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

How Christopher Hitchens and I Became Friends

Writing about web page http://www2.warwick.ac.uk/knowledge/culture/christopherhitchens

Until my mid-teens I had friends but with little choice over who they were. My mother chose them, or their school desk was next to mine, or their bed was next to mine (from twelve I attended a boys’ boarding school). We got on with each other, but then we had to.

My dormitory friendships, as I recall, were pretty brutal. We all knew too much about each other and exploited whatever we could find out to grab advantage and push each other down.

One of my “friends” had the nickname “Handy Arse.” He got it like this. He had a middle initial, O. At first it was a mystery. It could have been Oliver, but it wasn’t. One day he let slip that it stood for Ozanne. In English lessons they were reading Shelley’s poem Ozymandias (“My name is Ozymandias, king of kings: Look on my works, ye Mighty, and despair!"). In five minutes Ozanne became Ozymandias, and Mandy Arse in ten. From there, it was a short step to Handy Arse. And that’s how he became known.

It was pretty funny, although maybe not for him. I can recall many much more cruel exchanges. As long as I wasn’t the target, I just joined right in.

The lesson was: Don’t share. I learned this the hard way. I too had a nickname, which I got from revealing that I had athlete’s foot. Even now I don’t want to tell you what it was. I was a boarder at the school for five years, and it stuck to me until the day I left. My “friends” used this nickname every day and made absolutely certain that each incoming group of new boys got to know it and use it freely.

In my mid-teens I acquired my first friends on the basis of affinity. It probably began with Bevis Sale (now an artist), who was my house mate at school, but lived locally and was not a boarder. Bevis brought me into a new circle including Christopher Hitchens, Michael Prest (who became a journalist), and the late Guy Cunnah.

These were the first friends whose company I chose. I liked them; they liked me. We called each other by our given names, Mark, Christopher, and so on. We could share a confidence and not have it instantly betrayed. There was brotherhood. And there was an escape from the unbearable proximity of the other “friends.” I can’t overstate what it meant to me.

Christopher and I hardly saw each other after leaving school, so I’ll always remember him as he was then: slightly built, with dark floppy hair and a gaze that could flash from boredom to intense concentration in a microsecond. A year or so ago I met his daughter Antonia on a doorstep and was shocked to see the same liquid eyes.

This photo, taken not long after he left school, shows how I remember Christopher.

Christopher and I did lots of stuff together, most often with Prest and Cunnah (and maybe others but I’ve forgotten). They were already running an unofficial school magazine, so I got involved. I discovered that I could write and draw for pleasure. And there were ideas, which we bubbled with.

This was the early sixties so nonconformism and rebellion were in the air we breathed. We rebelled. This was not easy because our school was itself nonconformist (in the religious sense, so the chapel, which we were required to attend, was Methodist, not Church of England). Rebellion meant that we were atheists and did not bow our heads with the others or close our eyes in prayer, although we submitted to compulsory attendance. My housemaster called me in and enquired, in a concerned sort of way, about this demonstration. But it was tolerated; there were no unpleasant consequences of any kind.

Also in the air was the forward march of socialist ideas. There were general elections in 1964, when Labour ousted the Conservatives, and 1966, which was more of a Labour landslide. We got hold of Labour posters and displayed them around the school. We spoke up for an end to the privilege of private schooling and to stop selective admission to state grammar schools. Again, our rebellion was tolerated, which was a little infuriating and a big relief; I had no desire to be a martyr.

We also cared about the outside world and we were moved by events in South Africa. In 1964 Nelson Mandela and others were on trial in Johannesburg, and imprisoned for life, for their part in the struggle against apartheid. I was deeply affected by the case of Bram Fischer, a communist lawyer, who was sent to Robben Island with Mandela (and died there). It seemed straightforward to me that a black South African would want to overthrow apartheid, but Fischer was a white Afrikaner; he could have enjoyed a life of privilege, and he deliberately put it aside and threw in his lot with the people who were being oppressed. It was a very troubling and inspiring example.

Christopher and I set out on our bikes one afternoon to find the local branch of the communist party (we failed). We wrote to the communist party in London to ask how to help the struggle. I got a letter back from Jack Woddis, the communist party’s international secretary, which I treasured for many years. Later I joined the communist party and studied the Soviet Union and China, and I got to see the seamy underside of communism at first hand. Whatever you think about communism now, and I certainly left it behind many years ago, there’s no doubt that the movement had many fine people and real heroes alongside the hacks and rogues.

