economics

This is an interesting press release: 

In response to the policy challenges presented by the economic crisis and the need to develop fresh approaches to economic theory, a group of top academics, policy-makers, and private sector leaders today announced the creation of the Institute for New Economic Thinking (INET)....

The Institute was established with a pledge of $5 million per year for 10 years from Open Society Institute Chairman George Soros, a long-time critic of classical economic theory, who will fund the effort through the Central European University (CEU).

The Institute will make research grants, convene symposia, and establish a journal. A first conference will be at King's College, Cambridge on April 9-11. Scholars will explore the implications of the financial crisis for regulatory policy. The first round of research grants will be made before the end of the year to cutting-edge scholars working with leading universities around the world. INET’s Executive Director will be Robert Johnson, an economist with long experience in government, academia, and the private sector....

Speaking in Budapest at the CEU, through which INET will be funded and which will be a hub of the INET network, Soros said, “The entire edifice of global financial markets has been erected on the false premise that markets can be left to their own devices, we must find a new paradigm and rebuild from the ground up. I decided to sponsor INET to facilitate the process. I hope others will join me.” Because he is both an INET benefactor and proponent of a particular theory, Reflexivity, Soros will recuse himself from the grant-making process.  “While I hope reflexivity will be one of the concepts examined, there are numerous alternatives to the prevailing dogma that must be explored.” Soros added. 

Based on his track record, Soros is not very good at influencing political movements, but he is quite good at influencing the world of ideas.  So, it's quite possible that this new institute will wean economists from the neoclassical paradigm. 

Over at Newsweek, Michael Hirsch certainly thinks this is important: 

It might be tempting to dismiss all this as a war of words among brainiacs. It's not. The critical issues being discussed in Washington about the future regulation and control of the financial industry—the very nature of Wall Street and the health of the economy—depend on this battle of ideas. What led to wholesale deregulation in the '90s and '00s wasn't just Wall Street lobbying money. It was also that key legislators and policymakers, among them Larry Summers, persuaded themselves that deregulation was sound economics and good policy, and that markets and Wall Street institutions could take care of themselves. Many of those views have been discredited by the crisis. But in the absence of a new paradigm of economics, confusion still reigns in Washington. With no new concept of the proper role of government and regulation in the economy, of the proper balance between the markets and their minders, the old school still dominates.

Similarly, Veronique de Rugy is freaked out by this Soros initiative, which suggests it might actually matter.   

I think Hirsch is correct about the persistence of market-friendly ideas contained in Washington Consensus.  Let's call this the zombie Washington Consensus, because it keeps moving on even after suffering politically fatal blows. 

That said, real shifts in ideas only take place when one dominant idea is replaced by another dominant idea that has both intellectual and political cachet.  Looking at Soros' Board of Advisors, I'm not sure there is a consensus about what paradigm should replace a free market approach. 

Hopefully, this institute will lead to a mess of heterodox work that forces everyone to bring their "A" game to the problems at hand -- includind free market enthusiasts.  The worst-case scenario is that George Soros is funding the economic equivalent of Ross Perot's Reform Party.    

Developing....

Everyone and their mother is linking to this Calvin Trillin op-ed from a few days ago, in which a martini-swilling guy "in a sparsely populated Midtown bar" volunteers his explanation to Trillin of why the financial crisis took place:  "The financial system nearly collapsed because smart guys had started working on Wall Street." 

OK, I'll take the bait... I find this to be a pretty stupid argument. 

The alleged nub of the argument is what happened when the smart guys started displacing the schleps who used to be traders on Wall Street:

"When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness."

“So having smart guys there almost caused Wall Street to collapse.”

“You got it,” he said. “It took you awhile, but you got it.”

The theory sounded too simple to be true, but right offhand I couldn’t find any flaws in it. I found myself contemplating the sort of havoc a horde of smart guys could wreak in other industries. I saw those industries falling one by one, done in by superior intelligence. “I think I need a drink,” I said.

This has led to many nodding heads in the blogosphere about how smart people can be so dumb and greedy, etc. 

Except that, if one takes Trillin's tale at face value, the problem isn't the smart guys -- it's the fact that the dumb guys are supervising the smart guys.  They're no less greedy than the smart guys... just less intelligent.  Even if one takes Trillin's model as sound, it's the combination of smart and stupid that's the problem. 

Now, there are two directions one can go from that conclusion.  One could fire the smart guys so the dumb guys don't get put in that position ever again... or one could hire smart guys for both management and operations. 

You make the call. 

