All 54 entries tagged Politics

The Value of a Vote and China's Governance Deficit

Writing about web page http://www.bbc.co.uk/news/world-us-canada-20233064

Whatever you think of the outcome this morning, it's clear that American voters placed a high value on their chance to choose the next president. In the East Coast states buffeted by Hurricane Sandy, where many are homeless or without power, turnout was heavy.

That's not how it is in China, where the next leadership will "emerge" in a few days' time from the communist party's eighteenth national congress.

Although not a professional China watcher, a few months ago I began to notice a rash of articles telling us how much better off China is with its supposedly meritocratic leadership selection process. What's more, we are told, it's such a great system that the Chinese people themselves endorse it. China's leadership, although selected in secret by unknown rules, is apparently "legitimate." I saw this first in February in an influential article in the New York Times by the Shanghai "venture capitalist" Eric X. Li on Why China's Political Model is Superior. In August the China-based academic Daniel A. Bell was extolling the merits of China's meritocracy in The Huffington Post. A few days ago the China pundit Martin Jacques repeated the same message in the BBC Magazine.

Some contributions in this vein refer to the empirical research of the Harvard political scientist Tony Saich. Saich has carried out repeated opinion surveys in China. These indicate that Chinese respondents are generally more critical of the lower tiers of government. However, high proportions are "relatively or extremely satisfied" with higher tiers, and their satisfaction rises with distance so that at least 80 percent are satisfied with China's central government. Moreover, satisfaction levels have been rising over time.

An alternative source gives a different picture. The Worldwide Governance Indicators dataset measures perceptions of the quality of government in over 200 countries since 1996 on six dimensions -- Voice and Accountability, Political Stability and Absence of Violence/Terrorism, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption. Each indicator is based on hundreds of individual underlying variables, taken from a wide variety of data sources. Each indicator is scaled from +2.5 to -2.5, with the global average set to zero. (The dataset is described by Daniel Kaufmann, Aart Kraay, and Massimo Mastruzzi, "The worldwide governance indicators: methodology and analytical issues," Policy Research Working Paper Series 5430, issued by the World Bank in 2010; RePEc handle: http://ideas.repec.org/p/wbk/wbrwps/5430.html).

The advantage of the Worldwide Governance Indicators is that they are worldwide; they allow one country to be measured against others on a uniform methodology. For China I'll give you the 2011 results, but the Worldwide Governance Indicators go back to 1996 and they are fairly stable over time.

In the table below, the first column shows that the data include most countries in the world. The second column shows the percentage of countries that score below China on each of the six dimensions. The third column shows China's score. Since we are also given the standard errors associated with the scores, we can also work out whether China's difference from the world average (zero) is statistically significant. An asterisk indicates that China's score is significantly above or below zero at 5 percent.

Three things stand out:

• China scores below the median country in the world in every dimension except one: effectiveness. China's citizens definitely agree that their government can make decisions and carry them out.
• In two dimensions, effectiveness and regulatory quality, China's score is not signficantly different from the world average. In the other four, it is significantly below.
• In voice and accountability, China is grouped among the worst countries in the world.

How can we reconcile China's deficit in the Worldwide Governance Indicators with praise for the "legitimacy" of the communist one-party state? I'd start from Tony Saich's finding that Chinese people are least critical of the level of the government that is farthest from them. It would seem that in their society there is still a place for the myth of the "just monarch": the benevolent ruler in the faraway capital city.

According to this myth, the just ruler thinks of nothing but the plight of his people. But his will is said to be distorted by ambitious and corrupt intermediaries -- his ministers, the provincial barons and local authorities, who stand between the people and the king. The king relies on the people to tell him of the injustices from which they suffer; supposedly, only he can put them right. If they will reach out to him directly, bypassing those that pervert his intentions, he will answer their prayers and petitions and right their wrongs.

People who believe this can thus reconcile personal experience of oppressive and corrupt rule with the idea of a kindly but distant ruler who will eventually vindicate them.

One reason the myth endures is that it is open to manipulation. A ruler who is not benevolent but self-interested and power-seeking can exploit it to remain in power. From time to time he will give up some local princeling to assuage popular anger and build his own legitimacy. Stalin did this; Mao did it; today's Chinese communist party does it.

But managing the mythology of benevolent dictatorship is like riding a tiger. For the myth of the just monarch does not make the people passive; on the contrary, from time to time they may rise up in the name of the ruler to act directly against those that oppress them. (See for example Daniel Field, Rebels in the name of the tsar, published by Houghton Mifflin in 1976.)

Finally, in many peasant societies, as China was until quite recently, this myth has persisted until the illusion is shattered by some collective blow. There will be some setback, some outrage, or some scandal that is too deep for the myth to endure -- at least, until some new ruler emerges who can once more take up the mantle of the true king.

Mark Harrison : 07 Nov 2012 11:05 |  Tags: China Obama Politics |  Comments (0) |  Close comments |  Report a problem

Markets versus Government Regulation: What are the Tail Risks?

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.

Mark Harrison : 15 Oct 2012 12:22 |  Tags: China Economics History Politics Recession Russia Stalin |  Comments (0) |  Close comments |  Report a problem

A Bad Bargain

Writing about web page http://blogs.spectator.co.uk/coffeehouse/2012/09/a-bad-bargain-we-should-give-up-nationwide-pay-bargaining-for-public-employees/

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.

The Evidence

• 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.

Mark Harrison : 19 Sep 2012 08:40 |  Tags: Economics Greece Politics Trade-Unions |  Comments (0) |  Close comments |  Report a problem

The China Deal: Why China's economic success is fragile

Writing about web page http://ideas.repec.org/p/cge/warwcg/91.html

Why has China succeeded where Russia failed?

The explanation that is most widely shared is that the Chinese rulers kept political control and used it to reform the economy gradually. They pursued Deng Xiaoping's "four modernizations" (of agriculture, industry, defence, and science and technology) but rejected calls for the so-called "fifth modernization" (democracy). In the Soviet Union at the same time, in contrast, Mikhail Gorbachev abandoned the levers of totalitarian control. He allowed the Berlin Wall to be pushed over. The Soviet communist party imploded; insiders "stole the state." The Soviet Union collapsed and Russia entered a decade of near anarchy.

