Category: Economics

The trade deficit and the dollar

America has had persisting trade deficits, so some economists think the dollar is due for a big plunge. The magazine The Economist cites some commentators as suggesting a 40 percent decline against the Euro. Read the commentary of Brad DeLong, who resists making such a prediction himself. See Brad’s longer and more detailed discussion, where he raises the possibility that capital inflow into the U.S. will slow down and the dollar will plummet. He tells us that the whole process has gone on far longer than he would have expected, but again he stops short of offering his own prediction. He wonders when foreign investors will start worrying about the risk of a huge dollar depreciation.

I am more optimistic than the doomsayers (N.B.: I do not read Brad as belonging to this group, though perhaps he is flirting with the idea of joining), in part because I think that strong growth and productivity, which currently appear to be in the cards, can avoid or postpone a “day of reckoning” of this kind. America is simply a good place to invest, and will remain so for the foreseeable future. The dollar did decline by over 50 percent in the 1980s, against major currencies, but at that time high dollar values were more obviously a speculative bubble in the first place.

The Economics of Child Labor

No, not paper routes or roadside car washes, this is about the tough stuff, like Moroccan children in carpet factories. 186 million children, between the ages of 5 and 14, perform illegal child labor. 111 million of these jobs involve hazardous work. Kaushik Basu offers his analysis and observations in the latest issue of Scientific American.

Obviously wealth is the best cure for hazardous and oppressive child labor. By the latter part of the 19th century, child labor was declining in the richer nations.

Basu notes that many anti-child labor campaigns backfire. A 1990s boycott of Nepalese carpets, made with child labor, led many of those children to become reemployed as prostitutes. Boycotts are ineffective when the available alternatives are worse. Anti-child labor regulations can backfire for another reason as well. Many children work simply to help their families achieve a threshold level of income, such as subsistence. The lower the wage that the children earn (think of the regulations as lowering the net returns from child labor), the more they will need to work to reach that threshold.

We learn also that history matters. Adults who worked as children are more likely to send their children out to work, even after adjusting for income.

Basu is skeptical of many interventions but he does not recommend laissez-faire. He argues that there are “multiple equilibria,” and that government can move an economy, in the right stage of development, from one equilibrium to another. The more children that work, the lower the overall level of wages, and the lower the stigma from sending one’s child out to work. Basu argues you can “tip” an economy into considerably less child labor. If you can cut out a big chunk of child labor, wages rise, making child labor for many other families less necessary. The stigma attached to child labor rises as well, and fewer people will send their children out to work. Once an economy is moving away from child labor, the process can happen quite rapidly.

The stigma of bankruptcy

According to one estimate, between 15 and 17 percent of all households in the United States could benefit financially from filing bankruptcy. Only about one-tenth of them do so. I learned this from The Two-Income Trap (reviewed by me immediately below). The book draws on the research of Michelle J. White, here is her on-line summary of her work. This also suggests that current bankruptcy law is unsustainable in the long run, here is one of many calls for reform.

Why does the middle class feel so poor?

I’ve just read The Two-Income Trap: Why Middle Class Mothers & Fathers are Going Broke, by Elizabeth Warren and Amelia Warren Tyagi. This book has received a good deal of popular press.

Having children is a big part of the financial burden, Americans have been spending less on appliances, food, and clothing. Housing prices are the real killer, especially if the family has children. Good schools and safety are becoming increasingly hard to buy. In real terms, families with children paid 79 percent more for housing, comparing 1983 to 1998.

Having just overpaid for a house, to put my stepdaughter into a good school district, I can sympathize with this argument. But I don’t understand the core logic as a more general claim. The authors claim that this financial predicament is affecting very large numbers of middle class Americans. At the same time we are told that good schools are increasingly hard to come by. Which is it? If there are a small number of homes with good schools, not too many people can be overpaying. If there are a large number of such homes, good schools cannot be that scarce, and the bidding war should not be so fierce.

I nonetheless recommend the book to stimulate your thoughts. It also argues for anti-usury laws, claiming that debt-ridden families will make rash decisions and overborrow at excess rates. You might recall Adam Smith made a similar claim over two centuries ago.

