Sunday, 11 December 2011

of apes and men

Scientific American has an excellent article on group violence and socio-economic stress, by Eric Johnson:

The portrait of a powerful leader was pulled from the wall and sent dangling from a balcony as angry voices below cursed him and the other “fascists” believed responsible for their condition. One man, a lathe operator who had gone on strike, ran onto the balcony holding up two plates loaded with cheese and sausage. “Look and see what they eat,” he shouted to the crowd below, “yet we cannot get such food!”
The Novocherkassk riot on June 2, 1962, was Soviet Russia’s largest public uprising to date. More than two thousand took to the streets in response to the Communist Party’s decision to increase food prices by 30 percent at the same time that wages were being reduced. Workers walked out on the job, students left their classrooms, and men and women of all ages joined the chorus of protest. The crowd marched peacefully through lines of soldiers backed by armored vehicles that had been hastily assembled and went to voice their grievances directly with a communist government that claimed to be on the side of the worker.

There are clever observations from biology as well... a great read.

The Finally Final Deal

... to save the Euro. Yawn. I was on Monocle Radio and Berlin Inforadio during the recent Brussels summit, trying to explain how the latest package was going to help. It's not an easy question. While British isolation garnered a lot of headlines, the substance could hardly be more depressing. First of all, the much-touted "fiscal union" is no more than a growth-and-stability (for which, read, austerity-and-stagnation) pact writ large. Let's forget the problem that the old rules were never implemented, and skip over the question why these ones should be. Austerity is the answer, with debt-brake rules to be written into constitutions, etc. The idea that this will solve anything is more of a collective form of delusion (along the lines Benabou's brilliant paper) than economic policy proper. Sure, it would have been nice if Greece and Italy had saved a bit more during the noughties. But take Spain - it ran government surpluses for much of the post-Euro time. It had debt-to-GDP ratios way below Germany's for much of the time. Even if the current treaty had been in place (and implemented) have helped? Not at all. Spanish wages and prices won't fall by 20%, to make the country more competitive, any time soon. It'll take 10 or 20 years until German wages have risen enough so that Spain restores competitiveness and can seriously start to export. Of course, as house prices slide ever faster, it'll become easier to fill the export gap with asset sales. But effectively - a few niceties apart - the current setup condemns the Club Med to decades of stagnation and high unemployment.

The best thing that could happen? Another Black Wednesday. On Sept 16, 1992, Britain was ejected from ERM, due to a speculative attack by George Soros - an event much lamented in the press back then. It turned out to be a great blessing for Britain, which avoided the worst of the early-1990s recession and entry into the Euro as a result. The recent rout in bond markets, if it were to resume (and I see little reason why it shouldn't) could play a similar role, ejecting Spain and Italy from the Eurozone. In the short term, there would be real blood on the floor -- banks needing recapitalization, capital flight, etc. But in a few years time, people would recognize it for a heavily disguised blessing -- the only plausible way out of the current stagnation and austerity union.

Monday, 28 November 2011

my Spanish elections review...

on Bavarian radio [in German].

optimism out of nowhere

Markets today were "upbeat" about the prospects of an eventual Eurozone rescue... the basis? Some vague reports that the Germans are pushing for....? You guessed it, tougher fiscal rules. Exactly what Europe needs. Sigh. Just like Germany definitely needed another wage-and-price-cutting package in 1931. How is that going to help? Let's see... more austerity will be a tit-for-tat. In exchange, the ECB will buy everyone's bonds in a bid to make that nasty PSI aftertaste go away (that grand idea of scr**ing Greek bondholders so as to reassure the others). That is what some people think. It's part of that true-and-tested model that says - if things are really bad, they will get better, because now people need to do something. Except that they haven't. For about 18 months. My take? Never underestimate human stupidity. I will believe it when I see it. The German government has decided that, after pretending that Greece had a liquidity problem (when it actually had a solvency one), everyone now has a solvency problem (even if the issue is liquidity and self-fulfilling prophecy scambles for the exit). I am waiting for the market counterreaction when people realize that there is only tit, and no tat...

more war, better states...

Good things come to those who wait... and Nicola's and my paper on state capacity and war has certainly taken a bit of time. The idea? In many historical accounts of the rise of states in Europe, war does the heavy lifting: You fight more, hence you invest more in centralization, bureaucratization, tax raising, etc. There are two problems with this: First, warfare is not exactly an early modern European exclusive. Hunter-gatherer societies have lots of violent death; there are no strong hunter-gatherer states. Second, war means that you can disappear as an independent power, as did Poland, Burgundy, and a long string of independent states and statelets in early modern Europe.

Nicola and I decided to put things together in a single model that can explain 1. divergence between powers 2. a rise in state capacity as the cost of warfare escalates. The abstract is:
In 1500, Europe was composed of hundreds of statelets and principalities, with weak central authority, no monopoly over the legitimate use of violence, and multiple, overlapping levels of jurisdiction. By 1800, Europe had consolidated into a handful of powerful, centralized nation states. We build a model that simultaneously explains both the emergence of capable states and growing divergence between European powers. In our model, the impact of war on the European state system depends on: i) the importance of money for determining the war outcome (which stands for the cost of war), and ii) a country's initial level of domestic political fragmentation. We emphasize the role of the "Military Revolution", which raised the cost of war. Initially, this caused more internally cohesive states to invest more in state capacity, while other (more divided) states rationally dropped out of the competition. This mechanism leads to both increasing divergence between European states, and greater average investments in state building on the continent overall.

Friday, 18 November 2011

The arithmetic gets better and better

Over at WSJ marketbeat, they report on Goldman Sachs' latest thinking re the Greek restructuring. They seem to have concluded that the proposed 50% haircut is not enough to return Greece to debt sustainability:
In our view the key problem lies with the structure of the PSI itself, namely the insistence on a 50% reduction in face value for bond holders. From an investor’s perspective, a 50% haircut reduces both the final payment but also the coupon payment. Thus the impact on the NPV of the bond is much larger than 50%. The voluntary nature of the deal assumes some incentive for investors. Thus, the IIF have suggested an increase in coupons for the new bonds in order for investors to be compensated in terms of cash flows at least.
 The problem, of course, would be that this by itself undermines sustainability -- higher coupon payments mean bigger deficits. As GS points out, what Greece needs is the exact opposite: lower coupon payments right now, so that the worst of austerity can be undone. Once growth resumes, and interest rates fall a bit, sustainability will look a lot better quite quickly. I guess there is something not altogether great about thinking up restructuring rules as a fly-by-night operation between a handful of overwrought, half-numerate politicos... 

Thursday, 17 November 2011

Productivity in Process - this week in the Economist - Economics Focus

The Economist this week discusses research by my old college friend Tim Leunig (LSE) and myself on process innovations - that's two Econ Focus highlights in three weeks... Here is the abstract of the paper (available on SSRN):

Fifty years ago economic historians found surprisingly small gains from 19th century US railroads, while more recently economists have found relatively large gains from electricity, computers and cell phones. In each case the implicit or explicit assumption is that researchers were measuring the value of a new good to society. In this paper we use the same techniques to find the value to society of making existing goods cheaper. Henry Ford did not invent the car, and the inventors of mechanised cotton spinning in the industrial revolution invented no new product. But both made existing products dramatically cheaper, bringing them into the reach of many more consumers. That in turn has potentially large welfare effects. We find that the consumer surplus of Henry Ford’s production line was around 2% by 1923, 15 years after Ford began to implement the moving assembly line, while the mechanisation of cotton spinning was worth around 6% by 1820, 34 years after its initial invention. Both are large: of the same order of magnitude as consumer expenditure on these items, and as large or larger than the value of the internet to consumers. On the social savings measure traditionally used by economic historians, these process innovations  were worth 15% and 18% respectively, making them more important than railroads. Our results remind us that process innovations can be at least as important for welfare and productivity as the invention of new products. 

decision time

In August, I gave an interview to Der Spiegel, saying that the Euro can't last another 5 years in its current form. At the time, many people thought I was nuts. Now, some 3 months later, it looks as if the beginning of the end is near. Yields on AAA-countries like Austria are moving up. Bloomberg reports that Spanish 10-year yields are now above 7%. That's not a catastrophe just yet - Spain can pay a bit more interest, and the debt profile isn't that short-term. But if it lasts any length of time, this is going to be very painful: Higher interest rates mean that the country will need more austerity measures to keep the future debt path under control; output will fall yet further; yields may increase even more. It's now abundantly clear that the last rescue package was a disaster on a monumental scale - forcing a 50% haircut on the private creditors felt good, but now everyone is asking who will be next. If all the promises over Greece were worthless, is the same true for Spain and Italy? Of course; they are too big to rescue outright. The only solution is to convince the markets to keep buying. It's a confidence trick that makes the markets work; once confidence goes, the spreads explode. The more people worry, the higher the yields, the higher the collateral requirements, the weaker the banks.