My latest column for The National Interest Online is now available.  It takes a longer look at the implications of Obama's tire tariff decision.  The more I look at this move, the more freaked out I get.  I think I've figured out the precise contours of Obama's trade strategy -- and trade plays a very small role: 

With Obama... this dip in the protectionism pool feels like the beginning of something much greater. Many Democrats feel warm and fluffy about protectionism, as a mechanism to improve labor standards or an ironclad guarantor of union jobs. This love affair isn’t going to stop. Thea Lee, the chief economist of the AFL-CIO, told the New York Times that “the trade decision was the president’s first down payment on his promise to more effectively enforce trade laws, and it’s very much appreciated.” Unions are already demanding additional action against Chinese steel....

All presidential administrations engage in protectionism—it’s often the cost of pushing through other forms of trade liberalization. While the previous two administrations engaged in these kinds of actions, they could proudly point to ambitious agendas of trade liberalization as well. The Clinton administration sought to add contentious labor and environmental side agreements to its trade deals—but Clinton also spent political capital to get NAFTA and the Uruguay round through Congress. Bush imposed the steel tariffs—but his administration also secured the passage of (now expired) trade promotion authority, launched the Doha round, and completed major trade agreements with Australia and Central America. President Bush also rejected this action against Chinese tires on four separate occasions.

Barack Obama has no record of trade liberalization to fall back on when defending this measure. Indeed, this is the first major trade action his administration has taken. Based on the political reporting of this trade action, it seems clear that Obama will use trade policy as a sop to his base in order to keep them behind his major policy initiatives on health care, financial regulation, and environmental protection.

Obama has largely decided to become a domestic-policy president. His supporters, his base and the politicking of his underlings indicate things will only get worse. With the global economy in deep crisis, protectionism is a terrible way to build a recovery.

Go read the whole thing. 

To put it gently, international macroeconomic policy coordination has not had a glorious history over the past century.  Usually, the domestic political and economic costs were large enough to impede most efforts to coordinate.  Sham coordination was far more common than genuine coordination. 

Most successes in global policy coordination occurred when two of the following three conditions held.  First, when there was a state powerful enough to go it alone, coordination was usually a matter of the hegemon unilaterally providing the necessary public goods to facilitate coordination (see:  Marshall Plan, Dodge Line).  Second, when countries were being asked to take actions that boosted their domestic economies, they were willing to coordinate policy.  Contractionary fiscal or monetary policies have proven to be far more difficult to coordinate than expansionary actions.  Third, policymakers needed to be right on the economics.  Agreements to coordinate on an unsustainable set of policy prescriptions - such as the interwar gold exchange standard, Bretton Woods, or the Growth and Stability Pact - had a short half-life. 

Now, to give the G-20 some credit, this current crisis has led to greater levels of coordination than in the past -- and more than I expected.  This might be a function of policy learning from the debacles of the interwar period.  But it could also the fact that, to date, governments have been asked to pursue expansionary policies.  Each country was going to do something like what they are doing anyway -- the G-20 just acted as a useful focal point to cajole some of the more reluctant countries. 

What happens when it's time to clamp down?  Australian PM Kevin Rudd and South Korean President Lee Myung-bak proffer some recommendations in the Financial Times for the hard part of macroeconomic policy coordination: 

At Pittsburgh, G20 leaders should agree to a three-stage process. First, national governments should develop their own national strategies for recovery. Second, they should agree to deliver these strategies to the International Monetary Fund before the end of the year and ask the IMF to report back on their consistency with balanced and sustained global growth. Third, G20 leaders should meet again in 2010 (when South Korea is the chair of the G20) to agree their responsibilities and actions to achieve this goal within the framework of post-crisis global economic management. 

Steps one and two make a great deal of sense, and even have a good chance of being implemented.  The wording of step three is a bit vague, for it to mean anything it boils down to, "make everyone scales back on priming the pump in a coordinated manner." 

If that actually happens, well, tip your cap to the G-20, because the G-7 -- a much more homogenous group of countries -- never succeeded at that task. 

Question to readers:  does the G-20 have a chance in hell of succeeding in their next task? 

When your agency is less popular than the federal institutions responsible for torture enhanced interrogation techniques, tax audits, and the requirement that you take your shoes off at the airport, you know you have a public image problem. 

So I wonder if the following news will help or hurt the Fed: 

The Federal Reserve has made a $14bn profit on loan programmes that have provided hundreds of billions of dollars in liquidity to the financial system since the start of the crisis two years ago, according to Fed officials.

The internal estimate is based on the difference between the fees and interest on the lending facilities and the interest the Fed would have earned had it invested the funds in three-month Treasury bills.

The central bank earned about $19bn in income from charging interest and fees to financial institutions and investors that tapped the new facilities to obtain much-needed funds during the turmoil. The interest the Fed would have earned by investing the same amount in T-bills was an estimated $5bn, leaving a $14bn gain since August 2007....

The calculation by Fed staff, which has neither been audited, published or risk-adjusted, only deals with its liquidity facilities.

