I\’ll just admit up front that the vast inequities that exist even before children start school bother me, and that I am predisposed to favor programs that would help disadvantaged children early in life. Thus, I was delighted when Head Start announced some years back that it was going to carry out a randomized control trial–that is, to assign some preschool children randomly to Head Start and others not–so that it would be possible to do a statistically meaningful test of how well Head Start worked. I presumed that the test would provide ammunition for my pre-existing views.
But as the evidence has built up, Head Start is failing its test. The latest evidence appears in the \”Third Grade Follow-up to the Head Start Impact Study: Final Report,\” which was released in December. The report was carried out by a company called Westat and published by the Office of Planning, Research and Evaluation, Administration for Children and Families, U.S. Department of Health and Human Services. Basically, the report shows that Head Start provides short-term gains to preschool children, but those gains have faded to essentially nothing by third grade.
To appreciate how depressing this conclusion is, you need to appreciate the high quality of the study. It\’s based on a nationally representative sample of more than 5,000 3 and 4 year-olds from low-income families who were eligible for Head Start. These children were randomly either assigned to Head Start, or not. Data collection started in 2002, and so by 2008, data was available on how the children were performing in third grade. The study didn\’t just look at test scores: it considered a range of data on how Head Start might affect aspects of cognitive development, social-emotional development, health status and services, and even parenting practices.
The findings are summarized in this way: \”In summary, there were initial positive impacts from having access to Head Start, but by the end of 3rd grade there were very few impacts found for either cohort in any of the four domains of cognitive, social-emotional, health and parenting practices. The few impacts that were found did not show a clear pattern of favorable or unfavorable impacts for children.\”
Of course, because I am predisposed to favor these kinds of programs, I look for silver linings. Perhaps for certain specific subgroups such preschool programs can be useful? Perhaps certain kinds of curriculum are more likely to make a lasting difference? Perhaps helping children from low-income families catch up before they start school is insufficient, but a sustained set of interventions continuing through elementary school would show lasting results? Sometimes studies of early preschool interventions have found little gain in measured outcomes a few years into school, but later gains like greater rates of high school completion or reductions in certain risky behaviors in adolescence. Maybe as the Head Start study continues, these sorts of longer-term gains will emerge?
I don\’t have an answer here. Some years ago, I edited a paper in a special issue of the Future of Children about the enormous gaps in school readiness for preschool children. Equal opportunity is an important goal of public policy, and as a society, we are clearly not providing equal opportunity to many children–who are already well behind before their first day of school. If the Head Start study had positive results about the long-run efficacy of preschool programs, I\’d trumpet it to the hills. But the unfolding evidence isn\’t backing up the conclusion I would prefer.
Bruce Everett of the Fletcher School at Tufts University offers a healthy double-helping of reality in his essay entitled \”Back to Basics on Energy Policy: For the past 40 years, political leaders have promised that government can plan and engineer a fundamental transformation of our energy industry They were wrong.\” It appears in the Fall 2012 edition of Issues in Science and Technology. He begins:
\”In June 1973, President Richard Nixon addressed the emerging energy crisis, saying that “the answer to our long-term needs lies in developing new forms of energy.” He asked Congress for a five-year, $10 billion budget to “ensure the development of technologies vital to meeting our future energy needs.” With this speech, the federal government set out to engineer a fundamental transformation of our energy supply. All seven subsequent presidents have endorsed Nixon’s goal, and during the past 40 years, the federal government has spent about $150 billion (in 2012 dollars) on energy R&D, offered $35 billion in loan guarantees, and imposed numerous expensive energy mandates in an effort to develop new energy sources. During this time, many talented and dedicated people have worked hard, done some excellent science, and learned a great deal. Yet federal energy technology policy has failed to reshape the U.S. energy market in any meaningful way.\”
For example, about 30% of that energy R&D spending went to nuclear power, with President Nixon forecasting 40 years ago that nuclear would provide half of the nation\’s electricity supply by 2000. But nuclear power plateaued at 20% of the electricity supply in 1991, and given the lack of new plants and the gradual retirement of older ones, it seems certain to be a declining contributor in the next few decades.
Over the last 40 years, the U.S. government has backed a number of renewable energy technologies: hydro-power, solar, wind, solar, geothermal, synthetic fuels including ethanol, burning municipal waste, and others. Over that time, the share of all these renewables in energy consumption went from 6% in 1973 to 8% at present. Hydropower and corn ethanol comprise more than half that total. Current projections from the Energy Information Administration hold that solar power will quadruple by 2035–at which point it will still be less than 0.5% of U.S. energy consumption.
