Month: December 2013

Most of the commentary on the ultra-low interest rate policies that have been pursued over the last five years or so by the Federal Reserve and other central banks has focused on whether they were useful in limiting the length and depth of the Great Recession, and whether or how long they should be continued. In their recent discussion paper for the McKinsey Global Institute, Richard Dobbs, Susan Lund, Tim Koller, and Ari Shwayder acknowledge and accept the conventional wisdom that the ultra-low interest rate policies were useful and appropriate as part of the effort to stave off the Great Recession, but that there is some controversy over continuing the policies. But in \”QE and ultra-low interest rates: Distributional effects and risks,\” they then tackle a different if related question: Who has won and who has lost from the ultra-low interest rates? Although their analysis is international, I\’ll focus mainly on the U.S. results here.

Ultra-low interest rates will have two main sets of distributional effects: the first set involve interest payments made or received; the second set involve how interest rates affect the level of asset prices like homes and bonds. Here\’s a figure looking at how ultra-low interest rates have affected interest income and payments from 2007-2012.

Of course, lower interest rates help borrowers pay less, while those who are receiving interest payments get less. Thus, the big winner from ultra-low interest rates is the U.S. government, which over the 2007-2012 period could owe $900 billion less in interest payments. Indeed, the McKinsey report also notes that central banks like the Federal Reserve have been buying assets as part of the \”quantitative easing\” policies in recent years, and funds earned by the Fed over and above operating expenses go to the U.S. Treasury. They estimate that the quantitative easing policies gained the U.S. government another $145 billion or so during this time period. So overall, the ultra-low interest rate policies have been worth about $1 trillion to the U.S. government.

Nonfinancial U.S. corporations have interest-bearing debt in the form of bonds and bank loans, so the low interest rate policies have been worth $310 billion to them. U.S. banks have also seen a rise in their net interest income–that is, the amount by which the interest they received from borrowers exceeded the interest they paid to depositors. (In contrast, banks in Europe as a group have been worse off as a result of the ultra-low interest rate policies.)

On the other side, those who were depending on receiving interest payments are worse off. For example, insurance and pension funds that were relying on interest payments for part of their returns are down $270 billion from 2007-2012. As the report points out, many of these companies hold bonds that they purchased before interest rates fell, and so they have been somewhat protected from the fall in  interest rates. But as the period of ultra-low interest rates continues, insurance companies will either need to shift toward purchasing higher-risk products in search of higher returns, or they may become insolvent.

Household that were relying on interest payments also suffered.  However, because younger households tend to be borrowers, while older households are more likely to be relying on interest income, these losses fall heavily on older households. They also fall heavily on households that have high levels of wealth–in particular, on the 10% or so of US households that have 90% of the financial wealth.

Finally, the rest of the world holds large amounts of U.S. dollar debt: for example, think of China\’s $3.7 trillion in U.S. dollar reserves. The rest of the world has received about $480 billion less as a result of the ultra-low interest rate policies from the U.S. Federal Reserve during 2007-2012.

Now shift over to thinking about the effect of ultra-low interest rates on asset prices. The McKinsey report estimates that as a result of the ultra-low interest rates, U.S. housing prices are about 15% higher than they would otherwise have been (although this estimate is not intended to be precise!) and value of fixed-income bonds is about 37% higher. (If a bond was issued at some point in the past when interest rates were higher, and now interest rates fall, then the bond is worth more as a result.) The report argues that the effect of lower interest rates on stock prices is minimal. But the first two effects mean that household wealth is up about $5.6 trillion as result of ultra-low interest rates. Of course, these gains are experienced either by those who own a house or by those who own bonds–which again would be the 10% or so of all households that hold 90% of the financial wealth. It\’s a little tricky to think about these gains in asset values, because presumably at some point when interest rates return to more normal levels, these gains from ultra-low interest rates will fade away.

These distributional effects of ultra-low interest rates may well be less important than the macroeconomic issues of using the low rates to limit the economic carnage of the Great Recession. But the distributional effects are surely large enough to deserve notice. The big gainers are the U.S. government and nonfinancial corporations. The big losers are those trying to save for the future: older households, pension funds, life insurance companies. Other countries around the world have gotten hit in two ways:  not just much lower interest payments than they expected, and also potentially unstable inflows of U.S. investment dollars. When U.S. interest rates are rock-bottom, U.S. dollar investment funds flow into smaller economies around the world seeking higher returns; when it seems as if U.S. interest rates might rise, these U.S. dollar investment flows can easily flee back to the U.S. economy, destabilizing the capital markets and exchange rates of the smaller economies.