Those include discount window and Term Auction Facility loans to banks, currency swaps with other central banks, purchases of commercial paper and financing for investors in asset-backed securities.

If I'm reading this right, this assessment does not include the Troubled Assets Relief Program (TARP).  According to Daniel Gross, however, it seems like TARP will at least break even.   

The spreadsheets at financialstability.gov document the status of the 667 investments, worth $204.4 billion, made under the CPP. Morgan Stanley, which borrowed $10 billion in October 2008, paid back the cash in June and purchased the warrants for $950 million on Aug. 12, giving taxpayers a 12.7 percent return, according to SNL Financial. For the 22 companies that have bought back shares and warrants, the taxpayer received an annualized return of 17.5 percent—better than most hedge funds have done lately. (Another 15 have repaid part or all of the principal.) Since many of the largest financial institutions have left the program, the 37 "exits" represent 34 percent of the total cash initially disbursed. The bottom line: taxpayers have received $70.3 billion in principal, plus about $10 billion in dividends and warrant payments....

Investors have seen other returns. Since the Treasury Department in July converted the $25 billion CPP loan to Citi into common stock, at $3.25 a share, the U.S. taxpayer now holds 7.69 billion shares of the once mighty bank. As of Aug. 26, thanks to the rallying market, taxpayers were sitting on a $10.52 billion paper gain....

Given the results of the central-bank bailout thus far, Herb Allison, the former TIAA-CREF CEO who was tapped to run TARP, notes that "it's quite possible we'll have a positive return on the CPP program as a whole."

Regardless, the CPP —combined with all the other stabilization efforts—has become less of a political and financial liability than it was last fall. In late August, the Office of Management and Budget said the lower-than-expected cost of bailing out the financial system—including the money paid back from the CPP—meant the 2009 fiscal deficit would be $1.58 trillion, $262 billion less than the prior estimate of $1.84 trillion. Lee Sachs, counselor to the Treasury secretary, invokes the MasterCard ad in weighing the true yield. "Dividends: 5 percent; equity warrants: 2 percent. Financial system not going into total abyss: priceless."

In essence, the U.S. Federal Reserve has acted like the Mother of All Sovereign Wealth Funds for the past two years.  It placed a huge bet that most financial assets were being radically undervalued during the Great Panic last fall.  That bet appears to have paid off handsomely.  Oh, and the complete and utter collapse of the financial system was averted. 

Ben Bernanke has some significant political skills, and one would expect him to be able to put the best possible spin on this kind of news. 

Still, I wonder if it will do him any good.  When you have a 30% approval rating, it's pretty easy for the other 70% to concoct stories that take good news and turn it into a narrative of evil. 

In this case, I can easily imagine Bernanke's opponents combining this news with rumors about the Plunge Protection Team, nostalgia for the gold standard, a jeremiad by William Greider, and the belief that if the Fed made a profit that means it must have screwed the old, the poor and minorities out of their hard-earned money.  Mix together well, and I think you have a story that would make Fed-haters feel quite comfortable in their convictions.

Readers are encouraged to proffer their narrative for why Ben Bernanke is evil despite apparent policy successes in the comments.  The more outlandish, the better -- I want to be ahead of Glenn Beck and Keith Olbermann on this one. 

In the New York Times, Alexei Barrionuevo has a long story on Brazil's renewed oil nationalism.  Some highlights: 

Faced with the world’s most important oil discovery in years, the Brazilian government is seeking to step back from more than a decade of close cooperation with foreign oil companies and more directly control the extraction itself.

The move is part of a nationalistic drive to increase the country’s benefits from its natural resources and cement its position as a global power. But it could significantly slow the development of the oil fields at a time when the world is looking for new sources, energy and risk analysts said....

For Brazil, the stakes are high. Many here see the oil as a magic bullet for tackling the country’s biggest social challenges. Luiz Inacio Lula da Silva, Brazil’s popular president, wants to alter energy laws to funnel more revenue from the undeveloped fields to government coffers and set up funds to improve education and health care. His proposal will be delivered to Congress sometime next week, one of his aides said Monday.

Despite its recent economic boom, Brazil still struggles with extreme poverty, inequality and an illiteracy rate over 10 percent.

Government officials here insist Brazil will not be swept up in the sort of nationalistic fervor that has washed across Latin America in recent years. As Mexico did in the late 1930s, Venezuela, Bolivia and Ecuador have reduced the presence of foreign energy companies, only to have their production of oil and natural gas stagnate or decline....

With Brazil’s green and yellow flag draped over the stage, oil union members watched a new documentary here last month, “The Oil Must be Ours — Ultimate Frontier.” In the film, geologists, union leaders and even a 92-year-old physician, Maria Augusta Tibiriçá, discuss how the new fields could generate “trillions of dollars” and transform Brazil’s future.

