Current Policy and Concurrent Economic Performance

Among people interested in politics, there is a natural desire to discover a positive relationship between their favorite party and good economic performance. I shared this belief, and it only faded slowly after many years of studying and teaching economics. Why shouldn’t many people share this belief? Our politicians certainly encourage it, taking credit for positive outcomes, and blaming opponents for negative outcomes. I have accumulated data on quarterly real GDP growth from the Reagan administration through the first two years of the Trump administration, and presented the data in a series of graphs to informally test the hypothesis that current policy influences current economic performance. As a note, fourth quarter 2018 growth during the Trump was estimated by the Atlanta Federal Reserve.

The first graph shows the quarterly growth of real GDP by administration from 1981 to the present. The data in red demarks the first term of a Republican president, and the data in blue, a Democrat president. Likewise, the light red reflects the second administration of a Republican president, and the light blue, a Democrat president. I could not visibly determine a difference in outcomes by party. Other readers may pick up trends that I missed.

The first histogram displays real GDP growth 88 quarters (22 years) of Republican administration and 64 quarters (16 years) of Democrat administrations. The red is the Republican, the blue, the democrat, and the purple, the overlap between the two parties. There are differences in the performance between the two parties. Republican administrations seem to have weathered the most severe downturns, and enjoyed the highest levels of economic growth. More striking is the overlap. The red represents the histogram of Republicans and the blue and purple, the Democrats. The distribution of growth between the two parties center around the same mean, 2.7 for the Republicans and 2.9 for the Democrats.

Picking on President Trump because he is the current president, and because he recently asserted that second quarter 2018 growth is “an economic turnaround of historic proportion,” the second histogram separates the Trump administration figures from the other Republican administrations. Growth to date for his administration averages 2.8%, splitting the difference between Democrats and other Republicans.

The final graph places real GDP quarterly growth by administration along with the average level of growth, and both a two standard deviations upper and lower band. Growth during the Trump administration is nothing out of the ordinary. It centers around the mean and does not approach the two standard deviation threshold. While disproving President Trump’s claim of historic growth, it also dispels the notion that Trump’s policies have already ruined the economy. 

The fact that current policies do not seem to immediately influence economic outcomes is not my belief alone. The European IGM Economic Experts Panel was recently asked to respond to the statement, “Voters overestimate the effect that current governments have on their economies’ concurrent economic performance.” Sixty-four percent of the respondents strongly agreed or agreed whereas only 4% strongly disagreed or disagreed. Six percent were uncertain, while 4% held no opinion, and the remaining 22% did not answer the question. As an aside, several of the economists surveyed offered valuable comments. 

There are many reasons why policy seems to have no immediate impact. We participate in a market economy, and the independent actions of economic agents attempting to maximize their outcomes might overwhelm the actions of any president or party. Perhaps policy of both parties is more similar than different. Autonomous agencies, like the Federal Reserve, might have more impact than presidential administration. Professional bureaucracies that span administrations may act as a ballast to policies that deviate from norms. Finally, both good and bad policies might take time before their impact is realized, and might not be easily associated with a past administration, suggesting that policy is important, but its impacts are often not immediate.

Read more!

De Soto on Egypt

Hernando De Soto, a Peruvian economist argues that the economic situation of the poor can be substantially improved by establishing and enforcing property rights for all citizens within a country.  His books, “The Other Path: The Economic Answer to Terrorism”, and “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else” are important contributions to the economic literature.  He describes his involvement as an adviser to the Egyptian government and explains why the lack of property rights contributed to discontent in Egypt in “Egypt's Economic Apartheid.”

In 1997, the Egyptian government hired the Institute for Liberty and Democracy, De Soto’s think tank, to measure the size of the extralegal economy, those working and living without the protection of property through law and the institutions that enforce it.  Those living outside the boundaries of the property rights system define the economically and politically marginalized citizens.

De Soto led a team of over 120 experts who worked with over 300 local Egyptian leaders and interviewed thousands of marginalized Egyptians.  They issued a 1,000 page report in 2004 that estimated the underground economy hired 9.6 million people, 2.8 million more than the above ground legal private sector, and 3.7 million more than the public sector.  An astounding 92% of the population lives without legal titles to their homes.  De Soto’s team measured the value of extralegal businesses and homes at over $400 billion.  If afforded legal protection, the value of these assets would grow rapidly as would the Egyptian economy.The report was approved for implementation by Minister of Finance Muhammad Medhat Hassanein, but before the plan was to be implemented Hassanein was ousted and the reforms shelved.  Why would anyone oppose reforms that would directly improve the lot of the poor and contribute to the overall prosperity of Egypt?

North, Willis and Weingast suggest an answer in “Violence and Social Order.”  Governments in developing nations, termed limited access orders by the authors, trade economic rights to groups who can cause violence for a promise to maintain peace.  The marginalized citizens began a popular uprising that is at the point of turning violent as the powerful political insiders jostle violently or otherwise to establish a new political equilibrium that will maintain or enhance their privileged position in society.  The difficult to impossible task of democratic elements is to maintain the peace, disarm political insiders who can violently demand their privilege, and expand legal access to the economy to the marginalized Egyptians.
Read more!

