Latvia and Sweden

The situation in once fast-growing Baltic tigers is dire. As the Economist writes, the third quarter of 2008 was marked by a 4.2% contraction in economic activity and unemployment reached the level of 7.2%. The country had to face problems in its banking sector - Parex Bank, the second largest financial institution in Latvia, had to be nationalised after clients escaped to secure subsidiaries of Scandinavian banks. Latvia's plans of accession to the Eurozone complicate the situation even more, as the local currency, lat, is pegged to euro and the central bank has had to defend the fixed exchange rate recently.

Next year the economic slowdown will most likely deepen. The positive point is the IMF help package, which is nevertheless linked to austerity measures.

Going further, the situation in Latvia is bad, but also interesting from an economic point of view - it even led to the creation of a specialised blog: http://latviaeconomy.blogspot.com/.

Nevertheless, probably the most bizarre phenomenon is the initiative of young Latvian students. As Gazeta.pl (a major Polish web portal) wrote, a group of them decided to mock government actions and formulated a petition in which they request Sweden to take over Latvia (!).

The petition can be found here.

Although the petition is a clear joke with political undertones, it is true that Sweden experienced a financial crisis at the turn of the 1990s. And yes: some compare today's global crisis to the Swedish experience.

Is there, nonetheless, any lesson from the Swedish crisis for Latvia?

Prophet

Being a prophet is hard....


Source of information: http://www.manageria.pl/manageria/1,85811,5868754,Peter_Schiff_z_polskimi_napisami__Zaklad_o_1_centa.html

Economic Culture in Chinese Diaspora (I of II)

It is indisputable that in the minds of the Chinese Diaspora population there is not one but three strands of definite cultural intensity: Confucianism, Buddhism and Taoism. However, in most current socioeconomic theory, Buddhism and Taoism are neglected to be mentioned.

With the rise in popularity of socioeconomic theories relating to the success of the Chinese in business, particularly dealing with Confucianism, in this post I attempt to try my hand at a little theorising with respect to the other Chinese traditions. This is the first part of a 2 part series, providing a brief introduction detailing the link between Taoism and Buddhism respectively with economic success by Chinese Diaspora populations. Chinese diaspora often left China before the time of the Cultural Revolution, and in many cases the traditions of these streams are more prevelant within them than within their mainland Chinese counterparts.

An introduction
Taoism is yet another form of Chinese religion/philosophy, which surfaced around the same time as Confucianism (Chad; 2007). Its founder is believed to be the mysterious Lau Tzu (many historical accounts actually believe that he never existed), and is based on two books said to compile his sayings and teachings, the Daode Jing and the Zhuang Zi. (Chad; 2007). This article addresses two of the more obvious Taoist beliefs relating to economic success: that directly derived from scriptures associated with the government, and the concept of wu wei. In this article only wu wei shall be discussed, as the concept of government is irrelevant for Chinese diaspora unless the government they are living under displays Taoist tendencies in an economic sense (such tendencies centre around non-interference in economic matters, tending towards free market sympathies).

On wu wei (无为)
Wu wei is not an easily translatable concept. It can be explained as taking the path of least resistance as a way to solve problems (Encyclopaedia Britannica). But this too does not fully portray its depth, and is shown most easily through how water has wu wei. Water is most esteemed by the text of Taoism for its adjustability, and strength yet softness.

Adjustability
Water is flexible; adjustable: if one was to pour it into a container, it would take that shape. If one was to change the shape of the container, it would also change shape. Yet the water itself does not change (Park; 2005). Water is analogous to the person, and the container to the situation: the person should be able to change “shape” in order to do what is required in the situation, yet without changing themselves.

This is beneficial for the overseas Chinese populations: they are encouraged to adapt to different situations, such as those in which the logic used is unlike their own. The emphasis on adaptability and flexibility encourages them to make the most of this kind of situation and find a way to succeed. This is especially useful in for the migrant Chinese, who may or may not be working with other Chinese when they conduct business, enabling them to take opportunities which may have otherwise not been possible.

Alternative logic also provides the end result that those with this belief are more likely to think their actions through before performance, or re-evaluate during and after the act. This also adds to the likelihood of success in a potentially hostile environment (Robinson; 2008).

Strength through Softness
Water is strong: it can wear away rocks. Yet it is also soft: one can jump in without hurting oneself. Water in this case is meant to be analogous to the person’s behaviour: it should be soft enough to get out of conflicts, yet hard enough to do what needs to be done (Park; 2005). This is an important skill which can benefit the Chinese diaspora: the ability to get one’s point across while still appearing amicable to others. Useful in business negotiations, it could be that this skill allows for them to create networks outside their own networks with relative ease, thereby integrating them into the business society as a whole and exposing them to a greater number of opportunities which could result in potential success.

Conclusion
All in all, it cannot be said that Taoism plays no role in the psyche of the overseas Chinese. Its role due to its philosophy of wu wei and emphasis on adaptation to the situation as it presents itself. However, this is by no means the full story: Buddhism plays a similar role in supporting economic success in these peoples, and will be elaborated on in a later article. Although, I must admit, that the richness in cultural background means that it is unlikely for any article to ever fully do such a topic justice.

Bibliography
Berg, H. van den. Economic Growth and Development. Lincoln: McGrawHill
Irwin. (2001)
Chad, H. "Taoism". The Stanford Encyclopedia of Philosophy. Zalta E.N. (ed.)
(2007)
Accessed: 14 April 2008
Dorn, J.A. China in the New Millennium: Market Reforms and Social Development. Cato
Institute (1998)
Encyclopaedia Britannica. “Wu-Wei”. Accessed: 14 April 2008
Park, S-W. “Economy of Water: A Spiritual Basis for an Alternative Economy”. The
Ecumenical Review. Geneva: World Alliance of Reformed Churches. Vol.5 No.2 (2005)
Robinson, B.A. “Taoism”. (2008)
Accessed: 13 April 2008

North Korean Economy and Geopolitics

Author: Nicolas Levi.

North Korea is definitly the strangest country in the world, as far as it can be compared to other countries.

To give you some indication, it is the only country in the world where the use of the Internet is prohibited and out of a 23 million population, only 200 persons are free to travell within the country.

The country has nuclear weapons, violating the non-proliferation agreements, and is, thus, a constant headache for world's leaders.

The reclusive state tries to limit its economic relations with other countries based on the propaganda concept of Juche, i.e. the self reliance. Nevertheless, it seems that economic cooperation between China and North Korea is developing well.

North Korea's heavy industry is in a sorry state, but Pyongyang is hoping that Chinese investment will help the collapsing economy, while China sees the North as a source of minerals. Moreover, China serves as North Korea's chief food supplier and has accounted for nearly 90 percent of the country's energy imports. In turn, North Korea's principal exports to China are metals: lead, gold, iron, steel and zinc. The Pyongyang regime imports also advanced machinery, transport equipment petroleum and chemicals.

Chinese trade and investment in North Korea now totals $2 billion per year and is increasing yearly by 7% since 2000. As a comparison Chinese trade with Poland (a 38 M European country) equals around $2 billion.