There’s not much more to tell. After leaving school, Christopher and I soon lost touch. For a long time we went different ways politically. Christopher was a lot more adventurous than I was; at school he was a self-proclaimed anarchist and at college he went into the Trotskyist revolutionary movement. By comparison I was a plodder and a gradualist. If we’d stayed in touch, most likely we would have quarrelled, and I’m glad that didn’t happen. Judging from Christopher’s writings, we came back closer together again in more recent times.

A couple of years ago, a mutual friend put us back in touch and we began to email each other. We hoped to meet up again but Christopher’s illness was taking hold, and we never made it. I’m sad about that. At least I have the memory of when we were all sixteen.

Mark Harrison : 19 Jan 2012 09:39 |  Tags: Hitchens |  Comments (0) |  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

Happy Christmas … And I Mean This

Writing about web page http://www.economist.com/node/21541767

The Christmas issue of The Economist has a piece on euphemisms. Euphemisms are things you say that soften your true meaning. Now, I think of myself as someone that normally favours plain speaking. Interpreted consistently, that suggests I would avoid euphemisms. Not so. I am British, after all, and the British invented insincerity.

Here are my three most frequent ways around the truth. If you are a student and you've had a letter from me, you've almost certainly met at least one of these before.

Thank you for your request.

This really means: "You're wasting my time." Here's another:

I should be glad if you would" (do something).

This really means: "Do it. Now!" (As does "It would be most helpful if you could".) And one more:

I realize you will be disappointed by this outcome.

This really means: "I'm impressed you made the effort to write your idiotic suggestion down in words."

To conclude, let me offer all my readers:

Very best wishes for Christmas and the New Year.

Which really means: "I want food and drink in front of the telly. Leave me alone!"

Mark Harrison : 21 Dec 2011 14:25 |  Tags: Truth |  Comments (1) |  Close comments |  Report a problem

Help Me, Daddy

Writing about web page http://www.bbc.co.uk/news/world-asia-16239693

The death of Kim Jong-il, who ruled North Korea from 1994, reminded me of something a Korean friend told me a few years ago. My friend is an expert on North Korea and told me this "for a fact." Now, I also remember many things I was told "for a fact" in Moscow in Soviet times. This is a fact I've never had the opportunity to verify (and wouldn't know where to look), so I'll put everything in quotes as my friend told it to me.

In order to facilitate his system of personal rule, Comrade Kim Il-sung devised a subcommittee of the party politburo to help him take the most important political and military decisions. The subcommittee had five members, so it became known as the Committee of Five.

Initially, the Committee of Five consisted of Kim Il-sung himself, his son Kim Jong-il, and three other senior party figures.

Note. Kim Il-sung was North Korea's first ruler, and the father of Kim Jong-il. The idea of a Committee of Five is very plausible. A key to the personal power of a totalitarian dictator is "divide and rule." One aspect of divide-and-rule is the compartmentalization of information and responsibilities, so as to minimize the number of people that have an overview of everything. Stalin was a master of this technique, and became notorious after the war for dividing the Politburo members into little subcommittees with limited oversight of particular aspects of policy. These subcommittees became known as the the Quintet, the Septet, and so on. Kim Il-sung's Committee of Five would have excluded other members of the Politburo from general oversight.

Time passed and took its toll. In 1994, Kim Il-sung "went to meet Marx." Following his death, he was promoted to the country's President for Eternity.

Note. This part is certainly true.

Since Kim Il-sung continued to be a state official, although dead, it was clearly out of the question to remove him from the Committee of Five, so he was not replaced. As the three other members of the Committee of Five aged and died, they too were not replaced, probably because there was no one that Kim Jong-il trusted sufficiently. Despite this, the Committee of Five lived on.

Eventually, only Kim Jong-il was left.

My friend concluded (this would be around ten years ago):

At the present time when important political and military decisions must be made, the Committee of Five continues to meet, but when it meets Kim Jong-il is alone in the room. After announcing each item on the agenda, he looks to the ceiling, clasps his hands, and says: "Help me, Daddy!"

This seems like a good precedent for Kim Jong-il's son and successor, Kim Jong-un, to follow. He'd better pray to Daddy; there's no one else he can trust.

