Friday, 21 February 2014

Week links (4)

Another edition of the best from the rest in the blogosphere and beyond:

1. Ryan Avent, "Labour markets: A theory of troubles", The Economist, Free Exchange blog - a great article on the productivity puzzle that has been going on for quite a while. Here are some of the key trends in the past 30 years (during the ongoing third industrial revolution) that he summarizes: 
"Since the early 1980s, labour markets have polarised or “hollowed out” (Employment in high- and low-skill positions has risen substantially relative to middle-skill jobs.)
Polarisation is mostly attributable to elimination of “routine” tasks by trade and technology (automation and trade are responsible for displacement of routine tasks previously done by middle-skill workers, in both manufacturing and clerical or service activities, leading to polarisation of local and national labour markets)
Since the early 1980s, polarisation has occurred almost entirely during recessions

(This pattern is linked to the phenomenon of “jobless recoveries”, which followed the recessions of 1990-1, 2001, and 2007-9 but not earlier downturns)
The jobless recoveries of the past generation have been characterised by a change in the cyclical behaviour of productivity (It has since risen relative to trend in recessions and fallen relative to trend in expansions)
Productivity-rich recessions, and jobless recoveries, are a product of sticky wages (Productivity therefore rises during recessions—rising most in industries where wage rigidity is most binding—reducing the incentive to take on new workers despite relative wage flexibility among the unemployed)"
Read the whole thing, it's very intuitive.

2. "Massive open online forces", The Economist, Free Exchange, the print edition - add to this the Schumpeter column from the same issue last week where they discuss how the open online courses (MOOCs) are presenting a real threat to some business schools, and more importantly how these business schools, who should be teaching their students (MBA grandaunts) how to adapt to an ever-changing environment, are themselves failing to do the same. 

3. Nicholas Kristof, "Professors We Need You!", New York Times - expressing a concern that the vast academic knowledge available out there simply isn't being used to its fullest capacities. 
"A basic challenge is that Ph.D. programs have fostered a culture that glorifies arcane unintelligibility while disdaining impact and audience. This culture of exclusivity is then transmitted to the next generation through the publish-or-perish tenure process. Rebels are too often crushed or driven away.
A related problem is that academics seeking tenure must encode their insights into turgid prose. As a double protection against public consumption, this gobbledygook is then sometimes hidden in obscure journals — or published by university presses whose reputations for soporifics keep readers at a distance."
True that. This is why many notable academics "talk" to the public via their personal blogs. And this, at least in the economic science, is deepening the debate, bringing some old papers to new light and furthering the understanding of economics among the population (hopefully). Krugman raises a few good points on this as well. As does Noah Smith

4. David Brooks, "The American Precariat", New York Times - a bit on social mobility, mobility in general, and a change in the value system in America, giving rise to the so-called Precariat.
"...the Precariat is the growing class of people living with short-term and part-time work with precarious living standards and “without a narrative of occupational development.” They live with multiple forms of insecurity and are liable to join protest movements across the political spectrum.

The American Precariat seems more hunkered down, insecure, risk averse, relying on friends and family but without faith in American possibilities. This fatalism is historically uncharacteristic of America."
5. And finally, a couple of Mankiw articles on inequality, Wall Street and CEO wages.

Monday, 17 February 2014

Graph of the week: Wine consumption and academic performance

One of the most important lessons of economics is that correlation does not imply causation. Just because we see a pattern in the data, or we observe one event following another, does not mean one event CAUSED the other. In order to prove (abiet partially) a causal relationship you need to observe the two effects while controling for a whole number of possibilities that can affect both. This is why econometrics is used in social sciences which tend to suffer from a deficiency of clearly proving a certain hypothesis.

Keeping this in mind we have a look at this week's graph of the week, depicting the alleged relationship between wine consumption and student achievement. The graph was originally produced by a Cambridge graduate, and was used by the Economist:
Source: The Economist
The graph seems to point to an interesting positive correlation between how much does a Cambridge or Oxford college spend on wine to the percentage of students gaining a first class degree. This would make us conclude that colleges in which students drink more, their students perform better as well.

That would be a false conclusion.

There could be a whole number of drivers behind this relationship. To make such a conclusion just from such a simple correlation we would inadvertently suffer from something econometricians call the omitted variable bias. An omitted variable bias implies that the causal relationship between the two variables we are observing (independent, Y and explanatory, X) could be subject to some unobserved (unincluded) variables (effects). For example, one can find that lower class size leads to better grades of its students. But perhaps performance is driven by other socio-economic characteristics. For example, schools with lower class size may be schools in wealthier neighborhoods or may have better quality teachers. And while controlling for teaching quality is hard, controlling for income in a neighborhood is rather easy.  

