29 December 2009

Trust and Climate Change

Niranjan Rajadhyaksha has a good piece in the Mint on the reasons why Copenhagen failed to deliver, taking up a fitting example of the water crisis in Mumbai and how difficult it is to cooperate even within his housing society on ensuring rules, despite the following reasons why this should be easier than creating a global consensus.
It is easier to build this consensus in a small housing colony than on a global scale. Consider some possible reasons.
1. There is a high level of trust and even affection in a housing colony set up by a group of Marathi writers while international relations are cursed with deep divisions based on history, geography and culture. Getting the rich and poor countries to accept a common timetable to cut carbon emissions is a tough task.
2. The people who stay in our housing society are a homogeneous lot, coming from similar backgrounds and with similar incomes; climate change talks involved countries with different cost-benefit calculations. For example, the Maldives can do almost nothing to mitigate climate change but will surely be the first nation to bear the full brunt of its effects.
3. There is an incentive to protect your reputation in a housing colony or small community, since residents depend on each other for a variety of reasons. A nation at the bargaining table is more concerned about domestic pressures than protecting its international reputation.
4. A related disciplining catalyst is that people who stay in a small community have a long history of cooperation. Our housing colony is 40 years old and people have memories of cooperation and altruism. There is also the risk that reneging on a water deal right now would affect future behaviour of other residents. None of this is true in global climate change talks.
5. While water is not priced and hence market-based incentives cannot be used to curb usage, the city authorities have already imposed caps on our water usage. This is some sort of external enforcement that can cement a deal. In another context, the World Trade Organization does this for global trade. There is no such external enforcement institution as far as climate change commitments go.



Some political theorists and game theorists say that people are conditional altruists, standing between the cold utility maximizers of economics mythology and the saintly altruists of neo-Gandhian mythology. Conditional altruists do have an inbuilt concern for fairness but will follow selfish strategies because they fear that others will take a free ride on their commitments to good behaviour. They behave altruistically only when they are convinced that there are enough others who they can trust to behave similarly.
Such levels of trust take a lot of hard work, a history of reinforcing behaviour and credible assurances. It does not take much to realize that much of this was absent at the Copenhagen talks, which came close to being a morality play between the good guys and the bad guys.


The paper he has based his piece on is available at Partha Dasgupta's website here : Trust and Cooperation among Economic Agents, June 2009
Abstract

The units that are subject to selection pressure in evolutionary biology are "strategies", which are conditional actions ("Do P if Q occurs"). In contrast, the units in economics select strategies from available menus so as to further their projects and purposes. As economic agents don't live in isolation, each agent's optimum choice in general depends on the choices made by others. Because their projects and purposes involve the future, not just the present, each agent reasons about the likely present and future consequences of their respective choices. That is why beliefs, about what others may do and what the consequences of those choices could be, are at the basis of strategy selection. In this article I construct a catalogue of social environments in which agents not only promise one another cooperation, but rationally believe that the promises will be kept. Unfortunately, non-cooperation arising from mistrust can be the outcome in those same environments: societies harbour multiple "equilibria" and can skid from cooperation to non-cooperation. Moreover, a pre-occupation among analysts with the Prisoners’ Dilemma game has obscured the fact that cooperative arrangements can harbour not only inequality, but exploitation too. The analysis is used to discuss why international cooperation over the use of global public goods has proved to be so elusive.


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Wishing all readers a healthy and productive year ahead in 2010!

19 December 2009

Environment and COP 15

 Environment Decade - the Guardian puts the milestones across the years since 2000:

Ten years ago, Kyoto was on the rocks; Bush ruled the roost, and the New Orleans levee and Antarctic ice sheet were still intact. As the decade draws to a close, we look back on the biggest environmental stories milestones of the noughties


The Guardian also gives a roundup of what was achieved and how we failed in COP 15


And this is the clearest blog I have found explaining COP 15 issues:
Instead the overwhelming evidence points to a deal that, no matter what our leaders say, is a total failure to address the severity of the climate problem.







05 December 2009

Argentina - positive natural resource shocks and domestic adjustments


Leandro Serino, CAPORDE colleague, has a paper out on the 'Positive natural resource shocks and domestic adjustments in a semi-industrialized economy: Argentina in the 2004-2007 period'
Abstract
This paper evaluates the domestic adjustment to recent positive external shocks in Argentina's natural resource sectors. Although there is no single, exclusive determinant of Argentina’s fast economic growth in the period 2003-2007, the paper illustrates the favourable contribution of certain economic policies to this outcome.
According to counterfactual simulations performed with a dynamic Computable General Equilibrium (CGE) model especially designed to capture structural features of the Argentine economy, export taxes on natural resource products and Argentina’s competitive exchange rate policy have counteracted Dutch disease adjustments associated the positive terms of trade shock (which may be contractionary in the medium-term if no economic policies are implemented) contributing to productive and export diversification and to bring about output growth.
The analysis also shows that in a context of strong demand impulses spending the income collected with export taxes may not be beneficial for the overall competitiveness of the economy, hence counteracting one of the purposes of the tax policy. This implies, first, that subsidies to producers of wage-goods may be ineffective to control overall price increases, and second, that optimizing the contribution of public investment in infrastructure to improve the competitiveness of the economy requires special attention to the timing of public investment.
Click here to download the full text of the working paper

About the author

Leandro Serino has recently obtained his PhD in Development Studies from the International Institute of Social Studies (ISS) of Erasmus University Rotterdam, The Netherlands. His thesis is entitled: 'Productive diversification in
natural resource abundant countries: limitations, policies and the experience of Argentina in the 2000s'.
He graduated as an economist at the University of Buenos Aires (UBA) and completed a M.Sc. in Development Economics in 2003 (jointly dictated by the ISS, Free University Amsterdam and Wageningen University).
Until recently, he worked at MECON as an adviser to the Secretary of Economic Policy and coordinated a research unit. In addition, Leandro has been consultant for ECLAC Argentina, where he developed the demo of an encyclopedia on development economics (http://www.cepalnacionesunidas.com.ar). He was also involved in teaching and research at the University of General Sarmiento and UBA in Argentina.
At present Leandro is working as a lecturer at the University of General Sarmiento (UNGS) and is participating in a project to update Argentina’s Social Accounting Matrix at the Ministry of Economy and Finances - MECON (Argentina) .
Source: ISS

