the industry minister, last year. “Developed countries are those that have industry and we're going to protect our own.” 
Yet Brazil's growing protectionism risks locking in high costs. The country has “a competitiveness problem, not a trade problem,” says Ricardo Mendes of Prospectiva, a consultancy in São Paulo. Manufacturing's share of GDP has fallen from 17.2% in 2000 to 14.6% in 2011. Falling industrial production was one reason Brazil's economy grew by just 2.7% last year. The blame lies mainly with high interest rates and other domestic burdens."
Here once again lies the crucial difference, and the importance of openness as opposed to protectionism:
"Mexico's stance reflects the openness of its economy, at least to trade in goods (many service businesses in the country are in the hands of cosseted cartels). Its average tariff, weighted by the composition of imports, is 5.56%, compared with Brazil's 10.47%, according to the World Trade Organisation. In 2010 almost two-thirds of its imports entered free of duty, compared with just over a quarter in Brazil. 
Mexico suffered a big shake-out of its industry when NAFTA came into effect in 1994. A decade ago it saw several hundred thousand jobs in assembly plants go to China. But openness to global competition has made Mexico's surviving industries highly efficient. Industrial production has grown again in the past two years. Manufacturing's share of GDP has remained steady at between 17% and 18% since 2003."
I'd like to add just one point here on the first sentence of the upper quote on how Brazil sees the domestic market as an asset that needs to be protected. Opening your economy and accepting competition from abroad can only amount to raising the efficiency of the domestic economy and lowering the overall costs for the population. This raises wealth of the population since it opens room for new efficient ways of organizing production, creating value, or allocating capital and labour resources. 

Protecting the domestic market from foreign competition isn't helping it, not even in the short run. It's only making the situation worse by resisting a switch to a more efficient equilibrium and a higher stage of development. The current benefit of emerging economies of Latin America and Asia are its benefits of economies of scale or the new supply chains, but the point of all this is to help the economy reach a higher level of development where economic growth won't be an average 10% any more, but an average of 3%. Manufacturing industries, trade openness etc. will only help a country reach higher wealth faster. 

The final example on why trade is important is Gaza (a bit differently than the previous two cases). A paper from Assaf Zimring tells us of the significant negative impacts on declining trade flows during isolation. Here's the abstract: (HT: Tyler Cowen)
"This paper uses detailed household expenditure and firm production data to study the welfare consequences of the blockade imposed on the Gaza Strip between 2007 and 2010. Using the West Bank as a counterfactual, I find that being removed from world markets reduced welfare by 17%-28% on average. Moreover, households with larger preblockade expenditure levels experienced disproportionally larger welfare losses. These effects are substantially larger than the predictions of standard trade models. I show that this large decline in welfare may be due to a combination of resource reallocation and reduced productivity.

Using firm level data I find that the blockade triggered reallocation of workers across firms and sectors, especially from manufacturing to services, and from industries that use imported inputs intensively, or export. In addition, labor productivity fell sharply by 24%-29%. This decline was however significantly higher in manufacturing (45%) than in services (5%). These findings suggest that access to world markets did not only determine the location of the Gaza economy on a given Production Possibility Frontier, but also determined the shape of this PPF."
In the last blog post I mentioned Libya and its descent in 2011, followed by a rapid bounce-back in 2012. Another good example of the positive effect of openness on both relative and absolute wealth in an economy. 

Thursday, 22 November 2012

Graph of the week: Doubling your GDP

Is it possible to double one's GDP in a single year? Apparently it is:

Source: The Economist
...but only following a significant exogenous shock in the year before. 

Having seen this, I can't help at wonder is this what the demand-side economists mean when they say "broken window" is good for growth? So are broken windows good for growth? I stick with the conclusion of my earlier text and claim No, they are not. 

The graph above seems to suggest that Libya, with its projected growth this year of 122%, should be thankful for what happened in 2011 not only in terms of getting rid of a dictator, but also in spurring rapid economic growth and a swift recovery:  
"Libya’s economy shrank by about 60% in 2011, as the country descended into civil war and foreign oil firms evacuated their staff. Sharp contractions set the stage for rebounds, both economically and statistically. They can create a lot of slack—unused capacity or unemployed workers—that can be swiftly exploited when the economy recovers. They also create a smaller “base”, from which subsequent growth is measured. If a country’s GDP shrinks by 60%, it must grow by 150% just to restore its former size. Thus even if Libya fulfils the IMF’s forecast for this year, its GDP will still be smaller than it was in 2010."
Ok, maybe not that good of a recovery, but it's still impressive. 

