The wisdom of Dani Rodrik

by on June 9, 2012 at 12:11 pm in Current Affairs, Economics, Political Science | Permalink

Sometimes agnosticism is so…appropriate:

The main lesson I take from all this is the need to avoid easy generalizations that do not respect country peculiarities. Fiscal austerity missionaries are surely off base when they say Latvia’s experience decisively proves Keynesians and advocates of currency depreciation wrong.  It is too early to judge the Latvian experience a success.  But it is also too early to say Latvia has been a failure.  Growth may continue, in which case the country will look better and better.

The full post is here, and it is full of interesting detail.

Steven Kopits June 9, 2012 at 1:33 pm

An article on the economics of self-driving electric vehicles I wrote for Foreign Policy:

“How the Electric, Self-Driving Miracle Car Will Change Your Life”
http://www.foreignpolicy.com/articles/2012/06/08/self_driving_car?page=0,0

Michael Heller June 9, 2012 at 2:10 pm

It’s pretty dumb for anyone to bringing in one or three Baltic states to demonstrate success or failure on the basis of 2 year numbers. If you’re looking at structural adjustment from beginning to end including origins and outcomes then the more obvious examples are Latin America in the 1980-1995 and East Asia 1996-2006. In both regions (multiple cases to compare) I believe Dani Rodrik has usually been more wrong than right. Basically the lesson is suffer some pain, control the debts and deficits, sell SOEs, deregulate where needed, and let market economy do its work. Things turn out alright within a few years. Remember for example the record 13% growth rates achieved in Peru 1990s? Improve the recipe, don’t reject it. Improve the recipe by adding in the institutional reforms — as in the recipe the unfairly maligned Germany is trying to persuade the world to support.

Michael June 9, 2012 at 2:34 pm

I thought Rodrik’s post was good overall, but that bit at the end, it seemed like he was trying a little too hard to force the conclusion of “both sides are wrong.” I didn’t think the article he linked to was making the point that Latvia was a failure, rather it wasn’t the stunning success story people claim (and not for the reasons they claim either). But wasn’t that one of Rodrik’s own points, that “Fiscal austerity missionaries are surely off base?”

His conclusion seemed to be that the people who say Latvia is a success are wrong, but the people who say it’s not a success are also wrong. If “success” is wrong, then “not a success” must surely be right, right? But, he doesn’t want to say that. Instead, he assumes that people who say, “not a success” actually mean “failure,” and proves why “failure” isn’t correct either, even though the people he says are calling it a failure, are really just making the same point he is, that it’s not correct to label it a success right now.

dan1111 June 10, 2012 at 3:30 am

I think the article does clearly paint Latvia as a failure:

“If you do what the Troika is prescribing, you will have a devastating recession with vast unemployment”
“‘Internal devaluation’ does not work…”
“calling Latvia a ‘success’…is like calling the Great Depression a success.”

Most importantly, the author is already quite sure that the Latvian approach “does not work.” This does directly conflict with Rodrik’s point that it is too soon to tell.

derek June 9, 2012 at 2:39 pm

Institutions have reformed. They almost all have structured themselves around the assumption that money is unlimited and at no cost. What? Do the same with 10% less money than last year? Indeed the end of the world as we know it.

An interesting study would be how Canada changed the structure of government to achieve fiscal sanity. I know from experience that working for or contracting to government here changed from easy money gravy train with no accountability to almost not worth your while. Amazing how not having the political option of borrowing money reformed the way things were done.

I must add that many of the bad habits of government have returned with deficit spending.

Roxy June 9, 2012 at 4:36 pm

Tyler, no one would be talking about Latvia had it not been hailed as a success for austerity.

Sure, agnosticism is often “so … appropriate,” but there are practical problems to be dealt with at the moment and consequential decisions to be made, so standards of proof must be adjusted accordingly.

One of the most subtle forms of bias is to adjust standards of proof to suit one’s priors.

Mark A. Sadowski June 9, 2012 at 5:24 pm

What did Rodrik learn in Latvia? Based on what he wrote, almost nothing.

