iceland dust up
There has been enough coverage that I won’t summarize the entire debate, suffice to say that Krugman offered a picture like this:
Some writers from the CFR (I am not completely sure how to attribute authorship), offered this picture, along with some analysis and links (and further pictures). The key point is that the second picture considers a longer time horizon, and all of a sudden the relative performance of the different countries has changed:
They argue that in this light, looking over the longer time horizon, the Icelandic story appears mediocre rather than impressive relative to some of the other small countries. A few points:
1. Arvind Subramanian argues we should look at per capita growth and also PPP vs. market exchange rates, read here.
2. Arvind’s point aside, that the pictures give different impressions is more important than either picture taken alone.
3. The second picture brings value-added to the debate, and it suggests stories which the first picture taken alone does not. I’ll come back to that.
4. The debates have mixed together a few different questions, such as “how well have the countries done?,” “how well have the countries’ policies done?,” and “should we be looking at both pictures?” Since the answer to the first two is obviously agnostic — too soon to tell — I will focus on the last of these questions and the answer is yes, we definitely should be looking at both pictures.
Krugman’s response, once you get past the inappropriate insults, doesn’t serve up much. He has arguments against the view “Don’t look at the first picture” but no good arguments against “Look at both pictures very carefully and integrate.”
Ryan Avent offers a more polite response here. He focuses on convergence (maybe we should have expected the Baltics to have outperformed Iceland, so a tie means Krugman wins), but this estimate suggests the fixed exchange rate did not really cost the Baltics much in the way of convergence points. In any case I fear the goalposts are being shifted and what we know about convergence and its speed is iffy anyway; for instance anyone worried about bad monetary policy, and opposing 1980s style RBC theories, should be a convergence pessimist for the short run.
Most importantly, there is still no argument against looking at both pictures in a serious way.
So what additional thoughts come to mind looking at the second picture, which you might not get so much from the first picture alone? Here are two:
a. Some countries simply may be more volatile than others, and this may or may not have to do with their policy responses. I’ll note Cowen’s Second Law, namely that there is a literature on this and the people who work in that literature consider this to be a plausible proposition (which does not mean it is here the operative explanation, however).
b. The size of an initial run-up, possibly bubbly at that, is correlated with the size of the later collapse and also the difficulty of recovering from that later large collapse.
There is a literature on that too, start here, it is not an absurd proposition by any means.
By the way, did I mention a 2009 IMF Staff Report which concluded that Latvian “output exceeded potential by 9 percent in 2007.”? That supports the relevance of b) and possibly a) as well, and it discriminates against Krugman’s story of the peak being a point reattainable through policy management.
I take Krugman to be suggesting something like c): all the relevant information for understanding performance is contained in post-bust policy, so we needn’t look at earlier years and in fact doing so may mislead us.
Yet this attempts to pre-settle the dispute by putting all of the explanatory burden on post-crash policy. In general commentators often overattribute results to policies and in any case we should not build in this bias a priori.
Are you a fan of Dani Rodrik’s “every country is different” hypothesis? If so, you probably should think that both graphs are important. Country characteristics don’t morph away overnight, so earlier data points should matter for understanding current policy results.
If we look carefully at both pictures, I say we still don’t know what is going on, but we do have a richer sense of the possibilities.
From now on these two pictures should be shown and considered together.
Recently, the International Federation of Icelandic Horse Association (FEIF) passed a new law stating that Icelandic horses may not be named any name not registered in the WorldFeng database. If a horse owner wants to name the horse something else, their suggestion needs to be approved by the horse naming committee.
According to Vísir, a horse farmer in Skeggsstaðir farm, Guðrún hrafnsdóttir, suggest the name Mósan for her mare. The committee rejected the name since it doesn’t conform to Icelandic name traditions.
The Icelandic Ministry of Industries and Innovation is currently investigating if rulings of the horse naming committee are legal or not. So far, Guðrún has waited for 5 months for a reply from the ministry, Vísir reports.
Paul Krugman describes their policies as a mix of “debt repudiation, capital controls, and massive devaluation.” Matt Yglesias refers to putting some of their bankers in jail. But I say there is not a generalizable formula here.
Neither mentions that a major part of the Icelandic recipe was letting foreign deposit holders twist in the wind. That’s a transfer of wealth to the domestic economy and furthermore it was politically palatable; it is also a choice which won’t much help any larger country where most of the deposit holders are domestic. It is noteworthy that this kind of choice loomed large for Cyprus, another small country with a lot of foreign depositors.
Iceland is also so small that cutting off these creditors won’t much damage the broader global economy or lead to significant contagion. Today, in a much safer macroeconomic environment, we’re not even sure the same could be said for Grexit, and Greece is a pretty small country in economic terms.
