Saturday, 30 March 2013

North Korea is at their technological peak

...or technological breakthrough. I don't see any other conclusion coming from this picture.
Do you?

Now the only question is, does this make their recent war threats credible enough?
(yes, I am being sarcastic)

Thursday, 28 March 2013

Tracking the recovery (3) - USA

"Tracking the recovery" section continues in its third edition from the start of the blog. The first version was done in February last year (featuring final data for January or December), while the second version was done by the end of July, beginning of August (featuring final data for May and June). Things were in much turmoil at the time, with severe confidence and uncertainty problems in the beginning of the year following the panic of November 2011, and significant volatility of confidence in the months to come following events such as Greece elections, Spanish bank bailout and other exogenous shocks. Notice that the pattern has more or less continued, except now the most recent exogenous shocks were Italian elections and the Cyprus bailout. The effects of these events on confidence will be seen later in the year, probably in the September edition of the Tracking the Recovery section. 

In the first version back in February 2012, I presented an overview of business cycle indicators and valuable sources useful to familiarizing oneself with the business cycle theory. I advise the current readers to take a look, simply to get a better idea of the difference between leading, coincident and lagging indicators, and why and where economists use them. The indicators I observe here aren’t necessarily the best ones, but they do have a certain reputation for precision and robustness. 

As was the case before, I start with the United States (for which there is a wide range of data available) while the next two posts will be concerning Europe and business and consumer confidence.

United States

Starting where we left off in July, the second half of 2012 was mixed for the US economy. After a 3.1% growth in Q3, the economy stagnated in Q4 growing at only 0.4% (BEA data). The reason was most likely the uncertainty regarding the fiscal cliff by the end of the year. The BEA also mentions are falling inventories, resulting from downturns in inventory investment in manufacturing industries and wholesale trade, declining exports, and a fall in federal spending on defense. In total, growth in 2012 was 2.2%, which is an improvement from 1.8% in 2011, however according to many still not enough for a robust recovery, and still way below the pre-crisis potential output. In light of this, I have read a couple of interesting findings of how the US potential output is actually much lower then perceived, so that the recovery isn't all that bad (I plan to write a separate blog on this topic).

Let's review some of the leading indicators to assess the US recovery. 

New housing building permits (a good leading indicator, as it provides insight into upcoming activities in housing construction and economic activity - induced in LEI)

Source: St.Louis Fed, FRED
The housing market is according to this indicator pointing to a decent recovery, and it could be a good explanation for some of the positive growth figures we saw in the past. I've wrote about this back in December when Goldman Sachs predicted the recovery using the graph on private savings and government deficits, and emphasized how the recovery in residential investments is supposed to be the driver of future growth. According to the housing permits leading indicator, it could be inferred that US growth will pick up and once again housing will be its driver. 

New orders in manufacturing: New orders in durable goods (maybe not so precise as a leading indicator for recessions, but may signal a potential recovery, although the indicator can be biased due to volatility in the transportation sector or defense which can drive monthly figures unexpectedly) - depicted in the upper left on the figure below (click to enlarge): 

As we can see most of the manufacturing orders indicators are improving, particularly in the beginning of 2013, following the passing of the temporary confidence blow due to the potential fiscal cliff crisis. The fiscal cliff threat still hasn't entirely passed, but so far at least in manufacturing businesses are showing positive signs of improved confidence and more spending and investment. Adding this picture with the one on the housing market, this set of leading indicators is showing significantly positive signals. However, this is still fragile and can be easily reversed following some temporary shock to the economy. Also, one should have in mind that these indicators only predict short-run future economic activity, and are bad at figuring out a structural problem to the economy, which the US certainly has. 

Fixed domestic investment (a powerful leading indicator that can drive aggregate demand; it falls faster during a recession and grows faster during a recovery than the GDP) - depicted in the upper left corner of the figure (click to enlarge):

Fixed domestic investment is consisted of non-residential (lower right) and residential fixed investment (lower left), where both seem to reaffirming the trend they had 6 months ago: a careful recovery in the residential category (for the first time showing a slight increase in trend) and a continued recovery of the non-residential investments. On the upper right graph I show the total business inventories as the only indicator that has reached its pre-crisis trend line of growth. This is a tough indicator to understand and explain, primarily since it's hard to tell whether an increase is due to higher expected future demand or pilling up stock due to overestimated demand. According to the rest of the indicators, the former might be the case (6 months ago, I made the opposite conclusion). 

Employment - population ratio: The first time I used an actual leading indicator - unemployment insurance claims - however, the increasing trend of people leaving the labour force made me switch last time to a much more precise and unbiased indicator.