This explanation has obvious appeal but is incomplete on closer inspection. It is widely believed that the Soviet leaders did not try the China solution of gradual economic reform without political reform. The historical record shows, however, that this is untrue. Over a period of many years, while their system of one-party rule was completely intact, the Soviet leaders tried all the reforms that the Chinese communists followed to revitalize their economy. This included several experiments with a household responsibility system, the so-called zveno, in agriculture (1933, 1947, and 1966); a regional decentralization (from 1957 to 1965); and several rounds of public sector reform (beginning in 1965), culminating in new laws to reduce the compulsory obligations on state-owned enterprises, allowing them to supply the market directly at higher prices (1987), and to permit private enterprise (1988).

In other words, rash political reforms are not the factor that decided why communism failed in Russia. The collapse of Soviet rule came only after the gradual economic reform initiatives that worked in China failed in Russia.

We must look somewhere else, therefore, to explain China's success. In a survey of Communism and Modernization, I suggest that the answer must begin with China's capacity for continuous policy reform. To break out of relative poverty and catch up with the world technological leader, an economy must undergo continuous reform of its policies and instutions. Continuous policy reform is fragile. The reason for its fragility is that, as the economy undergoes successive stages of modernization, policy reform at each stage must infringe upon the vested interests formed in the previous stage. Where continuous reform becomes blocked (as in Italy, for example), the economy will lag and fall behind. From the 1970s, the Chinese economy institutionalized a capacity for continuous policy reform. This is what has enabled China's spectacular rise.

Continuous policy reform was a by-product of China's system of "regionally decentralized authoritarianism" (described by Xu 2011). This system set China's 31 provincial leaders to compete with each other economically and also gave them considerable freedom to choose how to do so. Those leaders who could make their provincial economy grow faster, if necessary by attracting labour from neighbouring provinces, would rise politically; the laggards would fall. Such incentives were very strong.

Deng Xiaoping allowed the provincial bosses to strike a "China deal" that created new space for private business to come out of the cold and thrive within market socialism. This opening of markets to private entrepreneurs, modest at first, became much more radical than the limited "deals" struck in the Soviet Union and Eastern Europe. Economic reforms under European communism gave legitimacy, at most, to low-powered, short-term profit-based incentives, insider lobbies, and shady sideline trading networks.

In China the main limit that was placed on market access was political: China's new business class must continuously demonstrate its loyalty to the one-party state. The best way to prove loyalty was through political and family connections to the regime. This raised the danger of the new business class exploiting their personal links to power to grow rich without economic effort. One answer, but an imperfect one as we see today, was to expose them to foreign competition. In fact, there was more product market competition in export markets than across China's internal provincial borders.

A crucial and completely accidental advantage on China's side was its size. The Chinese population was so large that its 31 provinces each formed an economic region with tens of millions of people -- the size of a large Western European country. In contrast, the Soviet Union decentralized economic management across a much larger number of much smaller provinces, averaging little more than a million people each. Unlike a Chinese province, the typical Soviet province was highly dependent on its neighbours. The danger was that a Soviet provincial boss could gain more by sabotaging his neighbours than by honest effort within his own limited sphere. In the Soviet Union regional rivalry turned out to carry high costs and few if any benefits.

If regional rivalry was not productive within the Soviet Union, why did it not work across Eastern Europe as a whole? After all, each East European country had considerable freedom to experiment with national economic models, and was more like a Chinese province in size and diversity than a Soviet province. Nonetheless, international competition did not work any better than interprovincial rivalry. Most likely, East European communist leaders had too much job security and tenure, did not depend on doing better than their neighbours to keep their jobs, could not be promoted to Moscow, and, even if they succeeded economically, could not build on success to attract labour from their neighbours because international borders, even within the communist brotherhood of nations, were rigidly sealed.

It may also have been a factor that East European and Soviet leaders just did not "get" continuous policy reform. They thought catching-up growth could be achieved by one-off reforms or interventions. It is also a good question whether Chinese leaders "got" continuous policy reform, or whether they stumbled across a design for it by accident.

Either way, the result was this: The recipe that happened to make communism work in China was tried and did not work in Europe. That raises a question of vast proportions: Will the same recipe continue to work in China's future?

Here we come back to the fragility of continuous policy reform. China's level of output per head has multiplied several times over the level of the 1970s. It must multiply several more times before China can approach the level of the world's richest countries. This is a very long haul. For China to maintain the continuity of policy reform over the distance is beyond unlikely. At some point, some coalition of interests is bound to form that will be strong enough to block it, at least for a time. At that time China's oligarchy must be willing to intervene on the side of movement, not stability. If not, the China deal will come unstuck.

References:

Harrison, Mark. 2012. Communism and Economic Modernization. CAGE Working Papers no. 92. University of Warwick. Repec handle http://ideas.repec.org/p/cge/warwcg/91.html.

Xu, Chenggang. 2011. The Fundamental Institutions of China's Reforms and Development. Journal of Economic Literature 49:4, pp. 1076-1151. Repec handle http://ideas.repec.org/a/aea/jeclit/v49y2011i4p1076-1151.html.

Mark Harrison : 29 Jul 2012 15:23 |  Tags: China Economics History Politics Russia |  Comments (0) |  Close comments |  Report a problem

Passing the Parcel: Who Will End Up Holding Europe's Democratic Deficit?

Writing about web page http://www2.warwick.ac.uk/knowledge/business/eurodead

It is widely thought that Europe has a democratic deficit (Follesdal and Hix 2006; The Economist 2012). This means that the European Commission and European Parliament exercise powers in the name of a European community and identity that do not really exist. In reality, these bodies are accountable only to national electorates. There are no true European parties, and national electorates make their choices on national, not European calculations. As a result, European institutions hold powers that are neither accountable nor legitimate. This is one source of the current crisis.

Since the Euro is unworkable in its current form, it must change. An interesting question is what will happen then to the existing democratic deficit. Whatever changes, the democratic deficit will not go away. Instead, it will be redistributed across the terrain of the Eurozone. Different upheavals will pass it around in different ways. Two scenarios illustrate the point.

