Conversable Economist

Two recent reports start by observing that long-term interest rates have been at extraordinarily rock-bottom levels for several years now. But from that common starting point, the analysis of the reports heads in different directions.

The Council of Economic Advisers in a July 2015 report called \”Long-Term Interest Rates: A Survey,\” which notes at the start: \”The long-term interest rate is a central variable in the macroeconomy. A change in the long-term interest rate affects the value of accumulated savings, the cost of borrowing, the valuation of investment projects, and the sustainability of fiscal deficits.\” Ultimately, the CEA report takes the position that the very low long-term interest rates are mostly a matter of supply and demand in the market for loanable funds–and in particular, the result of a high global supply of saving.

In contrast, the Bank of International Settlements in its 85th annual report expresses a concern that long-run interest rates at such low levels for such a long time are not a healthy development. For example, the BIS report states: \”Our lens suggests that the very low interest rates that have prevailed for so  long may not be “equilibrium” ones, which would be conducive to sustainable and balanced global expansion. Rather than just reflecting the current weakness, low  rates may in part have contributed to it by fuelling costly financial booms and busts. The result is too much debt, too little growth and excessively low interest rates.\”

Of course, your view on these two perspectives will in substantial part determine your views about yesterday\’s decision by the Federal Reserve not to raise its target federal funds interest rate at this time. The short-term federal funds interest rate is a specialized market in which banks and big financial institutions make very short-term loans to each other. The Fed has held that short-term interest rate as near zero percent for seven years now, first as part of its efforts to ameliorate the 2007-2009 recession, and now as part of its effort not to disrupt an upswing. Changing short-run interest rates does not automatically lead to a one-for-one shift in long-run interest rates, because the long-run interest rates are affected by a wide array of supply and demand forces in capital markets. But central bank decisions about short-run rates do have an effect on long-run rates.

For factual background, the CEA report offers a basic graph showing real long-run interest rates, together with the inflation rate. The nominal rate is the rate that is typically quoted in a market transaction, like borrowing for a mortgage or what a bank pays on a savings account. The real interest rate is adjusted for inflation. Thus, a simplified way to think about the real interest rate is to take the nominal interest rate and subtract the inflation rate. But in the real world, this calculation can be more complex. If you consider an financial asset that pays a certain nominal interest rate over the next 10 or 20 or 30 years, you obviously don\’t know the rate of inflation in advance. When what the \”real\” interest rate will be is uncertain in the present, and various analytical complications ensue. In this diagram, the real interest rate is calculated by taking the interest rate on a 10-year Treasury bond and subtracting the average of current inflation and inflation during the previous five years. Thus, the implicit assumption here is that when investors purchase these bonds, and form a guess about what future inflation will be, they will look back at recent inflation experience for a guideline.

The CEA writes: \”[T]he real 10-year interest rate has been on a steady decline since the mid-1980s, undergoing the longest sustained decline since 1876. … The real interest rate has recently dipped into negative territory. Negative real interest rates have been observed previously in U.S. history and indeed have been much more negative—reaching almost negative 10 percent in the aftermath of World War I and negative 5 percent after World War II. In those episodes, the exceptionally negative real rate was a consequence of very high inflation. At the current time, it is the low nominal interest rate and not high inflation that is behind a negative real interest rate.\” Moreover, this decline in long-run interest rates isn\’t just in the US economy, but also has occurred in other high-income countries. In a globalizing economy, of course, with large international movements of capital, it\’s not a shock that long-run interest rates should tend to move together, too.

The CEA report offers a detailed and in places somewhat technical analysis of the determinants of long-run interest rates. Here are their key takeaways:

• Long-term interest rates are lower now than they were thirty years ago, reflecting an outward shift in the global supply curve of saving relative to global investment demand. …
• Factors that are likely to dissipate over time—and therefore could lead to higher rates in the future—include current fiscal, monetary, and exchange rate policies; low-inflation risk as reflected in the term premium; and private-sector deleveraging in the aftermath of the global financial crisis.
• Factors that are more likely to persist—suggesting that low interest rates could be a long-run phenomenon—include lower forecasts of global output and productivity growth, demographic shifts, global demand for safe assets outstripping supply, and the impact of tail risks and fundamental uncertainty.

For those not familiar with the Bank of International Settlements, it\’s been around since 1930. It\’s membership is made up of central banks, and it\’s mission is to provide a forum in which those central banks can discuss, collaborate, and interact.

 The factual starting point for the BIS report is the same as the CEA report, but the perspective is different. The BIS report opens in this way (references to graphs omitted):

Interest rates have never been so low for so long. They are low in nominal and real (inflation-adjusted) terms and low against any benchmark. Between December 2014 and end-May 2015, on average around $2 trillion in global long-term sovereign debt, much of it issued by euro area sovereigns, was trading at negative yields. At their trough, French, German and Swiss sovereign yields were negative out to a respective five, nine and 15 years. Such yields are unprecedented. Policy rates are even lower than at the peak of the Great Financial Crisis in both nominal and real terms. And in real terms they have now been negative for even longer than during the Great Inflation of the 1970s. Yet, exceptional as this situation may be, many expect it to continue. There is something deeply troubling when the unthinkable threatens to become routine.

The gist of the BIS report is that the ultra-low interest rates are being encouraged by central banks in pursuit of the short-run economic goal of stimulating their domestic economies. However, the BIS fears that the low interest rates are creating other dangers. Here are some of the concerns expressed by the BIS report:

Ultra-low long-term interest rates lead to disruptions in the rest of the financial system. As one example, pension funds can be much worse off. BIS writes:

\”Such [low interest rates] rates sap banks’ interest margins and returns from maturity transformation, potentially weakening balance sheets and the credit supply, and are a source of major one-way interest rate risk. Ultra-low rates also undermine the profitability and solvency of insurance companies and pension funds. And they can cause pervasive mispricing in financial markets: equity and some corporate debt markets, for instance, seem to be quite stretched. Such rates also raise risks for the real economy. …  Over a longer horizon, negative rates, whether in inflation-adjusted or in nominal terms, are hardly conducive to rational investment decisions and hence sustained growth.\”

Another risk is that when low long-term interest rates make borrowing very cheap, it often seems easier for government to address their structural budgetary and economic issues by borrowing more, rather than, well, actually trying to fix them. In the euro area, for example, a focus on how to borrow more and restructure govenment debts in that way seems easier, while dealing with the underlying economic issues underpinning the problems of the euro gets continually postponed. Yet another issue is that low interest rates in high-income countries raise economic risks in emerging markets.