And its showing still no sign of recovery on the US labour market. A lot of people are still out of the labour force and most likely will stay there until we see some improvement in business investment and private sector activity. Another explanation could be that this is the new "normal" for the US labour market, as many elder workers chose early retirement, but weren't replaced by enough new workers; there weren't as many, which is why the labour participation rate is lower. This is one of the arguments for lower than usually estimated US potential output: an ageing workforce. To this I would add a natural transition due to many old jobs being lost and new jobs that are yet to come (and would come much faster if it wasn't for the multitude of constraints preventing the re-specialization in jobs and skills). 

Finally, here is a joint, weighted-averaged US Leading economic index (LEI).

And it's the only indicator predicting a slowdown in the coming months. This is surprising after looking at most of the indicators that usually consist the LEI, and particularly with respect from the LEI measured by the Conference Board, which is showing an entirely different pattern:

Verdict: The uncertainty that was looming 6 months ago seems to be over for now. The fiscal cliff conundrum has passed without major casualties (for now), but fear is still present among businesses and investors, even though things seem to be going back to normal. As I've already mentioned, we need to keep in mind that these set of indicators can only point to a short-run recovery, and cannot foretell possible risks of outside shocks (these aren't stress tests) nor can point out to the underlying structural problems of the US economy. If more attention was divided into overcoming the US structural issues, even the short-run indicators would look more strongly than they are now. 

Tuesday, 26 March 2013

Mexico's new heights

There are a lot of promising trends happening in Mexico in the last couple of years. I have stumbled upon more positive texts on the changes in Mexico than in any other country. Thomas Friedman wrote in the New York Times a couple of weeks ago: 
"Something happened here. It’s as if Mexicans subconsciously decided that their drug-related violence is a condition to be lived with and combated but not something to define them any longer. Mexico has signed 44 free trade agreements — more than any country in the world — which, according to The Financial Times, is more than twice as many as China and four times more than Brazil. Mexico has also greatly increased the number of engineers and skilled laborers graduating from its schools. Put all that together with massive cheap natural gas finds, and rising wage and transportation costs in China, and it is no surprise that Mexico now is taking manufacturing market share back from Asia and attracting more global investment than ever in autos, aerospace and household goods."
I wrote about Mexico's trade policies once before, comparing them to the protectionism in Brazil and some other Latin American countries, and even though I warned that major institutional reforms are still to be done, their expansion of trade, rising oil production and booming manufacturing are sending positive signals on increasing levels of relative wealth and rising living standards in Mexico. And these positive spirits seem to be justified when one looks at the big picture of a once drug war stricken country.  

A particularly positive change was the one in office, even though it happened only a few months ago (December 2012). The win of Enrique Peña Nieto as the new President is certainly favourable in shaking up Mexico's unsustainable political concessions, corruption, and huge government orchestrated monopolies. Furthermore it will continue the predetermined path of a strong trade-oriented economy. It is a good example of what I emphasized back in April last year for Greece - political stability as the first pre-assumption for reforming an unsustainable economy. The second is a strong rule of law, and it is here where Pena Nieto is trying the most.

Several recent events point out to the changes in that perspective. One was the recent arrest of Mexico's leader of the Teacher's Union, Elba Esther Gordillo, one of the most politically influential and powerful figures in Mexico. She was accused of embezzling millions of dollars of the Union's funds for personal luxuries.  Even though this kind of news would trigger initial worry over worker's rights, it was a known fact in Mexico that the Union's President and chief officers were committing these types of frauds. The new regime has put a stop to this, which largely came as a surprise to the population who got used to seeing powerful persons escaping their punishment. 

The second example is an attempt to curb one of the countries biggest monopolies: telecommunications  thereby directly affecting the World's richest man, Carlos Slim. It plans to open it up to competition and break up the telecom empires controlled by Mr Slim. OECD has estimated that the lack of competition in the telecommunication sector is costing Mexico's economy $25bn per year due to high prices (see graph below). Acemoglu and Robinson divide a certain amount of attention to the success of Mr Slim, and all those alike him in their groundbreaking book "Why Nations Fail". They emphasize the difference in approaches that led to the enrichment of Mr Slim and his government initiated monopoly, in opposed to for example the enrichment of people like Bill Gates. While both Gates and Slim had similar incentives to control most of the market and establish monopolies, institutions in one country (the US) did not let that happen. Even when Slim tried to penetrate the US market in a similar way he does in Mexico, the US legal system prevented him from doing so. This example was a case in point how Mexico's failures are mostly institutional, meaning that Mr Pena recognized the right place of where to start. 

On the way to reforms
On the freedom index Mexico has improved mostly on open markets, meaning trade freedom and investment freedom, whilst still stagnating on the rule of law category (property rights and corruption). It is here where Mr Pena Nieto's government is expected to do the most. It's still a moderately free economy, but having a look at other similar reports, the trends seem to be positive. 

Its relatively high grades of investment and trade freedom are visible in the World Bank Doing Business Report, where it is ranked 48th (compared to the Latin American average of 97; in additional comparison  China is ranked 91st, Brazil 130th). It's business environment is relatively favourable, particularly in time it takes to start a business (doubling in efficiency from 2012 to 2013; only Chile is ranked higher) and get a construction permit. The problems still lay in registering the property and getting electricity, something that's mostly due to poor infrastructure. Overall in most of the categories Mexico seems to be improving. 