The fundamental problem, Everett argues, is that showing something is possible at high cost is one thing, but commercializing it at low costs is quite another. He writes: \”The mantra of the energy R&D program has always been, “If we can put a man on the Moon, we can do anything,” but this comparison is wrong. Apollo was a conceptual and technical triumph with no commercial aspirations. Between 1969 and 1972, the United States landed 12 astronauts on the Moon at a cost of $12.5 billion (in 2012 dollars) per astronaut. The purpose of the program was to accomplish a technically difficult feat a few times despite the enormous cost. Civilian technology requires the exact opposite: the ability to do something on a large scale at a low cost.\”
As a matter of public policy, Everett argues, the government has shown a pattern of trying to force-feed commercialization before it is actually ready to happen, through subsidies to nuclear power, or synthetic fuels, or wind, or battery-powered cars. It\’s always politically enticing to promise that a few temporary subsidies will jump-start large industries with many new jobs, but the record in energy is that the subsidies are often long-lasting and large, while the subsidized companies are short-lived. Managers get their bonuses, but sustainable jobs aren\’t created. (And for those who argue that fossil fuels are subsidized as well, Everett points out that the taxes collected on oil use are vastly higher than any public support received by the oil industry.)
Everett doesn\’t emphasize the point, but the newfound ability of U.S. energy producers to access vast reserves of natural gas will reshape energy markets in manifold ways. I\’ve posted in the past about \”Unconventional Natural Gas and Environmental Issues\” and also about my own preference for \”The Drill-Baby Carbon Tax,\” which would be a policy of moving ahead with all deliberate speed in developing U.S. fossil fuel resources while also imposing a carbon tax and addressing the costs of other environment issues as well.
But after 40 years of watching the U.S. government try to force energy markets on to a different path, it\’s time for an alternative approach. The U.S. government should stop subsidizing commercial energy firms, and instead put that money into a dramatic increase in energy research and development.
The proportion of U.S. adults who are \”in the labor force\”–that is, who either have jobs or are unemployed and looking for a job–has been falling for a decade, as I explored in an April 26, 2012, post on \”Falling Labor Force Participation.\” But for one demographic group, the elderly, labor force participation is rising substantially.
Braedyn Kromer and David Howard of the U.S. Census Bureau offer some snapshots of the data in their just-released survey brief, \”Labor Force Participation and Work Status of People 65 Years and Older.\” For example, here are some comparisons for the labor force participation of men and women, for those over 65 and for some age subgroups. While labor force participation is down a bit for the 75+ age group, it is noticeably higher since 1990 for the 65-69 and 70-74 age group.
From a slightly longer-run perspective, 1990 was roughly the time period when labor force participation rates among the elderly were at their lowest. Here are a couple of figures from \”The Increasing Labor Force Participation of Older Workers and its Effect on the Income of the Aged,\” by Michael V. Leonesio, Benjamin Bridges, Robert Gesumaria, and Linda Del Bene, which appeared in the Social Security Bulletin earlier in 2012. The figures show that for men over age 62, rates of labor force participation were falling through the 1980s, bottomed out around 1990, and have been rising since then. For women, the pattern is a little different, because a much greater proportion of women entered the paid workforce in the 1970s and 1980s, and so compared with earlier generations, a larger share of women continued working into their 60s and 70s, too.
The rising labor force participation of the elderly in the last two decades represents a remarkable social change. Here\’s a figure created with the ever-useful FRED website at the Federal Reserve Bank of St. Louis, showing the labor force participation rate of those over age 55, going back to the late 1940s.Through the 1950s, 1960s, and 1970s, the notion that more and more people would retire earlier and earlier seemed like an inexorable social trend. But the patterns have changed–and they changed long before the Great Recession.
When I was starting off as a young adult in the paid workforce in the 1980s, I remember looking at this kind of data and thinking about how I might be retire–like many other people!–in my mid-50s. But that\’s clearly not going to happen for me; instead, my current expectation is to be working well into my late 60s or 70s. A steadily rising average age of retirement has become the new normal. But then, a pattern of \”keep living more years while working fewer years\” was never a viable long-term option.