Besides, China is leading various infrastructure projects in North Korea. Since 2003, over 150 Chinese firms have started operations in North Korea.

Economic collaboration is also focused on transport industry. China has reached an agreement for a 50-year lease with the nearby North Korean port of Rajin. The Rajin Port Development of China is one of desired project of Beijing authorities: China's export boom is an economic success story of the last 25 years, but it is limited by a lack of ports. In particular, the country lacks a port on the Sea of Japan. As North Korea's dependence on China has been recently increasing, the Rajin Port Joint Development Project is attracting attention regarding how much impact it will make on the relations between China and North Korea in the future.

Nevertheless, there are some shadows on the economic cooperation. Chinese President Hu Jintao's visit to Pyongyang in October 2005 and Kim Jong-il's visit in January 2006 accelerated the path of the deepening of economic relations between the countries. Trade between North Korea and China have, however, on the same time decreased.

Before the Beijing Olympics, the Chinese government has imposed controls on pollution emissions placing North Korean material exports to China in a difficult position. According to the South Korean agency KOTRA (Korea Trade-Investment Promotion Agency), the volume of North Korea's minerals exports to China is estimated at around $250 million in 2006.

Despite these drawbacks, it seems that the economic relations between China and North Korea will blossom. China must have a buffer zone against the U.S. Besides, it recognizes North Korea's political crisis, influx of refugees as a potential and even real threat to the stability of its regime. China want also to use the low cost of labor and minerals of North Korea for its economic development.

To sum up, the relation is beneficial to both China and North Korea and, putting it in a broader geopolitical context, it makes the solution of the North Korea nuclear problem more difficult.

The author of the text is the main publisher of the website www.northkorea.pl. Nicolas is writing a Phd focused on Kim Jong Il family and is regularly publishing articles covering Korea in various media. For more information, he may be reached at Nicolas_levi(at)yahoo.fr

Reference:

Bayer, Jerzy and Waldemar Jan Dziak. Korea & Chiny Przyjaźń i współpraca, rywalizacja i konflikty. Tom 1 : Strategia i polityka. Tom 2 : Gospodarka i granice (Eng: Korea and China. Friendship and cooperation, rivalry and conflicts. Vol 1 Strategy and politics. Vol 2 Economy and borders). Instytut Studiów Politycznych 2006.

Martin, Bradley K. Under the Loving Care of the Fatherly Leader: North Korea and the Kim Dynasty. Thomas Dunne Books 2004.

Cheong, Seong Chang. Idéologie et système en Corée du Nord - De Kim Il-Sông à Kim Chông-Il. (Eng. Ideology and system in North Korea. From Kim Il-Sung to Kim Jong-Il). L’Harmattan 1998.

The growth of BRICs

According to some analysts, the repercussions of the current crisis could be mitigated by the fast growth in BRICs (Brazil, Russia, India and China), generating demand for exports.

The current problems have, nevertheless, already spilled over to some BRIC countries.

Firstly, a piece from Financial Times:

Banks across Russia have faced a rise in outflows as depositors have begun to lose trust in all but the biggest state banks, VTB and Sberbank, which have received most of the government’s liquidity support.Tatyana Sadovskaya, the director of a branch of Khnati Mansisk Bank in the city of Nizhnevartovsk, on Wednesday told Interfax news agency that in response to rumours of her bank’s insolvency: “People have formed long lines at cashiers and at bankomats, people are taking their deposits and closing their accounts.”Natalia Elisseva, vice-president for financial development at the Bank Nizhni Novgorod, based in the city of the same name, said the number of clients closing accounts had risen. “If there is something that can sink the banks, it is panic amongst the population . . . If there is a panic, not one bank will stand, regardless of state support.

On the other, the Economist reports that China is well-placed to cushion the global slowdown:

China’s GDP growth slowed to an annual rate of a mere 10.1% in the second quarter of this year, from 12.6% a year earlier, and most economists expect it to drop to 8-9% in 2009. But this slowdown should partly be welcomed, because the economy had been exceeding its speed limit for several years. Better still, China’s growth next year will come entirely from domestic demand, as its trade surplus shrinks. If the global downturn forces China to switch the mix of growth from exports to consumption, it would also help to make its future growth more sustainable.

The government is expected to supply a fiscal stimulus to keep growth above 8%. The package will include tax cuts and extra infrastructure spending. Economists are also urging increased spending on social welfare to encourage consumers to save less and spend more. China has ample room for a stimulus because it boasts the healthiest fiscal position of any big economy. According to Stephen Green, an economist at Standard Chartered, it has a budget surplus of 2% of GDP, if measured in the same way as in rich economies, and public-sector debt is a mere 16% of GDP. China’s readiness to use fiscal lubrication is the best reason for hoping that its economic motor will not stall.

Amidst the financial crisis, Forbes publishes a very interesting appeal to Silicon Valley Entrepreneurs. After enumerating various achievements of Silicon Valley, Sramana Mitra starts here main point:

In all this, leaders of Silicon Valley, you have identified problems, found technology-leveraged solutions and built industries, not just companies.

I ask you, then, to rise up to the challenge again. Education, health care, social security: These domains need your voices, your intellect, your credibility, your time and your money. In each of these domains, there are some early successes. Edward Fields is breaking through the morass of education problems with his start-up, HotChalk (see "A Technological Fix For Education"). Kirk Loevner is cracking health care with Epocrates. Their experiences offer some insight into alternative business models, marketing models and approaches to problem solving--most notably using advertising dollars to fund resources for teachers, students, doctors and patients. In education and health care, a tremendous amount of inefficiencies can be tackled with technology.

For me, the appeal is interesting - it does not call only for a government action, but also for a grassroot approach to problems. The question is, however, whether technology and new business models can solve very intricate reality of American healthcare. They may solve the problem of costs, but coverage may pose greater political challenges. Whoever heard what happened to Hillary Clinton's efforts know what I am talking about.

A physicist's view on the current crisis

As an addition to my last week's piece, I would like to quote a very interesting opinion of a theoretical physicist, Mark Buchanan, writing for New York Times:

Well, part of the reason is that economists still try to understand markets by using ideas from traditional economics, especially so-called equilibrium theory. This theory views markets as reflecting a balance of forces, and says that market values change only in response to new information — the sudden revelation of problems about a company, for example, or a real change in the housing supply. Markets are otherwise supposed to have no real internal dynamics of their own. [...]

Nearly two decades ago, a classic economic study found that of the 50 largest single-day price movements since World War II, most happened on days when there was no significant news, and that news in general seemed to account for only about a third of the overall variance in stock returns. A recent study by some physicists found much the same thing — financial news lacked any clear link with the larger movements of stock values.

And later:

Certainly, markets have internal dynamics. They’re self-propelling systems driven in large part by what investors believe other investors believe; participants trade on rumors and gossip, on fears and expectations, and traders speak for good reason of the market’s optimism or pessimism. It’s these internal dynamics that make it possible for billions to evaporate from portfolios in a few short months just because people suddenly begin remembering that housing values do not always go up.