A similar pattern is visible in the WEF Competitiveness Report, where Mexico improved in ranking in the past few years, from 66th to 53rd. Corruption and high crime rates are still the most problematic factors recognized for doing business, in addition to inefficient bureaucracy, access to finance and restrictive labour regulations. There is still a lot of work left to be done and a lot of challenges left for Mexico and its President, particularly in the institutional environment (rule of law, property rights, fight against corruption and crime), but from the looks of it things are in motion. 

Source: The Economist
In the following video from the Economist, they praise his pace of reforms and welcome it as a big change from the previous administration particularly with respect to the accomplishments in the first three months in power. The government has focused on passing the "easier" reforms first, while leaving the tougher ones for later (which seems like a sound political strategy, as they first need to prove to the people that they are capable of reforming the system, and then ask once again for support to finish them and reach a new, more inclusive level of institutional development). 

The education reform and the breaking up of the telecommunication monopoly are the two reforms that people will respond to with highest praise. And it makes perfect logical sense to get public support for reforms first, before moving on to the really tough ones (like the fiscal reform).

The important factor is a broad-based public support in favour of reforms and against the vested interests. This looks like a good start of a new, strong Mexico. Let's just hope there Pena Nieto will have the courage and will to finish what he started, and maybe in a couple of years (more likely decades) we might see the reversed immigration from the US to Mexico.

Saturday, 23 March 2013

Graph(s) of the week: best from the 2013 Budget

Even though the focal point of attention this week was Cyprus, in Britain the central issue was the 2013 Budget, for which I found some policies encouraging but some of them deeply disappointing  implying that there Osborne still hasn't got a clue as to how to initiate the recovery. 

Anyway, from the Budget and the OBR report I found a couple of interesting graphs, some good, some bad. I start off with tax competitiveness and how the UK has significantly increased its competitiveness vis-a-vis the corporate tax rate cuts on KPMG's survey (the survey is based on businesses responding to the changes): 

Even in comparison the 20% announced corporate tax rate (in 2015) is beginning to look very good:

On this list, among the lower rates, the UK has by far the strongest institutional system and rule of law, thereby triggering positive signals to attract new investments. It's unfortunate for the US and Japan not to follow upon this. The US is particularly troublesome in this perspective especially with regards to the first graph and the business perception of their tax competitiveness. 

Moving on to the OBR report, with slightly worse off news regarding the slow recovery and declining Total Factor Productivity. First up is the output gap, estimated to be -2.7% in 2012: 

Using the same method they have calculated the declining Total Factor Productivity (TFP), which is starting to turn into a serious issue for the British economy: 

And it's a real puzzle: 
"...the cyclical indicators imply a sharp fall in trend TFP through 2012, which would imply that the economy has become noticeably less efficient in its ability to combine inputs to produce a unit of output. Given likely movements in the capital stock, this also implies a fall in trend labour productivity. A sustained fall in trend TFP and trend labour productivity seemed plausible during 2008-09, given the severity of the financial crisis at that time, its impact on output from the financial sector, and the consequences for capital allocation in the rest of the economy. In recent quarters, however, the financial system has not been under anything like the same strain (although it remains impaired)." (OBR, Economic and Fiscal Outlook, pg.31)
However, some explanations are afloat: 
"Output per hour and output per worker were 12 per cent and 13 per cent below their pre-crisis levels in the fourth quarter of 2012... In December we set out various possible explanations for very weak productivity seen in the UK economy since the 2008-09 recession, some of which imply a permanent hit to productivity and potential and some of which imply a temporary hit...
  • A recent ONS paper ... [looks at] firm-level data ... dispersion of productivity across firms in 2008 and 2009 has increased, with high productivity firms becoming more productive and low productivity firms less so, and in some cases experiencing negative productivity. This gives some support to the view that there has been an increase in the degree of misallocation of capital in the economy. The widening distribution suggests that some firms continue to operate despite low or even negative returns, potentially hindering capital flow to firms with higher returns.
  • A Bank of England working paper ... looks at the long and short-term effects of financial crises on labour productivity, capital and output. The findings support the view that credit rationing and impaired financial markets can negatively affect productivity. Banking crises on average are found to reduce the short-run growth rate of labour productivity by between 0.6 and 0.7 percentage points per year and permanently reduce the level of productivity by around 1 per cent for each year of the crisis. 
  • A paper by Goodridge ... investigates the exclusion of investment in intangibles from GDP... The authors argue that real output growth was probably underestimated in 2009-2011, but overstated in most of the 2000s, as a result of this omission. They believe this measurement error explains only a small part of the puzzle from the start of 2011." (OBR, Economic and Fiscal Outlook, pg.32)
I would add my arguments on distorted signals to employers resulting from the government's work schemes, where employers lack the incentive to hire but are encouraged to take the government benefit and pile up on some workers who aren't necessarily improving production or adding anything to the company. These are all just theories for now, with neither fully explaining the productivity downturn, but there could be truth in each of them. I believe this could be a fruitful ground for future research, especially for labour market economists.