A standard line in economics, which I\’ve certainly emphasized often enough, is the remarkable ability of the social institution of markets to transmute self-interested behavior into social welfare. When firms are seeking a profit, they try to provide a combination of price and quality that appeals to customers. When people work at a job, they try to provide the combination of effort and skill that will result a certain mix of wages and work conditions. When customers shop for the best deal, they provide an incentive for firms and workers to act in these ways. The result of these interacting forces is a set of incentives that translate into improved standard of living. Of course, the narrow pursuit of self-interest can also lead to connivance, fraud, crime, violence, war, and politics. Jack Hirshleifer made this case in a memorable 1993 speech entitled \”The Dark Side of the Force,\” in which he argued that economists were too sunny in their view of self-interest, and needed to look more closely at both sides.

But as economists have quarreled over how society might best shape and direct the force of self-interest, they have opened themselves to an attack from the philosophers who argue that rather than assuming that people are motivated by narrow self-interest, why don\’t we seek a world in which people are motivated by virtuous behavior? Luigino Bruni and Robert Sugden seek to counter this critique in \”Reclaiming Virtue Ethics for Economics,\” which appears in the Fall 2013 issue of the Journal of Economic Perspectives. (Full disclosure: All articles in the JEP are freely available online courtesy of the American Economic Association. I\’ve been Managing Editor of the JEP since its inception in 1987.)

Bruni and Sugden point out that the critique that economic behavior is instrumental, rather than virtuous in itself, goes back a long way. For example, they quote Aristotle’s Nicomachean Ethics:
“The life of money-making is one undertaken under compulsion, and wealth is evidently not the good we are seeking; for it is merely useful and for the sake of something else.” They sketch the views of modern philosophers who also argue that economic behavior lacks virtue because it is not an end in itself, but instead is an activity that is in some sense socially compelled and performed for the sake of something else. As Bruni and Sugden note, responding to this argument by saying that markets raise the standard of living would miss the point.

Instead, Bruni and Sugden seek to confront this argument about virtue and market behavior head-on. They point out that virtue is typically defined in the context in which a person operates. Thus, even if a soldier or a doctor earns a paycheck, the virtues of their professions lie in courage or in healing. Of course, describing virtues in this way does not mean that all soldiers or all doctors are are virtuous!

Bruni and Sugden then argue that market behavior contains the possibility of intrinsic virtue as well, which lies in the action of participating in an activity in which mutual gains are realized. They write: \”But economic freedom is not the freedom of each person to get what he wants tout court; it is his freedom to use his own possessions and talents as he sees fit and to trade with whoever is willing
to trade with him. We suggest that the common core of these understandings of markets is that
markets facilitate mutually beneficial voluntary transactions.  … [A] market virtue in the sense of virtue ethics is an acquired character trait with two properties: possession of the trait makes an individual better able to play a part in the creation of mutual benefit through market transactions; and the trait expresses an intentional orientation towards and a respect for mutual benefit.\” With that perspective in mind, here is the list virtues that they see in market behavior:

Universality. \”If the market is to be viewed as an institution that promotes the widest possible
network of mutually beneficial transactions, universality has to be seen as a virtue. Its opposites—favoritism, familialism, patronage, protectionism—are all barriers to the extension of the market.\”

Enterprise and Alertness. \”[E]nterprise in seeking out mutual benefit must be a virtue. Discovering and anticipating what other people want and are willing to pay for is a crucial component of entrepreneurship. … The virtue of alertness to mutual benefit applies to both sides of the market: for mutual benefit to be created, the alertness of a seller has to engage with the alertness of a buyer. Thus, the inclination to shop around, to compare prices, and to experiment with new products and new suppliers must be a virtue for consumers.\”

Respect for the Tastes of One\’s Trading Partners. \”The spirit of this virtue is encapsulated in the business maxim that the customer is always right. This virtue is closely related to the idea that market transactions are made on terms of equality, and opposed to the paternalistic idea that the relationship of supplier to customer is that of guardian to ward.\”

Trust and Trustworthiness. Because the monitoring and enforcement of contracts is often difficult or costly, dispositions of trust and trustworthiness (qualified by due caution against being exploited by the untrustworthy) facilitate the achievement of mutual benefit in markets. If that is right, these dispositions must be market virtues.\”

Acceptance of Competition. \”[A] virtuous trader will not obstruct other parties from pursuing mutual benefit in transactions with one another, even if that trader would prefer to transact with one or another of them instead.\”

Self-Help. \”Thus, it is a market virtue to accept without complaint that others will be motivated to satisfy your wants, or to provide you with opportunities for self-realization, only if you offer something that they are willing to accept in return. … Seeing self-help as a virtue makes it easier to understand how people can find satisfaction in work that they would not choose to do if they were not paid for it.\”