Early in 2012, my book The Instant Economist: Everything You Need to Know About How the Economy Works, was published by Penguin Plume. Here\’s the Amazon link; here\’s the Barnes & Noble link. At the tail end of the year, the book was named an \”Outstanding Academic Title\” by Choice magazine, which is published by the American Library Association. It was also listed as one of the Best Books for 2012 in the \”Business\” category by Library Journal, another prominent trade publication for librarians.
Here\’s the review from the August 2012 issue of Choice:
\”Currently The Instant Economist is the most readable and up-to-date summary of a typical US college principles of economics course. Following the traditional table of contents–from microeconomics through macroeconomics and international topics–and using original, helpful metaphors (and only two graphs), Taylor (managing editor, Journal of Economic Perspectives) takes the reader through the terminology, key concepts, and controversies dominant in today\’s economics profession. Noteworthy additions to the standard textbook canon are a chapter on personal investing and detailed accounts of the minimum wage, corporate merger, and inequality debates, introducing readers to the data issues that lie behind these controversies. The 36 short chapters reflect the book\’s origin in the author\’s Teaching Company recording, Economics; however, the book is a valuable stand-alone option. For supplementary coverage of the history of economic thought and more complete institutional context, see Robert Heilbroner and Lester Thurow\’s Economics Explained (4th ed., 1998; 1st ed., CH, Oct\’82). Summing Up: Highly recommended. All levels of undergraduate students as well as general readers wanting a readable introduction to economics. — M. H. Maier, Glendale Community College
And here\’s the review from the Library Journal:
\”Taylor’s (managing editor, Journal of Economic Perspectives) volume can help conversationalists looking to raise the bar for their watercooler chats and casual readers who want to understand better the current economic condition of the United States. Taylor uses simple language with field-specific vocabulary to explain economic concepts, and each concept is successfully reinforced with a real-life—and usually entertaining—example. He hits all the subjects that might interest a layperson, such as division of labor, supply and demand, wages, competition and monopoly, inflation, banking, and trade, for a total of 36 petite chapters—just enough information to give the reader a basic but well-rounded understanding of the subject. VERDICT This highly readable, nonpoliticized look at some of the economic principles that shape our society, presented in an engaging, anecdotal fashion, is highly recommended for armchair economists and anyone with a general interest in the state of our economy. —Poppy Johnson-Renvall, Central New Mexico Community Coll. Lib., Albuquerque
As these reviews emphasize, the book is written for the general non-economist reader who would like to gain some insight into the terminology and structure of economic thinking. Those who are interested in knowing a bit more about the genesis of the book might check here. As one of the reviews notes, this book was rooted in a course I several years ago for the Teaching Company, which is available here. Or if you are teaching or taking an introductory college-level course in economics, I of course recommend my Principles of Economics textbook, available here.
Back in 1974, Richard Easterlin published a paper called \”Does Economic Growth Improve the Human Lot? Some Empirical Evidence\” (available here and here, for example). Easterlin raised the possibility that what really matters to most people is not their absolute level of income, but their income level relative to others in society. If relative income is what matters, then an overall rise in incomes doesn\’t make me any better off relative to others, and so my happiness does not increase. Income becomes a sort of arms race: even as we all race to get more, it doesn\’t actually make us any happier.
Since then, the question of whether income brings happiness has been much-debated by economist and other social scientists. In \”The New Stylized Facts about Income and Subjective Well-Being,\” Daniel W. Sacks, Betsey Stevenson, and Justin Wolfers offer a compact and readable summary of the evidence (much of which they generated in earlier research) that income is not just relative–and so more income does increase happiness. The paper is available as IZA Discussion Paper No. 7105, released in December.
At a basic level, this research looks at economic data on levels of income and compares it with survey data on on life satisfaction. For example, the Gallup World Poll provides data from 122 countries on the question: “Please imagine a ladder with steps numbered from zero at the bottom to ten at the top. Suppose we say that the top of the ladder represents the best possible life for you, and the bottom of the ladder represents the worst possible life for you. On which step of the ladder would you say you personally feel you stand at this time?”
As a starting point, let\’s compare countries across the world in terms of real per capita GPD, along with their answers to this question on a scale from 0-10. The horizontal axis of the graph is a logarithmic scale: that is, rather than rising by a fixed amount between each tic mark, it rises by a fixed proportion (in this case, doubling) between each tic mark.