03 December 2009

Labour employability and global movements

An article of mine in the Financial Express this week highlighted the issue of Indian firms employing Chinese workers due to paucity of suitable skilled workers in India.
The government has 'fixed' the problem by insisting that all foreigners enter only on business visas—there are no visas to be given for unskilled/low-skill work, for which Indians are available—the problem actually lies in how ‘skill’ has been defined. Skills are defined typically as occupational skills where workers have the requisite training/qualification for a particular job description. If we look at the problem from the employer’s point of view, it is not a question any more of whether there are Indian electricians or welders, etc in abundance. As an Indian company executive employing Chinese labour noted, the Chinese would complete the job in 15 months while the Indians would take 8 years. The minute the time dimension enters, and therefore cost overruns loom, skill takes on a different meaning. Of course there is the added aspect of quality of output. In short, efficiency and productivity are not a part of the skill sets defined. The sad reality is that even while on paper many Indian workers have the requisite skills, they are just not employable.


My article spoke of the problem of employability in the Indian workforce:
Skill deficits have heavy social and political consequences, which are already being reflected every day on the news.As the India Labour Report 2007 , authored by TeamLease Services and Indicus Analytics, put it, “We believe that the skill deficit is more dangerous than the infrastructure deficit because it not only reinforces inequality but also amplifies it.” The longer it takes for the government to get its act together, the worse the situation will become.


I had not spoken about the migration of skilled labour from the country, given the constraints of the length of the article. The rate at which the country has lost quality work force is a function of  the lack of opportunities within the country. This has been changing in recent times with many Indians returning to take part in the 'Indian growth story'., even as other parts of the world seem less attractive. The latest : the fallout of the Dubai crisis has meant that skilled workers that India had 'exported' are now returning, at a time when the country needs them badly.
The ongoing crisis in Dubai may just prove to be a boon for the Indian infrastructure sector that is on a hiring spree and scouring the world for top and middle-level talent. The infrastructure sector, which includes construction of roads, highways, ports, airports, real estate, transportation, mining, steel, power and telecom, is witnessing a manpower shortage. “The infrastructure sector in India is in dire need of people who can manage projects and ensure their timely implementation. Such skill sets are hard to find here,” said Sanjiv Sachar, partner at Egon Zehnder International.


However, for  the Indian government,  this does not detract from the responsibility of creating an environment where employability of the Indian labour force is raised across the board, in all regions.

02 December 2009

Messages from Dubai

Two articles about the lessons from the Dubai debt issue stand out here:

The first by Anantha Nageswaran talks of the underlying problem - a mindset that demands instant gratification - and its implications for the developing world.


Amid all the hand-wringing over Dubai, what is being forgotten is that what has happened in Dubai over the last several years is only a manifestation of a global phenomenon. That is the problem of instant gratification. This affliction lies behind the global financial crisis. ....
Cities cannot be built in half a decade. Cities are not about tall concrete, steel and glass structures. They are breathing, living organisms with culture. Culture is historical. It takes time. Similarly, economic growth has to occur at a sustainable pace. Debt seduces us into thinking that we can have more of it than what is good for us.
If the hubris about breaking speed limits to growth and the achievement of permanent great moderation in economic cycles has brought the severest test yet of the US’ global supremacy, the prevalence of the same mindset in the developing world does not augur well for the great decoupling that some have taken for granted and some await with bated breath.
Hence, to be generous to today’s wannabe leaders in the developing world, the 21st century might ultimately be viewed as the period of transition for the hitherto poor nations but, on current evidence, it may not be the century of their arrival.
All this might be good for op-eds. But investors would be questioning its relevance for their actions. The answer is the same. Mind the risk and mind the price one pays for assets, and those are the equivalent of accepting delayed gratification in life.
On behalf of all of us, praying for a year of learning to accept delayed gratification.

 The second article by Simon Johnson 'Does Dubai matter?Ask Ireland' highlights not just the interconnectedness of the world in the matter of flows of activity, but also the impact of responses taken by certain regions to combat crises in other parts of the world:

The thinking is that a partial bailout – with creditor losses – for Dubai from Abu Dhabi implies something about how Ireland will be treated within the European Union (and the same reasoning is also more vaguely in the air for Greece).  ...

The main effect will be to strengthen the hand of Ben Bernanke in Fed policymaking discussions – so US interest rates will stay low for a long while.  If financial intermediaries draw the appropriate lessons from Dubai, Ireland, and Greece (and Iceland, the Baltics, Hungary, etc), they will be more careful about extending credit to places that are becoming overexuberant – even when it is cheap to increase debt levels.
But an outbreak of caution and care on the part of our biggest banks (and other investment managers) does not seem likely.

Both these articles point to greater issues of unsustainable/unwarranted debt levels, but both appear to be pessimistic over the question whether better sense will prevail.

25 November 2009

New Economics as Mainstream Economics

The Cambridge Trust for New Thinking in Economics has organised a conference in January 2010 - details available here.


New thinking in economics is an interdisciplinary approach to economic problems that acknowledges and respects the insights and analysis from other disciplines, especially those from ethics, history and engineering as well as complexity and evolutionary theory. Four issues can be highlighted, each of which has been either ignored by traditional economic modelling of the problem or treated in a misleading way that discounts the insights from heterodox economics and other disciplines.
  1. The economy is a complex, non-linear dynamic system with technological change inherent in economic growth. Many economic policy issues are potentially non-marginal changes to the system in the context of strong uncertainty.
  2. Many issues of economic policy (traditionally called “welfare economics”) are primarily ethical-economics in nature, and should be informed by moral philosophy rather than economics in isolation. Traditional economic models adopt an extreme form of utilitarianism, with a questionable choice and use of discount rates, ignoring the philosophical literature and the concept of justice.
  3. Engineering and history inform economics through studies of the production processes involving the supply and demand of materials, energy, skills and entrepreneurship. Economic history is critical in understanding the relationship between economics and technological change because the technologies evolve in response to economic conditions, e.g. carbon-price signals. Traditional models assume continuity and path independence.
  4. The politics of mitigation implies unstable alliances and trade-offs between governments and political parties. By the use of the social welfare function (required for the calculus), traditional economists simplify social choices and pre-empt political negotiation, claiming an optimality for their subjective assumptions and market interpretations

What I appreciate best are the principles governing the work in the Trust:

(a) that economic behaviour is primarily social rather than individual;
(b) that economic behaviour is influenced by aesthetic and ethical values as well as economic values: and
(c) that the pursuit of self-interest in economic behaviour can impact adversely on both society and the environment.