Yamarik, Johnson and Compton on War

As my students know, I question the common conclusion that the United States government’s economic response to World War II lifted the country out of the Great Depression.  I don’t believe that the United States has benefited economically from any war beginning with the Spanish American War and our wars were or are being fought off our shores.  My conclusion is more one-sided than the economic literature.

Yamarik, Johnson and Compton in “War! What Is It Good For? A Deep Determinants Analysis of the Cost of Interstate Conflict” (Peace Economics, Peace Science and Public Policy, Vol 16, No 1, 2010) write that

…there is no clear consensus on the economic consequences of interstate wars.One line of reasoning argues that war is harmful to the economy. Simply put, war kills people, destroys property, restricts trade, and retards capital formation. Marwah and Klein (2005) find that military expenditures reduced private investment and thus lowered the growth rate for the Southern Cone of Latin America. Blomberg, Hess, and Thacker (2006) estimate that major external conflict in the previous two years has a negative contemporaneous impact on growth. Sevastianova (2009) finds that international war has a negative impact on the one- and two-year growth rate, but an insignificant impact on the longer five-year growth rate. Glick and Taylor (2010) also find a negative short-run relationship between war and growth. They estimate that the indirect cost of World Wars I and II stemming from lost trade was even greater than the direct costs associated with the loss of life.

An alternative line of reasoning argues that the macroeconomic effect of war is ambiguous, or even positive. In the short-run, wartime expenditures increase aggregate demand and the level of real GDP.4 Military research and production can increase innovation and technological progress in the long-run (Alchian, 1963; Kuznets, 1964; and Ruttan, 2006). Similarly, war can eliminate distributional coalitions, thereby reducing rent seeking, especially for the “losers” of the conflict (Olson, 1982). For the U.S., conventional wisdom is that the Second World War saved the U.S. economy from an even longer depression and planted the seeds for future prosperity.

Their empirical research adds to the literature that concludes that war is bad for an economy.  They conclude

We find that a one standard deviation increase in fatality-weighted conflict results in an average reduction in real GDP per capita of between 0.09 and 0.14 of a standard deviation. Our estimate is consistent with common sense and is fairly stable across different specifications of our cross-country regression. Most surprisingly, these results suggest that the costs of war stay with a country much longer than is implied by previous studies. Even if an economy grows quickly after a war is over, our results imply that this will not be enough to return standards of living to where they would have been in the absence of conflict. War is more than a transitory supply shock, it permanently alters the economic potential of the country.

Read more!

A Coup in Ecuador?

South American countries are not democratic in the same sense that the United States and other Western countries are as demonstrated by a recent coup attempt in Ecuador (“Ecuador in state of seige, region supports Correa”).

QUITO, Ecuador (AP) - Ecuador was under a state of siege Friday, the streets quiet with the military in charge of public order, after soldiers rescued President Rafael Correa from a hospital where he'd been surrounded by police who roughed him up and tear-gassed him earlier.

Correa and his ministers called Thursday's revolt - in which insurgents also paralyzed the nation with airport shutdowns and highway blockades - an attempt to overthrow him and not just a simple insurrection by angry security force members over a new law that would cut benefits for public servants.

With very little information (meaning I am offering little more than a guess), I interpret events differently than President Correa.  It sounds like a simple coup attempt to protest cuts in benefits for public servants, the norm in South America.  While I do not generally support coups, elections in much of South America do not deserve the public sanctity that they are given in Western countries.  Control of the press, intimidation of other candidates and electoral fraud are all standard operating procedure on the continent. 

I do not conclude that Correa is a rightwing president trying to dismantle the public sector based on campaign rhetoric and political alignment.  His second inauguration was attended by President of Argentina Cristina Fernández de Kirchner, President of Bolivia Evo Morales, President of Cuba Raúl Castro and President of Venezuela Hugo Chávez, a rather undemocratic, left of center bunch, and in his address he promised to continue the socialist revolution while railing against the media.  Even leftwing governments are limited in benefits that they can distribute to public servants.

Based on the work of North, Willis and Weingast (“Violence and Social Order”), I will propose in class that the ability of groups to seek economic rewards through the use or threat of violence is a major cause of slow growth in South American and much of the world. 
Read more!

Samuelson on Population Growth and Deficits

Throughout most of my life, many social scientists have warned of a Malthusian population bomb that threatens our planet's limited resources. Thomas Malthus (1776-1834), an influential economist, observed that population tends to grow geometrically and food production, arithmetically. But here the similarity between many of today's demographers and Malthus ends. He concluded that mankind was not starving so other economic forces must be at work to extend life and that it was the role of the economists to study these forces.

With the aging of Western countries, economists are revising theories of population growth and finding that there is much to recommend at least stable populations. Robert Samuelson explores the impact of population growth on the U.S. economy and discusses tax policies to encourage birth in "Taxes, Fertility and Economic Growth."

...a budget is not just a catalogue of programs and taxes. It reflects a society's priorities and values. Our society does not -- despite rhetoric to the contrary -- put much value on raising children. Present budget policies punish parents, who are taxed heavily to support the elderly. Meanwhile, tax breaks for children are modest. If deficit reduction aggravates these biases, more Americans may choose not to have children or to have fewer children. Down that path lies economic decline.