Perhaps the best part of the article was his opening observation:

“Briefly, Latvia rejected much external advice and did not devalue, despite a huge current account deficit that exceeded 20% of GDP in 2007. The lat had been pegged to the euro in anticipation of Eurozone entry and the government refused to do anything that would jeopardize that goal.”

That is the nature of the Latvian problem in a nutshell. They could have devalued but they chose not to because it would have meant a delay in adopting the euro. As a consequence they suffered a huge current account reversal, as did all countries pegged to the euro (Estonia, Lithuania and Bulgaria). with the exception of Denmark . And the Baltic states have been hit harder by the global recession than any other EU countries (or any country on earth for that matter).

Rodrik then proceeds to make himself look like a fool by blithely reporting what Latvian officials told him without any hint of scepticism. In particular this made me wince:

“Iceland, which was hit with an even larger financial crisis, imposed capital controls, devalued its currency, and avoided as sharp an economic contraction as Latvia. When I brought up this counterfactual, Rimševičs cut me short and argued that Iceland benefited from special export conditions.”

This is pure unadulterated horse manure. Until the Great recession exports were a larger share of GDP in Latvia than in Iceland. Moreover, although both countries are small, Latvia’s exports are fairly diverse (wood and wood products, machinery and equipment, metals, textiles, foodstuffs) whereas Iceland’s major exports are fish, animal products, aluminum and silicate alloys. The only “special export condition” I can think of is the failure to devalue.

Rodrik does put in a good point when he makes the following observation:

“Even though Latvia’s external imbalance was eliminated, it is not clear that there has been a sizable improvement in competitiveness. The much vaunted internal devaluation has been small. Wage cuts have been mostly in the public sector, where they don’t really help with export competitiveness. Private sector wages have been surprisingly resilient.”

Most of the cuts in labor compensation have been precisely where it will do the least good: in the public sector. But most economists would draw the obvious conclusion that by itself fiscal austerity has not, and cannot, solve Latvia’s problems. Rodrik just merrily rolls on infatuated with his own detached agnosticism.

Then to pour salt into open wounds he brings up the January 2009 Riga Riots without mentioning them by name:

“When I brought up the news articles that mentioned Lativa’s largest street protests since the Russian occupation at the height of the crisis, my hosts assured me that these were in fact minor. Just a few hundred people, acting up for the cameras, they said. Greece this was not.”

I am visualizing Rodrik nodding in affirmation.

Just how large were the Riga Riots really? Well, the best estimates I’ve read say put the number of protesters at 10,000-20,000, and over 50 people were injured and over 100 people were arrested. This doesn’t sound like much until you remember Lativa’s population is only 2.2 million. To get an idea of the scale of the riots for such a small country try multiplying it by how many magnitudes larger the population of a reference country might be.

Here’s what the NYT said about the Riga Riots:

http://www.nytimes.com/2009/01/15/world/europe/15latvia.html

Here’s some eyewitness video:

http://www.youtube.com/watch?v=yKGL8OPb1aI

So was this nothing like Greece? Just a few hundred people? You decide.

And, since the international news has done such a dreadful job of covering the state of affairs in Latvia, most people are completely unaware that there have been several large riots since.

But when he says this I tear my hair out:

“It is too early to judge the Latvian experience a success. But it is also too early to say Latvia has been a failure. Growth may continue, in which case the country will look better and better.”

No, it will not.

We already know what Latvia’s future looks like. Real GDP per capita more than doubled in the decade through 2007 (up over 120%), rising from 26% of Germany’s to 50%. Latvia was well on its way to converging to the rest of the EU in living standards. Now however, according to IMF forecasts, GDP per capita is not expected to match what it was in 2007 until 2016, by which point it will have fallen to 45% of Germany’s.

Latvia is looking ahead to a near decade long depression, with no real progress in living standards, and instead of catching up, will fall even further behind the rest of the EU.