So how does this relate to the aforementioned text on Are natural disasters good for growth? It all depends on the stage of development where a country finds itself in. Economies with low levels of capital stock but rich in resources and with a highly mobile, unused labour stock can quickly react to new inflows of capital (such as foreign companies opening up new refineries or mills) or re-opening old capital stock. Libya (and most of the countries on that list - Equatorial Guinea in particular reacted to discoveries of oil reserves) is a good example of this. 

As we can see from the second graph, Libya experienced a 60% decline of GDP in its revolutionary year. So a 122% growth is close to quickly bringing the country back on its potential output path. It was simply a matter of opening the oil refineries and continuing with the construction works that were shut down temporarily due to the revolution. 

In case of a natural disaster this capital stock gets destroyed, not shut down temporarily. This helps explain why Haiti isn't among the countries in the first table. And it can also explain why Japan or the US didn't recovery swiftly and abruptly after their natural disaster shocks. 

As for Libya, it will be restored in 2013 to its low, bad equilibrium. The recovery due to re-using the existing capital won't do any good for its future development nor will it be helpful in shaping Libya's institutions. Just as it wasn't helpful in Equatorial Guinea. They are both stuck in a lower asymmetric equilibrium from which the only way out is a reform of political institutions from extractive to inclusive. Libya made the positive effort of ousting a dictator, but will it be able to consolidate afterwards it is left to be seen.   

Finally, how is having two whole years lost just to bring the economy back to its previous steady-state level supposed to have any positive effect on a country's development? Provided that no institutional changes follow the recovery process. The case of Equatorial Guinea is different in that perspective as incoming capital stock due to the discovery of oil reserves did actually increase the country's potential output. But in Libya it only restored it to its previous bad equilibrium. 

Do you see my point? I can't understand the obsession of restoring the previous output path when the growth model operating under that output path was unsustainable. What is needed are new patterns of sustainable specialization and trade which are likely to bring a country to a higher potential output path. Once again, Equatorial Guinea did experience this, but it failed to adjust its institutions to support the new patterns of specialization and thus lead to a higher development stage. 

Saturday, 17 November 2012

Another one on tax hikes vs spending cuts

This is becoming one of the most frequent topics on the blog, just as much as the Eurozone was exactly around this time a year ago (in fact, November 2011 was the boiling point for the Eurozone crisis).

The debates on the recovery are still occupying most of the attention among economists, especially in perspective to elections and politics. These debates tend to be divided on the basic approach as to how are we supposed to initiate stronger economic growth. Those on a center-left political and economic spectrum often speak of negative consequences of the austerity approach, emphasizing the "austerity vs. growth" story. Their approach is to initiate a stimulus combined with higher taxes on the rich immediately (in the short run), and then combat the fiscal sustainability in the long run. The center-right economic and political arguments desire an immediate combat of the deficit and the debt (austerity) and want to do it mainly through spending cuts and tax cuts (in order to decrease the size of government in the long run).

The IMF is usually the biggest critic of the austerity approach. Their highly cited 2011 paper on expansionary austerity aims to show the negative short-term effects of a fiscal consolidation on economic activity by comparing two approaches: (1) the conventional approach that "identifies discretionary changes in fiscal policy using a statistical concept such as the change in the cyclically-adjusted primary balance (CAPB)" (this approach can be biased since non-policy changes like the stock market boom can eliminate potentially contractionary effects of the consolidation); and (2) 

"To address these possible shortcomings, we examine the behavior of economic activity following discretionary changes in fiscal policy that historical sources suggest are not correlated with the short-term domestic economic outlook. In particular, we consult a wide range of contemporaneous policy documents to identify cases of fiscal consolidation motivated not by a desire to restrain domestic demand in an overheated economy, but instead by a desire to reduce the budget deficit. As Romer and Romer (2010) explain, such fiscal actions represent a response to past decisions and economic conditions rather than to prospective conditions. As a result, they are unlikely to be systematically correlated with other developments affecting output in the short term, and are thus valid for estimating the short-term effects of fiscal consolidation on economic activity." 

So basically, they identify changes in policy motivated to reduce the budget deficit, not to respond to economic conditions. They refer to this as the "historical approach", or better yet "deficit-driven consolidations". 