Societies that cannot replace their populations discourage investment and innovation. They have stagnant or shrinking markets for goods and services. With older populations, they resist change. For a country to stabilize its population -- discounting immigration -- women must have an average of about two children. That's a "fertility rate" of two. Many countries with struggling economies are well below that. Japan's fertility rate is 1.2. Italy's is 1.3, as is Spain's...

The U.S. fertility rate isn't yet close to these dismal levels. In 2007, it was at the replacement rate of 2.1 children per woman, reports the National Center for Health Statistics...

While having a child is a deeply personal decision, it's also shaped by culture, religion, economics and government policy...

We need to avoid Western Europe's mix of high taxes, low birth rates and feeble economic growth. Young Americans already face a bleak labor market that cannot instill confidence about having children. Piling on higher taxes won't help. "If higher taxes make it more expensive to raise children," says demographer Nicholas Eberstadt of the American Enterprise Institute, "people will think more about having another child." That seems common sense, despite the multiple influences on becoming parents.

How to reconcile this with deficit reduction is unclear. From 2011 to 2020, the Obama administration projects budget deficits of $8.5 trillion. Other estimates are higher. Even if spending and benefits for the elderly are cut -- as they should be -- higher taxes will still almost certainly be needed. Parents ought to be shielded from the steepest increases.

Any tax system rewards some activities and punishes others. A case in point is the mortgage interest rate deduction that rewards people for buying larger homes with more debt. We might reduce this dubious subsidy and shift some savings toward children. Stein advocates combining pro-child tax breaks (the personal exemption, the child tax credit, the child-care credit and the adoption credit) into one generous credit. Whatever the details, policies should have a pro-family bias because parenting is, as he writes, "one of the most important services any American can perform."

Read more!

China: Limited Access Order and Google

In "Violence and Social Orders," North, Wallis, and Weingast argue that economists have under appreciated the importance of controlling violence in establishing social order in which economic activity occurs.  They describe three types of social orders from most to least violent: primitive, limited access, and open access.  China is a limited access order.  The government creates a governing coalition by trading economic favors to groups who will in turn refrain from violence or help control violence. 

Limited access orders not only limit economic rights of the majority of its citizens but are also careful about granting economic entry into their countries by foreign interests.  This lack of freedom limits economic innovation and growth.  China has been growing rapidly by opening access to both domestic and foreign interests, but its growth may ebb if it fails to evolve into an open access order.

China's governing coalition's dealings with Google may signal the limits to the growth of access to its economy.  Recent cyber attacks on Google which may have been initiated by a university with close ties to the Chinese military ("Chinese schools deny Google cyber-attack links").  Those attacks and demands for censorship by the Chinese government may force Google to close shop in China ("Google’s China Advertising Clients Urged to Defect (Update1)").  This will be good for Baidu Inc., China's main Internet company, which will increase its market share, but it will be bad for consumers and technological advance ("CORRECT: Baidu Shares Rise On Reports Google Near Closing China Site".
Permanent link
Read more!

Sevastianova on War and Economic Growth

In "WWII and the Economy," I hypothesized that war was not good for the economy and stated three conditions that I believed would not hold to "prove" my hypothesis in a type of proof by contradiction.  The conditions were that consumers do not mind the consumption of armaments, that the war is fought on foreign soil, and that little value is placed on the value of lost lives. 

Daria Sevastianova address the impact of war on a country's economy in "Impact of War on Country per Capita GDP: A Descriptive Analysis" which was published in Peace Economics, Peace Science and Public Policy, Vol. 15, 2009.  Her conclusion reads   

This paper applies empirical growth framework to study the effect of war on economic growth. We model growth over one, two-, and five-year time periods, as well as check robustness of findings with OLS and FE estimation. Along with a standard set of explanatory variables included in growth regressions, COW data on civil and international war are used to code war incidence during 1970-2000 in a panel of 90 countries.

Regression analysis demonstrates that the average effect of civil and international war is to decrease income growth. Civil war harms all economies, while international war might boost growth in some countries. The findings in this paper point to the fact that economies with low growth rates are involved in civil war, whereas faster growth economies are involved in international wars. In addition, the negative effects of war are more pronounced in the short run growth models based on annual and biannual data (where we find negative and statistically significant coefficients), whereas the effect of war on five-year growth rates is statistically insignificant. 

The study also provides a descriptive analysis of how civil and international wars affect income per capita level, where war incidence is plotted against real GDP per capita in a sample of countries. A visual examination of data corroborates the results of regression analysis: while civil war mostly reduces income, there is much more ambiguity in the effect of international war. Some countries, in fact, are able to sustain economic growth throughout the duration of war.

Preliminary results obtained from graphing war data on an individual country basis from 1970 to 2000 point to the fact that there is a considerable amount of variation in the economic effects of political instability. The impact of war appears to vary considerably with conflict severity, time period, and by country. The wide variation in these results warrants a more detailed multivariate analysis in order to ascertain how intra- and interstate conflict affects real income per capita. Focus on different levels of conflict intensity, as well as sample heterogeneity might prove productive for future investigation, where conflict data collected by political scientists are applied in the empirical growth framework.

