All 56 entries tagged Economics
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November 15, 2013
I contributed recently to the Politics at Warwick blog, which I thank for its hospitality. My post elicited a comment to which I'd like to respond; my response is longer than my original post so I decided to include it here. First I'll put up my original post, dated 13 November 2013. Then I'll quote the comment and respond to it.
How should the economics curriculum respond to the global financial crisis and ensuing recession? Community activists and students have become vocal in this discussion, as recently described by journalist Aditya Chakrabortty and Matthew Watson.
Events have prompted questions about economists’ understanding of financial markets; the same events have generated a deluge of new data. How should economists respond? Economic research has already responded; hundreds of new articles have analysed global imbalances, market efficiency, corporate behaviour, regulation and deregulation, policy rules, the politics and economics of past crises, and the relative fragility of economic and political institutions in history.
The core curriculum has been slower to change. Here are two reasons. The first is that we no longer teach from handwritten notes and a chalkboard; students and teachers demand comprehensive textbooks with instructor manuals, PowerPoint slides, and websites. These take years to develop (and revise). Although slow, change is already visible. Because change is slow, there is more to be done. Change will probably accelerate through initiatives like the CORE (Curriculum Open-access Resources in Economics) project.
A better reason for inertia in the curriculum is our foreknowledge that the full meaning of recent events will take decades to establish – although many people believe that they are already obvious. To illustrate, today we continue to make new findings about the last Great Depression, which began in 1929, although many who lived through the 1930s were so certain of the answers that they were willing to kill and die on that basis.
How should the core curriculum change? A common complaint is that economics is dominated by a single school of “neoliberalism” or “market fundamentalism.” There are calls for more diversity in economics; some students want more access, specifically, to Keynes and Marx.
It is simply untrue that mainstream textbooks reflect principles of market fundamentalism. I can’t think of a principles text that doesn’t follow the initial explanation of market equilibrium with an immediate, detailed discussion of the varied sources of market failure and the regulatory interventions that might follow.
While one may learn from both Keynes and Marx, what is to be gained from taking them outside their historical settings? A Keynesian model focuses on flows (of income and employment) while neglecting stocks (of capital and debt). Yet capital and debt are very important! Keynesian principles are linked to a model of household behaviour (the “marginal propensity to consume”) that half a century of applied research has comprehensively invalidated. A Marxian model simplifies the continuum of capital ownership into a two-class society; additionally it throws out efficiency and substitution, so distribution is all that remains. In the context of today’s mainstream, each of these is now a stagnant, oxygen-starved backwater.
The importance of competing traditions is much overrated. Those that wish to organize the curriculum around them seem to believe that the major decision each economist must make is “Which dead economist must I follow?” and after that her research findings and policy recommendations will follow. This may be a natural reaction to the fact that mainstream economists are often unenthusiastic about policies that gather widespread popular support, for example rigid immigration controls, employment protection, and double taxation of corporate income. It might be easier for the supporters to say “Oh, those economists are all neoliberals who are ignorant of Keynes and Marx” than work patiently back through the evidence that fails to confirm their biases.
“Economics ought to be a magpie discipline,” writes Chakrabortty. But Economics is a magpie discipline. Most non-specialists – and most journalists – think public and private finance are all we do. They are amazed when I describe the sheer diversity of research that is done just in my department (here and here). We suck up topics and data from any time and place; we don’t care what discipline claims to own them. Then they backtrack and say, “Of course, I didn’t mean to criticize you (or Warwick), I meant Friedman (or Chicago).” The fact is there are no clear intellectual boundaries among schools of thought; we should all mingle in the same fluid mainstream, which is broader, deeper, and faster than you think.
Concluding, Chakrabortty reports a lament for the good old days. Tony Lawson recalls the Cambridge economics faculty in the time of Nicky Kaldor and Joan Robinson: “There were big debates and students would study politics, the history of economic thought.” I remember; I was there too, as a student. The big debates were an exercise in identity politics, not economics. Hostile clashes between intolerant armed camps ended in a war of attrition that benefited no one, least of all students. There is a warning here: be careful what you wish for.
On the day that my post appeared, the anonymous blogger Unlearning Economics posted a comment which you can read in full here after scrolling to the bottom. Here's my response, with excerpts from the comment inset.
Unlearning Economics quotes me and comments:
“A Keynesian model focuses on flows (of income and employment) while neglecting stocks (of capital and debt).” First, Keynes didn’t ignore capital or debt at all; that is simply false ... Keynes carried over some silly marginalist concepts like the efficiency of capital (clearly he mentioned capital once or twice).
My response: It is useful to distinguish between “things Keynes wrote about at various times” and “things that are core principles of the Keynesian model.” Of course we could argue about the division, but it seems to me capital and debt belong to the former, not the latter. The point is exemplified by Keynes’s model of consumer behaviour (more below), in which capital and debt play no role, although they were fundamental to other models available at the time. As for the marginal efficiency of capital, Keynes introduced this to rationalize his discussion of investment (a flow), not to understand the behaviour of the capital stock.
Again, Unlearning Economics quotes me and comments:
“Keynesian principles are linked to a model of household behaviour (the “marginal propensity to consume”) that half a century of applied research has comprehensively invalidated.” Which research would this be? “People don’t consume all of their income” is hardly a false statement.
My response: Yes, it's true that “people don’t consume all their income,” but that isn’t the issue. The issue is whether the main thing in consumption is a stable proportion between household consumption and current income at the margin, as Keynes believed. I should add that he not only advanced this idea in theory but also applied it in practice, for example in his writing about how to pay for World War II. Franco Modigliani, Milton Friedman, and others investigated this idea after the war and failed to find it in the data. They did identify a stable relationship between consumption and wealth, or lifetime (or "permanent") income, to which changes in current income make a small or negligible contribution. Because permanent income is uncertain, the future (including expectations of inflation and the real interest rate) are fundamental. Modern new-Keynesian models drop the marginal propensity to consume (and the multiplier) and focus exclusively on intertemporal substitution intended to smooth consumption over time. Which takes me on to our next point.
Unlearning Economics adds:
Second modern post-Keynesian is *all about* stock-flow consistent models ... people like Godley, Keen etc have updated [Keynes’s] work.
My response: Yes, certainly. Here another distinction arises, between Keynes and the post-Keynesians (or Marx and the post-Marxists). Naturally, there is development in the Marxian and Keynesian traditions. I could not dispute that, when a great economist produces an insight that turns out partial or incomplete or defective in some respect, it may be fixable. There is evolution. Evolution has produced neo-Keynesians and post-Keynesians (and Marxists). Evolution is better than stagnation. At some point it generates new species. Every year I help teach a “new-Keynesian” model of the macroeconomy to Warwick undergraduates, and every year I (and I hope they) learn something new. Yet the label “new-Keynesian,” like George Box’s economic models (more below), although useful, is also wrong. Would Keynes recognize it as his? It’s debatable. Does it matter? Only if you want to claim ownership over Keynes’s legacy.
Unlearning Economics quotes me and comments:
“A Marxian model simplifies the continuum of capital ownership into a two-class society; additionally it throws out efficiency and substitution, so distribution is all that remains.” Marx spent a lot of time talking about the difference between financial capital and industrial capital; Lenin updated his work in the context of ‘globalisation’ (imperialism). I also have no idea how you got that Marx “throws out efficiency and substitution”: he continually praised the efficiency of capitalism, and substituting capital for labour is the main driving force behind the tendency of the rate of profit to fall.