Note how the IMF researchers follow the austerity vs. growth story, implying that the calls for austerity are only based on deficit cutting, and are in no way a response to improve economic conditions. This is, in fact, true since the current set of austerity policies in Europe are actually only aimed at cutting the deficit, primarily by using tax hikes, which is, as the paper later shows and which I have emphasized several times, a wrong approach. 

Anyway, this is their result:

"Our estimates imply that a 1 percent of GDP fiscal consolidation reduces real private consumption over the next two years by 0.75 percent, while real GDP declines by 0.62 percent."
Note the big difference in the results of the two approaches. The crucial point of the paper, I think, was to point out that conventional austerity economic policies are from the start based on faulty economic thinking (the idea of 'expansionary consolidation'). I don't think that's true for economists, but more for politicians using such an approach, since it is important to differentiate between various ways of using the fiscal consolidation approach. 

They do this by comparing tax-based and spending-based consolidations:

The conclusion they reach is very similar to the one from Alesina, Favero and Giavazzi (2012): spending cuts are much less painful and costly in terms of loss of output than tax hikes. 

Also, notice how private consumption is again (just as in Alesina et al, 2012) lagging the recovery of GDP. This means that private consumption will not lead the recovery, as the demand-side approach tends to think. Private sector investment will. 

In addition, Gareth Jones looks at how this relates to the standard Keynesian story:
"Notice that the graphs are saying that the tax multiplier is bigger than the spending multiplier, at least in these settings. Quite the opposite of undergraduate Keynesianism. This isn't the final word on the matter, but if you'd like to see another study of multipliers that doesn't fit neatly into the Keynesian box--and written by top New Keynesians--check out the abstract and conclusion of this paper by Blanchard and Perotti."
Here's from the Blanchard and Perotti (2002) paper: 
"The results consistently show positive government spending shocks as having a positive effect on output, and positive tax shocks as having a negative effect. One result has a distinctly nonstandard flavor: both increases in taxes and increases in government spending have a strong negative effect on investment spending."
So, once again, why are the politicians using the tax-based approach and not a spending-based consolidation approach? Even this behaviour of politicians is quite logical given the pressure they are facing to close the budget deficit and keep a favourable investment grade. My earlier text sums up the reasons: 

All the laid off public sector workers that are supposed to find jobs in the private sector are unable to do so since the private sector isn't hiring due to the many existing constraints it is facing. Unemployment starts to go up, supported by an increasing number of graduating youths for whom finding a job is now even more difficult, making the situation look bad for the politicians in power. This means that the politicians, under even more pressure to close the budget deficit, now need to cease spending cuts and stop firing more civil servants and bureaucrats, since they don't want to make the unemployment picture even worse than it already is. In addition, more unemployed would depress consumption even further. So the government then relaxes the spending cuts and public sector reforms and focuses mostly on increasing taxes to close the budget deficit. The government starts running out of options, as further spending cuts become politically unfavourable while increased taxation is needed to continue closing the budget deficit. 
What is missing is political will. 

Tuesday, 13 November 2012

Money and elections

Back to political economy again. The recently finished US elections offered a unique perspective on what campaign money can and can't do. 

And while the majority is worried that more money being allowed to circulate in campaign spending will inevitably result in the end of democracy, others claim that this election is proof that it won't.

There is an academic paper by Ansolabehere et al. (2003) "Why is there so little money in US politics", that claims that individuals, not interest groups, are the main drivers in campaign spending, that campaign contributions fall as a % of GDP, not rise, and finally that there is little relationship between money and legislator votes. They tend to overturn the traditional argument (conventional wisdom) that differences in campaign spending drive electoral outcomes. The strength of this argument in political science was exemplified by old regression models that could easily establish a positive relationship between money and electoral victory. However, with modern tools and approaches, newer findings, newer data and even field experiments money seems to play a significantly less important part in securing an electoral victory (assuming that an initial threshold has to be fulfilled). Garret Jones of EconLog has a nice sum up of the whole subject. 

In addition, the divergence between voters in America fails to support the argument that their votes can be bought, even with undecided voters in swing states. 

Is it a stimulus? 

But what occupied my mind in the whole money and politics debate is the total amount of money spent by both candidates. This sums up to around $7.4bn just on TV ads. Counting in for all other spending, plus the spending in the Republican primaries from the beginning of the year, the aggregate amount spent is very likely to go up over $10bn. (Also check out this video of money bombs from The Economist). 

