conversableeconomist

Is the Great Depression is the Right Analogy for the Great Recession?

\”Economic History and Economic Policy,\” which is available at his website. He begins (footnotes omitted):

\”This has been a good crisis for economic history. It will not surprise most members of this audience to learn that there was a sharp spike in references in the press to the term \”Great Depression\” following the failure of Lehman Bros. in September of 2008. More interesting is that there was also a surge in references to \”economic history,\” first in February of 2008, with growing awareness that this could be the worst recession since you know when, and again in October, coincident with fears that the financial system was on the verge of collapse. Journalists, market participants, and policy makers all turned to history for guidance on how to react to this skein of otherwise unfathomable events.\”

Eichengreen discusses with care and detail whether analogies are chosen because they are the best example, or because they are a salient example almost within living memory, or because they deliver an already-selected policy conclusion. Drawing on a wide variety of political and economic examples, Eichengreen points out that since historical episodes never precisely match present events, often the most productive way to use history in making economic policy is not to use a single analogy, but instead to consider a number of somewhat relevant episodes, and to compare and contrast the events, policies, and outcomes.   He makes the provocative point that the choice of analogy has a tendency to guide policy responses. In the case of the analogy from the Great Depression to the Great Recession:

\”The analogy legitimated certain responses to the collapse of economic and financial activity while delegitimating others. It legitimized the notion that the Fed should respond aggressively to prevent the collapse of a few investment funds from precipitating a cascade of financial failures. This reflected the widespread currency of Friedman and Schwartz‘s interpretation of the Great Depression – that what had made the Depression great was the inadequate response of the Federal Reserve. … The analogy with the Great Depression informed the policy response to the crisis more generally. The Federal Deposit Insurance Corporation increased deposit insurance coverage to $250,000 per depositor exactly one day after press references to the Great Depression peaked. The action was presumably informed by the view of the banking panics of the Great Depression as runs by uninsured depositors, and the historical interpretation, widely shared, that those panics had played a key role in the contraction of the money supply and the impairment of the payments system. The analogy with the Great Depression similarly lent legitimacy to the argument that the Congress and Administration should respond with fiscal stimulus. This reflected the \”lesson\” of history that the depth and duration of the Depression were attributable in no small part to the fact that fiscal stimulus was not used to counter the collapse of private demand. …

The analogy with the Great Depression also delegitimized the temptation to respond with protectionist measures designed to bottle up the remaining demand. This reflected the lesson, widely taught to undergraduates and invoked by policy makers, that the Smoot-Hawley Tariff aggravated the crisis of the 1930s. In fact, this \”lesson\” of history is not supported by modern research, which concludes that Smoot Hawley played at most a minor role in the propagation of the Depression.\”

Eichengreen points out that these policy lessons are not the only possible lessons from the Great Depression, and that choosing other historical episodes might have emphasized other lessons. 

\”Did we need a new Neal Deal? Well, that depended on whether you sided with historians who argue that the New Deal helped to end the Depression or only prolonged it. Did we need a jolt to the exchange rate to vanquish deflationary expectations? The answer depended on whether your view was that Roosevelt‘s decision to take the U.S. off the gold standard in 1933 was the critical decision that transformed expectations and ended deflation or whether you thought it was a sideshow. For those attempting to move from metaphor to analogy, this was a reminder that the distilled, authoritative incapsulation of the period remains a work in progress.
Although the Great Depression was clearly the dominant base case in discussions of the 2008-9 crisis, there were other possible analogies. There was the 1873 crisis, driven by an investment boom and bust like that of the period leading up to 2007, which led to the failure of brokerage houses, in parallel with the problems in 2008 of the investment banks. There was the 1907 crisis, in response to which J.P. Morgan organized a lifeboat operation that resembled in important respects the 2008 rescue of Bear Stearns by none other than JP Morgan & Co.\”

Eichengreen also makes the point that the connection from past to present also works in reverse: for example, current economic events will alter our historical understanding of the policy reactions to the Great Depression.

\”The mainstream narrative is that the experience of the Depression led to a series of institutional and policy innovations making it less likely that something similar thing would happen again. American economic historians refer in this connection to federal deposit insurance, unemployment insurance, Social Security, the Securities and Exchange Commission, the concentration of monetary-policy-making authority at the Federal Reserve Board, and automatic fiscal stabilizers. Historians of other countries have similar list. Although the stabilizing impact of particular entries on these lists has been disputed, the thrust of the dominant narrative is clear.

