Category: Economics

Estonia Schadenfreude

by  Tyler Cowen in

It is now common in the left-leaning blogosphere to cite Estonia, its rapidly collapsing economy, and its earlier free market policies.  Sometimes the name of Dan Mitchell pops up as well.

I would add a cautionary note.  Recall for instance that Chile and South Korea and New Zealand also had collapsing economies, for a while (the early 80s for Chile and late 80s for NZ) but they rebounded because they were built on relatively sound economic policies.  The point can be made that they, like the Estonians, indulged in too much speculative excess but most Estonian decisions have been good ones.

Which Eastern European economy has suffered least from the financial crisis?  By most accounts it is Bulgaria.  Should we envy their economic policies?  Should you prefer the Bulgarian Way to the Estonian Way?

Which country has a future you would bet upon?

Etc.

This paragraph has an idea I hadn’t heard before

by  Tyler Cowen in

What sweet words those are.  Here is the paragraph, from The Economist:

Matt King, an analyst at Citigroup, believes that the surge in
securitisation during the bubble can partly be explained by a massive
mismatch between the regulatory regimes of American and European banks.
Those American banks whose regulator imposed a leverage ratio had an
incentive to move assets off their balance-sheets. European banks which
operated only under a risk-weighted capital regime were able to buy
those very same assets because they attracted a low capital charge.
With risk weightings on the rise, and leverage ratios all the rage, the
capacity of European banks to purchase these assets is shrinking.

The broader question is to what extent the securitization model will make a comeback anytime soon.

Addendum: Arnold Kling comments.

Gary Gorton’s new paper

by  Tyler Cowen in

Find it here, with this abstract:

The
'shadow banking system' at the heart of the current credit crisis is,
in fact, a real banking system – and is vulnerable to a banking panic.
Indeed, the events starting in August 2007 are a banking panic. A
banking panic is a systemic event because the banking system cannot
honor its obligations and is insolvent. Unlike the historical banking
panics of the 19th and early 20th centuries, the current banking panic
is a wholesale panic, not a retail panic. In the earlier episodes,
depositors ran to their banks and demanded cash in exchange for their
checking accounts. Unable to meet those demands, the banking system
became insolvent. The current panic involved financial firms 'running'
on other financial firms by not renewing sale and repurchase agreements
(repo) or increasing the repo margin ('haircut'), forcing massive
deleveraging, and resulting in the banking system being insolvent. The
earlier episodes have many features in common with the current crisis,
and examination of history can help understand the current situation
and guide thoughts about reform of bank regulation. New regulation can
facilitate the functioning of the shadow banking system, making it less
vulnerable to panic.

Addendum: Arnold Kling summarizes some of the recommendations:

1. Senior tranches of securitizations of approved asset classes should be insured by the government.
2. The government must supervise and examine "banks," i.e.,
securitizations, rather than rely on ratings agencies. That is, the
choices of asset class, portfolio, and tranching must be overseen be
examiners.
3. Entry into securitization should be limited, and any firm that enters is deemed a "bank" and subject to supervision.

The Politics of Cap and Trade

by  Alex Tabarrok in

Good overview in the NYTimes on the politics of cap and trade.  The bottom line:

How did cap and trade, hatched as an academic theory in obscure
economic journals half a century ago, become the policy of choice in
the debate over how to slow the heating of the planet? And how did it
come to eclipse the idea of simply slapping a tax on energy consumption…

The answer is not to be found in the study of
economics or environmental science, but in the realm where most policy
debates are ultimately settled: politics…Cap and trade…is almost perfectly designed for the buying
and selling of political support through the granting of valuable
emissions permits to favor specific industries and even specific
Congressional districts.That is precisely what is taking place now in the House Energy and Commerce Committee…

Here is how Tyler and I put it in Modern Principles: Microeconomics

With a tax, firms
must pay the government for each ton
of pollutant that they emit. With pollution
allowances, firms must either use
the pollution allowances that they are
given or if they want to emit more they
must buy allowances from other firms.
Either way, firms that are given allowances
in the initial allocation get a
big benefit compared to having to pay
taxes. Thus, some people say that pollution
allowances equal corrective taxes
plus corporate welfare.
That’s not necessarily the best way of
looking at the issue…

…To make progress against global warming, may require building
a political coalition. A carbon tax pushes one very powerful and interested
group, the large energy firms, into the opposition. If tradable allowances are
instead given to firms initially, there is a better chance of bringing the large energy
firms into the coalition. Perhaps it’s not fair that politically powerful
groups must be bought off but as Otto von Bismarck, Germany’s first chancellor,
once said,”Laws are like sausages, it is better not to see them being made.”
We can only add that producing both laws and sausages requires some pork.

Careful readers may recognize a friendly jab at a competitor. 