This is an estimate from, run by the Center for
Responsive Politics, which usually tracks campaign funding.
Their direct estimate on total campaign spending was $6bn
So the main question is, should we consider this a fiscal stimulus to the economy? After all money was redistributed from the rich (donors) to the rest (media, gas, posters, etc). Think about it, those who directly  made money were the media (and indirectly via attracting more audience); all those who printed badges, signs, posters; the gas companies who supplied all the gas to travel cross-country; the auto industry which sold new trucks (provided that the parties bought new stuff, and didn't re-use their existing vehicles); PR firms; design experts (someone had to design all the wonderful posters and logos), and so on, and so on. 

In fact this sort of fiscal stimulus can be even more efficient than the usual type since there are no bureaucrats involved in distributing the funds to the real economy. The decisions on which product to buy are made based on price competition, not political favours (even though PR agencies are chosen a bit differently). 

What does make it a stimulus is the fact that the political campaign was a perfect example of an artificial one-off allocation of resources towards favourable industries. Favourable in this case is completely randomly determined, since neither of these industries strive on election campaigns (well, apart from badge and poster makers, and political PR firms). Finally, it's also a fair allocation, since the money was distributed (voluntarily, which makes it more fair than taxes, at least) from the rich (this includes interest groups), to the "real" economy. Maybe even some jobs were created. Perhaps this drove the September unemployment figures downwards (recall a similar phenomenon in the UK with the 2012 Olympic games). 

So will this significant fiscal stimulus help the economic recovery? No. Election campaigns, just like natural disasters, never before proved to have had any positive impact on economic growth or wealth creation. And since I mentioned the UK's Olympics job boost, the effect is likely to be similar for the US - temporary, and without any benefit in increasing confidence, reducing uncertainty, or inducing the banks to lend more. 

In terms of stimulating the economy, the campaign money will fall under the category of what money can't do. 

Does it boost chances to be elected? 

People still say this is a huge amount of money. But to what extent was it crucial for re-electing Obama? In a divided electorate, featuring a milestone for the future of the country, and crucial issues such as healthcare, the fiscal cliff, and the economic recovery, campaign money couldn't have made much of a difference. Candidate positions, attitudes and gaffs did. 

However, one might still say that in the primaries Romney won cause he had the most money riding for him, along with the biggest donor and organizational support. This is false as it fails to account for the omitted variable bias and reversed causality. As I've said before, Romney was from the beginning deemed the most electable candidate, so a majority of Republican donors with an interest to defeat President Obama immediately signed up to support Romney, seeing him as the most probable alternative. This means that strong candidates will attract cash as a sign of their strength and electability. More money won't cause their strength, it can only perpetuate it.

After all, when thinking of primaries we can go back to the elections of 2008, where the Republican party had the same case of one highly electable and probable candidate John McCain who attracted most of the party donations (and who had a much bigger across-party support than Romney ever did), whilst the Democrats had two equally deserving candidates pledging to win their party nomination: Hilary Clinton and Barack Obama. But it wasn't like this at the beginning of their campaign. At the beginning Hilary was the "most electable" candidate, as much as McCain was supposed to secure his nomination (or Mitt Romney). But the campaign of Barack Obama focused almost all of its initial spending on the first four states in the primaries. Obama won three (Iowa, Nevada, South Carolina) and tied in New Hampshire, thus gaining significant momentum. (This is where the importance of the initial monetary threshold comes in. It's all about how one uses the money). 

So this wasn't a question of money that helped Obama secure his party nomination, but a unique strategy of his campaign that gained him the momentum. 

Santorum tried to pull off a similar thing at the beginning of this year's Republican primary and out of nowhere became the main challenger to the front-runner Mitt Romney. Of course, it took him some time to gain that advantage and become the main challenger, but his initial win in Iowa (the first caucus state) ignited him and his chances. Before the victory in Iowa he had but a few percentages, where no one considered him a credible candidate to win. After that victory the donors came about. So again, money didn't cause him to gain strength, it emerged as a result of it. 

