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The Great Recession of 2008–09 badly shook the global market, changing the landscape for finance, trade, and economic growth in some important respects and imposing tremendous costs on average citizens throughout the world. The legacies of the crisis—high unemployment levels, massive excess capacities, low investment and high debt levels, increased income and wealth inequality—reduced the standard of living of millions of people. There is an emerging consensus that global economic governance, as well as national policies, needs to be reformed to better reflect the economic interests and welfare of citizens.
Global recovery is sluggish and the outlook uncertain. The economies of the Eurozone, which may have fallen into a “persistent stagnation trap,” and Japan remain highly vulnerable to deflation and another bout of recession; in the advanced economies that are growing, recovery remains uneven and fragile. Growth in emerging and developing economies is slowing, as a result of tighter global financial conditions, slow growth of world trade, and lower commodity prices. Because consumption and business investment have been tepid in many countries, the gradual global recovery has been too weak to create enough jobs. Official worldwide unemployment climbed to more than 200 million people in 2013, including nearly 75 million people aged 15–24.
Professor Roubini, one of the few economists who predicted the 2008 crisis, has argued that the global economy is like a four-engine jetliner that is operating with only one functioning engine, the “Anglosphere.” The plane can remain in the air, but it needs all four engines (the Anglosphere, the Eurozone, Japan, and emerging economies) to take off and stay clear of storms. He predicts serious challenges, including from rising debt and income inequality.
Relatively slow growth in the advanced economies and potential new barriers to trade over the medium term have significant adverse implications for growth and poverty reduction in many developing countries. Emerging economies, including China and India, that thrived in recent decades in part by engaging extensively in the international economy are at risk of finding lower demand for their output and greater volatility in international financial flows and investments. A combination of weaker domestic currencies against the US dollar and falling commodity prices could adversely affect the private sector in emerging economies that have large dollar-denominated liabilities.
Rising inequality is holding back consumption growth. The ratio of wealth to income, as well as the income shares of the top 1% of income earners, has risen sharply in Europe and the United States since 1980, as Professor Piketty has shown.
The ratio of the share of income earned by the top 10% to the share of income earned by the bottom 90% rose in a majority of OECD countries since 2008, a key factor behind the sluggish growth of their household consumption. During the first three years of the current recovery (2009–12), incomes of the bottom 90% of income earners actually fell in the United States: the top 10%, who tend to have much lower propensity to consume than average earners, captured all the income gains. In developing countries for which data were available for 2006–12, the increase in the income or consumption of the bottom 40% exceeded the country average in 58 of 86 countries, but in 18 countries, including some of the poorest economies, the income or consumption of the bottom 40% actually declined, according to a report by the World Bank and IMF.
Some signs of possible relief may lie ahead. In September 2014, leaders at the G20 summit in Brisbane agreed on measures to increase investment infrastructure, spur international trade and improve competition, boost employment, and adopt country-specific macroeconomic policies to encourage inclusive economic growth. If fully implemented, the measures could add 2.1% to global GDP (more than $2 trillion) by 2018 and create millions of jobs, according to IMF and OECD analysis. (These estimates need to be treated with caution, as the measures that underpin them and their potential impact are uncertain, and the nature and strength of the policy commitments vary considerably across individual country growth strategies.)
Another potential sign of hope is the sharp decline in the prices of energy, a reflection of both weaker global demand and increased supply (particularly of shale oil and gas from the United States). The more than $40 a barrel decline in Brent crude prices is likely to raise consumers’ purchasing power in oil-importing countries in the OECD area and elsewhere and spur growth, albeit at considerable cost (and destabilizing effects) for the more populous and poorer oil exporters. It could also be a harbinger of energy price spikes down the road, as the massive investments needed to ensure adequate supplies of energy may not be forthcoming as a result of their unprofitability at low prices.
Major global challenges have wide-ranging long-term implications for the average citizen. By 2030, the world’s population is projected to reach 8.3 billion people, two-thirds of whom will live in urban areas. Massive changes in the patterns of energy and resource (particularly water) use will be needed to accommodate this 1.3 billion person increase—and the elevation of 2–3 billion people to the middle class.
A citizen-centered policy agenda would need to reform national economies to spur growth and job creation, placing greater reliance on national and regional markets and the sustainable use of resources; emphasize social policies and the economic health of the lower and middle classes; invest in human capital and increase access to clean water, sanitation and quality social services, including a stronger foundation during the early years of life and support for aging with dignity and equity; improve labor market flexibility to employ young people productively; and enhance human rights and the freedom of people to move, internally and internationally. These policies would need to be complemented by policies that use collective action to mitigate risks to the global economy.
To prevent another global crisis, there is an urgent need to strengthen global economic governance, including through global trade agreements that favor the bottom half of income distribution; reform of the international monetary system, including the functioning and governance structure of the international financial institutions; encouragement of inclusive finance; and institution of policies to discourage asset bubbles. To achieve sustainable growth, all countries need to remove fossil fuels and other harmful subsidies and begin pricing carbon and other environmental externalities.
Worldwide surveys show that citizens everywhere are becoming more aware and active in seeking changes in the global norms and rules that could make the global system and the global economy fairer and less environmentally harmful. This sense is highest among the young and better-educated, suggesting that over time it will increase, potentially leading to equitable results for all citizens through better national and international policies.
Headline image: World Map – Abstract Acrylic, by Free Grunge Textures. CC-BY-2.0 via Flickr.
Atif Mian and Amir Sufi’s House of Debt, a polemic about the Great Recession and a call to action about the borrowing and lending practices that led us down the fiscal pits, already made a splash on the shortlist for the Financial Times‘s Best Business Book of 2014. Now, over at the Independent, the book tops another Best of 2014 list, this time proclaimed, “the jewel of 2014.” From Ben Chu’s review, which also heralds another university press title—HUP’s blockbuster Capital by Thomas Piketty (“the asteroid”):
As with Capital, House of Debt rests on some first-rate empirical research. Using micro data from America, the professors show that the localities where the accumulation of debt by households was the most rapid were also the areas that cut back on spending most drastically when the bubble burst. Mian and Sufi argue that policymakers across the developed world have had the wrong focus over the past half decade. Instead of seeking to restore growth by encouraging bust banks to lend, they should have been writing down household debts. If the professors are correct—and the evidence they assemble is powerful indeed—this work will take its place in the canon of literary economic breakthroughs.
We’ve blogged about the book previously here and here, and no doubt it will appear on more “Best of” lists for business and economics—it’s a read with teeth and legs, and the ostensible advice it offers to ensure we avoid future crises, points its fingers at criminal lending practices, greedy sub-prime investments, and our failure to share—financially and conceptually—risk-taking in our monetary practices.
For this American, my favorite holiday has always been Thanksgiving. Why? I have an image in my mind of Native Americans and colonists meeting and sharing food together; they share knowledge and stories. In the midst of their concerns about each other, they found respect for each other. Their spirit of sharing is a great inspiration.
As an economist in this upside-down world of people stressing over their future and present, I find answers in that image of Thanksgiving. People eventually survive by sharing with each other as a community. The poor are fed. The sick are cared for. The struggling are helped, and communal ties are strengthened.
There is a term in economics, social capital. This term refers to the cultural interactions within a society forming cohesion, coordination, and cooperation that allow an economy to function better. An economy relies on people from diverse backgrounds talking, sharing concerns, negotiating, making plans, and working toward common goals. The social quality of their communication determines the true strength and potential of their economy.
When the Native Americans and the colonists met and shared, I see social capital being built. The society became stronger. People would be better able to have their needs met. There would be less conflict and more enjoyment of work. The societuy would be able to grow in potential.
The focus of my research as an economist is in the area of labor share, which is the percentage of the income from production that is shared with labor. I research how changes in labor share affect such things as potential production, employment, productivity, investment, and even monetary policy from a central bank.