My response: I considered proposing that “efficiency of capitalism” belongs to “things Marx wrote about at various times” rather than “things that are core principles of the Marxian model.” On reflection, however, I am not convinced that Marx had a concept of efficiency at all, not in the sense that economists use it today (when you can’t reallocate resources without using more of some input or consuming less of some output). Marx did write a lot about the productiveness of capitalism, but I do not think he was thinking about total factor productivity.
Similarly, I do not think Marx had a concept of substitution in the sense of a choice between alternatives that varies with their relative price. Yes, it’s possible to rewrite Marx’s idea of the organic composition of capital (the constant/variable capital ratio) as capital/labour substitution, but that is not at all how Marx described it. His idea (Capital III, chapter 13) was that over time the ratio of constant and variable capital in value terms will tend to rise, but that seems to be driven by the accumulation of capital, not by relative factor prices. What is described is a process that piles capital up faster than labour; there is no process that allows substitution between them along a frontier. With labour the only source of surplus value, the rate of profit on capital must tend to fall.
Since Unlearning Economics charges me at the outset with “complete ignorance of Keynes and Marx,” I thought I had better come up with a test of Marx’s understanding of substitution. When I teach the subject of economic warfare I put a lot of emphasis on substitution. People who are not mainstream economists (military commanders, for example) often make biased predictions about the effectiveness of blockades and sanctions, and this is because they lack a concept of substitution. They expect a blockade to curtail production and so to cause the rapid downfall of the blockaded economy. In history, the curtailment of trade has generally brought about relative price changes that stimulate substitution and in turn this will make the blockade less effective than expected. So I looked to see how Marx wrote about blockades.
In 1861 the American Civil War led to a blockade of the Southern ports. The Confederacy responded with a cotton embargo; they thought this would trigger such a crisis in Britain’s textile industry that London would have no choice but to intervene on the Confederacy’s behalf. In the autumn of 1861 Marx wrote (in several places including here, for example) predicting that the stratagem would succeed: “England is to be driven to break through the blockade by force, to declare war on the Union, and thus to throw her sword on the scales in favour of the slave-owning states.”
It did not happen. In Britain the price of raw cotton shot up (which Marx could see), and this stimulated a search for alternative supplies, soon found in Egypt and India (which Marx entirely discounted). He had made the characteristic error of someone who does not get substitution.
Back to George Box, who wrote that “all models are wrong, but some are useful.” The models you can find in Keynes and Marx are no different; they are all wrong in the Boxian sense. Are they useful? Sometimes, yes. Marx’s idea of surplus extraction is useful for understanding societies with closed elites and extractive economies, although not modern capitalism. Keynes’s idea of animal spirits gives insight into modern capitalism as a nice corrective to the idea of rational expectations. But, why should I, or you, or anyone confine themselves to the limits of any “wrong” model by declaring that I am a Keynesian or a Marxist? When scholars do that, it surely tells us more about the politics of identity than about their scholarship.
In fact, I fear that the tone of this discussion may exemplify my final point: when social science is polarized into schools of thought, s/he who is not with me is against me and personal rancour is the likely product.
October 14, 2013
Writing about web page http://www.conservativepartyconference.org.uk/Speeches/2013_George_Osborne.aspx
At the Tory conference George Osborne, Chancellor of the Exchequer, made an interesting point about the views of Ed Milliband, Leader of the Opposition:
For him the global free market equates to a race to the bottom with the gains being shared among a smaller and smaller group of people. That is essentially the argument Karl Marx made in Das Kapital. It is what socialists have always believed.
Osborne’s point made me think about the influence of Marx on modern intellectual life. To many this is something of a puzzle. Isn’t Marxism discredited as a political philosophy? Haven’t the economic policies of Marxist regimes generally failed to provide for “an association, in which the free development of each is the condition for the free development of all” – the words by which Marx once distilled the goal of communism? How many of those that identify with the ideals of socialism today have actually read and followed even one page of the fifty volumes of the Marx-Engels Collected Works?
My answers: Yes, Yes, and Not many. Yet Marxism shows no sign of dying out; it lives on in a variety of political movements and branches of academic and cultural life.
Why’s that? The question is puzzling only if we think of Marx as the the reason why Marxist ideas exist. Of course Marx was the originator of Marxism, but I am quite sure that if Marx had never been born to invent Marxism, some other scribbler would have taken his place. The basic ideas that underlie Marxism pre-existed Marx, and would have existed without his writings, and are continually reborn and propagated among people who know nothing of Marx for a straightforward reason: because such ideas correspond with how most people experience everyday life. Marx’s importance, therefore, was not as the discoverer of these ideas but as the writer that gave them a scholarly form.
What are the experiences to which Marxist economics correspond? Behind the complicated terminology of capital and value and Marx’s elaborate philosophical and historical argumentation of them are four simple ideas:
- The market is a jungle, a chaotic struggle of each against all, in which the strongest, most ruthless predator wins. Lurking behind every transaction is the chance that someone will rip you off.
- Of all the possible functions of market prices – accounting, economising, distributive – the only one that matters is distribution. A rise in the price of food or fuel cuts the real income of workers and redistributes it in favour of the producers that employ them.
- Work is hard and stressful, and the main source of pressure is the employers' drive to make you work harder and longer, in order to save them money or increase their profits.
- You can’t do anything about this on your own. Idealistic advocacy has no traction without numbers. Everyone should get together and intervene forcibly to bring about radical improvement.
What kind of economics do these four ideas make? They make the economics of everyday lived experience for most of the world’s seven billion people. I’m not talking just about the poor and ignorant. It’s nothing to do with education or position in society. My guess would be that most people in my immediate circle of family and friends that are not trained economists hold, most likely, two or three of the four ideas; I expect that all might hold at least one.
Suppose you decided to give your life to elaborating these four ideas and you spent years working them up into a philosophy of economics: What kind of book would you write? I think you’d end up writing something pretty much like Das Kapital. In other words, Marxism is a philosophization of the economics of lived experience, but it's the economics of lived experience that should really demand our attention.
What kind of economics would lived experience support? It would make, in the words of Frederic Bastiat, the economics of “that which is seen.” It would take into account only the most immediate effects of things. It would leave out the other effects, those that “unfold in succession – they are not seen: it is well for us,” Bastiat went on, “if they are foreseen. Between a good and a bad economist this constitutes the whole difference – the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee.”
What’s wrong with the economics of “that which is seen”? By analogy, think of the physics of “that which is seen”: the earth is flat and parallel lines never meet. Or the chemistry of “that which is seen”: burning is the release of phlogiston. I’m not saying that economics is a science like physics or chemistry in all respects. What I’m saying is that Euclidean geometry, the idea of a flat earth, and the theory of phlogiston are perfectly serviceable for making sense of a number of things everyone can see from day to day. It’s true, though, that these ideas miss out badly on other things and this prevents them from being useful in many contexts. For the purposes that are missing, we need more; we need the physics and chemistry of “that which is not seen,” including molecular science, gravity, and relativity.
What is added by the economics of “that which is not seen”?