 \”As monetary policy in the core economies has pressed down hard on the accelerator but failed to get enough traction, pressures on exchange rates and capital flows have spread easy monetary and financial conditions to countries that did not need them, supporting the buildup of financial vulnerabilities. A key manifestation has been the strong expansion of US dollar credit in EMEs [emerging market economies], mainly through capital markets. The system’s bias towards easing and expansion in the short term runs the risk of a contractionary outcome in the longer term as these financial imbalances unwind. … One thing is for sure: gone are the days when what happened in EMEs largely stayed there.\”

Notice that none of the BIS concerns are about the risk of a rise in inflation–which it does not think of as a substantial risk. However, the BIS makes a discomfiting comparison. Before the financial crisis, interest rates were low to stimulate the economy and inflation was also low. As we all now know, financial imbalances were building up, in a way that brought a deep recession to the high-income countries around the world. Now, we are again in an environment of low interest rates to stimulate the economy together with low inflation. The argument at the Federal Reserve and other central banks for today\’s low interest rates is that they are needed because of events that were triggered in part by the low interest rates before the financial crisis. The BIS writes:

After all, pre-crisis, inflation was stable and traditional estimates of potential output proved, in retrospect, far too optimistic. If one acknowledges that low interest rates contributed to the financial boom whose collapse caused the crisis, and that, as the evidence indicates, both the boom and the subsequent crisis caused long-lasting damage to output, employment and productivity growth, it is hard to argue that rates were at their equilibrium level. This also means that interest rates are low today, at least in part, because they were too low in the past. Low rates beget still lower rates. In this sense, low rates are self-validating. Given signs of the build-up of financial imbalances in several parts of the world, there is a troubling element of déjà vu in all this.

The BIS report raises the uncomfortable question of whether we are riding a merry-go-round in which sustained ultra-low interest rates bring financial weakness in various forms, and then the financial weakness is the justification for continuing ultra-low interest rates.

Each year, the US Census Bureau publishes a report with percentage of Americans living in households with incomes below the official poverty line. The most recent update is Income and Poverty in the United States: 2014 , by Carmen DeNavas-Walt and Bernadette D. Proctor (September 2015, P60-252). Here, let me offer a few of he headline findings from the US Census Bureau, and then skip to some thoughts inspired by Charles Dickens about how society views the poor.

The US Census Bureau reports that 46.7 million–that is, 14.8% of Americans–were below the US poverty line in 2014, which is not significantly different from 2013.

The thresholds of income for being below the poverty line depend on how many adults and children live in a household. Here are the poverty thresholds from the US Census Bureau.

Finally, the age distribution of poverty has evolved over time. Back in the 1960s, those above age 65 were more likely to fall below the poverty line. Now, it\’s children under the age of 18 who are most likely to fall below the poverty line. (And remember, because the poverty line doesn\’t take noncash government support programs into account, the value of Medicare coverage to the elderly isn\’t part of this poverty rate calculation.)

In years past, I\’ve reviewed some of the arguments and issues about how this poverty line is measured. For example, the official poverty line is based on after-tax income, and so it does not include the value of noncash government programs to assist the poor like Medicaid and Food Stamps. If one calculates a poverty rate based on consumption, rather than on income level, it looks as if the actual poverty line is much closer to zero. But in some ways, discussions of poverty always need to need to start with the attitude that one takes toward the poor.

As a conversation starter on the subject, here\’s a short essay from Charles Dickens. It was published in a magazine called All the Year Round that Dickens edited during the 1860s. This particular essay, \”Temperate Temperance,\” appeared in the issue of March 18, 1863. The articles in the magazine did not name its authors , but a group of Australian researchers attributed it to Dickens by using \”computational stylistics\”–which is basically using a computer analysis of the style of the writing and comparing it to manuscripts whose authorship is known to determine the author. The entire essay is short and readable, but here are two quick excerpts that jumped out at me.

Asking the poor to change their habits is asking a very great deal. Here\’s Dickens:

\”Heaven knows, the working classes, and especially the lowest working classes, want a helping hand sorely enough. No one who is at all familiar with a poor neighbourhood can doubt that. But you must help them judiciously. You must look at things with their eyes, a little; you must not always expect them to see with your eyes. The weak point in almost every attempt which has been made to deal with the lower classes is invariably the same — too much is expected of them. You ask them to do, simply the most difficult thing in the world — you ask them to change their habits … and to abandon habits and make great efforts is hard work even for clever, good, and educated people.\”

There is a tendency to treat the poor as if the most central part of their identity was a criminal, a substance-abuser, or extreme immaturity. None of these reactions is appropriate or useful. Dickens writes:

There must be none of that Sunday-school mawkishness, which too much pervades our dealings with the lower classes; and we must get it into our heads — which seems harder to do than many people would imagine — that the working man is neither a felon, nor necessarily a drunkard, nor a very little child. … There is a tendency in the officials who are engaged in institutions organised for the benefit of the poor, to fall into one of two errors; to be rough and brutal, which is the Poor-law Board style; or cheerfully condescending, which is the Charitable Committee style. Both these tones are offensive to the poor, and well they may be. … Who has not been outraged by observing that cheerfully patronising mode of dealing with poor people which is in vogue at our soup-kitchens and other depôts of alms? There is a particular manner of looking at the soup through a gold double eye-glass, or of tasting it, and saying, \” Monstrous good — monstrous good indeed; why, I should like to dine off it myself!\” which is more than flesh and blood can bear.

And here\’s the full 1863 essay.

TEMPERATE TEMPERANCE

WE want to know, and we always have wanted to know, why the English workman is to be patronised? Why are his dwelling-place, his house-keeping arrangements, the organisation of his cellar, and his larder — nay, the occupation of his leisure hours even — why are all these things regarded as the business of everybody except himself? Why is his beer to be a question agitating the minds of society, more than our sherry? Why is his visit to the gallery of the theatre, a more suspicious proceeding than our visit to the stalls? Why is his perusal of his penny newspaper so aggravating to the philanthropical world, that it longs to snatch it out of his hand and substitute a number of the Band of Hope Review?

It is not the endeavour really and honestly to improve the condition of the lower classes which we would discourage, but the way in which that endeavour is made. Heaven knows, the working classes, and especially the lowest working classes, want a helping hand sorely enough. No one who is at all familiar with a poor neighbourhood can doubt that. But you must help them judiciously. You must look at things with their eyes, a little; you must not always expect them to see with your eyes. The weak point in almost every attempt which has been made to deal with the lower classes is invariably the same — too much is expected of them. You ask them to do, simply the most difficult thing in the world — you ask them to change their habits. Your standard is too high. The transition from the Whitechapel cellar to the comfortable rooms in the model-house, is too violent; the habits which the cellar involved would have to be abandoned; a great effort would have to be made; and to abandon habits and make great efforts is hard work even for clever, good, and educated people.

The position of the lowest poor in London and elsewhere, is so terrible, they are so unmanageable, so deprived of energy through vice and low living and bad lodging, and so little ready to second any efforts that are made for their benefit, that those who have dealings with them are continually tempted to abandon their philanthropic endeavours as desperate, and to turn their attention towards another class: those, namely, who are one degree higher in the social scale, and one degree less hopeless.

It is proposed just now, as everybody knows, to establish, in different poor neighbourhoods, certain great dining-halls and kitchens for the use of poor people, on the plan of those establishments which have been highly successful in Glasgow and Manchester. The plan is a good one, and we wish it every success — on certain conditions. The poor man who attends one of these eating-houses must be treated as the rich man is treated who goes to a tavern. The thing must not be made a favour of. The custom of the diner-out is to be solicited as a thing on which the prosperity of the establishment depends. The officials, cooks, and all persons who are paid to be the servants of the man who dines, are to behave respectfully to him, as hired servants should; he is not to be patronised, or ordered about, or read to, or made speeches at, or in any respect used less respectfully than he would be in a beef and pudding shop, or other house of entertainment. Above all, he is to be jolly, he is to enjoy himself, he is to have his beer to drink; while, if he show any sign of being drunk or disorderly, he is to be turned out, just as I should be ejected from a club, or turned out of the Wellington or the Albion Tavern this very day, if I got drunk there.