Buchanan does not only criticises the view, but provides support for his arguments by writing information about computer models of financial markets, based on the behaviour of individual actors. The models go deeper than classic equilibrium theory and allow to determine at what point a financial meltdown could take place, i.e. when market stability disappears and panic sell-offs start.

Sadly, at least according to Buchanan, economists look not very favourably on the models.

Is it a problem of the dominance of an old scientific paradigm (in the way Kuhn saw it), or maybe mainstream economists have valid claims? We shall return to the problem soon...

Casting some doubts

I shall most likely respond to Andre's piece next week. I am currently undecided when it comes to the bailout, but I would like to raise some doubts. The bailout bill passed, so the question is not if it should be implemented, but whether it is a correct policy.

Firstly, although Wall Street firms are in turmoil, this is not the case for Main Street commercial banks. As Alan Reyonold from Cato Institute writes in Forbes:

Contrary to many comments, consumer and industrial loans actually increased in the latest week. Troubled giant banks have cut back on lending, but smaller banks have picked up the slack. Consumer and real estate loans dipped insignificantly through Sept. 17, remaining much higher than they were a year earlier.

Reynolds proceeds with presenting FED data. The question, however, is for how long that is possible. What will happen when commercial banks are hit by current deleveraging in financial markets? Some of commercial banks may have some ties to financial markets and if they lose due to deleveraging, they may seek more cash and limit their credit supply. As the Economist writes:

What hurts finance affects the rest of the economy in spades. Tim Bond, of Barclays Capital, reckons that, thanks to the gearing effect, a shortfall of bank capital of around $170 billion may reduce the potential supply of credit by $1.7 trillion.

Secondly, Professor Eichengreen points out that dollar going down together with fast-growing BRICs will put the American economy on the right track soon. This is self-explaining - decreasing dollar makes exports more profitable. As Eichengreen writes:

And what the contraction of the financial services industry taketh, the expansion of exports can give back, what with the continuing growth of the BRICs, no analog for which existed in the 1930s. The ongoing decline of the dollar will be the mechanism bringing about this reallocation of resources. But the U.S. economy, notwithstanding the admirable flexibility of its labor markets, is not going to be able to move unemployed investment bankers onto industrial assembly lines overnight. I suspect that I am now less likely to be regarded as a lunatic when I ask whether unemployment could reach 10 per cent.

Here understanding Professor Eichengreen is a bit difficult: we can't say if the crisis will touch the economy at large or just the financial sector. My intuition tells me that a 5% increase in unemployment cannot be caused just by layoffs in financial sector, so the latter is most likely true. Nevertheless, the question remains how fast the effect of dollar going down will be, relatively to problems in financial markets affecting other industries.

A glooming bright future for the non-financial sector

Which is likely to be true?

The Paulson Plan, whatever its final form, will not bring this upheaval to an early end. The consequences are clearly spreading from Wall Street to Main Street. The recent performance of nonfinancial stocks indicates that investors are well aware of the fact.

So comparisons with the Great Depression, which have been of academic interest but little practical relevance, take on new salience. [...]

It is hard to avoid concluding that the Fed erred disastrously when deciding that Lehman Bros.

Or:

The non-financial sector today looks nothing like it did in 1930. The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse.

[...]

The Treasury and the Fed should let Wall Street drown alone, to be replaced by new financial service providers who can swim as robustly as are non-financial American businesses.

Before pointing to the authors, take a look at the graphs below. That's the Brazilian stock market main index (IBOVESPA) and the tipping point is just after US House of Representatives' rejecting the edited version of the Paulson plan. This is relevant not only because of the time frame, but because the Brazilian stock market has evolved a lot in the past years and - unlike its Russian counterpart, for instance - had not faced severe swings in a long time. Oh, and the fact that I'm Brazilian may have something to do with it...!

It would be great if the markets were always efficient and we could let havoc take place, relying confidently in creative destruction. This, however, is not the case and professor Barry Eichengreen's warning - that US unemployment rate may reach 2 digits - should be taken very seriously. He's the author of the first quote, taken from And now the Great Depression, at Vox Eu. Professor Barry Eichengreen, from University of California, Berkeley, has been frequently quoted these past days thanks to his Anatomy of a Crisis. He seems to be inspired and we'll be keeping an eye out for more insights.

The second quote is from Casey Mulligan's Wall Street Will Drown Alone. His core argument can be found in Greg Mankiw's A Note of Optimism. Oh, yes, professor Mulligan is from (surprise, surprise!!) University of Chicago.


PS: After writing this, the Bovespa reopened... Let's see where it goes now.

Economics International is back

Dear Readers!

Economics International is back after the vacations break and ready to bring you new insight on international finance, trade and business.

In the coming academic year, we aim at enlarging the number of authors, obtaining more academic articles written by PhD students and touching upon topics not covered anywhere else.

As to the latter, the article on the interactions between Eastern philosophies and economic life of Chinese diaspora by Lea Tan will be ready soon.

We hope that you will find the visit on our website interesting, entartaining and inspirating!

Best wishes,
Economics International

On Death, Pestilence and War

I picked up my copy of The Economist today and I read an article which made me shiver. It was from the Middle East and Africa section and it was entitled Ethiopia. Will it ever be able to stave off starvation?

The article spoke about famine in that country:

“Life here is still akin to serfdom […]. The government owns the land […]. Yet
labourers get by in Goru Gutu district much as they have always done, tilling
soil by hand, digging ditches, doing whatever it takes to buy a few cups of
grain to keep their families alive. […] As you head deeper into the hills, the
animals get thinner, the children more listless. The food on the market is too
expensive, and there are no informal sales on the road-side No one is eating.”[1]

Food shortages have always been problem in the Horn of Africa, especially in Ethiopia, Africa’s second-most-populous country – we all remember the 1985-1985 famine in Ethiopia where Bob Geldof and Phil Collins others organized Live Aid and Band Aid to help the millions effected by the famine – and they seem to be occurring again.

It’s difficult to say whether or not the current crisis in Ethiopia should be viewed as a consequence of the current global food price crisis – which has already sparked riots in some other African countries – or as an independent case, but what is made clear by the article is that the government of Ethiopia has brought this onto itself to some extent.

“The government is supposed to have 450,000 tonnes in a grain stockpile, with
100,000 tonnes in reserve to keep prices from rising too much. But it has only
65,000 tonnes left.
If Goru Gutu district is an indicator, things will get
far worse; many people will starve to death. Ibsaa Sadiq, a local government
official, reckons that nearly half of the 116,000 people who live here,
especially women and children, need food aid to survive. A feeding centre run by
the government, assisted by Catholic nuns, cares for some 800 of the hungriest
children. They spend days or weeks in a metal shed smelling of diesel and
disinfectant.”[2]

Of course a major part of this problem is beyond anyone’s control; it has to do with failed harvests, high fuel prices, and lousy weather. But it is without a doubt in my mind that this tragedy is also the fault of the Ethiopian government. This is another clear-cut example of a failed system of state control over the economy. “Aside from coffee, qat (a narcotic leaf chewed by Somalis), horticulture and a little tourism, Ethiopia is one of Africa’s very few countries that still has virtually no serious private business – and thus few jobs – outside the state sector. Almost three-quarters of the population may be under- or unemployed.”[3] It is without surprise that in a country that can almost be described as still rather communistic there be problems with food production. There are few jobs, so there is very little wealth; this means there is little or no savings; people are thus penny-less and at the mercy of the weather when it comes to food.