- The market creates many opportunities for sellers to abuse buyers, yet the market is not chaos: it enables specialization and competition. The same market economy that often feels like a jungle is the mechanism that has sustained the West’s unprecedented prosperity and is also the hope for sustained progress of the Rest. But this is not seen because it has taken hundreds of years to materialize; life’s too short for it to be seen. (My colleague Omer Moav makes a similar point in a penetrating review, which he showed me recently, of Ariel Rubinstein's Economic Tales.)
- If something that you consume is in short supply so that the price goes up, you lose in the short term, and this is seen. Beyond this, however, is an unseen process by which all gain. There is adaptation. Responding to the increased cost, we economize on uses, we search for substitutes, and we find or create new sources of supply. The adaptation is not seen because it would require the simultaneous observation of a million small responses.
- Work is stressful, and a predatory employer can increase the stress for the sake of profit. But that is incomplete. In the Marxian perspective there is only one kind of surplus, called profit, one source of surplus, called labour, and one class of recipients, the capitalist class. In the competitive market economy every transaction gives rise to a surplus on both sides. Day by day, billions of small surpluses accrue to both sides, buyers and sellers, that are party to every transaction. In other words, there are surpluses everywhere and they accrue to everyone; they are not the monopoly of one class. But this, too, is not seen.
- Everyone getting together to force change does not always make anything better, and this might be the case quite often. This is not seen for two reasons. First, in every case to establish the results of intervention requires the careful construction of a counterfactual (in other words, what would have happened without the intervention) which, to most people, seems intolerably speculative. Second, when intervention has demonstrably not brought about the benefit sought, there is a natural human tendency to shift the responsibility from our own action to the counteraction of those that disagree with us, whom we make into scapegoats.
Whatever things are not seen, it’s hard to know they are there. Understandably, therefore, most people stick to the economics of what they can see for themselves. Most of those don’t think of themselves as Marxists or even socialists. Still, it ensures a reservoir of instinctive sympathy in our society for ideas that are aligned with Marx's and helps to explain his lasting influence. This reservoir is continually refilled from everyday experience. That's why Marxist ideas live on and will often be well received by well educated, well intentioned people.
Full disclosure: In years gone by I considered myself a Marxist and I read a lot of Marx, Engels, Lenin, Stalin, Mao and others. At various times I joined a Capital reading group, and taught the economics of Marx (alongside Smith, Ricardo, List, and Schumpeter), and I even wrote a pamphlet called The Economics of Capitalism; I still have a copy; one day I’ll scan it and put it on line. Somewhere between that time and this, however, I changed my mind for reasons that I wrote down here.
September 16, 2013
Writing about web page http://www.ft.com/cms/s/0/03377ccc-16e0-11e3-9ec2-00144feabdc0.html#axzz2ezCPilYN
Last week I went to Downing Street for an informal discussion about Britain and China ... No, not with the prime minister, but between some academic China watchers and a couple of prime ministerial aides. Here I can only say what I said myself, but I thought afterwards whether I could package it for general interest. Here's the basic idea.
The Chinese government is currently trying to rebalance the economy. This will create both opportunities and risks for a country like Britain that exports worldwide and also has some world-class corporations that are willing to invest worldwide. It's important to be aware of what the opportunities are, and also the risks.
What does rebalancing mean? It means, primarily, trying to build China's mass market for consumer goods and services. The composition of China's spending must shift somewhat away from government and infrastructure towards consumption and the mass market. This does not mean that the government will become unimportant or that China will stop building new towns, universities, and transport systems. All of these are already huge and since the economy is still growing relatively rapidly they will remain important and also continue to grow. But net exports and capital formation together account for well over half of China's GDP, making one of the highest saving rates ever recorded for a modern economy. In other words, there is a lot of room for consumer spending to grow more rapidly at the margin, if only the pressure of government spending on infrastructure and military projects will allow it.
When China's prime minister Li Keqiang says "we will expand consumer demand" (in the FT, 8 September 2013), that doesn't make it happen, of course. The UK coalition government has talked about rebalancing our economy away from financial services to manufacturing for some time. That hasn't made it happen. Even in a totalitarian police state, rebalancing the economy can be quite difficult. Stalin's first attempt at rebalancing came in 1932, the last year of his first five-year plan, when too much capital formation and rearmament were killing off millions of people from famine. Rebalancing was urgent -- literally, a matter of life and death. The second five year plan was being written. It was supposed to rebalance the economy back towards consumption. Consumption did recover, but it was not a great deal more than a dead cat's bounce. After a year or two investment and rearmament took off again. The whole economic system had been designed around creating a surplus for accumulation and military spending. Given that, it was pretty hard for it to do anything else.
China's economic mechanism has also been designed around accumulation and military spending. An important problem with rebalancing China towards consumption is that success might weaken the drivers of the mechanism underlying China's huge success of the last 30 years. This mechanism is the rivalry of China's provincial leaders, each of whom compete with each other to win favour with Beijing and promotion to Beijing by pushing the growth of production in their own province. That growth depends a lot on infrastructural investment. If the provincial leaders can't push infrastructure as strongly before, then Beijing will have made it harder for them to compete. If they don't compete as strongly, the economy may falter, undermining the core purpose of rebalancing.
Still, China's ruling party has come to accept that a growing mass market can stabilize society and relax social tensions, making China stronger internationally. So let's suppose they can make it happen. There are opportunities here for British businesses to meet rising consumer demand, whether by exporting or by investing in China and producing within China's borders. As people get richer they want to be healthier, and better informed, and to enjoy faster communication. There is sure to be rising demand for things like telecoms and pharmaceuticals that Britain is good at making and doing.
One problem with exporting to China and investing in China is that China's market is very wide -- too wide, in fact. It is spatially highly dispersed, because too many Chinese live in small towns and rural settlements. It is also not very well integrated, with significant barriers to internal trade across provincial boundaries -- a product of the inter-provincial rivalry that has helped China's past growth. In other words, if you sell to the Chinese, you might expect to go to a market of 1.3 billiion people, but what you actually reach is one of 30 or so provincial markets. Of course, this isn't so bad because a typical province in China is the size of a European country in population, which is pretty big. It's also true that China's market integration is most likely improving over time. Still, it doesn't yet add up to the idea of selling a lightbulb to every Chinese family.
Another problem is that China's market has many, many opportunities for vested interests to conspire with government officials against competitive threats (and therefore against the consumer). Corruption remains a huge problem. China's government is currently waging an anti-corruption campaign. Anti-corruption is fine, but the campaigning aspect is problematic. The best way to reduce corruption is to reduce product market regulation and have open, competitive markets and the rule of law. China's communist party continues to prefer party rule to the rule of law. The result is that, when you see a person (like Bo Xilai) or an organization (like GlaxoSmithKline) targeted for corruption, you can't really be sure whether they are guilty as an impartial court would see the evidence, or whether the political authorities decided to make them guilty of something and then make the evidence up.
That's a particular risk for foreign investors in China. Of course, foreign investors face risks everywhere. Anyone who has followed the recent history of BP in the United States will be aware that a foreign corporation can become a target even in a liberal democracy with an independent judicial system. The point may be that at least BP had first to do something wrong before it became a target. In a corrupt police state like China's, in contrast, you can get into trouble even if you did nothing wrong. Or perhaps, more accurately, there are contexts in which everyone bends the rules, or the rules may be so complex and pervasive that you can't operate at all without breaking them somehow. Then, the foreign investor either sticks to the rules, which leaves you unable to compete, or you compete and break the rules like everyone else, but that means you are making yourself ever vulnerable to those in power. Indeed that might be one purpose of a rule book that no one can adhere to conscientiously.