In almost all advanced countries, even in China where labor share was already low, labor share has fallen in an exorbitant way since the turn of the century. What has been the effect of labor receiving less share of a national income? Potential output has fallen. Unemployment will be higher than before. Productivity growth will stall much quicker, or even fall as in the United Kingdom. Nominal interest rates from central banks will be stuck near 0%.
The fall in labor share represents a problem in the social capital of advanced countries. Labor is being excluded from economic development. Their concerns are not being heard, while corporate profits extend to new records. Labor’s wages are expected to fall in order for companies to be more competitive globally.
Stop. Take a moment of silence.
Acknowledge the growing problem of inequality, and return now to celebrate this holiday of Thanksgiving. Within this day exists the answers to our economic concerns. As societies, we only need to share more. And in sharing, we show our respect for the value of people within society.
A man can’t get rich if he takes proper care of his family.
The Navajo, or Diné, have a saying: “A man can’t get rich if he takes proper care of his family.” The wisdom embodied in this saying is immense. The wisdom not only assures the strength of each member of the community by building social capital, but it assures a stronger economy.
Now we need to answer the question: Who is family?
Here comes the true meaning of Thanksgiving: We are all family. The poor, the rich, the uneducated, the educated, the powerful, and the powerless, as well as those of different races and cultures. Families, friends, and strangers are invited into our homes to celebrate Thanksgiving. The abundance is shared and ties of respect are celebrated.
The extent to which a society can see everyone within the society as family determines the potential of their economy and eventually the quality of life. So Thanksgiving is a moment to celebrate how different people can embrace each other in a spirit of sharing. In that sharing, a broader vision of family is cultivated. In that vision, sick economies can be healed.
Featured image ‘Home to Thanksgiving’ litohraph by Currier and Ives (1867). Public domain via Wikimedia Commons
Jose Nuñez lives in a homeless shelter in Queens with his wife and two children. He remembers arriving at the shelter: ‘It’s literally like you are walking into prison. The kids have to take their shoes off, you have to remove your belt, you have to go through a metal detector. Even the kids do. We are not going into a prison, I don’t need to be stripped and searched. I’m with my family. I’m just trying to find a home’.
Maryann Broxton, a lone mother of two, finds life exhausting and made worse by ‘the consensus that, as a poor person, it is perfectly acceptable to be finger printed, photographed and drug-tested to prove that I am worthy of food. Hunger is not a crime. The parental guilt is punishment enough.’
Palma McLaughlin, a victim of domestic violence, notes that ‘now she is poor, she is stigmatised’; no longer ‘judged by her skills and accomplishments but by what she doesn’t have’.
People in poverty feel ashamed because they cannot afford to live up to social expectations. Being a good parent means feeding your children; being a good relative means exchanging gifts at celebrations. Friendships need to be sustained by buying a round of drinks or returning money that has been borrowed. When you cannot afford to do these things, your sense of shame is magnified by others. Friends, even close relatives, avoid you. Your children despise you, asking, for example: ‘why was I born into this family?’. Society similarly accuses you of being lazy, abusing drugs or promiscuity, assumed guilty until proved innocent. You can even be blamed for the ills of your country, the high levels of crime or its relative economic decline. The middle class in Uganda ask: ‘how can Uganda be poor when the soils are rich and the climate is good if it’s not the fault of subsistence farmers’?’
In the US, as in Britain, it may be welfare expenditure that is blamed for stifling productive investment.
Shame is debilitating as well as painful. People avoid it by attempting to keep up appearances, pretending everything is fine. In so doing, they often live in fear of being found out and risk overextending finances and incurring bad debts. People in poverty typically avoid social situations where they risk being exposed to shame; in so doing lose the contacts that might help them out when times get particularly harsh. Sometimes shame drives people into clinical depression, to substance abuse and even to suicide. Shame saps self-esteem, erodes social capital and diminishes personal efficacy raising the possibility that it serves also to perpetuate poverty by reducing individuals’ ability to help themselves.
Shame also divides society. While the stigma attaching to policies can be unintentional, sometimes the result of underfunding and staff working under pressure, the public rhetoric of deserving and undeserving exacerbates misunderstanding between rich and poor, nurturing the presumption that the latter are invariably inadequate or dishonest. Often around the world, stigmatising welfare recipients is deliberate and frequently supported by popular opinion. Blaming and shaming are commonly thought to be effective ways of policing access to welfare benefits and regulating anti-social and self-destructive behaviour. However, such beliefs are based on two assumptions that are untenable. The first is that poverty is overwhelmingly of people’s own making, the result of individual inadequacy. This can hardly be the case in Uganda, Pakistan or India. Nor is so elsewhere. Poverty is for the most part structural, caused by factors beyond individual control relating to the workings of the economy, the mix of factors of production and the outcome of primary and secondary resource allocation. The second assumption is that shaming people changes their behaviour enabling them to lift themselves out of poverty. However, the scientific evidence overwhelmingly demonstrates that shaming does not facilitate behavioural change but merely imposes further pain.
Jose, Maryann and Palma were not participants in a research project. Rather they are members of ATD Fourth World, an organisation devoted to giving people in poverty voice, and their testimonials are available to read online. Echoing Martin Luther King, Palma dreams that one day her four children will be judged not by the money in their bank accounts but by the quality of their character.
Headline image credit: ‘Someone Special to Someone, Sometime’ by John W. Iwanski. CC BY-NC 2.0 via Flickr.
For investors and asset managers, expected stock returns are the rates of return over a period of time in the future that they require to earn in exchange for holding the stocks today. Expected returns are a central input in their decision process of allocating wealth across stocks, and are essential in determining their welfare. For corporate managers, expected returns on the stocks of their companies, or the costs of equity, are the rates of returns over a period of time in the future that their shareholders require to earn in exchange for injecting equity to their companies today. The costs of equity play a key role in the decision process of corporate managers when deciding which investment projects to take and how to finance the investment. Despite the paramount importance, no consensus exists on how to best estimate expected stock returns. In fact, one of the most important challenges in academic finance is to explain anomalies, empirical patterns of expected stock returns that seem to evade traditional theories.
A manager should optimally keep investing until the investment costs today equal the value of future investment benefits discounted to today’s dollar terms, using her firm’s expected stock return as the discount rate. This economic logic implies that all else equal, stocks of firms with high investment should have lower discount rates than stocks with low investment. Intuitively, low discount rates lead to high discounted values of new projects and high investment. In addition, stocks with high profitability (investment benefits) relative to low investment should have higher discount rates than stocks with low profitability. Intuitively, the high discount rates are necessary to offset the high profitability to induce low discounted values for new projects and low investment.
To implement this idea, we use a standard technique in academic finance that “explains” a stock’s return with the contemporaneous returns on a number of factors. In a highly influential study, Fama and French (1993) specify three factors: the return spread between the overall stock market and the one-month Treasury bill, the return spread between small market cap and big market cap stocks, and the return spread between stocks with high accounting relative to market value of equity and stocks with low accounting relative to market value of equity. Carhart (1997) forms a four-factor model by augmenting the Fama-French model with the return spread between stocks with high prior six to twelve month returns and stocks with low prior six to twelve month returns.
We propose a new four-factor model, dubbed the q-factor model, which includes the market factor, a size factor, an investment factor, and a profitability factor. The market and size (market cap) factors are basically the same as before. The investment factor is the return spread between stocks with low investment and stocks with high investment. The profitability factor is the return spread between stocks with high profitability and stocks with low profitability. The q-factor model captures most of the anomalies that prove challenging for the Fama-French and Carhart models in the data.