We now have had a graphic reminder that we have less than fully succeeded in corralling threats to economic and financial instability. While policy responses may avoid the repetition of past threats, they are no guarantee against future threats. Markets tend to adapt to stabilizing policy innovations in ways that render those innovations less stabilizing. As memories of the earlier crisis fade, policy makers themselves become more likely to consort with market participants in this effort. I suspect that we will now see more attention to these longer-term adaptations to the legacy of the Great Depression and less to the short-term policy response.\”

conversableeconomist

U.S. Poverty by the Numbers

Each September the U.S. Census Bureau releases an annual report on the U.S. poverty rate. Each year, the report is grist for the media mill for a few days, with arguments that the official poverty rate overstates or understates \”true\” poverty. But at least in the days right after the poverty numbers come out, I prefer not to perform in this annual dance of the definitions. Here, I\’ll make four more basic points, with minimal editorializing: 1) Show the 2010 poverty thresholds and trends over recent decades; 2) Show how poverty has come to affects the young more than other age groups; 3) Show the drop in median household income not just since the start of the recession in 2007, but back to 1999; and 4) Preview an argument about definitions of poverty that is coming next month. 

1) The 2010 poverty thresholds and trends over recent decades

The poverty rate is based on money income. As the report explains: \” If a family’s total money income is less than the applicable threshold, then that family and every individual in it are considered in poverty. The official poverty thresholds are updated annually for inflation using the Consumer Price Index (CPI-U). The official poverty definition uses money income before taxes and tax credits and excludes capital gains and noncash benefits (such as Supplemental Nutrition Assistance Program benefits and housing assistance). The thresholds do not vary geographically.\” The poverty thresholds are adjusted for household size and for number of children in the household. Here they are for 2010:

As an economist, I lack any talent for drama. But I do sometimes try to give a little life to the poverty thresholds by pointing out that the poverty line for a three-person household with two children is $17,568. Divide that by 365 days in a year, and by three people per meal. It\’s about $16 in total consumption per person per day. There are high-end restaurants in most U.S. cities where $16 will buy you a fancy appetizer. The share of the population below this poverty line–the \”poverty rate\”– dipped in the 1960s, but since the 1970s has hovered between about 12-15% of the population.

2) How poverty has come to affects the young more than other age groups

In the early 1960s, poverty was more prevalent among the elderly. But in the early 1970s, the poverty rate for the elderly dropped below that for those in the under-18 age group. From the mid 1980s up to about 2000, poverty rates for the elderly were similar to those for the age 18-64 population. Since about 2001, poverty rates for the elderly have been below those for the 18-64 age group. Currently, the poverty rate for those over 65 is 9.3%; for the 18-64 age group, 13.7%; for those under 18, 22%. As we discuss the problems of our aging society and how we have set up Social Security and Medicare systems whose current financing will not be able to deliver the promised benefits, it\’s worth remembering that more than a fifth of those under age 18 are living in households below the poverty line.

In fact, the closer you go to the poverty line, and below the poverty line, the more the under-18 population is overrepresented. Specifically, those under age 18 are 24.4% of the total population;  31.3% of the population with income below 200% of the poverty threshold; and 35.5% of the population below 100% of the poverty threshold.

3) Median household income has dropped not just since the start of the recession in 2007, but compared to 1999

The median household is the household where half of all households have more money income and half have less: that is, the household at the 50th percentile of the income distribution. Income gains for those at the top of the income distribution affect average income, but they do not affect median income. The report points out:  \”Real median household income was $49,445 in 2010, a 2.3 percent decline from 2009 … Since 2007, median household income has declined 6.4 percent (from $52,823) and is 7.1 percent below the median household income peak ($53,252) that occurred in 1999 …\” Here\’s the figure:

4) A Preview of a Coming Debate over the Supplemental Poverty Measure

The Census Bureau is of course perfectly aware of the disputes over how poverty should be measured, and has long offered alternative measures of poverty for those who took the time to read the fine print. Back in 1995, there was a big National Academy of Sciences report on ways of measuring poverty. In October, the Census Bureau is planning to come out with a measure of poverty that is more closely linked to actual consumption:

\”The official poverty measure, which has been in use since the 1960s, estimates poverty rates by looking at a family’s or an individual’s cash income. The Supplemental Poverty Measure will be a more complex statistic, incorporating additional items such as tax payments and work expenses in its family resource estimates. Thresholds used in the new measure will be derived from Consumer Expenditure Survey expenditure data on basic necessities (food, shelter, clothing, and utilities) and will be adjusted for geographic differences in the cost of housing. The new thresholds are not intended to assess eligibility for government programs. Instead, the new measure will serve as an additional indicator of economic well-being and will provide a deeper understanding of economic conditions and policy effects.\”

conversableeconomist

Africa\’s Growing Middle Class (!?!)