Thursday, 21 March 2013

UK Budget 2013: the analysis

Similar to what I did last year, this year I will once again analyze the new UK budget announced yesterday by the (downgraded) Chancellor George Osborne. 

The initial reaction is actually better than last year, except for some policies which haven't changed and some new woeful ideas. You can read summaries of the budget from a variety of sources: Financial Times, BBC, Telegraph, Guardian, CityAM, think tanks (ASI, IEA, CPS) or watch this interesting video from the FT:

Before we move on the budget itself, the UK Office for Budget Responsibility issued their revised growth forecasts, and things still look rather gloom for the UK. Growth was revised to 0.6% this year and 1.8% in 2014. (Last year the prediction was 0.8% in 2012 and 2% in 2013 - so take the prediction for the recovery in 2014 with slight suspicion, as it always is with growth forecasts). Employment figures still seem to be increasing (even above forecasts), and with stagnating GDP this implies that productivity is still poor. Here is an interesting finding: 
"Business and consumer surveys, and other cyclical indicators, suggest that spare capacity in the economy was flat or shrank in the final quarter of 2012. This would imply that the weakness in output over this period was structural and that trend total factor productivity (TFP) had contracted. As in December we believe wider indicators are hard to square with severe renewed structural weakness. So we assume that the output gap was -2.7 per cent of potential in the fourth quarter, consistent with flat rather than negative trend TFP growth over 2012." (OBR, Economic and Fiscal Outlook, pg.8)
This is in my opinion the biggest worrying sign for the UK at the moment. And I'm surprised very little is being done to fix it. Expectations of a short term boost to the economy by the Chancellor's policies aren't enough and they haven't been enough for the past three years. 

Let's go through the budget itself. A positive thing is a cut of corporate taxes to 20% (the main rate) in 2015, which will present a total decrease of 8 percentage points (from 28% in 2010) in just 5 years. A brave and commendable policy that the businesses will welcome.  

The personal allowance was raised to £10,000 by 2014 (ahead of schedule), which is a welcomed move and an indication that this may go up ever higher to equate the minimum wage rate in the years to come.

I'm particularly happy to see employer's national insurance bills cut by £2000 for every company, which will hopefully present an even stronger boost to employment. Furthermore, this move will take out 450,000 micro businesses out of the Employer's NIC altogether. I have proposed in my paper for the ASI "Unburdening Enterprise" a complete abolishment of the Employer's NIC, however this is a move in a positive direction, particularly with respect to those businesses who are taken out of the system. 

What the Chancellor failed to do is to reverse the 5.6% increase in business rates which still present a significant cost for businesses, and has failed to overhaul the regulatory system and the tribunal claims. Without a complete pledge to focus on enhancing competition, improving productivity and resolving some of the largest structural issues for the British economy there will be no significant recovery and Britain will persist in this growth-less recovery and completely emulate the Japanese lost decade(s). 

As for other important measures, the 3p fuel duty rise was scrapped, together with a 3p rise in beer duty (this has actually been cut by 1p). Budget cuts of 1% have been announced for most government departments in the next two years (with schools and the NHS being exempt from this), while the 1% cap on public sector pay was extended to 2015/2016. There is also a long term infrastructure program announced that is prepared to give an extra £15bn for new road, rail and construction programs by 2020, and a range of other baked and half-baked solutions aimed at some sort of a short term boost, with questionable outcomes. With such schemes the government is still picking winners and favourable industries, while spending and borrowing are still rising (still no sign of a proper fiscal consolidation).  

The Bank of England was called to do more monetary activism to help the real economy, but the 2% inflation target remained intact. However, it has given hints that the BoE should focus more on growth and employment figures as well as inflation (so closer to the FED model, I think). Anyway, market monetarists probably won't be too happy, but at least the interest rates are kept credibly low, with the dubious funding for lending scheme scheduled to carry on. 

