Economics

Why did the U.S. financial sector grow so large?

by on May 19, 2012 at 6:15 am in Books, Economics | Permalink

Edward Conard, author of Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong, offers a hypothesis.  He suggests the underlying cause is the (relatively recent) prevalence of risk-averse foreign capital:

With an abundance of risk-averse offshore capital, the constraint to increase investment and risk taking has been the capacity of risk underwriters, not capital providers.  Today, Wall Street uses financial innovation to decouple risk from investment capital and predominantly sells risk to risk underwriters, which is no different from an insurance broker or insurance company.  Wall Street deconstructs, prices, underwrites, syndicates, trades, and makes markets for risk.  Because Wall Street now performs the more abstract function of syndicating risk rather than merely raising capital, people — even people as well informed as former president Bill Clinton — have naively concluded that these transactions serve “no economic purpose.”  Risk underwriting is every bit as important as funding investment, perhaps even more so in today’s economy where the trade deficit leaves us awash in risk-averse short-term debt to fund investment provided someone else underwrites the risk.

So far I find parts of this book brilliant and other parts dead wrong.  In any case it is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.

96 comments submit to reddit

Jared Diamond reviews *Why Nations Fail*

by on May 18, 2012 at 2:26 pm in Books, Economics, History, Political Science | Permalink

There is much in the review, excerpt:

In their narrow focus on inclusive institutions, however, the authors ignore or dismiss other factors. I mentioned earlier the effects of an area’s being landlocked or of environmental damage, factors that they don’t discuss. Even within the focus on institutions, the concentration specifically on inclusive institutions causes the authors to give inadequate accounts of the ways that natural resources can be a curse. True, the book provides anecdotes of the resource curse (Sierra Leone cursed by diamonds), and of how the curse was successfully avoided (in Botswana). But the book doesn’t explain which resources especially lend themselves to the curse (diamonds yes, iron no) and why. Nor does the book show how some big resource producers like the US and Australia avoid the curse (they are democracies whose economies depend on much else besides resource exports), nor which other resource-dependent countries besides Sierra Leone and Botswana respectively succumbed to or overcame the curse. The chapter on reversal of fortune surprisingly doesn’t mention the authors’ own interesting findings about how the degree of reversal depends on prior wealth and on health threats to Europeans.

Do read the whole review (that is not just the usual cliched command to do so), and I will gladly link to any response by Acemoglu and Robinson.  Here is Diamond’s bottom line:

My overall assessment of the authors’ argument is that inclusive institutions, while not the overwhelming determinant of prosperity that they claim, are an important factor. Perhaps they provide 50 percent of the explanation for national differences in prosperity. That’s enough to establish such institutions as one of the major forces in the modern world. Why Nations Fail offers an excellent way for any interested reader to learn about them and their consequences. Whereas most writing by academic economists is incomprehensible to the lay public, Acemoglu and Robinson have written this book so that it can be understood and enjoyed by all of us who aren’t economists.

114 comments submit to reddit

What is the potential for German fiscal stimulus?

by on May 18, 2012 at 9:48 am in Economics | Permalink

This idea has been overpromoted for a long time:

Even if Germany manages to increase domestic demand, there is no guarantee that the additional spending will find its way into the peripheral euro-zone economies. A simple macroeconomic simulation suggests that a permanent increase in German government consumption equivalent to one percentage point of GDP would raise output in Ireland and Greece by 0.1% at most, and in larger countries, such as Spain and Italy, by much less than that.

That should come as no surprise. After all, exports to Germany account for just 2.5% of the combined GDP of Italy, Ireland, Portugal, Spain and Greece. In order to make a difference, Germany would therefore have to embark on a fiscal expansion that is too big even for the largest economy in Europe.

What about households and companies? German household saving is relatively high at 11%, in theory providing some scope for additional private spending. Here, too, however, there are difficulties. Designing a fiscally neutral set of measures that encouraged spending would be challenging because German households have, on average, less net wealth than their counterparts in France or Italy.

There is also the possibility of faster wage growth in Germany, which would undoubtedly help stimulate consumption. But only a small portion of that additional spending would be directed toward the troubled countries. And Finance Minister Wolfgang Schäuble, while acknowledging the likelihood of more rapid German wage growth, also warned that the economy should not lose its focus on competitiveness, implying that there is a limit to how much wage growth German authorities will tolerate.

That is from Amit Kara, here is more.