• Scenario 1

If current proposals for a fiscal union across the present Eurozone are adopted, member states will lose much of their already limited sovereignty over public spending and taxes. Their remaining sovereignty will be pooled in Brussels and Strasbourg. Thus, the democratic deficit will continue to be Europe-wide.

Many citizens will get the feeling that the democratic deficit has widened, but this will be more apparent than real. The democratic deficit will be felt more, because its true scale will have been formalized in new unaccountable powers, whereas in the past the deficit was merely implicit in powers that were often deployed ineffectively. This feeling, however, will be particularly acute in the two poles of the Eurozone, Germany and Greece. This is because German voters will contribute most to the new fiscal transfers against their will, and because Greek voters will lose most sovereignty to new fiscal controls.

• Scenario 2

Suppose instead that one or more Club Med countries are ejected from the Eurozone, as may still happen. Provided the Euro itself survives, in the Eurozone core the democratic deficit should then shrink for two reasons. First, the required severity of new fiscal controls and the scale of new fiscal transfers within the Eurozone will be less, so Brussels and Strasbourg will acquire fewer new powers. Second, the sense of a shared European identity among the core countries may well be greater than at present, because the national electorates that remain will be those that feel more affinity with Germany.

Under this scenario the democratic deficit may shrink in the core of the Eurozone but expand in the countries that exit. Again there are several reasons. In theory, the exiting countries will regain sovereignty over their own affairs. In practice they will have less sovereignty even than now, because their financial systems and their international credit will have been wrecked in the process. As a result, their voters will face few, if any, good choices. In the face of national humiliation, the voters may well turn to anti-system, anti-democratic parties that will steal power first from the discredited democratic leaders, and then from the voters themselves.

In short, there do not seem to be any easy ways to make good the democratic deficit that has been built into European institutions. At best, all we can do is pass it round.

References

Economist, The. 2012. The Euro Crisis: An Ever Deeper Democratic Deficit. The Economist, May 26. Weblink: http://www.economist.com/node/21555927.

Follesdal, Andreas, and Simon Hix. 2006. Why There is a Democratic Deficit in the EU: A Response to Majone and Moravcsik. Journal of Common Market Studies 44:3. pp. 533-562. Repec handle: http://ideas.repec.org/p/erp/eurogo/p0002.html.

Mark Harrison : 29 Jun 2012 08:28 |  Tags: Economics Euro Greece Politics |  Comments (2) |  Close comments |  Report a problem

Taxing the Rich: Redistribution Versus Citizenship

Writing about web page http://www.ft.com/cms/s/0/30177568-61fa-11e1-807f-00144feabdc0.html#axzz1tpB8SkZF

Always a hot potato, the top rate of tax is getting hotter. George Osborne is under fire for cutting taxes on incomes over £150,000 from 50p to 45p (this rises to 56p in the pound if you include payroll taxes). In the United States the marginal rate on incomes over $388,000 is 35 cents (rising to 42.5 percent with Medicare and payroll taxes) but many allowances mean it's not always paid. Barack Obama wants to put in place a "Buffet tax" to ensure those earning more than a million dollars pay at least 30 percent on average. François Hollande, likely winner of the French presidential election, wants to set a 75 percent tax rate on incomes above a million euros.

One way to understand the issues at stake is to recognize and reflect on two conflcting purposes of taxation in a democracy. In one view, taxes go along with citizenship. In the other, taxes help to re-engineer society. Where should we strike the balance?

• Taxation in a democracy

Many journalists and some economists write about taxes as if the optimum rate should be the one that maximizes the revenue from it. As a general principle, that can't be right. To understand why not, ask yourself what rate a coolly rational totalitarian dictator would set who treated the public finances as his personal housekeeping money and cared nothing for social welfare. This ruler would set taxes to maximize his revenue -- would he not?

What level would that be? Even for a dictator, the optimal tax rate is not 100 percent. The reason is that all taxes are in some degree "distorting," that is, they are a disincentive to engage in the activity that is taxed, so that the economy becomes less efficient and less is produced. Think of taxes as a proportion t of income, so if T is the revenue and Y is the income then T = tY. Because taxes are distorting, as you push up t, Y falls. When t = 100 percent, the disincentive to produce is so overwhelming that Y is zero and so is tY. Reduce t; Y will grow and so will tY up to a point. At some point, the product of t and Y is maximized.

Actually, a farsighted ruler might set today's taxes below even this level, and forego some of the revenue available today for the sake of more revenue tomorrow. Why's that? He would be aware that higher taxes may cause lower growth (Heady et al. 2008; Arnold et al. 2011). If so, the dictator who maximizes his revenue today will encounter lower revenue tomorrow. Given this, a dictator might well choose to hold back today and encourage the economy to grow so that he will be able to levy taxes from a larger base in the future.

If we take the dictator as a benchmark, how should a well-meaning democratic leader set taxes, having internalized the welfare of society? As Mançur Olson (1993) pointed out, the dictator values only his own welfare; the democratic leader values the welfare of society, which includes private income as well as public revenues. In the same spirit, the dictator seeks to avoid the distortions associated with taxation only to the extent that they undermine his own revenue, and will be indifferent to private losses; the democratic leader will set some value on the private losses too.

For these reasons the democratic leader should set income taxes at much less than the rate that a dictator would set. If even a dictator should go below the rate that maximizes revenue in the short term, the democratic leader should go some way below that.

Summary: maximizing revenue is not a legitimate purpose of taxation in a democracy.

• Taxing top incomes

Why then do some economists advocate setting the upper rate of income tax at the revenue-maximizing rate? In a recent paper Peter Diamond and Emmanuel Saez (2011) argue that the optimal rate that should be levied on the top 1 percent of U.S. incomes is more than 70 percent. They find this to be optimal because it would extract the maximum revenue from upper income recipients, taking into account the fact that they will probably reduce their taxable income in response. For given revenue needs, extracting the maximum out of the richest in society would then minimize the burden on taxpayers with lower incomes.