Now for the really problematic policies. The most worrying one is the Help to Buy scheme. This is the idea to issue taxpayer guarantees to risky mortgages in order to boost mortgage lending and base the recovery on the housing market. Here is Alistair Heath's comment:
"Help to buy is made up of two schemes – an “equity loan” where the government lends buyers who put in a five per cent deposit up to 20 per cent of the value of a new build home and a “mortgage guarantee” where lenders will be incentivised to make more mortgages available, with the government shouldering a vast amount of risk. Both these policies are absurd and will merely push prices up, while encouraging people to take on excessive risks."
This sounds painfully close to Krugman's suggestions to Alan Greenspan in 2002 to initiate a housing bubble to offset the NASDAQ bubble. I am very surprised that the policymakers have so quickly forgotten the lessons from the 2008 mortgage market collapse. These types of guarantees is exactly what Fanny and Freddie were doing in the US in the past decade and what has caused an never-before seen bubble on the mortgage market. Not to mention the consequential artificial demand created for mortgages, upon which a whole range of financial products were being built. A disaster was looming. And with a similar scheme (just like with credit easing), the Chancellor is doing the opposite of what he is supposed to; instead of reforming Britain and enabling a new sustainable growth model, he is building the recovery (or what he hopes to be a recovery) on the worse possible incentive for a short term growth boost. Too much politics, too little economics. 

Tuesday, 19 March 2013

The Cyprus bailout

This week the negotiations in Cyprus over its fragile banking system reached a new low. Cyprus was given a 10bn bailout (they desired 17bn initially) from the Eurozone to recapitalize its banking system, with the price they have to pay for this being dire. This radical bailout plan forces a 9.9% tax on deposits over 100,000, and 6.7% on deposits under 100,000. Unlike previous bailouts in Greece, Portugal or Spain where bond-holders took a big cut, this is the first time a bailout proposal will fund itself from peoples' savings. The signal this is sending is that small savers (not responsible for the crisis) should be punished while the bond-holders who willingly took risks should be protected. Needless to say such a bailout proposal is very likely to turn into a disaster for the domestic economy. Investors were spooked, the people went to the streets, mainly to pull out their money from banks, while markets dropped at the sight of such news at the start of trading day on Monday. 

This time the policymakers actually caused a bank run. Touching into people's savings is an extremely risky policy, particularly if it comes from a government considered to be incompetent. The situation resembles the one that has happened in Argentina in 2001 under the Corralito, where an exchange rate depreciation was made that has reduced the people's savings by three quarters. This is what caused huge riots and an immediate bankruptcy of the Argentine economy. Even though things aren't as radical in Cyprus at the moment, the Argentine case is a good example of what happens when peoples' savings are tampered with. It leads to panic, bank runs, riots and protests, immense political instability, great economic distress and altogether it completely rules out any chance for recovery any time soon. 

It's not only the immediate problem of capital flight; such a move would trigger an even worse long-term deal where savers will be completely discouraged from ever depositing their money in Cypriot banks. Both domestic residents and particularly foreigners. It won't be long until a number of Russian citizens (who account for half of the deposits in the country) start pulling their money out of Cyprus. It seems that Cyprus will be a tax haven no more (they were forced to raise their corporate tax rates by 2.5 percentage points as well). And this was actually the crucial part of the negotiations over the plan. It is easy to understand why Eurozone (Germany) was reluctant to drop a lot of money on Cyprus only to save wealthy Russians.
The markets reacted with disturbance after the bailout
 deal was initially announced. The bounce back could
 have been explained by the fact that Cypriots rejected
the proposal, which would be a precedent where a
rejection of the bailout proposal sent positive signals
onto the market. Enough said. Source: The Economist

So, even if we can somehow justify the tax rate on deposits higher than 100,000, as this will mostly strike wealthy Russian depositors with money of dubious origin (so it is claimed), the levy on small savers is completely unfair and self-defeating. But there could be an explanation for this as well. Schumpeter, the columnist in the Economist, has a good idea why: "The most plausible explanation is that the Cypriot government itself preferred to spread the pain rather than wipe out non-resident depositors and jeopardise its long-term prospects as an offshore financial centre for Russian and other money."

Regardless of their motives, the idea is still an economic disaster, particularly if one thinks of how this news will transcend itself across the continent. This is a dangerous precedent that discourages savings and keeping money in banks. With enough problems as it is with banks not lending, more people pulling their money out and lowering their deposits would stifle bank lending even further, thus completely diminishing Eurozone's chances for recovery. And this time the blame will fall on Europe's policymakers who are proving to be completely incompetent in solving crisis situations. Greece and Spain were good examples of this, Italy shot itself in the foot, and now Cyprus is likely to turn into the worse solution yet. 

I will end with the following thought
"The bail-out appears to move Europe further away from the institutional reforms that are needed to resolve the crisis once and for all. Rather than using the European Stability Mechanism to recapitalise banks, and thereby weaken the link between banks and their governments, the euro zone continues to equate bank bail-outs with sovereign bail-outs. As for debt mutualisation, after imposing losses on local depositors, the price of support from the rest of Europe is arguably costlier now than it ever has been."
P.S. I have been corrected that the tax levy is not a tax on deposits per se. It is a one-off levy for which the depositors will be compensated by with the equivalent  amount in shares in their banks. For more details see here

Oh, and the banks have been shut until Thursday to avoid a bank run until the deal is done. Parliament is scheduled to vote for the deal later today, and it is expected to change the levy for small depositors. 