Looking forward to reading more of their work. 

24 November 2009

Empowerment and RTI

The Right to Information Act in India has managed to do wonders in ensuring that benefits of govt. programmes and policies reach the intended targets:
In an interview with Wall Street Journal, Aruna Roy, activist (former administrative officer and Magsaysay Award winner) explains how:



WSJ: On the Right to Information (RTI) Act, with which you've been closely associated since its inception 4 years ago, what is the progress so far?
AR: The RTI has become a lifeline for democracy in our country. Despite the failures of various state commissioners or government to implement Section 4. (This mandates the government to publicly disclose as many as 17 bits of information, including its budget, personnel, areas of work, etc.) That's why today the government can't touch the RTI without touching the whole of India. Because it's been used by a variety of people for a variety of reasons, with reasonable success. Sharing information is sharing power and nobody understands this better than the bureaucracy and the politicians, in that order.
But the people are now asking for their, for our share of governance, our share in decision-making, in fact if the tribals of India had had RTI 40 years ago, the situation that we face today wouldn't have happened. Wherever I travel, people feel the RTI is their Act and they own it. This is a fundamental change from what existed years ago.
Of course, a number of problems remain, of infrastructure, non-delivery, of systems not being in place, information commissioners not being trained, etc. But on the whole, the Act has worked.
WSJ: But despite its success, the government wants to amend it. Why?
AR: The government wants to put all file notings under wrap. Meaning, all discussions, consultations, all reasons for decision-making should become secret. Which means you'll know nothing about the process, just the end decision.
WSJ: But so far the process has been open?
AR: Yes, so far the process has been open, although they now want to close that. The Department of Personnel & Training which comes under the Prime Minister's Office, which is responsible for the functioning of the RTI, is now saying that the "consultative process" as well as anything that protects the "candour" of people expressing their opinion, will not be revealed. Behind this move to amend the Act and to kill its spirit, is the bureaucracy.
WSJ: So the government which gave the RTI to the people four years ago is now taking it away?.
AR: Equally horrifying is that all applications which are "frivolous or vexatious" will be disallowed. Now who is going to decide what that is? Possibly, the policeman or the 'patwari' (village revenue official) or the 'sarpanch' (village headman)… Naturally, everything will be "vexatious"…The move undermines the entire Act itself.
WSJ: You've been involved with the NREGA on the ground, how well do you think it has worked?
AR: I will say that this is the first rural development service where people know what they are receiving so they can monitor it, where there has been concurrent evaluation, where we know what the losses or gains are. So, every time I read about corruption in the NREGA I am thrilled, not because there is corruption but because for the first time, so many people are protesting against waste of public money. India should be proud.
WSJ: Give me an example…
AR: A women's group in Sitapur, Uttar Pradesh, has got 1400,000 rupees ($29,710) as unemployment allowance because they applied for work and didn't get it. According to the Act, you have to get work in 15 days within five kilometers of your village, and if the government can't give you work, it has to pay you unemployment allowance…Could you ever think of something like this before?
WSJ: But what about the enormous leakages and lakhs of rupees down the drain…
AR: For the first time, we know where the money has gone, even if its down the drain. We know who's swindled it and how it has been swindled. In Bhilwara, in Rajasthan, we have just completed a social audit. We used RTI to access public records and bring them out into the public domain, share it with people whose names are on the records and took a public meeting to testify whether their names were rightly or wrongly there.
You see, RTI is a mandatory provision in the NREGA, which means transparency and accountability on the part of government functionaries is now mandatory. That's how you find out what's going on, because now the people can't be refused information. It's mandatory for every 'panchayats' to do a social audit before the next installment of money is released by the government.

Read more about social audits and government-public relations in the interview.



While the RTI amendment is being fought, it is not being given enough prominence in the media. Peeyush Bajpai's blog post points to the role of media and RTI :

The power of RTI lies in the hand of the citizen- the “aam-aadmi”, it gives him the power to get the information.  In nine out of ten cases the information would concern specific issues to an individual or a small community.

Unfortunately, these amounts and issues are 'too small' to 'merit' national attention and reports fall by the wayside, even though there is so much happening on this front.

As Peeyush points out:

The media houses have always prided on their role as custodians of impartial information dissemination.  This is thus a challenge for the media to evolve a mechanism of disseminating such specific information in a focussed manner.

Meanwhile, we hope that blogs carry these stories forward.


23 November 2009

Stabilities and instabilities in the macroeconomy

Axel Leijonhufvud's latest piece in Voxeu concludes:
(I have put some sentences in bold font to emphasise the most pertinent points being made)

There are four issues to watch for:

  • Twin dangers looming ahead are Japanese-style stagnation on the one hand and Latin-American-style high inflation on the other. In more normal times, we would regard these prospects as both unlikely and very far apart on a spectrum of eventualities. High levels of public debt, large unfunded liabilities, and large current deficits mean that they are not at all far apart in the current situation. The apparent political difficulties in decisively remedying the public finances are likely to mean that this is not just a temporary predicament. The navigable channel between Scylla and Charybdis has become quite narrow.
  • One overwhelmingly important fact should guide policy over the near-term future – since current bailouts and stimulus policies have stretched public finances to the utmost, governments do not have the fiscal resources to handle another bubble bursting. Policy, therefore, should be conducted in a fail-safe mode. The current policies of extremely low interest rates are not fail-safe. They are aimed at reflating asset prices just enough to stave off a deeper recession. This is a delicate operation, not a robust, fail-safe move. It is creating strong incentives for the banks to return to the tables and resume the game of maturity transformation at high leverage that got us into our current troubles in the first place. It is evident that the banks are responding promptly to those incentives
  • High leverage has been the big culprit in the current disaster. To reduce the risk of another crash, we must curb leverage. But governments do not want the financial sector to deleverage now because the requisite falling asset prices and curtailed credit would deepen the recession. The question, of course, is: If not now, when?
  • The central banks are planning “exit strategies” by which they mean returning their balance sheets, which are presently bloated beyond recognition with a mix of strange assets, to a condition more resembling that normal to central banks. This will not be easy. If they succeed, however, they will still face the prospect of having to engage in many of the same desperate, unconventional policies in a future crisis. Under present arrangements, the responsibilities of central banks have no well-defined limits. This problem can only be solved by regulation of the financial sector. At present, it does not seem that we know how to do it.