As the ECB tried to tell politicians for the last year - sovereign bonds are too important as a risk-free asset in the financial system to mess with them. The only solution now, to avoid defaults of Spain and Italy in the near future, is to offer a blanket guarantee of all existing EU debt, incl. Greece; undo the haircut on Greek bondholders; and introduce unlimited bond-buying by the ECB. I won't like it any more than the average German, but there is really no alternative short of a wholesale implosion of the weaker Eurozone economies.  

Wednesday, 16 November 2011

at last...

someone is thinking about the mountain of unrecognized losses in Spanish banks due to bad real estate deals, and the need to recapitalize. Bloomberg runs a story that the PP - poised to take power in Sunday's election - is preparing either a bad bank solution or will force capital injections. The latter (especially if done right - break up some of the bigger banks) would be a sensible step in the right direction... but my money is that there will be a half-botched bad bank instead, with taxpayer money dropped on the banks in exchange for some vague hope of starting lending again.

Friday, 4 November 2011

A new paper

Europe's spectacular own-goal

The latest Euro summit was meant to build a firewall around Greece, and to isolate it from the other weaker members of the Eurozone. One week later, it is clear that this has failed spectacularly. Yields on Italian bonds are rising; the IMF has now been called in to monitor the budget. What is going on? Why does even the extended bailout fund not do more to stabilize investor confidence? The truth is actually very simple. The 50% "haircut" imposed on the private sector lenders to Greece is a gross violation of everything that European politicians promised until a few months ago. That's a bad way of reassuring investors.

Remember all the claims that no member of the Euro zone would ever default? That speculators betting on this would go bankrupt? That there would be no touching the creditors before 2013? All of this has gone out of the window, as a result of an ugly display of political strong-arming. Just as Germany's first post-war Chancellor Adenauer once said - "what do I care about the rubbish I talked yesterday". True, the politicians had the banks over a barrel; Ackermann could not say no to Mrs Merkel when she insisted on this voluntary write-down. But the obvious implication is that all other promises and declarations are equally empty - that bondholders of Spain and Italy might find themselves in exactly the same spot as the ones who hold Greek paper. Guess what? If you know you can lose up to 50% (up from 21% just 3 months ago -- latest update in November - Greece would now like to default/"voluntarily restructure" 75% of its debt in NPV terms), you don't feel that confident. About anything. How this was meant to solve the deeper crisis is anyone's guess.

With the benefit of hindsight, it's pretty clear that Europe should have just written an XXL-sized cheque for Greece a year ago. The Financial Times Germany is citing a few economists - Aghion, Alesina, me - saying precisely that. Austerity isn't working, and won't work. A single bad day on the exchanges destroys more value than all of Greece's external debt. Yes, Greece don't "deserve" another penny, but that's not the point. Europe has to do what is right for itself, without worrying about moral hazard (let's be honest - how many countries would want to follow the Greek route even if they get a big cheque?) It's time to switch from moralizing and punishing to actual crisis prevention.

Thursday, 3 November 2011

CNN reflections

CNN has an op-ed by yours sincerely on the Greek crisis, and analogies with the case of Argentina in 2001. As they say - history doesn't repeat itself, but it certainly rhymes. 

Thursday, 20 October 2011

The Economist

The Economist in its "Economics Focus" column this week features Jacopo Ponticelli's and my work on unrest and austerity... as well as my earlier paper on Latin America, making a related point -- the more you cut, the higher the level of unrest will be. 

Wednesday, 12 October 2011

What's Greek for "Erfüllungspolitik"?

Today came the news that Greece (again) missed its deficit targets, with the red ink growing in September. Slow growth is typically blamed, and surely austerity doesn't help much in stabilizing growth. How do we make sense of the grim determination paraded around by the Greek government, and round after round of austerity? One interpretation says - it just can't be done, the cuts are too much for growth and tax collection plummets with GDP. The other interpretation thinks of the current posturing by the Greeks as theatre: Look, it really cannot be done, so please spare a few billion euros (insert transfer from the EU/debt forgiveness here).

My money is on the latter interpretation. It's pretty clear that only a small part of the overall fiscal mess can be attributed to slow growth. An inability/unwillingness to go after tax dodgers, throw them in jail, and make them pay (to encourage the others) is more than half the story. I think the Greeks are taking a leaf from the book of another country with monumentally high debts, and then failed to repay them: Germany.

After World War I, Germany was saddled with reparations payments of unspecified magnitude. The politicians charged with running the country's first full democracy didn't like it any better than the right-wing nuts who would have liked to say no, with a good chance to start the war. Their solution? Trying to convince the Allies that it really cannot be done. Taxes went up, inflation was soaring, and still, the Germans didn't manage to generate surpluses, and transfer them successfully to the victors of 1918. The attempt was better than half-hearted, but a good deal less than whole-hearted. It had a name -- "Erfüllungspolitik", the politics of fulfillment. For a country that had just been forced to reduce its army to 100,000 men, it's hard to think of an alternative (which didn't stop right-wing extremists from murdering politicians in charge, such as Walter Rathenau, the then foreign secretary). The cost, for sure, was terrible. By 1923, inflation had destroyed middle class wealth on an unimaginable scale, and output was still below 1914 levels.

And yet, in terms of its primary aim Erfüllungspolitik "worked". By 1924, everyone realized that Germany needed help and a respite. The solution - a big loan from the US - ushered in Weimar's only halcyon years. The Greeks seem hell-bent to demonstrate to the world that they cannot pay, as did the Germans; and they are equally good at destroying their economy along the way.

Friday, 30 September 2011


... is alive and well, and writing the script for Russian news anchors. I was in New York yesterday, to give a talk about anti-Semitism at NYU. To make the most of my time there, I gave an interview to  Russian TV about the European bailout package, release 2.0. Or so I thought. All was well for the first minute or so... until someone must have handed the wrong sheet to the girl, who promptly proceeded to quizz me about oil prices, Obama, and the Arab spring. There is always a risk of something going wrong on live television, but this was a curved ball I didn't see coming at all. You can see my flabbergasted expression about 1.10 into the clip over at youtube. It's funnier after the fact than when it happens... It gets slightly better after that:

Sunday, 25 September 2011

EFSF leveraging - a miserable accounting trick

The Euro rescue fund, known as EFSF, could be made bigger at no extra cost to the tax payer - or so leading Eurocrats seem to suggest. To me, this looks like a bad accounting trick. Currently scheduled to top out at a lowly €440 bn, the fund could be allowed to leverage itself by borrowing from the ECB. In that way, it could, say, get 5€ for each € of capital, and really get going on ... buying Italian, Spanish, and Greek sovereign bonds. Overall, the EFSF's firepower could amount to a cool 1.5-2 trillion €. Surely, that would be enough to banish the default genie back into its bottle?