Thursday, 14 March 2013

Public Choice Society Conference final thoughts

After the final day of the conference which was on Sunday and after spending a few days travelling back home (!) my final impressions of the conference are overwhelming. I was very pleased to have had the opportunity to meet with some of the best and brightest minds in the field of public choice theory. From Nobel Prize winner Vernon Smith, Geoffrey Brennan, Iain McLean, Charles Plott, Norman Schofield, Richard Wagner, Ed Lopez, Peter Boettke, Randall Holcombe, and many more, including young scholars who are yet to excel in the field. I was excited to witness the mixture of both senior, established scholars and professors, and the young PhD students and assistant professors, all joined together in celebrating the acomplishements of the field of public choice theory. 

Having said enough already on the conference itself (see previous two posts), I promised I would finish the coverage with my impressions on some of the papers I've had a chance to listen to. I won't rank them, I'll just point out the most interesting ones (from the ones I saw, meaning that I will necessarily have to leave out some surely impressive papers).

I really enjoyed the papers on institutional economics and corruption, as these were the two subjects I am most involved in at the moment. From that area I particularly enjoyed the presentations from Randall Holcombe on "Institutional quality and the tenure of autocrats" (co-authored with Chris Boudreaux), and Karl Dunz on "Macro shocks, regulatory quality and costly political action" (co-authored with M. Dorsch and P. Maarek). They both had very similar conclusions which is why I draw them together. The first paper presented by Holcombe reached a conclusion on how autocrats are able to increase their tenure in power if they increase the quality of domestic economic institutions (a sort of a benevolent dictator hypothesis). The paper by Dorsch, Dunz, and Maarek draws similar findings where they test two theoretical hypotheses; the first saying that negative growth shocks are more likely to lead to a protest in autocracies (a finding well confirmed in the field by many papers so far), and the second new hypothesis claiming that there will be a smaller probability of protest in autocracies with better regulations (read institutions). Interesting as the findings may be, I was primarily concerned with the empirical approximations of institutional (or regulatory) quality, with the use of the Fraser Institute freedom index. I have no objection to the index itself but I do find possibilities for reversed causality as perhaps richer countries can afford better quality institutions. This was the reason why Acemoglu, Johnson and Robinson in their paper "Colonial Origins of Comparative Development" try to use a different approach in estimating institutional quality (they look at settler mortality, which is applicable in their case as they observe colonial development, but can hardly be applied in the modern autocracies - some other IV should be thought of instead). In the same session as prof. Holcombe was Andrew Young's paper on "Sovereign debt crises and institutional quality" (co-authored with J. Bologna), which aims to prove Robert Higgs's claim that crisis episodes tend to lead to an increasing size of government over the long run. 

In a similar set of topics in day 2, I found interesting papers in the "Corruption, Freedom and Growth" session, by D. Spengler on "Endogenous detection of collaborative crime: the case of corruption" and by S. Jones on "Why security is but a symptom: understanding the persistence of state failure". I also enjoyed the sessions "Polycentric collectivity in public finance" and the papers from Da Empoli on the preference revelation for public goods, and Wagner on free riding. Their follow up discussion was particularly interesting. Another good one was the first one I went to on "Value and preferences of voters" where I liked Alan Hamlin's paper on "Conservative value" (co-authored with Geoff Brennan) and Alexander Funcke's "Making empathy obsolete: changing norms and enforcing conventions", which draws coherent findings on the possibility of change in society's informal institutions (from a very interesting viewpoint and a fun game theoretic analysis). 

I went to every plenary session and every panel discussion where I had the chance to listen to and meet some of the greatest authorities in the field. This has unfortunately made me miss some other interesting paper presentations, but I feel no regret as all of the papers were available to me on the Conference webpage. 

For example it was a shame to miss the session on "Empirical papers on institutional change" where I had my eye on "Democratic transitions and institutional change" by M. Rode (co-authored w/h C. Bjornskov) and "How do institutions change?" by G. Caballero. I was also unfortunate to miss out on the session "Corruption evidence" which was mostly preoccupied with alternatives to measuring corruption and concrete evidence on it. "Development and the size of government" was another good one, as well as "Political budget and business cycles" and "Regulation, market failure, and government finance" where I was particularly interested in the presentation of prof. Munger's paper "The anatomy of government failure". 

But anyway, the plenaries and the panels were good enough of a substitute. The particularly good ones were the Special tribute to James Buchanan, and the other tribute to the Ostroms, the plenary on Experimental Economics (chaired by Vernon Smith) and the panels on Brennan and Lomasky's book "Democracy and Decision: The Pure Theory of Electoral Choice" and the panel comparing Lawrence White's "The Clash of Economic Ideas" and Leighton and Lopez's "Madmen, Intellectuals and Academic Scribblers". The very last session was also an interesting one on the Future of Social Choice, where I particularly enjoyed the speeches from Christian List and Iain McLean. 

All together it was a truly memorable event and I hope to be going to more of these in the foreseeable future.