There must be none of that Sunday-school mawkishness, which too much pervades our dealings with the lower classes; and we must get it into our heads — which seems harder to do than many people would imagine — that the working man is neither a felon, nor necessarily a drunkard, nor a very little child. Our wholesome plan is to get him to co-operate with us. Encourage him to take an interest in the success of the undertaking, and, above all things, be very sure that it pays, and pays well, so that the scheme is worth going into without any philanthropic flourishes at all. He is already flourished to death, and he hates to be flourished to, or flourished about. 

There is a tendency in the officials who are engaged in institutions organised for the benefit of the poor, to fall into one of two errors; to be rough and brutal, which is the Poor-law Board style; or cheerfully condescending, which is the Charitable Committee style. Both these tones are offensive to the poor, and well they may be. The proper tone is that of the tradesman at whose shop the workman deals, who is glad to serve him, and who makes a profit out of his custom. Who has not been outraged by observing that cheerfully patronising mode of dealing with poor people which is in vogue at our soup-kitchens and other depôts of alms? There is a particular manner of looking at the soup through a gold double eye-glass, or of tasting it, and saying, \” Monstrous good — monstrous good indeed; why, I should like to dine off it myself!\” which is more than flesh and blood can bear.

We must get rid of all idea of enforcing what is miscalled temperance — which is in itself anything but a temperate idea. A man must be allowed to have his beer with his dinner, though he must not be allowed to make a beast of himself. Some account was given not long since, in these pages, of a certain soldiers\’ institute at Chatham; it was then urged that by all means the soldiers ought to be supplied with beer on the premises, in order that the institution might compete on fair terms with the public-house. It was decided, however, by those in authority, or by some of them, that this beer was not to be. The consequence is, as was predicted, that the undertaking, which had every other element of success, is very far from being in a flourishing condition. And similarly, this excellent idea of dining-rooms for the working classes will also be in danger of failing, if that important ingredient in a poor man\’s dinner — a mug of beer — is not to be a part of it.

The cause of temperance is not promoted by any intemperate measures. It is intemperate conduct to assert that fermented liquors ought not to be drunk at all, because, when taken in excess, they do harm. Wine, and beer, and spirits, have their place in the world. We should try to convince the working man that he is acting foolishly if he give more importance to drink than it ought to have. But we have no right to inveigh against drink, though we have a distinct right to inveigh against drunkenness. There is no intrinsic harm in beer; far from it; and so, by raving against it, we take up a line of argument from which we may be beaten quite easily by any person who has the simplest power of reasoning. The real temperance cause is injured by intemperate advocacy; and an
argument which we cannot honestly sustain is injurious to the cause it is enlisted to support. Suppose you forbid the introduction of beer into one of these institutions, and you are asked your reason for doing so, what is your answer? That you are afraid of drunkenness. There is some danger in the introduction of gas into a building. You don\’t exclude it; but you place it under certain restrictions, and use certain precautions to prevent explosions. Why don\’t you do so with beer?

For those with a taste for this subject, last year when the Census Bureau released its poverty line statistics I discussed a passage from George Orwell\’s 1937 book, The Road to Wigan Pier, which details the lives of the poor and working poor in northern industrial areas of Britain like Lancashire and Yorkshire during the Depression. Orwell is writing from a leftist and socialist perspective, with deep sympathy for the poor. Bur Orwell is also painfully honest: for example, he laments that the poor make such rotten choices about food–but then he also points out how unsatisfactory it feels to patronizingly tell those with low incomes how to spend what little they have. Indeed, as I pointed out last year, there\’s some evidence in the behavioral economics literature that poverty can encourage some of the behaviors, like a short-run mentality, which can then tend to perpetuate poverty.

Imagine that you take an action to prevent an event from happening, and as it turns out, the event doesn\’t happen. Did your action prevent the event, or was your action unnecessary–at least to some extent?

For example, the US spends about $100 billion per year in fighting terrorism. It\’s very difficult to figure out if the anti-terrorism spending was justified, or some of it was over-the-top.  All we know is that we have not had a major terrorist attack on US soil since September 11, 2001. Or imagine that those concerned about climate change were able to enact a comprehensive anti-carbon agenda. Say further that the costs of doing so were high, and that the standard of living both in high-income and low-income countries was lower as a result, but the predicted perils of climate change didn\’t occur. It would be difficult to figure out if the actions were justified, or excessive. All we would observe is that a potential harm did not occur.

Seven years ago in September 2008, the US economy suffered what I think of as a near-meltdown. Some key events of that month included the Lehman Brothers investment bank going broke; the government-sponsored mortgage enterprises Fannie Mae and Freddie Mac going broke; the insurance company AIG getting an $85 billion credit line; a huge money market fund, the Reserve Primary Fund, announcing that it had lost money, leading to a run on money market funds; and the Troubled Asset Relief Program (TARP) being introduced in Congress (and being enacted in early October).
The policy response in the months that followed included a number of extreme actions: for example, the Federal Reserve holding its target interest rate at near-zero levels for seven years, while buying several trillion dollars of Treasury bonds and mortgage-backed debt; monumentally large budget deficits by the US government; and bailout loans and investments extended to certain banks, insurance companies like AIG, and auto companies like GM and Chrysler.

The claim is that these and other extreme actions were needed to avert what could have turned into another Great Depression. But although the US economy experienced a Great Recession from 2007-2009 and what is sometimes called the \”long slump\” of sluggish growth that has followed, a Great Depression didn\’t actually recur. So how can we judge whether the extreme actions were indeed necessary?

Jason Furman, chair of the Council of Economic Advisers, takes a shot at this question in a September 9, 2015 speech, \”It Could Have Happened Here:The Policy Response That Helped Prevent a Second Great Depression.\”  Furman writes:

With the unemployment rate at 5.1 percent it has become easy to forget just how close our economy came to the brink seven years ago. But during the Great Recession, comparisons to the Great Depression were by no means hyperbolic. I remember sitting in my West Wing office in early 2009 looking each day at a chart comparing the U.S. stock market in the wake of the financial crisis to previous corrections. And each day added a new point to the graph heading directly on the same trajectory as 1929 and considerably worse than every other episode. 

Furman offers a series of graphs showing the stock market, household net worth, housing prices, bond yields, unemployment rates, and flows of international trade to back up his argument that for a time in late 2008 and into 2009, the US economy appeared to be on a Great Depression track. But during the Great Depression, unemployment reached 25% and the rate of deflation (that is, negative inflation) was more than 9% in 1931 and 1932, and 5% in 1933. By comparison with that catastrophe, the Great Recession has been mild.