On top of all that, not paying back the foreign depositors was a transfer to Iceland. It is easy enough to see why Icelanders might like that idea, but the objective foreign analyst, who ought not favor the more Nordic peoples above the others, also should consider the loss side of the ledger, namely in the UK and Netherlands.
Don’t forget that the value of the Icelandic stock exchange fell by 90% – how many other countries could endure that or would accept it? That is easier to pull off when there are only six stocks trading on your exchange and those equities are not central to your savings.
Capital controls are also not an option for many economies, including those that are serious about being financial centers or having reserve currencies. More to the point, the flight of foreign capital is very often not a problem in the first place. And we have plenty of experience with capital controls and the overall record is at best mixed; this is hardly a neglected heterodox innovation. The imposition of Icelandic capital controls may well discourage foreign investment looking forward, and so the “record to date” will be misleading in this regard. This is again a way in which Iceland has transferred the costs of its adjustment into the future. On top of that, we still don’t yet know how well the Icelandic removal of capital controls will go.
I’m all for devaluing and accepting higher inflation in a lot of crisis situations. This part of the Icelandic recipe is generalizable. It’s worth noting, however, that the devaluation (especially with capital controls) imposed a harsh and immediate “austerity” on the Icelandic people, namely it was very hard to buy foreign goods for a while. In other words, rapid real wage cuts were imposed on just about everybody. If your country can do that, great, but it needs to be outlined how most economies will manage that trick. See also Scott Sumner’s remarks on whether Iceland avoided traditional fiscal austerity.
Given some very tough circumstances, Iceland also did a reasonable job of “ring-fencing” its banks and separating the good from bad assets. That may be generalizable too, although it doesn’t have the polemic punch of some of their other policy choices.
Overall, the experience from Iceland, upon closer inspection, is not very easily generalizable. I suspect it receives much of its praise for reasons of mood affiliation — what could sound tougher than putting bankers in jail? But overall, Iceland faced very different constraints and opportunities, relative to other countries in the financial crisis.
Addendum: Here are some relevant earlier posts.
I agree with Megan McArdle’s general point that the winners and losers from this financial crisis have not yet been sorted out. Here is Jon Danielsson, with some negative notes on Iceland’s economic performance:
Based on the current state of the Icelandic economy, the Fund’s claim of success [for Iceland] does not stand up to scrutiny.
- Public finances are not on a sustainable path,
- Exchange rates are not fully stable even with capital controls,
- Investment has collapsed, and
- The financial sector is dysfunctional.
At the same time, the Fund forced Iceland to impose a high interest-rate policy at the time when every other developed economy was doing the opposite…
GDP has declined by about 11% since the crisis of October 2008, but modest and volatile growth has returned, sustained primarily by an increase in private consumption catching up after two years of austerity. Worryingly, export growth is low, even with a sharp fall in the exchange rate, while investment is at a record low.
Business investment rates in Iceland equalled the EU average from 1995 to 2008, according to Eurostat.
- Over the past two years the investment rate in Iceland collapsed to 10% whilst the EU only suffered a small decline to 17%.
…Initially, the capital controls were touted as a temporary measure to prevent a sharp depreciation of the currency, but by now the domestic economy has adapted to their presence, and become increasingly inward looking. The signs point to the controls remaining.
…Unfortunately, the government has also been using the capital controls as means to implement industrial policy, politically selecting those allowed to use cheap offshore kronas to buy Icelandic assets. Such direct political selection of investors can only breed corruption, mistrust, and inefficiency.
The petroleum sector is about 21% of gdp and half of exports. It’s not just that prices are down, rather quantities produced have been declining throughout the oughties. (That is the less well known angle here.) Currently Norwegian oil production is at about half of its 2000 level, and the sector is now bracing for 40,000 job cuts.
The group has documented how Norwegian politicians all too often have approved major investment projects that benefit far too few people, are poorly managed and plagued by huge budget overruns. Costs in general are way out of line in Norway, according to the group, while schools are mediocre, university students take too much time to earn degrees and mainland businesses outside the oil sector lack enough prestige to help Norway diversify its oil-based economy. The group mostly blamed the decline in productivity, though, on systemic inefficiencies and too much emphasis on local interests at the expense of the nation.
Is this entirely reassuring?:
Prime Minister Erna Solberg recently spoke of the need to invest in areas where people actually live…
After you adjust for wage differences, it costs 60% more to build a road in Norway than in Sweden.
“Approximately 600,000 Norwegians … who should be part of the labor force are outside the labor force, because of welfare, pension issues,” says Siv Jensen, the finance minister.