The model that she employs is tested with data, making it more than a story like the one I told.  It does not directly contradict my conclusions although it demonstrates that some countries are able to sustain growth through a conflict.  For example, income could grow, but the availability of consumer goods could stagnate or decline.

In attempting to contact Sevastianova about her article, I found an interview taken from the Evansville Business Journal (EBJ), October 2008.  I liked her response to one question because it deals with a strange demographic in economics faculties, they are dominated by men.  When asked what she enjoys about her current position she replied

I like sparking people's interest in economics, and I really like it when girls see they can learn economics and are aware of all the various job opportunities there are in the field.

Hear, hear.
Read more!

Forceps

A public good has two characteristics.  It is non-rivalrous and, once provided, exclusion by others is difficult.  Non-rivalrous means that the use of the good by one does not stop use by others.  An idea, knowledge, is a public good.  It is non-rivalrous; my use of algebra or a song does not affect yours.  Exclusion is difficult; once algebra or a song is know, it is difficult to stop people from using it. 

We want people to introduce new ideas into the market; they cause the economy to grow.  They will not be provided unless those who introduce them can profit.  Inventors protect their ideas through secrecy and governments protect them with copyrights, trademarks, and patents.  We also want the ideas to spread to others so they can be built upon and expanded by others.  Achieving a balance between encouraging new ideas and granting the innovators monopoly use rights is an important yet tricky function of government.

Steven Levitt and Stephen Dubner provide a gruesome example of knowledge that was protected too long by secrecy in "Super Freakonomics."  The relevance of the example and its application to lawmakers in determining how long to protect new ideas should be clear.

There is another powerful, if bittersweet, example from the realm of childbirth: the forceps.  It used to be that when a baby presented itself feet- or derriere-first, there was a good chance it would get stuck in the uterus, endangering both mother and child.  The forceps, a simple set of metal tongs, allowed a doctor or midwife to turn a baby inside the uterus and adroitly pluck it out, headfirst, like a roast suckling pig  from the oven.

As effective as it was, the forceps did not save as many lives as it should have.  It is thought to have been invented in the early seventeenth century by a London obstetrician named Peter Chamberlen.  The forceps worked so well that Chamberlen kept it a secret, sharing it only with sons and grandsons who continued in the family business.  It wasn't until the mid-eighteenth century that the forceps passed into general use.

What was the cost of this technological hoarding?  According to the surgeon and author Atul Gawande, "it has to have been millions of lives lost."

Read more!

4th Quarter GDP Growth

The Drudge Report headline read "NOW FOR SOME GOOD NEWS: 5.7% GDP!," but linked to a Yahoo Finance article by an AP writer with a less enthusiastic headline, "4th quarter's fast economic pace likely to wane."  James Hamilton explains the schizophrenic view of the same Bureau of Economic Analysis report ("Strong GDP growth with weak fundamentals," Econbrowser) after a quick review for some and preview for others of national income accounting.

Gross Domestic product (GDP) is the statistic that attempts to measure the market value of all final goods and services produced within a country over a specified time period, usually one year.  The economy is growing when we produce more and 5.7% growth is good.  To better understand the causes of growth, GDP is broken into four components: consumption, investment, government purchases, and net exports (exports less imports) and the sum of these four components equals GDP.  Those components are further broken into subcomponents.  To understand why the economy grew so rapidly in the fourth quarter, it is necessary to understand how inventories are treated.  As Mankiw explains ("Principles of Macroeconomics: Fifth Edition," Chapter 10: Measuring a Nation's Income," 

...the treatment of inventory accumulation is noteworthy.  When Dell produces a computer and, instead of selling it, adds it to its inventory, Dell is assumed to have "purchased" the computer for itself.  That is, the national income accountants treat the computer as part of Dell's inventory investment spending.  (If Dell later sells the computer out of inventory, Dell's inventory investment will then be negative, offsetting the positive expenditure of the buyer.)  Inventories are treated this way because one aim of GDP is to measure the value of the economy's production, and goods added to inventory are part of that period's production.

Hamilton explains why changes in inventory played such a big part in the BEA report.

Three-fifths of that Q4 GDP growth came from the fact that businesses were drawing down inventories more slowly than they had the quarter before. Firms sold $8.5 billion more goods (at a quarterly rate) in 2009:Q4 than they produced, and met those sales by drawing down inventories by $8.5 billion. This reduction in inventories counts as negative investment spending of -$8.5 billion at a quarterly rate (or -$34 B at the annual rate these numbers are typically reported) for purposes of calculating fourth-quarter GDP. Firms sold $34.8 billion more than they produced in 2009:Q3, which amounted to negative inventory investment of -$139 billion at an annual rate for Q3. Since this component of investment spending went from -139 to -34, it counts as positive growth [-34-(-139)] when you compare Q3 GDP with Q4 GDP. This mechanism alone contributed 3.4 percentage points to the 5.7% growth rate for real GDP reported for Q4.