13 November 2009

Whats wrong with modern macroeconomics?

Mark Thoma points to the conference on the theme 'Whats wrong with modern macroeconomics' at Munich last week.
Some excerpts from the comments on that
THOMA: One thing I learned from it is that I need to read the old papers by Sonnenschein (1972), Mantel (1974), and Debreu (1974) since these papers appear to undermine representative agent models. According to this work, you cannot learn anything about the uniqueness of an equilibrium, whether an equilibrium is stable, or how agents arrive at equilibrium by looking at individual behavior (more precisely, there is no simple relationship between individual behavior and the properties of aggregated variables - someone added the the axiom of revealed preference doesn't even survive aggregating two heterogeneous agents).


Roberto Cruccolini said... I think, this phenomenon of forgetting and/or neglecting former knowledge, e.g. the whole discussion and aspects of aggregation, which is really central to the methodology of modern macro, as the notion of microfoudations via optimizing agents was one of the core-arguments of New Classical Makro Revolution, is deeply unsettling. You could also add the oblivion of coordination & interaction problems, of discontinuities & emergence as probably central aspects of makroeconomics, which seem to be the reasons, why macro was once thought to be necessarily a different approach than micro.
There seem to be two ways to deal with this finding. One is to complain about the way modern macro has developed, and to suggest other/better solutions; this is, what we see most of the time right now.
That is of course worthwhile and understandable, but there remains a strange aspect: nearly all of nowadays criticisms were already mentioned 20 or 30 years before (recall Solow 1978 at the same conference as Lucas & Sargent, or Summers 1986 in response to Prescott, or Blinder 1987, or, which is sort of funny, Kirman 1989 & 1992 and - again - 2009,...)
And this leads to the interesting question, why modern macro/new classical methodology & thinking was so successful in conquering the field:
why did economists think, that Lucas 1976 said something new, given the reflections of Marshall how to theorize given ever changing structures, given Haavelmos ideas on the autonomy of economic relations, given the debates between Keynes and Tinbergen of econometrics and structural instability, and so on?
And why did they follow him in applying a Walrasian program using the representative-agent methodology given all these challenging aggregation results (see for the makro-production-function Fisher 1969 or Fisher&Felipe 2003 & 2006 and the bunch of literature to the Cambridge Capital Controversies and of course the literature interpreting the Sonnenschein-Mantel-Debreu results, f.e. Rizvi 1994 or 2006)
And in what sense does it make sense to describe modern macro models as "microfounded", if at the same time, you need some Friedman-1953-as-if argumentation to justify & make plausible your way of modeling, which is often referred to, that the inner functioning of your model is a black box and unknown, only built to generate predictions, not less. but certainly not more, in the sense that we think the way of modeling is reasonably realistic and corresponding to some mechanisms in the real world. Why should we, or why is this commonly called "microfoundations"??

Gallagher and Chang on Globalisation

There's a video interview up on Real-World Economics Review Blog:
Ha-Joon Chang and Kevin P. Gallagher talk about the central theme of their books:

Chang demolishes some of the myths on free trade and points to the need for asymmetrical protectionism benefiting the developing nations, for poorer nations to break the model of low return primary commodity based production etc.

Bad Samaritans; The myth of free trade and the secret history of capitalism. Bloomsbury.

Gallagher focuses on Mexico and NAFTA and talks of the US-Mexico policy, the need for developing countries to move away from attracting FDI, for the sake of inflows, and to look at the integration of these flows into the economies, rather than creating enclaves within.

The Enclave Economy  Foreign Investment and Sustainable Development in Mexico's Silicon Valley by Kevin P. Gallagher and Lyuba Zarsky, The MIT Press



10 November 2009

On the Berlin Wall

Three papers up on Voxeu examining the impact of the fall of the Berlin Wall, 20 years on.
Michael Burda's article Half-empty or half-full?East Germany two decades later concludes:
It’s my guess that East Germany in the 21st century will reproduce the existing north-south divide in the West. This is because convergence is not only about equating East and West Germans’ levels of physical and human capital but also endowing them with the same level of social, institutional, business and marketing infrastructure. On this metric, the Eastern German economy looks like a mixed bag, like much in life, a glass half-empty and half-full at the same time.


This is an important paper, its conclusion has interesting implications for all states with wide regional disparities


Volker Nitsch and Nikolaus Wolf's paper Tear down this wall:on the persistence of borders in trade  reports:
Notably, it makes hardly any difference whether we analyse data for 101 regional units and 10 industry groups or 27 regional units and 24 industry groups: the trade effect of the former Iron Curtain across Germany continued to be highly significant throughout the period under investigation, although this effect clearly declined over time. Given that we can extrapolate the results, we estimate that it would take between 33 and 40 years, or roughly one generation, to remove the effect of the former political border entirely.
These findings are difficult to square with the “political barriers” or the “artefact” explanation of border effects but strongly suggest that some fundamentals are driving the effect. We conclude that the biggest challenge to globalisation is neither technological nor political barriers to trade, but barriers stemming from economic fundamentals. While we can change infrastructure and even remove political borders, it takes at least a generation to tear down the wall in our heads.



Gerlinde Sinn and Hans-Werner Sinn's Muffed jumpstart puts their conclusion baldly:
Germany’s political unification has succeeded; its economic unification has not....
The failed unification of the East and West German economies has also dragged down West Germany in an international comparison. Until German unification, West Germany had grown properly and in terms of per capita national income had held a top position in Europe, at about the same level as Denmark. Under favourable conditions, it could have maintained this growth thereafter and Germany as a whole could have grown much faster than the rest of Europe due to the convergence of East Germany to the Western European level. But this is not what happened. Since 1995, both parts of the country have crept along in step and have taken turns with Italy for the lowest rung on the European ladder. Things turned out worse than we had expected.
The economic crisis has enforced a new realism in Germany. Net transfers to East Germany have been declining for a few years, wage increases have become more modest, and the constitution prohibits East German states to continue their policy of rising indebtedness from 2020. The times of easy money are past, and that is why a phase of growth may start now. Unfortunately, it is twenty years late.