Consider again the above correlation. First of all such a simple graph doesn't take into consideration the number of students at a particular college (i.e. size of college), nor does it evaluate the relationship if per-capita expenditure on wine instead of total expenditure is compared with performance, as many commentators have noticed under the Economist's original post. It also fails to control for wealth of a college or gender (assume that male-dominated colleges drink more than women-dominated). I would easily assume that gender plays a big role, as well as college size, of course. So a good empirical analysis of this potentially interesting issue would include all those controls and make several robustness checks in measuring the main explanatory variable as well as the main dependent variable (try total alcohol consumption for example), before it would be viable to conclude of any relationship between wine consumption and academic performance. 

Being an empiricist is an exhausting job. It's not just crunching numbers. 

Friday, 14 February 2014

Emerging market troubles

There has been a series of posts on emerging market troubles in the past few weeks. Dani Rodrik, Nouriel Roubini, Kenneth Rogoff, Tyler Cowen and the FT's Beyondbrics have all pondered on the great issues facing the emerging markets in the past few years and months (Project Syndicate has an entire section devoted to the loss of momentum in the EMs dubbed "Subemerging Markets?"). Many of the concerns they express don't seem to be fading, in fact they are likely to become even more pronounced in the years to come. 

Arguably the main issue over the past months have been declining currencies and capital flight, mostly due to various political disruptions (Argentina, Brazil, Turkey, Ukraine, Thailand, India, etc.). In addition the tapering of Fed's quantitative easing (tighter monetary policy) is causing havoc to many countries whose currencies are tied to the dollar and whose foreign debt is dollar-denominated. 

It seems that the economic crisis in the West has after all affected the emerging markets. It was actually quite foolish to think that EMs would be intact following the decline of aggregate demand in the West. After all, Europe and America are the EM's biggest export markets. As Reinhart and Rogoff have warned us in their influential book "This Time is Different": banking crises in the West slow its economic activity thus hitting exports of EM countries, lowering the access to foreign currency the EMs need to service their debts. Weak global growth will depress commodity prices thus further reducing earnings of commodity exporters (mostly EM countries). The global credit squeeze makes in even harder for the EMs to raise new debt and fund their activities, while the decrease of investor confidence means that investors are taking their money away from riskier assets and moving it to low-yield government securities. This again implies troubles for the EMs which find it harder to borrow on the international market as their bond yields become less attractive to investors. Even though throughout the scope of the Western crisis and recovery some EM countries have been (more or less) robust to the global credit squeeze (it was mainly Europe that suffered, or to be more precise the peripheral Europe), this was mainly thanks to the rise of China as the alternative financial superpower. However as the Chinese growth model slows down, its vulnerabilities get exposed, and as the West recovers, imposing tighter monetary policy, the financial crisis-related problems are re-emerging for the EMs. 

It's hard to blame the EMs for this, since the global crisis was hardly their fault. But it makes sense to blame them for not adjusting to this problem when it became rather obvious. 

A missed opportunity 

Over the past few decades one can actually speak of a fairly convenient position the EMs were in: high commodity prices, low global interest rates (recall  the famous Bernanke's global savings glut), large exposure to foreign financing (inflow of capital), and more prudent domestic macro policies (such as central bank policies aimed at lowering inflation). It's no wonder they experienced rapid growth rates. 

But the real question is how have their domestic governments used this favourable position? Back in July last year, in the midst of the many protests arising simultaneously in several EM countries (Brazil, Turkey, Egypt, Indonesia, Bulgaria), I suggested that the largest issue for all these countries has been the fact that they failed to utilize on the strong growth they had in the pre-crisis decade. Years of above average growth rates have been accumulated mostly by the political and corporate (crony) elites, not the majority of the population. This of course causes great distress in the population which can culminate in even the slightest detail (such as the increase of bus fares in Sao Paolo or a construction site at a park in Istanbul). 

When anti-government protests combine with worsening macroeconomic conditions, then an obvious reaction from the financial markets is to punish such behaviour. In particular to punish political instabilities, lack of reforms and downright cronyism that lead to macro vulnerability and weakening currencies. Financial markets fear the possible descent of these countries into further depreciation spirals, rising inflation and interest rates, problems of debt repayments and consequentially a full-blown financial crisis. 

Apart from institutional reforms the policymakers in emerging markets must think of good short-term macro remedies. Most of these can be solved jointly by a pledge to reform a crony system which would send a clear signal to the financial markets of the (anticipated) stability of these countries, which may very well turn the tide in a different direction. Some positive examples imply this is possible (Mexico, Malaysia, Chile), even though there's still a long way to go. 