I have no view on whether 2 trillion would do the trick. Eventually, once almost all public debt of Southern Euro member states is owned by either the EFSF or the ECB, politicians can safely ignore what the markets say. A couple of trillion help, but they won't last for more than a year or two. Leveraging the EFSF reminds me of one of Private Baldrick's cunning plans (link here), of Captain Blackadder fame. The reason is simple -- the leveraging is simply a silly accounting stunt. If the EFSF buys a euro of government debt, and it goes bad, who pays? The EU taxpayer. If it leverages that investment, by borrowing from the ECB 5 euros, and the investment goes bad, who pays? Exactly. Either the Euro taxpayer (by underwriting the leveraged loss of the EFSF) or the Euro taxpayer (by having to recapitalize the ECB after it loses a ton of money). If politicians feel they cannot, in good conscience, explain more than €440 bn in rescue funds to their voters, then they cannot justify the idea of leveraging.

Of course, the idea of going for broke shows just how fundamentally flawed and unworkable the system of ever-greater rescue packages really is. The alternative? Let the Greeks default. Nationalize and recapitalize the banks that lose their shirts - and use this as a golden opportunity to cut the banks down to size, by selling the nationalized banks in sizes that are 1/10 of their size today. That way, we also reduce the risk of a major financial meltdown every time a bank gets into trouble.

RAC1 interview

You can listen to my words of wisdom about the future of the Euro (and about who is more useful - astrologers or economists) over at RAC1 [in Spanish - program intro is in Catalan].

As part of the media reaction to my Spiegel interview, there is also a bit more over at CNN's excellent background piece on the origins of the Euro crisis, and interviews with European news service EURACTIV with Austrian newspapers Kleine Zeitung and Salzburger Nachrichten

Friday, 16 September 2011

Tuesday, 13 September 2011

Facebook revolutions

The Arab spring and London riots created a lot of media hype about how the internet and cellphones can create mass movements. I was a bit sceptical, not least because Jacopo Ponticelli and I (in our paper on Austerity and Anarchy) didn't find much when we looked at media penetration and the likelihood of demonstrations, riots, etc. Now, Navid Hassanpour has a new paper on "Media Disruption and Revolutionary Unrest". He looks at what the effect is of cutting off cell phone service. Here is the abstract:

Conventional wisdom suggests that lapses in media connectivity - for example, disruption of Internet and cell phone access - have a negative effect on political mobilization. I argue that on the contrary, sudden interruption of mass communication accelerates revolutionary mobilization and proliferates decentralized contention. Using a dynamic threshold model for participation in network collective action I demonstrate that full connectivity in a social network can hinder revolutionary action. I exploit a decision by Mubarak's regime to disrupt the Internet and mobile communication during the 2011 Egyptian uprising to provide an empirical proof for the hypothesis. A difference-in difference inference strategy reveals the impact of media disruption on the dispersion of the protests. The evidence is corroborated using historical, anecdotal, and statistical accounts.

It's a really nice study - cleanly identified, detailed, and timely. Let's see what the media make of it.

Saturday, 10 September 2011

talk about the euro

It was my first time on a TV talkshow - last week, German ARD had an hour-long program "Menschen bei Maischberger" on "The Euro Crisis - Never-ending horror?". The other guests included the parliamentary secretary at the German Economics Ministry, Peter Hintze, the SPD elder statesman Klaus von Donanyi, Tissy Bruns, Chief Political Correspondent of the Berlin daily Tagesspiegel, Anja Kohl, ARD stock market expert, and Heinz Kammerer, representative of the German banking association. It was certainly educational for me. About half the time, Hinze highjacked the occasion with long sermons about the importance of Euro rescue packages for the political future of the EU. He is an ex-pastor, after all, and uplifting rhetoric that is long smooth phrases and short on analysis comes easily to him; how theology qualifies him to be a major player in German economic policy-making I will never know (compare that to the qualifications of Alan Krueger, serving in a similar position at the US Treasury). Von Donanyi impressed me the most; sharper than many people half his age, at age 83, he had read everything and thought about everything, down to the latest Reinhardt-Rogoff book. I still differed with his conclusions, but he was in a different league from from Hintze... having served in the same capacity under Helmut Schmidt, in the 1970s. Someone should write a bit about the decline and fall of the German political class.

Friday, 9 September 2011

Europe after the End of the Euro

[this is the English original of my article published in Le Monde]:

Europe after the Death of the Euro

For years, countries struggled to defend the rigid link between their currencies. Speculators attacked; country after country implemented austerity programs to make debts sustainable, to win the trust of international investors. At the same time, the economic downturn deepened. Unrest became more common; political systems buckled under the strain of more cut-backs, surging unemployment, and unsustainable debts. And still, the common currency was widely regarded as the best way to assure stability. Without it, no trust in governments, in economic management, no end to economic turmoil, or so the refrain went. And then it all disappeared, almost overnight. Countries abandoned the common currency. And the earlier they did so, the faster their recovery. None of the terrible predictions about the end of the world as we know it actually turned out to be true.
            The time? The early 1930s. The common currency? The gold standard. What sounds like a description of modern-day Europe is actually very similar to the drama played out some 80 years earlier. Cutting the link with gold turned out to be the single best policy measure politicians could take. Britain left early – in 1931 – and only suffered a mild downturn, compared to the US which stuck with gold at the old parity until 1933, or France, which hung on even longer. Where the link with gold was severed, deflation and austerity measures came to an end, debts became more sustainable, growth recovered, unemployment fell. And when people looked back at the interwar gold standard, they soon asked – how could we be so wrong? Sacrifice so much for such a misguided policy?
            Europeans after the end of the Euro will ask the same questions. Why did they waste more than a decade with interest rate policies that were too high for some, too low for others, creating boom and bust as well as unsustainable debt burdens and banks that eventually implode? How did they stomach all these austerity programs and bailout packages, for so little gain? Presented to electorates as a policy without alternative, the Euro is actually a poorly designed currency arrangement that was always more about political symbolism than about sound economics. Today, member countries of the EU have eleven currencies – the euro and ten national ones of members states that have not joined EMU. The European Union will not fall apart if eleven currencies become twelve or fifteen. The Euro can only survive if the German, Austrian, Dutch and Finnish taxpayers are willing to sign a blank cheque; or if economic reforms and austerity packages on a truly frightening scale are implemented. Neither option is politically feasible. It may take a few more rescue packages and a few more years for politicians to finally realize this, but electorates in Europe are already growing restless. Once the true economic and political costs of “rescuing the Euro”, again and again, are fully understood, it will need to be abandoned.    
With the Euro gone, we will see a return to the currency world before 1999. Some countries will follow German monetary policy, either by sharing a currency or by copying everything that Frankfurt does. This is the future for Holland, Finnland, Austria, perhaps the Scandinavian countries. The southern European countries will probably stick with a rest-Euro. Interest rates will be set appropriately; growth recovers; unemployment falls; asset price bubbles become less likely. Some countries may default, and banks in several countries may need to be nationalized, as they were in Scandinavia in the early 1990s. The euro will devalue against the new Deutschmark; exports from Italy, France, and Spain will be more competitive, and German export surpluses will shrink, reducing economic imbalances in the European Union. At the same time, vacations by the Mediterranean, French wine and Italian cars become cheaper for the Dutch, the Danes, and the Germans. This is not a vision of economic apocalypse – it is the way rebalancing should work.
What does this mean for Europe’s political future? Surprisingly little. To be sure, many prominent European politicians will have a lot of egg on their faces. Megalomaniac fantasies about the “United States of Europe” will be laid to rest. The so-called bicycle theory – that Europe has to move ahead or crash – will be forgotten. We will have more pragmatic policy-making, with Brussels starting to look out for the things that actually matter, and trying much harder to make them work. What matters are the single market – free trade, freedom of movement, intellectual exchange, fair play for European companies trying to compete for government contracts elsewhere, or trying to buy another firm.
Instead of the grand visions and grand pronouncements, Brussels will have to focus on the hard, boring, beneficial nitty-gritty. Implementation of existing rules and schemes is important, and Europe currently leaves much to be desired. The single market works only in part; mutual recognition of degrees, for example, is often only a legal fiction. My dubious Oxford PhD cannot be validated in Spain, for “technical reasons”. Don’t ask why it needs to be “validated” at all. Germans are not allowed to buy holiday homes in Denmark; European governments often stop the sales of companies to foreign buyers for no good economic reason; and so on. European integration should be guided by what is good for its citizens and companies.
Sharing the same pieces of paper in the wallets of Europeans turned out to be a bad idea. It has failed at its only conceivable purpose, making the lives of Europeans better than they otherwise would be. Giving up the Euro now will do less damage to the European project than several “lost decades” of unemployment, stagnation, austerity, and riots. The European Union is much more than monetary union, and Europe is so much more than the EU. European citizens know this, but politicians need reminding that this prestige pet project is not the same as Europe’s future.