To put it another way, if consumers, businesses, foreigners, and the government had all purchased exactly the same quantity of real goods and services in 2009:Q4 as they had in 2009:Q3, more of those sales would have come out of inventory drawdown in Q3 than in Q4, so even without any gain in final sales we would have had to produce more stuff in Q4 than Q3, specifically, 3.4% more stuff at an annual rate. In fact real final sales to consumers, businesses, foreigners, and the government were not stagnant, but grew at a 2.3% annual rate during the fourth quarter, and the two effects combined give us the 5.7% reported GDP growth.

Just because the production gains can be accounted for in terms of slower inventory drawdown doesn't mean they aren't real, and doesn't mean they can't continue. I noted in July that we might expect inventory restocking to add 1.6% to the annual GDP growth rate for each of the first four quarters of the economic recovery, and we haven't even yet begun that inventory restocking process. The question, though, is what we'll see for the other components of GDP. Exports grew more than imports in Q4, with the result that net exports contributed 0.5 percentage points to that 2.3% growth in real final sales. That's certainly a very welcome development and a critical step for correcting the imbalances that have been very troubling over the last decade.

Those who project a slow rebound note that growth from slower inventory drawdown cannot continue forever because firms will run out of inventory, and fear that consumer spending will remain sluggish, limiting future hiring.

As a reminder not to read too much into a story, the growth in GDP should not be viewed as evidence that the Obama administration's stimulus package was successful any more than growing unemployment over the past year should be viewed as evidence that the stimulus failed.  A researcher would need to construct a model specifically designed to measure actual economic activity against the projected activity in the absence of a stimulus or measure how different government policies affected economic activity over time and across countries.  Menzie Chinn of Econbrowser has several posts on this topic here.
Read more!

Aiding Haiti's Earthquake Victims and Growth

I was sent via e-mail a copy of an article by Brian Concannon writing for Counter Punch in "Working with the Haitian Government." Concannon is a human rights lawyer working in Haiti, a laudable career and I wish him well, but I believe that he has made several errors that have characterized developmental aid in the past that we should avoid in the future.  He writes 

Haiti’s lack of infrastructure and history of corruption should be considered in shaping the international response to Tuesday’s earthquake. But these factors should be a reason for investing in infrastructure and good governance, not for bypassing Haiti’s government.

Arnold and Schulz (From Poverty to Prosperity) use the "resource curse" to explain why it might be bad to funnel foreign aid through a government.

Economists have coined the phrase "the resource curse" to describe countries whose wealth consists primarily of diamonds or oil.  The problem is that resource wealth is more characteristically stolen than earned.  Natural resources do not reward work, capital accumulation, or innovation.  They reward those who can establish and maintain control over the resource.

Some economists believe that foreign aid, because it is unearned, can be a similar curse.  When aid is channeled through the recipient government, it gives the leaders an incentive to remain in power, in order to control the wealth represented by the aid.  Just as the owner of a diamond mine tries to hang on his franchise, the leader of an aid-dependent nation tries to exclude others from power.

Thus, unearned income serves to undermine the work of ethic and the public service ethic.  Resources and government aid offer rewards to those skilled at taking things rather than those skilled at creating or improving things.  Unearned income makes corruption relatively easy and profitable.  

Concannon continues

Haiti’s devastation exposed the disadvantages of an extremely limited government. The earthquake itself was a natural phenomenon, but its horrible toll was largely the product of manmade factors like the failure to prevent shoddy construction on precarious slopes (or provide safer housing) and a health care system already stretched to the breaking point. Sixteen months ago, and five years ago, similar factors produced high death tolls from tropical storms that hit neighboring countries harder but less lethally.

As a defender of limited government, I would substitute "ineffective" for "limited" in the above paragraph.  Nor is the prevention of shoddy construction simple a function of government regulations or a strained health care system the result of governmental neglect.  Markets have something to do with the provision of goods and services.  Rather than blame shoddy construction for damage, I would blame extreme poverty.  People working through markets recognize Haitian poverty and produce a market driven construction code.  Imagine the rise in building expenses and homelessness if the government could effectively impose Los Angeles' building code on Haiti.  How many Haitians could afford our health care or even Mexico's health care?  The issue is how to bring economic growth not how to provide better goods and services which are a byproduct of growth.

Concannon concludes

An effective international response to the earthquake will minimize the damage of the next stress in Haiti, by including both short- and long-term measures to develop the government’s capacity to provide basic, honest services to its citizens.

Accepting Concannon's belief that is the role of the international community to "develop the government's capacity to provide basic, honest services to its citizens" I would ask if this is the right goal and do we have the capacity to achieve it?  Substitute "Haitian's" for "government's" in the above paragraph and you might be headed in a better direction for growth.  As North, Wallis, and Weingast point out in Violence and Social Orders countries that advance in wealth and prosperity do so by developing more private and local governmental organizations.  The authors suggest that this growth is organic.  Perhaps foreign efforts to encourage the growth of organizations outside the federal level will fail as have past efforts to work through them. As William Easterly observes ("Interview with William Easterly," in From Poverty to Prosperity)

There's been $2.3 trillion spent over the last fifty years in foreign aid.  And that's in today's dollars. And really, there's surprisingly little to show for it.  The main objective of foreign aid, of course was the permanent reduction of poverty; the main objective was to promote economic growth.  And unfortunately, there's no connection at all between aid and economic growth according to the empirical evidence that we have. 