Saturday, 10 November 2012

Technological shocks and (un)employment

I ran across a great article from Ken Rogoff on Project Syndicate a few weeks ago where he dismantles the ever-present assumption among politicians and voters that new abrupt technological changes lead to massive unemployment.
"Since the dawn of the industrial age, a recurrent fear has been that technological change will spawn mass unemployment. Neoclassical economists predicted that this would not happen, because people would find other jobs, albeit possibly after a long period of painful adjustment.

By and large, that prediction has proven to be correct. Two hundred years of breathtaking innovation since the dawn of the industrial age have produced rising living standards for ordinary people in much of the world, with no sharply rising trend for unemployment. Yes, there have been many problems, notably bouts of staggering inequality and increasingly horrific wars. On balance, however, throughout much of the world, people live longer, work much fewer hours, and lead generally healthier lives.

...the basic point is that the market has a way of transforming jobs and opportunities in ways that no one can predict. [my emphasis]
For one thing, mankind will be confronted with more complex economic and moral questions as technology accelerates. Still, even as technological change accelerates, nothing suggests a massive upward shift in unemployment over the next few decades.

Of course, some increase in unemployment as a result of more rapid technological change is certainly likely, especially in places like Europe, where a plethora of rigidities inhibit smooth adjustment. For now, however, the high unemployment of the past several years should be mainly attributed to the financial crisis, and should ultimately retreat toward historical benchmark levels."
Rogoff raises a few excellent points. The most important one is that no one can predict the new way of transforming technological growth into new jobs and opportunities. In addition, technological improvements will always have a net positive effect on job creation in the long run. Here's some of the effects, summarized by a research done from the St.Louis Fed in 2001: 

Source: Chiodo, Owyang (2001) "Low Unemployment: Old Dogs or New
 Federal Reserve Bank of St.Louis
As you can see technological growth seems to be causing a downward shift in unemployment. However, their conclusions state that technological changes aren't the only cause, as there is strong evidence that a part of this decrease in unemployment was caused by the aging baby-boom generation. They assign these two factors roughly similar weights in explaining the decrease in unemployment. 

Since this was done in 2001, I tried to find more data to see how these effects continued in the next decade. I didn't take technology as an index but rather as a real value of total inventories in IT industries (let's think of this as a proxy of some sort). 

Source: St.Louis Fed, FRED database 
Overall, we can see unemployment and (a proxy for) technological growth moving opposite to one another. This is far from proving anything, but can be an interesting though for future research. 

The aggregate demand 2007-2009 shock and the impact of technology 

In an earlier text back in January, I covered a part of this topic as a reaction to the 'iPhone causing a loss of work' story in the New York Times. The story that got everyone worked up was that Apple's iPhone production being outsourced to China was causing a loss of manufacturing jobs in the US. In this case, a development of a new technology (not even a development, but rather an update, or whatever we wish to call it), caused a shift of jobs from the US to China. This was only one case in point, as many industries decided to switch production in the past decade due to a new shift in supply chains, and outsource a lot of business to Asia. 

As a result this made a lot of home workers redundant (both European and US), but there was no consequential job losses to follow, i.e. the Western companies failed to adjust their demand for labour back home. As the crisis struck, revenues decreased and it became to costly to keep all these excess workers employed. But the onset of the labour market crisis was a natural transition in the patterns of labour specialization where a range of constraints (mostly political) were holding back the restructuring in the labour market. In particular they were holding back the process of rediscovering new skills and new ways to create and sustain value. They were holding back the switch towards new technologies. Have in mind that prior to 2000s, only businessmen, bankers and diplomats had cellphones and laptops, the internet wasn't as nearly developed and used as it is today, and information was relatively scare (compared to today). Now we have a vast availability of information and a variety of new technologies at our disposal. This isn't just stuff for personal use (like ipods or smartphones), but for business use as well. Using outdated equipment meant facing bankruptcy. Using newer equipment meant a better way to create more value with less input (thus defying the central law of scarcity in economics). Sure this would cause an initial decrease of employment, but those workers would have been quickly rearranged into new productive sectors. A transition such as this usually takes up to a couple of decades, but in the midst of the recent crisis it developed rather quickly.

London's big shift 

An example in recent history always brings me back to the case of London and the UK. London (or the UK) was once a bearer of a proud and strong shipping industry (among other manufacturing industries), but got completely restructured into a world financial giant. What was once shipping and mining is now finance, forex trading, and insurance. The initial effect that made the change was technology. The significant development of the IT industry to support high-frequency trading and financial services made it possible for London to take advantage of this and position itself as a global leader (even though the UK wasn't the economic powerhouse of the world anymore). 