The underlying logic is diminishing marginal utility. The social benefit of a dollar consumed by the rich, Diamond and Saez argue, is much less than that of a dollar consumed by the poor. For example, if the benefit of consumption increases in proportion to the logarithm of income, then each doubling of income would increase well being by a given amount. They estimate that a dollar of consumption when income is at the top-1-percent margin in 2007 (around $1.4m) is worth less than 4 percent of a dollar when income is at the median ($53k) in the same year. One way of improving social welfare, they conclude, is take dollars from the rich family (which hardly misses them) and give them to the poor family (to whom it means a lot). On this argument, the result of putting up taxes on top incomes and reducing taxes on middle incomes is that well-being will rise on average.

Where do you stop? Because 4 percent is close to zero, Diamond and Saez summarize, the value of marginal income to the very rich is so low that we can ignore it. It follows that the tax rate on upper incomes that maximizes social welfare is pretty much the same as the tax rate that maximizes the revenue from the tax -- and this turns out to be around 73 percent.

Summary: Diamond and Saez make a case for maximizing revenues from top incomes -- even in a democracy. Since this is pretty much textbook stuff, what is there to disagree with? I'll set out two views of taxation. In one view, taxes are an instrument for redistribution. In the other, taxes go with citizenship. Both views can be taken to an extreme. I'll argue that both extremes are undesirable, but it's important to acknowledge the link from taxes to citizenship. There is no such link in Diamond and Saez.

• Taxation for redistribution

In this debate, Diamond and Saez are extremists for social engineering. That is, they subordinate all other considerations to distributing welfare as evenly as possible. Before I go on to the other view, I'm going to say why I think this is economically misconceived. There are several reasons.

First, the Diamond-Saez framework presumes that everyone maps income onto personal well being at the same rate at each income level. I've explained the average relationship. But people are not all average. An example can give the intuition. Suppose my income is $1.4m. (It's not, and never will be. I make this clear for those readers that don't easily get the difference between a working assumption and a tax declaration.) To repeat, suppose my income is $1.4m. At that point, I may well value a dollar of consumption at less than 4 percent of a dollar when my income falls to $53k. It does not follow that I will value a dollar of my consumption at less than 4 percent of the value the next guy puts on a dollar when his income is at $53k.

Think about it: If my income was 30 times his, was I luckier, or better connected, or more talented than him, or did I just want money more than he did? A new paper by Eugenio Proto and Aldo Rusticchini (2012) suggests that the slope of the relationshp between income and life satisfaction differs systematically for people with different personality traits, so this is not an abstract possibility. If so, taking money from me, given that I have more because I value it more highly, and giving it to him, when he has less because he values it less, is not an obvious way to improve average well being.

[Now for a short digression. Some readers might stop short here and ask: "Why ever not? That's exactly what I want to happen!" Maybe you'd get personal satisfaction from taking money away from me, precisely because I value it. I understand that; if so, however, your preference is likely to be rooted in a dislike of rich people and high consumption. Some people who take this line dislike bankers, neglecting the simple fact that many people with high incomes have nothing to do with finance. Others do not think anyone should receive an income 30 times the median on principle -- even though their own consumption may well be 30 times what was the median in their own country just 200 years ago, or 30 times the median income of some other country just 2,000 miles away. All these people are expressing a third view of taxation, namely taxing people because you don't like their values and want to punish them. That's enough about that.]

The same issue has a more general form. It is about giving the government the authority to treat everyone as an average citizen with average abilities and average preferences, to discount entirely the welfare of some of them at the margin, and radically to re-engineer the distribution of income, motivated by the wrong assumption that we are all the same (or if we're not that's too bad). It's egalitarian, certainly; but not, perhaps, in a good way.

If you followed the logic of taxes as social engineering to the limit, you'd want the government to set everyone an individual personal tax schedule, based on knowing deeply each person's individual capabilities, endowments, and preference map. That way lies a dystopian nightmare. We should neither pretend to have this information nor expect to be able to gather it. The collection of such knowledge in one place woujld be more consistent with a totalitarian state than with a decentralized, free market economy.

Finally, we all pay an economic price for social engineering. On top of the other evidence linking higher taxes to lower growth, Arnold et al. (2012) also show that a higher top rate of personal income tax is damaging specifically to productivity growth in industries that have high rates of firm entry. They suggest this arises because new firms have to take more risks and are also less likely to be incorporated. In other words, there is a channel through which raising taxes on top incomes is likely to make the market economy less dynamic. That matters too.

Summary: I've given several reasons not to follow the logic of taxation for redistribution to the limit.

• Taxation and citizenship

The alternative view can be summed up as "no representation without taxation." In a democracy, taxes are a membership due, or a moral obligation on the citizens to share society's burdens as well as benefits. Our democracy needs most families to pay their dues and so, when they vote, to have a stake, however small, in how (and how much) public money is raised. This view is also widely held, although it pops out most commonly when people react against tax loopholes for the rich and tax allowances for charitable giving. Shouldn't these people pay their taxes first?

The logic here is that you pay because you're an citizen. Equal citizens should contribute equally. Again, this is not something to take to extremes. Why not? The logic of taxes as membership dues is that everyone pays. To my British readers I'll say: Remember the poll tax. For others, the poll tax was Margaret Thatcher's attempt to fund local government through a level tax on all householders, and it arguably destroyed her premiership. In fact, not everyone can pay; their ability to pay is not equal. Many regular clubs and societies recognize ability to pay through concessionary rates for the young, the old, the sick, and those out of work. Just about all tax systems recognize ability to pay through income tax thresholds and marginal rates that rise with income. In this way, they modify the citizenship concept with a necessary nod to redistribution.

Diamond and Saez call their paper "The Case for a Progressive Tax." As far as I'm concerned, the case for income tax to be progressive was already made. I didn't need convincing. Given unequal ability to pay, the rich should pay more than the poor in proportion to their incomes. But the case Diamond and Saez make goes far beyond that: they advocate a tax system that completely confiscates the marginal social benefit of consumption from top incomes in order to minimize the burdens lower down. In their framework the middle and lower income families become clients of the state, not citizens. There is no acknowledgement that citizens have obligations, or that voters should have a private stake in how public revenue is raised. They push redistribution to an extreme, diminish citizenship, give the government too much power, and threaten long term damage to the market economy.