It\’s easy to compile a list of reports dating back several decades about how the economies of sub-Saharan Africa are really truly about to take off and grow this time. But over the last 10 years or so, there is some evidence that the predictions may at last be coming true. I posted a few months back about the modest but real increases in foreign direct investment to Africa and exports from Africa in recent years. Last May, the African Development Bank put out a report in May called \”The Middle of the Pyramid: Dynamics of the Middle Class in Africa.\”

In developing economies, the \”middle class\” is usually take to run from $2/day to $20/day in consumption per person. By that standard, here\’s what Africa\’s distribution of income looked like in 2010:

The African Development Bank reports: \”Recent estimates put the size of the middle class in the region in the neighborhood of 300 to 500 million people, representing the population that is between Africa\’s vast poor and the continent\’s few elite. Africa’s emerging middle class comprises roughly the size of the middle class in India or China.\”

The increase in the middle class has been substantial in the last few decades.  The middle class was 26.2% of the population in 1980, 27% in 1990, 27.2% in 2000–and then 34.3% in 2010. To be sure, a lot of this growth was in the lowest level of the middle class, those consuming $2-$4/day on a per person basis. If one looks only at the middle class from $4-$20/day, their share of the population actually declines a bit from 1980 to 2010. The progress here is obviously slow, but nonetheless seems real.

The middle class is important for a number of reasons. It creates a local market that didn\’t exist before for many goods and services, and can have a positive effect on governance. The ADB reports: 

\”Strong economic growth in the past two decades has helped reduce poverty in Africa and increased the size of the middle class. Although the growth in Africa’s middle class has not been very robust, it has nonetheless been noticeable and contributed to increased domestic consumption in many African countries, a development that could help to foster private sector growth in African countries. Sales of refrigerators, television sets, mobile phones, motors and automobiles have surged in virtually every country in recent years. Possession of cars and motor cycles in Ghana, for example, has increased by 81% since 2006. As such, the middle class is helping to foster private sector growth in Africa as they offer a key source of effective demand for goods and services supplied by private sector entities.

The middle class is also helping to improve accountability in public services through more vocal demands for better services. The middle class is better educated, better informed and has greater awareness of human rights. It is the main source of the leadership and activism that create and operate many of the nongovernmental organizations that push for greater accountability and better governance in public affairs, a position that augurs well for creating a suitable environment for growth and development.\”

And here\’s one other statistic that jumped out at me: \”The number of internet users [in Africa], which can be used as a proxy for middle class lifestyles, has increased from about 4.5 million people in 2000 to 80.6 million people in 2008.\” 

conversableeconomist

The U.S. Loses its Dominance in Initial Public Offerings

The United States used to dominate the market for provision of initial public offerings, but no longer. 
Craig Doidge, G. Andrew Karolyi, and René M. Stulz document the patterns in a March 2011 paper \”The U.S. Left Behind: The Rise of IPO Activity Around the World.\” It can be downloaded at SSRN, or for those with access to NBER working papers, it is available as #16916.
 
Initial public offerings matter for at least two reasons. In a direct sense, they are an important way in which successful entrepreneurial companies have access to financing for expansion. In an indirect sense, IPOs tend to go where the financial and legal institutions are favorable. Thus, a drop-off in IPOs is bad news for entrepreneurs, and also acts as a sort of canary in the coal mine, telling you that the institutional environment for raising capital in this way isn\’t favorable. Here is their overview:

\”We build a comprehensive sample of 29,361 IPOs from 89 countries constituting almost $2.6
trillion (constant 2007 U.S. dollars) of capital raised over 1990 to 2007. Although the worldwide share of IPO activity by U.S. firms still ranks near the top, during the 2000s, U.S. IPOs have not kept up with the economic importance of the U.S. In the 1990s, the yearly average of the number of U.S. IPOs comprised 27% of all IPOs in the world while the U.S. accounted for 27% of world Gross Domestic Product (GDP). Since 2000, the U.S. share of all IPOs has fallen to 12% whereas its share of worldwide GDP has averaged 30%. The average size of a typical IPO in the U.S. is larger than that in the rest of the world so that IPO proceeds may be a more relevant metric. Yet, in the last five years of our sample, IPO proceeds raised by U.S. firms drop to 16.2% of world IPO proceeds, despite the fact that the stock market capitalization of the U.S. relative to that of the world averages 41% during this period.\”

The first figure that follows shows counts of the total number of IPOs: the red line showing the world total, and the other lines showing those occurring in the U.S., the UK, and China. The second figure shows proceeds from IPOs, measured in millions of dollars. The third figure shows the declining U.S. share of the IPO market over time as measured by the number of IPOs done.

conversableeconomist

Charles Ponzi and Social Security

 In January 2009, Larry DeWitt of the Social Security Administration Historian\’s Office wrote a \”Research Note\” called \”Ponzi Schemes vs. Social Security.\”  DeWitt includes a nice short history of what Charles Ponzi actually did.

\”Charles Ponzi was a Boston investor broker who in the early months of 1920 was momentarily famous as a purveyor of foreign postal coupons who promised fabulous rates of return for his investors. Ponzi issued bonds which offered 50% interest in 45 days, or a 100% profit if held for 90 days….