P.S. here is once again the paper I presented, with the abstract available below:
"The paper examines how is it possible for an incumbent political party to stay in power for long periods of time without having to trade-off rents for holding office. It presents a new way of explaining and measuring the real effects of rent-extraction on political re-election in local government. It models local government due to the different and exact way rent-extraction can be measured there; through pork-barrel spending on public goods upon which a political party is able to extract rents. By setting rents as an endogenous variable the paper alters certain typical assumptions of political agency models, which permits it to evaluate their effect on political re-election and preservation of power in a more realistic scenario of politics. 

The incumbent’s decision on budget redistribution and rent-extraction directly affects the state of the economy upon which the voters decide whether to re-elect the incumbent or not. Incumbents make their decisions based on observing a stochastic growth shock which affects the next period budget redistribution. In a repeated game setting an incumbent chooses an optimal strategy with respect to the observed shock. This way, for high enough levels of economic growth an incumbent party may stay in office for an infinite amount of periods and keep maximizing rents with respect to the given constraints, without having to trade-off rents for holding office. The paper presents empirical evidence on United States gubernatorial and state legislature elections from 1992 to 2008 to evaluate the underlining theory."

Sunday, 10 March 2013

Public Choice Society Conference Day 2

The Conference continues. Today the conference was even more exciting and fulfilling than yesterday, with several plenary sessions lifting the experience altogether. 

I started off by attending the "Institutions and Entrepreneurship" session to look into a paper on how informal institutions influence entrepreneurial spirits (or at least this is what I was hoping to find out). Unfortunately that paper is still a work in progress so I haven't had a chance to find out more, but the author gave me a promise that in the next couple of months he will continue his work on this very interesting topic. I'm interested in the idea purely from the perspective on how informal institutions influence the incentives to become an entrepreneur in different economies. In particular how can formal institutional changes affect the low quality informal institutions (meaning norms, customs or mentality preventing entrepreneurial ideas from happening), in order to generate better economic outcomes. 

After this there was a plenary session chaired by Nobel prize winner Vernon Smith on "Experimental Economics", featuring speakers Charles Plott, Daniel Houser, Bart Wilson and Ryan Oprea, who all had an interesting point of view on explaining the importance of naturalized experiments in economic and social science research. After this there was a panel discussion on Brennan and Lomasky's book "Democracy and Decision: The Pure Theory of Electoral Choice", (20th anniversary of its publication) which I just recently read and was hence interested to hear what Heckelman, Munger and Vanberg had to say as a comment. 

Because of this I had to unfortunately miss a promising session on "Empirical Papers in Electoral and Institutional Change", where two papers in particular caught my attention; "Democratic Transitions and Institutional Change", by Rode and Bjørnskov, and "How Do Institutions Change? Economic Institutionalism and Theoretical Approaches to Institutional Change" by Caballero, along with some others as well. 

The awards luncheon that followed afterwards awarded the best papers published in Public Choice in 2012, and presented us with two new tributes to the Elinor and Vincent Ostrom and James Buchanan. Same as yesterday, the tributes were very touching and respectful towards these three biggest names (or at least some of the biggest names) in public choice theory and social sciences altogether. I found the video commemorating James Buchanan on youtube: 

Afterwards I attended the session on "Corruption, Freedom and Growth", followed by the final plenary on the "Future of Social Choice and the Past Presidents of the Public Choice Society", chaired by Bernard Grofman and featuring presentations from Christian List, Iain McLean, Norman Schofield and Maxwell Stearns. Needless to say they were a great ending to another fruitful day at the Public Choice Society Conference. 

Saturday, 9 March 2013

Public Choice Society Conference Day 1

I'm at the Public Choice Society 50th annual conference this weekend, being held in New Orleans, presenting my paper on Persistent Electoral Success with Endogenous Rents on Sunday. The conference program is available here. For those yet unaware of the Public Choice Society, it has for years been the forefront of both theoretical and empirical research in the field of political economy (well, public choice theory to be precise). The Society was founded by James Buchanan and Gordon Tullock in 1963 and has since been an active advocate of progressive research in social sciences. Its current president is Edward Lopez, while past presidents include an impressive list of names, from Mancur Olson, William Riker, Dennis Mueller, Peter Ordeshook, Vernon Smith, Vincent and Elinor Ostrom, William Niskanen, Geoff Brennan, Randall Holcombe, and of course the founders (Tullock and Buchanan) to name only a few. It is affiliated with three journals; Public Choice, Constitutional Political Economy and the Review of Austrian Economics. It's also closely affiliated with George Mason University, where the Center for Study of Public Choice is situated along with the IHS and many brilliant economists and political scientists.
The conference itself is featuring over 250 presenters and guests and provides a unique opportunity to find out the newest research in the field, and encounter a whole range of interesting ideas that necessarily spur ones intellectual curiosity. 