This article once again confirms my belief that the free market is the best way to create wealth and avoid the tragic human misery that is described. This is especially important in the field of development. For developing countries such as Ethiopia, it is essential that they reform and adopt market-oriented approaches to economic growth. Is it a simple coincidence that the poorest countries in the world also happen to be the least free? Ethiopia is a prime example: it is ruled by an authoritarian strongman, Meles Zenawi, who has done little to reform the country to promote private enterprise, who violently oppresses the opposition, and who even attempts to hide that there is a famine going on by holding back information and banning photographs being taken in affected areas – reminiscent of Stalinism in the USSR. Is it really that surprising then that Ethiopia also ranks amongst the poorest countries in the world? Of course not! There is a connection between the level of economic freedom and the level of development.

Anther important issue the article mentions, but only briefly, is population. The problem with Ethiopia, indeed the problem of Ethiopia, is the population problem. “Ethiopia still has too many people eking out a living on too little land, depending on rains that can never be relied on.”[4] With a population of over 77million there is a major cause for concern. With 85% of the people living off agriculture – a very basic form of agriculture mind you – even under the perfect weather conditions and the most fruitful of harvests, many millions would still be left destitute[5]. This of course immediately reminds us of Thomas Malthus and his Essay on the Principle of Population. In Ethiopia it seems, the Malthusian disaster has occurred, and what’s worse – from a Malthusian perspective – even war, famine and pestilence have not been enough to keep the population in check.

The Economist article ends with a very pessimist look at the chances of Ethiopia’s progress. I personally hate to agree with this pessimism but unless real reforms occur in that country, I’m going to have to. What Ethiopia needs if it wants to avoid periodic famines is a change in leadership; economic reforms (beginning with the introduction of private property); and encourage foreign investment – now I’m not necessarily advocating Jeffery Sachs’ “Shock Therapy”, but some major reforms in the economic system are dreadfully needed. Ethiopia also needs to make some deep-rooted changes in its culture with regards the family; nearly half the population is under 15 years of age. It is with no surprise that under such a situation, you will have a population problem. In order to fix this, major family planning programs need to be implemented; better education and higher availability of contraceptives is needed – perhaps dictator Meles could divert some of the 350million dollars he spends on defense every year[6] and direct some of it towards education and family planning schemes.

-------------------
[1] The Economist, Ethiopia. Will it ever be able to stave off starvation?. June 14th 2008
http://www.economist.com/world/africa/displaystory.cfm?story_id=11549764
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] http://www.voanews.com/english/archive/2006-03/Ethiopian-Population-Expected-To-Grow-by-More-than-100-Percent.cfm
[6] http://chora.virtualave.net/budget-2002.htm

An interesting cross-country test for the Ricardian equivalence

Tim Harford comments on the practical impacts of American and British tax plans, and defends that their impact will be the same, despite the different reasoning behind them.

"Here's why: Since neither the U.K. nor U.S. government intends to alter its spending plans, these tax holidays will be funded by government borrowing, borrowing that must eventually be repaid. That will require taxes to go up in the future or not to fall when they otherwise might."

By his concluding remark, Mr. Harford's interest is the political economy of the measure - whether people be fooled by this measure and vote for the wizard politicians. I personally wonder whether consumer behavior will vary between the two sides of the Atlantic. Could British people be more concerned about the well-being of their children than Americans are, or vice versa?


Other references about the tax-rebate:

• "Consumer response to tax rebates [PDF]", by Matthew Shapiro and Joel Slemrod
• "Honey, I ate the rebate", by Daniel Gross

The Democrats and Free Trade

I have been quite busy these days so I must apologize for being a couple of months late in noticing this, but I was amazed, AMAZED, when I watched the Clinton/Obama debate in Cleveland, Ohio that took place past February on MSNBC. In the debate, both candidates spoke out against NAFTA, threatening to pull out if the treaty wasn’t renegotiated. Just take a look at what Clinton and Obama had to say:

http://www.youtube.com/watch?v=5jO05Dd0Hd0

I find it amazing that the two key democratic candidates running for president refuse to be pragmatic enough to recognize the benefits of free trade. This is especially surprising when looking at Hillary Clinton since her husband is the one who came up with NAFTA in the first place. As the high-caliber politician that she is, she should know better. And as for Barack Obama, for a candidate who keeps talking about “hope” and keeps calling for “change”, this kind of rhetoric sure sounds a lot like same-old, same-old democrat populism.

In the debate, both candidates kept talking about the hardships that middle- and working-class workers in Ohio, Michigan, and up-state New York have to go through. That may be true, but I think both candidates are too preoccupied with wooing unemployed workers and are failing to see the big picture. In the 21st century it is absurd to deny that free trade and globalization is the future.

Globalization benefits everyone. It brings down prices and gives consumers a wider choice. It creates jobs and makes companies as dynamic as they have ever been. And this applies to America especially – America still has some of the most competitive and creative companies in the world and the standard of living of its workers is still arguably the best. Thanks to NAFTA, Mexico has seen its poverty rates fall and incomes have gone up remarkably. And policy-makers in both America and Canada are in favor of more integration. In this regard, the republican candidate John McCain is right on target when he tells unemployed workers from middle-America that “I can't look you in the eye and tell you that those steel mills are coming back"[1]. Instead he encourages them be innovative and adapt with the changing world: “I will commit to giving these workers a second chance. They need it, they deserve it."[2] NAFTA does not need to be renegotiated, if anything, there should be more trade liberalization with the rest of Latin America.

Hillary Clinton has even gone as far as to doubt the Doha round trade talks, talks which if successful, could mean a world of benefits for some of the world’s poorest countries. In a Financial Times interview she suggested that the US should take “time out” on all new trade agreements. How retrograde!

I am especially disappointed with Barack Obama. He was supposed to be the candidate of hope! He’s half Kenyan half American; he was meant to be the personification of global attitudes and global partnership. Instead, he has chosen a protectionist and populist attitude, making promises to desperate workers and playing on their fears. Obama has promised to improve America’s reputation worldwide, but how will protectionism help improve America’s reputation?

A lot of commentators have said that in reality both candidates are in favor of free trade but are just wooing their base in order to get elected. I truly hope that is the case, but if it is, it’s also sad to see that the democrats are incapable of talking to their voters as if they were adults. If Clinton and Obama are really in favor of free trade, they should take a lesson from McCain and tell it like it is. And if they are genuinely against free trade then they should pull out of the race and pick up an economics textbook, because the world cannot afford more protectionism.