The country has largely deindustrialized, oil of course aside. And there is a fair amount of debt-financed consumption.
The country has falling and below average PISA scores by OECD standards.
Not everyone admires Norway’s immigration policy, and there is periodic talk of banning begging in the country. It seems there are only about 1000 beggars — mostly Roma — in a country of about five million, so you can take that as a sign they are not very good at processing discord. Far-right populist views do not seem to be going away.
For sure, Norway will be fine. Did I mention per capita income is over $100,000 a year and they have no current problems which show up in actual life? Hey, the “over” in “overrated” has to come from somewhere! The country also has the world’s largest sovereign wealth fund and owns about one percent of global stocks. Still, the idea of a rentier economy makes me nervous. When most people don’t “have to” do that well, often cultural erosion sets in.
They’ve made a new film : “Here’s a beautiful video of Iceland and Norway, time-lapsed and tilt-shifted to show the hustle, the bustle, and the beautiful splendor of Scandinavia from a more toy-like perspective. Called The Little Nordics, it was filmed by Dutch design team Damp Design. Happy Friday!”
Addendum: Here is my earlier post on whether Sweden is an economically overrated country. At least it is cheaper to build a road there.
Also known as the continuing case for agnosticism, especially when it comes to small countries. There is actually a paper on this topic (Cowen’s Second Law!), let’s look at the end part:
Currency depreciation is said to stimulate aggregate demand by increasing its net export component. On the other hand, it is said to discourage aggregate supply by increasing cost of imported inputs. The ultimate impact is ambiguous on theoretical grounds. A recent review article reveals that in developing countries, devaluation or real depreciation is indeed contractionary in the short run. In the long run, however, devaluation is neutral in most countries. Emerging economies have received no attention and we try to fill this gap in this paper.
In this paper we consider the experience of nine emerging countries of Belarus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Russia, and Slovak Republic with currency depreciation. Using the bounds testing approach to cointegration and error-correction modeling that distinguishes the short-run effects from the long-run effects, the results turn out to be country specific. In the short run we find that real depreciation is expansionary in Belarus, Latvia, Poland, and Slovak Republic; contractionary in Czech Republic, Estonia, Hungary, and Russia; and has no effect in Lithuania. In almost none of the countries, the short-run effects lasted into the long run.
A few remarks on this:
1. I have read dozens or maybe hundreds of blog discussions about the wage effects of depreciation/devaluation. I can’t recall very many on the input and portfolio effects. I can’t recall any serious assessment of which effects are more import (sorry if I have forgotten your post or didn’t read it). I also don’t see many discussions of whether observed short-run effects persist in the longer run.
2. I am not trying to push the particular conclusion of this paper on you (“Ah, now I understand where Belarus falls!”), rather I wish to indicate that the matter is not so simple as to always favor floating rates. I am myself usually in the floating rate camp, but with far more agnosticism than I usually see when this topic is tossed around these days. Furthermore the growth literature does not in general indicate that simply sticking with a fixed rate offers inferior long-run performance.
3. It is fine to argue that this 2008 paper may not apply to the conditions of 2012. That would again leave us will very little sound basis to go on for assessing 2012, as we would be asserting that the previous evidence no longer is relevant. Such an attitude should not then push us into a dogmatic point of view, one way or the other.
4. In general I worry that the literature on contractionary devaluation does not have clearly defined exogenous events, or good independent measures of how bad the economic situation is in the first place.
5. The people who actually study this topic, if I dare introduce them into this discussion, very often end up believing that country-specific factors are extremely important. This makes “Econ 101” (or is that 306?) discussions of the topic misleading.
6. It is not the fault of any single individual, but overall I find it disconcerting, and not reflecting so favorably on the econ blogosphere, how disconnected this discussion has been from the actual literature.
7. As a good rule of thumb, any time you hear a dogmatic macroeconomic pronouncement in the econ blogosphere, or the assertion that someone else doesn’t know what he or she is talking about, the actual reality is usually far less certain than the view which is being pushed on you.
Either later today or tomorrow I will address some remarks to the latest dust-up over Iceland, but you can take this post as useful background.
LA Times: Aziz Ahmed was supposed to die. In 2006 he used a meat cleaver to kill a friend he thought had been sleeping with his wife. He confessed and was sentenced to be hanged.
But last month Ahmed won his freedom; not because his confession was recanted or fresh evidence was presented, but because of a wad of cash. He paid the victim’s family $9,400 and walked out of prison a free man. The slain man’s relatives said they would use the money to buy the widow a cookware shop in this dusty farm town in Punjab, near the Indian border.
