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.

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".

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.

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

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!

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...