20 comments submit to reddit

*China Airborne*

by on May 18, 2012 at 5:58 am in Books, Economics | Permalink

That is the new book by James Fallows.  On the surface it is a book about aviation in China, but it is also one of the best books on China (ever), one of the best books on industrial organization in years, and an excellent treatment of economic growth.  It is also readable and fun.

Highly recommended, it is sure to make my best books of the year list.

8 comments submit to reddit

Agricultural yields and the returns to schooling

by on May 17, 2012 at 12:27 pm in Economics, Food and Drink | Permalink

Agricultural yields, which reflect real returns and are not contaminated by “signaling,” are another independent way to measure the returns from schooling.  Starting with Ted Schultz, this is a significant theme in development economics, and now from John Parman we have a new paper on schooling and agriculture in early 20th century America:

Formal schooling has a significant impact on modern agricultural productivity but there is little evidence quantifying the historical importance of schools in the early development of the American agricultural sector. I present new data from the Midwest at the start of the twentieth century showing that the emerging public schools were helping farmers successfully adapt to a variety of agricultural innovations. I use a unique dataset of farmers containing detailed geographical information to estimate both the private returns to schooling and human capital spillovers across neighboring farms. The results indicate that public schools contributed substantially to agricultural productivity at the turn of the century and that a large portion of this contribution came through human capital spillovers. These findings offer new insights into why the Midwest was a leader in the expansion of secondary education.

The paper is here, hat tip goes to the always excellent Kevin Lewis.  Excellent ungated slides you will find here.  One of the early slides indicates that in stable conditions “experience” outperforms education for generating agricultural productivity, but the value of education is high during times of dynamic change.

30 comments submit to reddit

Solomon’s Knot and Gray Markets

by on May 17, 2012 at 7:24 am in Books, Economics, Law | Permalink

Solomon’s Knot: How Law Can End the Poverty of Nations has received less attention than some of other recent big books on development but I found it to be rich in institutional detail, wisdom and practical advice. The authors, Robert
Cooter and Hans-Bernd Schafer, are law professors and as befits their expertise they spend less time on why institutions differ and more on the details of how institutions differ–there is more in Solomon’s Knot, for example, on issues like relational finance, venture capital, joint-stock companies, contract law and bankruptcy law than in other books with a similar theme.

Here is one idea that I had not previously considered, should judges enforce contracts in the gray market?

…businessmen and workers must violate many regulations in order to get things done, especially in poor countries. Thus a builder in Cairo violates building restrictions, a worker and employer in Brazil evade employment taxes, and a manufacturer in Russia runs a factory without a permit to do business.

Throughout the world, much of the economy operates in the “grey market”…a survey of 145 countries estimated that gray
markets activities produce between 30% and 40% of GNP (gross domestic
product). The gray market’s share of total employment is even higher than its
share of GNP.

Judges in many countries will not enforce contracts in the gray market considering them null and void due to the extra-legality. Even when the contracts might be enforced, participants fear that they will be otherwise punished if they make use of the legal system. Cooter and and Schafer argue, however, that such contracts should be enforced and a strict separation be kept between law and regulation. They point to Germany as an example:

…Unlike many developing countries, German legal doctrine and practice avoid this
result. German regulatory violations seldom void contracts, and German
prosecutors seldom act on regulatory violations revealed in a civil trial. Thus a
gardener in the German gray market who does not pay taxes can sue an
employer for unpaid wages without fear of triggering regulatory prosecution.
And a customer who buys a restaurant meal at an hour when law requires the
closing of restaurants still has to pay his credit card bill. The same applies for a
construction contract that violates zoning regulations, or a credit contract that
violates banking regulations. Although seldom discussed in constitutional law,
separating the civil courts from the regulators and police is an important part of
the separation of powers, especially in countries with a large gray market.

The case for separation is strongest for gray markets because the underlying acts are not per se illegal but could the argument be extended even to black markets? Jeff Miron and Miron and Zweibel (JSTOR) argue that one reason that drug prohibition increases violence is that when courts are unavailable, violence becomes the least costly method of dispute resolution. What Cooter and Schafer suggest, however, is that it is at least conceivable to have a situation where the act remains illegal but the actors can resolve disputes in court. Imagine, for example, a drug user taking a dealer to court for cutting the product or a prostitute suing a john for not paying.

It seems naive to expect that we would enforce a rule not to use information from civil court to prosecute illegal behavior. Yet there is a precedent; if a police officer obtains evidence illegally, even without intent, then we throw such evidence out of court. A very strange incentive system. Nevertheless, if we can let murderers go free because the evidence against them was obtained illegally then perhaps we could also let drug dealers bring their contract disputes to court without on that basis prosecuting them for drug dealing.