[1]http://www.reuters.com/article/politicsNews/idUSN2247270520080422?pageNumber=2&virtualBrandChannel=10112
[2] Ibid.

Some interesting links...

A couple of links that some of you may find interesting:

1. Dani Rodrik writes once more about his programme: New Thinking in Development Studies.

2. NY Times argues that the legacy of Milton Friedman is not all gone in the times of turmoil.

3. Finally, Businessweek publishes the list of 50 most-innovative companies. See the shape of things still to come...

GOLD FEVER

According to expectations, the gold price, having followed a continuous upward movement, has indeed surpassed the $1000 mark in February 2008. Credit crunch, stock market crash, and inflation have been enticing people all over the world to invest in gold. The press comments that gold has become the world’s most powerful currency. In contrast to paper currencies, gold cannot be arbitrarily augmented.

Figure 1: Gold price in Dollar

Source: The Bullion Desk (2008)

While bonds and certificates of deposit depend on the creditworthiness of the issuer, gold investments are unbound to payment promises of firms or governments. Possessing physical gold represents an insurance against a devaluation of both currency and assets. Notwithstanding, this does not mean that the gold price cannot fall. Speculators also get in on gold and can contribute to overheating and fierce adjustments (the current gold price is below 1000 dollar). The rising gold price is also linked to excessive borrowing arrangements. Due to the lax monetary policy of central banks the share of credits in US GDP rose from 150% in 1969 to currently 340%. At the same time, investors’ risk awareness kept decreasing, as they could incur additional debts or pay debts with new debts without difficulty. Things are difficult when the “monetary fuel” runs short and the borrower is unable to repay his debts.

Hitherto the gold price often used to increase rapidly during phases of low or negative real rates (Fed fund real rates), i.e. whenever the inflation rate considerably exceeded interest rates (so that depositors could not make gains on their assets). In that case, the main disadvantages of gold investments, i.e. that one cannot earn interests or dividends, do not matter. Not only the fear of inflation but also the rising demand from newly industrialising countries inflates the gold price. More and more people from those countries can afford jewellery and gold bars. Accordingly, China’s demand has increased to nearly 300 tons per year since the gold market liberation in 2002 (private property and ownership of gold were forbidden before). With a demand of more than 700 tons per year India has the world’s largest gold market. Indian wives regard gold property as a form of life insurance and old-age provisions, while in the Western world gold is still regarded as something exotic.

Most of the gold is processed in the adornment industry. According to GFMS, jewellers processed 2407 tons of gold in 2007, which was 63% of the worldwide gold supply. The remainder dispersed among the industry, dental technicians, gold investors, and gold mines. Despite the rising gold price the worldwide gold mining remains stagnant. This can be explained by the ongoing increases in costs of material, energy, and logistics with respect to gold mining and the scarcity of new sources with high gold content. Moreover, there are hindrances such as institutional problems and time: The phase from gold discovery to commercial production takes at least seven years. Besides, projects drag on because of interminable licensing procedures and environmental protection amendments. Also, gold producers shrink away from investing in regions of political instability due to lacking legal security. Finally, investment opportunities deteriorated in light of the credit crunch and stock market crisis.

People who would like to purchase gold assets are advised to choose services offered by internationally famous and acknowledged bullion dealers. The prices of their products almost move together with the gold value. People who want to stock their bars and coins in bank safes should acquire sufficient information on insurance coverage; those who prefer to stock at home ought to make sure that the household insurance is adjusted. Also the home safe has to meet standards as required by the insurance. Alternatively, banks offer investments in gold (price) certificates, which are free of storage or insurance expenses. Moreover, they are more tradable compared to physical gold. However, gold certificates are bearer debentures and thus are receivables against the issuer. If the issuer’s credit standing deteriorates or if he becomes insolvent, the certificate owner also runs the risk of losing his stakes or parts of them.

Contrary to investment funds or Exchange Traded Funds (ETF), certificates do not represent separate assets which are protected in bankruptcy cases. An alternative to certificates are ETFs which purchase gold with investors’ money; the gold bars are then kept by a fiduciary. Investors who are only aimed at short-run gold price movements are not recommended to gamble with gold bars. Although the demand for gold has been increasing, the proportion of gold in investors’ portfolios is still very low, despite the fact that gold has been performing better than stocks for years, something that is expected to remain also for the next few years, according to the Dow-gold ratio. This ratio is calculated by dividing the average Dow Jones index level of a period by the gold price in US dollar of the same period. A decreasing ratio means that gold performs better than US stocks and vice versa. Even if this concept does not say much about the absolute price development, it proved to be a fairly good long-run indicator.

Figure 2: Dow-gold ratio

Source: www.chartoftheday.com (2008)

Central banks and IMF held 29955 tons of gold at the end of 2007, with a market value of 890 billion dollar. This gold largely stems from times when the issuance of paper-money had to be backed by gold. It is actually unknown which of this gold are still in the safes of central banks or has been already sold to the market. The USA possesses the largest hoard of gold with 8134 tons, followed by Germany (3417 tons) and IMF (3217 tons), but they strictly reject sales of gold so far. Theoretically, central banks and IMF are capable of flooding the gold market and, in this way, beating down the gold price which represents a crisis indicator to them.

Links and References:

• http://www.ft.com/cms/s/0/aa269476-0013-11dd-825a-000077b07658.html?nclick_check=1 (about speculators who cut bets on rising gold price)

• http://search.ft.com/ftArticle?queryText=gold+price&y=5&aje=true&x=15&id=080307000043&ct=0&page=3 (about rising gold and oil prices)

• http://search.ft.com/ftArticle?queryText=gold+price&y=5&aje=true&x=15&id=080117000508&ct=0&page=5 (about declining jewellery demand in the face of rising gold price)

• Doll, F. (February 18, 2008). Omas olle Klunker. Wirtschaftswoche, pp.126-137

The Japanese Labor Market - Integration into the Capitalist Global System

Our author Barbara Kits prepared an excellent analysis of the Japanese labour market.

“The [Japanese] economy experienced a major slowdown starting in the 1990s following three decades of unprecedented growth, but Japan still remains a major economic power, both in Asia and globally.” (CIA Factbook; Japan)

During the 20th century, Japan’s economic performance has been quite remarkable. First of all, there was the ‘economic miracle’ after the Second World War: post-war Japan was able to rebuild its economy in less then 2 decades. Second of all, Japan’s unemployment rate has been at approximately 2% for almost 3 decades, a very low average compared to other OECD countries, and thus often referred to as the ‘unemployment miracle’.

However, these miracles started fading away when Japan stepped into a ‘Lost Decade’ in the 1990s. The recession that prevailed took forms that had thus far been unseen anywhere in the industrialized world of capitalism. Interest rates, to name but one variable, fell to nearly 0%, while the ‘Unemployment Miracle’ seemed to end. The ‘Lost Decade’ of Japan was caused by the burst of a bubble in the stock market and the consequent fall into a liquidity trap. These developments also proved that the Japanese labor market system was not resistant to large negative shocks in output: as a consequence of the liquidity trap, Japan’s unemployment rate rose to a record high in comparison to the past 40 years, and only recovered once thorough restructuring of the labor market had taken place.