The "original sin"

The FT however is far more pessimistic reporting that the EMs are still characterized by all the same troubles they had back in the 90s: "dollar-denominated debt backed by local-currency revenues (the so-called 'original sin')". They report a rapid rise of cross-border bank lending but even more importantly a rapid expansion of private sector bond issuance (see the figures below). 

Source: FT: Nomura and BIS.
Some explanation is needed here: "It is standard practice for central banks to identify issuers by country of 
residence rather than nationality – so that if the Brazilian subsidiary of Banco Santander, for example, issues 
a bond, it will appear as part of the private sector debt of Brazil rather than of Spain. And if an overseas
 subsidiary of a Brazilian company issues a bond in, say, the Cayman Islands, it will appear in the debt
 of the Cayman Islands, not of Brazil." FT, Feb 7th 2014
Furthermore the FT reports:
"...over the past decade ... the amount of debt issued by EM corporations through overseas subsidiaries has grown quickly – adding substantially to the stock of original sin. Pretending it is not there does nothing to reduce the vulnerability of the ultimate issuing nation.
Drilling down a bit further, we see that while the bulk of such issuance has come from governments and banks, in some countries – India and China stand out in our sample – a significant part of the increase has come from non-financial corporations (NFCs).
Hyun Song Shin and Laura Yi Zhao, in a recent paper from Princeton, argue that, especially in China but also in other countries such as India, Indonesia and South Korea, such issuance constitutes surrogate financial intermediation and has contributed to the stock of credit available in those countries."
Which brings us to the bubble story in China (its enormous shadow banking system) and the rising vulnerability and exposure of the EM countries to China's problems. Even though China is a bubble waiting to burst, its burst may not turn out to be so devastating (at least for them) if  higher consumption steps in to replace the malinvestment bubble. But their temporary decline in growth is already causing problems for many EM countries. If China goes into a full financial crisis (no matter how quickly it may recover), the EMs are likely to suffer much more than in the post-2008 period. This can once again lead us to conclude that, regardless of the buffer you're using, unsustainable foreign-denominated debt, coupled with political instability and state capture of democracies, always get punished by financial markets. 

Tuesday, 11 February 2014

Week links (3)

An overview of the best of the rest in the economic blogosphere and beyond (and some news as well).

1. The US unemployment rate is down to 6.6% (BLS)
"Total nonfarm payroll employment rose by 113,000 in January, and the unemployment rate was little changed at 6.6 percent ...

After accounting for the annual adjustment to the population controls, the civilian labor force rose by 499,000 in January, and the labor force participation rate edged up to 63.0 percent. Total employment, as measured by the household survey, increased by 616,000 over the month, and the employment-population ratio increased by 0.2 percentage point to 58.8 percent...."
Yet the E-P ratio is still where it was in 2009 (even though some of the people who lost jobs in the crash got them back, others (e.g. new entries) are still reluctant to entering the market. There is also a matter of many elderly workers choosing early retirement, in addition to many old inefficient jobs being lost, while the process of rediscovering new skills and specialization patterns is rather slow). It is obvious by now, the US in on a new output path and a new E-P ratio

2. Paul Krugman featured on the Colbert report last week. The topic was Obamacare as a job killer (following the findings of the CBO report). Here's the video if you've missed it (it was very funny, as usual): 

The Colbert Report
Here is the link if the video doesn't work. 

3. Michael Boehm, "Job polarization and the decline of middle-class workers' wages", VoxEU

A sign of weakening creative destruction perhaps?

4. Noah Smith, "Does cutting the government make it more efficient?" Noahopinion blog - discussing the logical incoherence that cutting inefficient governments makes them more efficient. Basically he's saying that governments usually don't make hiring decisions based on a monetary marginal cost/marginal benefit calculation, so forcing the government to downsize actually makes it even less efficient as in the process it may lay off some of its most productive workers. A very interesting line of reasoning.

5. Arnold Kling, "What should Austrian macroeconomics resemble?" askblog - continuing his previous Austro-Keynesian ideas and trumping New Classical economics: 
"Maybe the worst-measured variable of all is productivity. How many workers in the U.S. are in large organizations where they spend time reading email, producing reports, and going to meetings? I am going to go out on a limb here and say that these are, on average, productive activities. They produce some sort of organizational capital. But they do not produce output in the here and now. So if you divide this month’s output by this month’s hours spent on the job, that is inaccurate, because a lot of this month’s work is about output in later periods." 
"The bottom line: Austrian economics ought to resemble PSST, not New Classical."
6. The Economist published its traditional Big Mac Index.