Addendum: Here is a good interview of Cooter by Nick Schulz and an excerpt from the book.

39 comments submit to reddit

How emigrants try to run their fiscal policies

by on May 16, 2012 at 4:49 am in Economics, Games | Permalink

In survey data collected as part of the study, Washington, D.C.–based migrants from El Salvador report that they would like recipient households to save 21.2 percent of remittance receipts, while recipient households prefer to save only 2.6 percent of receipts.

This is one reason why emigrant workers do not send more back home all at once, namely that the sender does some ex ante forced saving on behalf of the recipient, who otherwise is not trusted to do it.  Remitters also send relatively small sums — typical is $300 — but they send many times a year (16.9 times on average, in one study, despite some fixed costs of sending).  That is to stop the recipient from spending all of the aid at once.

Perhaps you have noticed that cross-national and multilateral aid is also often doled out in multiple parts, rather than all at once.

Is this socially optimal?  Maybe not.  Is this nearly universal?  Possibly so.

The quotation is from Dean Yang, here is more (pdf, see p.12).

15 comments submit to reddit

I know, I know, M2 isn’t exactly the right indicator

by on May 16, 2012 at 1:48 am in Economics | Permalink

Still, I find this interesting:

M2 money supply growth rates are plunging in Greece (down -16.8% y/y through February), Spain (down -4.7%), and Portugal (-3.8% through January). It is up only 1.3% through February in Italy.

Germany’s M2 is up 7.5% y/y through February. Some of that growth is coming from Greece, Portugal, and Spain, where money supplies are falling as depositors move their funds to banks they deem to be safer in Germany.
The article is here.  Most notable is how the various rates of money supply growth start to diverge around 2010.  For the pointer I thank Alexander Schibuola.

8 comments submit to reddit

The Rent is Too Damn High

by on May 15, 2012 at 11:46 am in Economics | Permalink

From London:

On 30 April, the housing minister, Grant Shapps, announced that the government was creating a nationwide “beds in sheds” taskforce, to identify the thousands of sheds and outbuildings being illegally rented out, often to illegal migrants. He said it was “a scandal that these back-garden slums exist to exploit people, many of whom … find themselves trapped into paying extortionate rents to live in these cramped conditions”.

The story closes with this:

There are only two toilets, which she says, “is not at all enough”. She is looking forward to returning to Hyderabad, where the living conditions will be much better.

38 comments submit to reddit

The Myth of Chinese Meritocracy

by on May 15, 2012 at 11:27 am in Current Affairs, Economics, Education | Permalink

No doubt you have heard how the leadership of China is meritocratic and composed of technocrats with PhDs. Minxin Pei suggests that there is less than meets the eye.

…Contrary to the prevailing perception in the West (especially among business leaders), the current Chinese government is riddled with clever apparatchiks like Bo who have acquired their positions through cheating, corruption, patronage, and manipulation.

One of the most obvious signs of systemic cheating is that many Chinese officials use fake or dubiously acquired academic credentials to burnish their resumes. Because educational attainment is considered a measure of merit, officials scramble to obtain advanced degrees in order to gain an advantage in the competition for power.

The overwhelming majority of these officials end up receiving doctorates (a master’s degree won’t do anymore in this political arms race) granted through part-time programs or in the Communist Party’s training schools. Of the 250 members of provincial Communist Party standing committees, an elite group including party chiefs and governors, 60 claim to have earned PhDs.

Tellingly, only ten of them completed their doctoral studies before becoming government officials.

Simply put, Chinese institutions are not as good as those in say Mexico. Thus, China will not overtake Mexico in terms of GDP per capita any time soon, hence Chinese growth rates will fall. All we are seeing today is the logic of the Solow model in action.

104 comments submit to reddit

How much structural unemployment was there during the Great Depression?

by on May 15, 2012 at 12:58 am in Books, Economics, History | Permalink

A few times recently Paul Krugman has raised the issue of structural unemployment in the Great Depression, so I thought I would offer a look at what has been written on the topic.  Here is Richard J. Jensen, from a survey article:

Economists agree that Keynesian stimuli would not have helped structural or hard-core unemployment, only cyclical unemployment. As Table 1 suggests, about half of the unemployment was cyclical from 1931 through 1933; it was then that stimulus was needed and might have worked. By 1933, the appearance of a large, new, structural/hard-core element raised the natural level of unemployment from the 5 to 6 percent range to 12 to 15 percent. If a Keynesian stimulus had been tried and it had eliminated cyclical unemployment, the remaining unemployment still would have been io to 15 percent. Further fiscal or monetary stimuli would have resulted in inflation.