Specifically, during the period from January 1972 to December 2012, the investment factor earns an average return of 0.45% per month, and the profitability factor earns 0.58%. The Fama-French and Carhart models cannot capture our factor returns, but the q-factor model can capture the returns on the Fama-French and Carhart factors. More important, the q-factor model outperforms the Fama-French and Carhart models in “explaining” a comprehensive set of 35 significant anomalies in the US stock returns. The average magnitude of the unexplained returns is on average 0.20% per month in the q-factor model, which is lower than 0.55% in the Fama-French model and 0.33% in the Carhart model. The number of unexplained anomalies is 5 in the q-factor model, which is lower than 27 in the Fama-French model and 19 in the Carhart model. The q-factor model’s performance, combined with its economic intuition, suggests that it can serve as a new benchmark for estimating expected stock returns.
Dwight D. Eisenhower described leadership as “the art of getting someone else to do something you want done because he wants to do it.” Eisenhower was a successful wartime general and president. What made him successful? It was not a full head of hair and a fit physique, two of the physical traits of a CEO. What made him an unsuccessful university president? Was it luck or skill, or his social interactions with those he led?
There are many theories on what makes a leader effective, where effective leaders go, and whether leaders are born or created, but little empirical work. We cannot run a field experiment to study leadership of an organization in a high-stakes setting. Empirical tests of leadership theories have to come from quantitative studies of leaders and organizations, but large, longitudinal datasets on CEOs and companies are rare. A unique longitudinal data set on Union Army soldiers augmented with information on the regiment level provides a testing ground for leadership theories. This sample (available at uadata.org), created from men’s army records and linked to their census records, is the most comprehensive longitudinal database in economic history. It has been used to study the economics of aging (Costa 1998) and the role that social capital plays in people’s decisions (Costa and Kahn 2008). The data contain information on men’s promotions and demotions, their jobs during the war, their socioeconomic and demographic information at enlistment, and their jobs and locations after the war.
Who became a leader and what made leaders effective? The more able, i.e. the literate and men who were in higher status occupations, were more likely to become officers. So were the tall and the native-born. There were benefits to being an officer – higher pay and lower odds of death, both on and off the battlefield. Game theoretic models of leader effectiveness have emphasized that one way to elicit effort from followers is to lead by example. Although on average commissioned officers did not imperil themselves in battle, when they did, it was an effective strategy in creating a cohesive fighting unit. Company desertion rates were lower for companies in which the regimental battlefield mortality of commissioned officers relative to enlisted men was higher.
After the war leaders moved to where their talent would have the highest pay-off, as predicted by economic models of sorting. The former sergeants and commissioned officers were more likely than privates to move to larger cities which provided higher wages and greater diversity in the dominant economic activity of the time, manufacturing. Even men who started in low status occupations in cities were able to climb the occupational ladder.
Are leaders created or born? The Army, and a large management literature, stresses that leaders have character, presence, and intellectual capacity. In contrast, economic theory emphasizes the management skills that can be learned. Union Army soldiers who missed being promoted because casualty rates were relatively low in their companies were likely to be in a large city after the war compared to men who were promoted, suggesting that in the long-run leaders are created. One of the skills learned in the army may have been to be a generalist. Sergeants and commissioned officers with more than strict military tasks while in the army were more likely to be in large cities.
A Civil War context for testing theories of personnel economics may be unusual. The 150th anniversary of the Civil War has focused more on historical research and re-enactments. But if a stress test of theories is their explanatory ability in very different contexts, academic personnel economics does very well.
Headline image credit: Field Band of 2nd R.I. Infantry. Photo by Mathew Brady. War Department. Office of the Chief Signal Officer. Brady National Photographic Art Gallery. US National Archives and Records Administration. Public domain via Wikimedia Commons.
The construction or recertification of a nuclear power plant often draws considerable attention from activists concerned about safety. However, nuclear powered US Navy (USN) ships routinely dock in the most heavily populated areas without creating any controversy at all. How has the USN managed to maintain such an impressive safety record?
The USN is not alone, many organizations, such as nuclear public utilities, confront the need to maintain perfect reliability or face catastrophe. However, this compelling need to be reliable does not insulate them from the need to innovate and change. Given the high stakes and the risks that changes in one part of an organization’s system will have consequences for others, how can such organizations make better decisions regarding innovation? The experience of the USN is apt here as well.
Given that they have at their core a nuclear reactor, navy submarines are clearly high-risk organizations that need to innovate yet must maintain 100% reliability. Shaped by the disastrous loss of the USS Thresher in 1963 the U.S. Navy (USN) adopted a very cautious approach dominated by safety considerations. In contrast, the Soviet Navy, mindful of its inferior naval position relative to the United States and her allies, adopted a much more aggressive approach focused on pushing the limits of what its submarines could do.
Decision-making in both organizations was complex and very different. It was a complex interaction among individuals confronting a central problem (their opponents’ capabilities) with a wide range of solutions. In addition, the solution was arrived at through a negotiated political process in response to another party that was, ironically, never directly addressed, i.e. the submarines never fought the opponent.
Perhaps ironically, given its government’s reputation for rigidity, it was the Soviet Navy that was far more entrepreneurial and innovative. The Soviets often decided to develop multiple types of different attack submarines – submarines armed with scores of guided missiles to attack U.S. carrier battle groups, referred to as SSGNs, and smaller submarines designed to attack other submarines. In contrast the USN adopted a much more conservative approach, choosing to modify its designs slightly such as by adding vertical launch tubes to its Los Angeles class submarines. It helped the USN that it needed its submarines to mostly do one thing – attack enemy submarines – while the Soviets needed their submarines to both attack submarines and USN carrier groups.
As a result of their innovation, aided by utilizing design bureaus, something that does not exist in the U.S. military-industry complex, the Soviets made great strides in closing the performance gaps with the USN. Their Alfa class submarines were very fast and deep diving. Their final class of submarine before the disintegration of the Soviet Union – the Akula class – was largely a match for the Los Angeles class boats of the USN. However, they did so at a high price.
Soviet submarines suffered from many accidents, including ones involving their nuclear reactor. Both their SSGNs, designed to attack USN carrier groups, as well as their attack submarines, had many problems. After 1963 the Soviets had at least 15 major accidents that resulted in a total loss of the boat or major damage to its nuclear reactor. One submarine, the K429 actually sunk twice. The innovative Alfas, immortalized in The Hunt for Red October, were so trouble-prone that they were all decommissioned in 1990 save for one that had its innovative reactor replaced with a conventional one. In contrast, the USN had no accidents, though one submarine, the USS Scorpion, was lost in 1968 to unknown causes.
Why were the USN submarines so much more reliable? There were four basic reasons. First, the U.S. system allowed for much more open communication among the relevant actors. This allowed for easier mutual adjustment between the complex yet tightly integrated systems. Second, the U.S. system diffused power much more than in the Soviet political system. As a result, the U.S. pursued less radical innovations. Third, in the U.S. system decision makers often worked with more than one group – for example a U.S. admiral not only worked within the Navy, but also interacted with the shipyards and with Congress. Finally, Admiral Rickover was a strong safety advocate who instilled a strong safety culture that has endured to this day.
In short, share information, share power, make sure you know what you are doing and have someone powerful who is an advocate for safety. Like so much in management it sounds like common sense if you explain it well, but in reality it is very hard to do, as the Soviets discovered.
Feature image credit: Submarine, by subadei. CC-BY-2.0 via Flickr.
In 2007, the UK Parliament passed the Legal Services Act (LSA), with the goal of liberalizing the market for legal services in England and Wales and encouraging more competition—in response to the governmentally commissioned ‘Clementi’ report finding the British legal market opaque, inflexible, overly complex, and insulated from innovation and competition.
Among other salient provisions, the LSA authorized the creation of ‘Alternative Business Structures,’ permitting non-lawyers to take managerial, professional, and ownership roles, and explicitly opening the door to law firms raising capital from outside investors and combining with other professional services firms—even listing publicly on a stock exchange. All this has made the UK’s £25-billion/year legal marketplace “one of the most liberalized in the world,” according to the Financial Times.