Finally, helping China to build its mass market is an opportunity for British business, but it is important to recognize that for China's leaders building the mass market is not an end in itself but an exercise in national power-building. Prime minister Li acknowledged this when he linked China's mass market with sustainable growth and both of the latter with "national strength." In other words, if we help develop China's consumer market, we should do so with open eyes: we are also colluding with a project that is designed to reduce our own country's relative power and influence in the world to China's benefit.
Is that a reason to stand aside? In my view, not at all. In the long run, free trade and investment have civilizing power. (In case anyone thinks that's snobbish, I mean it literally: free exchange develops civil-society institutions in ways that governments cannot.) Countries that make themselves economically interdependent are are then somewhat less likely to come into conflict. That's not a deterministic statement, by the way. The power of trade is double edged, because trade can be exploited to build national power. The civilizing influence of trade takes lots of time. It works through probabilities, not certainties. It's an average thing, with plenty of variation and historical counter-examples.
So we should trade with China and invest in China with our eyes open. We should remain aware that China's rulers are heirs to the communist tradition. In this tradition the world is an arena for a zero-sum power struggle in which, in the long run, one country's gain is likely to be another's loss. These leaders want China to develop its mass market not for the sake of consumer welfare but because a more sustainable Chinese economy and a more stable society will better support their national and international strategic goals.
The benefits that we should seek from economic interaction with China are those that will flow to the citizens of both countries, and to consumers as well as producers. For example, the benefits of trade and investment will come back to the British economy not only through our exports to China's growing market but also by access to imports from China that lower prices and raise living standards in Britain.
August 29, 2013
Since last week’s gas attack on a Damascus suburb, the political class has been gripped by the idea that “something must be done.” Meanwhile Wall Street, already declining through early August, fell further as this week began. At the same time oil prices have ticked up sharply, not because Syria is a significant oil producer, but in response to fears for Middle Eastern supplies generally.
A military attack on Syria would clearly affect stock values. War diverts trade: some businesses lose while others gain. Is war good for business in the aggregate? Not likely. When an economy is depressed, and the fighting is at a comfortable distance, additional military spending might give a short-run stimulus to business for everyone. In the long run, however, war is a wealth-destroying activity. Because stock values reflect long-run profit expectations, the chances of a positive aggregate effect from hostilities are vanishingly improbable.
It is a somewhat different question whether the launching of an attack will move stock values on the day. Cruise missiles rarely come from a blue sky. Those for whom war has clear implications will usually have looked into the future and hedged their bets.
On the day the fighting starts, it is true, war changes from a probability to a certainty. But if the probability was already seen as close to 100%, the impact on asset values will inevitably be small. Only a true surprise would move them by much.
Economic historians first became interested in this topic in connection with World War I, the outbreak of which was a surprise to many. Niall Ferguson (in the Economic History Review 59:1 (2006)) and others (Lawrence, Dean, and Robert in the Economic History Review 45:3 (1992) have documented that as the war began European bond prices fell and unemployment rose in London, Paris, and Berlin. The panic on Wall Street was so great that the New York Stock Exchange was closed for the rest of the year.
To update the record across the last 100 years, the chart below shows closing values of the Dow Jones Industrial Average in New York for the ten working days before and after eight war onsets (the value on the day itself is omitted).
Source: Mark Harrison, "Capitalism at War," forthcoming in The Cambridge History of Capitalism, edited by Larry Neal and Jeff Williamson for Cambridge University Press. [Thanks to Christopher Renner for drawing my attention to a misprint and a small error in the first version of this chart.]
The days shown are:
- September 11, 2001: Al-Qaeda attacks American cities
- August 2, 1990: Iraq invades Kuwait
- August 7, 1964: Gulf of Tonkin Resolution
- June 25, 1950: North Korea invades South Korea
- December 7, 1941: Japan attacks Pearl Harbor
- September 1, 1939: Germany invades Poland
- March 1, 1917: The Zimmermann telegram published
- July 28, 1914: Russia mobilises against Germany
Only two of these events saw stock prices climb, and then only slightly. In five cases they fell, and in two the stock market was closed (for more than four months after the outbreak of World War I in Europe, and for four days after 9/11).
Notably, although stock prices rose a little after Hitler’s attack on Poland in 1939, they fell thereafter. When Pearl Harbor arrived, they remained below the level recorded two years earlier. The median change in stock prices over the eight crises was a 5.3% decline.
Contrary to commonly held opinion, war has also been bad news generally for the very rich. Tony Atkinson, Thomas Piketty, and Emmanuel Saez have collected historical data on top incomes in many countries across the twentieth century. These show sharp wartime declines in the personal income shares of the very rich in every belligerent country for which wartime data are available.
This does not rule out the idea that a few corporations gain business, and a few people become richer as a result of conflict. It just tells us that the average effect goes the other way. Besides, war is always first and foremost a political act. If Western bombs fall on Damascus in the next few days, it will be because someone decided it made good politics, not good business.
Mark Harrison does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.
July 16, 2013
Writing about web page http://www.pieria.co.uk/articles/in_defence_of_protectionism
On Pieria, John Aziz writes in defence of protectionism, that is, the use of taxes and subsidies to shield a country's economy from foreign competition. He begins from the Ricardian story of the benefits of two countries sharing the benefits of free trade based on comparative advantage.
England was good at producing wool, Portugal wine, so they trade and both are better off. There is the fairy tale about how because market transactions are always voluntary and always beneficial that trade, being simply a market transaction across borders, is always win-win.
But this, he says, is a "fairy tale." In real life, he argues, comparative advantage has little to do with resource endowments and is generally artificial. Comparative advantage may be part of the historical pattern, he concedes. But it misses something essential. What's missing? He goes on.
Let's imagine a model with two different goods, say, guns and butter. England specialises in producing guns and munitions, and Portugal in butter and agricultural produce. For years, they trade and enjoy the benefit of maximising output through specialisation. Then, England starts a trade dispute with Portugal. They cease trading. England loses access to butter and various agricultural products from Portugal's large population of butter-producing cows, having to replace Portuguese butter with lower-quality and higher-priced Welsh butter. Portugal, however, loses access to guns and munitions. Although this is immediately recognised as a risk to national security, and Portugal quickly tries to start up its own domestic firearms industry, the trade dispute escalates into full-blown war and with their geostrategic advantage in guns, England swiftly triumphs and occupies Portugal.
The implication is clear. Portugal should have insured itself against the contingency of conflict with England by limiting trade through protectionism. By means of an interventionist industrial policy, Portugal would have developed its own guns and could then have resisted England.
Several things are noteworthy about this argument.
First, it too is a fairy tale. As John Aziz rightly points out, there's nothing intrinsically wrong with that. All our models are fairy tales. The point is that some are useful and others not. How can we tell? We test them against stuff that has actually happened. If they survive the confrontation, then we can use them to suggest practical implications for the future. So, the fact that it's a fairy tale is of interest, but it's not a problem. Let's move on.