Later he moves directly to the key question:

…we need to discover how the war cured hard-core unemployment permanently. On the supply side, the growth of high schools and colleges, the postwar draft, and Social Security retirements removed young and old from the labor force. Wartime training and experience, in industry and in the military, made workers more productive, and upgraded skills so that the supply of unskilled labor was much smaller. In terms of efficiency wages, employers reshaped jobs to suit the skills and increase the productivity of available workers. They had to use men (and women) whom they would not have dreamed of hiring a few years before.

Personnel management became even more important. The number of industrial-relations staff rose from 2.5 per 1ooo employees in 1937 to 8.o in 1948. They were charged with improving productivity despite the extraordinary shortage of manpower, the high quit rates, the government-imposed wage freeze, and the new strength of labor unions. They dropped categorical restrictions against the poorly educated, the unemployed, women, the old, the handicapped, and sometimes, in spite of intense resistance, blacks. Recruitment of new workers became an art form, with sound trucks blaring in the streets beseeching people to come to work and earn big money. Jobs were restructured so that fewer skills were needed. Intensive in-shop and in-school training programs reached millions. Anyone with a modicum of skill was rapidly promoted, even to the status of foreman or instructor. The results further justified the use of efficiency-wage procedures, but this time efforts were made to find the right niches for workers who had been “hopelessly unemployable” in the 1930s.

In other words, the path out of high unemployment involved much more than a mere reflation of nominal values.  (By the way, when it comes to terminology I might not use the phrase “structural unemployment,” but it also is not “simple cyclical unemployment.”  I would say that in some circumstances the traditional distinction between cyclical and structural unemployment breaks down, but note that in terms of its parent literature this piece is using the terms properly, even if they sound somewhat off in a 2012 blogosphere context.)

In any case, history suggests that stimulus policy has to take some very specific forms to reach those “called cyclically unemployed by some, structurally unemployed by others” unemployed workers and that is the practical upshot.

Another practical upshot is that you still can believe in labor market hysteresis, as presented by DeLong and Summers.  Without some analysis like the above, the DeLong/Summers claims are otherwise contradicted by American post-Depression productivity once joblessness lifted.  Where were the long-term scars?  Well, they were fixed but it wasn’t easy.  So the relevance of hysteresis can be saved, but we still are left with proper stimulus being very difficult to do, unemployment being quite sticky, and proper policy requiring lots of structural attention.  The Great Depression is evidence for all of those views, not against them.

Here is one more bit, with a sad sting at the end:

The war, by removing millions of prime men from the labor market, by restructuring the work process, by subsidizing wages, and by massive retraining, finally gave the private sector the methods and the incentives to rehire the hard-core. Never since has hardcore unemployment affected more than one worker in a hundred.

Michael A. Bernstein’s book, The Great Depression: Delayed Recovery and Economic Change in America, 1929-1939, also considers the significant role of structural unemployment (don’t forget my taxonomic caveat) in the Great Depression.

It is important to learn from this literature rather than dismiss it.

52 comments submit to reddit

What is austerity?

by on May 14, 2012 at 1:41 pm in Economics, Uncategorized | Permalink

Or should that read what is “austerity”?

The May 11 IHT has a headline “German line on austerity appears to soften,” and the article is about monetary policy and inflation targeting (I don’t see it on line).  While monetary policy has ramifications for fiscal policy and output, I would not refer to tight money as “austerity,” in spite of the mood affiliation.

I googled “austerity define” and Wikipedia reports this:

In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided.

Notice that is mostly about spending, and notice the word “and.”  I find this definition confusing, especially if one interprets the “and” strictly.  Tax hikes are then mentioned:

Austerity policies are often used by governments to try to reduce their deficit spending while sometimes coupled with increases in taxes to pay back creditors to reduce debt.

That seems to make the “tax hikes” something other than “austerity policies.”  The Macmillan on-line dictionary makes it all about spending and not about taxes at all.

A financial source in the top ten, Investopedia, reports this:

A state of reduced spending and increased frugality in the financial sector. Austerity measures generally refer to the measures taken by governments to reduce expenditures in an attempt to shrink their growing budget deficits.