05 November 2009

'Cheap Money Mischief' False sense of comfort

This is a mail from Suyodh Rao who points to two articles:
The first by Gillian Tett Financial Times  'Rally fuelled by cheap money brings a sense of foreboding'
The second by Roubini also in the FT 'Mother of all carry trades faces an inevitable bust'


The two put together answer some questions as to why asset prices are rising even though things dont 'feel' so good. Companies are reporting decent results no doubt. I have not looked at Market PE Ratios, that will give a better idea whether equities are reasonably or otherwise priced.
The factor that cannot be ignored is where the money that is being pumped in by govts is finally ending up. One chunk of stimulus money obviously went to shore up financial institutions balance sheets. Leftovers of that stimulus will find its way into either consumer prices or asset prices.
What the articles talk about is how the loose monetary policy & the fiscal stimulus of the US are both fueling worldwide asset price inflation. Realty prices world-over are still on the higher side when one compares them to trend-line relationship with incomes. Incomes (real) are down if anything and should push house prices even lower. As for stock prices, one will have to look at PEs.
The current crop of policy-makers seem to have not read their Economic History texts, or have forgotten them. While that may sound like an audacious statement, I take the support of two statements of two individuals (quoted below) who, in most respects, have had the most impact on economic policy-making in the 20th century (and onwards). In the days when these were written, there weren't the fancy hedge and fence funds of today. Nor was the stock market hogging newsprint. That may have allowed them to give Money Supply the respect that was due to it. There were three variables that they focused on - Employment, Output & Price Level. Today the financial sector employs tens of times more folks (percent of workforce), and that has changed the focus of policy. In my opinion, that is an unwelcome change. But then, the counter-tautological statement would be that if the financial sector goes down the drain, then the real sector is doubly hurt. That statement has its merits. But, since the financial sector doesn't matter, let us tinker with it. Therein lies our mistake.

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. 
John Maynard Keynes, 1920


My own studies of monetary history have made me extremely sympathetic to the oft-quoted, much reviled and as widely misunderstood, comment by John Stuart Mill. "There cannot ....," he wrote, "be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order".


True, money is only a machine, but it is an extraordinarily efficient machine. Without it, we could not have begun to attain the astounding growth in output and level of living we have experienced in the past two centuries - any more than we could have done so without those other marvelous machines that dot our countryside and enable us, for the most part, simply to do more efficiently what could be done without them at much greater cost in labor.

But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines. - 
Milton Friedman, 1968


PS The above has been written on the fly, may miss some connections, but seems to make sense. Hope it does the same when it meets the reader's eye :) If my last para above doesn't make sense at first, read the quote of Friedman and then re-read my para.

What I am saying in essence is that Money Supply increases take time to show their impacts. Asset-price inflation and/or consumer price inflation will follow Money Supply increases. Asset prices have to revert to their historical trend-lines and relationships with other economic variables such as income etc. The reversion will be in Real terms, and very likely in Nominal terms too. When that correction comes, it is not going to be pretty. When the economic history of the first decade of the 21st century is written, the rally of 2009 may not occupy more than a square inch.

04 November 2009

Revisiting the orthodoxy: the experience of emerging economies

An edit in the Business Standard today highlights the changes in thinking with regard to forex reserves and cross-border flows:

This episode has clearly highlighted the need for re-assessing the benefits of accumulating large foreign exchange reserves. Once viewed as inefficient by the orthodoxy, “self-insurance” is now being seen as a legitimate crisis-management strategy.


Alongside this, the orthodoxy about the desirability of capital inflows is also being questioned. Brazil is a prominent example of having recently imposed a tax on short-term portfolio inflows, a variant of the class of instruments generally known as Tobin taxes.
Contrary to the orthodox view that Tobin taxes will queer the pitch for foreign capital, a clear delineation of the transactions on which they are to be levied may actually incentivise more desirable long-term portfolio and direct investment inflows because they promise a more stable balance-of-payments and exchange-rate environment. 

RBI Deputy Governor's speech at the FSA Turner Review Conference also deals with the space for unorthodoxy

Much of the current debate on many issues centres on the epicenter of the crisis, the developed economies with relatively advanced financial systems. The emerging markets, though, can bring a different perspective from their own past experience. Many of the emerging countries, including India, are part of the global effort in search of a harmonized framework but certain key differences in perspectives in these two sets of economies need to be appreciated. The status of the financial sector of the emerging economies is different from that of the advanced economies with different set of imperatives having different implications for the trade off between financial stability on the one hand and financial development, financial inclusion and growth, on the other. For instance, with regard to identification and mitigations of sources of systemic risk, the emerging market concerns are heightened because of the fact that many sources of systemic risk lie outside their jurisdictions. There could also be the issue of negative externality of larger than warranted capital requirements without careful calibration which could adversely impact the flow of credit to productive sectors, particularly in bank funding based financial systems. Emerging economies are faced with the challenge of managing volatile capital flows which is not a source of systemic vulnerability for developed economies,




Clearly the experience of the developing/emerging economies has much to offer in reshaping the prevalent ideology.

03 November 2009

Soros asks for a 'New Economics'

Frustrated with the inability of economics to develop realistic thinking, fund manager and global investor George Soros has decided to set up an institute 'New Economic Thinking'


The group, to be called the Institute of New Economic Thinking, will gather luminaries in the field of economics to reflect on the ideas that allowed the latest economic crisis to transpire and to bring new ideas to a profession that some argue has become too deeply entrenched in free-market ideology.
The group’s advisory board will be studded with economists such as Jeffrey Sachs, George Akerlof, Kenneth Rogoff and Joseph Stiglitz as well as public commentators such as Anatole Kaletsky and John Kay, a Financial Times columnist. Mr Soros is pledging $5m a year for 10 years.

While we wait for output from that institute, realistic academic economic thoughts can be found at the new  Real World Economic Review Blog




23 October 2009

US Dollar shortage and global policy response


BIS Working Paper No 291 titled 'The US dollar shortage in global banking and the international policy response' by Patrick McGuire and Goetz von Peter deals with the international policy response to the stresses in the banks balance sheets last year. 