Our question for today is whether this bracing demolition of guild-like protectionist rules will stop at the English coastline—more specifically, whether it will leap the North Atlantic to the US, the single largest legal marketplace in the world by far, now just north of $250-billion (£150-billion) per year. It would be the irresistible force meeting the immovable object.
Two predictions may be made without fear of contradiction.
First is that the American Bar Association (ABA), with its 400,000 members, will resist any incursions into US lawyers’ monopoly over legal services with every weapon at their disposal short of, perhaps, violence. A core function of the ABA is promulgating the “Model Rules of Professional Conduct,” which have the force of law in 49 states. ABS’s would flatly offend Rule 5.4(a), prohibiting fee-sharing with a non-lawyer, and 5.4(d), prohibiting practicing in any organization where a non-lawyer owns an interest.
We know ABA opposition will be fierce because it happened once before. In 2000, the ABA’s governing House of Delegates entertained a proposal to amend the ethical rules to permit “multidisciplinary practices” (consider them the functional equivalent of the UK’s ABS’s). This went down to “crushing defeat” as the state bars of Illinois, New Jersey, New York, Florida, and Ohio joined in “strident” denunciation of the heresy of fee sharing and vehement “reaffirmation of the core values of the law of lawyering.”
The horrified opposition cited fears of the invasion of the profession by predatory investors prepared to sacrifice clients on the altar of profits. Adam Smith – or for that matter Peter Drucker – might be skeptical of the long-run viability of a business premised on putting its clients last, but be that as it may, I’m reminded of the remark by American Lawyer editor-in-chief Aric Press some years ago that the magazine’s creation of the notorious profits-per-partner scorecard for law firms “did not introduce the profession to greed.”
Lest you believe the world might have moved on in the intervening decade and a half, and that we have learned guilds tend to collapse of their own sclerosis by now, permit me to disabuse you of that hope. Earlier this year the state bar of Texas issued a binding opinion that law firms there may not include the terms “officer” or “principal” in the job title of non-lawyer employees. “Don’t mess with Texas,” indeed.
Finally, note that the states leading the charge here are six of the ten largest in the US, comprising nearly one-third of the country’s total population. Their opposition will not be trifling: They have ground troops.
My second prediction: A barrier which will effectively halt the flow of money and ideas at any essentially arbitrary line—such as a national border—has yet to be invented. If you doubt this, I refer you to the extended and unblemished track record of abject failure in US attempts to control or limit political campaign financing.
If globalization stands for anything, it is the accelerating movement of capital, people, and ideas across jurisdictional borders – movement which, despite hiccups and speed bumps, is becoming steadily more frictionless and irreversible. In the case of Law Land, this would mean a UK-based ABS coming to our shores (and I devoutly hope their beach-head would be little old New York – I want a front-row seat to this brawl) with a checkbook and an appetite for expansion.
The moment the announcement is made, I predict that two inter-related dynamics would begin playing themselves out.
First, managing partners of US-based firms would go through the famous stages of grief: denial, anger, bargaining, depression, and ultimately acceptance. Acceptance here could only translate into a demand for a “level playing field” for their firms. Since, then as now, they presumably will lack the votes in Parliament to repeal the LSA, that would mean adopting a functional equivalent – permitting MDP’s – here in the US. And a level playing field is, after all, a bedrock imperative of fairness. They would be making a nice argument.
Second, someone would sue. It matters not whether it be the ABS suing for permission or an aggrieved US lawyer suing for prohibition; a “real case or controversy” would be presented for adjudication. I’m not going to practice antitrust or constitutional law in these pages, but my strong intuition is that a challenge to the bar prohibitions on non-lawyer involvement would prevail on a combination of antitrust and commerce clause claims (the “commerce clause,” Article I, §8.3 of the US Constitution, prohibits unduly burdensome state interference with interstate commerce, and since at least the era of the New Deal it has been given extraordinarily wide reach).
But the outcome really shouldn’t be determined by tidy legalities. At root, it should come down to a socioeconomic and ethical choice driven by which of these views of the legal profession is on the right side of history.
Do we prefer the cozy walled precincts of the guild, righteously defending its economic rents under the cloak of claims of “the best interest of the client,” “confidentiality,” “privilege,” and so forth? Or do we prefer Schumpeter’s, or Silicon Valley’s, bracing call for “creative destruction,” as messy and fraught with failed experiments as we can be sure it will be?
I certainly know where my heart lies, and it’s with the best interests of the client truly and rightly understood. Unleash the market’s Darwinian selection process.
As Nehru was India’s longest serving prime minister, and both triumph as well as tragedy had accompanied his tenure, this is a fit occasion for a public debate on what had been attempted in the Nehru era and the extent of its success. I must per force confine myself to the economics. This, though, serves as a corrective to the tendency of political historians to mostly concentrate on the other aspects of his leadership. For instance, Sarvepalli Gopal’s noted three-volume biography bestows a single chapter on Nehru’s economic policy. However, reading through the speeches of Nehru we would find that the economy had remained his continuing pre-occupation even amidst the debates on social policy in the Lok Sabha or on de-colonisation in the United Nations. Reading these speeches is indeed advisable, as strongly held positions on the economy in the Nehru era have often been crowded in by ideological predilection when they have not been clouded over by ignorance.
The objective of economic policy in the 1950s was to raise per capita income in the country via industrialisation. The vehicle for this was the Nehru-Mahalanobis strategy, the decision to this end having been taken as early as 1938 by the National Planning Committee of the Congress constituted by Subhas Chandra Bose during his all-too-brief and ill-fated presidentship of the Party. The Committee was chaired by Nehru. The cornerstone of the strategy was to build machines as fast as possible as capital goods were seen as a basic input in all lines of production. While a formal model devised by Prasantha Chandra Mahalanobis had lent a formal status to the strategy it was the so-called ‘plan frame’ that had guided the allocation of spending. In retrospect, the allocation of investment across lines of production in the Second Five-Year Plan was quite balanced with substantial attention given also to infrastructure, the building of which, given the state of the economy then, the public sector alone would have initiated.
The Nehru-Mahalanobis strategy had attracted criticism. I discuss two of these criticisms at this stage and turn to the third at a later stage. Thus, Vakil and Brahmananda argued that the Mahalanobis model neglected wage goods, being those consumed by workers who were the majority of the country. While important per se, in practical terms, this criticism, turned out to be somewhat academic, as the plan frame – as opposed to the model – had given due importance to agriculture. In fact, the Green Revolution which is dated from the late 60s cannot entirely be divorced from the attention paid to agriculture in the Nehru era. The Grow More Food campaign and the trials in the country’s extended agricultural research network all contributed to it. Next, B.R. Shenoy had written a note of dissent to the Second Five-Year Plan document which queried the use of controls as part of the planning process. Shenoy’s is a well-known position in economic theory that the allocative efficiency of the competitive market- mechanism cannot be improved upon. While this is a useful corrective to ham-handed government intervention it was known even by the 1950s that a free market need not necessarily take the economy to the next level. The Pax Britannica had been a time of free markets, though coated with political repression, and this had not helped India much during the two centuries since Plassey. Moreover many of the extant controls were war-time controls that had not been rescinded. Investment licensing though was a central element in planning in India and Shenoy was right in identifying it as such.
As the maxim ‘the proof of the pudding lies in the eating’ must apply most closely to matters economic, the Nehru-Mahalanobis strategy can be considered only as good as its outcomes. It had aimed to raise the rate of growth of the economy. With the distance that half a century affords us and the aid of superior statistical methods we are now in the position to state that its early success was nothing short of spectacular. Depending upon your source, per capita income in India had either declined or stagnated during the period 1900-47. Over 1950-65, its growth was approximately 1.7 percent. India’s economy, which was no more than a colonial enclave for more than two centuries had been quickened. It is made out that this quickening of the economy in the fifties was no great shakes as the initial level of income was low and a given increase in it would register a higher rate of growth than at a later stage in the progression. This confounds statistical description with an economic assessment. It is a widely recognised feature of economic growth that every increase in wealth makes the next step that much easier to take due to increasing returns to scale. The principle works both ways, rendering the revival of an economy trapped at a low level of income that much more difficult. It is worth stating in the context that the acceleration of growth achieved in the nineteen fifties has not been exceeded since. Also, that India grew faster than China in the Nehru era.