The general pattern is clear those in higher-income countries tend to report more life satisfaction. The best-fit straight line is drawn through the data. The much lighter dotted line is a \”non-parametric\” line which is a best-fit line that isn\’t required to be straight,and thus flattens out near the bottom and curves more steeply at the top than a straight line. Broadly speaking, it seems as if each doubling of income does lead to a distinct rise in the happiness scale, both for low-income and for high-income countries.
Of course, this result by itself doesn\’t prove the case either way. It could be that people in high-income countries are happier because they perceive that they are not in low-income countries, and so the happiness from their income is relative, rather than absolute. Thus, a second test is to look within individual countries at the happiness level of those with different income levels. If happiness from income is a relative concept, one might expect that, say, the rise in income from being a low-income person in the U.S to being a high-income person in the U.S. would bring more happiness, but the rise in happiness should be much less within a country than it would be across countries. However, the rise in happiness as a result of higher incomes within a country ends up looking very much like the relationship between countries.
Yet another test is to look at comparisons over time: that is, as economic growth gradually raises income levels, do people on average within a given country report a higher level of happiness. The data here is harder to interpret, because long-run data on happiness measures isn\’t available for many countries, and the wording of the survey questions about life satisfaction often changes over time. While acknowledging that the existing evidence is messy and difficult to interpret firmly, the authors argue that it is at least consistent with the same finding: that is, higher income levels over time are correlated with higher reported life satisfaction.
But not for the United States! Sacks, Stevenson, and Wolfers write: \”The US, however, remains a paradoxical counter-example: GDP has approximately doubled since 1972 and well-being, as measured by the General Social Survey, has decreased slightly.\” The authors point out that any individual country may have specific social changes that alter the reported \”life satisfaction.\” In particular, they point out that inequality of income started rising in the U.S. economy in the 1970s, which may explain why the typical or median person in the economy isn\’t feeling much better off. They write: \”We suggest that the US is more of an interesting outlier than a key example.\”
Those who want to sort through why Sacks, Stevenson, and Wolfers reach different conclusion from Easterlin can dig into the paper itself: a lot of the difference, they argue, is just that more and better data is available now.
For my own part, I confess that I find happiness surveys both intriguing and dubious. It seems to me that higher levels of income are typically correlated with more health, education, travel, consumption, and a higher quality of recreation, so it\’s not a surprise to me it seems to me that happiness rises iwth income. On the other side, it does seem to me that survey questions about life satisfaction are answered in the context of a particular place and time. If a person says that their life satisfaction was a 7 in 1960 on a scale of 0-10, and another person says that their life satisfaction is a 7 in 2013, are those two people really equally satisfied? To put it another way, if the person from 2013 was transported by a time machine back to live in 1960, with all their memories and knowledge of the technologies, medicines, foods, education, and travel available in 2013, would that time traveller really be equally happy in either time period? I suspect that when most people are asked to rank happiness on a scale of 0-10, they don\’t say to themselves: \”Well, people living 100 years from now might have extraordinarily high levels of income and technology, so compared with them, I\’m really no more than a 2.\” At best, survey questions on a scale of 0-10 seem like an extremely rough-and-ready way of measuring life satisfaction across very different countries or across substantial periods of time.
Thomas Piketty and Gabriel Zucman have been building up an intriguing set of estimates of wealth/income ratios, both over time and across countries. The U.S. wealth/income measures look quite mainstream by European standards, both in the last few decades and when looking back to 1870. The graphs that follow are from an October 2012 presentation called \”Capital is Back:Wealth-Income Ratios in Rich Countries 1870-2010.\”
Just to be clear, \”income\” to economists is a \”flow\” concept over a period of time–for example, it might be what you receive in compensation for your labor and in return on your savings in a certain year. Wealth, on the other hand, is a \”stock\” concept of the accumulation of assets over time–for a person, it would include the value of equity in your home, as well as the value of what\’s in your savings account or other financial investments. High income and wealth do tend to go together. But it\’s possible to have high income, spend it all, and have little wealth; alternatively, it\’s possible to have low income but steady saving, or perhaps the good luck to invest in the early days of IBM or Apple or Google, and end up with high wealth.