Non-Rivalry. \”Thus, it must be a market virtue to see others as potential partners in mutually beneficial transactions rather than as rivals in a competition for shares of a fixed stock of wealth or status. A disposition to be grudging or envious of other people’s gains is a handicap to the discovery
and carrying through of mutually beneficial transactions. The corresponding virtue is that of being able to take pleasure in other people’s gains—particularly those that have been created in transactions from which you have gained too.\”

Stoicism about Reward. \”But an adequate account of market virtue cannot maintain that what a person earns from market transactions is a reward for the exercise of virtue, in the sense that a literary prize can be seen as a reward for artistic excellence. A person can expect to benefit from market transactions only to the extent that she provides benefits that trading partners value at the time they choose to pay for them. To expect more is to create barriers to the achievement of mutual benefit. Thus, market virtue is associated with not expecting to be rewarded according to one’s deserts, not resenting other people’s undeserved rewards, and (if one has been fortunate) recognizing that one’s own rewards may not have been deserved.\”

Again, just to be clear, Bruni and Sugden are certainly not claiming that everyone who participates in markets is virtuous in these ways. They are also certainly not claiming that those who are most virtuous in these ways will accumulate the highest riches.

What Bruni and Sugden are trying to do, it seems to me, is to point out the possibilities of virtue in the everyday lives that most of us lead. It\’s easy to talk about virtue in the context of those spend their lives working in a leper colony, or creating great art, or educating impoverished children. But some of the philosophers who criticize economic behavior for its inordinate focus on self-interest and lack of virtuous behavior seem to say fairly explicitly that the everyday life of, say, a bricklayer or a factory worker or a file clerk must necessarily lack even the opportunity for virtuous behavior, because their efforts to make a living are without a possibility of intrinsic merit. Indeed, the argument that economic behavior cannot be virtuous seems to shade into a claim that only those who don\’t need to work for a living can be virtuous. In contrast, Bruni and Sugden argue that market behavior of everyday life has its virtues worth defending, too.

For a contrasting argument that expresses concerns about how markets may infringe on other important social values, the same issue of JEP has an article by Michael J. Sandel called \”Market Reasoning as Moral Reasoning: Why Economists Should Re-engage with Political Philosophy.\” I posted on one aspect of Sandel\’s argument a couple of weeks ago in \”Is Altruism a Scarce Resource that Needs Conserving?\”

Jagdish Bhagwati gives his perspective on the state of the Doha Round of world trade talks in \”Dawn of a New System,\” which appears in the December 2013 issue of Finance & Development. It\’s useful reading as background for the Ninth Ministerial Conference conference of the World Trade Organization that starts tomorrow in Bali.

As Bhagwati looks back at the status of the Doha Round of trade talks that started back in 2001, he considers three options. One choice, which he calls Doha Heavy, represents the grand bargain in which nations all around the world make substantial movements toward reducing trade barriers and government subsidies. This choice isn\’t happening. But in 2011, a more modest trade liberaliztion deal was on the table that Bhagwati calls Doha Lite. In Bhagwati\’s telling, this deal was acceptable to developing countries around the world, as well as to David Cameron in the UK and Angela Merkel in Germany, but \”Obama was unwilling to confront the U.S. business lobbies, which held out for major new concessions by the bigger developing economies.\” 

So the choice that remains is what Bhagwati calls Doha Lite and Decaffeinated, which will be discussed starting tomorrow at the conference in Bali. Basically, this agreement would on the \”trade facilitation\” agenda, which according to an OECD study would emphasize issues like \”the availability of trade-related information, the simplification and harmonization of documents, the streamlining of procedures and the use of automated processes.\” Indeed, the OECD maintains a website of 16 trade facilitation indicators. The OECD writes: \”[C]omprehensive implementation of all measures currently being negotiated in the World Trade Organization’s Doha Development Round would reduce total trade costs by 10% in advanced economies and by 13-15.5% in developing countries. Reducing global trade costs by 1% would increase worldwide income by more than USD $40 billion, most of which would accrue in developing countries.\”

In the context of the world economy, these gains aren\’t very large–but they are still worth having. Also, as Bhagwati points out, even a Doha Light and Decaffeinated agreement would help support the other aspects of the multilateral trade agreement: setting rules on issues like antidumping and government subsidies, and the dispute settlement mechanism. Bhagwati has characteristically sharp observations to make about the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnerships that are also under negotiation. But like many trade economists, Bhagwati fears that a proliferation of regional trade agreements won\’t work well as global supply chains become ever-longer and emerging economies like China, Brazil, and India play an ever-larger role in the world economy.