Economists and austerity errors

By Srinivas Raghavendra

Sir, – The famously infamous spreadsheet error by economists Carmen Reinhart and Kenneth Rogoff (Martin Wolf, Business, April 24th) and the subsequent debate on austerity has rightly or wrongly brought forth one important issue: the sensitivity of techniques, tools and methods that economists use to analyse economic data have immense consequences for economic policy.

The Massachusetts economists’ study that replicated the original Reinhart and Rogoff’s paper argues that in addition to the coding error they have also uncovered a non-standard weighting scheme and selective exclusion of available data, and they show that taking all these into account leads to the conclusion that the average GDP growth for countries with public-debt-to-GDP ratio of over 90 per cent is actually 2.2 per cent and not -0.1 per cent as estimated by Reinhart and Rogoff.

Read the rest here.

The Second Industrial Divide and the Third Industrial Revolution

According to Chris Anderson, the editor of Wired, in his recent book Makers: “the word desktop is being added to industrial machinery, with equally mind-blowing effect. Desktop 3-D printing. Desktop computer-controlled routing, milling, and machining. Desktop laser cutting. Desktop computer-controlled embroidering, weaving, and quilting. Even desktop 3-D scanning, or 'reality capture,' digitizing the physical world. Desktop fabrication is leading to full-on desktop manufacturing.” The idea is a bit like the old (relatively speaking) book by Michael Piore and Charles Sabel on The Second Industrial Divide, which suggested that flexible specialization was making mass production obsolete.

The idea is that desktop manufacturing is creating the conditions for mass market for niche products, as he says, bringing down the barriers to entry in many sectors. There is a bit of wishful thinking in the book (not done yet, but will report back at the end), but one should note that the author nails the importance of manufacturing for development. In his words: “any country, if it wants to stay strong, must have a manufacturing base. Even today, about a quarter of the U.S. economy consists of the manufacturing of physical goods. When you include their distribution and sale in retail outlets, you’re talking about closer to three-quarters of the economy. A service economy is all well and good, but eliminate manufacturing and you’re a nation of bankers, burger flippers, and tour guides. Software and information industries get all the press, but they employ just a small percentage of the population.”

Note that this suggests that the U.S. economy, which is ahead in the desktop manufacturing technology (e.g. 3-D printers, used recently to create ... yes, a gun!; 3-D scanners, laser cutters, computer numerical control routers, etc.) is actually still at the forefront of the industrial revolution, in spite of the talk about deindustrialization.

The two meanings of dollarization

This is part of an entry written for the Wiley-Blackwell Encyclopedia of Globalization. From the intro:

The expression of ‘dollarization’ has at least two different meanings. In the narrow sense, it refers to massive currency substitution, in which a country, most likely a developing one, supplements its domestic unit account of fiduciary reserve assets with a foreign currency, more often than not the United States dollar or, in some cases, the euro. Note that currency substitution could be complete and might even imply the elimination of a domestic token. Full dollarization in that sense has taken place in small countries, mostly in Latin America, the Caribbean and the Pacific which are heavily dependent on the United States. Dollarization, in this sense, is the exemplification of a country foregoing its national ‘monetary sovereignty’ (Mundell 1961, p. 661).

In the broader sense, dollarization refers to US hegemony in the world economy as a result of the US dollar being the numeraire currency in international markets. This christens the United States as the premier international monetary authority that regulates and dictates the flows of international financial commitments for global economic activity. Of particular importance in this context is the fact that the key international commodities, including oil, are priced in US dollars in international markets. The former conception of dollarization can be described as dollarization strictu sensu, while the latter as latu sensu dollarization, i.e. not the specific use of the dollar by a country, but by the whole world economy—an international system in which the dollar is de facto a global fiat money (Vernengo, 2006).

Read the rest here.

Tom Palley on Gattopardo economics

New paper by Tom Palley on the failure of economics (mainstream) after the crisis. From the abstract:

Gattopardo constitutes change that keeps things the same. Gattopardo is relevant for understanding the economics profession's response to the financial crash of 2008. This paper explores gattopardo economics as it applies to the issues of the macroeconomics of income distribution; the global financial imbalances; and inflation policy. Gattopardo economics adopts ideas developed by critics of mainstream economics, but it does so in a way that ignores the thrust of the original critique and leaves mainstream analysis unchanged. Gattopardo economics makes change more difficult because it deceives people into thinking change has taken place. By masquerading as change, it crowds-out space for real change. That makes exposing gattopardo economics a matter of vital importance.

The Political Aspects of Unemployment at Seventy

Michal Kalecki’s (1943) classic paper, “Political Aspects of Full Employment” remains surprisingly modern, and its message still is worth revising. If you read and/or watch the current debates on economic policy in the mainstream media you would think that public deficits and debt are the main economic problem ahead. Further, if you look at Obama’s budget proposal, with the offer of reducing payments to social security recipients, you would think that entitlement programs are unsustainable and must be overhauled. On the other hand, the mainstream media is not as vocal on the unemployment problem, and in some quarters the current rate of unemployment, 7.6%, is seen as not too high, and only slightly above full employment, which is put by some at 5.5% (the so-called natural rate).