So far, after the first day has passed, my impressions are exuberant. I'm gonna try to sum up some of the most interesting parts of the conference's first day. 

Today we had two Plenary sessions, one devoted to the late James Buchanan and the other one to the late Elinor and Vincent Ostrom, where we had an opportunity to listen from those who worked with these extraordinary political economists first hand. In my opinion, Brennan's portrait of prof. Buchanan was particularly touching, even though the presenters of the Bloomington School, Roberta Herzberg and James Walker, offered us an even more personal approach into the lives of Elinor and Vincent Ostrom. 

Apart from the Plenary sessions there were also a bunch of other regular sessions, out of which many very interesting ones, however the time and size constraints led us to choose only a few to attend. I sat down for "Value and Preferences of Voters" in the first morning session, "Institutions and Fiscal and Political Outcomes" in the afternoon session and a panel on two great books, The Clash of Economic Ideas by Lawrence H. White and Madmen, Intellectuals, and Academic Scribblers by Wayne A. Leighton and Edward J. Lopez, in the early afternoon session. I don't regret either of my choices even though I missed on some great topics such as "Development and the Size of Government", "Corruption Evidence", or "Political Budget and Business Cycles".

I won't yet talk about the individual papers I've listened to (or read), I want to leave that for last and pick out the ones I thought were most interesting (to me at least). In the mean time I'll keep enjoying being part of the intellectual forefront in political economy.

Monday, 4 March 2013

When comedy turns into tragedy

Italian electoral results were funny to me at first. I was entertained by the fact that  25% of Italians voted for an actual comedian lacking a serious political program, thus fully emphasizing the absurdity of the Italian political system. Usually these types of ridicule parties such as Mr Beppe Grillo's don't get more than a few percentage points of the total vote. They participate in public debates, make a few people laugh, but no one really takes them seriously. This time they did (ironic, isn't it?). To analyze the reasons of their electoral success would be beyond the point of the text and the blog itself (there is a variety of potential factors that can explain this, some also mention the frustration of young people expressing their anger against the political elites). 
I at first considered the results as a clear signal Italians sent to their vastly corrupt political elites incapable (and unwilling) of tackling corruption, special interests, the judicial system and the inefficient public sector.

However, then I realized that Berlusconi's coalition got even more votes than Grillo's Five Star Movement, and only slightly less than Bresani's coalition, thus once again enabling him to become a recognizable political force in Italy. It stopped being funny then. And it all turned into a potentially dangerous gridlock further crippling the country from continuing it's fragile recovery. 
Source: The Spectator
The reaction of the markets was swift both across Europe and on Wall Street (calling it the "worse possible outcome"), thus again stressing out the importance political will can have in solving or further extending the crisis, and how sensitive markets get on electoral results. This is both good an bad for the same reason - we still depend on politicians initiating the institutional reforms that will resolve the countries' accumulated systemic instabilities.

It's a shame for Italy to find itself in such a pickle just after things started to improve (at least on the bond markets). While Spain and Greece were falling deeper and deeper, Italy was seemingly offering hope that reforms would work. Even though they were incomplete they did work and started giving hope that Italy will pull itself out of the recession and initiate a new growth model sometime before the end of this decade. However, the voters obviously weren't prepared for this. As the Economist's Leading article said, just like in France last year, Italians ran away from reforms, and are following the path of economic and political decline that has characterized Japan in the past two decades. 

The electoral gridlock has other important consequences:
"In the meantime, the worry is of no progress with the reforms that are desperately needed to restore vitality to an asphyxiated economy. To do nothing, as Italy’s voters seem to wish, is not the answer to the country’s problems. Italian GDP per head has actually shrunk during the euro’s first 13 years of existence. This performance has little to do with a lack of demand caused by excessive fiscal austerity, as some euro critics loudly claim. It has everything to do with year after year of steadily rising labour costs and falling productivity, which have undermined Italian competitiveness and exports. If Italy’s government cannot regain lost competitiveness and reignite growth through greater liberalisation of its labour and product markets and reforms to the country’s legal and welfare systems, the economy will suffer, and youth unemployment will climb even higher than today’s 36%."
It is obvious that this is not a good solution. It's far from being sustainable and the longer Italy will choose to take this path, the longer will it take for them to achieve any kind of robust economic growth. But since Italy is not an isolated country (on the contrary, it's the third largest economy in the Eurozone), this draws serious implication to the rest of Europe. The Economist predicted a gloomy outlook for the Eurozone as a whole, where more and more electoral results are rejecting the current austerity plans
"But without growth, Italy will not be able to service its debts. The possible pattern is clear: a series of crisis meetings, a few half-hearted efforts at reform to buy off Germany’s Angela Merkel, not enough growth, too much austerity, and then another crisis. The euro survives, but at immense economic cost. The euro zone becomes Japan."
However, it's not that there are no positive examples out there. But in order to emulate them, political will is crucial. Which brings us back at the start.