A dozen union members led off the evening with a rendition of Brazil’s national anthem, then “It Will Happen,” a song written for the movie that blends bossa nova and samba rhythms.

If oil “is very deep under the sea,” they sang, “will we play to win?”

The new nationalistic fervor recalls the 1970s and 1980s, when Brazil’s military government declared that “the Amazon is ours” to ward off foreign encroachments on the rain forest. 

Hmmm..... it is certainly possible that Brazil can avoid the Bolivarian conundrum.  Many national oil companies (NOCs) are as well-run as private oil companies and with strong anti-corruption controls.  

Those NOCs are the exception rather than the rule, however -- and the history of Brazilian governance does not fill me with confidence (the fact that Lula's choice to succeed him is also "the chairwoman of the Petrobas board of directors" could cut both ways as well).

The use of nationalism to gin up support for this strategy is also worrisome.  Nationalism is a powerful force, and to be fair to Lula, there's no evidence that he's whipping up nationalist fervor to support aggressive foreign policy actions.  In my experience, however, nationalism provides excellent political cover for all kinds of institutional and economic chicanery.  Which means that the odds of the best-laid intentions going awry in this oil project seem pretty damn high to me. 

Developing......

Nouriel Roubini provides a rundown of the national economies that have weathered the Great Recession pretty well: 

All economies have been affected by the crisis, but a combination of policy responses and strong fundamentals has given some countries, especially some emerging market economies, a relative edge. These same strengths could lead the countries I highlight below to perform better as the global recovery begins, even if their growth rates remain well below 2003-07 trends.

What do these countries have in common? One major theme is that they tended to have lower financial vulnerabilities due to more restrictive regulation and less developed financial markets, as well as larger and stronger domestic markets that sustained domestic demand. Moreover, they had the resources to engage in countercyclical fiscal and monetary policies, actions that were not possible in past crises.

With one exception, there's one other common denominator to the countries on Roubini's list -- none of them are big enough to act as a "locomotive" to power the rest of the global economy out of recession. 

The obvious exception is China, but I have serious doubts about the sustainability of their fiscal and monetary expansion.  As Roubini acknowledges, there's a lot of "asset bubbles, overcapacity and nonperforming loans" going on across the Pacific. 

So I'm a bit worried that the lessons drawn from these countries contain a mixture of good (prudent macroeconomic policies) and bad (greater levels of autarky) if implemented by a larger swath of economies.  And I'm not sure the good outweighs the bad on a global level.

 Am I missing anything? 

Here I am this morning, furiously trying to avoid online distractions and Red Sox news at the breakfast table, when I stumble upon this Eric Zencey op-ed in the New York Times.  Sure enough, the content of this op-ed is rich enough in stupidity that I have no choice but to spit out my coffee and declare, "to the Blogcave!" 

Zencey's basic argument is about the use of gross domestic product as a metric for economic well-being.  He points out that because GDP measures only economic activity, it misses out on a lot:  volunteer activities, nature, etc.  Furthermore, GDP overstates the benefit of reconstruction efforts -- like, say, post-Katrina spending -- because GDP counts it as new economic activity rather than salvaging pre-existing assets. 

So far, so good -- anyone who takes an Econ 101 class is told this immediately after they are introduced to the concept of GDP. 

The problem with the op-ed is two-fold.  First, the NYT editor was apparently asleep at the wheel, because otherwise sentences like this do not ever see the light of day: 

In general, the replacement of natural-capital services (like sun-drying clothes, or the propagation of fish, or flood control and water purification) with built-capital services (like those from a clothes dryer, or an industrial fish farm, or from levees, dams and treatment plants) is a bad trade — built capital is costly, doesn’t maintain itself, and in many cases provides an inferior, less-certain service.

Why, yes, I look back with nostalgia when the natural-capital provision of flood-control services was in its heyday.  I believe it was called "flooding."  Ah... good times.  The modern-day system is definitely an inferior product.

This is a venal sin in the op-ed, a case of an editor not helping out his writer.  Now we get to the mortal sin.  Here's Zencey's core argument for why we should discard the idea of GDP: 

Wise decisions depend on accurate assessments of the costs and benefits of different courses of action. If we don’t count ecosystem services as a benefit in our basic measure of well-being, their loss can’t be counted as a cost — and then economic decision-making can’t help but lead us to undesirable and perversely un-economic outcomes.

OK, that's an interesting argument.  And I would be persuaded to take it seriously if the op-ed provided a single data point to back up that assertion. 

Instead, we get.... nothing.  Nada.  Zilch.  No evidence is provided whatsoever that reliance upon standard GDP measures has distorted U.S. economic policies.   

Someone needs to sit the op-ed team at the New York Times down and explain to them the concept of "opportunity cost."  Because the cost of publishing this unedited dreck instead of something more interesting was pretty big.