An important point noted by the paper:

Beyond addressing the immediate exigencies, however, the international swap arrangements are of broader interest from an institutional perspective. The structure of the arrangements appears to overcome two challenges commonly associated with international lending of last resort. First, the Federal Reserve and its foreign counterparts have the power, in principle, to create any amount of money, in contrast with international financial institutions administering limited resources. Demands in other currencies can similarly be met by including the respective currency-issuing central banks in the network of swap lines. Second, the swap network does not compound the informational problems that can give rise to moral hazard. By lending against collateral to foreign central banks that intermediate those funds to banks in their jurisdictions, the Federal Reserve assumes no credit risk vis-à-vis the ultimate borrowers, and delegates the task of monitoring the banks (or collateralising the loans) to the national authorities closer to the bank supervision process.


Conclusion of the paper:

The recent financial crisis has highlighted just how little is known about the structure of banks’ international balance sheets and their interconnectedness. The globalisation of banking over the past decade and the increasing complexity of banks’ international positions have made it harder to construct measures of funding vulnerabilities that take into account currency and maturity mismatches. This paper partially fills this void, investigating how banks funded their international positions across currencies and counterparties. The analysis shows that between 2000 and mid-2007, the major European banking systems built up long US dollar positions vis-à-vis non-banks and funded them by interbank borrowing, borrowing from central banks and FX swaps. We argue that this greater transformation across counterparties in fact reflected greater maturity transformation across these banks’ balance sheets, exposing them to considerable funding risk. When heightened credit risk compromised sources of short-term funding during the crisis, the chronic US dollar funding needs became acute, particularly in the wake of the Lehman Brothers bankruptcy.


In contrast to many previous international financial crises, it was banks’ international exposures to other industrialised countries that deteriorated, and the global interbank and FX swap funding structure which seized up. The build-up of such stresses at the global level can only be identified by tracking the extent of cross-currency funding, and by implication, banks’ reliance on short-term interbank and FX swap positions. What pushed the system to the brink was not cross-currency funding per se, but rather too many large banks employing funding strategies in the same direction, the funding equivalent of a “crowded trade”. Only
when examined at the aggregate level can such vulnerabilities be identified. By quantifying the US dollar overhang on non-US banks’ global balance sheets, this paper contributes to a better understanding of why the extraordinary international policy response was necessary, and why it took the form of a global network of central bank swap lines. A broader message of this paper is that vulnerabilities in the international financial system are best measured along the contours of banks’ consolidated balance sheets, rather than along national borders. ....
The macroprudential perspective afforded by these data shows that (i) stresses can build up in a national banking system that cannot be identified with the home country’s residencybased statistics alone, and (ii) banks’ cross-border positions are large relative to countries’ external positions, clouding the interpretation of what the “national balance sheet” implies for domestic residents.

19 October 2009

Food Security and Poverty

My article on the proposed Food Security Act in India is in the Financial Express today. The Government's proposal in principle extends the right to food to all citizens in India but limits the legal binding on it only for the population that lies below the poverty line (BPL) - and here there is a wide range of the estimates of poverty in the country - ranging from 38% according to the Tendulkar committee set up by the Planning Commission recently to 77% set by the 2007 Arjun Sengupta Committee. The NC Saxena Expert Group for the 2009 Census of BPL households in rural areas puts the estimate at 50%, but says that 80% of rural households would be more appropriate if the calorie consumption is to be 2,400 calories in rural areas

Read the Report of the committee on the methodology for estimating the population in India below the poverty line, particularly the dissent note by P. Sainath for a compelling argument on why coverage of the food security act should be universal.

My conclusion in the article:

The reason behind limiting coverage of the Act has to be fiscal, and the Centre should admit that outright. Under the present Public Distribution System (PDS), the higher estimates of BPL population can raise the food subsidy bill by 25% to 140%, depending on which estimate is used. However these estimates assume that the PDS continues in its present form. Instead of looking at the high subsidy costs as a deterrent, the Centre should keep the spirit behind a Food Security Act foremost in mind—systems set up should be decentralised and allow greater flexibility to the states with the idea for organisational cost savings. A simple example is to distribute coarse cereals, pulses, fruits and vegetables suited to the local conditions through a revamped, new PDS, rather than use rice or wheat transported long distances from other states.


In fact, if the primary responsibility of providing food security is to lie with the state governments, as the Act proposes, why not minimise the role of the Centre to being a facilitator, rather than a controller of the whole food stock trade and distribution? There is much to be said for making the right to food a universal right and there is ample evidence to show that targeted systems increase the scope of corruption. Clearly, the Food Security Act is an important step forward, but it should not narrow its focus and result in two steps back in the battle against hunger in this country.

13 October 2009

Elinor Ostrom and Economics

Good to see the 'Nobel' Prize going to a 'non-economist'..Elinor Ostrom is a political scientist.
Read a list of her work here

Here is her CV 
For those who want to debate whether she 'deserved' the Prize at all, like the big discussion that raged over the weekend on Obama, you can put in your comments at this site.. Some comments are pretty low level here, showing that a lot more effort will be needed to get economics to accept a multi-disciplinary approach. So whether she 'deserved' the prize or not, whether there are others who 'deserve' it more or not, discussion is endless..still, this is a step in the right direction on bringing plurality back into focus. A refreshing change from the market vs. government arguments, she stresses on cooperation e.g farmer managed irrigation systems etc..


In an interview
The first woman to win a Nobel economics prize, announced today, emphasizes in her work, for example, how pools of users manage natural resources as common property, such as how lobster fishermen in Maine in the 1920s came together to self-police the industry due to too many of the sea creatures being captured threatened their extinction
"They regrouped and thought hard of what to do, and over time developed a series of ingenius rules and ways of montoring that have meant the lobster fishery in Maine is the most successful in the world," she said today, in a wide-ranging interview with Adam Smith, editor-in-chief of the Noble prize group's Web site, Nobelprize.org. "There are many other small- to medium-size groups that have taken on the responsibility for organizing the source governance."
She agreed her award might catch on with the public in more broad ways, arguing that government oversight isn't the only way to solve a problem.
"I hope," she said. "That's what I've been working on for all my life. Humans have great capabilities, and somehow we had sense that the 'officials' have genetic capabilities that the rest of us didn't have. I hope we can change that."
You can hear the whole interview here


UPDATE: Here is Paul Romer on Ostrom's significance:


Cheers to the Nobel committee for recognizing work on one of the deepest issues in economics. Bravo to the political scientist who showed that she was a better economist than the economic imperialists who can’t tell the difference between assuming and understanding.