For starters, here\’s the wealth/income ratio for nine countries from 1970-2010. To help make sense of the graph, let\’s pick out a few of the countries. The line that peaks far above other countries in the middle of the figure, at around 700% in 1990, is Japan at the height of its stock market and property bubble. The country with the highest wealth/income level in 2010 was Spain, presumably driven by a property-market price bubble in that country. The line of black squares, marching higher in recent years, is Italy. In short, a high wealth/income ratio can be a danger signal of possible bubbles in asset markets. Meanwhile, fundamentally healthy economies like Germany (dark triangles) and Canada (light triangles) have seen a rise in wealth/income ratios, but are at the bottom of the range of this group of countries. The U.S. (hollow triangles) is in the middle of the pack. If you look closely, you can see a rise in the U.S. wealth/income ratio in the late 1990s for the dot-com bubble, and again in the mid-2000s for the housing price bubble, but the 2010 value for the U.S. is near the bottom of the range.
Now here\’s a longer-term perspective, from 1870 to 2010, comparing several major economies of Europe and the United States. In this long-run perspective, both Europe and the U.S. have had a U-shaped pattern of wealth/income ratios over time, but the European U rises higher and dips deeper than the American U.
Just what the wealth/income ratio telling us? Here are some thoughts:
1) When wealth/income spikes up, it\’s a potential danger sign of financial instability in the economy.
2) Wealth is typically much more concentrated than income, and so when the wealth/income ratio is high, the political power of those holding lots of assets is probably stronger. The power of mega-rich billionaires, not just in the U.S. and Europe, but also in China and across fast-growing economies of the world, is large and growing.
3) The long-run data suggests that the wealth/income ratios observed from, say, 1940 up to about 1980, were historically on the low side. Thus, it may be that the rise in wealth/income ratios in the last few decades is a return to historical norms. (Piketty and Zucman make this case in more detail.)
4) As Picketty and Zucman write: \”There’s nothing bad about the return of capital: k is useful; but it raises new issues about k regulation & taxation.\” In general, as wealth becomes relatively more important, it deserves a larger share of our social discussion and public policy attention.
For a few years now, one of my mental images of the world economy is that the U.S. economy is by far the major importer of capital, while the major exporters of capital are China, Germany, and Japan. While that mental image remains true, the situation isn\’t as extreme as a few years back.
Here\’s are the pie graph for 2005, from the Global Financial Stability Report of the IMF. That year, the U.S. economy absorbed nearly two-thirds of all global capital imports. Japan was the major exporter of capital that hear, followed by China and Germany, with Saudi Arabia and Russia also playing large roles.
Now here\’s the comparable graph for 2011. The U.S. economy is now absorbing only about one-third of all global capital imports. Germany has become the world\’s largest capital exporter, edging out China, and then followed by Saudi Arabia and Japan.
On the U.S. side, a large part of what is driving this change is the reduction in the U.S. trade deficits. Here\’s a figure showing U.S. current account balances as a share of GDP, created with the ever-useful FRED website run by the St. Louis Fed. After the trade deficit had truly plummeted around 2006, at the worst of housing bubble, it is now back to the depths plumbed during the mid-1980s.
And here\’s a figure showing quarterly inflows of foreign capital to the U.S. economy. Notice how the U.S. economy became dramatically more dependent on inflows of foreign capital as the housing price bubble inflated during the mid-2000s. In addition, one the reasons behind the financial crisis and lack of available capital during the darkest times of late 2008 and early 2009 was that inflows of international dropped so dramatically–actually turning into outflows for a brief time. The inflow of international capital then rebounded before plummeting again, and turning into outflows during the second quarter of 2012.
Thus, it\’s fair to note that the U.S. economy is not absorbing the same share of global capital imports as it was a few years back–but it still absorbs an outsized share of global capital imports. In addition, the sharp drops in the quantities of foreign capital coming into the U.S. economy, both during the Great Recession and then from mid-2010 into early 2012, show how the U.S. has come to depend on these inflows of capital imports–and how the U.S. economy can be vulnerable to these inflows being disrupted.
But of all the problems with subsidizing the production of ethanol from corn–the cost, the distortions in price of farmland, the lack of any reductions in carbon dioxide emissions, and others–clearly the most serious problem is that that it is causing people in low-income countries to go hungry. Timothy A. Wise lays out \”The Cost to Developing Countries of U.S. Corn Ethanol Expansion\” in a working paper published in October 2012 by the Global Development and Environment Institute at Tufts University.
The article offers a lot more detail, but the basic outline is simple enough. Primarily because of government subsidies, the share of the U.S. corn crop going to produce ethanol has risen dramatically in the last few years, up to about 40%.
There are number of reasons why global prices for corn have gone sky-high in the last few years, like the drought in summer 2012 that cut the U.S. corn harvest, but one of the major factors is clearly that government subsidies are diverting large share of corn production into ethanol. Here\’s a graph of global corn (\”maize\”) prices.