So if the Nehru-Mahalanobis strategy had led to such a good start, why were the early gains not sustained? The loss of the early vitality in the economy had to do partly with political economy and partly with a flaw in the strategy itself. The death of Nehru created a crisis of leadership in the Congress Party which was transferred to the polity. It took almost a decade and a half for stability to be restored. The consequence was felt in the governance of the public sector, and public investment which had been the engine of growth since the early fifties slowed. Additionally, the private corporate sector, which contrary to conventional wisdom had flourished under Nehru, was initially repressed by Indira Gandhi. Private investment collapsed. This held back the acceleration of economic growth.
Even though we now have reason to believe that the mechanism of long-term growth that remains to this day, which is that of cumulative causation, had been ignited by the Nehru-Mahalanobis strategy, the strategy itself was incomplete. This is best understood by reference to the Asian Development Model as it had played out in the economies of east Asia. These economies had pursued more or less the same strategy as India in that the state fostered industrialization. But a glaring difference marks the Indian experience. This was the absence of a serious effort to build human capabilities via education and training. In the east this had taken the form of a spreading of schooling, vocational training and engineering education. In India on the other hand public spending on education had turned towards technical education at the tertiary level too early on. The slow spread of schooling ensured that the growth of productivity in the farm and the factory remained far too slow. Now the pace of poverty reduction also remained slow, and via positive feedback slowed the expansion of demand needed for faster growth of the economy.
It is intriguing that the issue of schooling did not figure majorly among India’s planners, especially as it was part of Gandhi’s Constructive Programme. This had not gone unnoticed even at that time. B.V. Krishnamurthi, then at Bombay University, had pointed out that the priorities of the Second Five-Year Plan undergirded by the Mahalanobis model were skewed. He castigated it for a bias toward “river-valley projects”, reflected in the paltry sums allocated to education. But it was the argument advanced by him for why spending on schooling matters that was prescient. He argued that education would enable Indians to attend to the question of their livelihood themselves without relying on the government, thus lightening the economic burden of the latter, presumably leaving it to build more capital goods in the long run as envisaged in the Mahalanobis model. But this was not to be, with enormous consequences for not only the economy but also the effectiveness of democracy in India.
While the failure to initiate a programme of building the capabilities of the overwhelming majority of our people is a moral failure of colossal proportions, we would be missing the wood for the trees if we do not recognize the economic significance of the short Nehru era in the long haul of India’s history. A moribund economy had been quickened. This would have been the pre-condition for most changes in a country with unacceptably low levels of per capita income. It is yet to be demonstrated how this could have been achieved in the absence of the economic strategy navigated through a democratic polity by Jawaharlal Nehru.
For those addicted to politics, newspapers and magazines have long provided abundant, sometimes even insightful coverage. During the last hundred years, print outlets have been supplemented by radio, then television, then 24/7 cable TV news. And with the growth of the internet, consumers of political news now have access to more analysis than ever.
One analytical tool that the politics-following public will not have access to this year is Intrade, an on-line political prediction market. Political prediction markets work very much like financial markets. Investors “buy” a futures contract on a particular candidate; if that candidate wins, the contract pays a set amount (typically $1); if the candidate loses, the contract becomes worthless. The price of candidates’ contracts vary between zero and $1, rising and falling with their political fortunes—and their probability of winning. You can see a graph of Obama and Romney contracts in the months preceding the 2012 election here.
Organized political betting markets have existed in the United States since the early days of the Republic. According to a 2003 paper by Rhode and Strumpf, during the late 19th and early 20th centuries wagering on political outcomes was common and market prices of contracts were often published in newspapers along with those of more conventional financial investments. Rhode and Strumpf note that at the Curb Exchange in New York, the total sum placed on political contracts sometimes exceeded trading in stocks and bonds.
Political betting markets became less popular around 1940. Betting on election outcomes no doubt continued to take place, but it was a much less high-profile affair.
Modern political prediction markets emerged with the establishment in 1988 of the Iowa Electronic Markets (IEM), a not-for-profit small-scale exchange run by the College of Business at the University of Iowa. The IEM was created as a teaching and research tool to both better understand how markets interpret real-world events and to study individual trading behavior in a laboratory setting. The IEM usually offers only a few contracts at any one time and investors are allowed to invest a relatively small amount of money. As of mid-October, the Iowa markets—like the polls more generally—were predicting that the Republicans will gain seats in the House and gain control of the Senate.
An important feature of political prediction markets—like financial markets—is that they are efficient at processing information: the prices generated in those markets are a distillation of the collective wisdom of market participants. A desire to harness the market’s ability to process information led to an abortive attempt by the Defense Advanced Research Projects Agency in 2003 to create the Policy Analysis Market, which would allow individuals to bet on the likelihood of political and military events—including assassinations and terrorist attacks–taking place in the Middle East. The idea was that by processing information from a variety disparate sources, monitoring the prices of various contracts would help the defense establishment identify hot-spots before they became hot. The project was hastily cancelled after Congress and the public expressed outrage that the government was planning to provide the means (and motive) to speculate on—and possibly profit from–terrorism.
Another, longer-lived—and for a time, quite popular–prediction market was Intrade.com. This Dublin-based company was established in 1999. At first, it specialized in sports betting, but soon expanded to include an extensive menu of political markets. During recent elections, Intrade operated prediction markets on the presidential election outcome at the national level, the contest for each state’s electoral votes, individual Senate races, as well as a number of other political races in the US and overseas. Thus, Intrade offered a far variety of betting options than the IEM.
Intrade was forced to close last year when the US Commodities Futures Trading Commission (CFTC) filed suit against it for illegally allowing Americans to trade options (by contract, the IEM secured written opinions in 1992 and 1993 from the CFTC that it would not take action against IEM, because of that market’s non-profit, educational nature). The CFTS’s threat to Intrade’s largest customer base very quickly led to a dramatic drop-off in visitors to the site, which subsequently closed. Alternative off-shore betting markets have entered the political markets (e.g., Betfair), but their offerings pale by comparison with those formerly offered by Intrade and are probably too small at present to spur the CFTC to action.
I regret the loss of Intrade, but not because I used their services—I didn’t. Given the federal government’s generally hostile view toward internet gambling, I felt it was prudent to abstain. Plus, having placed a two-pound wager on a Parliamentary election with a bookmaker when I lived in England many years ago convinced me that an inclination to bet with the heart, rather than the head, makes for an unsuccessful gambler.
No, I miss Intrade because it provided a nice summary of many different political campaigns. Sure, there are plenty of on-line tools today that provide a wide array of expert opinion and sophisticated polling data. Still, as an economist, I enjoyed the application of the mechanisms usually associated with financial markets to politics and observing how political news generated fluctuations in those markets. No other single source today does that for as many political races as Intrade did.
Feature image credit: Stock market board, by Katrina.Tuiliao. CC-BY-2.0 via Wikimedia Commons.
While food insecurity in America is by no means a new problem, it has been made worse by the Great Recession. And, despite the end of the Great Recession, food insecurity rates remain high. Currently, about 49 million people in the U.S. are living in food insecure households. In a recently-released article in Applied Economics Policy and Perspectives my co-authors, Elaine Waxman and Emily Engelhard, and I provide an overview of Map the Meal Gap, a tool that is used to establish food insecurity rates at the local level for Feeding America (the umbrella organization for food banks in the United States).