Ponzi opened his company, \”The Securities Exchange Company,\” at 27 School Street in Boston the day after Christmas 1919. He was penniless at the time and had to borrow $200 from a furniture dealer in order to furnish his new office. Within days he was collecting money from his initial rounds of investors. He then expanded the circle of investors by collecting money from a larger round of investors. When the bonds of the first investors came due he paid them, with their miraculous profit, using the money collected from the second round of investors. The news of these extraordinary profits swept up and down the east coast and thousands of investors flocked to Ponzi\’s office for an opportunity to give him their money. Using the money from this new surge of investors he paid off the next round of bonds as they came due, with their full profit, which excited even more frenzy. …

Ponzi started his scheme on December 26th. Precisely seven months later, on July 26th, at the insistence of the Massachusetts District Attorney, Ponzi quit accepting deposits from new investors. It was estimated that Ponzi had been taking in $200,000 a day of new investments prior to the halt. At that point he had already collected almost $10,000,000 from about 10,000 investors. As word got out about his legal troubles, worried investors swarmed his office. Ponzi confidently greeted them and assured them all was well. …

From July 26th until he was jailed on August 13th, Ponzi kept up this practice, appearing at the office each day and redeeming bonds from worried investors. During this time he actually redeemed $5,000,000 of his bonds in a futile attempt to convince the authorities that he was on the up and up. At his bankruptcy trial, it was discovered that Ponzi still had bonds outstanding in the amount of $7,000,000 and total assets of about $2,000,000. Indeed, the seemingly lucky investors who redeemed their bonds after July 26th had to return their windfalls to the bankruptcy court to be distributed among Ponzi\’s larger circle of creditors. Ultimately, after about seven years of litigation, Ponzi\’s disillusioned investors got back 37 cents on the dollar of their principal, with, of course, no whiff of any profits from the nation\’s first and most notorious Ponzi scheme.\”

How does Ponzi\’s arrangement differ from the Social Security system? As DeWitt points out, the U.S. Social Security system is a transfer program between generations, from those in working age to those in retirement, not a pyramid scheme that relies on attracting continually increasing numbers of \”investors\” to pay off those who invested earlier. DeWitt writes: 

\”If the demographics of the population were stable, then a pay-as-you-go [Social Security] system would not have demographically-driven financing ups and downs and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. During periods when more new participants are entering the system than are receiving benefits there tends to be a surplus in funding (as in the early years of Social Security). During periods when beneficiaries are growing faster than new entrants (as will happen when the baby boomers retire), there tends to be a deficit. This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes, or any other fraudulent form of financing, it is simply the nature of pay-as-you-go systems….The first modern social insurance program began in Germany in 1889 and has been in continuous operation for more than 100 years. The American Social Security system has been in continuous successful operation since 1935. Charles Ponzi\’s scheme lasted barely 200 days.\”

Thanks to David Henderson at EconLog for the pointer.

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If Only the Government Could Wave a Magic Wand and Create Jobs

I\’ve written a \”Commentary\” for Minnesota Public Radio\’s news site, \”If only the government could wave a wand and create jobs.\” You can check it out at the MPR website, with an actual photo of me, or just read it here:

\”If only the government could wave a wand and create jobs\”

by Timothy Taylor

September 15, 2011

Back in 1993 there was a movie called \”Dave,\” which I went to see because it starred Kevin Kline. But for an economist, the ending of the movie was physically painful, because I was rolling my eyes so hard.

In \”Dave,\” an everyday person who looks like the president of the United States ends up through a comic chain of implausibilities actually becoming president. The big end-of-movie wind-up for Kevin Kline\’s \”Dave\” character, acting as the wise and beloved president, is passing a law to eliminate unemployment by having the government guarantee a job for everyone.

You don\’t have to be an economist to suspect that solving unemployment isn\’t this simple. Really? The only reason the United States has unemployment is that we haven\’t passed a law guaranteeing jobs for all? And this great idea of eliminating unemployment by guaranteeing jobs for all hasn\’t occurred to Germany or Sweden or Japan or any other country?

Off the movie screen, incentives and tradeoffs can\’t be ignored. If the government is going to guarantee jobs with wages, it needs to pay for it with taxes, which affects incentives for those who pay current taxes, or with borrowed money, which tends to crowd out private-sector borrowers in the present and also affects the workers who will need to pay taxes to repay that borrowing in the future. Moreover, if you \”guarantee\” a job, what will be the pay and benefits? Is the job permanent? Does the government also pay for transportation and child care? Can the government require that you move to another place to take the job? What\’s the motivation to do the guaranteed job if you can\’t be fired? How will firms react when their current and potential employees can take these government jobs? How do we draw the line between helping those who would be unemployed and turning on a government spending spigot that will be hard to shut off?