Furman offers an argument that the various monetary, fiscal, and other policies enacted since 2009 are responsible for avoiding a Great Depression. I fear that in some places, his argument comes close to this syllogism: 1) Steps were taken; 2) A Depression didn\’t recur; 3) The steps worked. As noted above, this case is very difficult to prove. My own sense is that some steps were more defensible than others at the time, and that some steps that made good sense in the few months after September 2008 might not have continued to make sense several years later.

But my point here is not to parse the details of economic policy over the last seven years. Instead, it is to say that I agree with Furman (and many others) on a fundamental point: The US and the world economy was in some danger of a true meltdown in September 2008. Here are a few of the figures I used to make this point in lectures, some of which overlap with Furman\’s figures. The underlying purpose of these kinds of figures is to show the enormous size and abruptness of the events of 2008 and early 2009–and in that way to make a prima facie case that the US economy was in severe danger at that time.

Let\’s start with a couple of figures related to real estate. The blue line shows a national index of home prices, and how they rose with time. The red line shows the inflation rate. These two lines are set so as to have a base value of 100 in the year 2000, and then to change relative to that base year. The figure shows that housing prices rose pretty much in line with overall rates of inflation in the 1970s, 1980s, and 1990s. But around 2000, the jump in housing prices relative to inflation rates–followed by the subsequent fall–stands out.

With these changes, the value of household owner\’s equity in real estate rose from about $6 trillion in 1999, to $13,3 trillion in the first quarter of 2006, and then fell back to about $6 trillion by the first quarter of 2009. The value of household owner\’s equity in real estate stayed around $6 trillion through 2011, before starting to rise again. My preference is to put these numbers in the context of the broader economy: that is, to divide the total value of household owner\’s equity in real estate by the size of the GDP. That calculation produces this figure, which shows that relative to GDP, the value of household equity rose well above its usual historical levels during the bubble, then fell below its usual historical levels, and now is back in more-or-less the historical range. But look at that precipitous drop!

The fall in housing prices meant problems for the banking sector. It was clear that many housing loans previously viewed as safe weren\’t going to be repaid. Moreover, economic prospects looked grim. Banks were terrified to lend. Here\’s a graph of net lending by the financial sector taken from the CBO\’s January 2011 Budget and Economic Outlook: Fiscal Years 2011 to 2021 (p. 33). Net lending is new loans minus repayments and write-offs of bad loans. The historical pattern is that during recessionary periods in the past, there was sometimes a quarter or two where lending turned negative for US banks or for money market funds. But for the US financial sector as a whole, net lending was positive every single quarter from 1950 up to 2008, when it veers wildly from more than 10% of GDP on the positive side to a decline of 10% of GDP on the negative side. This enormous change shows an almost paralyzing fear of lending in the US financial sector.

A similar near-vertical decline happens at the international level. Here\’s a figure showing the net inflow of capital into the US economy since 1995. The US economy had become used to inflows of foreign capital. During the seemingly easy money to be made in the US economy during the go-go days of the housing market bubble, the inflows exceeded $700 billion per quarter for a time in early 2007.  Again, watch the capital inflows plummet and then turn negative into capital outflows. The world was pulling its money out of the staggering US economy, too.

Finally, a standard measure of fear in the banking and financial sector is known as the TED spread. You calculate this measure by subtracting two interest rates. One interest rate is called the London Interbank Offer Rate, or LIBOR for short. It\’s the interest rate at which big international banks borrow overnight from each other. Because these are big banks and the loans are extremely short-term, such loans are usually viewed as very safe and the LIBOR rate is usually low. The other interest rate is the 3-month Treasury bill rate–that is, the rate paid by the US federal government for short-term borrowing. These two interest rates are usually pretty similar. The LIBOR interest rate is a bit  higher, because borrowing by a bank, even a well-established bank, has larger than US government borrowing. However, the two rates usually move pretty closely.

But in fall 2007, and then again in September 2008, a large gap suddenly emerges between the LIBOR interest rate and the three-month T-bill interest rate. The risks of lending between big banks, even on a very short-term basis, are suddenly looking larger and rising. If you are staring at this graph in September 2008, as it shoots up, it looks frighteningly like it could be heading toward a breakdown of the global financial system, loosely defined as a situation where banks become unwilling to deal with each other without high transactions costs, because all other banks are perceived as too risky.

As I\’ve said several times already, these kinds of graphs don\’t prove that a Great Depression definitely would have happened in 2009 or 2010 without the government interventions that did occur. When something doesn\’t happen, you can\’t prove that it would have happened.  But consider the situation of September 2008 as a matter of probabilities. Say that there was \”only\” a 10% chance of global financial meltdown, or a 20% or 30% chance. For me, that risk is plenty high enough to justify some extreme policy actions. It\’s why I\’m reluctant to criticize too strongly the decisions made by policy-makers from September 2008 through mid-2009. It\’s impossible to know how close the US economy came to a true Depression, but it was a genuine and legitimate worry at the time.

As a social scientist, I\’m predisposed to favor collecting and disseminating more information. But a February 2015 Report of the Task Force on Federal Regulation of Higher Education, called Recalibrating Regulation of Colleges and Universities, offers a useful reminder that producing all that information isn\’t free.

As background, the task force was created by a bipartisan group of US Senators. It was made up mostly of presidents and chancellors and top executives from a range of higher education institutions, including the University of Maryland, Vanderbilt University, Colorado Christian University,University of Colorado, Hiram College, Hartwick College, Sam Houston State University, California Community College, Laureate Online Education, American University, Rasmussen College, North Carolina Agricultural and Technical State University, Tennessee Independent Colleges and Universities Association, University of North Carolina, and Northern Virginia Community College.

As you might expect from such an authorship, the report includes lots of terms like consolidate, promulgate, problematic, and process improvements. But more to my taste, the report also has some intriguing big-picture estimates and vivid examples. For example, one estimate is that costs of compliance with federal rules represent more than 10% of total costs at a major university:

Another far-reaching analysis was launched by Vanderbilt University in 2014. Initial findings reveal that approximately 11 percent, or $150 million, of Vanderbilt’s 2013 expenditures were devoted to compliance with federal mandates. Nearly 70 percent of these costs were absorbed into different offices, affecting a broad swath of faculty, research staff, administrative staff, and trainees in academic departments. Vanderbilt is currently working with other institutions to test its methodology on different campuses.