For 35 years, Feeding America has responded to the hunger crisis in America by providing food to people in need through a nationwide network of food banks. Today, Feeding America is the nation’s largest domestic hunger-relief organization—a powerful and efficient network of 200 food banks across the country. You can learn more about food insecurity rates in America by listening to the below podcast:
What are the state-level determinants of food insecurity? What is the distribution of food insecurity across counties in the United States? How do the county-level food insecurity estimates generated in Map the Meal Gap compare with other sources? Along with reviewing Map the Meal Gap and finding out the answers to these questions, we discuss ways that policies can and are being used to reduce food insecurity in the United States.
Headline image credit: Supermarket trolleys, by Rd. Vortex. CC-BY-2.0 via Flickr.
Organizing and organizations have largely been seen as spatial constructs. Organizing has been seen as the connecting of individuals and technologies through various mechanisms, whereas organizations have been construed as semi-stable entities circumscribed by boundaries that separate them from their external environments. The spatial view enables us to appreciate the difference between Microsoft and Apple, between Manchester United and Liverpool, between a family and a firm, and between the government of Iraq and the government of France, as they are made up of different actors, exhibit different patterns of actions, pursue different strategies, and relate to different external stakeholders.
A spatial view is a powerful one, mainly by enabling correspondence. By looking at the pattern of the way that Manchester United plays their matches during a certain period of time, the team can be distinguished from its rivals. It also enables analysis of how it plays differently from how it has played during earlier times, which again may be held up against the results of the matches. When a certain team formation appears successful, it becomes associated with the wins and ascribed the manager who implemented the formation. The manager is then seen as the person who had the ability to conceive and implement the formation, which confers particular qualities upon him. Those qualities prevail until the results begin to degrade, in which case alternative ways are found to explain the limitations of the formation, as well the manager’s abilities to make it work. In order for this way of making sense, a line of separation is drawn between the manager and the team in order to make for a correspondence that explains the variation in results over time. The overall picture becomes a mosaic numerous little pieces, neatly arranged, make up a plausible story of wins and defeats. Although the overall picture may change, the pieces remain small self-contained pieces.
When they are moved around to make another picture, the new formation is seen as different and distinct from the previous one. It is seen at a different instant, and the state in which it is seen as assumed to prevail as a sort of averaged out state for the duration of the period associated with that state. The change is the difference between the images. To see a changing thing at two different instants and making the inferences based on the differences between the instants is what the French philosopher Henry Bergson referred to as a series of immobilities. What is seen is a succession of images, where each image represents a static situation. A problem with such a view is that it is an incomplete rendering of what actually takes place, because it tells little or nothing about actual movement that takes place. As Bergson pointed out, what characterizes movement is precisely that it cannot be divided into imaginary stops, because it is indivisible. On the contrary, it leaves us with what Alfred North Whitehead called ‘simple location’. Simple location conveys an image of a process consisting of inert matter moved along in a series of mysterious jumps. We see that the mosaic has changed, but we know nothing about the process of changing it.
Yet, organizing is a vibrant process in which each instant plays a role. It is an infinitely complex world of encounters, instants and events, all taking place in time. To better understand how organizing works as a process, the very notion of time needs to be given its due attention. Unfortunately, although time and space have been seen as constituting an interwoven continuum in physics for nearly a century, in the social sciences they have been kept apart in a sort of Newtonian conception of the world. A process orientation to time, on the other hand, treats time as the very essences from which experience is made. Rather than being seen as a Newtonian inert framework against which movement is measured, time takes the role of mattering. Time matters, not just in the sense of being important, but by shaping the matter at hand, such as football players, teams, and leagues.
It is in the flow of time that organisations carve out their temporal existence. It is this ‘carving out’ that provides them with a temporal sense of where they come from and where that may be heading. The ‘carving out’ is done in a state of constant suspension between past and future, and is enacted at many instants. Streams of acts, decisions, emails, tweets, chats and many other types instants make up the temporal mosaic of the organization and contribute towards its becoming in time. Thus the formation of the football team is not a static entity, but a living process of instantiations as the match is played. In this view the formation does not make the acts, but the acts make the formation. Such a view does not deny formation as a spatial image. During a match a specific formation may be pursued. What it does, is explain the work of sustaining the formation. It explains how the formation, rather than just existing as an inert template, is given life. It confers temporal direction upon the formation and invites questions about its past and possible future, in the moment it is being played out.
Headline image credit: Stocks Reservoir, Forest of Bowland. Panoramic by MatthewSavage.Photography. CC-By-2.0 via Flickr.
Paula Yoo is a children’s book writer, television writer, and freelance violinist living in Los Angeles. Her latest book, Twenty-two Cents: Muhammad Yunus and the Village Bank, was released last month. Twenty-two Cents is about Muhammad Yunus, Nobel Peace Prize winner and founder of Grameen Bank. He founded Grameen Bank so people could borrow small amounts of money to start a job, and then pay back the bank without exorbitant interest charges. Over the next few years, Muhammad’s compassion and determination changed the lives of millions of people by loaning the equivalent of more than ten billion US dollars in micro-credit. This has also served to advocate and empower the poor, especially women, who often have limited options. In this post, we asked her to share advice on what’s she’s learned about banking, loans, and managing finances while writing Twenty-two Cents.
What are some reasons why someone might want to take out a loan? Why wouldn’t banks loan money to poor people in Bangladesh?
PAULA: People will take out a loan when they do not have enough money in their bank account to pay for a major purchase, like a car or a house. Sometimes, they will take out a loan because they need the money to help set up a business they are starting. Other times, loans are also used to help pay for major expenses, like unexpected hospital bills for a family member who is sick or big repairs on a house or car. But asking for a loan is a very complicated process because a person has to prove they can pay the loan back in a reasonable amount of time. A person’s financial history can affect whether or not they are approved for a loan. For many people who live below the poverty line, they are at a disadvantage because their financial history is very spotty. Banks may not trust them to pay the loan back on time.
In addition, most loans are given to people who are requesting a lot of money for a very expensive purchase like a house or a car. But sometimes a person only needs a small amount of money – for example, a few hundred dollars. This type of loan does not really exist because most people can afford to pay a few hundred dollars. But if you live below the poverty line, a hundred dollars can seem like a million dollars. Professor Yunus realized this when he met Sufiya Begum, a poor woman who only needed 22 cents to keep her business of making stools and mats profitable in her rural village. No bank would loan a few hundred dollars, or even 22 cents, to a woman living in a mud hut. This is what inspired Professor Yunus to come up with the concept of “microcredit” (also known as microfinancing and micro banking).
In TWENTY-TWO CENTS, microcredit is described as a loan with a low interest rate. What is a low interest rate compared to a high interest rate?
PAULA: When you borrow money from a bank, you have to pay the loan back with an interest rate. The interest rate is an additional amount of money that you now owe the bank on top of the original amount of money you borrowed. There are many complex math formulas involved with calculating what a fair and appropriate interest rate could be for a loan. The interest rate is also affected by outside factors such as inflation and unemployment. Although it would seem that a lower interest rate would be preferable to the borrower, it can be risky to the general economy. A low interest rate can create a potential “economic bubble” which could burst in the future and cause an economic “depression.” Interest rates are adjusted to make sure these problems do not happen. Which means that sometimes there are times when the interest rates are higher for borrowers than other times.
What is a loan shark?
PAULA: A loan shark is someone who offers loans to poor people at extremely high interest rates. This is also known as “predatory lending.” It can be illegal in several cases, especially when the loan shark uses blackmail or threats of violence to make sure a person pays back the loan by a certain deadline. Often people in desperate financial situations will go to a loan shark to help them out of a financial problem, only to realize later that the loan shark has made the problem worse, not better.
Did your parents explain how a bank works to you when you were a child? Or did you learn about it in school?