Think of the effect of this change on the labour market. Initially, after closing shipyards and mining mills, a lot of workers got redundant and lost their jobs. But after a while they changed occupations and moved to different careers, even though they probably never got over the fact that their industries were destroyed. Think of how this affected their children in the long run. Instead of working in a shipyard, the children had an opportunity to get a good education and move to a new industry - finance. Think of the significant increase of personal wealth this brought to the average family. And think of the significant impact on newly created wealth for the UK as a whole. Closing inefficient industries (or better yet, stopping to support them), opened up room for a range of other, better, higher-paying industries. No one can predict where the patterns of new specialization will end up, but provided that they are left without external interference  they are very likely to produce a much more efficient and sustainable outcome. 
It is also interesting to note how a restructuring of UK's and London's industrial advantage didn't come without significant resistance from those affected. Unions went on strikes to oppose these changes but the changes were made and more importantly, they were irreversible. Even though the unions and their members will never admit this was good for the UK economy, they too have been affected in positive ways and were offered better lifestyles and more wealth than before. 

This is why we need to let the labour market readjust, not constrain it with burdensome regulation. As Rogoff said, in Europe this is apparently much harder to do due to its existing constraints. In the US, it should have been much simpler, but it isn't (as you may recall from here). The question is who is constraining the US labour market from recovering and restructuring? 

Tuesday, 6 November 2012

Graph(s) of the week: US electoral predictions and results

Diverting from economics for a brief movement, and switching to politics.

Note: This was a two day post, the first part covering predictions, the second part covering the results. 


During today's (yesterday's) election day the New York Times had an interesting interactive feature in the form of a game theoretical "tree" where different outcomes were paired together based on the electoral result in 9 swing states. 

This is my prediction from yesterday on the outcomes in swing states (click to enlarge):

Source: NY Times, 512 Paths to the White House
As you can notice, my prediction is an overall Obama victory in a scenario in which he looses Florida, North Carolina, Virginia and Colorado to Romney, but retains victories in Ohio, Wisconsin and Iowa. I would have given both Nevada and New Hampshire to Obama as well (despite Romney's summer house being located in the former state). However the last two states wouldn't make any difference since the paring was made based on the relative significance of the swing states. 

The mechanism is very simple; you look at which candidate wins states based on their importance and size of electoral college votes. The first in line is a choice between who wins Florida. I put Romney. Then you go down the first big red line and pick a winner for Ohio (no backward induction this time I'm afraid). For Ohio I chose Obama. I gave the following two states to Romney to spice things up a bit (and to keep my line going). However, I ended up giving Wisconsin to Obama, moving me to a different equilibrium point. And so on, until you reach the optimal, predicted strategy. (ok, it's not really game theory, but it's kinda close)

I based my predictions on the latest polls from those states from Real Clear Politics (they have a decent aggregation of most recent polls), the Economist, NY Times, and my own hunches. There was also this web page, called Intrade, which was taking bets from investors on who wins the elections, and is very often a more precise estimator of the likely winner than electoral polls, simply because in here people actually put their own money at stake. I generally feel that expectations on who will be the likely winner reveal much more than the polls themselves. For example, during the Republican primary, Romney was trailing behind Perry, Cain, Gingrich and Santorum at several points during his campaign, but at every point in that time he was considered as the most electable and the most probable candidate. The same thing is with the race for President, where even though Romney was in the popular lead a few times, Obama always seemed as the most probable victor. This has interesting implications on behavioral political economy, and how expectations of certain outcomes can reversely affect the outcome itself.


Well, it seems I was a bit off, apart from the overall result: (click to enlarge)

Source: NY Times

It took Obama to win only the first two states on the "swing state tree", Florida and Ohio, to secure his victory. So that graphic from above is simplified to the first equilibrium point, where Obama retains Florida and Ohio and wins, regardless of the result in other swing states. 

Overall there was much less uncertainty regarding the electoral college vote. The popular vote was close, in the swing states as well, but that was hardly a surprise. The swing states weren't that "swing" after all, as they all, except North Carolina, ended up supporting Obama. In that perspective my predictions were right for all swing states except for Florida, Virginia and Colorado (the ones I though Romney would win). 