Iraq and the Marshall Plan

According to some estimates, we will spend $20 billion on Iraqi infrastructure over the next year, half of Iraqi gdp (don’t take Iraqi gdp statistics too seriously!). Andrew Sullivan has been asking how our assistance to Iraq compares to the Marshall Plan of postwar Europe. Here are some answers, drawn from a 1985 piece I wrote “The Marshall Plan: Myths and Realities,” click here for an on-line summary, the piece appeared in Doug Bandow’s U.S. Aid to the Developing World.

The Marshall Plan did not ever exceed 5 percent of the gross national product of the recipient nations. In the case of Germany, note that we were taking more out of Germany, in the forms of reparations and occupation cost reimbursements (11 to 15 percent of West German gnp), than we were ever putting in. Then throughout the mid-1950s, Bonn repaid half of the aid it had received. Note that German economic recovery followed from liberalization and reforms, which predated Marshall Plan aid.

In 1949-50, our Marshall Plan aid to France was roughly equivalent to French military expenditures abroad in Indochina and North Africa.

Of the European nations, arguably Belgium recovered from World War II most rapidly, and this happened before Marshall Plan aid kicked in.

At the end of World War II, the Austrian economy was one of the most desperate in Europe. Austria received high per capita aid sums, but the economy stagnated. Austria later recovered, when it improved its monetary and fiscal policies. Marshall Plan supporter Franz Nemschak wrote: “The radical cuts in foreign aid in the last year of the Marshall Plan and the stabilization tendencies in the world economy forced Austria to make a basic change in economic policy.” Greece received high per capita aid as well, but had a poor recovery.

The lesson for Iraq?: Simply spending money won’t get us there. See these Rand Corporation figures, showing that per capita aid does not correlate obviously with the eventual success of a reconstruction. The key question is whether the Iraqis can build healthy institutions. Walking away is not the answer, but don’t feel good just because you see more money being spent.

Addendum: I have scanned the whole essay and put it on-line.

The power of quality certification

Consumer Reports has become so influential among car shoppers that some automakers now send preproduction cars to the magazine’s test engineers for suggested changes before the vehicles hit showrooms.”

At least forty percent of car buyers consult Consumer Reports for information about their forthcoming purchase, at least sixty percent of minivan buyers. The company refuses to accept advertising from automakers. Suzuki and Isuzu have sued the magazine for making false statements and “product disparagement.” For the full story, click here.

Arguments against micropayments

Why not use web technology to charge people very small bits for downloading songs, or reading blogs for that matter? An earlier note of mine discussed mental transactions costs — having to ponder the small charge each time — as a potential problem. An excellent post by Daniel Davies provides further, and better, ammunition against the micropayments idea. His key point: at some point micropayments have to clear through real financial institutions and the real shuffling of paper. Right now we don’t have the technology to do this more cheaply than credit card companies do, and they don’t find very small transactions to be worth their while.

Addendum: Here is a good response in defense of the practicality of micropayments.

Cannabis Emptor

When goods are prohibited, quality tends to fall because of lack of competition and legal recourse. Quality in illegal markets, however, may still beat that available from government production. Health Canada spends millions of dollars growing marijuana for distribution to patients with medical need. The government grown pot is so awful, however, that patients are returning their 30 gram bags and asking for refunds! The government certifies and advertises that their product contains 10.2% THC but independent labs report only 3% THC. Furthermore, the government pot is contaminated with lead and arsenic. “This particular product wouldn’t hold a candle to street-level cannabis,” said Philippe Lucas of Canadians for Safe Access, the group that sponsored the tests. Thanks to Eric Crampton for alerting us to this story.

The economics of diets

Meat sales are up and bread sales are sluggish. The Atkins diet tells us to dump bread, pasta, and rice, and allows us to eat plenty of meat. Could it be driving this trend? Slate examines the economic impact of diets and offers a cautionary note. Only six million people –about three percent of national population — have tried the Atkins diet. Most people are buying convenience, the growth is beef sales is centered in ready-to-serve products. By the way, sales of Krispy Kreme donuts grew last year. In case you didn’t already know, they are forbidden under the Atkins plan. Cookie and potato chip purchases are up as well. When it comes to weight gain, some economists blame sedentary jobs and cheap, readily available foods.

Addendum: Today’s Wall Street Journal reports that Krispy Kreme sales are now sagging, though keep this in perspective, the company has averaged a 63% growth in operating earnings, per quarter, over the last ten quarters.