Next noteworthy point: Let's test this model against something that actually happened. Not literally, because England has not been to war with Portugal since long before gunpowder came along. Replace Portugal by Germany, however, and the fairy tale suddenly acquires an ominous ring of truth. Doesn't it have an uncanny fit with what happened in 1914?
No, not exactly. In 1914 Germany and Britain went to war. While Britain was the pioneer of free trade, Germany had practised protectionism since 1879. German tariffs limited trade and promoted self-sufficiency in both industrial and agricultural goods. In Britain, by contrast, free trade accelerated the decline of agriculture and maximized the exposure of the British economy to imports. In 1913 at least 60 percent of the calories used at home for human consumption were imported. Many observers thought that left Britain ridiculously vulnerable to wartime blockade. German naval strategists agreed. It's true that in World War I food became a weapon of war just as much as guns.
Yet in the outcome it was Germany, the protectionist power, that struggled to manage the wartime disruption of trade and saw civilians die of hunger, while the British got by without serious shortages.
What explains this turnaround? As Mançur Olson (1963) argued (and before him Friedrich Aeroboe), the German economy entered the war in 1914 already weakened by protectionism. Food tariffs had encouraged peasant farmers to stay on their farms. This kept a large subsistence agriculture in being and reduced productivity and incomes. Because German farmers were already well into diminishing returns it was then hard to increase output at need, when war broke out.
As for industry, because imports of food into Germany were restricted in peacetime and labour held back in agriculture, German urban employers faced higher wage costs. To compensate for higher wage costs, industrial firms economized on labour and pushed up productivity. But across the economy as a whole, efficiency and average incomes were reduced.
A history of protectionism gave no national advantage in either World War. I've argued (in several places; see Harrison 2012 for example) that the main factors that gave systematic advantage were a country's size and wealth, and the main source of disadvantage was a peasant-based agriculture.
In that case, what's protectionism all about? In understanding protectionism, redistribution is much more important than development. Whether tariffs and subsidies raise or lower long-run growth, in the short run they redistribute income away from consumers and exporters to import-competing firms, often by very large amounts. This should draw attention to their political significance. As Dani Rodrik (1995, p. 1470) once wrote:
Saying that trade policy exists because it serves to transfer income to favored groups is a bit like saying Sir Edmund Hillary climbed Mount Everest because he wanted to get some mountain air.
In history, protectionism has given politicians a powerful instrument to bind those "favored groups" into their projects. To Bismarck, protectionism was political: it brought together the interests of "iron and rye" to share rents and support Germany's "peaceful rise." Similar motivations lie behind most real-life experiments in protectionism that I am familiar with. The only real exception is the Soviet experience of autarkic industrialization; that was different because Stalin was an absolute dictator who ruled by fear and had no need to pay off campaign funders.
Modern promoters of the developmental state (including Dani Rodrik) could reply that they advocate only those selective interventions that are designed to improve social welfare, not corrupt the political process. That's an argument I understand, but it requires a benevolent, far-sighted government with the power to intervene and the self-restraint to do so only for the common good, not for the good of its supporters. That's a bit of a problem. I don't see a political system anywhere, short of totalitarian dictatorship, in which you could advance those policies and see them implemented without vested interests jumping on your bandwagon and hijacking it for their own purposes, which will have nothing to do with social welfare.
(It's ironic, then, that John Aziz lists "graft and corruption" as a problem of trade liberalization, because opportunities for corruption are created only where the government has something to withhold.)
The historical link between protectionism and aggressive nation building is strong. Using data for 1950 to 1992 Erik Gartzke (2007) has shown that restricting a country's trade and capital flows is a good predictor of its propensity to engage in conflict. From data for 1865 and 1914, Patrick McDonald and Kevin Sweeney (2007) have shown that protectionism was a robust precursor of engagement in "revisionist" wars.
John Aziz concludes with a warning:
China's monopoly on rare earth metals which have very many military applications may have national security implications for other nations including Britain and the United States whose ability to manufacture modern military equipment might be impeded by a trade breakdown.
Shouldn't we worry? Yes, but that's because we need to understand China, not because we should be preparing for war. Indeed, one of Mancur Olson's key conclusions was that it's a mistake to think of particular raw materials, and even oil or food, as in some way "strategic" or "essential." Only the final uses of resources are essential. In practice, if some particular material suddenly becomes scarce, the price goes up and and opportunities present themselves to economize at the margin or find alternative sources or substitutes.
The price goes up, it's true. In other words, the alternatives may be costly. But the richer you are, the more easily you can meet the cost. That's why rich countries survive trade disruption and win wars. As for protectionism, to the extent that it diverts resources from their best uses, it makes the country poorer in advance and so less able to afford the measures that might become necessary in a national emergency.
Which brings me to the last noteworthy point about the arguments that John Aziz makes: They have nothing to do with personal well being. As he correctly comments:
The relative value of outcomes is simply a matter of one's criteria.
In truth, the two fairy tales that he tells differ in addressing completely different criteria. The free-trade fairy tale always was and is about the personal welfare of all members of society. Here, society is global: when trade is free, all gain, not just the residents of one country. The protectionist fairy tale, in contrast, is about nation-building and facilitating conflict in a world where elite coalitions build states, states compete for power, and a gain for one country is a loss to others.
The world is a complicated place. In the same spirit as John Aziz when he notes that the free trade story has some merit, I'm going to accept that the unregulated interaction between real world economies sometimes creates losers. There have evidently been historical circumstances when protectionist policies accidentally did no harm, or even did good by accidentally correcting some market failure.
But the design of protectionism has generally been far more driven by vested interests and power building than by concern for social welfare. Those who enter themselves in the reckoning against free trade often rely on an idealized understanding of the record.
- Gartzke, Erik. 2007. The Capitalist Peace. American Journal of Political Science 51:1, pp. 166-191.
- Harrison, Mark. 2012. Pourquoi les riches ont gagné: Mobilisation et développement économique dans les deux guerres mondiales. In Deux guerres totales 1914-1918 − 1939-1945: La mobilisation de la nation, pp. 135-179. Edited by Dominique Barjot. Paris: Economica, 2012 (here's a preprint in English).
- McDonald, Patrick J., and Kevin Sweeney. 2007. The Achilles’ Heel of Liberal IR Theory? Globalization and Conflict in the Pre-World War I Era. World Politics 59:3, pp. 370-403.
- Olson, Mançur. 1963. The Economics of the Wartime Shortage: A History of British Food Supplies in the Napoleonic War and in World Wars I and II. Durham, NC: Duke University Press.
- Rodrik, Dani. 1995. Political Economy of Trade Policy. In Handbook of International Economics, vol. 3, pp. 1457-1494. Edited by Gene Grossman and Kenneth Rogoff. Elsevier.
April 09, 2013
Writing about web page http://www.voxeu.org/article/economic-legacy-mrs-thatcher
Like a million other bloggers and tweeters, I woke this morning thinking about Margaret Thatcher, who has just died.
The front page of this morning's Coventry Telegraph calls her "The woman who divided a nation." In the Financial Times, Janan Ganesh notes that those who call her policies "divisive" often wish to avoid a simple fact: "It is almost impossible to do anything significant without enraging some people"; at best, they indulge "the fantasy that her reforms could have been undertaken consensually."