This rise in corn prices has hit many low-income countries especially hard. Wise explains: \”Over the last fifty years, and particularly since the 1980s, the world’s least developed countries have gone from being small net exporters of agricultural goods to huge net importers. … The shift came when structural reforms in the 1980s, usually mandated by the International Monetary Fund and the World Bank, forced indebted developing country governments to open their economies to agricultural imports while reducing their own domestic support for farmers. The result: a flood of cheap and often-subsidized imports from rich countries forcing local farmers out of business and off the land.\” Here\’s a figure showing how the agricultural trade balance for low-income countries has evolved.
Wise estimates: \”Using conservative estimates from a study on ethanol and corn prices, we find that from 2006-2011 U.S. ethanol expansion cost net corn importing countries worldwide $11.6 billion in higher corn prices with more than half of that cost, $6.6 billion, borne by developing countries.\” Of course, the high prices for corn hit the pocketbooks of low-income people in low-income countries the hardest.
It\’s been clear for awhile now that subsidizing the production of corn-based ethanol was primarily a subsidy that flowed to large agri-business concerns that grow and process most of the corn in the United States. These subsidies aren\’t just a costly and ineffective way of pursuing lower energy imports and reduced carbon emissions–they are also causing higher food prices and hunger for some of the poorest people in the world. They should be stopped.
A few weeks back on December 19, I posted on \”Can $12.1 Trillion be Boring? Thoughts on International Reserves.\” In that post, Edwin Truman explained the reasons why the enormous size of international reserves should be a legitimate policy concern. As a contrasting point of view, the Independent Evaluation Office of the International Monetary Fund has published a report on \”International Reserves: IMF Concerns and Country Perspectives,\” which makes the case that the IMF and others have overemphasized the potential problems of large international reserves and understated their benefits. (For the record, the IMF deserves credit for the existence of the Independent Evaluation Office, which was set up in 2001 with a staff of 11, mostly recruited from outside the IMF, to provide an alternative evaluation of IMF policies.)
Everyone agrees that international reserves have taken off in recent years, largely driven by changes in China, along with other emerging and developing nations.
Worrying about large and growign international reserves may be part of the intellectual DNA of the IMF; after all, the organization was formed in large part to provide a way of dealing with balance of payments problems imbalances across countries. But as the Independent Evaluation Office report points out, countries holding these reserves feel that the IMF should be turning its attention to other targets. Here are some of the arguments (footnotes omitted). International reserves are modest relative to overall global capital markets–and the private-sector portion of those markets in particular should be the real cause of instability and concern. \”International reserves remain small relative to the global stock of financial assets under private management … There is considerable historical precedent and economic analysis to suggest that concerns about global financial stability should focus more closely on trends in private asset accumulation and capital flows. Country officials and private sector representatives also noted that the IMF should be more attentive to the accumulation of the private foreign assets that are the consequence of persistent current account surpluses, and which from a historical perspective have arguably been more destabilizing than official reserve accumulation.\” For illustration, here\’s a figure showing those international reserves in comparison with other global financial assets.
Countries that hold large international reserves see them as providing a number of benefits. \”There was a common view among country authorities that the IMF tended to underestimate the benefits of reserves. Thinking about the tradeoff between costs and benefits of reserves, country officials often mentioned a range of benefits that they considered important but were not easily incorporated into either single indicators or formal models. In addition to precautionary self-insurance (also emphasized by the Fund), they mentioned other important advantages: reserves provide a country with reliability of access and the policy autonomy to act quickly, flexibly, and counter cyclically, and, as was evident during the global crisis, they inspire confidence. Reserves have also allowed authorities to avoid the stigma associated with approaching the Fund for resources—an issue that is very much alive in a number of countries.\” Large international reserves are a symptom of the concerns that countries have about instability of capital flows in the global economy, and rather than worrying about this symptom, policy-makers should focus on underlying causes.
\”Most country officials interviewed for this evaluation also felt that in a discussion of the stability of the international monetary system, there were more pressing issues to be considered. These included the fluctuating leverage in global financial institutions and its impact on global liquidity conditions and hence capital flows and exchange rate volatility; the role and effectiveness of prudential regulations and supervision in mitigating risks associated with cross-border finance; and the difficulty in managing capital flows in recipient countries.\” A final point made in the IEO report, which seems to me to have a ring of truth, is that a lot of the concern over outsized international financial reserves is really about the reserves held by China. The enormous reserves held by Japan, for example, don\’t seem to stimulate the same amount of angst. It\’s probably not wise to try to set a wide-ranging international reserve policy for countries across the world based heavily on the experience of China, which is an extraordinary case in so many ways.