Eighteen years after \”Dave,\” I still roll my eyes when people talk as if the government can cure unemployment by passing a law. However, when an economy is sunk in recession, government can help to ease the pain with a combination of temporary spending increases and tax cuts. Thus, although I have I have my quarrels with how the various laws were designed and targeted, I overall supported both the Bush economic stimulus package in 2008 and the Obama stimulus in 2009.

I was predisposed to support at least some of President Obama\’s most recent labor proposals as well, with the unemployment rate still above 9 percent, but the proposals don\’t seem politically serious. When Obama gave his speech last Thursday, exhorting Congress to pass his bill without delay, he had not yet sent Congress a bill.

Then, when the bill arrived early this week, it no longer proposed having the bipartisan deficit commission take the jobs plan into account in its plans to address the deficit in the middle term — as Obama had proposed in the Thursday speech — but instead called for limiting deductions for those with high incomes. I favor raising the tax burden on those with higher incomes as part of an overall medium-term deficit-reduction package. But raising that issue now works against gaining support for an immediate bill to help some of the unemployed.

Ultimately, all of these bills are temporary palliatives–aspirin to dull the pain of a feverish economy. Government-supported jobs and stimulus packages are worthwhile when the unemployment rate is stuck above 9 percent, but they aren\’t a long-run path to lower unemployment. The economy needs hiring by private firms.

A pro-jobs agenda for the long run is a tougher task than waving a \”Dave\”-type magic wand. Some useful steps might include the following:
 
Build a national program of apprenticeships to connect high school students with real-world job skills and possible future employers, as has been done in Germany.

Redesign unemployment and disability rules to encourage employment while still protecting the needy, as has been done in the Netherlands and Denmark.

Overhaul and retarget the 45 or so federal job training programs that already exist. Provide greater support for job search and for moving to take a job.

Other steps would focus on the broad climate for business:
 
Reform the corporate tax code to close loopholes, reduce tax rates and encourage investment.

Make sure that firms are following rules about environmental protection, financial disclosure and safety of workers and consumers, but then get out of the way and let them function.

Take concrete steps to put federal government finances on a sustainable path over the next five to 10 years.

For most of the second half of the 20th century, the U.S. economy could assume, through better and worse years, that many firms would do most of their production within America\’s boundaries. But in the globalizing economy of the 21st century, firms have more choices. The United States needs to rethink and redesign its economic institutions to make itself a more attractive location when firms are deciding where to produce and hire.
—-
Timothy Taylor is managing editor of the Journal of Economic Perspectives, based at Macalester College in St. Paul. He blogs at conversableeconomist.blogspot.com.

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Clean Energy Standard vs. Feebate vs. Carbon Tax vs. Cap and Trade

Alan J. Krupnick and Ian W.H. Parry of Resources for the Future have a nice short article on \”Decarbonizing the Power Sector: Are Feebates Better than a Clean Energy Standard?\” But if the policy goal is to reduce carbon emissions, there are at least four policies in play–all discussed in their article.

  • A clean energy standard. They write: \”Under this approach, electricity producers would be required to meet a rising fraction of their generation using zero-carbon sources or sources with lower carbon intensity (defined as CO2 emissions per kilowatt-hour [kWh]) than that of coal generation.\” In July, the Congressional Budget Office put out a report on \”The Effects of Renewable or Clean Electricity Standards:\” :
  • A \”feebate\” system, \”which involves fees for [electricity] generators with above-average emissions intensity and subsidies or rebates for those with below-average emissions intensity.\”
  • A cap-and-trade system, in which the government sets an overall cap on carbon emissions, and then allocates permits to emit this amount of carbon. These emission permits would have two important traits: 1) they would shrink over time, so a permit to emit amount of carbon in one year would gradually phase down to allow emitting only a certain percentage of that amount in future years; and 2) the permits could be bought and sold, so that those who could reduce emissions relatively cheaply would have an incentive to go ahead and do so, and to sell their excess permits to those who would find it more expensive to reduce emissions.
  • A carbon tax.  

I won\’t attempt to rank these options in any systematic way, but here are some of my thoughts about them.