In my heart, at the time, I was enraged by what Margaret Thatcher did. But now she belongs to history. In my head, looking back as an economic historian, I have to acknowledge the necessity of it. When she came to power, our country was a pretty miserable place: stagnant, strife-torn, and full of bullies. Money was more equally distributed than it is now, but money was worth less than power, and power was highly concentrated in the hands of state monopolies, private monopolies, and organized labour. If you are among the many that think heavier taxation and more market restrictions can make a more consensual, peaceful society, you need to take a closer look at this period of our history. In short, Margaret Thatcher did not invent social division and conflict, which were already present, but she redrew the lines in favour of market access and free enterprise.
When the economic historian looks back, what else is there to see? No one has looked back more clearly than my colleague Nick Crafts on yesterday's Voxeu, so I'll leave the last word on that to him.
I'll finish on a personal note. Nothing annoyed me more at the time than what Margaret Thatcher famously had to say about "society," for I am a social scientist and what she appeared to say was that society does not exist:
I think we have gone through a period when too many children and people have been given to understand “I have a problem, it is the Government's job to cope with it!” or “I have a problem, I will go and get a grant to cope with it!” “I am homeless, the Government must house me!” and so they are casting their problems on society and who is society? There is no such thing! There are individual men and women and there are families and no government can do anything except through people.
Yet a close reading shows that Thatcher had in mind something very close to the kind of model that all economists must use to understand the distribution of income in society, based on the idea that income must be produced by some before it can be redistributed to others:
When people come and say: “But what is the point of working? I can get as much on the dole!” You say: “Look” It is not from the dole. It is your neighbour who is supplying it and if you can earn your own living then really you have a duty to do it and you will feel very much better!”
It's a message for today. I didn't want to hear it at the time. Thatcher didn't seem too bothered by that, and that annoyed me even more. It's still hard for me to say it, but it was a good thing she didn't care.
April 03, 2013
Follow-up to From 1914 to 2014: The Shadow of Rational Pessimism from Mark Harrison's blog
Is the North Korean regime crazy or calculating? Here is a timeline of North Korea's actions since March 10, when I wrote last.
- March 11: North Korea revokes the armistice ending the Korean War in 1953.
- March 12: Kim Jong Un places the North Korean armed forces on maximum alert.
- March 20: Attacks on South Korean news and banking websites, possibly from North Korea.
- March 27: North Korea cuts a military hotline to the Kaesŏng special region (a joint economic project with South Korea).
- March 29: Kim Jong Un places the North Korean armed forces on standby to strike U.S. territories.
- March 30: North Korea warns of a state of war with South Korea.
- April 2: North Korea will restart weapons-related nuclear facilities.
- April 3: North Korea closes entry to the Kaesŏng special region.
In various ways, these are all costly actions. Some are financially costly to Pyongyang, such as restarting nuclear facilities and disrupting Kaesŏng-based production and trade. Other are reputationally costly, because they stake out positions that are hard to retreat from without loss of face. All of them have a common element of danger -- the risk of triggering a ruinous catastrophe.
Why is North Korea doing these things if they are so costly? In a common interpretation, the North Korean regime is crazy. They don't understand the world or know what is good for themselves. I think this is unlikely.
On the basis that the North Korean leaders are not insane, there are several possible ways to think about their actions and understand them, but in the end they all point to the same outcome.
Opportunity cost. While the measures listed above are costly, North Korea believes that it would not find a better alternative use of the resources consumed or put at risk as a result of their actions. There are few profitable opportunities for production in the world's worst economic system. Investing in confrontation may well be, for North Korea, the better alternative.
Diminishing returns.In the past, North Korea has extracted billions of dollars of aid from South Korea and the West by holding its own people hostage and showing a willingness to play with fire. The problem with this strategy is that Western countries and their Asian partners have learned how it works. As a result, the North Korean strategy has run into diminishing returns. Pyongyang can continue to extract an advantage only by going to greater and greater lengths. This means taking greater and greater risks with peace.
Rational pessimism (That's what I wrote about here). North Korea's leaders see two scenarios. In one, there is a peaceful future in which their regime will inevitably disintegrate and howling mobs will drag them into the street and tear them to pieces. In another, there is a high probability of war in which millions might perish but there is some faint chance of regime survival. You wouldn't jump at either, and you might not rush to make a choice. Still, ask yourself: If you were Kim Jong Un, and push came to shove, which would you prefer?
February 04, 2013
Writing about web page http://cpasswarwick.wordpress.com/overview-2/peking-conference/proposed-topics/
On Friday evening I found myself debating "Socialism vs Capitalism: The future of economic systems" at the Peking Conference of the Warwick China Public Affairs and Social Service Society. The organizers also invited my colleagues Sayantan Ghosal, Omer Moav, and Michael McMahon, who spoke eloquently. The element of debate was not too prominent because we all said similar things in different ways. I'm an economic historian and the great advantage of history is that it gives you hindsight. Anyway, here is what I said:
Let’s start from some history. There was a time between the two world wars when the capitalist democracies, like America, Britain, France, and Germany, were in a lot of trouble. In 1929 a huge financial crisis began in the United States and went global. There was a Great Depression. Around the world, many tens of millions of farmers were ruined. Tens of millions of workers lost their jobs.
As today, people asked: What was the cause of the problem? One answer they came up with was: Capitalism is the problem. Lots of people decided: the problem is the free market economy! The government should step in to take over resources and direct them! The government should get us all back to work! The government should get us building new cities, power stations, and motorways!
Another answer many of the same people came up with was: Democracy is the problem. Lots of people decided: the problem is too much politics! We need a strong ruler to stop the squabbling! Someone who can make decisions for the nation! Someone who can organize us to build a common future together!
So there was a search for alternatives to capitalism. Different countries tried different alternatives. The alternatives they tried included national socialism (or fascism) and communism under various dictators, like Hitler and Stalin.
What happened next? On average the dictators’ economies did recover from the Depression faster than the capitalist democracies.
(Here's a chart I made earlier to illustrate the point, but I did not have the opportunity to use it in my talk. Reading from the bottom, the democracies are the USA, France, and the UK; the dictatorships are Italy, Germany, Japan, and the USSR. You can see that Italy does not conform to the rule that the dictators' economies recovered faster. Without Italy, the average economic performance of the dictatorships would have looked even better.)
But solving one problem led to another. Before the 1930s were over the dictators’ policies had already caused millions of deaths. A Japanese invasion killed millions in China (I'm not sure how many). An Italian invasion killed 300,000 in North Africa. Soviet economic policies caused 5 to 6 million hunger deaths in their own country and Stalin had a million more executed.
And another problem: As political scientists have shown, democracies don’t go to war (with each other). Dictators go to war with democracies (and the other way round). And dictators go to war with each other. The result of this was that in the 1940s there was World War II. Hitler, Mussolini, Tojo, and Stalin went to war -- with the democracies and with each other. Sixty million more people died.
After the war, capitalism recovered. In fact, far from being a problem, it became the solution. By the 1960s all the lost growth had been made up. Think of the economic losses from two World Wars and the Great Depression. If all you knew about capitalist growth was 1870 to 1914 and 1960 onwards, you’d never know two World Wars and the Great Depression happened in between.