Summary: While remaining progressive, our fiscal system should leave room for an element of tax-paying as an attribute of citizenship. Everyone who can should pay something; only the neediest should pay nothing. The rich should pay at a rate higher than that on the middle and poor, but taxes on upper incomes should not aspire to confiscate all the gains from effort, enterprise, and talent. (And, if we leave untaxed a signficant share of the returns to effort, enterprise, and talent, we'll also have to accept that we leave undisturbed some part of the gains to connections and luck.)

In British terms, if the poorest pay nothing, and the middle pay 20 percent, then the rich can clearly pay 40 percent. That seems fine. The rest is politics.

References

• Arnold, Jens Matthias, Bert Brys, Christopher Heady, Åsa Johansson, Cyrille Schwellnus, and Laura Vartia. 2012. Tax Policy for Recovery and Growth. Economic Journal 121:550, pp. F59-F90. Available at http://ideas.repec.org/p/ukc/ukcedp/0925.html
• Johansson, Åsa, Christopher Heady, Jens Arnold, Bert Brys, and Laura Vartia. 2008. Tax and Economic Growth. OECD Economics Department Working Paper No. 620. Available at http://ideas.repec.org/p/oec/ecoaaa/620-en.html
• Olson, Mançur. 1993. Dictatorship, Democracy, and Development. American Political Science Review 87:3, pp. 567-576.
• Diamond, Peter, and Emmanuel Saez. 2011. The Case for a Progressive Tax: From Basic Research to Policy Recommendations. Journal of Economic Perspectives 25:4, pp. 165–190. Available at http://ideas.repec.org/a/aea/jecper/v25y2011i4p165-90.html.
• Proto, Eugenio, and Aldo Rustichini. 2012. Life Satisfaction, Household Income and Personality Traits. The Warwick Economic Research Papers no. 988. Available at http://ideas.repec.org/p/wrk/warwec/988.html

Mark Harrison : 04 May 2012 12:27 |  Tags: Economics Politics Taxes |  Comments (0) |  Close comments |  Report a problem

Political Costs of the Great Recession

Writing about web page http://www.ft.com/cms/s/0/5b1b5556-8d1d-11e1-9798-00144feab49a.html#axzz1styV0LMT

Monday's Financial Times recorded the dismal showing of Nicolas Sarkozy in the French Presidential first-round election, the record vote for France's far-right National Front, and the openings to the right of Sarkozy and François Hollande, who remain in the contest, as they compete to sweep up the votes of the eliminated candidates.

It reminded me of a recent NBER working paper by Alan de Bromhead, Barry Eichengreen, and Kevin O'Rourke on Right-wing Political Extremism in the Great Depression. (There's a non-technical summary on VOXeu.) What these authors show is that the rise of right wing extremism in the Great Depression was not just a German phenomenon. They define extremist parties as those that campaigned to change not just policy but the system of government. They look at 171 elections in 28 countries spread across Europe, the Americas, and Australasia between 1919 and 1939. They find that a swing to right-wing "anti-system" parties was more likely where the depression was more prolonged, where there was a shorter history of democracy, and where fascist parties were already represented in the national parliament. In short, de Bromhead and co-authors conclude, the Depression was "good for fascists."

I don't mean to imply that either Sarkozy or Hollande are fascists. They aren't. Neither of them wants to replace electoral democracy by authoritarian rule. But they are responding to the protest vote in their own country by proposing "solutions" to the problems of the already weakened French market economy that will weaken it further by increasing government entitlement spending, government regulation, and tax rates.

Where does the protest vote come from? There is anger and pessimism. There is a search for alternatives to free-market capitalism and representative democracy. The problem is that all the alternatives are worse. But none of the candidates (perhaps with the exception of François Bayrou, who did badly) has been willing to say this.

How do we know that all the alternatives are worse? We know it from history.

The chart below shows the total real GDPs of twelve major market economies from 1870 to 2008 (the countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Netherlands, New Zealand, Norway, Sweden, Switzerland, United Kingdom, and United States; data are by the late Angus Maddison at http://www.ggdc.net/maddison/). The vertical scale is logarithmic, so the slope of the line measures its rate of growth.

You can see two things. One is the steadiness of economic growth in the West over 140 years up to the recent financial crisis. The other is that two World Wars and the Great Depression were no more than temporary deviations. They are just blips in the data. For many people they were hell to live through (and sometimes these were the lucky ones), but in the long run the economic consequences went away. In fact, recent work by the economic historian Alexander J. Field has shown that the depressed 1930s were technologically the most dynamic period of American history.

One conclusion might be that the economic consequences of the current recession are not the ones that we should fear most. I don't mean that the economic losses arising from reduced incomes and unemployment are trivial; life today is unexpectedly hard for millions of people, young and old. Young people, even if they will not be a "lost" generation, will suffer and be scarred by the experience. If you're old enough, you could be dead before better times come round again. At the same time, the kind of pessimism that says that our children will be never be as well off as we were is groundless. The economic losses associated with the recession will eventually evaporate, just as the economic losses of the Great Depression went away in the long run.

We should be more afraid of the lasting political consequences. The effects of the Great Depression on politics were very deep and very persistent. World War I ended with the breakup of the German, Austro-Hungarian, Romanov, and Ottoman Empires. In the 1920s, most of the new countries that were formed became democracies. Then, we had the Great Depression. Across Europe there was anger, pessimism, and a search for alternatives to free-market capitalism and representative democracy. By the end of the 1930s Europe had recovered economically from the depression but most of the new democracies had fallen under dictators. That led to World War II, in which as many as 60 million people were killed. Fascism was defeated, but then Europe was divided by communism and that led to the Cold War.

It took until 1989 for the average of democracy scores of European countries (measured from the Polity IV database) to return to the previous high point, which was in 1919.