The report laments that federal regulatory burdens on institutions of higher education keep rising, that the process for judging whether institutions are complying with these burdens is often capricious and costly as well, and that in many cases the rules have little to do with actually educating students. Here\’s a taste of the discussion:

Two examples highlight the increasing complexity of the Department of Education’s reach. First, in the early 1950s, accrediting agencies qualified for recognition by the U.S. Office of Education by meeting five straightforward criteria. Today, however, statutory requirements fill nine pages of the HEA, and the Department’s application for agencies seeking recognition has expanded to 88 pages. Any agency that seeks initial or renewed recognition must expect to devote several person years to filing the appropriate federal paperwork. Another example is the expansion of data collection mandates imposed on colleges and universities. The Integrated Postsecondary Education Data Survey (IPEDS) was first implemented as a voluntary activity in 1985-86. Today, participation in IPEDS is mandatory and requires completion of nine separate surveys that together exceed 300 pages. …

Higher education institutions are subject to a massive amount of federal statutory, regulatory, and sub-regulatory requirements, stemming from virtually every federal agency and totaling thousands of pages. Focusing solely on requirements involving the Department of Education, the HEA contains roughly 1,000 pages of statutory language; the associated rules in the Code of Federal Regulations add another 1,000 pages. Institutions are also subject to thousands of pages of additional requirements in the form of sub-regulatory guidance issued by the Department. For example, the Department’s 2013-14 Federal Student Aid Handbook, a guidebook for administering student aid that amplifies and clarifies the formal regulations, is more than 1,050 pages. The Department’s Handbook for Campus Safety and Security Reporting (also known as the “Clery Handbook”) contains approximately 300 pages, and will soon expand significantly in light of new regulations issued in 2014. In 2012 alone, the Department released approximately 270 “Dear Colleague” letters and other electronic announcements—this means that more than one new directive or clarification was issued every working day of the year. …

Among the many federal rules with which colleges and universities must comply, information disclosure mandates are particularly voluminous. Section 485 of the HEA, which details institutional disclosures on a host of issues, runs some 30 pages of legislative text and includes 22 separate “information dissemination” requirements. … The Federal Student Aid office at the Department publishes a summary chart of the various consumer information disclosures. Although this chart is designed to provide consumer disclosures “At-a-Glance,” it is currently 31 pages long. Between crime reporting and policy disclosures, the Clery Act and related departmental guidance require more than 90 separate policy statements and disclosures. In sum, the sheer number of regulatory provisions that affects institutions of higher education constitutes a voluminous and expanding burden.

In a number of cases, attempts to define a certain rule never seem to end, but instead only lead to more rules. For example, consider the rules for disclosing whether vocationally-oriented programs lead to \”gainful employment\”:

[W]ith respect to gainful employment, the Department first issued a complex and lengthy set of rules on this topic in 2010. However, following a court challenge that struck down the Department’s proposed metrics for judging gainful employment programs, it began a new negotiated rulemaking session. Final regulations stemming from this second effort were issued in October 2014. The 2014 final rule is almost 950 pages long, including a 610-page preamble and more than 50 tables and charts. In deciding to proceed with a second rulemaking on this topic, the Department was undeterred by both a federal court decision and by the passage of legislation in the House of Representatives blocking further regulation in this area until Congress considered the issue. 

Or consider the Clery Act, which \”requires colleges and universities to report the crimes that occurred on campus in an Annual Security Report. They also must report incidents occurring on “noncampus property,” defined as a building or property owned or controlled by an institution and used in direct support of or in relation to the institution’s educational purpose. However, this broad definition has created enormous confusion,\” as the report spells out:

Guidance from the Department both in the Handbook for Campus Safety and Security Reporting and subsequent directives indicate that colleges and universities must report crimes that happen in any building or property they rent, lease, or have any written agreement to use (including an informal agreement, such as one that might be found in a letter, email, or hotel confirmation). Even if no payment is involved in the transaction, any written agreement regarding the use of space gives an institution “control” of the space for the time period specified in the agreement. The handbook requires colleges and universities to disclose statistics for crimes that occur during the dates and times specified in the agreement, including the specific area of a building used (e.g., the third floor and common areas leading to the spaces used, such as the lobby, hallways, stairwells, and elevators). Department guidance mandates that schools report on study abroad locations when the school rents space for students in a hotel or other facility, and on locations used by an institution’s athletic teams in successive years (e.g., the institution uses the same hotel every year for the field hockey team’s away games). As a consequence, institutions must attempt to collect crime data from dozens, if not hundreds, of locations … One institution has indicated that it requests data from 69 police departments, covering 348 locations in 13 states and five countries, including police at airports and on military bases. The mandate that colleges and universities must collect data from foreign entities is particularly troublesome. … In response to one such request, a foreign government accused a U.S. institution of espionage.

The Task Force also notes that certain substantial federal rules don\’t have much to do with evaluating education, or with health and safety of students, but the rules were instead enacted for other reasons–while requiring colleges to pay the costs.

However, an increasing amount of federal oversight has little to do with these responsibilities and has more to do with pursuing broader governmental goals. To cite several obvious examples, Selective Service registration, detailed voter registration requirements, peer-to-peer file sharing, and foreign gift reporting are unrelated to the central areas of federal concern in higher education. While the policy objectives are worthwhile, the responsibility for pursuing them should not fall to institutions. We believe, for example, that individuals should be held accountable for whether they register with the Selective Service, not the college or university where they happen to be enrolled. Further, while some rules may be tangentially related to higher education, such as disclosing institutional policies on candles in dormitories and student vaccinations, they are not of sufficiently widespread interest to warrant a federal mandate.

The high costs of federal regulation are clearly a real and substantial issue for higher education, contributing to the very high costs of higher education. But don\’t forget broaden your view and remember that these kinds of government rules about collecting and providing information are legion across the US economy, too. I do love information, as I said at the start. But it\’s very easy to come up with reasons why other organizations should collect all kinds of information. Such requirements aren\’t free.

The economic burden of dementia care is already enormous, and will only rise further as the population ages. In \”Improving Long-Term Care Dementia: A Policy Blueprint,\” a report for the Rand Corporation, Regina A. Shih, Thomas W. Concannon, Jodi L. Liu, and Esther M. Friedman consider what might be done to improve care. Let\’s start with a bit of background (footnotes omitted):

Dementia is a debilitating and progressive condition that affects memory and cognitive functioning, results in behavioral and psychiatric disorders, and leads to decline in the ability to engage in activities of daily living and self-care. In 2010, 14.7 percent of persons older than age 70 in the United States had dementia. With the expected doubling of the number of Americans age 65 or older from 40 million in 2010 to more than 88 million in 2050, the annual number of new dementia cases is also expected to double by 2050, barring any significant medical breakthroughs. Alzheimer’s disease, which accounts for 60 to 80 percent of dementia cases, is the sixth leading cause of death in the United States overall and the fifth leading cause of death for those age 65 and older. Additionally, recent research suggests that deaths attributable to Alzheimer’s disease might be underreported such that it could be the third leading cause of death overall. It is the only cause of death among the top ten in the United States without a way to prevent it, cure it, or even slow its progression.

Dementia is already the medical condition that imposes the highest annual cost in terms of market cost of services provided, ahead of cancer and heart disease. These market costs don\’t include the costs of care provided by family and friends, which in the case of dementia could double the total costs.

The data in the report suggests that there is going to be a substantial shift in dementia care over the next few decades. The number of people with dementia is going to rise more than the number of potential family caregivers. Thus, it seems likely to me that as a society we are going to shift toward paid caregivers for dementia.