Read more!

Kling and Schulz: The Importance of Markets

The first twenty pages of "From Poverty to Prosperity" by Arnold Kling and Nick Schulz has been a pleasure to read.  They compare the economy to a computer.  The hardware is the visible and countable resources of the economy, the operating system, the less visible, nonrivalrous system of law and institutions, and the software, the nonrivalrous ideas and innovation and that bring technological advance.  They argue that economic inquiry has shifted from the hardware to the operating system and software, which places renewed focus on markets.  Kling and Schulz write,

Economics 2.0 offers a completely fresh perspective on the role of markets in society, one that will become clear over the course of this book.  Traditionally, the debate over markets has been between the "Chicago school" and the "Harvard-MIT school."  The Chicago school says, "Markets usually work.  That is why we need markets."  The Harvard-MIT school says, "Markets often fail.  That is why we need government."

Economics 2.0 says, "Markets often fail.  That is why we need markets."

What do we mean by this?  Economics 2.0 says that overcoming market failure requires innovation.  Innovation is best delivered by markets.  It is rarely delivered by government.  Hence, the paradoxical conclusion is that markets are 0ften the best solution. 

The book includes interviews with Robert Fogel, Robert Solow, Paul Romer, Douglas North, William Easterly and others, and yes, I have skipped ahead to read several of the interviews.  After twenty pages and several interviews, I believe that the book is assessable to undergraduate students. 
Read more!

Slow Growth: A Glass Half Full

(HT Drudge Report)  Jeannine Aversa of My Way, explains new statistics released by the Commerce Department in "Recovery not as strong as previously thought."  It sounds very much like the glass is half full.  Growth is good, but too slow to bring the recession to a quick end.

WASHINGTON (AP) - The economy grew at a 2.2 percent pace in the third quarter, as the recovery got off to a weaker start than previously thought. However, all signs suggest the economy will end the year on stronger footing.

The Commerce Department's new reading on gross domestic product for the July-to-September quarter was slower than the 2.8 percent growth rate estimated just a month ago. Economists were predicting that figure wouldn't be revised in the government's final estimate on third-quarter GDP...

The main factors behind the downgrade: consumers didn't spend as much, commercial construction was weaker, business investment in equipment and software was a bit softer and companies cut back more on inventories, according to Tuesday's report.

Despite the lower reading, the economy managed to finally return to growth during the quarter, after a record four straight quarters of decline. That signaled the deepest and longest recession since the 1930s had ended, and the economy had entered into a new fragile phase of recovery.

Many analysts believe the economy is on track for a better finish in the current quarter.

The economy is probably growing at nearly 4 percent in the October-to-December quarter, analysts say. If they're right, that would mark the strongest showing since 5.4 percent growth in the first quarter of 2006 - well before the recession began. The government will release its first estimate of fourth-quarter economic activity on Jan. 29.

Yet even such growth wouldn't be enough to quickly drive down the unemployment rate, now at 10 percent. High unemployment and tight credit for both consumers and businesses are expected to continue to weigh on the economic recovery. Many economists predict the economy's growth will slow to a pace of around 2 or 3 percent in the first three months of 2010.

.
Read more!

Acemoglu on Wealth Creation

(HT Mankiw) In, "What Makes a Nation Rich? One Economist's Big Answer," written for Esquire, Daron Acemoglu of MIT, one of the word's best economists and a favorite of mine, explains how a poor nation can become rich. The name, Acemoglu, and his answer, change incentives, will sound familiar to my students.

People need incentives to invest and prosper; they need to know that if they work hard, they can make money and actually keep that money. And the key to ensuring those incentives is sound institutions — the rule of law and security and a governing system that offers opportunities to achieve and innovate. That's what determines the haves from the have-nots — not geography or weather or technology or disease or ethnicity.

Put simply: Fix incentives and you will fix poverty. And if you wish to fix institutions, you have to fix governments.

Acemoglu also describes policies that the U.S. should avoid and advance in promoting wealth creation.

If we know why nations are poor, the resulting question is what can we do to help them. Our ability to impose institutions from the outside is limited, as the recent U. S. experiences in Afghanistan and Iraq demonstrate. But we are not helpless, and in many instances, there is a lot to be done. Even the most repressed citizens of the world will stand up to tyrants when given the opportunity. We saw this recently in Iran and a few years ago in Ukraine during the Orange Revolution.

The U. S. must not take a passive role in encouraging these types of movements. Our foreign policy should encourage them by punishing repressive regimes through trade embargoes and diplomacy. The days of supporting dictators because they bolster America's short-term foreign-policy goals, like our implicit support of Muhammad Zia-ul-Haq in Pakistan starting in the 1970s, and our illicit deals with Mobutu's kleptocratic regime in the Congo from 1965 to 1997, must end. Because the long-term consequences — entire nations of impoverished citizens, malnourished and hungry children, restive, discontented youngsters ripe to be drawn toward terrorism — are too costly. Today that means pushing countries such as Pakistan, Georgia, Saudi Arabia, Nigeria, and countless others in Africa toward greater transparency, more openness, and greater democracy, regardless of whether they are our short-term allies in the war on terror.