Here is Ostrom on climate change (Thanks Suvrat, for this link)


The first part of the discussion moves from a review of systems thinking to focus on social-ecological systems and their resilience, to the challenge of managing these systems so they can be resilient: How will they best cope with change? In the second part of the conversation, Ostrom elaborates on the framework she’s been developing, which she describes as “a step toward building a strong interdisciplinary science of complex, multilevel systems that will enable future diagnosticians to match governance arrangements to specific problems embedded in a social–ecological context.” In wide-ranging observations, she also discusses how people self-organize successfully; the role of trust and reciprocity; and the preservation of ecological knowledge.

08 October 2009

Rate hikes again

The RBA is the first off the block raising rates this week. In a speech at the Istanbul conference on 'Where is Global Finance heading?', Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey made some key points about the role of central banks. It is important that the public and analysts appreciate what is behind the actions of central banks. And also to remember that each country faces a different set of conditions and priorities, timing and pace of rate decisions will necessarily differ.

Almost all economists agree that we are heading to a slow, gradual and painful recovery. And as a central banker who has spent almost 30 years in this profession, I can tell you that it is a miracle itself to have so many economists agree on one issue with so much vigor and conviction.
It is clearly understood that the only way to prevent future crises at the global scale is multilateral cooperation. However to establish and sustain multilateral cooperation is not an easy task. As (John Maynard) Keynes once said, “The biggest problem is not to let people accept new ideas, but to let them forget the old ones.“ It is very likely that economic agents will try to hold onto their old habits when the effects of the crisis subdue.
Appeals on regulators will pile up for a more lenient implementation of rules, regulations, and policies. Politicians will face pressure from their constituents to give priority to local concerns at the expense of global coordination. Dominant academic paradigm may restrict those who radically incorporate lessons of these days into their studies. And of course, central banks, as always, will be criticized for spoiling the party at its hottest moment by taking away the punch bowl. We should be aware that keeping the old habits will only give us a new and may be more severe crisis in the near future.

Of course, as a central banker, I am fully aware that identifying asset bubbles is not an easy task and it may also be challenging to convince the public and politicians about the necessity of raising policy rates at a time when economy is booming but the prices of goods and services are stable. However, the recent crisis has demonstrated that central banks may ignore imbalances in financial markets at their own peril.

06 October 2009

Financial crisis and central banking

Marc Faber in an interview recently praised the RBI for being amongst the best central banks in the world - mainly from the point of view of keeping an eye on financial stability:
The RBI has one of the best monetary policies in the world because they supervise the financial sector very closely. They have maintained relatively tight monetary policies and also they pay attention not only to core inflation which is not representative of the cost of living increases and is not representative of inflation in the system but the RBI also pays attention to rising and falling asset prices. So, I have to give them credit for being actually one of the best Central Banks in the world.


That's the view from the investment world, yet the RBI has often been criticised by economists for being ultra-conservative. Shankar Acharya talks of the good performance of the RBI in his article dealing with policy continuity at the RBI


But the conventional wisdom attributes this to an instinctively conservative and cautious approach of the RBI and its leadership, especially then governor Y V Reddy and deputy governor Rakesh Mohan. At best this is a partial truth and, at worst, it’s quite misleading. Let me explain. Reddy and Mohan should certainly get a lot of credit, but for much more than being instinctively conservative.

To begin with, maintaining a cautious stance in the boom years of 2003/4-2007/8 was itself quite a feat in those exuberant times when the financial community, the media and even the government were pressing for rapid progress on conventional, financial liberalisation. 

But the Reddy-Mohan RBI did much more than just preserve key elements of the policy/regulatory framework. Over the boom years, as the perceived scale and risks of global financial excesses mounted inexorably, the RBI evolved a diverse set of heterodox policy responses to deal with the problem. These included:

  • The inclusion of “financial stability” as an explicit objective of monetary policy;
  • Active management of surging and volatile capital inflows through partial “sterilisation” by market stabilisation scheme (MSS) security issues, cash reserve ratio (CRR) hikes and liquidity adjustment facility (LAF) operations, thus retaining substantial, discretionary control over monetary and exchange rate policies;
  • Moderation of bank exposure to asset bubble-prone sectors such as real estate and equity markets through countercyclical provisioning requirements and differentiated risk weights for bank lending to such “sensitive” sectors;
  • Extension of stronger regulation to systemically important non-bank finance companies;
  • Enhanced supervision of financial conglomerates;
  • Bringing bank exposure to non-banks within the prudential framework;
  • Tighter guidelines for securitisation and a sceptical stance towards complex financial products.
After a challenging year of crisis management, Governor Subbarao has explicitly endorsed the key elements of the Reddy-Mohan heterodoxy. It has probably helped that mainstream, international thinking on these issues has been driven much closer to the Reddy-Mohan positions by the global financial crisis. For those, like me, who backed the Reddy-Mohan approaches to monetary and regulatory policies, the continuity shown by Subbarao’s RBI is very heartening. For earlier critics of these approaches there may be some disappointment and discomfort.

So true! For those who are looking for a short roundup of the issues plaguing EMEs today, Subbarao's latest speech on the crisis and EMEs is worth reading. His conclusion:
It needs to be recognized that after a crisis, with the benefit of hindsight, all conservative policies appear justified. But excessive conservatism in order to be prepared to ride out a potential crisis could thwart growth and financial innovation. The question is what price are we willing to pay, in other words, what potential benefits are we willing to give up, in order to prevent a black swan event? Experience shows that managing this challenge, that is to determine how much to tighten and when, is more a question of good judgement rather than analytical skill. This judgement skill is the one that central banks, especially in developing countries such as India, need to hone as they simultaneously pursue the objectives of growth and financial stability.