To sum up, not much has changed in America: same President, same Senate control (Dems), same House control (Reps). So far this combination wasn't particularly good for the recovery (recall the fiscal cliff debate in August last year, in addition to many further quarrels down the road). I hope things do turn out better for the US in the end, although it's hard to see how any of the two current political options would make that happen, in both the short and the long run. 

Monday, 5 November 2012

Are natural disasters good for the economy?

A classical Keynesian approach would suggest that they are. Consider the following example. According to the demand-side approach to kick-starting a recovery, getting governments and consumers to spend more will induce higher consumption, which will raise aggregate demand and ultimately result in higher short-run GDP growth, which will be the basis point for a longer-run restoration of the pre-crisis growth path. 

This theory implies that the government should step in and provide the jobs for those who lost it during the crisis in order to stimulate economic activity. In terms of pure logic, the government should attempt to provide even the most meaningless jobs like digging holes and filling them up in order to get more cash to consumers and incentivise their spending. 

But why is it better to pay the unemployed to dig up holes instead of simply sending them welfare checks every month? Well, since digging up holes adds to GDP as a newly produced government infrastructure investment. 

Hurricane Sandy "broke the windows"  

Bringing this to a more realistic level, let’s look at the applicability of this approach to the present situation in the United States. I’m referring to the hurricane Sandy of course, not the US Presidential election, although it’s hard to tell which event is likely to have a more adverse effect on the US economy. 

After the devastation caused by hurricane Sandy a lot of things need to be repaired, particularly in New York (see the gloomy outlook Arnold Kling predicts for NYC). The transport system and the electrical grid are priorities in restoring the city back to normal, in addition to cleaning up all the mess from the streets. All this requires hard work and more importantly more new jobs to help rebuild the shattered parts of the city and bring the people back to their homes. 

For demand-side economists this comes as a blessing in disguise, where the government is given an excuse to build or rebuild the existing infrastructure in a city as big as New York. Since there is a lot that needs to be repaired, many capital and human resources will now be reallocated into different productive activities and use resources in this fashion. This will create new jobs and redistribute a lot of income, which is supposed to incentivise more spending and give rise to aggregate demand. But the crucial point is that these resources could have been used in a much more efficient manner than rebuilding the economy if it hadn't been for the natural disaster in the first place. 

This sort of reasoning is typical of the broken window fallacy. But here’s what they miss:
The loss of key transportation infrastructure raises the cost of imports (food, construction materials, etc.), even as exports (financial services) go down. This drives down equilibrium real wages in many secondary industries (food service, for example), but the adjustment process is not at all smooth. Many small businesses fail and many jobs are lost.  
In order to remain ongoing concerns, many financial services firms will "temporarily" relocate to suburban offices and to virtual offices. These "temporary" adaptations will become so well entrenched that many of these businesses will not return to Manhattan. 
My favourite answer to all those who succumb to the broken window fallacy is: why don’t you let me smash all the windows on your house? This will create the job for the local glazier and you will redistribute your income to him. But perhaps you had different plans with your money. Now that you have to pay for your windows to be fixed, you won’t be able to, for example, take your family to a restaurant this weekend, meaning that you deprived the restaurant owner of his income. 
Source: Financial Times

By creating a job for one part of the economy you unwillingly deprive the other, perhaps more successful part of the economy of their income. You are sending a signal that the restaurant owner should go out of business as he won’t have any clients since they will all be spending their money on fixing their windows. 

This is a vast simplification but the point is clear. Destruction caused by a war or a natural disaster does not result in increasing wealth nor does it kick-start aggregate demand, primarily because most of the supply is destroyed. A war or a natural disaster is a type of an exogenous shock that also reallocates resources, but it is highly unlikely that this is the most efficient allocation. 

Natural disasters don't seem to increase GDP growth

In addition, so far the US experienced even worse and more costly hurricanes (see the graph above), and none of these seemed to have had a positive impact on raising GDP or increasing wealth, especially not in the local areas. Think of New Orleans after hurricane Katrina, or the BP oil spill, or even better, the Japanese earthquake and tsunami in 2011, and what they all meant for economic growth. 

Japan is particularly interesting as the destruction there was much worse than in the East Coast today. This exogenous shock translated itself across borders through trade linkages, and was blamed as one out of many causes of the double dip recession in the West. In addition, Japan did not experience a massive bounce back emerging after this event. (see graph below)

Source: Trading Economics
Neither will the United States. Don’t expect the Keynesian demand-side theories to work in this case.