Read the rest here.

Naming names

Krugman comments on the Ferguson gay-childless Keynes bashing affair, and gives a list of other recent members of the Lunatic Fringe. His list:

1.Robert Barro pointing to the decline in private spending during World War II as evidence that multipliers are small, somehow forgetting rationing and all that.
2.John Cochrane and Eugene Fama confusing accounting identities with causal relationships, and reinventing the Say’s Law fallacy.
3.Robert Lucas misunderstanding Ricardian equivalence.
4.Robert Samuelson and Olli Rehn asserting that Keynes wouldn’t have been a Keynesian given current debt levels, without checking actual British debt in the 1930s (which was much higher than debt now).
5.John Taylor equating Fed policy to hold down interest rates with a price ceiling on, say, apartment rents.

This list could be complemented with the one by Brad DeLong on other authors (which include Mankiw and Schumpeter) who have used similar arguments against Keynesian economics.

Energy demand and costs: Swanson's Law

Graph below shows the distribution of energy demand in the US, from wood burning at the time of independence to gas and oil now.

Renewable sources are still a small share. But there are good news in that front, with solar energy prices falling at a fast pace. According to The Economist, "Swanson’s law, named after Richard Swanson, the founder of SunPower, a big American solar-cell manufacturer, suggests that the cost of the photovoltaic cells needed to generate solar power falls by 20% with each doubling of global manufacturing capacity." Hope springs eternal.

What caused the Great Moderation?

Well not the great policies of credible inflation concious central banks, according to Nate Cline and Nate Perry. The Nates say in a new paper (here) that it was wage compression, associated to lower rates of unionization and higher average unemployment (or lower growth) and lower pass-through effects, which are associated with globalization. The abstract below.

"Several explanations of the “great inflation moderation” (1982–2006) have been put forth, the most popular being that inflation was tamed due to good monetary policy, good luck (exogenous shocks such as oil prices), or structural changes such as inventory management techniques. Drawing from Post-Keynesian and structuralist theories of inflation, this paper uses a vector autoregression with a Post-Keynesian identification strategy to show that the decline in the inflation rate and inflation volatility was due primarily to (1) wage declines and (2) falling import prices caused by international competition and exchange rate effects. The paper uses a graphical analysis, impulse response functions, and variance decompositions to support the argument that the decline in inflation has in fact been a “wage and import price moderation,” brought about by declining union membership and international competition. Exchange rate effects have lowered inflation through cheaper import and oil prices, and have indirectly affected wages through strong dollar policy, which has lowered manufacturing wages due to increased competition. A “Taylor rule” differential variable was also used to test the “good policy” hypothesis. The results show that the Taylor rule differential has a smaller effect on inflation, controlling for other factors."

PS: An alternative title for the post would be "Nates and the Great Moderation." My son actually loved the Nate the Great books.

US Foreign Policy and the Latin American Left

Economics is an essential part of foreign policy. One cannot think of the Cold War without the Marshall Plan that allowed reconstruction in Western Europe and containment of the Soviet Union in Western Europe. In Latin America one cannot dissociate the Cuban Revolution and the subsequent Alliance for Progress, which basically provided credit for allies in the region, pushed by Kennedy to contain Communism in the region. Geopolitics is, however, often ignored by economists, and political scientists tend to use only mainstream economics when discussing political economy issues.

In the case of US-Latin American affairs, the inability to understand the political elements of the economic process, and the incapacity to comprehend the deep causes of underdevelopment in the region explain, in part, the problematic relationship of the Obama administration with the left of center governments in the region. The Obama administration has compounded old mistakes and aggravated the mistrust from progressives in Latin America (for an early discussion of the topic go here; subscription required). John Kerry, the Secretary of the State, has referred recently to Latin America as the American “backyard,” and the Obama administration has not recognized the democratically elected government of Nicolás Maduro in Venezuela.

Read the rest here.

Was Keynes always right? A disclaimer

I don't really publish uninformed comments suggesting that the views in this blog are that whatever Keynes said is the word of God, and, hence by definition correct. It is a bit silly, to say the least, since anybody that has read the posts knows that actually the views taken here suggest that the General Theory, in spite of being a great book (for having effective demand) and being essential reading for economists, failed in making the point that effective demand stands in the long run.

The reason, again as noted extensively in the blog, is Keynes' acceptance of the marginalist theory of value and distribution, and its implications on the investment schedule. In other words, Keynes, even though he wanted to get rid of the natural rate, by accepting the inverse relation between investment and the rate of interest, ended up conceding that there would be a level of the rate of interest that would equilibrate it with full employment savings. In other words, a natural rate.

So the point is NOT that Keynes is always right, and everything he said is sacred. In fact, a good chunk of his theoretical framework must be dropped in order to say something coherent, from a logical point of view, and that fits the evidence. Something similar applies to the classical authors.