(To illustrate that point, here's another chart I made earlier, but did not use. It averages the economic performance of Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Netherlands, New Zealand, Norway, Sweden, Switzerland, the UK, and the USA.)
After World War II fascism and national socialism fell into disrepute, but communism carried on. In China, Mao Zedong’s economic policies caused more deaths. In 1958 to 1962, 15 to 40 million people starved. Communist rule led China into thirty years of stagnation and turmoil. After that Deng Xiaoping made the communist party get its act together. And the communists forgave themselves for their past and agreed to forget about it.
Here's the takeaway.
Liberal capitalism isn’t perfect, but it has done far more for human welfare than communism. It has been the solution more often than the problem. Last time capitalism experienced some difficulties, many countries went off on a search for alternatives. That search for alternatives led nowhere. It wasn’t just unproductive. It was a terrible mistake that cost many tens of millions of lives. Lots of people have forgotten this history. Now is a good time to remember it.
Postscript. At one point I thought of calling this blog "Alternatives to capitalism: the search for a red herring" (a "red herring" is something that doesn't exist but people look for it anyway.) But I realized that would have been wrong, because alternatives to capitalism have actually existed. The problem with the alternatives is not that we cannot find them. It is that the people who went searching for them fell into a dream and woke up to a nightmare.
October 15, 2012
Writing about web page http://ideas.repec.org/a/aea/jeclit/v45y2007i1p5-38.html
Tail risks are the risks of worst-case scenarios. The risks at the far left tail of the probability distribution are typically small: they are very unlikely, but not impossible, and once or twice a century they will come about. When they do happen, they are disastrous. They are risks we would very much like to avoid.
How can we compare the tail risks of government intervention with the tail risks of leaving things to the market? Put differently, what is the very worst that can happen in either case? Precisely because these worst cases are very infrequent, you have to look to history to find the evidence that answers the question.
To make the case for government intervention as strong as possible, I will focus on markets for long-term assets. Why? Because these are the markets that are most likely to fail disastrously. In 2005 house prices began to collapse across North America and Western Europe, followed in 2007 by a collapse in equity markets. By implication, these markets had got prices wrong; they had become far too high. The correction of this failure, involving large write-downs of important long term assets, led us into the credit crunch and the global recession.
Because financial markets are most likely to fail disastrously, they are also the markets where many people now think someone else is more likely to do a better job.
What's special about finance? Finance looks into the future, and the future is unexplored territory. Only when that future comes about will we know the true value of the long-term investments we are making today in housing, infrastructure, education, and human and social capital. But we actually have no knowledge what the world will be like in forty or even twenty years' time. Instead, we guess. What happens in financial markets is that everyone makes their guess and the market equilibrium comes out of these guesses. But these guesses have the potential to be wildly wrong. So, it is long-term assets that markets are most likely to misprice: houses and equities. When houses and equities are priced very wrongly, chaos results. (And in the chaos, there is much scope for legal and illegal wrongdoing.)
When housing is overvalued, too many houses are built and bought at the high price and households assume too much mortgage debt. When equities are overvalued, companies build too much capacity and borrow too much from lenders. To make things worse, when the correction comes it comes suddenly; markets in long term assets don't do gradual adjustment but go to extremes. In the correction, nearly everyone suffers; the only ones that benefit are the smart lenders that pull out their own money in time and the dishonest borrowers that pull out with other people’s money. It's hard to tell which we resent more.
If markets find it hard to price long term assets correctly, and tend to flip from one extreme to another, a most important question then arises: Who is there that will do a better job?
It's implicit in current criticisms of free-market economics that many people think like this. Financial markets did not do a very good job. It follows, they believe, that someone else could have done better. That being the case, some tend to favour more government regulation to steer investment into favoured sectors. Others prefer more bank regulation to prick asset price bubbles in a boom and underpin prices in a slump. The latter is exactly what the Fed and the Bank of England are doing currently through quantitative easing.
Does this evaluation stand up to an historical perspective?
We’re coming through the worst global financial crisis since 1929. Twice in a century we've seen the worst mess that long-term asset markets can make -- and it's pretty bad. A recent estimate of the cumulative past and future output lost to the U.S. economy from the current recession, by David H. Papell and Ruxandra Prodan of the Boston Fed, is nearly $6 trillion dollars, or two fifths of U.S. output for a year. A global total in dollars would be greater by an order of magnitude. What could be worse?
For the answer, we should ask a parallel question about governments: What is the worst that government regulation of long term investment can do? We'll start with the second worst case in history, which coincided with the last Great Depression.
Beginning in the late 1920s, the Soviet dictator Stalin increasingly overdid long term investment in the industrialization and rearmament of the Soviet Union. Things got so far out of hand that, in Russia, Ukraine, and Kazakhstan in 1932/33, as a direct consequence, 5 to 6 million people lost their lives.
How did Stalin's miscalculation kill people? Stalin began with a model that placed a high value (or “priority”) on building new industrial capacity. Prices are relative, so this implied a low valuation of consumer goods. The market told him he was wrong, but he knew better. He substituted one person’s judgement (his own) for the judgement of the market, where millions of judgements interact. He based his policies on that judgement.
Stalin’s policies poured resources into industrial investment and infrastructure. Stalin intended those resources to come from consumption, which he did not value highly. His agents stripped the countryside of food to feed the growing towns and the new workforce in industry and construction. When the farmers told him they did not have enough to eat, he ridiculed this as disloyal complaining. By the time he understood they were telling the truth, it was too late to prevent millions of people from starving to death.
This case was only the second worst in the last century. The worst episode came about in China in 1958, when Mao Zedong launched the Great Leap Forward. A famine resulted. The causal chain was pretty much the same as in the Soviet Union a quarter century before. Between 1958 and 1962, at least 15 and up to 40 million Chinese people lost their lives. (We don’t know exactly because the underlying data are not that good, and scholars have made varying assumptions about underlying trends; the most difficult thing is always to work out the balance between babies not born and babies that were born and starved.)
This was the worst communist famine but it was not the last. In Ethiopia, a much smaller country, up to a million people died for similar reasons between 1982 and 1985. If you want to read more, the place to start is “Making Famine History” by Cormac Ó Gráda in the Journal of Economic Literature 45/1 (2007), pp. 5-38. The RePEc handle of this paper is http://ideas.repec.org/a/aea/jeclit/v45y2007i1p5-38.html.
Note that I do not claim these deaths were intentional. They were a by-product of government regulation; no one planned them (although some people do argue this). At best, however, those in charge at the time were guilty of manslaughter on a vast scale. In fact, I sometimes wonder why Chinese people still get so mad at Japan. Japanese policies in China between 1931 and 1945 were certainly atrocious and many of the deaths that resulted were intended. Still, if you were minded to ask who killed more Chinese people in the twentieth century, the Japanese imperialists might well have to cede first place to China's communists. However, I guess there is less national humiliation in it when the killers are your fellow countrymen than when they are foreigners.
To conclude, no one has the secret of correctly valuing long term assets like housing and equities. Markets are not very good at it. Governments are not very good at it either.
But the tail risks of government miscalculation are far worse than those of market errors. In historical worst-case scenarios, market errors have lost us trillions of dollars. Government errors have cost us tens of millions of lives.
