Friday, April 23, 2010

Joe Stiglitz on R. Skidelsy and his new book on Keynes

Robert Skidelsky has published a new book, 'Keynes: The Return of the Master', and my ex-student Alexandros Stavrakas who is now editor-in-chief of Bedeutung, a magazine of Philosophy, Current Affairs, Art and Literature was kind enough to bring to my attention a review of the book written by Joseph Stglitz.

Here are the opening paragraphs:
It has become a commonplace to say, in the aftermath of the Great Recession, that ‘we are all Keynesians now.’ If this is so, then Keynes’s great biographer, Robert Skidelsky, should have much to say about the recession, its causes and the appropriate cures. And so indeed he does. I share with Skidelsky the view that, while most of the blame for the crisis should reside with those in the financial markets, who did such a poor job both in allocating capital and in managing risk (their key responsibilities), a considerable portion of it lies with the economics profession. The notion economists pushed – that markets are efficient and self-adjusting – gave comfort to regulators like Alan Greenspan, who didn’t believe in regulation in the first place. They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression; and they gave justification to those, like Larry Summers and Robert Rubin, Treasury secretaries under Clinton, who opposed doing anything about derivatives, even after the dangers had been exposed in the Long-Term Capital Management crisis of 1998.

We should be clear about this: economic theory never provided much support for these free-market views. Theories of imperfect and asymmetric information in markets had undermined every one of the ‘efficient market’ doctrines, even before they became fashionable in the Reagan-Thatcher era. Bruce Greenwald and I had explained that Adam Smith’s hand was not in fact invisible: it wasn’t there. Sanford Grossman and I had explained that if markets were as efficient in transmitting information as the free marketeers claimed, no one would have any incentive to gather and process it. Free marketeers, and the special interests that benefited from their doctrines, paid little attention to these inconvenient truths.

The review is, of course, much more than a review so it would be a good idea to read it and get a sense of how things are in the profession and in the world right now.

On page 5 of the article Stiglitz discusses the situation that Greece and other PIIGS are facing:'
... There are speculative attacks against the weakest countries, which find themselves caught between a rock and a hard place. They worry that deficits will lead to higher interest rates, not because (as is usually argued) public spending will crowd out private spending, but because of growing ‘risk premiums’. But the effect is much the same: more government spending will force cutbacks in private spending, with the obvious adverse effects on the economy. The financial markets that caused the crisis – which in turn caused the deficits – went silent as money was being spent on the bail-out; but now they are telling governments they have to cut public spending. Wages are to be cut, even if bank bonuses are to be kept.

If markets were rational, there would be an easy policy response. Spending on investments that yielded even moderate real returns (say, of 5 to 6 per cent) would lower long-term debt levels; such spending increases output in the short run, thus garnering more tax revenue, and the future returns generate still more tax revenue. If markets could be convinced, for example, that European governments can and will meet their debt obligations, interest rates would fall, and even the countries with the highest levels of debt would find it easy to meet their obligations. But markets are not necessarily rational, and even when they are, they are not always well intentioned. The objective of a speculative attack is to generate profits for the speculators, regardless of the cost to the rest of society. They can make money by inducing panic and then feel pleased with their ‘insight’: their concerns were justified, but only because of the responses to which their actions gave rise.

Since the time of Keynes, the ability of markets to mount such speculative attacks has increased enormously. But governments are not powerless to tame them, and in some cases can counter-attack, as Hong Kong did in foiling Wall Street’s famous ‘Hong Kong double play’, when speculators simultaneously sold short both the currency and the stock market. The speculators knew that governments traditionally respond to a currency attack by raising interest rates, which lowers stock prices. If Hong Kong failed to raise interest rates, they would make money by shorting the currency. If Hong Kong did raise them to save its currency, the speculators would make money by shorting the stock market. Hong Kong outsmarted them by simultaneously raising interest rates and supporting the stock market by buying shares. Taxes on short-term capital gains, regulations on the ever more powerful speculative instruments (like credit default swaps), and – especially for developing countries – the imposition of barriers on the uncontrolled movement of short-term capital across borders, can reduce the scope for and returns from this kind of behaviour.

The article is found here.

PS: May 2010 IB candidtates taking the Higher or Standard Level Economics exam on May 19/20 should definitely read this and take down a couple of notes. Examples and awareness of what is going on in the world are always much appreciated by examiners. Do not forget that. Even a mediocre essay will earn higher marks if it includes some relevant examples.

Thursday, April 22, 2010

oh, how true...

Europe does not need the French plan for coordination of tax policies, or another IMF, but there does need to be fiscal discipline to prevent other countries from free riding, as the Greeks seem to have done. They apparently assumed that the rest of Europe would overlook continuing high deficits, and that, as eurozone members, the market would consider their debt to be just like German bonds, though issued by friendly and welcoming people in an agreeable climate, and with a glass of ouzo on the side.