The beast isn’t starving

I caught a lot of flak from conservatives when I wrote in an op-ed that the so-called Bush tax-cuts were a fraud. If spending isn’t cut then in the long run taxes can’t be cut either. Since spending has gone up under Bush, all he has done, I argued, is to raise our future taxes (at precisely the wrong time too given the coming fiscal problems created by demography) . Conservatives complained that I missed the strategic beauty of the Bush plan. A tax cut, they said, will keep spending down, it will “starve the beast.” Well Bush is now asking for another $87 billion to fight the war in Iraq, employment is down everywhere but in the federal government where it is higher than under Clinton, and Bush is already touting how his administration is responsible for the largest increase in Medicare in its 38 year history. Apparently, on the Bush diet you can eat all you want and still lose weight.

Globalization and poverty: a debate

The Cato Institute offers an on-line debate on globalization and poverty, here is the last installment. Johan Norberg, author of In Defense of Global Capitalism, takes on Robert Kuttner, of The American Prospect. I am closer to Norberg’s market orientation, but Kuttner gets the better of this exchange. Norberg needs to concede a clear role for government in development, in producing public goods and basic infrastructure, and emphasize that most developing countries today don’t have strong enough markets or anything close to it. That debate he could win.

Should we be surprised that the Cancun WTO talks failed?

Cnn.com and other major news sources use the word “collapse.” The rich countries won’t give up their agricultural subsidies, some of the poor countries won’t open up their investment and procurement rules.

A recent IMF Working Paper, “The WTO Promotes Trade: Strongly but Unevenly,” by Arvind Subramaniam and Shang-Jin Wei (not on-line) provides an account of the longer history. In the early days of WTO (GATT), developed nations used the institution to reduce their average tariff barriers from 27 to 4.5 percent. Since that time the institution grew and deteriorated in quality: “our result is a more damning indictment of the WTO than even that in Rose [the link is from me, of course, not the authors of the paper]…He found that membership in the WTO had no significant effect on trade. We find that membership has a significantly negative effect on trade…”

It is the developing countries that drive the negative result. The authors emphasize that the result is not statistically robust, but in any case this is hardly a ringing endorsement of WTO.

Addendum: The paper is now on-line.

Sweden rejects the Euro

The margin is decisive, so far it looks like 56 percent against, 42 percent for, read here for one early account of the voting.

It is a tough call, but I think the Swedes did the right thing. Mostly the Swedes feared that the fiscal discipline of the EU will curtail their welfare state, but I don’t think this should have been the main issue. The Netherlands, another small country, has created a generous welfare state (albeit with some spending cuts), prosperity, and relative fiscal responsibility, all under the rubric of the EU. In the long run it is hard to see the EU curtailing Swedish spending more than international capital markets and other competitive pressures would. And it remains to be seen how binding the EU fiscal requirements will prove, after France is violating them.

What is really the advantage if Sweden had adopted the EU? Price competition would have become more intense, as buyers would have an easier time comparing prices across countries with only a single currency unit (admittedly this violates various economic theories, which suggest people “see through” the monetary unit, but it nonetheless seems to be true, noting that in the short run prices get bumped up before later falling). That counts as a real gain, but on the other side the Swedes would have given up the ability to control their own monetary policy.

The Swedes have a history of pursuing a monetary policy independently of Western Europe. The Swedish depression of the 1930s was milder than for the rest of Europe, in part because Sweden broke with gold, devalued, and avoided a disastrous deflation, for one treatment read here.

Supposedly the Swedes don’t now have the “proverbial seat at the table,” but as more countries adopt the Euro, how much is this worth anyway? They decided to keep a whole table of their own, albeit a much smaller one. Does anyone really know how the European Central Bank will operate over time, as more members join, or if a crisis hits? Some critics charge that foreign investors will now stay away from Sweden, due to exchange rate volatility, that would be one factor on the side of Euro adoption.

Perhaps it will prove most important that the Swedish government supported the change, and voters didn’t cooperate. Swedes usually have great trust in their government, more than we are accustomed to seeing in the United States. This may signal a break between Swedish elites, who often have closer ties to Europe, and many Swedish voters. The consequences of today’s vote will likely include more than just macroeconomic policy.