Monday, 5 September 2011

talkshow entertainment

Tomorrow night, you'll have a chance to see yours sincerely on German TV -- over at ARD-1st German Television, in a talk show called "Menschen bei Maischberger". 

Monday, 15 August 2011

The sharp end of history

It's been a pretty exciting week on the beach... my paper with Jacopo Ponticelli about austerity and anarchy in Europe, 1919-20009, got a ton of press, including interviews with the BBC, France24, and Die Welt. The fact that London burned a mere week after we posted the working paper surely helped. Typically, with economic history papers, something that seems topical now, when you start working on it, will barely elicit a yawn when you are done. This time, we got lucky... we started working a year ago on the topic, inspired by the Greek protests and an invitation to do a paper on fiscal policy in historical context, for the Central Bank of Chile (a far-sighted lot, it turns out). I first finished a similar paper on Latin America, and then we got this one out.

I hope the paper doesn't become any more topical...via Haaretz, I found the photo above, of what Israeli protesters installed on Rothschild Boulevard in Tel Aviv.

Thursday, 11 August 2011

Another big problem with cross-country growth regressions...

as explained by Tim Harford.

Germans and the bailouts... Michael Lewis/Antonin Scalia edition

In his How to Write A Sentence, Stanley Fish rightly spends a few pages lauding and analyzing Antonin Scalia's beautiful sentence:
Interior decorating is a rock-hard science compared to psychology practiced by amateurs.
I was reminded of it because a friend sent me the link to Michael Lewis's "It's the Economy, Dummkopf", published by Vanity Fair. The abstract reads:
With Greece and Ireland in economic shreds, while Portugal, Spain, and perhaps even Italy head south, only one nation can save Europe from financial Armageddon: a highly reluctant Germany. The ironies—like the fact that bankers from Düsseldorf were the ultimate patsies in Wall Street’s con game—pile up quickly as Michael Lewis investigates German attitudes toward money, excrement, and the country’s Nazi past, all of which help explain its peculiar new status.
I normally like Michael Lewis's writings, from Liar's Poker to The Big Short. This one, however, is a very long amalgamation of stereotypes, with almost no insight mixed in -- starting with the entirely non-novel idea that German potty-training (too early) is somehow related to the countries sinister ways (always lurking behind the corner) to the allegedly ordered and disciplined approach to anything. It's basically pop psychology (Germans are hung up about shit, and hence do the most awful things, from the Holocaust to buying subprime debt) combined with what every newpaper-reading halfwit already knows about the European debt crisis (only the Germans thought EMU was serious, and that rules meant something; the Greeks and everyone else who borrowed more than they now want to pay only did what was natural). Page after page, from the description of German finance ministry officials to the Autobahn, Goering's Air Ministry, and the Reeperbahn, Germans are portrayed as goosestepping automatons animated by the busy executive's version of From Dr Caligari to Hitler

You can debate if you want to devote 17 pages to predictable nonsene, writing or reading. I don't think Lewis is wrong about the notion that there is something like national character. He just gets it wrong, or at least 90% of it, after his multi-day fact-finding mission to Germany. What gets me the most is how smoothly Lewis skips over the disorderly, get-it-done, anarchic side of my countrymen - with all its good and bad sides. Try to have your flight cancelled in Frankfurt, and make it to the counter... in the UK, they would queue. In Germany, you will have one big melee, people getting their elbows out, fighting to get onto the next plane. It's a kind of can-do-anarchy, disorderly, results-oriented, each man for himself, and not very rule-bound.  It isn't always pretty, but it's ... very different from Michael Lewis's image, which seems to come straight out of a 1950s Hollywood war movie. Tax officials in local offices (whose name and a number appears on your tax notification) can make decisions on fining you, or taking that fine off. Every year in my classes, when I ask questions that require people to think outside the box, the German students do much better than many other nationalities -- the school system emphasizes the exact opposite of rote learning, from an early age. In days of old, the German army, despite being an instrument of a deeply anti-democratic state, used "empowerment" before the term was invented, pushing independent, important decision-making down to the level of sergeants and privates (which made for very high efficiency, as analysed in Martin van Creveld's wonderful Fighting Power). And several German classmates of mine are I-bankers... and doing pretty well as far as I can tell.

What does all of this mean for the EU debt crisis? To be honest, I think national character has very little to do with it. Germans behaved much like the Greeks in the interwar period, borrowing right, left, and center, building public swimming pools with the proceeds of bond issues, and then defaulted on ... those (stupid) Americans. Much of this is eloquently described in what is still the best book about the Weimar economy  -- Harold James's The German Slump: Politics and Economics 1924-1936. No need for potty-training fairy tales here. Back then, in the late 20s, American financier J.P. Morgan Jnr. lost faith in German borrowers, in the way that Germans are now updating their beliefs about Greeks. His comment? "...Germans are a second-rate people".

Sunday, 7 August 2011

Austerity and Unrest Over the Long Run

With riots in London last night and the heavy smell of tear gas still lingering over the Acropolis, Jacopo Ponticelli and I thought we'd look at the connection between budget cuts and unrest more systematically. The working paper is now out. We look at the extent to which riots, demonstrations, political assassinations and general strikes increase as governments cut expenditure in Europe, 1919-2009. Here is the abstract:
Does fiscal consolidation lead to social unrest? From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble cross-country evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyse interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

And here is our answer, in one slide:
The bars show the number of incidents - CHAOS aggregates them all, and then you have the components -- demonstrations, riots, assassinations, and general strikes. As the bars get darker, cuts get deeper. Once you cut expenditure by more than 2% of GDP, instability increases rapidly in all dimensions, and especially in terms of riots and demonstrations.

Sure, there are many incidents that can lead to an eruption of violence– from the killing of Mark Duggan in London last Saturday to a high-speed pursuit gone wrong (in the case of the Rodney King riots in LA in 1992). The more interesting question is -- why are cities at some points in time more akin to a tinderbox? Why does it only take one incident for massive violence, riots, or anti-government demonstrations to erupt? Even if there is something else that provides the spark, you want to know why there is so much dry wood around that you get a conflagration. Here, our results suggest that the role of budget measures is important.

We also use some additional, more detailed data on the causes of each demonstration to confirm our hypothesis that the link is causal. Incidentally, the same pattern is apparent in Latin America since 1937.

So, if you ever found yourself reading papers by Alesina and co-authors arguing that i. budget cuts can be good for growth ii. there is no punishment at the polls for governments cutting expenditure, and wondering why governments don't engage in more austerity - maybe here is your answer. Even if (and it's a big if, given the IMF's latest research) Alesina et al. are right, and growth can follow cuts, the pain may be concentrated amongst some groups. If these become massively unhappy... it can start to look pretty ugly out there in the streets, and I doubt that that'll be good for growth. As a matter of fact, Nick Bloom of Stanford has a bunch of fantastic papers showing just how painful uncertainty shocks are in terms of subsequent economic performance.

Friday, 29 July 2011

My next (academic) book

... is one step closer to completion. Peter Temin and I have been working away in the archives of Hoare's Bank for a some years now, producing a couple of articles along the way [for a "best off", click here or here]. We now have a book manuscript, entitled "Prometheus Shackled: Goldsmith Banks and England's Financial Revolution after 1800", which we are circulating prior to a book conference at Yale in early October.