Most of the burden of caring for people with dementia is shouldered by family and friends. More than 15 million Americans currently provide family care to relatives or friends with dementia. These family caregivers typically shoulder a heavy burden: Nearly 40 percent reported quitting jobs or reducing work hours to care for a family member with dementia. Many of these caregivers also experience negative physical and mental health effects. …

With respect to formal care, about 70–80 percent of those who provide LTSS [long-term services and supports] are direct care workers, including nursing aides, home health aides, and home- or personal-care aides. This workforce benefits substantially from training in how to manage behavioral symptoms related to dementia. Inadequate training for dementia in the direct care workforce has been identified as a main contributor to poor quality of care, abuse, and neglect in nursing homes. Another significant gap in the LTSS workforce stems from the growing imbalance between the demand for—and supply of—qualified paid workers. This shortage results from high turnover and difficulty attracting qualified workers. Shortfalls in this workforce are often filled via the “gray market,” meaning that untrained, low-cost caregivers are hired, leaving older adults vulnerable to poor or unregulated quality of care. … As one indicator of the greater need for formal care among persons with dementia, 48.5 percent of nursing home residents and 30.1 percent of home health patients in 2012 had dementia. … The Alzheimer’s Association has estimated that the average per-person Medicaid spending for Medicare beneficiaries age 65 and older with dementia is 19 times higher than the average per-person Medicaid spending for comparable Medicare beneficiaries without dementia. …

Demographic trends suggest that the current heavy reliance on family caregiving is unsustainable. As the median age of the U.S. population, including baby boomers, trends upward, there will be a growing imbalance between the number of people needing care and family caregivers available to deliver it. To illustrate, the AARP Public Policy Institute estimates that the ratio of caregivers aged 45–64 to each person aged 80 and older who needs LTSS will decline from 7:1 in 2010 to less than 3:1 in 2050. … In addition, life expectancies have increased so that it is possible for two generations within one family to be living with dementia at the same time.

The report has lots of worthy and sensible recommendations focused on improving the quality of care for dementia: more outreach and education for the public and caregivers on recognizing symptoms of dementia; access to training and perhaps also some financial support for informal caregivers; better training, pay and coordination for formal caregivers; expanding home and community-based services where possible, and coordinating these with each other and with institutional care as needed; and more research into possibilities for prevention and treatment.

But this report ducks the hard question of costs. The report has some short comments about encouraging more long-term care insurance, whether through linkages to current health insurance, or through public/private partnerships of some kind, or through a national single-payer system. But the hard fact here is that the costs of dementia care–again, which is already the single most expensive medical condition–are going to grow very rapidly in the next few decades. Many elderly persons and going to face crushing financial costs, and their families are going to face costs of both money and time. I suspect that the demands for government financial and regulatory interventions in the area of long-term care for those with dementia are going to become very powerful. It\’s high time to start thinking about what policy options make more sense that others.

The canonical source for data on flows of foreign direct investment are the reports from the United Nations Conference on Trade and Development, more commonly known as UNCTAD. It\’s World Investment Report 2015 provides a discussion of trends up through last year.

To interpret these patterns, it\’s important to remember how foreign direct investment, or FDI, differs from \”portfolio investment.\” Portfolio investment involves foreign investment that do not involve any kind of management voice. Thus, buying debt issued in another country is counted as portfolio investment, as is buying a mutual fund of stocks of firms from another country. By contrast, UNCTAD defines foreign direct investment in this way:

FDI refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in cases of FDI, the investor´s purpose is to gain an effective voice in the management of the enterprise. … Some degree of equity ownership is almost always considered to be associated with an effective voice in the management of an enterprise; the BPM5 [Balance of Payments Manual: Fifth Edition] suggests a threshold of 10 per cent of equity ownership to qualify an investor as a foreign direct investor.

Thus, FDI matters not just because of the financial size of the flows, but also because it often involves a transfers of managerial or technological expertise, or a commercial buying-or-selling connection. FDI can often be part of global value chain connections across the world economy.

FDI inflows to developed economies have been quite volatile over the past two decades. In contrast, inflows to developing economies have risen much more steadily–and indeed, inflows of FDI to developing countries were more than half of global FDI inflows in 2014.

What are the economies receiving the lion\’s share of these FDI inflows? For those who think of China\’s economy as largely closed to outside investment, it\’s interesting that China and Hong Kong are at the top for size of FDI inflows in 2014. The US, the UK, and Canada also rank highly, in part because of how these economies often see FDI investments back and forth among their borders.

What about outflows of FDI? Here, the story is that the share of FDI outflows from developing economies has been rising, both as an overall amount and as a proportion of the total, and now constitutes about one-third of all FDI outflows.

What countries mainly account for FDI outflows? It\’s perhaps no surprise to see the US, China, and Hong Kong near the top of the list. However, developed economies like Japan, Germany, Canada, and France play a substantial role in outflows of FDI, too.

It\’s clear that the first Labor Day celebration was held on Tuesday, September 5, 1882, and organized by the Central Labor Union, an early trade union organization operating in the greater New York City area in the 1880s. By the early 1890s, more than 20 states had adopted the holiday. On June 28, 1894, President Grover Cleveland signed into law: \’\’The first Monday of September in each year, being the day celebrated and known as Labor\’s Holiday, is hereby made a legal public holiday, to all intents and purposes, in the same manner as Christmas, the first day of January, the twenty-second day of February, the thirtieth day of May, and the fourth day of July are now made by law public holidays.\” (Note: This post has been reprinted on this blog on Labor Day since 2011.)

Five years ago in September 2010, the Economist magazine ran a lengthy article titled: \”A Latin American decade? The reformers have won, but they have yet to consolidate their success.\” Now, the September 2015 issue of Finance & Development (published by the IMF) has a seven-paper symposium titled \”Latin America: Finding its Footing. The tone of the discussion is about \”the many challenges facing the region today\” and how to go about \”avoiding a prolonged slowdown.\”  What\’s happening in that region?

The lead essay by José Antonio Ocampo sets the stage: \”But this positive picture has changed dramatically. Growth per capita ground to a halt in 2014 and much of the region is again viewed with a sense of forgone promise. … In contrast to the halcyon decade that ended in 2013, the recent economic performance of Latin America has been poor. Growth fell sharply in 2014 to just 1.1 percent—barely above the region’s current low population growth of 1.0 percent—and will continue at a similar or even lower rate in 2015 … Investment also declined in 2014, and will continue to do
so in 2015. Poverty ratios have stagnated at 2012 levels … and, although no hard data are yet available, this seems also true of income distribution.\”

Here\’s a figure showing annual growth rates of GDP for the region. Notice that from the 1950s through 1970s, annual growth of GDP tended to be in the range of 4-7% per year, with some exceptions. During what\’s called in Latin America the \”lost decade\” of the 1980, annual growth rates were more likely to be in the range of 0-2%. and sometimes negative for the region as a whole. Growth rates of GDP rebounded around 2004, but now seem to be sagging again.

Ocampo explains the underlying factors:

\”The change in Latin America’s fortunes results in large part from a reversal of the benevolent external conditions that fostered the boom. The excellent performance from 2004 until the middle of 2008 reflected the extraordinary coincidence of four positive external factors: rapid growth of international trade, booming commodity prices, ample access to external financing, and migration opportunities and the burgeoning remittances that migrants sent home.Two of these positive factors—migration opportunities and rapid world trade expansion—have disappeared, probably permanently, as a result of the financial crisis in advanced economies. Migration opportunities to the United States are more limited than before the crisis, and high unemployment in Spain has prompted many South American migrants to return home. Remittances, which help prop up demand in recipient countries, have recovered but are still below the 2008 peak. Likewise, world trade experienced the worst peacetime contraction in history after the September 2008 collapse of the Wall Street investment firm Lehman Brothers. Although trade swiftly recovered, since 2011 it has settled in at a slow rate of growth. … [R]eal commodity prices have followed long-term cycles since the late 19th century. If this continues to be the pattern, the world is at the beginning of a long period of weakening commodity prices.