That starts with spending, then shifts to the financial sector (?), and the second sentence shifts back to spending.  That’s confusing too.  How do higher taxes fit in?  What are the baselines?

Krugman I do not think has offered a definition or measure of austerity (he spends more time doing a link-less attacking of others, including possibly myself, for claims about austerity which he does not document anyone making or they simply did not make), but he seems to think that automatic stabilizer-driven spending increases do not count as spending increases for the purpose of defining austerity.  Neither does spending on bank bailouts count for him.

I could imagine a definition something like this: “the net effect of all government fiscal policies on ngdp, relative to the baseline of a stabilized path for expected ngdp growth.”  Or should it read: “…relative to what will happen to ngdp growth in the absence of budgetary changes”?  I wonder if some Keynesians have in mind the baseline of “the expansionary policies which I think would be appropriate,” in which case doing less than the Keynesian optimum is always a form of austerity.  Angus notes correctly that clear definitions of austerity are hard to come by.

In Bucharest I cannot alas consult my library for further definitions.

In any case, austerity is a misleading and often misunderstood word.  It is better if we describe policies more concretely, and in fact that is not hard to do.  Furthermore, insisting on a clearer accounting should not be equated with “austerity denial.”

126 comments submit to reddit

Genoeconomics

by on May 14, 2012 at 7:31 am in Data Source, Economics, Medicine, Science | Permalink

An interesting piece from the Boston Globe on “genoeconomics”:

Though the name wasn’t coined until 2007, genoeconomics flickered briefly into existence once before. In 1976, the late University of Pennsylvania economist Paul Taubman published the results of a study in which he followed the financial lives of identical twins, and found there were curious similarities in how much money they made as adults. Taubman concluded that between 18 percent and 41 percent of variation in income across individuals was heritable.

It was a startling conclusion, and one that Taubman’s fellow economists didn’t quite know what to do with. One joked that Taubman’s findings meant the government might as well shut down welfare, since clearly some people would remain poor no matter what.

….After Taubman, the idea that genes had an important role to play in decision-making was largely abandoned in the world of economics. But with the completion of the Human Genome Project in 2000, the first full sequence of a human being’s genetic code, people started wondering if perhaps it would be possible to push past broad heritability estimates, of the sort that Taubman generated, and figure out what part of a person’s genome influenced what aspect of his behavior.

…Over time, social scientists started coming to terms with the fact that even the most heritable of traits, such as height, were influenced not by one or two powerful genes, but by a combination of hundreds or even thousands—and that environmental factors, like a person’s upbringing, play a complex role in determining how those genes are expressed. “Every single direction has proved to be less promising than people originally expected,” said Laibson.

… hope lies in a new approach to data-gathering that is only just getting underway, wherein researchers look for patterns among thousands, and even millions of people—numbers that are only just becoming possible thanks to massive collaborations linking gene studies being conducted all over the world.

The researchers in question, Daniel Benjamin, David Laibson, David Cesarini and others, seem worried about the possibility of tracing attributes and behavior to genetics. Most of the big news is out already, however, and more easily observed in phenotype than genotype.

For more on the new approach see The genetic architecture of economic and political preferences.

26 comments submit to reddit

Genoeconomics

by on May 14, 2012 at 1:31 am in Economics, Science | Permalink

Here is one paragraph of an interesting-but-treads-quite-lightly story about what is possibly a new field of economics:

To talk to the genoeconomists about their vision for the field is to listen to people acutely reluctant to overpromise, or to come off as naive. Much of their forthcoming paper in the Annual Review of Economics, in fact, describes how the vast majority of studies that appeared to link individual genes to specific outcomes—the amount of education people receive, whether or not they are self-employed, how they invest their money—have turned out to be impossible to replicate. Their hope lies in a new approach to data-gathering that is only just getting underway, wherein researchers look for patterns among thousands, and even millions of people—numbers that are only just becoming possible thanks to massive collaborations linking gene studies being conducted all over the world.

Jeff, the source, offers some discussion here.

Addendum: I now see in the blogging software panel that Alex has a post on the way, covering this same article, it should be up later today and maybe his take is different than mine.

10 comments submit to reddit

Sentences to ponder

by on May 13, 2012 at 1:52 pm in Economics | Permalink

Given the complete “credit isolation” of Greece’s banks and the private sector from the rest of the Eurozone, the ECB is powerless to improve liquidity conditions in that nation.

That is from Sober Look.

12 comments submit to reddit

← Previous Entries

Next Entries →