The argument? Over the last 30 years, economic historians have learned that growth was "slow" in Britain after 1750 (Crafts, Harley, Antras and Voth). At the same time, there is plenty of evidence that the "mechanical arts" progressed quickly (Mokyr, Temin) - a wave of useful gadgets found its way into the British workplace. How do we explain the disconnect? Our answer is - finance. Or, more precisely, the absence of it, as well as the wrong kind. Scholars have long talked about a "financial revolution" after 1700 in Britain (Dickson). This revolution was about public finance, not credit intermediation. Using detailed micro-evidence, we examine why, in Postan's words:

“the reservoirs of savings were full enough, but conduits to connect them with the wheels of industry were few and meagre … surprisingly little of her wealth found its way into the new industrial enterprises …”

Our answer is that government regulations in the form of the usury laws and the Bubble Act stifled the development of private finance; government borrowing shocks - crowding out - in addition made financial intermediation much more difficult. In combination, this slowed things down a lot. Britain's industrial transformation after 1750 could have been a lot faster if private finance had played a bigger role. The fact that private capital did not find its way into enterprise readily, and that most financing took the form of retained profits, is a cause for the big rise in the capital share of output, as recently documented by Bob Allen (amongst others).

We document all these challenges through the lens of five goldsmith banks, whose records have survived to the present. The banking in industry in 1700 looked more like Silicon Valley today - lots of entry, lots of exit, little permanence. By 1750 or so, stability had become the norm -- this is what Peter and I call the "Triumph of Boring Banking". We show how these firms survived and eventually learned to prosper, despite stifling government regulations. We like to think it's an interesting exercise in "business history meets macro and financial history", but now it's time for advice from some of our readers.

You can have a peek here:

Temin-Voth book manuscript

Wednesday, 27 July 2011

The reigns of power...

pass to Fernando Broner at the end of the month - I am stepping down as the director of the ITFD Master. Fernando has been the deputy director for most of the last 3.5 years. Time whizzed by rather quickly -- it seems like yesterday that we planned the program in 2007, and started in 2008-09 with 18 students. In September, we will probably have 40 or so, from all over the globe. Less apparent from the outside, perhaps, is that we have a bit of a special governance structure, with a steering committee of four academics (Fernando, Jaume Ventura, Antonio Ciccone, me) setting the broad academic path, and the director being in charge of implementation and day-to-day running of the program. From my perspective, the structure has worked well, and fine-tuning over the years has made the master a lot stronger.

One of the pleasures of the job is keeping in touch with alumni, and following their trajectories. Just recently, I heard from Antonella Liberatore (who now has a permanent position at the Economic Research and Statistics Division of WTO in Geneva) and Jasper Hamerlynck (VP at the Institutional Equity Division of Morgan Stanley). If any ITFD students are reading this - do drop us a line, or even better, drop in when you are in town!

Friday, 22 July 2011

if this is private sector pain...

I want some. The EU finally got its act together: There will be a selective default to make the private sector pay... but the banks and insurance companies that agreed to the bond swap are not the only private investors out there. There was news that vulture funds were buying Greek bonds for 50 Eurocents on the € in early July, and now, the EU deal is making some people out there a lot better off. Some of the price action today:

Greek Eurobonds, inflation-indexed, 2003 (25) + 28.9%
EO-notes 2009 (19) + 21.1%
EO-notes 2009 (14) + 14.4%

...and so on, across the entire maturity spectrum. The rally started at a very low level, as we all know, and the 2009(14) for example is still trading at 63% of face value, for a yield to maturity of 24.9% p.a. That's down from over 35% a few days ago. Over the last year or so, every additional aid measure has been greeted with a relief rally, only to be followed by an ever-deeper slump. Will this one come to stay? I think it just might. Once markets factor in the lower bond yields, debt sustainability will look a lot better. That justifies lower yields, and so on. The mountain of debt hasn't gone away, but paying for it will have become just that much easier so that, together with the EU generously sprinkling aid on Greece, an outright default might not be on the cards after all...

Monday, 18 July 2011

The "transfer problem"

Larry Summers today wrote an interesting piece for Reuters. His first point - worth considering - is that the German obsession with wrapping the private sector's knuckles and enforcing discipline is overblown + dangerous. It is, indeed, what many thought before Lehman, and that one didn't end well. The second point he makes is about the chances of Greece actually paying up. Summers says " country can be expected to generate huge primary surpluses for long periods for the benefit of foreign creditors." Of course, if true, it also means that countries cannot credibly run up sizeable foreign debt positions. Pointing to Keynes' famous point in the Economic Consequences of the Peace, he argues that transferring so much money abroad is simply politically infeasible.

If I get my numbers right, Greece would have to produce primary surpluses of 5-10%, to be transferred to the rest of the EU (in the main) for the next 20 years or so. Of course, many regions in Europe transfer this much to other regions -- but not in exchange for past goods + services received, contrary to the Greek case. One example, close to home? Catalunya. One of the most productive regions in Spain, it is currently sending approximately 9% of its GDP to the rest of the country. Of course, Catalunya is not a separate country, but part of Spain, and all the taxes for which its citizens get precious little payback were not exactly embraced enthusiastically. But pay they do, regardless. This simply shows that open revolt need not follow on the heels of high transfers of a region's riches elsewhere; it depends on the way this is sold to the population. Catalans, while grumbling, are on the whole remarkably placid on the issue. What surprises me is that, in contrast to the rest of the Europe, where regions with their own culture + language are normally "bribed" to stay, Catalans end up paying for being part of a larger entity they do not much care about. Perhaps they should take some lessons from Southern Sudan, and sign up George Clooney to push their case internationally...

Wednesday, 13 July 2011

Debt trouble

I was teaching "Financial Crises" in the CREI Macro Summer School last week (link here). As I was brushing up the syllabus, I realized just how much great work Mian and Sufi have done on the recent crisis. I already knew their paper in the QJE on the subprime crisis, where they show that areas with high latent demand for mortgages in 1997 (i.e. high denial rates) saw a big increase in lending, lower denial rates, higher LTVs, without any improvement in economic conditions. 

Now, they also have a paper (with Francesco Trebbi, in the AER) on the voting of Republicans and Democrats on the bailout packages for homeowners, and for the financial industry. Guess what? Your ideology matters.... but only up to a point. What also matters a lot are the economic interests of your constituents. So if you are a god-fearing Republican who believes in small government, Ronald Reagan, the right to bear arms, and not helping anyone in need... you may rethink the last bit if your constituents are looking at a lot of foreclosures. As Groucho Marx said - these are my principles, and if you don't like them, I have others.
Mian and Sufi also have a small new paper, published in the SF-Fed's Economic Letters, on which areas of the US are suffering the most from the current recession... and it's all about debt levels. The first thing that is stunning is the size of the debt binge in the last 10 years (figure above). The second killer chart in the paper looks at the differential performance in auto sales:
Counties with a lot of household debt saw a big decline in sales in the run-up to 2008 already, and have stayed depressed. The low-debt counties have roared back, as everyone should have done in a normal recovery. Slow recovery? Maybe there is something more to it than a bit of pump-priming via the government deficit, and QE1-3. Without inflation, it's hard to see what will help those suffering counties reduce their debt burdens.

All of this goes to show that the analogy of debt binges and alcohol-infused parties is quite apt - fun while the punch is on tab, less so the next morning. That was also the argument about the Great Depression, made by Barry Eichengreen and Kris Mitchener almost a decade ago (in a much underappreciated paper). The title? The Great Depression as a credit boom gone wrong.

Surprise of the day... another bad idea

from the EU. This time, the collected EU finance ministers seem to think that by buying back Greek debt at depressed prices, they can really make those irritating, overpaid bankers pay. There may be clever ways of engineering such an outcome, but the basic idea doesn't work. In one of their classic papers, Bulow and Rogoff (QJE 91) show that buying back debt is no way to reduce the burden of too much debt. Open market buybacks, at least, "allow creditors to reap more than 100 percent of any efficiency gains". Why? A country's repayment capacity is its repayment capacity. As you buy back debt, you effectively spread that capacity over ever fewer bonds - there is more blood, sweat, and tears squeezed from the Greek taxpayer for each bondholder remaining. The secondary market price of debt rises as repurchases proceed. Most likely, the market value of all bonds outstanding stays roughly constant as the face value declines. So, what to do? Maybe buy-backs are the answer, but to get it right, get a good advisor to design the process - like Paul Klemperer of Nuffield, Oxford, who advised the UK government on G3-spectrum auctions.