Sometime agnosticism just makes one look like a blithering idiot.

dan1111 June 10, 2012 at 3:36 am

The problem with your last point is that maintaining 2007 conditions was not an option for Latvia. There was going to be major economic upheaval no matter what. No one is agnostic about whether the Latvian economy is worse in 2012 than it was in 2007. They are agnostic about how the policy they chose performed relative to other potential policies.

Mark A. Sadowski June 10, 2012 at 5:58 am

“They are agnostic about how the policy they chose performed relative to other potential policies.”

Then you must be referring to a different article than the one I read.

Rodrik presents the common sense point of view concerning how Latvia could have been more like Iceland, and alludes to the simple unquestionable fact of the massive riot in 2009, and allows his hosts to respond with what are clearly preposterous statements without even a murmer of dissent. He is even agnostic about what are the obvious implications of his own analysis concerning the ability of fiscal austerity to impact internal devaluation. And then he concludes by saying it is too early to judge Latvia a failure.

Of course it is a failure. Nations that chose to devalue with respect to the euro have done much better than Latvia and are forecast to continue to do much better than Latvia for many years to come.

Some, like Poland have not even experienced a recession. In fact, by 2016, when Latvia catches up to where it was nine years before, Poland is forecast by the IMF to have increased its real GDP per capita by over 40%, and will have risen from 47% to 60% of Germany’s GDP per capita.

But evidently, views still differ on the shape of the earth.

Pete June 10, 2012 at 12:57 pm

Hmm.. no one that has traveled to these countries would dream of comparing the Greece riots with what happened in Riga. As for a youtube video, you can always make one that makes things look terrible, that would be true even in the US with the Occupy movement.

Rodrik hits the nail on the head but doesn’t go far enough. The key point is his last sentence. In Latvia there was a general acceptance of the adjustment for several reasons, not the least of which was that many in the country remember the days of the USSR and want to make sure they can get as close as possible with the rest of the EU. While there was a risk they could have been forced to devalue this was never a desirable option for the country. Economists that recommended that course of action basically ignored the whole political institutional arrangement in Latvia. Not the first time they do that.

Mark A. Sadowski June 10, 2012 at 1:58 pm

“In Latvia there was a general acceptance of the adjustment for several reasons, not the least of which was that many in the country remember the days of the USSR and want to make sure they can get as close as possible with the rest of the EU.”

There is much less acceptance of the current adjustment (depression?) in Latvia than you imply. Of course there is a desire for more integration within the EU but one should also be wary of adopting policies, such as the euro, that have such consequences. There is also an equal if not greater distrust of the USSR within the Visegrad Group and yet there is much less of a rush to join the eurozone by most of those governments.

“While there was a risk they could have been forced to devalue this was never a desirable option for the country.”

The only downside to devaluing from Latvia’s perspective was a delay in the adoption of the euro. And given the situation on the EU’s other peripheries right now, I think there is more than ample reason to think that it would be preferable to wait until the eurozone has more highly developed institutions and the ECB adopts better policies.

P.S. I’ve been to Latvia but not Greece. I have family in both Poland and Lithuania.

Pete June 10, 2012 at 2:20 pm

“There is much less acceptance of the current adjustment (depression?) in Latvia than you imply.”

That’s your opinion. Having visited Riga several times during the crisis and talked with many people, including journalists and political analysts, I reached a different conclusion. As did the voters which never supported anyone who talked of devaluing the currency.

A delay in joining the euro was hardly the only downside. It would have raised the serious risk of defaults across the whole economy and a deepening of the crisis. People in Riga where quite aware of what happened to Argentina and they did not think it was a model worth imitating.

In the end they did it their way, based on their political preferences. They are now growing again and they did so without raising questions about their legal system. Could they have done it in another way? Maybe, if they had different institutions and political preferences. But they don’t and they didn’t. Whatever you may think of their outcome people in Latvia do think they were “successful’ or at least as successful as could reasonably be expected, given their circumstances.

Talk of how long it will take them to get back to their previous peak is useless. The previous peak was the result of a bubble, and as such not very relevant as a point of comparison.

Mark A. Sadowski June 10, 2012 at 8:08 pm

“That’s your opinion. Having visited Riga several times during the crisis and talked with many people, including journalists and political analysts, I reached a different conclusion. As did the voters which never supported anyone who talked of devaluing the currency.”