Pankaj Ghemawat of the IESE Business School at the Univesity of Navarra in Spain, together with Steven A. Altman, is the author of the DHL Global Connectedness Index 2012. The report has a lot of interesting angles for looking at the extent of globalization in recent years, but I was especially interested in an argument I\’ve made a few times–that while globalization has definitely increased by historical standards, the movement toward globalization is nowhere close to complete, and has in fact stalled in the last few years. The report looks at many dimensions of global connnectedness: here, I\’ll focus on international flows of goods and services, flows of capital, and international flows of communication and information.
For international flows of goods and capital, this figure shows total exports of goods and services as as share of world GDP. Of course, the estimates from the 19th century and first half of the 20th century are based on less data, but the overall patterns are clear: a first wave of 19th century globalization that lasted up until about the start of World War I, the stagnation or even decline of globalization until after World War II, and then the second wave of globalization since then. Globalization is near an all-time high by this measure, but notice that it after the drop associated with the Great Recession, this measure of globalization is about the same in 2011 as it was in 2007.
A couple of other thoughts to help put this figure in perspective. While the levels of exports/world GDP is high by historical standards, there\’s still a lot of room for it to expand further. As the report says: \”Furthermore, while 20% (or even 30%) of goods and services being traded across borders is far more than the same ratio mere decades ago, it is still far short of the 90% or more that one would expect if borders and distance did not matter at all. If the world truly became “flat,” countries’ exports-to-GDP ratios would tend toward an average of 1 minus their shares of world GDP since buyers would be no more likely to purchase goods and services from their home countries than from abroad. Borders and distance still matter a great deal, implying that even the most connected countries have substantial headroom available to participate more in international trade.\”
In addition, although the volume of trade has risen, the distance that trade travels on average, between the sending and the receiving country, has not risen. In that sense, geographical distance still very much affects trade.\”The global connectedness patterns traced in this report also highlight how distance, far from being dead, continues to depress connectedness of all types. While the distance between a randomly selected pair of countries is roughly 8,500 km, the average distance traversed by merchandise trade, foreign direct investment flows, telephone calls, and human migration all cluster in the range from 3900 km to 4750 km. This accords with the finding that most international flows take place within rather than between continental regions. …
[F]ocusing on trade in goods only rather than goods and services combined, as of 2011, 47% of trade took place between countries in different regions rather than within the same region, a proportion that has typically been between 40% and 50% since 1965. The average distance traveled by a dollar worth of traded merchandise in 2011 was roughly 4,750 kilometers, also in line with historical norms over the past four decades … Thus, while the depth of merchandise trade (the volume of goods traded in comparison to total economic output) has scaled new heights in recent decades, that trend has not been matched by an extension of the distances traveled by traded goods on average. Rather, much of the action in terms of trade integration has been the weaving together of national economies within the same region.\”
When it comes to flows of foreign direct investment, a similar pattern holds: it\’s at an historically high level, but it\’s still recovering from the Great Recession. Here\’s the figure.
More detailed analysis shows that the \”breadth\” of foreign direct investment, as measured by gthe range of different countries receiving such investment, has declined since 2007.The report expalins this way: \”This pattern of declining breadth scores was not matched by declines in the average distance “traveled” by FDI or the proportion that occurs between rather than within regions. Rather, the average distance “traveled” by FDI flows rose from 2007 to 2010 from roughly 4000 to 4900 kilometers and the proportion taking place within regions declined from 58% to 52%. These patterns suggest that while investors are indeed keeping more money at home (declining depth), they are not generally shifting their foreign investments from distant countries to neighbors. Rather, they are selectively choosing a narrower set of investment destinations, some of which may be distant safe havens, selected in part to diversify risks in investors’ home regions.\”
We all know that the internet and related technologies have opened up extraordinary possibilities for information and communication to flow across national borders. But by and large, people are still using those technologies to connect with others closer to home. Here are some comments from the report:
\”While new technologies indeed have made it far easier and cheaper to share information with people on the other side of the world, we actually tend to use these technologies much more intensively to connect to people close to home. Consider, first of all, postal communications. As a result of efforts spearheaded by the Universal Postal Union, organized in 1874 and one of the world’s first global institutions, it has long been fairly simple to send mail anywhere in the world. And yet, only about 1 percent of all letter mail sent around the world is international.