Friday, 7 February 2014

Graph of the week: EU cross-country corruption

"Corruption in the EU is breathtaking!" the EU Commission reports. It is estimated to cost Europe at least 120bn euros annually. It's probably even bigger than that. This is the first time the Commission has done such a survey across all 28 states. So this may explain why they were so surprised with the results. 

Here's only a few interesting findings from the report:
"The country analyses show that public procurement is particularly prone to corruption in the Member States, owing to deficient control mechanisms and risk management" 
"Provoked by the crisis, social protests have targeted not only economic and social policies, but also the integrity and accountability of political elites. High-profile scandals associated with corruption, misuse of public funds or unethical behaviour by politicians have contributed to public discontent and mistrust of the political system." 
"In some Member States, shortcomings exist regarding the supervision of state-owned companies where legislation is unclear and politicisation impedes merit-based appointments and the pursuit of the public interest. Moreover, there are insufficient anti-corruption safeguards or mechanisms to prevent and sanction conflicts of interest. There is little transparency regarding the allocation of funds and, in some cases, purchase of services by these companies." 
"Urban development and construction are sectors where corruption vulnerabilities are usually high across the EU. They are identified in the report as being particularly susceptible to corruption in some Member States where many corruption cases have been investigated and prosecuted in recent years."
This last one is the assumption I follow in my "Persistent electoral success with endogenous rents" paper, where I use the proxy of capital outlay spending (spending on infrastructure projects, buildings, purchase of equipment, etc.) to recognize potential rent-seeking activities of politicians and link this to their re-election probabilities. Too much of such spending throws a politician out of office, but only if preceded by a negative economic shock. 

Source: BBC

As can be seen on the map countries leading by bad example are Greece, Spain, Romania and Croatia (all reporting >50% respondents claiming corruption is affecting them in daily life). 

Another interesting thing to observe on this map are the higher levels of corruption in countries of the former Eastern bloc and the countries of the so-called Euro periphery vs the relatively lower reported corruption levels in Western Europe and Scandinavia. Could it be that corruption and political rent-extraction had something to do with the terrible shape most of the peripheral economies found themselves in? I've covered cronyism in Spain, Greece and Italy so far, am very aware of the same issues in Croatia, and have recognized such practices as one of the causes of the ongoing European sovereign debt crisis. In particular this is what I'm aiming at:

"...Greece and Italy [for example] had an additional constraint – corrupt politicians which cared more of self-preservation than the well-being of their country ... Their political elites used expensive populist policies to remain in power. They used cheep borrowing on the international market to “fund” their electoral victories by broadening its welfare states and offering concessions to particular electoral groups. They “bought” votes by increasing pensions, hiring more public sector workers and increasing their wages in order to create a perception of high employment. Their governments were perfect examples of how the inflow of foreign capital was used inefficiently to finance consumption and maintain power."

As I've mentioned many times before, the problem of peripheral Eurozone is purely political. All those European countries who cannot seem to get themselves out of a long-lasting recession have only their political elites to blame. 

Finally, do have in mind that this was a Eurobarrometer survey asking the participants to self-report their own opinion on how widespread corruption is in their country. I would definitely say that there is a high correlation between people's perception of corruption and the actual state of corruption (perhaps in some countries the corruption numbers are underestimated), which is why we should take this data seriously. On the other hand the deficiency of such analyses is well-known to social scientists. It would always be better to find some way, some experiment perhaps, to measure corruption with more precision. But then again, in terms of discovering illegal activities this can be very hard to do. 

Monday, 3 February 2014

Inequality in democracies: interest groups & redistribution

Acemoglu and Robinson have another excellent post at their Why Nations Fail blog. This time the topic is "Democracy vs. inequality".

We are by now more or less aware that income inequality in the US and in most of the rich OECD world is higher today than it was some 30 to 40 years ago. I've discussed the implications behind this increase several times before (see here and here) but the fact remains that inequality is exhibiting a persistent increase, which is robust to both expansionary and contractionary economic times. We might even say that it became a stylized fact of the developed world (amid some worthy exceptions of course). The question on everyone's lips is why would a democracy result in rising inequality?