Mark Harrison : 19 Dec 2011 09:01 |  Tags: History North Korea |  Comments (1) |  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

Russians, Be Careful What You Wish For

Writing about web page http://www.themoscowtimes.com/news/article/5000-protest-duma-election-results/449327.html

The Russian parliamentary elections show that, whichever party Russians voted for, whether they voted under free and fair conditions or not, they voted overwhelmingly for a strongman. United Russia (one half of the vote) is for Putin. The Communist Party (one fifth) is for Ziuganov. The Liberal Democrats (one tenth) are for Zhirinovskii.

Neither liberal nor democratic, the Liberal Democrats' favourite term of abuse for advocates of a free and competitive political system is der'mokraty, "shittocrats." The Communists have called for Russia to undergo "re-Stalinization." United Russia follows the hazy notion of "sovereign democracy," implying a non-competitive dialogue between rulers and ruled.

On the face of it, the outlook for democracy in Russia is hopeless. Apparently, nearly all Russians espouse one or another form of authoritarianism.

All the more surprising and encouraging that 5,000 Muscovites have taken the risky course of public demonstration against vote rigging and electoral fraud. But what do 5,000 demonstrators count, out of 65 million voters?

More than would appear at first sight, perhaps. A new article by Henry Hale(2011) of George Washington University suggests how much may be going on below the surface. Hale argues that we often misinterpret Russian opinion polls and election outcomes. When we find that many Russians take a dim view of "democracy," we fail to check that we and they understand democracy the same way; it turns out we don't. When we find that Russians frequently favour a strong leader, we assume that this is in conflict with the idea of competitive elections and we fail to check whether Russians see the same conflict. This too turns out not to be true.

On the evidence, Hale argues, most Russians do favour a strong leader, but the same Russians, even those who rail against der'mokratiia, also favour competitive elections. They want a strong leader that they have chosen, a strong leader who will govern according to the law, treat the people fairly, and then submit himself to competitive re-election as the constitution requires.

Such attitudes set up an obvious paradox, Hale observes. Russians know what they want, but they cannot have it for long. Any leader strong enough to rule as Russians want to be ruled is also strong enough to bend the law, pressure the courts, and stuff the ballot boxes. This seems like an electoral equivalent to the Weingast (1995) paradox: "A government strong enough to protect property rights and enforce contracts is also strong enough to confiscate the wealth of its citizens."

Hale has two conclusions. First, "Russia’s leaders, including even the highly popular Putin, are desired not as dictators but as powerful delegates with an expansive—but still limited—mandate to ‘get things done’. Limits include: that the basic rights of the opposition not be violated; that the leader not have a right to remain in complete power for life; and that the people retain the right to select a successor in a free, fair and competitive process when that leader’s constitutional term limits are up." It is logical therefore that, as Putin has increasingly overstepped these limits, he should gradually be losing his earlier support and legitimacy.

Second, Hale confirms that Russians are "the enablers of their own autocracy—but for reasons different from those usually given." The underlying problem is "not any kind of culturally embedded or historically developed support for autocracy, but the preference for a kind of democracy that nevertheless relies on electing a strong leader as a way of concentrating national efforts on the resolution of major national challenges."

Or, in the words of W. W. Jacobs: "Be careful what you wish for."

References

• Hale, Henry E. 2011. The Myth of Mass Russian Support for Autocracy: The Public Opinion Foundations of a Hybrid Regime, Europe-Asia Studies 63:8, pp. 1357-1375.
• Weingast, Barry R. 1995. The Economic Role of Political Institutions: Market-Preserving Federalism and Economic Development. Journal of Law, Economics, and Organization 11:1, pp. 1-31.

Mark Harrison : 07 Dec 2011 11:00 |  Tags: Politics Russia Stalin |  Comments (0) |  Close comments |  Report a problem

The Return of DIY Economics

Writing about web page http://www.ft.com/indepth/autumn-statement-growth-review-2011

Some years ago, David Henderson coined the phrase"do it yourself economics." DIY economics, he argued, was made up of the practical models of causation that ordinary people use to understand the economic world around them. In the world of DIY economics, he noted, public spending and exports are good because they create jobs;industry is more deserving of support than services; cheap goods made by foreigners are a curse, not a blessing; and whatever the problem is, the government ought to do something.

DIY economics is clearly expressed in responses to yesterday's autumn statement by the Chancellor. I'm going to comment on just one aspect: the length of causal chains. In the world of DIY economics there is never more than one step from cause to effect. I will give two examples, one concerning the burden of taxes and another concerning the housing market.