In short, the Great Depression stimulated a search for alternatives to liberal capitalism. This search was extremely costly and completely pointless. For a while in various quarters there was admiration for Hitler, Mussolini, or Stalin, their great public works, their capacity to inspire and to mobilize, and their rebuilding of the nation. But both fascism and communism turned out to be terrible mistakes.

Memories are short. Today's politicians want your vote. And many voters want to hear that some radical politician or authority figure has a quick fix for capitalism. It seems like we may have to learn from our mistakes all over again. Let's hope that the lesson is less costly this time round.

Mark Harrison : 24 Apr 2012 22:04 |  Tags: Economics Hitler Politics Recession Stalin |  Comments (1) |  Close comments |  Report a problem

The EU Shows the Risks of Selective Intervention

Writing about web page http://www.bbc.co.uk/news/world-europe-16803157

As Europe's leaders leave Brussels with a new fiscal treaty, I found myself thinking back to last June when Nicolas Sarkozy said:

Without the euro there is no Europe and without Europe there is no possible peace and security.

It makes you wonder how we got to this. If true, it would make the well-being and security of all Europeans hostage to the future of the Euro. Yet the euro is a relatively recent invention. It was not around for the first half century of the postwar era. Europe was peaceful and the European Union was working effectively long before the euro was brought in.

Given the model was already working reasonably well without the euro, you could understand Sarkozy to mean that Europe's architects willfully introduced a new feature that, if then removed one day, would bring it crashing to the ground. How dangerous is that!

Confronted by the possibility of eventual Eurozone disintegration, which the new fiscal treaty does not remove, I caught myself thinking:

If only Europe's builders had stopped with the single market.

The single European market, enacted between 1987 and 1992, was a huge achievement. The single market eliminated physical, technical and tax-related barriers to free movement [of goods and people] within the Community. The single market was enforced by tough laws that improved competition. In turn, competition and free trade within the community raised average productivity and incomes.

The European economy wasn't perfect. The common agricultural policy remained a blot on the European rural landscape. There was continual pressure on the member states to harmonize national social, employment, and fiscal policies. Within the single market itself there were still national currencies. The single market was marked by regional price differences arising from exchange rate fluctuations, currency exchange costs, and the lack of transparency associated with pricing in different currencies. The transaction costs alone might have been worth a few billion euros.

But perhaps it would have been better to have stopped there with the single market, and gone on paying those billion-euro costs, than to move on to the next stage of currency unification, ultimately facing today's trillion-euro costs of Eurozone bailouts and possible collapse.

Why didn't we hold the line there? What I forgot for a pleasant moment was the logic of the time. This logic led remorselessly onward from the single market to the single currency.

With hindsight the logic is sometimes portrayed as a simple economic inevitability, as if the single market just demanded to be made even better by a single currency, and would have been forever incomplete without it. "Without the euro there is no Europe"? Not so. There was an inevitability at work, it's true, but this was determined by politics, not economics.

You can think about it on the lines of what Oliver Williamson once called the impossibility of selective intervention. We'd like selective intervention to work like this. We live in a market economy, but from time to time the market fails. Then, when it fails, and only then, we'd like the government to step in and sort it out. When they've done that, we'd like them to stop.

In other words, in the best of all possible worlds, government intervention would be limited selectively to those measures that can improve social welfare over the results of the market economy. That way, surely, we would have the best of everything: the market when it succeeds, and government intervention to fix it when the market fails.

What could be wrong with that? Why can't we have the best of everything? The fundamental reason why selective intervention is impossible can be put like this:

A government that has the power to intervene when it chooses in the interests of the community also has the power to intervene when it chooses to serve its own interests.

In the case of the single market, Europe's leaders once saw an institutional deficit. For centuries, the competing nations of Europe were sources of technological, cultural, commercial, and industrial revolution. Revolution was spurred by rivalry. Too often, rivalry led to war. There was an institutional deficit, Adenauer, Schuman, and Spaak believed, that led European countries to make war, not trade. They decided to intervene to fix it.

The solution they sought was to bind Europe's nations together commercially. The European Economic Community, the forerunner of today's European Union, was the means to fill the institutional deficit that they perceived. But that turned out not to be enough. The next project was the European Union and the single European market.

In the process, they created a self-serving international bureaucracy. The European Commission in Brussels was supposed to oversee the single market. A legislature in Strasbourg was supposed to oversee the bureaucracy. But the lack of a strong popular European identity that could frame political competition on a continental scale led to Europe to exchange one institutional deficit for another.

Instead of an institutional deficit there was now a growing democratic deficit. That deficit became a refuge for politicians that had failed on the national stage or, as we sometimes call them, "elder statesmen." Defeated in a national election? Stand for the European Parliament. Just lost your party leadership? Become a European Commissioner. With a few exceptions these were vain, limited people. Unlimited only in their ambition, they tried to take control of Europe's destiny and shape it in their own interests.

What were the interests that the single currency served? It was another grand project. The worst fate of any political bureaucrat must be to enter office and be told there's nothing to do. Whoever got reelected or promoted by doing nothing? Every politician needs a stream of projects to oversee, institutions to build, offices to fill, and funding to allocate.

For such people, building the single market could never been enough. They needed something more to build after that. The single market was just a phase that added to their momentum. The logic of selective intervention is that nobody tells you when it's time to stop, and there is always good reason to go on. We could never have just "stopped there."

Not knowing when to stop is at the core of the impossibility of selective intervention. Selective intervention is supposed to improve things. And it can do this, up to a limit. But in the real world the limit of improvement is always fuzzy. If the government fixed one thing that needed fixing, this creates the justification for it to go on to fix something else. If that turns out to have made things worse, then this too becomes justification for another fix. There's never a reason to call a halt.

This is how a beautiful dream went too far, and so became a bit of a nightmare.

Mark Harrison : 31 Jan 2012 08:41 |  Tags: Economics Euro Politics |  Comments (1) |  Close comments |  Report a problem

A Flood of Cheap Chinese Goods

Writing about web page http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1964156

Late in the Old Year, I listened to a radio interview. The question was: "What has the world gained from China's emergence into global trade?" The response was something like this:

A few countries have gained by selling raw materials to China -- Australia, Canada, parts of Africa.