30 September 2009

Carbonate Surprises

Suvrat Kher, geologist, interviewed on the Reef Times
One excerpt:

Tell me about some of the “water crises” you’ve blogged on (like India) and why they are happening. 
India is facing a multitude of water problems. First there is the problem of water quality. Environmental regulation is new to India and is weakly implemented and that means that almost all the major rivers and lakes are polluted to unacceptable levels. Wetlands are disappearing through uncontrolled and unplanned development. Even an iconic wetland like the famous Bharatpur Bird Sanctuary is threatened.
Second is the impact of climate change on surficial water. If trends observed in the decline of Himalayan glaciers hold over the next couple of decades it would affect the summer runoff of Himalayan rivers that are a lifeline to hundreds of millions of people in northern India.
Finally there is the crisis facing groundwater. Unregulated extraction of this resource has lead to aquifer overdraft in many regions. This is a catastrophe in the making since groundwater irrigates over two thirds of arable land in India.

25 September 2009

Korea 'A militant tendency': A critique

This post has been sent in by Hee-Young Shin of New School for Social Research, who has also sent it to the  FT as a comment.

In a recent article featured on Financial Times ("A militant tendency," September, 18, 2009), a longtime Financial Times' Korean correspondent, Christian Oliver completely distorted the image of legitimate Korean trade union activities. He argued that militant trade union activists had been the number one obstacle to foreign investments in Korea. In addition, he cited recent tragic incidents and other anti-government protests as if they were stirred by a number of radical trade union activitists behind the scene.
But as any astute observer of social issues in Korea quickly recognizes, the example that Mr.Christian Oliver enumerated had nothing to do with trade union activities. First, a recent tragic accident that killed 6 urban poor was the result of brutal police suppression of those who struggled to protect their basic human rights in the face of terrifying urban gentrification.
Second, the massive protest against American beef import was also unrelated with what Christian Oliver called 'militant trade unionism.' The protest against the government decision to import American beef originated from some female high school students' peaceful candle light vigil. Their silence campaign performance turned into massive political protest against the incumbent President, Lee Myung-Bak, and other government officials because students' message and legitimate concerns for the food safety issue resonated among many ordinary Korean peoples including babycarrying house-wives. Thus, citing these examples as if they were incited or plotted by militant trade unionists' activities in some systemic ways is a complete distortion of the basic facts, and renders the credibility of this journalist's argument in serious doubt.
Even when we put aside this type of distortion of recent social issues, the remaining article only shows how Christian Oliver lacks of sufficient knowledge of Korean economic development and related social history.
First of all, a relative low record of Foreign Direct Investments (FDIs) in Korea was not due to what he called 'militant' tendency of labor unions but to historical path dependency in which FDIs had played a substantially minimal role from Korea's early industrialization. From the beginning, the rapid industrialization in Korea was not driven by FDIs but by 'induced investment' guided by the State's industrial and trade policy financed by high domestic saving. Thus, citing 'militant union' activities as if they were the root cause of relatively low FDI flows is completely misleading.
Second, unlike the article's claim, foreign portfolio and equity investment have been incredibly high, causing huge volatility in currency and asset markets. Many economists including Nobel Laureate Joseph E. Stiglitz, Paul Krugman once correctly pointed out that this volatile capital flows, its sudden stop, and subsequent rapid reversal caused the Asian Financial Crisis, with Korea being the latest victim a decade ago. The problem associated with this unregulated financial capital flow was later acknowledged even by the then Managing Director of the International Monetary Funds (IMF) Michel Camdessus and the then US Treasury Secretary Robert Rubin who vehemently advocated capital market liberalization in Asia during the early 1990s and end up with prescribing the failed Latin American type of structural adjustment program. After the financial crisis, Korea's capital market was further liberalized by a series of policies imposed by the IMF as parts of its loan conditionality. Since then foreign equity flows substantially rose, potentially increasing the vulnerability of the economy to the vagary of foreign investors. Thus, if Christian Oliver meant portfolio and speculative equity flows by indicating 'foreign investors being shy away from Korea because of militant unionists,' the trend has been completely opposite to what he seems to worry. The problem in Korean economy is not lack of foreign investors but rather too much speculative inflows of portfolio investment.
Third, the seeming 'radical' or extremely violent resistance on the part of Korean trade unionists (even if it were true) was a deplorable result of the authoritarian government's – long-lasting military dictatorship during the 1970s and 1980s, which was ideologically backed by Milton Friedman type of Chicago School at that time and incumbent right-wing conservative Lee government's overwhelmingly brutal suppression of basic union activities. How can socially marginalized trade unionists with less than 15 percent of union membership record nationwide become such a destabilizing force in Korean economy? The journalist simply failed to recognize the apparent fact that the root cause of the radicalization of unionists lies in the authoritarian government's mismanagement of labor relation and brutal suppression of basic trade union activities, something that should not happen in most OECD countries and Western European context.
Finally, the article shows how Christian Oliver naïvely think about the controversial issue such as the labor market flexibility in Korea. Unlike the incumbent Korean government's propaganda, the policy targeted toward improving labor flexibility simply has meant increasing the number of workers who can be easily fired and dismissed without having necessary social safety net. These 'nonregular' workers have had to face explicit discrimination in terms of wage compensation and job security. Even though they work the same working hours engaging in the same skilled task, their wages and salaries have been less than two third of their 'regular' counterpart. The increasing number of non-regular workers, which was a byproduct of drastic corporate restructuring during and after the Asian financial crisis, already soared to near 60 percent out of total workforce as of 2005. In addition, since most of these workers are women and young college graduates, the wage discrimination and increasing job insecurity sorely borne by them are no longer simply a matter of minor reservation of labor rights amid emergent economic crisis but became a serious infringement of basic human rights.
Considering all of these facts, it is certain that the journalist failed to convey accurate information about Korean labor relation today. In doing so, he selected a handful of extremely conservative government officials or those who represent the exclusive interest of Korean conglomerates for his interview, without even mentioning that some of them explicitly argued that the basic labor rights provisions should be dropped from the Constitution. Ironically, that interviewee, whose name is Park Ki-Seong, is the guy who is now heading Korea Labor Institute, a government-funded institute, which is supposed to engage in various researches for improving backward labor conditions and advancing labor relation in Korea. On balance, any journalist has a freedom to choose to have a certain ideology and perspective. But it is too sad to see a foreign-born journalist residing in Seoul Korea blindly swallowed what mistrusted government officials propagandized, without paying due attention to what other stakeholders demand and what basic facts reveal.

Ph.D candidate in Economics
New School for Social Research
New York, USA