Should we put a carbon tax on China?

by  Tyler Cowen in

Paul Krugman seems to say yes:

As the United States and other advanced countries finally move to
confront climate change, they will also be morally empowered to
confront those nations that refuse to act. Sooner than most people
think, countries that refuse to limit their greenhouse gas emissions
will face sanctions, probably in the form of taxes on their exports.
They will complain bitterly that this is protectionism, but so what?
Globalization doesn’t do much good if the globe itself becomes
unlivable.

I cannot agree with what I think is his recommendation.  I am not a global warming denialist but:

1. The Chinese are often paranoid (arguably for good reason) and we will get further being nice to them than by being confrontational.  Krugman himself admits that they don't seem themselves as culpable on this issue.  Chinese citizens wanting clean air at home are possibly our biggest ally so let's not alienate them.

2. Last I checked China was funding a big chunk of our government's debt.  Confronting them would have to be bundled with a regime of extreme fiscal conservatism and unilateral foreign policy.

3. It can be very hard to identify and isolate the energy inputs into an exported product, especially if the host government is uncooperative and a lot of money is at stake.

4. We cannot credibly penalize the Chinese until we solve our own pollution problem.  Even under Obama's proposed policies, in their purer forms, that is at best decades away.  In the meantime, what is it that is really being advocated?  Non-credible threats?

5. Once the political process gets its hand on such tariffs they will be directed against, say, Chinese cars, including maybe relatively clean ones, rather than the dirtiest Chinese exports.

6. Last I checked there was something called the United Nations and China sat on its Security Council.  The UN is the (supposed) forum for handling problems of this nature.  Yes, we could construct an alternative "League of Democracies" as John McCain (!) had suggested, in part to deal with global warming and other multilateral problems where the non-democracies won't cooperate.  I don't favor this change but if we are going to do it we need to realize how radical a foreign policy step it would be and how Russia would respond as well. 

One lesson I take from Krugman's piece is just how thin support for multilateralism really is.

I do understand the basic instinct of "this problem is really bad so we must do something…and now!"  I would suggest that we keep in mind the less obvious, but no less important intuition: "this problem is really bad and that means a lot of what we are tempted to do could make it even worse."

Stuff they don’t teach in graduate school

by  Alex Tabarrok in

Chris Blattman has a problem to do with his research that they just don't teach about in graduate school.  Which type of anti-malarial drugs should he provide for his research assistants?

I have more and more research assistants in the field these days, and it would
be really fantastic if none of them fell deathly ill because of, well, my
research papers.

Here's the question. We have at least two perfectly
common anti-malarial options–doxycycline and mefloquine–each of which cost a
few cents each. They've been around a while, so we know what to expect. Doxy:
sun sensitivity in the occasional case, and no milk in your coffee that morning
(which is a tragedy). Mefloquine: crazy dreams among a few (including
me).

Along comes a fancy-pants new drug, Malarone. It costs $6 a pill,
with insurance, and has to be taken every day. Why would I pay 120 times more
than the generic? Is it 10 times as effective? 1.2 times? Just as effective? As
far as I can tell, there aren't studies on the matter.

The health care costs budget fallacy

by  Tyler Cowen in

Today's report is this:

The financial outlook for Medicare and Social Security
has significantly worsened, as the bad economy and mounting job losses
have pushed both programs years closer to insolvency, according to a
grim report issued Tuesday by the Obama administration.

Maybe you once argued that "Social Security is fine," but dollars are fungible and the budget must be judged as a whole.  The consumption tax is coming, I am sorry to say.

I'm seeing nascent signs of a new (but actually old) fallacy, namely that since health care costs can (will?) crush the budget, we don't have to worry so much about other expenditures.  The mental story runs something like this: "if we don't cure health care cost inflation, it doesn't matter; if we do cure health care cost inflation, we can afford it."  That's exactly the kind of false mental framing that behavioral economics identifies as irrational in other settings.

Here is some stupid TV.

Elsewhere, Richard Posner makes many concessions.  I do not disagree; it's a mistake to think that a political movement can be very smart, especially after extended years in power.

New issue of Econ Journal Watch

by  Tyler Cowen in

Find it here.  The contents are described as follows:

Occupational Misfeasance of Labor Textbooks: Frank
Stephenson and Erin Wendt report that textbooks neglect occupational
licensing.

Do Economists
Believe American Democracy Is Working? A new survey by William
Davis and Robert Figgins indicates that Democratic, Republican, and
Libertarian economists are all of but little faith.

Adam Smith’s Invisible
Hand–Is That All There Is? Gavin Kennedy argues that it was
just a casual metaphor; Dan Klein dissents.

Guns and Crime, Round 2: Carlisle Moody and Thomas
Marvell rejoin, and Ian Ayres and John Donohue reply.

Intellectual Hazard:
97 quotations about our wanton ways.