At the microlevel, we can help foreign citizens by educating them and arming them with the modern tools of activism, most notably the Internet, and perhaps even encryption technology and cell-phone platforms that can evade firewalls and censorship put in place by repressive governments, such as those in China or Iran, that fear the power of information.

There's no doubt that erasing global inequality, which has been with us for millennia and has expanded to unprecedented levels over the past century and a half, won't be easy. But by accepting the role of failed governments and institutions in causing poverty, we have a fighting chance of reversing it.

Acemoglu is writing a book about his theory of inequality with James Robinson; a book that I will both buy and read.
Read more!

Easterbrook Eulogizes Norman Borlaug

Gregg Easterbrook is one of America's best developmental economists. These economists study economic development and attempt apply lessons learned to poor countries. Economists have learned a great deal, but on frustrating lesson is that it is difficult to quicken the pace of economic growth. Poverty remains a persistent problem in much of the world. In a Wall Street Journal article titled, "The Man Who Defused the 'Population Bomb'," Easterbrook describes the unique contribution of Norman Borlaug who greatly eased hunger. He is a man America should honor. In part, Easterbrook writes

Norman Borlaug arguably the greatest American of the 20th century died late Saturday after 95 richly accomplished years. The very personification of human goodness, Borlaug saved more lives than anyone who has ever lived. He was America's Albert Schweitzer: a brilliant man who forsook privilege and riches in order to help the dispossessed of distant lands. That this great man and benefactor to humanity died little-known in his own country speaks volumes about the superficiality of modern American culture...

As a young agronomist, Borlaug helped develop some of the principles of Green Revolution agriculture on which the world now relies including hybrid crops selectively bred for vigor, and "shuttle breeding," a technique for accelerating the movement of disease immunity between strains of crops. He also helped develop cereals that were insensitive to the number of hours of light in a day, and could therefore be grown in many climates...

Sometimes the environment (and people) are too important to be left to the environmentalists.

After his triumph in India and Pakistan and his Nobel Peace Prize, Borlaug turned to raising crop yields in other poor nations especially in Africa, the one place in the world where population is rising faster than farm production and the last outpost of subsistence agriculture. At that point, Borlaug became the target of critics who denounced him because Green Revolution farming requires some pesticide and lots of fertilizer. Trendy environmentalism was catching on, and affluent environmentalists began to say it was "inappropriate" for Africans to have tractors or use modern farming techniques. Borlaug told me a decade ago that most Western environmentalists "have never experienced the physical sensation of hunger. They do their lobbying from comfortable office suites in Washington or Brussels. If they lived just one month amid the misery of the developing world, as I have for 50 years, they'd be crying out for tractors and fertilizer and irrigation canals and be outraged that fashionable elitists in wealthy nations were trying to deny them these things."


Environmentalist criticism of Borlaug and his work was puzzling on two fronts. First, absent high-yield agriculture, the world would by now be deforested. The 1950 global grain output of 692 million tons and the 2006 output of 2.3 billion tons came from about the same number of acres three times as much food using little additional land.

"Without high-yield agriculture," Borlaug said, "increases in food output would have been realized through drastic expansion of acres under cultivation, losses of pristine land a hundred times greater than all losses to urban and suburban expansion." Environmentalist criticism was doubly puzzling because in almost every developing nation where high-yield agriculture has been introduced, population growth has slowed as education becomes more important to family success than muscle power...

Easterbrook sums things up nicely.

Often it is said America lacks heroes who can provide constructive examples to the young. Here was such a hero. Yet though streets and buildings are named for Norman Borlaug throughout the developing world, most Americans don't even know his name.

Read more!

Violence and Economic Growth

Douglas North, John Wallis, and Barry Weingast believe that economists do not properly include controlling violence in models that explain economic growth. Barry Weingast explains their theory on the EconTalk podcast, “Weingast on Violence, Power and a Theory of Nearly Everything.”

They divide countries into three types of societies or orders. The first is the hunter-gatherer or primitive order. It has very little specialization, an engine of economic growth, and a great deal of violence. Primitive orders are poor, producing less than $400 per capita GDP.

The next order is the limited access order and it solves the problem of violence by trading economic favors to specialists in violence for foregoing violence. The size of the payoff is directly related to the ability of commit violence. The government creates monopoly rents and uses the power of the state to quell competition. Per capital GDP in these orders ranges between $400 and $8,000. The limited access order is similar to Hernando DeSoto’s mercantilist society. North, Wallis and Weingast include countries as diverse as Bolivia, India and Russia as limited access orders.


The final order is the open access order. Economic competition is over price and quality, not violence. In an open access order, Schumpeterian competition through creative destruction permits new groups to spontaneously form to exploit new ideas, products and organizational forms. Open access orders are maintained by open access to a plethora of organizations including economic, political, social and religious. Normative beliefs in these societies promote the inclusion of new groups, and equality before the law. Constitutions that limit government power are also important. Open access societies begin at $8,000 per capita GDP, and goes up from there. In fact, the average per capita GDP exceeds $20,000.