In the following, an analysis of the Japanese labor market restructuring following the ‘lost decade’ will be provided, with the aim of assessing the current stance of the Japanese economy in the capitalist world system. The policies currently in place will be examined in connection to this, and will be assessed in terms of their effect on the economy in the future. The conclusion of the report consists of an advisory note on the future use of macro-economic policies of Japan.

To read more: please click here.

Notice:

The paper is based on:
“The Japanese Economy: Problems and Policy Solutions” (unpublished),
by:
Zahra Biniaz, Petulia Fung, Barbara Kits, Delphine Maho, Hsieh Lea Tan

CITIZEN OF EUROPE: How exchange rates influence migration.

The accession to the EU spawned a large wave of CEE (Central Eastern European) migrants in the UK. The number of Poles in the UK went so high that some pundits termed the UK the 17th Polish province...

Nevertheless, the number of Polish immigrants has started going down.

Why? Financial Times explains:

The wave of migration began when about a fifth of Polish workers were without jobs and Polish salaries were far lower than in western Europe. Over the last couple of years, however, official unemployment has dropped to 11.5 per cent, while the true rate is probably much lower. Pay packets are fatter – salaries rose in February at an annual rate of 12.8 per cent. The zloty has also risen sharply against both the pound and the euro, while Poland’s economy is also expanding much more strongly, with growth of 5.5 per cent expected this year.

As we can see, fluctuating exchange rates may have an impact not only on financial markets and trade, but also on the movement of people...

It would be actually good to do some regression analyses on what actually the impact of the falling pound is. Apart from pound, one could include many other variables: GDP growth rates in the UK, Poland and other countries, unemployment levels and take into account culture variables (individualism, mobility etc.). Furthermore, to get better results one could also make a panel data study: take data from various CEE (Central Eastern Europe) countries whose citizens migrated to the West.

But is the impact of the pound considerable? The idea is not mine, but I believe it just works as a deciding factor: you don't come back to Poland because the pound went down. There are other reasons: family, loneliness, depression etc. Exchange rates act like a "switch" - when your pay goes down significantly, you go back because of all other reasons. Money doesn't keep in the UK anymore.

Is the return good for British economy? I don't think so - of course British workers will be happier (migration from CEE did have an impact on wages and, thus, on unemployment), but it will only add to inflation problems (negative supply shock), and make the work of Mervyn King more difficult in the times of rising prices and stagnating economy...

PS: The report of the Office of National Statistics does show that unemployment among Britons went down. How come if standard labour economics theory says that two views, "immigrants take jobs that nobody wants to take" and "immigrants take our jobs", are just simplistic views of reality? In general, all else equal, the impact of immigrants should make wages go down. Well, here it seems that young Brittons give up competing with immigrants because of their small wage demands...

Can Gender Based Taxation boost female employment?

Female (un)employment is one of the hottest problems of modern economies, and yet it’s one not tackled enough as it should be. While everyone knows the many benefits that a higher female participation rate can assure to family incomes and national economies, the gender gap in labor participation is still dramatically relevant in many countries. Talking about Europe, the Lisbon Agenda sets a 60% women employment rate as the goal to be reached within 2010. Today, in Greece, Italy, Malta and Poland women employment rate is below 50%. In developing countries, the picture is even worse.

Last summer A. Alesina and A. Ichino, two famous Italian economists teaching at Harvard University and University of Bologna, proposed a gender based taxation (GBT) to foster female employment in Italy and, in general, in all countries with sharp gender differences in labor markets. They later published two very interesting papers (Gender Based Taxation and Gender Based Taxation and the Division of Family Chores), where they do some empirical calculations and they set up a model to explore gender elasticities in labor supply, considering elasticity both as exogenous and endogenous variable.

Their intuitive reasoning goes as follows: empirical evidence from many studies on OCSE countries shows that women have a more elastic labor supply than men, because of economic, cultural and biological reasons. On the contrary, men have a quite inelastic labor supply, since in the family the man usually works “in any case”, despite varying wage condition. A good way to boost female employment is therefore to tax women less and men more, as the Ramsey principle about optimal taxation would suggest.
This tax reallocation has two fundamental advantages: first, it changes the bargaining power within the couple, leading to more equitable redistribution of household duties and market activities, and to an increase in society welfare. Second, it can be implemented without any financial cost for the government, thus being easily approvable (compared with other expensive services reforms). This latter point comes again from elasticity implications: the raise in men’s taxation, and the subsequent raise in tax income – given low male elasticity – can greatly compensate a decrease in women taxation.

Alesina and Ichino’s calculations suggest that female tax rate can be 67% of male rate in Italy, while 91% in Norway (which has a opposite framework compared to Italy). Similar calculations could be carried out for many countries.


This GBT proposal arose, of course, many criticisms. T. Boeri et al. claim, for instance, that female labor supply is not so elastic: when the woman is the only worker in the family (e.g. single mothers), her elasticity is similar to the male one. Moreover, female unemployment is mainly due to lack of childcare services on the market and to cultural stigma on women not taking care of their young children; indeed, in Italy only 30% of women go back to work after having a child. An indiscriminate lower female taxation could benefit wives of stock-option-holding millionaires, while pushing single men on the black market to avoid higher taxation. An approach focused on specific categories of women would therefore be more advisable.


With presidential campaign going on in Italy, the topic of female labor participation has recently appeared again in newspapers. Somehow following economists’ suggestions, the leftwing candidate proposes a tax credit for working mother with low income. While this proposal would clearly benefit the targeted segment, it’s not clear why we should discriminate women who chose not to have children. Recent empirical evidence shows that women with higher income have more children: indeed, if we want to boost fertility, we should subsidize poor women without children.
Finally, while the tax credit proposal better deals with possible shortcomings of GBT proposal, it is not without costs. In this scenario, the government would actually raise fewer taxes, and budget coverage is not an easy matter, especially for countries with high deficit.


Given the many plausible benefits of GBT and its cost-free framework, why don’t give it a try as a starter for deeper changes?

Ron Paul and Gold Standard

American presidential campaign is in full swing and you are probably asking who I am supporting. Well, I am a centrist with rightwing inclinations, but I won’t tell you now. I will make my endorsement later.

I would like to point your attention to a very interesting phenomena: Ron Paul. Not that I am supporting the person. Just by contrast: his ideas of the return to gold standard is what astounds me, a person with New Keynesian inclinations (which is my inclination, and NOT of all blog ppl).

Just watch the video (a bit old, but still ok for the topic):



And this one as well:



There are so many arguments against gold standard. Here I will only mention government's inability to smooth economic fluctuations, rate of inflation dependent not on government policy but on mining gold, adjustment through interest rates and economic slowdown and not through exchange rates. You can easily find more on EconLib or Brad deLong website.

The phenomenon is, therefore, trully astounding and not easy to explain. It seems to me that it stems from the complexity of economics and people's inclination towards simple solutions.

But are these the only reasons, or maybe there is more to it that meets the eye?