\”Therefore, of the four conditions that fed the 2004 to mid-2008 boom, only one remains in place: good access to external financing.  …  Annual bond issues by Latin America have almost tripled— to $9.6 billion a month in 2010–14 compared with $3.5 billion in 2004–07—and the costs of financing have remained low for countries that issued bonds in international private capital markets. …  Global financial conditions may, of course, change given new uncertainties surrounding the euro area in the face of the Greek crisis or if a reversal of U.S. monetary policy draws away investment funds from the region. But at the time of writing, Latin America’s access to global capital markets remained favorable.\” 

This explanation seems sensible to me, but it contains a disagreeable underlying message: both Latin America\’s growth after about 2004 and its slowdown in the last few years were mostly about external factors. What steps should Latin America itself be taking so that at least over the long-run (setting aside inevitable short-run fluctuations)  it can do more to shape its own economic future and raise the standard of living? Here, the policy agenda seems less clear-cut to me, in the sense that there are lots of goals, but it\’s less clear what the practical steps and top priorities should be. For example, Ocampo says in the course of a few paragraphs that all Latin America needs is new methods of production, new technology, new trade patterns, lower and less volatile exchange rates, and better education and infrastructure.

\”It is essential, then, that the region invest in diversifying its production structure and place technological change at the center of long-term development strategies. This should include not only reindustrialization but, equally important, the upgrading of natural-resource-production technology and the development of modern services. Diversifying trade with China away from commodities is another essential element of this policy. … The best way to exploit richer domestic markets is through regional integration. But this requires, in turn, overcoming the significant political divisions that have blocked the advance of regional integration over the past decade. … In macroeconomic terms, the most important condition for more dynamic production diversification is more competitive and less volatile real exchange rates. … The region also needs to make major advances in two other areas: the quality of education and infrastructure investment.\”

Other papers in the symposium focus in on specific elements.  For example, Daniel Kaufmann writes on \”Corruption Matters.\” His research looks at difference measures of governance across countries. For Latin America as a whole he writes \”that on average, government effectiveness, control of corruption, and voice and accountability stagnated in the region, and overall regulatory quality and rule of law deteriorated. At the end of 2013, Latin America’s governance quality trailed that of other predominantly middle-income regions, such as central and eastern Europe …Similarly, except in voice and accountability (a relative strength of Latin America), east Asia, with its focus on a long-term strategy and independent merit-based bureaucracies, surpassed Latin America on many governance dimensions, including government effectiveness, rule of law, and corruption control. …
Latin America’s average score is below the world median in all governance indicators except voice and accountability, which barely tops the median. It rates particularly poorly on (implementation of) rule of law. And on personal security and common crime, the region is at the very bottom.\”

As another example, Augusto de la Torre, Daniel Lederman, and Samuel Pienknagura offer a more detailed trade agenda for Latin America in \”Doing It Right,\” suggesting that the goal for Latin America shouldn\’t just be more trade within the region, but greater connection with the global value chains of production:

We found that once endemic structural factors-such as geography, economic size, and natural resource abundance-are taken into account, Latin America fares relatively well compared with east Asia merely in terms of intraregional trade volume and connectivity among regional trade partners. Where Latin America differs markedly from east Asia is in those key features of trade-intra-industry trade and participation in global value chains. This suggests that policies aimed at simply boosting intraregional trade connections and volumes in Latin America are unlikely to do much to boost growth. Latin American authorities should design policies that favor a more vigorous participation in intra-industry trade and in global value chains.

Nora Lustig points out in \”Most Unequal on Earth\” that the distribution of income in Latin America remains more unequal than in other regions, despite some modest progress in the last few years. Lustig offers two main causes for the decline in inequality. One is a rise in \”conditional cash transfers,\” but by her calculations this accounts for only about 20% of the reduction in inequality. The bigger changes, she argues, is that improvements in education have tended to lead to reduction in the supply of workers with less education–and thus boosted the wages of this group.

More equal distribution of labor earnings among wage earners and the self-employed is the most important factor, accounting for 60 percent of the region’s decline in inequality. This is because wages of workers with very little education rose faster than those of more educated workers, especially those with tertiary—college or other postsecondary—education. …Government transfers have increased in size and are better targeted to the poor. Almost every country in the region runs a flagship cash transfer program that requires families to keep their children in school and receive regular health checkups as a condition for benefits. … Since they were first implemented in Brazil and Mexico in the second half of the 1990s, conditional cash transfers have constituted one of the most important innovations in social policy to benefit the poor. Today, about 27 million households in the region—most of them poor—are beneficiaries of so-called conditional cash transfers. In addition to improving the living standards of the poor, cash transfers have helped improve the health, education, and nutrition of children living in poverty and therefore carry the promise of better employment opportunities in the future. … 

There is a lot of useful information about recent developments in the economies of Latin America in this issue of F&D, but less about long-run perspective.  Ernesto Talvi offers some perspective in an essay on \”Latin America\’s Decade of Development-less Growth\” that appeared as a chapter of a report written for a meeting of the G-20 (a group of leaders from the largest world economies) in November 2014. Talvi points out that over time, per capita GDP in Latin America relative to the US level rose a bit from the 1950s to the 1970s, fell in the 1980s and 1990s, and how has rebounded a bit. Thus, there is a lack of catch-up convergence over the last six decades

Talvi\’s view (similar to Ocampo) is that Latin America\’s growth after about 2004 was mainly from external forces, but he draws a more discouraging lesson: that Latin America has largely not made progress in the internal factors that should be the basis for its own organic economic development. Here\’s Talvi: 

\”Latin America had a decade of uninterrupted high growth rates—with the sole exception of 2009 in the aftermath of the Lehman crisis—that put an end to a quarter of a century of relative decline in income per capita levels vis-à-vis advanced economies. However, high growth and income convergence were largely the result of an unusually favorable external environment, rather than the result of convergence to advanced country levels in the key drivers of growth. Moreover, income convergence was not associated either with a comparable convergence in key indicators of development. Fundamentally, the last was a decade of “development- less growth” in Latin America.\”

For illustration, Talvi offers some graphs. In these two figures, the blue lines are all set to 100, showing the level in 2004. The green bars then show a comparable level in 2013. In each figure, the first two bars sh ow the rise in income levels from 2004 to 2013,. The point is that on many other important measures for long run economic health, Latin America has not seen similar growth: that is, not on  measures of human capital, infrastructure, public services, trade integration, innovation, equality of opportunity by income, environmental protection, gender equity, or personal security.