The rest here.

On indutrial policy

We are discussing supply side policies and we mentioned industrial policy as an interventionist and rather controversial type.

Dani Rodrik of Harvard recently wrote a beautifully enlightening short article on it.

British Prime Minister Gordon Brown promotes it as a vehicle for creating high-skill jobs. French President Nicolas Sarkozy talks about using it to keep industrial jobs in France. The World Bank’s chief economist, Justin Lin, openly supports it to speed up structural change in developing nations. McKinsey is advising governments on how to do it right.

Industrial policy is back.

In fact, industrial policy never went out of fashion. Economists enamored of the neo-liberal Washington Consensus may have written it off, but successful economies have always relied on government policies that promote growth by accelerating structural transformation.

China is a case in point. Its phenomenal manufacturing prowess rests in large part on public assistance to new industries. State-owned enterprises have acted as incubators for technical skills and managerial talent. Local-content requirements have spawned productive supplier industries in automotive and electronics products. Generous export incentives have helped firms break into competitive global markets.

Chile, which is often portrayed as a free-market paradise, is another example. The government has played a crucial role in developing every significant new export that the country produces. Chilean grapes broke into world markets thanks to publicly financed R&D. Forest products were heavily subsidized by none other than General Augusto Pinochet. And the highly successful salmon industry is the creation of Fundación Chile, a quasi-public venture fund.

But when it comes to industrial policy, it is the United States that takes the cake. This is ironic, because the term “industrial policy” is anathema in American political discourse. It is used almost exclusively to browbeat political opponents with accusations of Stalinist economic designs.

Yet the US owes much of its innovative prowess to government support. As Harvard Business School professor Josh Lerner explains in his book Boulevard of Broken Dreams, US Department of Defense contracts played a crucial role in accelerating the early growth of Silicon Valley. The Internet, possibly the most significant innovation of our time, grew out of a Defense Department project initiated in 1969.

Nor is America’s embrace of industrial policy a matter of historical interest only. Today the US federal government is the world’s biggest venture capitalist by far. According to The Wall Street Journal, the US Department of Energy (DOE) alone is planning to spend more than $40 billion in loans and grants to encourage private firms to develop green technologies, such as electric cars, new batteries, wind turbines, and solar panels. During the first three quarters on 2009, private venture capital firms invested less than $3 billion combined in this sector. The DOE invested $13 billion.
The shift toward embracing industrial policy is therefore a welcome acknowledgement of what sensible analysts of economic growth have always known: developing new industries often requires a nudge from government. The nudge can take the form of subsidies, loans, infrastructure, and other kinds of support. But scratch the surface of any new successful industry anywhere, and more likely than not you will find government assistance lurking beneath.

Read the rest here.

PS: required reading (and, note taking -for examples- for my own little dorks)

Wednesday, April 21, 2010

no comment.....

Once again, doesn't look good...

on deregulation

These days in class we are discussing supply side policies and we initialy discussed two ways of distinguishing them. One route is to make the distinction between interventionist and pro-market policies and another way is to divide them into policies that are commonly accepted and policies that are considered more controversial which, in my opinion at least, include the 'pro-market' set and industrial policiy.

In discussing 'deregulation' I mentioned that quite a few consider the US banking and financial deregulation of the 1980s as being to a significant extent responsible for the current crisis.

Today, I was reading in Project Syndicate a short article by Hector R. Torres, a former Executive Director of the IMF.

The whole article is of nterest but these paragraphs are especially interesting for us:

Let us now consider the second question – whether the Fund suffered from a mindset that blinded it to the causes of what was happening. As early as August 2005, Raghuram Rajan, the IMF’s Economic Counselor (chief economist) at the time, was warning of weaknesses in the US financial markets. Rajan saw that something potentially dangerous was happening, warning that competition forces were pushing financial markets “to flirt continuously with the limits of illiquidity” and concealing risks from investors in order to outperform competitors.

Perhaps most revealingly, though, Rajan nonetheless optimistically argued that “[d]eregulation has removed artificial barriers preventing entry of new firms, and has encouraged competition between products, institutions, markets, and jurisdictions.” In other words, he clearly believed that regulation created “artificial barriers,” and that “competition between jurisdictions” – that is, between regulators – was to be welcomed.

Such beliefs come naturally to those committed to the view that markets perform better without regulation, and Rajan’s statement is a good illustration of the IMF’s creed at the time. And it was this boundless faith in markets’ self-regulatory capacity that appears to be at the root of the Fund’s failure to find what it was not looking for.

Read the piece here.

Friday, April 16, 2010

revenue and profit maximization

Ideas on past IB Economics HL P2 questions on profit vs. revenue maximization can be found here at the IB Freeway.

A short on trade

If you are a May 2010 candidate and you are taking higher economics you should be comfortable with the analysis of a tariff.