Why Sharing is good

As this was to be my first of a series of monthly postings for Economics International – or at least until I get fired – I was rather unsure what to begin with. The options were vast; there was whole world to write about out there: Sub-prime mortgage lending and its negative effects on Swiss banks (my most beloved of banks), the Bush tax cut – and the astronomic budget deficit, inflation, the economic effects of shutting-down of the greatest coffee shop in Utrecht… I could go on. But was I shocked yesterday when I was doing my daily quick check of the BBC website and read this article about oil prices reaching a record high.

It appears, that “A barrel of US light crude touched $103.05 during the day” on Friday, which alarmed me but at the same time I was not surprised. The article went on to quote Venezuelan president Hugo Chavez as saying "Everything indicates that the oil price will continue to get stronger". Well no surprise there, Mr. Chavez, of course oil prices will continue to rise if people like you keep holding the world’s oil consumers hostage!

Yes, I believe that one of the reasons oil and gas prices are so high is because big, populist, nationalistic governments are holding on to their oil and gas reserves and not sharing them with the rest of us.

We’re always hearing the phrase “it’s running out, it’s running out”. That may be true, but not to the degree that some scientists, and big governments, want you to believe. Geologists keep saying that the world’s oil reserves are running out, but I stopped believing them; they have been saying the same thing for decades. In 1974 M. King Hubbert said the “peak oil” would occur in 1995[1]. Laughable. Now, of course it is true that consumption patterns have changed since the 1970s but I still don’t think its fair to say that we are under an imminent threat of reaching peak oil. In fact, Abdallah S. Jum’ah CEO of Saudi Aramco, expects “fossil fuels to remain the dominant energy sources for the foreseeable future. In fact, the EIA (the Saudi Energy Information Administration) forecasts that the proportion of fossil fuels in the global energy mix will actually rise from 85.5 percent in 2001 to 87 percent by 2025”[2]. So not only is crude oil production going up, it will stick around with us for at least another century. And I have little reason to doubt Mr. Abdallah, he lives on top of the oil; he would know.

The problem here does lie with how much of it there is left, it’s who controls the oil and is refusing to share it with the consumers. According to Platts’ Middle East Editor Kate Dourian, “some countries are becoming off limits. Major oil companies operating in Venezuela find themselves in a difficult position because of the resource nationalism that's spreading. These countries are now reluctant to share their reserves”[3]. Yes it appears that Hugo Chavez, Evo Morales and the likes have begun to mix politics with crude oil, and although that may sound tasty I can assure you it’s not! It is because governments are nationalising their oil reserves that we are seeing such high prices.

We all remember in 2005 when Evo Morales used, or miss-used I should say, the Bolivian army to capture energy installations and claim them for the Bolivian state. In May 2006 he then signed a decree that said that all gas reserves were to be nationalized. Morales when on to say that "We are not a government of mere promises: we follow through on what we propose and what the people demand". This populism and demagoguery is not how you build an economy; bringing the army to capture and nationalize a gas plant may make hippies in the West smile adoringly, but it instills a false sense of hope in the Bolivian people and it contributes to high energy prices abroad.

The undemocratic governments of many of these oil-rich nations are enjoying very comfortable budget surpluses and from Caracas to Almati you are seeing hundreds of government officials spending their petro-dollars on Mercedes cars and Johnny Walker Blue Label. This is too much. I’m OK with governments wetting their beaks by taxing oil companies, but it’s when they deter private investment altogether and nationalize their oil fields that I get angry. I am sure that the world’s supply of oil and gas would increase incredibly if Shell and Total and Exxon were given access Russian, Venezuelan, and Kazakh oil fields.

Reference:

[1] http://www.hubbertpeak.com/hubbert/natgeog.htm
[2] http://www.worldenergysource.com/articles/text/jumah_WE_v8n1.cfm
[3]http://www.arabianbusiness.com/index.php?option=com_content&view=article&id=495829

Econ grades

George Bush got a B grade for Econ 101. But do school grades really matter when national economy stumbles?

One more thing on Cox and Alm

I always keep international economics in mind, so while reading for my earlier post, I took this interesting excerpt Cox and Alm's article. Their view for why consumption went up in past years is that prices have been falling. And why is that?

There are several reasons that the costs of goods have dropped so drastically, but perhaps the biggest is increased international trade. Imports lower prices directly. Cheaper inputs cut domestic companies’ costs. International competition forces producers everywhere to become more efficient and hold down prices. Nations do what they do best and trade for the rest.

Thus there is a certain perversity to suggestions that the proper reaction to a potential recession is to enact protectionist measures. While foreign competition may have eroded some American workers’ incomes, looking at consumption broadens our perspective. Simply put, the poor are less poor. Globalization extends and deepens a capitalist system that has for generations been lifting American living standards — for high-income households, of course, but for low-income ones as well.

By the way, if the theme interests you, I really recommend reading the whole thing.

Long live inequalities: The several gaps between rich and poor

Last week, Greg Mankiw quoted an article in The New York Times, by Cox and Alm, who report:

[I]f we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. [...]

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with [...] 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1.

The article touches on a very important issue, which is the way we measure inequality. This theme got special attention with Krugman's Conscience of a Liberal[1], where he "explains what can be done to narrow the wealth and income gap"[2]. The debate involves several aspects, such as its statistical measurement (see Mark Thoma’s “Increasing Inequality is Not a Statistical Illusion”) or, as the quoted NYT op-ed puts it, whether we should substitute consumption for income calculations.

The thing that troubles me, however, in all this wealth/income/consumption inequality debate, is very few people actually question its central assumption that inequality is bad! In that case, there’s another type of inequality we should really look into, because it could help explain some more of the above 2:1 proportion. Steven Landsburg provides an insight it for us:

In 1965, leisure was pretty much equally distributed across classes. People of the same age, sex, and family size tended to have about the same amount of leisure, regardless of their socioeconomic status. But since then, two things have happened. First, leisure (like income) has increased dramatically across the board. Second, though everyone's a winner, the biggest winners are at the bottom of the socioeconomic ladder. […]

[W]hen you compare modern Americans to their 1965 counterparts—people with the same family size, age, and education—the gains are still on the order of 4 to 8 hours a week, or something like seven extra weeks of leisure per year.

But not for everyone. About 10 percent of us are stuck in 1965, leisurewise. At the opposite extreme, 10 percent of us have gained a staggering 14 hours a week or more. (Once again, your gains are measured in comparison to a person who, in 1965, had the same characteristics that you have today.) By and large, the biggest leisure gains have gone precisely to those with the most stagnant incomes—that is, the least skilled and the least educated. And conversely, the smallest leisure gains have been concentrated among the most educated, the same group that's had the biggest gains in income.

Aguiar and Hurst can't explain fully that rising inequality, just as nobody can explain fully the rising inequality in income. But there are, I think, two important morals here.

First, man does not live by bread alone. Our happiness depends partly on our incomes, but also on the time we spend with our friends, our hobbies, and our favorite TV shows. So, it's a good exercise in perspective to remember that by and large, the big winners in the income derby have been the small winners in the leisure derby, and vice versa.