Sunday, 10 July 2011

hack attack!

The Barcelona GSE website was hacked last week, and remained down for much of it. I hope prospective students didn't get worried -- this kind of thing happens all the time, and the elves downstairs assure me nothing has been lost. As of Sunday, 11-7, we are back in business!

Wednesday, 6 July 2011

Happy memories... or not?

I have just come back from the BGSE graduation ceremony, at the AXA forum at the other end of town. It was the normal mixture of fun and speeches, saying good-bye to students that I had come to get to know and greeting the parents that produced the interesting, alert, curious boys and girls that we taught. I feel a bit nostalgic about everyone leaving - didn't I just get to know you a few months ago?

But before I get all bleary-eyed, perhaps I should heed a bit of advice that comes out of really interesting research. Ever found yourself moaning silently when some postmodernist quack cr***ed on about how reality is socially constructed? Well, it turns out that there is some truth to that. In Science, there is an incredible bit of research showing that people who can perfectly well remember events change their view if you surround them by people who say something else. The scientists in question used MRI scanners to find out how this happens. Turns out that two parts of the brain, linked to fear and emotion, are involved in us changing our memories -- the hippocampus and the amygdala. Get a computer to tell people they remember wrong, and these parts of the brain do nothing. With people, it's the opposite. So maybe that's the point of ceremonies -- to create salient events that help us recall all that was great about a really great class!

Wednesday, 15 June 2011

tear gas and "chicken"

Nathaniel Rothschild allegedly said that one should "buy to the thunder of cannons and sell to the sound of trumpets". I guess, the modern-day version would be to trade to the smell of tear gas, which has been wafting across Athens recently. Closer to home, in the beautiful park next to the university that houses the Catalan parliament, ministers and MPs were surrounded by Spain's own indignados movement... which made it just that touch harder to be in the office on time this morning, with riot police blocking many of the streets leading to the campus. It was pretty calm as things go, with no violent clashes, but the image of ministers being ferried in by helicopter reminded me a bit of President De La Rua's last day in office.

Back to the issue of trading: Even popular financial advice sites like marketwatch are now offering suggestions on how to make $$$ from a coming Greek default. I would say, not so fast... we are mainly witnessing a public game of "chicken" between the German finance ministry and the ECB. Some of this is squarely aimed at the wider public -- "look, we are trying to get tough with private creditors". While the EU has an amazing talent to screw up things, I would say -- uncharacteristically, as those who know my pessimistic side might think -- that this one is too important to go wrong, and that a deal will eventually get done, with no more than a bit of a Vienna-style initiative imposed on the creditors. Now, if only the Greek government will actually stay in office for long enough to see through the implementation of the next round of austerity...

Tuesday, 14 June 2011

I have been called many things...

but not a Jew. Nico Voigtländer and I wrote a paper on the persistence of anti-Semitism which is getting a bit of press. Now a pro-Palestinian website has decided that writing about pogroms is a sure sign of us being both Zionists and Jews. Needless to say, I am rather flattered that someone should think me a member of a tribe that has consistently produced more outstanding intellectuals and artists than any other group I can think of. And equally needless to say... neither Nico nor I are in fact Jewish. We just think that extreme hatred and an inclination to group violence are really interesting issues and deserve to be studied seriously, in a historical context, and that anti-Semitism is a particularly important example in this regard.

tea leaves reading hour

How much economics can you get out of a single graph? Here's is my entry: The Economist has a chart for salary expectations of graduates. Not many surprises there - Swiss grads expect more than those in Poland. More surprising - women expect less than men, but hey, they do earn less. They are just realistic. Then my eye wandered to the entries for two countries close to my heart - Germany and Spain. First of all, the Spanish graduates all expected starting salaries LOWER than the national average salary. Pretty much everywhere else, that's not the case. Note that educational attainment has risen quite quickly in Spain in recent decades, from a low base. That means that the average university graduate is comparing himself with a salary paid to people whose educational attainment is really quite low -- and they still think (and probably will) earn much less. The college premium? None in Spain. Truth be told, much of the university education here has consisted in handing out pieces of paper to people who sat in overcrowded lecture theatres long enough to lower the reported unemployment rate. There they were often taught by people with a degree from the university where they are now teaching [no, that's not UPF economics - we never hire our own doctoral students, and class sizes here are small]. So education mostly doesn't pay. That mainly because it's lousy on average, and the selectivity of higher education is so low that there is no premium in Spain.

Then I looked at the national wage rates for Germany and Spain -- the difference is factor 2! Now, Germans are more productive per head (and much more productive per hour - working hours in Spain are pretty long). But the ratio is off. A quick check confirms what I remembered: Spain is about 3/4 as productive per head as Germany, and not 1/2. That's another way of saying that, per unit of output, Spaniards earn less. How come? Normally, you would think that having low wages relative to output would be great for growth - profits should be high, and growth should take off. But not so fast.

The reason why the pay difference is large probably reflects two things: First of all, there are lots of side payments in small-and-medium firms that are not reported ("the envelope" with black money). This is a major source of inefficiency. The big firms can't and won't engage in this practice, which means that their wage costs are higher -- to get workers, they have to fork out more. The uneven tax cheating is driving employment into the inefficient small firms. Second, if the ratio of wages to output is lower than in, say, Germany, then someone must be getting the rest. Normally, that would be profits. Part of it is, I am sure, just payments to fixed factors of production, like rent... those silly prices for land, again. Finally, returns to entrepreneurs and the self-employed may be higher, but possibly not for the reasons we might like. Entry regulation etc has something to do with it. Spain is not exactly home to a large number of small + medium, world-beating companies. Most produce for the home or regional market. The reason why they are in business at all is that they know how to navigate the local forest of regulation and connections - and not higher efficiency. The political cast conspires to keep competition out, from the national level down. The country has one of Europe's most uncompetitive phone- and internet-markets (all those well-connected board members at Telefonica); there is a blatant breaking of EU competition rules when it comes to takeovers (remember EON's attempt to buy a utility in Spain?), etc. All of this shows up as profits somewhere, but it isn't exactly good for the economic performance of the country. This also suggests that "pay restraint" isn't the first thing to think about when it comes to restoring the country's economic vigor.

Tuesday, 7 June 2011

I am a sucker...

for a good title, and this one is just great:

[hat tip to Tyler Cowen]

White elephants, up close... real close

As part of our series on ITFD student policy projects, here is the summary of another one I learned a lot from: Kristin Keohan, Kevin McEvilly, Kevin Timoney and Kristoff Potgieter (supervised by fellow ITFD steering committee member Antonio Ciccone) analyse expansion plans for the giant MOZAL aluminum smelter in Mozambique. The IFC, the lending arm of the World Bank, got them of the ground. MOZAL is already huge... accounting for 66% of Mozambique exports. Phase III would now build on the earlier success, and add a lot of capacity. To that end, there would need to be fresh investment in dams to generate hydroelectric power, etc. Is this a good idea? You would think so. Mozambique was a basket case before MOZAL came along; nobody from the rest of the world wanted to invest there. Once the aluminium plant was up and running, the perception of investors changed; FDI started to flow.

Despite all this, the 4 K's make a (to me) convincing case that this is a bad idea. First of all, there is no longer any need to subsidize expansion - the project risk is low, and giant firms like BHP which own the majority of MOZAL can shoulder the costs if they are economically viable. Their key argument why neither the IFC nor the Mozambique government should subsidize is that the externalities seem very small. There are few backward linkages: MOZAL is producing aluminum from bauxite mined in Australia, using cheap energy from South Africa.  South Africa now increasingly needs its own electricity, and MOZAL III is largely an attempt to strong-arm the local government into providing subsidized energy. Crucially, the spilloves are tiny -- very few people are employed at MOZAL, and fewer are from Mozambique. In our urge to do "something" for development, it is tempting to bet on a project that seems like a winner... but it may be better  to do so elsewhere.