My own experience is that in discussions of economic reform in Latin America, there often seems to be a reflexive need for speakers to dissociate themselves from any suggestion that they favor market-oriented reform or capitalism. Of course, the history of Latin America in the last century is  full of populist political leaders who argued that the the problems and inequalities of society and the economy were due to big business and capitalists. The actual policies of most of these populist leaders, once in office, mostly tended to reinforce the pre-existing inequalities. However, the political strategy of  perpetually blaming free markets and capitalism often seems to keep working in Latin American politics and society, even while the actual governments operate in a way that is quite far from what a US-based economist would think of as a freer-market agenda. From my outsider perspective, many governments in Latin America practice policies of government planning and interventionism, along with favoritism for politically well-connected large corporations, and then blame free markets for the result.

These arguments took on a new edge a few decades ago. Those who tend to downplay market reforms look back at the long-run history of the Latin American region and argue that there approach was going pretty well from the 1950s through the 1970s–as shown by the convergence at that time–and that a wave of market-oriented reforms are mostly to blame for the relative decline in Latin America\’s economies in the 1980s and 1990s. The other side points out that the convergence in per capita incomes from the the 1950s to the 1970s wasn\’t all that large, and argue that it was  driven by a series of unsustainable government policies that crashed and burned in the 1980s, leading to a need for market-oriented reforms in the 1990s. They argue that in Latin America, market-oriented reforms have worked pretty well in the countries that gave them a try, even though they have had to fight the tide of economic populism.

About 10 years ago,we offered a pro-and-con example of this dispute in the Spring 2004 issue of Journal of Economic Perspectives (where I work as Managing Editor).  José Antonio Ocampo made the case that market-oriented reforms had not much helped in Latin America in \”Latin America\’s Growth and Equity Frustrations During Structural Reforms.\” On the other side, Arminio Fraga argued that the market-oriented reforms had started working and needed to be strengthened in \”Latin America since the 1990s: Rising from the Sickbed?\” 

An interview of Campbell Harvey by David A. Price appears in Econ Focus, published by the Federal Reserve Bank of Richmond (2015 First Quarter, pp. 26-30). Here are some comments that especially caught my eye, but the rest of the interview contains many additional nuggets like Harvey\’s comments on Bitcoin, a countercyclical risk premium, CEO overconfidence, and why people keep buying actively managed investment funds although they don\’t seem to beat the market on average.

Concerning the differences between doing work in practical finance inside a company and doing academic finance

To be published in academic finance or economics, the idea must be unique; it\’s the same in the practice of finance — you\’re looking to do something that your competitors haven\’t thought of.

There are differences, though. The actual problems that are worked on by practitioners are more applied than the general problems we work on in financial economics.

The second difference is that in academic financial economics, you have the luxury of presenting your paper to colleagues from all over the world. You get feedback, which is really useful. And then you send it in for review and you get even more feedback. In business, it\’s different; you cannot share trade secrets. You really have to lean on your company colleagues for feedback.

The third thing that\’s different is access to data for empirical finance. When I was a doctoral student, academia had the best data. For years after that, the pioneering academic research in empirical finance relied on having this leading-edge data. That is no longer the case. The best data available today is unaffordable for any academic institution. It is incredibly expensive and that\’s a serious limitation in terms of what we can do in our research. Sometimes you see collaborations with companies that allow the academic researchers to access to data that they can\’t afford to buy. Of course, this induces other issues such as conflicts of interest. … 

The fourth difference is the assistance that\’s available. Somebody in academia might work on a paper for months with a research assistant who might be able to offer five to 10 hours per week. In the practice of management, you give the task to a junior researcher and he or she will work around the clock until the task is completed. What takes months in academic research could be just a few days.

The fifth difference is computing power. Academics once had the best computing power. We have access to supercomputing arrays, but those resources are difficult to access. In the practice of management, companies have massive computer power available at their fingertips. For certain types of studies, those using higher frequency data, companies have a considerable advantage.

Concerning some major open questions in finance

One is how you measure the cost of capital. We had the capital asset pricing model in 1964, but the research showed very weak support for it. We have many new models, but we are still not sure. That\’s on the investment side. On the corporate finance side, it would certainly be nice to know what the optimal leverage for a firm should be. We still do not know that. In banking, is it appropriate that banks have vastly more leverage than regular corporations? Again, we need a model for that. Hopefully these research advances are forthcoming. Some people have made progress, but we just don\’t know.

Concerning the importance of looking for big research ideas

One thing that was pretty important for me in my development was an office visit with Eugene Fama, my dissertation adviser, where I had a couple of ideas to pitch for a dissertation. I pitched the first idea, and he barely looked up from whatever paper he was reading and shook his head, saying, \”That\’s a small idea. I wouldn\’t pursue it.\” Then I hit him with the second idea, which I thought was way better than the first one. And he kind of looked up and said, \”Ehh, it\’s OK. It\’s an OK idea.\” He added, \”Maybe you can get a publication out of it, but not in a top journal.\” He indicated I should come back when I had another. Even though he had shot down both of my ideas, I left feeling energized. The message from him was that I had a chance of hitting a big idea. That interaction, which I am sure he doesn\’t remember, was very influential — it pushed me to search for big ideas and not settle on the small ones.

When describing the benefits of learning economics to often-skeptical listeners, I often quote Joan Robinson (in the 1978 book Contributions to Modern Economics, p. 75): \”The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.\”

After all, if you don\’t know any economics, you are likely at some point to find yourself in a discussion of policy or social issues where at some point the other person says: \”Well, even a basic knowledge of economics will tell you that my view is correct.\” That person may be totally wrong; in my experience, that person is often totally wrong. But if you don\’t know any economics, you have no easy way to refute this claim about what \”economics\” implies.

David Colander makes a similar point more thoroughly in his \”Economics with Attitude\” column in the Fall 2015 issue of the Eastern Economic Journal, \”Economic Theory Has Nothing to Say about Policy(and Principles Textbooks Should Tell Students That)\” (41: pp. 461-465). He begins his way:

Let me start with a quiz: 

● Question 1: According to economic theory, whenever possible government should avoid tariffs.
● Question 2: According to economic theory, the minimum wage lowers the welfare of society.
● Question 3: According to economic theory, if there are no externalities, the market is the preferable way of allocating resources. 

The correct answer to each of these questions is false; economic theory, on its own, has nothing to say about policy.

Colander distinguishes between theorems and precepts, and discuses how the pedagogical emphasis has shifted between these over time. Theorems are results derived from models and assumptions. \”Precepts are based on the insights coming from models, combined with educated judgments about all relevant aspects of the decisions that the model assumes away for tractability reasons. These include moral judgments, historical knowledge, and institutional understanding. Precepts are the realm of economic statesmen, not economic scientists.\” With this distinction in mind, Colander writes:

 All students coming out of a principles course should know that before one can make a meaningful judgment about policy, there is a lot of history, moral philosophy, and additional peripheral knowledge that is needed to move from theory to policy. Even if we don’t teach the nuance, we can teach the need for nuance in policy discussion. Every beginning economics student should know that economic theorems are not enough to arrive at policy conclusion.

Colander has been contributing short, lively essays at the start of each issue for the EEJ, and the essays are freely available at least for a time. Earlier essays in 2015 include his remembrances of Gordon Tullock. an argument that there is too much intellectual in-breeding (that is, cross-hiring) at Harvard and MIT, and a critique of the overly enthusiastic reaction to Thomas Piketty\’s Capital in the 21st Century.