Some reasons why Canadian banking is special

by  Tyler Cowen in

Via Scott Sumner, here is a list from Nick Rowe:

…it doesn’t seem to be as simple as “Canadian banks are more tightly-regulated”.

1. We never had restrictions on interstate banking, so Canadian banks spread their assets and liabilities across Canada. (So it doesn’t matter if a local housing market goes bust).

2. We don’t have Glass-Steagal. The investment banks joined the retail banks some years ago.

3. We don’t have mortgage interest deductibility from taxes. So paying down your mortgage is a tax-free investment. So most people want to pay down their mortgages.

4. (Except in Alberta), mortgages are fully recourse. You can’t just walk away from a negative equity home and hand the keys to the bank; the bank will come after you for the difference.

I wouldn’t describe those differences as “Canada is more regulated”.

But we do have higher capital requirements. And mortgages over 80% must be insured (mostly by the government-owned CMHC).

I would add one more feature of the Canadian banking system, which it shares with a number of other systems.  If a Canadian investor wishes to take some risk, the New York-based banks may be the most efficient means of doing that.

Addendum: Megan McArdle offers a theory of Canada.

Chavez and the Power of the State

by  Alex Tabarrok in

Between 2002 and 2004 millions of Venezuelans signed petitions calling for a vote to remove Hugo Chavez from office.  Signatories were not anonymous and during the petition campaign Chavez supporters hinted darkly that there would be retaliation.  Chavez was in fact forced into a recall election, but unfortunately he won (not one of democracy's better moments).  After the election, the list of signatories was distributed to government agencies in an easy-to-use database.  The database included the names and addresses of all registered voters and whether they had signed an anti-Chavez petition.  Technology thus provided Chavez supporters the information they needed to retaliate.

Technology cuts both ways, however, and in a truly remarkable paper, Hsieh, Miguel, Ortega and Rodriguez match information in the petition database to another database on wages, employment and income.  What the authors find is shocking, albeit not surprising.  Before the recall election, petition signatories and non-signatories look alike.  After the election, the employment and wages of signatories drop considerably, about a 10% drop in wages relative to non-signatories.  Survey evidence conducted by the authors is consistent with retaliation by Chavez supporters especially in the form of job losses in the public sector.  The authors estimate that the retaliation was so widespread, many workers were pushed into informal employment, that the Venezuelan economy was significantly damaged.

This is original, important and actionable research.  Bravo to the authors, especially to Ortega who–as of this posting–has a job in Venezuela.

Countercyclical assets at Wal-Mart

by  Tyler Cowen in

Sometimes people enjoy the mere act of the purchase and the feeling of luxury or capture involved:

As people seek cheap ways to entertain, lower-end patio sets and
barbecue grills are selling well. Sprague admits she's puzzled by some
of the store's hot recession sellers, like $5 white toilet seats. "It
seems bizarre," she says, "but I can't keep them in stock." Her best
guess: unemployment and cocooning are leading people to put more wear
on their home bathrooms, and they're choosing her $5 seats over pricier
ones at Home Depot.

Here is the story and I thank TheBrowser for the pointer.  Dare I ask why anyone would want a white toilet seat?

How our macro book differs

by  Tyler Cowen in

Alex already has suggested some points related to economic growth; I'll add to that:

1. We make macroeconomics as intuitive as microeconomics.  Our macro is based on the idea of incentives, consistently applied.

2. We cover the current financial crisis.

3. We show a simple — yes truly simple — way of teaching the Solow Growth model.  I call it Really Simple Solow.  But if that's not simple enough for you, you can skip it and just call it Long-Run Aggregate Supply.

4. We offer equal and balanced coverage of neo Keynesian and real business cycle models.  Most other texts emphasize one or the other.

5. We offer an intuitive way of teaching real business cycle theory.  No intertemporal optimization representative agent models.  Can you explain to your grandmother why swine flu has been bad for the Mexican economy?  If so, you also think that real business cycle theory can be taught simply and intuitively.

6. Our version of the AD-AS model actually makes sense.  We don't mash together real and nominal interest rates into the same diagram, we don't treat the Taylor rule as an assumption for deriving an AD curve, and we do the analysis consistently in terms of dynamic rates of change.  (On the latter point for instance it is the rate of inflation which influences economic behavior, not the absolute level of prices per se, yet so often "p" rather than "pdot" goes on the vertical axis.) 

The AD-AS analysis covers both neo Keynesian and RBC models and can be done with three simple curves in one simple graph.  There is only one (consistent) model which needs to be taught for presenting the major macro ideas.

Alex and I vowed we would not stop working on this book until macro ceased to be the "ugly sister" of the micro/macro pair.  Modern Principles: Macroeconomics is the result of that Auseinandersetzung.

We are heartened by the response to our previous posts on the book.  Again, please do contact us if you are interested in a review copy for teaching purposes.  Here is the book's home page.