PAULA: I remember learning about how a bank works from elementary school and through those “Schoolhouse Rocks!” educational cartoons they would show on Saturday mornings. But overall, I would say I learned about banking as a high school student when I got my first minimum wage job at age 16 as a cashier at the Marshall’s department store. I learned how banking worked through a job and real life experience.
TWENTY-TWO CENTS is a story about economic innovation. Could you explain why Muhammad Yunus’s Grameen Bank was so innovative or revolutionary?
PAULA ANSWER: Muhammad Yunus’ theories on microcredit and microfinancing are revolutionary and innovative because they provided a practical solution on how banks can offer loans to poor people who do not have any financial security. By having women work together as a group to understand how the math behind the loan would work (along with other important concepts) and borrowing the loan as a group, Yunus’ unique idea gave banks the confidence to put their trust into these groups of women. The banks were able to loan the money with the full confidence in knowing that these women would be able to pay them back in a timely manner. The humanitarian aspect of Yunus’ economic theories were also quite revolutionary because it gave these poverty-stricken women a newfound sense of self-confidence. His theories worked to help break the cycle of poverty for these women as they were able to save money and finally become self-sufficient. The Nobel Committee praised Yunus’ microcredit theories for being one of the first steps towards eradicating poverty, stating, “Lasting peace cannot be achieved unless large population groups find ways in which to break out of poverty.”
Twenty-two Cents: Muhammad Yunus and the Village Bank is a biography of 2006 Nobel Peace Prize winner Muhammad Yunus, who founded Grameen Bank and revolutionized global antipoverty efforts by developing the innovative economic concept of micro-lending.
The business press and general media often lament that firm executives are exhibiting “short-termism”, succumbing to the pressure by stock market investors to maximize quarterly earnings while sacrificing long-term investments and innovation. In our new article in the Socio-Economic Review, we suggest that this complaint is partly accurate, but partly not.
What seems accurate is that the maximization of short-term earnings by firms and their executives has become somewhat more prevalent in recent years, and that some of the roots of this phenomenon lead to stock market investors. What is inaccurate, though, is the assumption that investors – even if they were “short-term traders” – would inherently attend to short-term quarterly earnings when making trading decisions. Namely, even “short-term trading” (i.e. buying stocks with the aim to sell them after few minutes, days, or months) does not equal or necessitate “short-term earnings focus”, i.e., making trading decisions based on short-term earnings (let alone based on short-term earnings only). This means that in case the media observes – or executives perceive – that firms are pressured by stock market investors to focus on short-term earnings, such a pressure is illusionary, in part.
The illusion, in turn, is based on the phenomenon of “vociferous minority”: a minority of stock investors may be focusing on short-term earnings, causing some weak correlation between short-term earnings and stock price jumps / drops. But the illusion is born when this gets interpreted as if most or all investors (i.e., the majority) would be focusing on short-term earnings only. Alas, such an interpretation may, in the dynamic markets, lead to a self-fulfilling prophecy – whereby an increasing number of investors join the vociferous minority and focus increasingly on short-term earnings (even if still not the majority of investors would focus on short-term earnings only). And more importantly – or more unfortunately – firm executives may start to increasingly maximize short-term earnings, too, due to the (inaccurate) illusion that the majority of investors would prefer that.
A final paradox is the role of the media. Of course, the media have good intentions in lamenting about short-termism in the markets, trying to draw attention to an unsatisfactory state of affairs. However, such lamenting stories may actually contribute to the emergence of the self-fulfilling prophecy. Namely, despite the lamenting tone of the media articles, they are in any case emphasizing that the market participants are focusing just on short-term earnings. This contributes to the illusion that all investors are focusing on short-term earnings only – which in turn may lead a bigger majority of investors and firms to actually join the minority’s bandwagon, in the illusion that everyone else is doing that too.
Should the media do something different, then? Well, we suggest that in this case, the media should report more on “positive stories”, or cases whereby firms have managed to create great innovations with a patient, longer-term focus. The media could also report on an increasing number of investors looking at alternative, long-term measures (such as patents or innovation rates) instead of short-term earnings.
So, more stories like this one about Rolls-Royce – however, without claiming or lamenting that most investors are just wanting “quick results” (i.e., without portraying cases like Rolls-Royce just as rare exceptions). Such positive stories could, in the best scenario, contribute to a reverse, self-fulfilling prophecy – whereby more and more investors, and thereafter firm executives, would replace some of the excessive focus on short-term earnings that they might currently have.
Political economy is back on the centre stage of development studies. The ultimate test of its respectability is that the World Bank has realised that it is not possible to separate social and political issues such as corruption and democracy from other factors that influence the effectiveness of its investments, and started using the concept.
It predates the creation of “economics” as a discipline. Adam Smith, David Ricardo, Thomas Malthus, James Mill, and a generation later Karl Marx and Friederich Engels, explored how groups or classes in society exploited each other or were exploited, and used their conclusions to create theories of change or growth.
Marx’s ideas were taken up in the 1950s by economists and sociologists of the left, such as Paul Baran (The Political Economy of Growth, 1957) and later Samir Amin (The Political Economy of the Twentieth Century, 2000) who linked it to theories of imperialism and neo-colonialism to interpret what was happening in newly independent African countries where nationalist political parties had taken power.
Marx and Engels in their early writings, and Marxist orthodoxy subsequently, espoused determinist theories in which development went through pre-determined stages – primitive forms of social organisation, feudalism, capitalism, and then socialism. But in their later writings Marx and Engels were much more open, and recognised that some pre-capitalist formations could survive, and that there was no single road to socialism. Class analysis, and exploration of the economic interests of powerful classes, and their uses of the technologies available to them, could inform a study of history, but not substitute for it.
That was how I interpreted what happened in Tanzania in the 1970s. The country was built around the economic interests of those involved, and the mistakes made, both inside Tanzania but also outside. It focussed on the choices made by those who controlled the Tanzanian state or negotiated “foreign aid” deals with Western governments—Issa Shivji’s bureaucratic bourgeoisie. These themes are still current today.
I am not alone. Michael Lofchie’s (A Political Economy of Tanzania, 2014) focuses on the difficult years of structural adjustment in the 1980s and 1990s). He argues how the salaried elite could personally benefit from an overvalued exchange rate. From 1979 on, under the influence of the charismatic President Julius Nyerere, Tanzania resisted the IMF and World Bank which urged it to devalue. But eventually, around the mid-1980s, they realised that they had the possibility of making even bigger financial gains if the country devalued and there were open markets, which would allow them to make money from trade or production. They were becoming a productive bourgeoisie.
Lofchie’s analysis can be contested. The benefits of the chaos that resulted from the extremely over-valued exchange rates of the 1980s were reaped by only a few. It is true that rapid growth followed from around 1990 to the present, but that is also due to the high price of gold on international markets and the rapid expansion of gold mining and tourism. There is still plenty of evidence of individuals making money illegitimately – corruption is ever present in the political discourse, and will continue to be so up till the Presidential elections due in October 2015.
A challenge for the ruling class in Tanzania, leaving the 1970’s, was would they be able to convert their economic strategies into meaningful growth and benefits for the population? By 2011 the challenge was even more acute, because very large reserves of gas had been discovered off the coast of Southern Tanzania, so money for investment would no longer be a binding constraint. But would those resources be used to create real assets which would create the prerequisites for rapid expansions in manufacturing, services and especially agriculture? Or would they be frittered away through imports of non-productive machinery and infrastructure (such as the non-existent electricity generators purchased through the Richmond Project in 2006 in which several leading members of the ruling political party were implicated)? Or end up in Swiss bank accounts? The jury is very much still out. To achieve the current ambition of a rapid transition to a middle income country will require much greater understanding of engineering, agricultural science, and much better contracts than have been recently achieved – and more proactive responses to the challenges of corruption. It will need to take its own political economy seriously.