1) A feebate system has some substantial advantages. Krupnick and Parry explain: \”The feebate approach has several potential advantages over a CES [clean energy standard]. For starters, the incremental costs of reducing CO2 are automatically equated across different generators, promoting a cost-effective allocation of emissions reductions within the power sector at a given point in time. Another attraction of the feebate is that it automatically handles changes in the future costs of different generation technologies or fuel prices. If, for example, the future expansion of nuclear power is temporarily held up, firms would be permitted a higher emissions intensity (at the expense of paying more fees or receiving fewer rebates); under a strict CES they would be required to meet a given emissions intensity standard, regardless of costs. Conversely, if the competitiveness of wind power improves, firms are rewarded for exploiting this opportunity and further cutting their emissions under a feebate system; with a CES, they have no incentive to do better than the emissions intensity standard. By establishing a fixed price on CO2 emissions, moreover, a feebate facilitates comparison of policy stringency across countries. This price could be set in line with estimates of the (global) environmental damages from CO2 (currently about $21 per ton, according to a recent review across U.S. agencies and subsequent use in U.S. regulatory impact analyses [U.S. Interagency Working Group on Social Cost of Carbon 2010]) or prices prevailing in the European Union’s Emissions Trading.\”

2) Anti-tax sentiment is a political constraint. I suspect that the clean energy standard is popular because, at least to politicians, it appears to have no costs. Similarly, cap-and-trade may appear to impose no costs either. In contrast, a carbon tax clearly looks like a charge. A feebate proposal does require collecting revenue and passing it to other actors–but there is no actual revenue retained by the government, so it may not look like a tax

3) The clean energy standard and feebate approaches both focus only on electricity generation, and for that reason would have less effect on carbon emissions than a broader-based cap and trade or carbon tax approach. This may also be a political selling point, because drivers using gasoline and firms that are heavy users of coal or oil or natural gas would be less affected by an approach that focused only on electricity generation. However, the feebate idea might have broader applicability. I have in the past seen feebate proposals in the past that focuses on automobile fuel efficiency: that is, those driving cars with below some level of miles-per-gallon pay a fee, and those driving cars above that level of miles-per-gallon get a rebate.

4) A clean energy standard is a pure regulatory approach, specifying what is \”clean\” and what is not, and thus is likely to be less effective than a cap-and-trade or a carbon tax approach. Here\’s how the CBO makes this point in its report: \”Even with a wide variety of compliance options, neither an RES [renewable electricity standard] nor a CES [clean electricity standard] would be as cost-effective in cutting CO2 emissions as a “cap-and-trade” program. Such a program would involve setting an overall cap on emissions and letting large sellers of emission-creating products (such as electricity generators, oil producers and importers, and natural gas processors) trade rights to those limited emissions. In that way, a cap-and-trade program would create a direct incentive to cut emissions; in contrast, an RES or CES would create a direct incentive to use more renewable or other types of clean electricity but would have only an indirect effect on emissions.\”

5) A carbon tax and auctioning of cap-and-trade permits would raise revenue that could be used to lower tax rates in other areas, in ways that could enhance efficiency–but it is difficult to guarantee that the revenues would be used in this way.

6) One great advantage of a carbon tax is that it reduces the incentives for political tinkering. A cap-and-trade proposal, for example, is likely to have extensive grandfathering of those who currently emit carbon, probably along with a parade of special rules and exemptions. Defining what is \”clean energy\” or even how the feebates would be structured are likely to be more highly political decisions. 

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No More Original Sin (in International Finance): Jackson Hole III

This is the third of three posts on some of the papers presented at the Jackson Hole conference held in late August by the Kansas City Fed. The first two posts are here and here. All the papers from the conference are posted here.

Back in the 1999 edition of the Jackson Hole conference, Barry Eichengreen and Ricardo Hausmann presented a paper on \”Exchange Rates and Financial Fragility.\”  In that paper they applied the term \”original sin\” in this way:

\”This is a situation in which the domestic currency cannot be used to borrow abroad or to borrow long term, even domestically. In the presence of this incompleteness, financial fragility is unavoidable because all domestic investments will have either a currency mismatch (projects that generate pesos will be financed with dollars) or a maturity mismatch (long-term projects will be financed with short-term loans). … Original sin seems to capture a fact about the world. What causes it is an open question. One hypothesis is that a history of inflation and depreciation renders investors reluctant to invest in domestic-currency assets and to invest long term. In fact, however, original sin appears to apply as well to more than a few emerging markets that do not have a recent history of high inflation. Essentially, all non-OECD countries have virtually no external debt denominated in their own
currency.\”

Original sin was often near the root of international financial crises during the last few decades, because when an emerging market economy had borrowed in another currency, and then its exchange rate fell, the repayment of loans in domestic currency could no longer repay the international debts in the foreign currency. At the most recent Jackson Hole conference, Eswar Prasad points out in \”Role Reversal in Global Finance\” that emerging economies have now responded to wash their hands of \”original sin.\”

Prasad points out that international financial integration is increasing: \”[T]here has been a generalized
increase in de facto financial openness, as measured by the ratio of the sum of gross stocks of external assets and liabilities to GDP. Among advanced economies, the median level of this ratio has more than doubled over the past decade. The increase is large but less spectacular for emerging markets. … China and India were relatively closed in de facto terms in 2000 but have become much more open since then. Other than Brazil and Russia, which experienced minor dips, virtually every major economy—advanced or emerging—has a higher level of assets and liabilities relative to GDP in 2010 compared to 2007, indicating that the financial crisis did not reverse or stop rising global financial integration. Rising gross external positions have important implications for growth, international risk sharing and financial stability. As gross stocks of external assets and liabilities grow in size, currency volatility will have a larger impact on fluctuations in external wealth and on current account balances.\”