\”What about telephone calls? Only 2 percent of voice calling minutes are international despite rapidly falling costs and improving call quality. These figures do exclude calls placed over the internet via services such as Skype, but including calls over such services would not push this ratio up past 5%. …
\”Global data on information flows over the internet, however, indicate that while internet traffic is more international than phone calls or mail, it remains primarily domestic, with international internet traffic accounting for about 17% of the total. And what about communications on social media? Facebook aims to provide a platform for “frictionless” sharing that theoretically makes it as easy to “friend” someone around the world as one’s next door neighbor. But the reality is that relationships on social media reflect offline human relationships that remain highly distance sensitive. Less than 15 percent of Facebook friends live in different countries. …
\”While the growth of international internet bandwidth implies that we can just as easily read foreign news websites as domestic ones, people still overwhelmingly get their news from domestic sources when they go online: news page views from foreign news sites constitute 1% of the total in Germany, 3% in France, 5% in the United Kingdom and 6% in the United States (and are in single digits everywhere else sampled – as low as 0.1% in China). Furthermore, news coverage by domestic sources itself tends to be very domestic. In the U.S., 21% of U.S. news coverage across all media was international according to a recent study, and of that 11 percent dealt with U.S. foreign affairs (such as U.S. diplomacy and military engagements), leaving only 10% of coverage for topics entirely unrelated to the U.S.\”
When it comes to focusing on the U.S. economy in particular, our particular experience of globalization differs from most other countries. The U.S. has a huge internal economy, and so our international trade–relative to the size of the huge domestic U.S. economy–is actually much smaller than most other countries. However, U.S. economic ties are very widespread: in the terminology of the report, U.S. global connectedness has a lot of \”breadth.\” In addition, U.S. global connectedness is more related to finance than to goods and services. Here\’s the report:
\”The United States ranks 20th overall [in global connectedness] and has the world´s second highest breadth score, reflecting its significant ties to nearly every other country around the world. It has a more modest rank on depth (89th), which is not unusual for a country with a very large internal market. The U.S. has its strongest position on the capital pillar on which it ranks 6th overall and 1st on breadth. On the other hand, the U.S. has a remarkably low score on the trade pillar, 76th overall and 139th (next to last) on depth. Merchandise and services exports account for only 14% of U.S. GDP and imports add up to only 18%. The U.S. has maintained a stable level of connectedness since 2007.\”
For those who doubt and oppose the movement to globalization, there is a good news/bad news story here: sure, globalization has risen, but it remains far from dominant. For those who welcome and support the movement to globalization, there\’s a converse good news/bad news story here: sure, globalization has risen, but there is so very much further to go. The report takes the second view, and offers an interesting argument that the potential gains from additional trade may be substantially larger than many economic models suggest:
\”[I]n calculating the benefits of additional trade, these kinds of models focus almost exclusively on growth generated by reductions in production costs as each country’s output becomes more specialized, a limited fraction of the potential gains. To broaden the range of benefits covered, consider a modified version of the ADDING Value Scorecard, a framework originally developed to help businesses evaluate international strategies. ADDING is an acronym for the following sources of value: Adding Volume, Decreasing Costs, Differentiating, Intensifying Competition, Normalizing Risk, and Generating and Diffusing Knowledge. Because traditional models assume full employment (especially problematic in times like these) and leave out scale economies, they capture only part of the gains in the first two categories, Adding Volume and Decreasing Costs. And they entirely leave out the last four categories, whose benefits can be seen clearly, for example, in the U.S. automobile industry. Decades ago, Japanese automakers started offering consumers differentiated (more reliable) products. Increased competition prompted U.S. automakers to improve their own quality. Now, GM sells more cars in China than in the U.S., diversifying its risks and helping it recover from the crisis. And cars are becoming “greener” faster because of international knowledge flows.\”
Taking these sorts of factors into account, the report estimates that reasonable expansions of globalization could generate gains on the order of 8% of world GDP: in round numbers, call that $5 trillion or so per year in benefits.
A final note: My discussion of the report touches on some of the main points that caught my eye, but completely leaves out other points, like discussions of specific countries, of regional differences, international migration, industry studies of mobile phones, cars, and pharmaceuticals, and more. Thus, those interested in additional detail and insights will find a lot more in this report.