A&R point to one of the seminal papers in political economy, that of Meltzer and Richard (1981), whose theoretical model emphasized that more democracy implies more redistribution and hence lower inequality. The idea is that the median voter is usually to the left of the mean income voter in a typical income distribution curve, which is always slightly tilted to the right (meaning there is more poor people than rich people in a society). The larger the gap between the mean income voter and the median population voter (i.e. the poorer the median voter), more redistribution will be demanded (under the classical Downsian assumptions). Which also implies that more unequal countries should have larger governments. We of course know this is not true, primarily since most unequal societies are NOT democracies, meaning that their ruling elites don't really care of the position of the median voter. But it is true that more democratic societies do on average have lower inequality:  

Note: The Freedom house democracy ranking is from 1 (the most democratic)
to 7 (the least democratic). Higher Gini implies higher inequality. The graph
deploys averages of the democracy index and the Gini in the past 20 years.
Source of data: Gini: World Bank. Democracy: Freedom House.
Note however that this is mere correlation, not even a strong one, and it doesn't tell us a lot on why inequality in the West is still rising. 

In their new paper Acemoglu, Robinson, Naidu and Restrepo (2013) discuss several theoretical possibilities of why democracies can fail to reduce inequality. The first is that they get captured by crony elites (something rather common to most newly created democracies, particularly to those of Eastern Europe), who hold de facto power in a society and can thus twist laws in their favorable direction. A newly founded democracy can also result in "inequality-increasing market opportunities ... when it opens up disequalizing opportunities to segments of the population previously excluded from such activities, thus exacerbating inequality among a large part of the population". And finally, democracies can transfer political power to the middle classes instead of the poor, which may not favor redistribution at all. 

But none of these factors hold for the US, or any of the rich OECD economies. 

Here are the empirical implications of their paper: 
  • "First ... the long-run effect of democracy is about a 16 percent increase in tax revenues as a fraction of GDP.
  • Second, there is a significant impact of democracy on secondary school enrollment and the extent of structural transformation, for example as captured by the nonagricultural share of employment or output.
  • Third, and in stark contrast to these results, there is a much more limited effect of democracy on inequality. Democracy just doesn’t seem to affect inequality much. ...
The limited impact of democracy on inequality might be because recent increases in inequality are “market induced” in the sense of being caused by technological change. But equally, this may be because, as in the Director’s Law, the middle classes use democracy to redistribute to themselves. But the Director’s s Law is unlikely to explain the inability of the US political system to confront inequality, since the middle classes have largely been losers in the widening inequality trendsCould it be that US democracy is captured? This seems unlikely when looked at from the viewpoint of our typical models of captured democracies. But perhaps there are other ways of thinking about this problem that might relate the increasingly paralyzing gridlock in US politics to capture-related ideas."
Interest groups  

So how come the median voter in the West is still disenfranchised? Shouldn't the persistence and consolidation of a democracy imply a gradual decline of inequality? We can even disregard the fact that this includes most newly created democracies in the 90-ies since the rich OECD countries have had democracy for a long time. 

The rapid rise of interest group power can help us provide an answer. As interest groups in democracies get better organised, they become more successful at increasing the size of government but bias that increase towards themselves. This leaves relatively less money for redistribution and programs aimed at the poorer ends of the society, particularly in terms of education and health care. Olson's theory of collective action perfectly explains this phenomenon where small, privileged groups possess enough information, have low enough organization costs, and are far more homogeneous in distributing the potential benefits to successfully solve the public good allocation problem. As the number of interest groups fighting for state redistribution increases, this becomes a wider burden for the society, whose productive resources are being suboptimally allocated. We can call this phenomenon "interest group capture" which unfortunately characterizes more and more democratic societies today (both rich and poor). 

Impact of technology 

If we can call that the macro reason for rising inequality, then the structural factors such as technology and education, arguably even more important, can be called the micro reasons. It is indicative that the inequality gap started increasing since the 80-ies (as shown by Atkinson, Piketty and Saez, 2011), just around the same time the third industrial revolution started changing the patterns of job market specialization

As mentioned before, the culprit for higher inequality, in my opinion, can be found in the interaction of several factors. Rapid technological progress in the past 30 years resulted in a typical creative destruction process where new jobs and careers made certain types of old jobs obsolete (automated work). Some of these obsolete jobs were outsourced to Asia (even though one phenomenon followed the other, this doesn't imply a direct link of causality; one has to test this hypothesis to see if it holds). In addition, a lot of low-skilled labour entered the market (mostly via higher immigration) who failed to adapt to the changes and were left stranded either at lower paid jobs or became long-term unemployed. Poor education played an important role as well, while stagnating wages in the "dying" sectors only widened the gap. On the other hand, the innovative part of the equation was working quite well taking advantage of the new technological wave, thus further raising the income of the top 10% (hence the great disparity between college and non-college degree workers). It's not hard to imagine how these two pulling forces (one downwards, one upwards) managed to widen the US inequality gap. 

However none of these issues affected the real US problem: stagnating social mobility. The underlying causes behind this structural phenomenon can indeed be blamed on interest group capture of democracies. The solution to this problem is thus, primarily political.