However, the form of these international assets and liabilities for emerging markets has dramatically changed. Back in the 1980s, the main international liabilities for these economies was debt incurred in foreign currency. But now, the liabilities for countries in emerging market economies have shifted dramatically. Prasad describes a figure this way: \”Stocks of foreign direct investment (FDI), portfolio equity (PE) and external debt are shown as ratios of total external liabilities (L). The stock of foreign exchange reserves is shown as a ratio to total external assets (A). … The weighted mean is the ratio of the sum of external assets and liabilities for all countries in the group expressed as a ratio of the sum
of nominal GDP for all countries in that group.\”

As the figure shows, there has been a dramatic shift in international liabilities for emerging markets toward foreign direct investment and portfolio equity. On the asset side, there has been a substantial move toward building up foreign exchange reserves, mainly in U.S. dollars. Here\’s Prasad\’s figure showing that build-up.

For emerging economies, the risks of international finance have changed quite substantially. With their huge foreign exchange reserves and their lack of borrowing in foreign currencies, they are much better insulated against shocks to their exchange rates than they were in the 1990s. However, instead of having risks on the liability side, from the risk that they would be unable to repay their borrowing in foreign currency, they now face two new risks.

A first risk is that their enormous foreign exchange holdings will be diminished in value, either because of a rise in inflation in the U.S., Europe and Japan which reduces the real value of the debt, or because of a depreciation of the dollar, euro, yen, and pound relative to the currencies of the emerging market economies. As Prasad writes: \”As the safety of these assets comes into question, the risk on emerging market balance sheets has now shifted mostly to the asset side. These countries may be forced to rethink the notion of advanced economy sovereign assets as being \”safe\” assets, although they are certainly highly liquid.\”

The second risk is that the current inflows of financial capital, in the form of foreign direct investment and portfolio equity, can create problems for domestic markets in emerging countries. Prasad explains: \”For emerging markets, the major risks from capital inflows are now less about balance of payments crises arising from dependence on foreign capital than about capital inflows accentuating domestic policy conundrums. For instance, foreign capital inflows can boost domestic credit expansions, a factor that made some emerging markets vulnerable to the aftershocks of the recent crisis. New risks from capital account opening are related to existing sources of domestic instability–rising inequality in wealth and in opportunities for diversification and sharing risk. Capital inflows and the resulting pressure for currency appreciations also have distributional implications as they affect inflation and adversely affect industrial employment growth. The right solution to a lot of these problems involves financial market development, especially a richer set of financial markets that would improve the ability to absorb capital inflows and manage volatility, broader domestic access to the formal financial system (financial inclusion), and improvements in the quality of domestic institutions and governance.\”

conversableeconomist

Too Much Debt? Jackson Hole II

This is the second of three posts on some of the papers presented at the Jackson Hole conference held in late August by the Kansas City Fed. The first post is here; the final post will be up later. All the papers from the conference are posted here.

Stephen G. Cecchetti, M. S. Mohanty and Fabrizio Zampolli of the Bank for International Settlements write about \”The Real Effects of Debt.\” They illustrate that a powerful trend during the last few decades toward more debt in a number of high income countries. For example, if one looks at a simple average debt/GDP ratio for 18 OECD economies, including the United States, the combined debt/GDP ratio for government, corporate, and household debt rose from 165% of GDP in 1980 to 310% of GDP in 2010. The biggest increase over this time is debt for the household sector, which tripled in real terms over this period. (Just to be clear, this is non-financial sector debt, so it doesn\’t count what financial institutions owe to other financial institutions in their role as intermediaries.)

While longer-run data on debt across sector isn\’t available for all 18 countries that they examine, they offer a longer-run picture of U.S. debt. As they point out, U.S debt tended to hover around 150% of GDP for most of the time until about 1985, when it started rising. (The bump in debt/GDP ratios in the Great Depression, of course, was because the denominator of GDP in that ratio fell so sharply.) Since the 1980s, household debt has been rising faster than private-sector debt.