Many accepted the peg as some indication of post-independence national seriousness, and that devaluing would be seen as some kind of defeat. I also think there was fear among those who had euro denominated debts. But in retrospect this has turned out to be irrational as it is difficult to pay a mortgage without a job or a business loan without a market. I think Latvian politicians were to some extent reacting to this kind of pressure, and to some extent were thinking about their own social standing, having been previously enthusiastic in their support of the peg. They were also under a lot of pressure from the Swedish banks. But not all Latvians had debts and not all Latvians that had debts had debts denominated in euros. And various devaluation scenarios were discussed frequently by politicians of nearly all stripes. Moreover in retrospect I think many have come to question the promises that were made concerning the pros and cons of devaluation as many of those promises have turned out to be flatly false.

“A delay in joining the euro was hardly the only downside. It would have raised the serious risk of defaults across the whole economy and a deepening of the crisis. People in Riga where quite aware of what happened to Argentina and they did not think it was a model worth imitating.”

You make it sound as though there hasn’t been a wave of defaults, bankruptcies, foreclosures and repossessions. How could there not be with 20% unemployment, a two thirds decline in property values and a high degree of leverage? I think in retrospect the Nordic banks realize they made a huge mistake worrying more about the level of debt than the income that would be required to repay the debt.

It’s true that back in 2008-2009 people were thinking mostly about Argentina which may or may not be relevant. I think Argentina has done much better than most people realize, but that is somewhat beside the point. These days most Latvians bring up the case of Iceland. Like Latvia, Iceland is a small homogeneous European country that had a real estate boom and was highly leveraged. Iceland survived by leaving the foreign creditors to bear losses and nevertheless managed a return to international debt markets less than three years later. Iceland is of course doing much better than Latvia. This is all the more telling because it has direct bearing on many of the antidevaluation talking points that Governor of the Bank of Latvia, Ilmars Rimsevics, was constantly hammering on back in 2008-2009. In particular Rimsevics asserted that since Latvia was running a large trade deficit and was dependent on imported equipment and raw materials necessary for production, neither consumers nor producers would gain much from devaluation. Well, of course, since Iceland’s economy is even less diverse than Latvia’s it is even more dependent on imported goods. Moreover, despite the fact it did not devalue, Latvia is no longer running a trade deficit so this is rather less relevant.

And it is not clear that Iceland is the appropriate comparison to be making. Poland practically borders Latvia. The zloty was devalued by about 30% with respect to the euro between July 2008 and February 2009. There was no wave of defaults. There was also no peak because there was no trough. In my opinion “bubbles” are a contrivance brought up by people who don’t believe in large scale aggregate demand deficiencies.

economist1 June 9, 2012 at 7:39 pm

My take on this article- Tyler was looking for some kind of support on Latvia, after being painfully wrong on Austerity for the UK and Ireland. Being that he wanted a sensible take, this was the strongest critique of the “Latvia does not prove austerity correct” position out there. Look for intellectually weaker (but more forceful) critiques in the near future to appear on MR as the right continues to show its intellectual prowess.

Ciaran June 9, 2012 at 8:03 pm

So basically both sides do it? Wow I haven’t heard that before , how serious and no partisan of you Tyler . As doug j would say, your a true Burkean moderate .

TheAJ June 9, 2012 at 10:23 pm

Well its a good thing Tyler and Rodrick are not professors of English, because they are clearly having difficulty understanding that “not success” is not the same as “failure.”

dan1111 June 10, 2012 at 3:41 am

I believe it should be “Well, it’s a good thing that Tyler and Rodrick are not professors of English.”

Pete June 10, 2012 at 10:38 pm

“In my opinion “bubbles” are a contrivance brought up by people who don’t believe in large scale aggregate demand deficiencies.”

Again, your opinion. Like your opinion that Latvians did not support the fiscal adjustment when it’s clear they did and there was no support for anyone who talked of devaluation.

It would serve economists well to understand more about politics and institutions.

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