Wednesday, 1 June 2011

some basic arithmetic for gauging austerity's impact...

Brad DeLong has a beautifully simple back-of-an-envelope calculation on what the deficit implications of austerity are. His figures are for the US, and they are ugly... austerity means higher deficits in the future. Exercise for today: plug a number (any number, really) for Greece, and put them through the same formula. You get the opposite result, big-time. I dare anyone to suggest a multiplier so high that you can undo the effect of interest rates in this case. So, do the German deficit-hawks have a point? Discuss, in no more than 1,500 words!

Slate covers "Persecution Perpetuated"

Ray Fisman, one of the most creative economists I know, writes in Slate about Nico Voigtländer's and my work on the medieval origins of anti-Semitism in the interwar period ("Persecution Perpetuated"). Grim subjects make for some interest, or so it seems...

On a small personal note, there is a silly little illustration how deeply ingrained mental habits become, which occurred to me looking at the picture that accompanies Ray's piece. If I am not mistaken, this is Adolf Hitler's personal bodyguard, the Leibstandarte, shaking hands with the Führer. The Leibstandarte had an exacting minimum height standard (5 foot 11). Back in the 1980s, I did national service looking after old people, cycling from house to house to help with household chores, shopping, cleaning, personal hygiene, you name it. And since I am a little taller than average (6 foot 4), many an elderly lady, in the sweetest of voices and with no ill intention, would pay me a compliment: "Wow, you are tall. You could be in the Leibstandarte!" It would always remind me how very lucky I am that I was born when I was, and that I could do national service as a conscientious objector, those 20 months of menial labor be damned (the only thing that would have been better would, of course, have been to skip it entirely; but it took Germany a long time to do the right thing and abolish the draft).

Saturday, 28 May 2011

How not to combat terrorism

Terrorism is driven by poverty and deprivation in the Third World, right? Surely, a great way to combat it is to give development aid, and make the lives of the poor, downtrodden masses better... or maybe not. ITFD students Cristina Yoong, Rachel Lund, Joonas Uotinen, and Sonja Settele look at the issue in their policy topics presentation. They offer some powerful arguments that question how much, in particular, the US should invest in the largely lawless FATA region in Northwestern Pakistan. They show that most leading terrorists come from more educated, well-off households, and that a proclivity towards terrorism is not significantly correlated across countries with poverty. Even the most optimistic studies suggest that aid would have to be in the hundreds of billions to reduce the recruitment of low-level terrorists by a significant number. Equally importantly, they show that much of the aid actually helps the Taliban directly, through protection money and the like. Their presentation is here:
Terrorism and Aid                                                                                           

Friday, 27 May 2011

Fabio Sola joins the World Bank in Brasilia

Congratulations to Fabio Sola (ITFD 2011) who will be joining the World Bank's country office in Brasilia this fall. He we work in the Lead Economist's office, and will have a chance to apply his econometric skills and understanding of macrofinancial issues.

Attack of the one-armed economists

Harry Truman allegedly said that he wanted to meet a one-armed economist, so as to spare himself the endless "on the one hand... on the other hand" that our profession can produce. Well, one of our aims here at ITFD is to breed Truman's favourite type of economists. Teams of 3-4 students practice being "one-armed" at the end of their time here, by writing and presenting a policy topics memo. The idea is to reverse the normal, analytical process where you start with a lit survey and then add gradually some nuggets of knowledge before hedging your conclusions in the summary at the end. Here, we want students to answer a policy questions. Working in teams, we had a bunch of presentations on interesting and creative topics:
  1. Should development aid be used to combat terrorism?
  2. One-to-one computing for Chile – is it worth it?
  3. Should Indonesia impose more stringent capital controls?
  4. The Costs and Benefits of a US$3 Billion Factory: Should Development Aid be used to expand the Mozal Mega-Project?
  5. Is stock market development a feasible and desirable channel for the sustainability of Botswana's growth?
  6. Charter City in Honduras - alternative for classical development aid?
  7. Should Mexico issue Diaspora Bonds?
  8. Microfinance in India: should the recently proposed regulation be introduced?
  9. Management of oil revenues: Should Angola create a Sovereign Wealth fund?

It takes a bit of a "gestalt switch" to do what is required here - start with the recommendation, say clearly why you favor it, think about counter-arguments, sum up. How did it work? For my part, I would say it was a pretty impressive show (pics here)

Sunday, 22 May 2011

What's really going on with Greek debt?

I have been thinking a lot about the Greek debt problem. About a year ago, I looked at the numbers and decided that on economic logic alone, this one will end in a restructuring -- the primary deficit was just too big, and the debt too high. Now that the markets and politicians are debating with ever greater intensity if "reprofiling" or a "soft restructuring" will take place, I am beginning to think that we might actually see this one settled without a default. What's changed? Apart from my contrarian instincts, I think it's important to remember that there are many moving parts here -- the European governments, financial markets, the Greek government, the ECB, and the electorates of Greece and the EU member states stomping up the cash. It's all a bit like a Ruby Goldberg machine, really. The spread on Greek debt has been soaring of late, and the EU needs to decide on some course of action now that the IMF and EU missions are checking that Athens is doing its share. I get the sense that some operators in financial markets are, in a way, lobbying for a default event - anything that allows people to cash in on their CDS.

I think they may be disappointed. I may be wrong, but the rhetoric coming out of Berlin (and recently, Paris) about reprofiling seems more designed to put pressure on Athens than a good predictor of events to come. I am not saying that a restructuring couldn't happen, but given that the ECB is vociferously opposed, and that no EU politician wants to be responsible for the next Lehman disaster (as predicted by the ECB if Greece defaults), I think the current discussion is more designed to get the Greek government going - or, more precisely, to give the Greek government an excuse to tell its electorate that there is nothing that can be done to avoid lots more austerity.

My money is on the following: 1. Tough budget cuts and markedly tougher privatization requirements for Athens, maybe in the form of a semi-autonomous agency a la the German Treuhand that handled sales of the East German assets 2. Fresh loans by the Europeans 3. A "voluntary" roll-over agreement with the banks so that they agree to take fresh Greek bonds as the old ones expire. Some of this will be painful in the short term for Greece and for the banks, but it will save the Greek financial system and keep access to outside funding open. As I have said before, making the tax system less distortionary is good for growth. Also, if the confidence trick works, Greek savers may start putting some money back in their own banks, which will help with recovery... and once hedge funds and private individuals in the markets see that Greek bonds offer 25% and are effectively guaranteed by the EU, yields will come down. That was the hope a year ago, and it didn't work. But that doesn't mean it cannot pan out this time...

Friday, 20 May 2011

Screw up now, enjoy later

Today, there are demonstrations in Barcelona and across Spain against "the political class, the crisis, and the fact that people who lose their house because they can't pay the mortgage still owe something to the banks..." or so my cabby explained. The last bit is interesting. Dación en pago, the idea that someone who borrows on mortgage can just hand back the keys, has become the fantasy of many Spanish house buyers who are faced with negative equity. In the US, this happens a lot; many states allow the practice. In almost all European countries, including Spain, it's a no-no.

So who is right? It's actually not very hard to think through the consequences. Allen and Gale have a beautiful paper that looks at exactly this kind of thing. It's called "Bubbles and Crises". The idea? If you have a "stupid" bank that, on average, loses money, its lending is likely to create bubbles galore. The reasons is risk-shifting. If you borrow to buy an asset, and it goes up in value - bingo, you are rich. If it goes down, you just hand it back to the bank. Since none of your money is at risk, you can't lose. How much of that asset do you want to buy? Me personally, a lot. Sign me up. Actually, double that. And so on. Of course, this creates price pressure upwards... The downside of the model was that it required a stupid bank that lost money on average. But if there is one thing we have learned in the last 10 years, it's that there is no shortage of stupid banks. So, while handing the keys back to the bank and cancelling all debts sounds nice ex post for those who got themselves mortgages that were too big relative to their incomes, it is really, really bad policy. The depressing thing, of course, is that given how loud vox populi is, it is not impossible that someone somewhere will want to garner some votes by changing the rules.