With these facts in mind, they raise a broader question: \”At moderate levels, debt improves welfare and enhances growth. But high levels can be damaging. When does debt go from good to bad?\” They use a regression framework that adjusts for many factors and tries to discern threshold effects, which a perfectly reasonable first shot at the issue, although it\’s the kind of approach that always raises questions about whether the correlation is a causation and whether there are omitted variables. They find:

\”Our examination of debt and economic activity in industrial countries leads us to conclude that there is a clear linkage: high debt is bad for growth. When public debt is in a range of 85% of GDP, further increases in debt may begin to have a significant impact on growth: specifically, a further 10 percentage point increase reduces trend growth by more than one tenth of 1 percentage point. For corporate debt, the threshold is slightly lower, closer to 90%, and the impact is roughly half as big. Meanwhile for household debt, our best guess is that there is a threshold at something like 85% of GDP, but the estimate of the impact is extremely imprecise.\”

The financial crisis of 2007-2009 brought home how easily household borrowing or corporate borrowing, when it goes bad, can turn into government borrowing for bailouts. When thinking about the problems of debt burdens facing the U.S. economy, it seems unwise to look only at government borrowing.

conversableeconomist

Dani Rodrik on economic convergence: Jackson Hole I

Each year the Kansas City Fed holds a research conference in Jackson Hole in late August that attracts many of the beset and the brightest in the central banking and economic research community. Back in the Paleolithic era, one used to have to wait months until the printed conference volume came out, or try to cadge a copy of working papers from authors. But now, of course, all the papers are posted here. In this post and the next two, I\’ll hit the high spots of three of the papers that particularly struck me.

Dani Rodrik offers a characteristically interesting reflection on \”The Future of Economic Convergence.\”   He starts with some nice figures to show the convergence that has occurred. The first shows growth trends in the world economy from 1950 to 2008. Rodrik writes:

\”The world economy experienced very rapid growth in the decade before the global financial crisis. In fact, once we smooth out the annual variations, growth reached levels that were even higher than those in the immediate aftermath of World War II (Figure 1), which is remarkable in view of the fact that growth in the early 1950s was boosted by reconstruction and recovery from the war.The growth pattern of the world economy since 1950 looks U-shaped: a downward trend from about 1960 until the late 1980s, followed by a strong recovery since then.

What this trend hides, however, is the divergent performance of developed and developing countries. As Figure 2 shows, developed countries have experienced a steady decline in growth since the 1960s, from around 3.5 percent per annum in per capita terms during the 1950s to below 2 percent in the early years of the new millennium. The recent recovery in global growth is due entirely to a remarkable improvement in the performance of the developing parts of the world. Growth in developing countries nearly tripled from around 2 percent per capita in the 1980s to almost 6 percent before the crisis of 2008. It is China (and the rest of developing Asia) that accounts for the bulk of this performance. But high growth in East and Southeast Asia predates the new millennium, and what is especially noteworthy about the recent experience is that Latin America and Africa were, for once, part of the high-growth club. Growth picked up in both regions starting around 1990, and surpassed levels not experienced since the 1960s …\” 

Rodrik then poses the hard question on which he has been gnawing for a few years now: What caused this convergence to occur and can it be relied upon to continue? He points out that the standard story of why convergence has occurred tends to emphasize good economic housekeepings: factors like getting monetary and fiscal policy under control, opening to international trade, improvements in governance, and the spread of global production networks. But he argues that China and other growth successes are hardly bastions of conventional economic wisdom. Rodrik writes:

\”China’s policies on property rights, subsidies, finance, the exchange rate and many other areas have so flagrantly departed from the conventional rulebook that if the country were an economic basket case instead of the powerhouse that it has become, it would be almost as easy to account for it. After all, it is not evident that a dictatorship that refuses to even recognize private ownership (until recently), intervenes right and left to create new industries, subsidizes lossmaking state enterprises with abandon, “manipulates” its currency, and is engaged in countless other policy sins would be responsible for history’s most rapid convergence experience. One can make similar statements for Japan, South Korea and Taiwan during their heyday, in view of the rampant government intervention that characterized their experience. As for India, its half-hearted, messy liberalization is hardly the example that multilateral agencies ask other developing countries to emulate. Foreign economists advise India to speed up the pace of liberalization, open its financial system, rein in corruption, and pursue privatization and structural reform with greater vigor. India’s political system meanwhile dithers.\”

So what explains why convergence starts at certain times, and why it takes hold in certain places but not in other? Rodrik looks at a sectoral level and finds that certain industries, if a country gets a foothold in those industries, seem to experience a rapid convergence to global productivity standards. These industries often involve tradeable manufactured goods, including cars, machinery and equipment, and motorcycles. He presents a striking result that when these industries are established, their tend to converge almost regardless of the government\’s economic policies–unless those policies are truly terrible.

Rodrik then makes the provocative claim that a difficult issue for many economies is whether they have the flexibility to expand and move labor into these \”escalator industries.\” If labor moves into these industries, overall economic convergence can occur. But in some cases–and he offers examples from Latin America and Africa–rapid productivity growth in one trade-oriented industry has reduced the need for labor in that industry, and thus thrown workers back into lower-productivity industries, a phenomenon he called \”growth-reducing structural change.\”

I\’m not always fully convinced by Rodrik\’s work, but I find it continually intriguing and thought-provoking.