“We’re not bitter about this at all,” said Mohammed Nasir, brother of the victim, Ghulam Sarwar. “This money will take care of Ghulam’s wife and children.”
What outsiders might describe as “blood money” is a tenet of Islamic law sanctioned by Pakistani jurisprudence and used, by some estimates, in up to 60% of homicide cases here. The practice is called diyat, and it could be the means by which the United States and Pakistan extricate themselves from a dangerous diplomatic row that has strained relations between the two governments.
It is important to understand that diyat arose as a progressive measure designed to substitute restitution for retribution. Restitution systems have a number of virtues. One virtue of restitution is that it puts the victim’s family at the center of the process rather than ignoring their interests. Criminal law, in contrast, replaces the interests of victims with the interests of the state. Perhaps this is sometimes necessary (what to do about victims without families?) but restitution systems have been quite sophisticated at dealing with these problems. David Friedman, for example, explains the Icelandic system of wergeld and Bruce Benson discusses the medieval Ango-Saxon system. I am not aware of much work, however, on Islamic diyat. Randy Barnett makes the case for restitution as a substitute for criminal law today.
If restitution is to work well it’s crucial that restitution be set at the right levels. It’s not always clear that this is done. In Saudi Arabia maximum compensation prices are as follows (from Wikipedia, according to this document, take at your own risk)
- 100,000 riyals if the victim is a Muslim man
- 50,000 riyals if a Muslim woman
- 50,000 riyals if a Christian or Jewish man
- 25,000 riyals if a Christian or Jewish woman
- 6,666 riyals if a Hindu man
- 3,333 riyals if a Hindu woman.
More generally, however, Diyat will vary by the wages and prospects of the deceased. If that sounds wrong do note that US tort law compensates in a similar way, although as a supplement rather than substitute for criminal law.
The optimal scope and overlap of criminal and tort law is an under-researched topic.
1. Exactly which national groups evolved a sufficient love of capitalist ways of life? Clark’s statistics show that the wealthy had more surviving kids in England, relative to the poor. Furthermore some numbers suggest that the same was less true in accident-prone primitive societies, where selection is based more on luck and physical force.
Even putting aside the debate on how long evolution requires (who will be the first to mention lactose intolerance and dachsunds in the comments?), does this explain the economic supremacy of England? Recall that England climbed out of the Malthusian trap but most of the rest of Europe did not. Was positive selection more pronounced in England than in Italy? Than in France? There is no evidence for those propositions, which in any case strike me as unlikely. Even if one buys into positive selection, we have at most "positive selection for some countries vs. others," not "positive selection elevating England over the rest of Europe and driving an industrial revolution." Positive selection doesn’t get us very far in explaining the climb out of the Malthusian trap, which was more or less unique to England and the Netherlands.
Clark mentions in passing that positive selection bred the Chinese to be natural capitalists. If we accept this portrait, I am now more confused about a) where positive selection operated and where it did not, and b) what was the marginal product of positive selection, vis-a-vis industrialization? Until the 1980s or so, the Chinese record simply isn’t very good over the last few centuries.
In fairness to Clark we have not yet finished his discussion of these factors.
I’ll also note that I see positive selection in terms of culture, family norms, and peer effects, rather than genes. Or you might think it is some mix of the two. If you focus on the biological issues in the comments I think you’re missing the strongest and most general version of the argument.
2. I am not persuaded by Clark’s argument that "institutions do not matter." True, medieval England had limited government intervention but it did not industrialize or "take off." Clark’s discussion is right on, and if the English example does not persuade you try medieval Iceland, which was probably even freer.
But my conclusion differs from Clark’s. I conclude "science is more important for growth than we had thought, and the simple fact of freedom does not itself guarantee much progress for science." In this view the institutions which support science matter profoundly. Science, science, science. I recommend Jack Goldstone’s forthcoming book, much of which focuses on science and engineering culture in early modern England.
Infrastructure also matters. In medieval England the state wasn’t strong enough to help establish a large open geographic area for trading. Early English economies were still local rather than national, and yes economies of scale matter.
That all said, I will accept a reformulated argument: "Institutions matter, but we should not take institutions as exogenous." On this middle ground just about all of Clark’s substantive contributions will hold up. So I view him as overstating his case, and taking too big a swing at institutional theories. This overreaching, however, does not negate his core arguments. So maybe you disagree with Clark on this point, as I do, but you cannot use it as reason to dismiss his other claims.
In closing, we can now see that Clark’s core arguments don’t depend on Malthusianism; they require only that economic growth is something very difficult to accomplish, and indeed that is the case.