Saturday, 7 May 2011

J-PAL Placement - Congratulations to Max Bode

The first ITFD graduate to join the Jamal Poverty Action Lab (J-PAL) is Max Bode, who is graduating this summer. He will be heading to India for a month of data work with Erica Field and Rohini Pande, before working at the Harvard location of J-PAL for the next two years.

Wednesday, 6 April 2011

When the facts change, I change my mind

About a year ago, I illustrated the standard debt-sustainability calculations with the case of Greece. If you plug in plausible numbers for growth, for interest rates, and for the debt stock, you get to a need for fiscal adjustment that is frightening. Indeed, it is so large – compared to, say, the fiscal tightening that undid the Weimar Republic – that one had to say “no way”. The necessary swing in the fiscal balance – from primary deficit to surplus – was around 10% of GDP.

Now, I am starting to think that this may not be mission impossible after all. The reason? It’s not what you think. For a while, much of the profession and, to a surprising degree, policy-makers seemed to have decided that the Alesina et al. view of fiscal adjustment was right – that you can cut yourself back to growth. The IMF has done some painstaking work last year, and this argument now looks pretty doubtful.

However, there is another story that can create a bit more hope. There is no question that countries that tax more are richer. Any scatterplot shows correlation is strong. Is it causal? Recent work by Besley and Persson says so. They look at the part of variation in tax capacity that can be explained by the history of military conflict after 1816. States with a history of lots of (expensive) wars still tax more; and that part of the variation is also strongly associated with being richer. Now, Dincecco and Prado (2010) have a new working paper in which they show that the number of battle deaths in the early modern period is also a good predictor of the taxman’s take today – and that this also explains how rich a country is. This strongly suggests that the link is causal – taxation is good for you.

Why? A lot of economics implies that high taxes should be bad. Disincentives for work and entrepreneurial activity are large; a bloated state is as likely as not to waste precious tax dollars. And yet, taxes also generate benefits. Besley and Persson show that capital markets work much better in countries where the government is more capable overall – enforcing laws, investing in education, building infrastructure, protecting property rights, ensuring that debts are collected. All of this costs money. Also, high tax revenue mostly means that everyone pays. The more uneven the tax burden, the lower the overall yield is likely to be. That would also imply that a high tax take is often associated with FEWER distortions.

It’s these kind of distortions in the PIIGS experiencing problems today that seem to suggest that maybe, there is a silver lining to the issue of excessive debts. In countries like Greece, Spain, and Portugal, the self-employed effectively escape taxation on a staggering scale. Many transactions take place with black money. Buying a house is often akin to a scene from a Hollywood gangster film – the buyer first goes to his or her bank, and exits with a suitcase full of cash. The cash is then exchanged at the notary’s office, before being paid in again by the seller. None of it is declared to the authorities. This is not some occasional, half-criminal type of transaction – this is the norm for house buyers today, in a Southern European EU country I know well. Taxation is hence not just too low relative to debt; it is also highly uneven, and hence, distortionary. For example, you end up with an awful lot of people working in property who should be working elsewhere.

As Spain, Greece, and Portugal, desperate to plug their fiscal holes, are scrambling to find fresh funds, they will have to go after the areas of the economy they have largely far left alone – such as construction, property transactions, and the self-employed. Many of the citizens that should, by rights, have been working in large companies in the taxed part of the economy are today working in the self-employed sector; only tax fraud makes this worthwhile, since it compensates for the low productivity of their labor. As that gap narrows, overall output will increase, and the tax take will rise. In the short term, austerity may spell hard times for the Club Med and Ireland. And yet, tax reform done right may very well pay rich rewards, not just in terms of revenue, but also in terms of economic efficiency. Maybe, Greece can pull it off after all.

Thursday, 17 March 2011

finally... a radio program I have been waiting for for over a decade

If you visit a British bookstore, you can find the European history corner by looking for a monumental collection of swastikas on the shelves... It used to amuse me as a student in Oxford, and then became a curiosity. A normal weekend in the UK will include some re-run of a World War II movie, a documentary about the last Spitfire pilot alive, and a few book reviews in the Sunday papers. Apparently, 850 books on the Third Reich were published in the UK in 2010 alone, including one on Collectible Spoons of the Third Reich. Now, the BBC actually has a clever radio documentary about why this is - over here. It's pretty good, but I would say that - my own working hypothesis (Britain can't get enough of being reminded of the last time it was actually Great) gets a pretty strong endorsement. The journalist even gets close to spoofing my all-time I-hope-this-is-never-actually-written-title Hitler's Willing Gardeners.

Thursday, 10 March 2011

First UPF doctoral candidate to go on the RES tour

The Economist recently profiled some interesting research showing that European output of scholarly articles was growing faster than that of US departments. Maybe Europe is also catching up in terms of producing PhDs? One swallow does not make a summer, but here is a nice leading indicator... even abstracting for the parental pride factor.

The Review of Economic Studies does a nice thing - every year, it brings seven of the most promising young PhD students who did well on the US academic market over to Europe, where they give seminars at a number of universities. This year, my doctoral student Peter Koudijs  will join the RES tour. If I am not mistaken, he is the first UPF doctoral candidate to do so. This is not a small thing - it's equivalent to semi-official confirmation that you were a star of the market in a particular year. What makes this particularly nice is that,  until now, there were only a handful of Europeans (meaning, economists with doctorates from European schools) who were on the RES tour until now (Dave Donaldson, now at MIT, and Markus Brunnermeier, now at Princeton, come to mind). Before he goes, he will have to make a decision on where to start his career as an assistant professor, having received a string of top offers, from NWU-Econ and Chicago-Booth to Stanford GSB, LSE-EcHist, and Columbia GSB.

Persistence over the very long run.

I am over at Harvard for a few days, giving a talk tomorrow. Nico Voigtländer and I have a bunch of papers on the long-run consequences of the Black Death. Since I have done some other work on Nazi Germany, one day, we wondered if there wasn't a parallel between the two periods worth exploring. As the plague sweeps through Europe, causing unprecedented mortality, people look for causes - and many blame the Jews for poisoning the wells. In many - but not all - towns and cities in Europe, the Jewish population is brutally murdered in 1348-50. We were wondering if there is some logic to the geographical pattern of violence - and in particular, if we can find the same pattern in the 20th century. It turns out that there seems to be a huge degree of persistence - areas where Jews were burned in the 14th century were much more antisemitic in the 20th. Here is the abstract of our paper [download HERE]:

Persecution Perpetuated: The Medieval Origins of Anti-Semitic Violence in Nazi Germany
How persistent are cultural traits? This paper uses data on anti-Semitism in Germany and finds continuity at the local level over more than half a millennium. When the Black Death hit Europe in 1348-50, killing between one third and one half of the population, its cause was unknown. Many contemporaries blamed the Jews. Cities all over Germany witnessed mass killings of their Jewish population. At the same time, numerous Jewish communities were spared these horrors. We use plague pogroms as an indicator for medieval anti-Semitism. Pogroms during the Black Death are a strong and robust predictor of violence against Jews in the 1920s, and of votes for the Nazi Party. In addition, cities that saw medieval anti-Semitic violence also had higher deportation rates for Jews after 1933, were more likely to see synagogues damaged or destroyed in the Night of Broken Glass in 1938, and their inhabitants wrote more anti-Jewish letters to the editor of the Nazi newspaper Der Stürmer.

With this, we are trying to contribute to the burgeoning literature on the long-run persistence of culture. Guiso, Sapienza and Zingales found that Italian cities with a history of independence had higher rates of trust and income even today; Jha shows that Indian cities with a mercantile past show less violence between Hindus and Muslims over a horizon of 300 years. Relative to these papers, we show a) persistence over a much longer horizon b) the survival of a pure cultural trait without obvious economic benefit, especially since Jews largely vanished from Germany after 1500.

*** Jonathan Haskel, whose intellectual judgement I hold in high esteem, actually called our results "the most amazing correlation he has ever seen". The title of his post? "Are the experts wrong?" ;-)