Second, a certain class of pundits and politicians are quick to see any increase in income inequality as a problem that needs fixing—usually through some form of redistributive taxation. Applying the same philosophy to leisure, you could conclude that something must be done to reverse the trends of the past 40 years—say, by rounding up all those folks with extra time on their hands and putting them to (unpaid) work in the kitchens of their "less fortunate" neighbors. If you think it's OK to redistribute income but repellent to redistribute leisure, you might want to ask yourself what—if anything—is the fundamental difference.

My moral here is: if we really want to end inequality, why not go all the way and adopt a totalitarian communist system? This reductio ad absurdum may seem odd, but it’s not the case that people are equal. Nor can we say for sure how they are different, but our ignorance should make us turn to a more merit-based system.

Such system would allow agents to make their own choices regarding the income they wish to work for, the wealth they aim at accumulating and how much leisure they are willing to give up for those. It’s not an easy choice: we all would like to consume more, accumulate money – be it for increasing consumption, leaving it for your kids or anything else – while having more free time.

This reminds me of a story about a very successful Brazilian investor. He and some friends were at a bar going through the financial reports of a firm, trying to find something to give an edge over the market. After hours of scrutinizing the books, they finally found what they were looking for and decided to celebrate. As they looked around looking for the waiter, they noticed the bar was empty. They had been working for hours, it was already evening (around 9pm to my recollection) and the place should be filled with people. This puzzled them until someone solved the mystery: it was New Year’s eve!

Of course the reporter interviewing him asked if he wasn’t upset about working so late during New Year’s eve, but no, he wasn’t. Now, how many people would be willing to work late on December 31st? Is it fair to infringe this person’s liberty by taxing him more than his co-worker who was enjoying his vacations instead of studying accounting books? I believe this answer involves not a subjective judgement, but can be answered by verifying which would yield more wealth to society.

The reality is we are constrained by time and some people are more productive, others are willing to work harder, while others would just like to earn their living and enjoy life. Why should we be opposed to a genius work-a-holic making millions of dollars, if he produces much more than that to society and few of us have that characteristic?

Let each person pick his own bundle of ability-effort-output and there shall be no (legitimate) envy. And inequality will undoubtedly be a good thing, for it will motivate harder work, simultaneously allowing more leisure.


Notes:

[1] For his summary of the theme and the book, you can check Krugman’s first blog post. There is also a highly controversial NYT review. You can also go straight for Mark Thoma’s comment on this, which gathers different sources.
[2] Quote from the book's back flap.

In Response to CITIZEN OF EUROPE: Do Central - Eastern European countries need their own Gordon Browns?

Jan Jablonski clashes with Citizen of Europe. The first blog debate starts!

The text makes two major points. Firstly, the fact that the UK stays outside the Eurozone allows it to make a necessary economic adjustment through currency depreciation rather than through “painful disinflation”. Secondly, as an opposite case, Spain didn’t have a freedom in altering the exchange rate, therefore the adjustment had to be done through prices and consequently affect employment. It actually all boils down to the question about whether it pays to join the Eurozone, as giving up the currency and monetary policy is the essence of a monetary union.

The discussion on this topic is already humongous starting from “the optimum currency area theory”. For the case of the UK the famous Five Economic Tests for assessing the UK's readiness to join the Eurozone can be mentioned. On the course of the discussion however, it does not become clear whether floating exchange rate regime helps dealing with shocks and adjustments or is in fact an another source of a shock. Additionally, Spain did not enjoy the benefits of having semi-world currency as the UK does (which brings substantial income), so giving up peseta was easier in that sense. Here:

“In Spain, the booming economy led to rising wages and, as a result, to a surging inflation. That in turn contributed to the loss of exports competitiveness and economic slowdown.”

The discussion is actually about business cycle. The supposition is that a proper monetary policy response would be the appropriate action. However, was a monetary policy in Spain an efficient tool in smoothing business cycle before joining the Eurozone? Maybe it was not? Maybe fiscal policy is actually a more efficient tool? Of course it is efficient only in case of a proper budget discipline, giving space for the automatic stabilizers to work.

Even if adopting euro was not really helpful to deal with the situation in Spain, is it also the case for EEC? The article is not really clear about how to relate the UK and Spanish example to the EEC, but certainly the first question to ask would be about business cycle synchronization. How much are the cycles of EEC synchronized with their biggest EU trading partners. Is it to the similar extent as in Spain? In case it is more synchronized, giving up monetary policy for European Central Bank would be less painful for the EEC than it was for Spain.

Author: Jan Jablonski, MSc, Economics International moderator

CITIZEN OF EUROPE: Do Central - Eastern European countries need their own Gordon Browns?

I have recently come accross an interesting piece in Financial Times. As Martin Wolf writes in his column, the sterling is about to follow the dollar in going abruptly down:

Like the US, the UK has had buoyant credit growth, huge rises in house prices, low private and national savings and a sizeable current account deficit. Like the US, it also absorbed the surplus savings of much of the rest of the world in the 2000s. It is, in short, one of the canonical “Anglo-Saxon” economies.

And furthermore:

Yet, until recently, sterling was a very strong currency. (...) Such high valuations were unlikely to last and have not done so. The strength was driven by the country’s stable economy, open capital markets and the highest nominal interest rates in the Group of Seven leading high-income countries. But now growth seems likely to slow sharply, short-term interest rates are set to fall and capital markets are suffering credit-crunch blues

So it seems that a potentially falling sterling will be the sign of a necessary economic adjustment. Surely, high current account deficit, rising housing prices and low levels of saving cannot last too long.

And what's even more important, Wolf makes a comparison to Spain, member of the Euroarea. In Spain, the booming economy led to rising wages and, as a result, to a surging inflation. That in turn contributed to the loss of exports competiveness and economic slowdown.

But in Spain, the adjustment cannot be made through exchange rate devaluation - no, Spain's monetary policy decisions are made in Brussels and the ECB will not devalue Euro, thus risking higher inflation!

So the only way for Spain, as Olivier Blanchard from MIT argues, is to go through a painful disinflation period and high unemployment (higher unemployment means lower pressure on wages and, thus, lower inflation).

I personally investigated the issue during my stay at Berkeley (together with my friend Ethan Lutske and under the guidance of Prof. Barry Eichengreen) and our solution to the problem was labour flexibility. Moreover, one of my friends (a student from Amherst College, name withheld) suggested in a private conversation that Spain should have foreseen the problems and done something to cool down the economy (e.g. curtail budget deficit drastically).

The question is why these solutions are or were not used? Can Europe afford to have flexible labour markets? And more importantly: should it?

More importantly: is Martin Wolf right in praising Gordon Brown for "saving the UK from Euro"? And do Central - Eastern European countries need their own Gordon Browns?

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With this post, we start the first DEBATE on Econ Int'l - it is a completely new feature (and not the only one to come!). Soon other posts on the topic will be published and you will be able to track the debate with the use of a special tab on the right!