First, who bears the burden of taxes? In the world of DIY economics, if you tax the rich and give a benefit to the poor, the rich become poorer and the poor become richer. Full stop. In other words, the burden of taxes is borne by those that write the cheques. The converse must also be the case, as Polly Toynbee argues in this morning's The Guardian:

George Osborne's autumn statement blatantly declares itself for the few against the many ... What was missing from his list? Not one penny more was taken from the top 10% of earners. Every hit fell upon those with less not more. Fat plums ripe for the plucking stayed on the tree as the poorest bore 16% of the brunt of new cuts and the richest only 3%.

The chain of causation suggested by modern economics is somewhat longer, yet each step is still simple and transparent. The burden of taxes is spread beyond those that write the cheques to the government. Ultimately, who pays for a tax on profits? A tax on profits increases the cost of capital to firms, so that less capital is employed and every worker is less productive. The result is lower wages (as well as lower profits). A tax on labour increases the cost of labour to firms, so that fewer workers are employed. The result is fewer jobs (as well as lower wages and profits).

In short, who writes the cheque is a poor guide to whether a particular tax will help the poor. Whether taxes are levied on capital or labour, the workers bear much of the cost, which is likely to exceed the revenue raised.

Second, who should we blame for the mess that George Osborne is trying to tackle? In the world of DIY economics, there is only one step from cause to effect. So, if you see the effect, you only have to go one step back to find the cause. The recession began with a credit crunch, so the suppliers of credit, the bankers, are to blame for everything. Most certainly, we are not to blame. This morning, as public sector workers strike to protect their pensions, my facebook page is full of comments that replicate the following confident assertion:

Remember when Teachers, Policemen, Police staff,Ambulance staff, Nurses, Midwives, Doctors and Fireman crashed the stock market, wiped out Banks, took billions in bonuses and paid no tax? No, me neither. Please copy and paste to status for 24 hours to show your support against the government's latest attack on pensions and public sector workers.

Behind this, however, lies a longer chain of causation that implicates us all. Where did the credit crunch come from?* The sub-prime housing market. Mortgage lenders in western economies had overextended credit to households that had no hope of repaying from their incomes. What provided the impetus to excess housing credit? Well meaning government policies that had responded to rising inequality by promoting and subsidizing "affordable" housing (actually the opposite). Bankers and mortgage lenders colluded actively with this, of course. So I'm not particularly delighted that part of the British government's strategy for economic revival is new help for homebuyers. Haven't we been here before?

Then, why did the housing crash ripple so devastatingly through the economy? Because the same governments had already given up their room for fiscal manoeuvre by bloating their public sector wage bills and unfunded pension promises. (Promises to whom? Oh! Teachers, policemen, ambulance staff, nurses, midwives, doctors and firemen.)

So, Mr or Mrs Public Sector Worker: No, I don't let you off the hook. In fact, no one should feel free of responsibility. I might blame the last Labour government, but somebody must have voted them in. (It might have been me.)

Not everyone will agree with this diagnosis. In the real world, causal chains are long and complex. For the same reason, they are also generally uncertain. That is enough reason for disagreement, before we get around to ignorance, bias, and vested interests! The one claim I make confidently, however, is that one-step causation is rarely enough.

* To anyone who wants to read more, I recommend any of the following. There's an American tilt in my list; I don't think our own investigators have done a good job yet (but more recommendations are welcome).

• Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (Time Books, 2011).
• Raghuram Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton University Press, 2010)
• John B. Taylor, Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis (Hoover Press, 2009).

Mark Harrison : 30 Nov 2011 08:14 |  Tags: Economics Politics Recession |  Comments (7) |  Close comments |  Report a problem

Plan B or not to B

Writing about web page http://clients.squareeye.net/uploads/compass/documents/Compass_Plan_B_web.pdf

Plan B was launched over the weekend to much fanfare. There was much excited analysis in The Guardian. In The Observer, one hundred economists told George Osborne that Plan A is failing.

I will focus on one small aspect, the Plan B critique of current fiscal policies. Behind Plan B is the idea that "current policies … may do the very opposite of their avowed intention, by actually increasing the deficit." The logic underlying this argument extends he Keynesian multiplier: public spending cuts put people out of jobs and reduce their incomes, so that they pay less in tax; if taxes fall by more than spending, the deficit will widen, ending in higher, not lower public debt. Turn this argument around and there would be scope, apparently, for Britain to spend its way out of debt.