The reason for this disparity is very simple. Markets are eventually self-correcting. "Eventually" is a slippery word here. Nonetheless, five years after the credit crunch, worldwide stock prices have fallen, house prices have fallen, hundreds of thousands of bankers have lost their jobs, and democratic governments have changed hands. That's correction.
Governments, in contrast, hate to admit mistakes and will do all in their power to persist in them and then cover up the consequences. The truth about the Soviet and Chinese famines was suppressed for decades. The party responsible for the Soviet famine remained in power for 60 more years. In China the party responsible for the worst famine in history is still in charge. School textbooks are silent about the facts, which live on only in the memories of old people and the libraries of scholars.
September 19, 2012
A thought experiment: Imagine what would happen to the Greek economy if a European trade union managed to secure the same salaries for Greece’s public employees as for their German counterparts. If that sounds like a bad idea to you, then consider the fact that in Britain we already have this arrangement across our country's regions.
Nationwide pay bargaining imposes a limited salary range for all public sector jobs of a given type across our country, so that local pay cannot vary to reflect local conditions. Think about the North East. This is our "Greece," a region where house prices and private-sector wages are lower than elsewhere. The national bargain means that in the North East public employees will be relatively overpaid. In contrast, the South East is our "Germany." There, house prices and private-sector wages are relatively high, so the same job for the same nominal pay will be underpaid. It sounds like the effects should balance out across the country as a whole, but the available research shows that they don’t. On balance, we lose.
In the North East the public sector can easily attract employees. At the same time the private sector is blighted: on the evidence of Giulia Faggio and Henry Overman, firms that could sell to the national or international market and would otherwise have the potential to grow are squeezed because they cannot attract workers away from high-wage public employment. On average, Jack Britton, Carol Propper, and John van Reenan have shown, the residents of the North East get good schools and good health care. But the average does not apply to everyone; as Alison Wolf has argued, the gains go primarily to the pockets of affluence; schools and hospitals in particularly deprived areas within the region still struggle to recruit competent staff.
In the South East, the same research shows, hospitals and schools have struggled to recruit because public employees are relatively underpaid. They rely excessively on agency staff and teaching assistants. The education of children and the health of residents have suffered. Within the South East the losses bear more heavily on more deprived communities, because better-off families can turn to private education and health care.
Do the gains balance the losses? No. Carol Propper and her co-authors have shown that the health and educational losses in regions where public employees are relatively underpaid exceed the gains where the converse applies. It doesn’t all balance out. As a result, our country as a whole is left worse off.
Who gains? Apparently, two minorities. One minority is the public employees in the low house-price, low private-wage regions, who gain real income. Another minority is the national trade union officials who have gained status and power from national bargaining. They achieve this by siphoning influence away from their own grass roots – and money out of the Treasury.
National pay bargaining in the public sector is a mechanism that benefits a few and leaves the community worse off. It demands reform. Individual wage bargaining in the public sector would move the public and private sectors towards a level footing in each region. The overwhelming majority of our citizens would gain. Proposals for individual bargaining are sensible, and this is why I support them.
- Britton, Jack, and Carol Propper. 2012. “Centralized Pay Regulation of Teachers and School Performance.” University of Bristol, Imperial College London, and the Centre for Economic Policy Research. Working Paper. Abstract: “Teacher wages are commonly subject to centralised wage bargaining resulting in flat teacher wages across heterogenous labour markets. Consequently teacher wages will be relatively worse in areas where local labour market wages are high. The implications are that teacher output will be lower in high outside wage areas. This paper investigates whether this relationship between local labour market wages and school performance exists. We exploit the centralised wage regulation of teachers in the England and use data on over 3000 schools containing around 200,000 teachers who educate around half a million children per year. We find that regulation decreases educational output. Schools add less value to their pupils in areas where the outside option for teachers is higher and this is not offset by gains in lower outside wage areas.” Available at: http://www.bristol.ac.uk/cmpo/events/2012/doctoralconference/britton.pdf.
- Faggio, Giulia, and Henry G. Overman. 2012. “The Effect of Public Sector Employment on Local Labour Markets.” London School of Economics, Spatial Economics Research Centre Discussion Paper no. 111. Abstract: “This paper considers the impact of public sector employment on local labour markets. Using English data at the Local Authority level for 2003 to 2007 we find that public sector employment has no identifiable effect on total private sector employment. However, public sector employment does affect the sectoral composition of the private sector. Specifically, each additional public sector job creates 0.5 jobs in the nontradable sector (construction and services) while crowding out 0.4 jobs in the tradable sector (manufacturing). When using data for a longer time period (1999 to 2007) we find no multiplier effect for nontradables, stronger crowding out for tradables and, consistent with this, crowding out for total private sector employment.” Available at http://www.spatialeconomics.ac.uk/textonly/serc/publications/download/sercdp0111.pdf.
- Giordano, Raffaela, Domenico Depalo, Manuel Coutinho Pereira, Bruno Eugène, Evangelia Papapetrou, Javier J. Perez, Lukas Reiss, and Mojca Roter. 2011. The Public Sector Pay Gap in a Selection of Euro Area Countries. European Central bank Working Paper no. 1406. Abstract: Abstract: “We investigate the public/private wage differentials in ten euro area countries (Austria, Belgium, France, Germany, Greece, Ireland, Italy, Portugal, Slovenia and Spain). To account for differences in employment characteristics between the two sectors, we focus on micro data taken from EU-SILC. The results point to a conditional pay differential in favour of the public sector that is generally higher for women, at the low tail of the wage distribution, in the Education and the Public administration sectors rather than in the Health sector. Notable differences emerge across countries, with Greece, Ireland, Italy, Portugal and Spain exhibiting higher public sector premia than other countries. Available at http://www.ecb.int/pub/pdf/scpwps/ecbwp1406.pdf.
- Propper, Carol, and John Van Reenan. 2010. “Can Pay Regulation Kill? Panel Data Evidence on the Effect of Labor Markets on Hospital Performance.” Journal of Political Economy 118:2, pp. 222-273. Abstract: “In many sectors, pay is regulated to be equal across heterogeneous geographical labor markets. When the competitive outside wage is higher than the regulated wage, there are likely to be falls in quality. We exploit panel data from the population of English hospitals in which regulated pay for nurses is essentially flat across the country. Higher outside wages significantly worsen hospital quality as measured by hospital deaths for emergency heart attacks. A 10 percent increase in the outside wage is associated with a 7 percent increase in death rates. Furthermore, the regulation increases aggregate death rates in the public health care system.” Repec handle: http://ideas.repec.org/a/ucp/jpolec/v118y2010i2p222-273.html.
- Wolf, Alison. 2010. More than We Bargained For: The Social and Economic Costs of National Wage Bargaining. CentreForum: London. Executive summary: “Britain’s centralised wage bargaining systems are bad for the country and getting more so. They create enormous barriers to the improvement of public services, and to rational decision making at a time of fiscal crisis. They penalise our poorest regions, by distorting their labour markets and standing in the way of economic growth. They do not need to be the way they are; and they do need to be changed. […] Britain needs to rid itself of rigid centralised wage bargaining. These systems are economically harmful, undermine quality in the public services, and perpetuate disadvantage. Swedish experience shows that individual contracts are popular and successful and Britain, too, should make that change.” Available at http://www.centreforum.org/assets/pubs/more-than-we-bargained-for.pdf.