Why don’t the limited access orders reform, adopting rules that will make them more like open access orders? Attempts to reform invite violence from previously favored groups that might be losing privilege. Reform would bring greater wealth over time if violence was avoided. But avoidance is not a given. The government might attempt to buy out the privileged, but this is also a difficult policy to implement. Can you promise the privileged a bigger payoff than they already realize? Furthermore, other groups may demand reform without payoffs, escalating the probability of violence.

Read more!

Kudlow On Obama And Taxes

Larry Kudlow in a Money and Politics column for CNBC titled, "Obama Declares War on Investors, Entrepreneurs, Businesses, And More," gives his opinion on the impact of the new Obama administration's budget and rhetoric on investment. He uses overtly political phrases that I would not use, such as "left-wing social vision" and "big-government onslaught, but much of the analysis is reasonable, well thought out, and defendable by economic research. He begins by declaring that the president's budget demonstrates a desire to tax people who are likely to invest, and that this is in conflict with his stated desires to rescue the economy.

Raising the marginal tax rate on successful earners, capital, dividends, and all the private funds is a function of Obama’s left-wing social vision, and a repudiation of his economic-recovery statements. Ditto for his sweeping government-planning-and-spending program, which will wind up raising federal outlays as a share of GDP to at least 30 percent, if not more, over the next 10 years.

Study after study over the past several decades has shown how countries that spend more produce less, while nations that tax less produce more. Obama is doing it wrong on both counts.

Certainly Mr. Obama believes that his policy will help the economy grow, but Kudlow is correct in focusing on individual incentives to invest, and those are weakened by proposals made by the Obama administration. Without citing specific research he does correctly observe that countries with a small government sectors tend to grow faster than those with large government sectors.

Kudlow traces how Obama policy would "tax" the middle-and lower classes.

And as far as middle-class tax cuts are concerned, Obama’s cap-and-trade program will be a huge across-the-board tax increase on blue-collar workers, including unionized workers. Industrial production is plunging, but new carbon taxes will prevent production from ever recovering. While the country wants more fuel and power, cap-and-trade will deliver less.

If the Obama administration is correct, and carbon dioxide emissions will result in huge costs to society, then the cap-and-trade proposal or a Pigovian tax would be logical policies to implement. But even if they are correct, the policy will successfully in drive up the prices of carbon based energy, the cheapest form of energy. Because this policy is not equally implemented world-wide, it will have a small impact on carbon fuel use but a big impact on the competitiveness of our industrial sector.

Finally, Kudlow sees beyond party lines, associating Johnson administration policies with those of the Nixon administration, and Reagan administration with those of the Clinton administration. Powerful economic trends overwhelm party platforms.

Essentially, the Obama economic policies represent a major Democratic party relapse into Great Society social spending and taxing. It is a return to the LBJ/Nixon era, and a move away from the Reagan/Clinton period. House Republicans, fortunately, are 90 days sober, as they are putting up a valiant fight to stop the big-government onslaught and move the GOP back to first principles.

Read more!

Acemoglu, The Financial Crisis and The Stimulus

In a recent post, "Acemoglu on Greed," I tried to highlight the difference between economists and others on the impact of greed on society.  His paper, "The Crisis of 2008: Structural Lessons for
and from Economics," is the best of two worlds: short on words but long on economic content, and I wish to share with my students and other readers a few of this thoughts, and recommend the entire paper.  To cut to the chaff, he gives guarded support for the stimulus as a way to avoid an "expectational trap" in which consumers and policymakers turn away support from a market system.

Acemoglu believes that preserving and strengthening market institutions and regulatory underpinnings of free markets is more important than escaping from the current recession.  

[I]t is obvious why we should heed issues of economic growth. Barring a complete meltdown of the global system, even with the ferocious severity of the global crisis, the possible loss of GDP for most countries is in the range of
a couple of percentage points, and most of this might have been unavoidable given the overexpansion of the economy in the prior years. In contrast, modest changes in economic growth will accumulate to much larger numbers
within one decade or two. Thus, from a policy and welfare perspective, it should be self-evident that sacrificing economic growth to deal with the current crisis is a bad option.

In an expectational trap, consumers and policymakers become pessimistic about "future growth and the promise of markets." 

We may see consumers and policymakers start believing that free markets are responsible for the economic ills of today and shift their support away from the market economy. We would then see the pendulum swing too far, taking us to an era of heavy government involvement rather than the needed foundational regulation of free markets.  I believe that such a swing and the anti-market policies that it would bring would be the real threat to the future growth prospects of the global economy.  Restrictions on trade in goods and services would be a first step. Industrial policy that stymies reallocation and innovation would be a second equally damaging step. When the talk is of bailing out and protecting selected sectors, more systematic proposals on trade restrictions and industrial policy may be around the corner.

He offers guarded support for the stimulus package.

A comprehensive stimulus plan, even with all of its imperfections, is probably the best way of fighting off these dangers, and on balance, there are sufficient reasons for academic economists as well as concerned citizens to support current efforts as insurance against the worst 0utcomes we may face.  Nevertheless, the details of the stimulus plan should be designed so as to cause minimal disruption to the process of reallocation and innovation. Sacrificing growth out of our fear of the present would be as severe a mistake as inaction.

In addition to the paper, interested readers would profit from listening to Russ Roberts interview with Daron Acemoglu. 

Read more!