Another idea behind Plan B is that "the UK national debt is not large by long-run historical standards." Judging from the historical record, it seems, Britain can easily afford a higher public debt. While debt reduction may sound virtuous, it is suggested, it is currently unecessary (and the policies designed to achieve it may be actively harmful).

The outcome of Plan A, according to Plan B, is economic "sado-masochism": We are enduring the pain of public spending cutbacks to no purpose (since the cutbacks will not reduce the deficit) when the purpose (to reduce the public debt) is not even necessary in the first place. Or is there pleasure for some in the pain of others?

This weekend, by coincidence, the Royal Economic Society Newsletter (no. 155, October 2011) published my short paper Surely You're Joking, Mr Keynes?This paper makes two points.

First, it's true that Britain has carried much larger debts relative to its GDP in the past, but this was almost entirely the result of wars; do we have a comparable excuse today? It's completely unhistorical, moreover, to compare Britain's credit today with that obtainable when Britain was the world's dominant economic and financial power. The world has changed; is that something we still need to get used to?

On this, I conclude:

Historically, having a debt twice the size of the national income has been a sign that something went terribly wrong: a run of major wars, for example. Faced with the worst recession in 80 years, the British government was right to let its budget go into deficit temporarily. At that moment an increase in Britain’s debt was inevitable. Now it looks essential to bring it back under control over a few years.

Second, there is no robust evidence in the historical data that deficit reduction is self-defeating. There is claimed to be evidence, but I show that it crumbles when you touch it. On average, in fact, deficit reduction has reduced the national debt -- as one would expect.

Here, I conclude:

It remains true that, once the public debt is set on a particular course, it is hard to change that course quickly. But this is only momentum that takes time to reverse; there is no evidence of destabilizing pushback from Keynesian multipliers.

To sum up: I have taken aim at two common beliefs about the British public finances. One is that we should borrow our way out of recession; the other is that we can spend our way of debt. These beliefs are based on intriguing stories. But, like many good stories, they are fictions. Our country cannot spend its way out debt. In today’s world, we can afford to borrow much less than in the past, and that may be just as well.

Mark Harrison : 31 Oct 2011 15:26 |  Tags: Economics Politics Recession |  Comments (4) |  Close comments |  Report a problem

Afghanistan: Ten Years in a Dead End Street

Writing about web page http://www.bbc.co.uk/news/world-south-asia-15209793

Marking ten years since the coalition invasion of Afghanistan, former U.S. commander Stanley McChrystal has said that the U.S. and its NATO allies are only a little better than half way towards reaching their war goals. He added:

Most of us -- me included -- had a very superficial understanding of the situation and history [of Afghanistan], and we had a frighteningly simplistic view of recent history, the last 50 years.

Respectfully, I disagree. The problem was not a lack of understanding specifically of Afghanistan's history, or of recent history. The problem was a lack of history in general. They did not understand how our modern world has been created.

The most basic acquaintance with European history since the tenth century would have told them two things.

• Democracy cannot be built overnight. It is a long, long process. A successful democracy depends on the rule of law. The rule of law comes first. Without the rule of law, electoral competition leads swiftly to chaos.
• A society based on patronage and rent sharing -- the kind of state that Afghans had before it was destroyed by a communist coup d'état and Soviet intervention -- can be more stable, more prosperous, and provide more rights than one based on chaos and looting. In fact, the right kind of patronage and rent sharing can foster the rule of law.

Based on ignorance of these two simple things, coalition policies in Afghanistan have been set up to fail from the word Go. We have failed to achieve our goals because the goals were fundamentally misconceived. Tens of thousands of troops and civilians have paid for this with their lives. The immense damage that has been done in Afghanistan and neighbouring countries will persist for decades.

Twenty/twenty hindsight? No. The first time I wrote this was on December 4, 2001. (I updated it on January 9, 2002, and expanded on it in 2009 on July 18 and August 30, and on January 1, 2010.)

I'll be modest about this -- I should be. I have made few predictions that have stood the test of time. Actually I have made few predictions, period. Not having to have a crystal ball is one of the good things about studying history.

I am not saying: Look, I got it right. I'm saying: Look, even I got it right. Why couldn't they?

Maybe because they didn't know the right kind of history.

Mark Harrison : 07 Oct 2011 09:38 |  Tags: Afghanistan History |  Comments (1) |  Close comments |  Report a problem