These are 2 past IB questions relating to tariff analysis:

* How do tariffs affect economic welfare? (Short trade 3)

* Using an appropriate diagram, explain who gains and who loses from the introduction of a tariff (Short trade 34)

An analysis that may be considered useful can be found in my wikispace here. The usual warning: make sure you listen to your own teacher before adopting what I say to my students....

On Greece and the IMF

The situation in Greece as it is unfolding doesn't look that good but one positive side effect is that you guys ('you' in a very narrow sense i.e. my year 1 students) will, by the time you graduate next year, know much more about the IMF than most other candidates from our school since 1993...!

Here is the transcript of an interesting IMF press briefing on what is going on right now between Greece and the Fund. Easy reading and you get an idea about the process.

The October 2009 World Economic Outlook can be found here. Downloading and skimming over Chapter 2 may be a good idea. Some stuff will sound familiar (and, as we move along the syllabus, you will understand more and more) but even just looking at some figures and tables and trying to 'read' them and make sense out of them is a good idea.

Thursday, April 15, 2010

IB May 2010 Exams - Economics

The May exams are approaching fast...

I had prepared this for my students and I think that it may be interesting (or, perhaps, even useful) to post here. The usual caveat: listen to your teacher and what he/she has to say before adopting someone else's approach.

Candidates are often asked to evaluate fiscal policy (in HP1 / SP1 or in HP3/SP2) so here are some thoughts:

Evaluating Fiscal Policy

Possible Strengths of Expansionary Fiscal Policy
* Fiscal policy is direct: any increase in government spending will automatically increase national income (Y) by at least as much, if not more
* If the government expenditure multiplier is greater than one (Christina Romer, the Chief Economist of Obama’s Council of Economic Advisors, estimates it at 1.6) then it is also a very powerful tool
* A decrease in taxes to reflate an economy (as part of an expansionary stimulus plan) may also have beneficial supply-side effects as lower taxes may improve the incentives to work and to invest
* In an economy in deep recession (or, depression) interest rates may be at or close to zero, so monetary policy is totally ineffective; in such a case policymakers have only fiscal policy to turn to
* If the institutional framework of the economy is equipped with unemployment benefits and a progressive income tax system then policymakers have the benefits of ‘built-in stabilizers’ (automatic stabilizers)
* If the increased government expenditures of a stimulus package include spending on infrastructure (roads, bridges, harbors, telecommunications etc i.e. physical capital typically financed by governments that create very significant positive externalities decreasing transaction costs across the board), health and education then a positive supply-side effect will also result
* If the increased government expenditures of a stimulus package include spending on the development of ‘green’ technologies then an additional long run benefit will be the improvement of the environment, permitting sustainable growth.

On the other hand (Possible Weaknesses of Fiscal Policy):
* The government expenditure multiplier may even be less than one as some economists claim (Robert Barro of Harvard, is one example)
* There are significant time lags associated with fiscal policy that may even end up destabilizing instead of stabilizing an economy
* Large deficit spending may increase national debt to unsustainable levels and may force significant tax increases in the future (so, in a sense the cost of such a policy is shifted on to future generations)
* There is also the chance that if the fiscal effect continues for longer than needed then inflationary pressures may arise
* There is always the possibility that the increased funding needs of a stimulus plan (remember the Government must borrow from the ‘loanable funds’ market to finance the deficit spending) may crowd-out private investment (and consumption) through a rise in interest rates or even directly (resource crowding-out)
* Also, fiscal policy suffers from an ‘expansionary bias’ because politicians often are irresponsible and prefer to spend more and tax less rather than spending less and taxing more as the former maximizes their short term re-election chances (Greece is now suffering from the ‘fiscal irresponsibility of governments of the last 30 years’….)

Lastly, contractionary fiscal policy to fight inflationary pressures is more difficult to employ compared to increasing interest rates (i.e. tight monetary policy).

On the size of the multiplier see Barro: ; for a more general discussion of the size of the multiplier read this.

Hope this helps.

PS: the word file that you can tweak can be found here at my wikispace as entry #9

Monday, April 12, 2010

Rogoff on the IMF and Greece

An interesting to read short article by Ken Rogoff:

...Now, the eurozone countries have agreed that the Fund can come into Greece and, presumably, Portugal, Spain, Italy, and Ireland, if needed.

...To be fair, the Fund’s reputation for imposing austerity is mostly an illusion. Countries usually call in the IMF only when they have been jilted by international capital markets, and are faced with desperate tightening measures no matter where they turn. Countries turn to the Fund for help because it is typically a far softer touch than private markets.

The stakes for the IMF in Europe are huge. It is not going to be an easy balancing act. If the Fund attaches tough “German-style” conditions to its loans, it risks provoking immediate confrontation and default. This is the last thing that it wants to do.

Read the article here.