What about the rest?

The rest of us have just had to face a flood of cheap Chinese goods.

To me this neatly encapsulated one of the central tenets of Do-It-Yourself Economics:

Production (and exports) good. Consumption (and imports) bad.

The mixed feelings with which the world's media greets the deluge can be readily illustrated by Googling the search terms "flood" and "cheap Chinese goods." On a recent morning, the first page of search results yielded the following:

Brazilian factories tested by Chinese imports - FT.com
But a growing flood of cheap Chinese manufactured goods into Brazil is testing the relationship. “The relationship with China is important but, ...

Why do we allow cheap chinese goods to wreck the western economies ...
Why do we allow cheap chinese goods to wreck the western economies? we sell them very little where they flood our markets with cheap products that used to ...

artificially cheap Chinese goods « Savvy Writers & e-Books online
What many American, Canadian and European citizens don't grasp is this: The flood of artificially cheap Chinese goods, putting America out ...

UK retailers tell Brussels: we want cheap Chinese goods | Business ...
UK retailers tell Brussels: we want cheap Chinese goods ... He has warned that a flood of cheap T-shirts and flax yarn is harming producers in Italy, ...

Chinese tyres cause accidents: police | The Zimbabwean
The flood of cheap Chinese goods has also retarded the reopening of many industries which cannot compete with the goods of cheaper quality. “I urge people to ...

CHINESE IN AFRICA: ON ASSIGNMENT: PHOTOGRAPHY BY PER ...
has created a Chinese market in Luanda flooded with cheap Chinese goods. The Chinese are currently working on two major railway renovation projects ...

It's good to talk - even better to sell
Cheap Chinese goods are flooding into Africa's markets. China's trade with Africa has increased from $900m (about £500m) in 1990 to nearly $30bn last year ...

Involvement of the People's Republic of China in Africa ...
China does not purchase manufactured products from Africa, while cheap Chinese imports flood the local marketplace, making it difficult for local industries...

Indonesian Study Shows Trade Pact Led to Flood of Chinese Goods ...
A wide range of Chinese goods has flooded Indonesia since the ... that cheap Chinese goods are swamping Indonesia under the free-trade ...

China Ties Aiding Europe to Its Own Trade Goals | Think on That!
Nevertheless, Europe must consider the effects of very cheap Chinese goods that some consider “unfairly priced” flooding their markets. ...

The reality is somewhat less dramatic than these quotes would suggest. What proportion of the goods that our firms and households buy is actually sourced from China? Almost certainly, less than you think.

In 2010, for example, the UK imported goods from China worth £30.6 billion (see the 2011 edition of the Pink Book published by the Office of National Statistics). This sounds like a lot, but is only two percent of the UK's £1.5 trillion national expenditure, or three percent of household consumption. Even this will overstate the proportion of British expenditure originating within China's borders since many Chinese exports incorporate components previously imported into China from abroad. In short, the Chinese economic tsunami is really more of a ripple, although a growing one.

Why is the perception so much more dramatic than the reality? Several reasons.

• China sells things that nearly every household is likely to buy, such as clothes, toys, and consumer electronics.
• These things are especially salient because they are sources of pleasure.

Oh -- and the domestic firms that are displaced by the Chinese goods we prefer then noisily beat the drum of "unfair" competition by tricky foreigners in pursuit of a clever plan to wash away our industries. You can hear that drumbeat clearly in the Google search results above.

Anyway, never mind the facts. Just how bad is this and how much worse can it get? We can learn something from a historical parallel: the tale of Indian textiles in the nineteenth century.

The last time we saw a flood of cheap goods from a single country was in the nineteenth century. At this time British factories sent a tidal wave of cheap textiles across the world. By 1913, Lancashire was providing four yards of cotton cloth for every man, woman, and child on the planet. The world price of textiles came crashing down.

Who lost and who gained? Most obviously, they gained whose labour and capital was employed in the Lancashire cotton mills. At its peak, cotton employed half a million English workers. These won a living wage, while the profits went to the Manchester millocracy and their agents overseas. At the same time the English cotton interest took only a small fraction of the total gain. They had to share the rest with 1.8 billion global consumers, many of whom found they could afford comfortable, washable, durable clothing for the first time. The mechanism that distributed this global gain was the market: as prices plummeted, more and more people in distant lands could pay for a cotton shirt or even a suit.

There were a few losers. These were the world's artisan spinners and weavers. The products of their hand labour were previously a luxury; only the well-to-do could afford them. When a new product came along that consumers preferred and could pay for, the same market mechanism that shared the gain from Lanchashire's high productivity across the world told the handloom weavers: "Stop now. You can find something better to do."

When the history England's industrial revolution came to be written, Lancashire's contribution was well remembered. But its gift to the world was little emphasized or ignored. Instead, what was remembered was the destruction of Indian hand spinning and weaving.

How were Indian consumers affected by the destruction of native artisan textiles? Did the flood of cheap British goods wash away the basis of Indian economic life? It should be possible to tell. A simple test would be this: Whatever happened to India's production of textiles, what happened to consumption? If the Indian economy was truly wrecked by imported cloth, then India's masses would surely have been excluded from the benefits.

A new paper by Tirthankar Roy tells the story. It comes in two parts:

Part 1. 1820 to 1860

• The Indian price of imported cloth relative to prices of hand-spun cloth fell by 80 percent.
• The outputs of Indian hand spinning and weaving did not change.
• Cloth imports into India rose from nothing to around four fifths of the level of domestic cloth production.
• Consumption of cotton cloth per head of the Indian population rose by about 60 percent.

Part 2. 1860 to 1900

• The price of imported cloth relative to those of hand-spun cloth fell by a further 50 percent.
• Hand weaving fell by one third and hand spinning disappeared.
• But it was new Indian cotton mills, not English mills that displaced the products of Indian handloom weaving; the total output of Indian cloth did not change.
• Cloth imports rose by two thirds, reaching around twice the output of domestic weaving.
• Consumption of cotton cloth per head of the population rose by a further 40 percent.

What's important here? Two simple facts:

• First, the flood of cheap English textile did not destroy the Indian textile industry. Native spinning and weaving were restructured by competition and became much more efficient.
• Second, however difficult was the transition, Indian consumers became better off on average at every stage of this process, and were markedly better off at the end compared with the beginning.

To summarize, innovation is local but the gains from innovation are global. Adjustment to changes in national competitive advantage is psychologically painful and economically difficult, as the English textile industry discovered in the twentieth century. But the same competition in international trade is the mechanism that redistributes the gains from innovation in one country to consumers in all countries.

In conclusion, whatever you think of Chinese politics or nationalism, the flood (or floodlet) of cheap Chinese goods is not a threat. Those whose business competes directly with Chinese products should aim to beat the competition or get out of the way. Whether they succeed or fail is up to them, and that's how it should be. Either way, there is a gain to be won from China's entry into the world market, and the gain will accrue to all the world's consumers, that is to say, to every one of us.

Mark Harrison : 03 Jan 2012 13:03 |  Tags: China Economics India Politics |  Comments (0) |  Close comments |  Report a problem

The Euro: What If …

Writing about web page http://blogs.ft.com/the-world/2011/12/eurozone-crisis-live-blog-19/#axzz1fweCvEJB

What if the Euro collapses? There's already more than enough speculation about that. I'm wondering what will happen if the Euro survives.

Since survival is always conditional, let's ask: What happens if the Euro survives the next three years, which should be enough to take us into the next upswing. Also, we know for sure that the Euro cannot survive in its present form, but let's say there is just enough peripheral shake-out (say, a Greek exit), enough extra liquidity (a "wall of money" to shield the other vulnerable countries from contagion), and enough institutional reform (movement towards a fiscal union) that in 2014 a currency union is still in place with most of its current members.

What then? With all eyes focused on financial and fiscal turmoil, the underlying problem is being forgotten: The Eurozone is still not an optimum currency area.

Robert Mundell (1961) first set out the conditions for a group of countries to benefit from monetary integration: He argued that, to make an optimum currency area, the member states must be convergent in at least one of the following:

• They should experience similar shocks, and respond similarly to them.
• Or. they should have flexible (high-mobility) labour markets.
• Or, they should have competitive (flexible-price) product markets.

If these conditions were met, the real exchange rates of the different member states of a currency union would remain aligned. Without them, a structural mismatch would inevitably evolve. Full employment with low, stable inflation in all parts would be impossible. Unless some parts of the currency union would accept rising inflation, other parts would risk permanent depression.

Using forecast bilateral exchange rate volatility with Germany to measure convergence, Bayoumi and Eichengreen (1997) showed that, from the start, many current Eurozone member states did not not "fit" the Eurozone. Encouragingly, they did find a pre-existing trend towards convergence on the part of countries like Greece, Italy, Spain, and Portugal (but not France or the UK).

There was then a short debate about whether the Eurozone might experience continued convergence so that, although not an optimal currency area at the outset, it might become one. Frankel and Rose (1997, 1998) were for. Feldstein (1997) was against. Then, the Euro was launched. For a while everything seemed fine. But we know now that Feldstein was right.

Behind the scenes, with the Euro in place, previous efforts towards convergence stopped. Greece, Italy, Spain, and Portugal moved further and further away from Germany, not towards Germany. This is shown by statistical series from productivity growth to real exchange rates, trade integration, and fiscal imbalances.

In other words, the Eurozone today is no more of an optimal currency area than it was in 1999 when the Euro was launched. The peripheral countries have not made their markets more competitive. With rare exceptions, labour is unwilling to move across frontiers. The economies of the Eurozone remain "otherwise different" in fundamental ways.

Behind current efforts to save the Euro is still the theory that Greece and Italy can eventually be made more like Germany. If fiscal union is not to commit Germany to subsidize the periphery forever, then it can only mean the application of ever more pressure. German prices must be allowed to bear down cruelly on Mediterranean costs. Their public finances must be topped and tailed to fit the Procrustean bed of German frugality. In the face of ever increasing pressure, the culture of the periphery must surely give way.

But this is almost exactly the same theory that was applied from 1999 to the present, and was found wanting. Pressure was tried before; the only difference in current efforts is the addition to "pressure" of the words "ever increasing."

In other words, whatever their short run expedients, in the long run, Merkel and Sarkozy plan to hold the Eurozone together by the exercise of pure will. Just as Europe's leaders ignored the Mundell criteria in 1999, they will continue to do so. They believe politics can trump economics.

Leadership matters. The price tag of a disorderly collapse of the Euro looks large enough that its leaders should try to avoid our having to pay it. But what can one say of leadership into a cul de sac? The willpower required to hold the Euro together in anything like the form currently envisaged is completely lacking in any Europe-wide popular mandate. The belief that Europe's leaders can look each others' national cultures in the face and remake them arbitrarily goes against all evidence.

In short: What if the Euro survives its present stage? Current efforts will buy time, at best. When time has been bought and paid for, the original flaw will still be there. A Eurozone that is sustainable indefinitely will be limited perhaps to Germany, Austria, and Benelux. It might not even include France, however hard that is to imagine. It will not include the UK.

References

• Bayoumi, Tamim, and Barry Eichengreen. 1997. Ever Closer to Heaven? An Optimum-Currency-Area Index for European Countries. European Economic Review 41:3-5, pp. 761-770.
• Feldstein, Martin. 1997. The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability. Journal of Economic Perspectives 11:4, pp. 23-42.
• Frankel, Jeffrey A., and Andrew K. Rose. 1997. Is EMU More Justifiable Ex Post Than Ex Ante? European Economic Review 41:3-5, pp. 753-760.
• Frankel, Jeffrey A., and Andrew K. Rose. 1998. The Endogeneity of the Optimum Currency Area Criteria. Economic Journal 108:449, pp. 1009-1025.
• Mundell, Robert. 1961. A Theory of Optimum Currency Areas. American Economic Review 51:4, pp. 657-665.

Mark Harrison : 08 Dec 2011 12:18 |  Tags: Economics Euro Greece Politics |  Comments (1) |  Close comments |  Report a problem