Headline image credit: Tanzania – Mikumi by Marc Veraart. CC-BY-2.0 via Flickr.
It is well known that obesity rates have been increasing around the Western world.
The American obesity prevalence was less than 20% in 1994. By 2010, the obesity prevalence was greater than 20% in all states and 12 states had an obesity prevalence of 30%. For American children aged 2 – 19, approximately 17% are obese in 2011-2012. In the UK, the rifeness of obesity was similar to the US numbers. Between 1993 and 2012, the commonness of obesity increased from 13.2% to 24.4% for men and for women from 16.4% to 25.1%. The obesity prevalence is around 18% for children aged 11-15 and 11% for children aged 2-10.
Policy makers, researchers, and the general public are concerned about this trend because obesity is linked to an increase likelihood of health conditions such as diabetes and heart disease, among others. The increase in the obesity prevalence among children is of concern because of the possibility that obesity during childhood will increase the likelihood of being obese as an adult thereby leading to even higher rates of these health conditions in the future.
Researchers have investigated many possible causes for this trend including lower rates of participation in physical activity and easier access to fast food. Anderson, Butcher, and Levine (2003) identified maternal employment as a possible culprit when they noticed that in the US the timing of these two trends was similar. While the prevalence of obesity was increasing for children so was the employment rate of mothers. Other researchers have found similar results for other countries – more hours of maternal employment is related to a higher likelihood of children being obese.
What could be the relationship between a mother’s hours of work and childhood obesity? When mothers work they have less time to devote to activities around the home, which may mean less concern about nutrition, more meals eaten outside of the home or less time devoted to physical activities. On the other hand, more maternal employment could mean more income and an ability to purchase more nutritious food or encourage healthy activities for children.
We looked at this relationship for Canadian children 12-17 years old – an older group of children than studied in earlier papers. For youths aged 12 to 17 in Canada, the obesity prevalence was 7.8% in 2008. We analysed not only at the relationship between maternal employment and child obesity, but also the possible reasons that maternal employment may affect child obesity.
We find that the effect of hours of work differs from the effect of weeks of work. More hours of maternal work are related to activities we expect to be related to higher rates of obesity – more television viewing, less likely to eat breakfast daily, and a higher allowance. On the other hand, more weeks of maternal employment are related to behaviour expected to lower obesity – less television viewing and more physical activity. This difference between hours and weeks of work raises some interesting questions. How do families adapt to different aspects of the labour market? When mothers work for more weeks does this indicate a more regular attachment to the labour force? Do these families have schedules and routines that allow them to manage their child’s weight?
Unlike other studies that focus on younger children, we do not find a relationship between maternal employment and likelihood of obesity for adolescents. Does the impact of maternal employment at younger ages not last into adolescence? Is adolescence a stage during which obesity status is difficult to predict?
The debate over appropriate policy remedies should not focus on whether mothers should work, but rather should focus on what children are doing when mothers are working. What can be done to reduce the obesity prevalence in adolescents? Some ideas include working with the education system and local communities to create an environment for adolescents that fosters healthy weight status, supporting families with quality childcare, provision of viable and high-quality alternative activities, or flexible work hours. Programs or policies that help families establish a healthy routine are important. It may not be a case of simply providing activities for adolescents, but that these activities are easy for families to attend on a regular basis.
I havewrittenabout the dangers of making economic policy on the basis of ideology rather than cold, hard economic analysis. Ideologically-based economic policy has laid the groundwork for many of the worst economic disasters of the last 200 years.
The decision to abandon the first and second central banks in the United States in the early 19th century led to chronic financial instability for much of the next three quarters of a century.
Britain’s re-establishment of the gold standard in 1925, which encouraged other countries to do likewise, contributed to the spread and intensification of the Great Depression.
Europe’s decision to adopt the euro, despite the fact that economic theory and history suggested that it was a mistake, contributed to the European sovereign debt crisis.
President George W. Bush’s decision to cut taxes three times during his first term while embarking on substantial spending connected to the wars in Afghanistan and Iraq, was an important driver of the macroeconomic boom-bust cycle that led to the subprime crisis.
In each of these four cases, a policy was adopted for primarily ideological, rather than economic reasons. In each case, prominent thinkers and policy makers argued forcefully against adoption, but were ignored. In each case, the consequences of the policy were severe.
So how do we avoid excessively ideological economic policy?
One way is by making sure that policy-makers are exposed to a wide range of opinions during their deliberations. This method has been taken on board by a number central banks, where many important officials are either foreign-born or have considerable policy experience outside of their home institution and/or country. Mark Carney, a Canadian who formerly ran that that country’s central bank, is not the first non-British governor of the Bank of England in its 320-year history. Stanley Fischer, who was born in southern Africa and has been governor of the Bank of Israel, is now the vice chairman of the US Federal Reserve. The widely respected governor of the Central Bank of Ireland, Patrick Honohan, spent nearly a decade at the World Bank in Washington, DC. One of Honohan’s deputies is a Swede with experience at the Hong Kong Monetary Authority; the other is a Frenchman.
But isn’t it unreasonable to expect politicians to come to the policy making process without any ideological bent whatsoever? After all, don’t citizens deserve to see a grand contest of ideas between those who propose higher taxes and greater public spending with those who argue for less of both?
In fact, we do expect—and want–our politicians to come to the table with differing views. Nonetheless, politicians often support their arguments with unfounded assertions that their policies will lead to widespread prosperity, while those of their adversaries will lead to doom. The public needs to be able to subject those competing claims to cold, hard economic analysis.
Fortunately, the United States and a growing number of other countries have established institutions that are mandated to provide high quality, professional, non-partisan economic analysis. Typically, these institutions are tasked with forecasting the budgetary effects of legislation, making it difficult for one side or the other to tout the economic benefits of their favorite policies without subjecting them to a reality check by a disinterested party.
In the United States, this job is undertaken by the Congressional Budget Office (CBO) which offers well-regarded forecasts of the budgetary effects of legislation under consideration by Congress. [Disclaimer: The current director of the CBO is a graduate school classmate of mine.]
The CBO is not always the most popular agency in Washington. When the CBO calculates that that the cost of a congressman’s pet project is excessive, that congressman can be counted on to take the agency to task in the most public manner possible.
According to the New York Times, the CBO’s “…analyses of the Clinton-era legislation were so unpopular among Democrats that [then-CBO Director Robert Reischauer] was referred to as the ‘skunk at the garden party.’ It has since become a budget office tradition for the new director to be presented with a stuffed toy skunk.”
For the most part, however, congressional leaders from both sides of the aisle hold the CBO and its work in high regard, as do observers of the economic scene from the government, academia, journalism, and the private sector.
These organizations each have their own institutional history and slightly different responsibilities. For the most part, however, they are constituted to be non-partisan, independent agencies of the legislative branch of government. We should be grateful for their existence.
Congrats (!) to House of Debt authors Atif Mian and Amir Sufi for making the shortlist for the Financial Times and McKinsey Business Book of the Year. Now in competition with five other titles from an initial offering of 300 nominations, House of Debt—and its story of the predatory lending practices behind the Great American Recession, the burden of consumer debt on fragile markets, and the need for government-bailed banks to share risk-taking rather than skirt blame—will find out its fate at the November 11th award ceremony.
From the official announcement:
“The provocative questions raised by this year’s titles have been addressed with originality, depth of research and lively writing.”
The award, now in its 10th edition, aims to find the book that provides “the most compelling and enjoyable insight into modern business issues, including management, finance and economics.” The judges—who include former winners Mohamed El-Erian and Steve Coll—also gave preference this year to books “whose influence is most likely to stand the test of time.”
To read more about House of Debt, including a list of reviews and a link to the authors’ blog, click here.
Long-run trends suggest a broad shift is taking place in the institutional financing structure that supports academic research. According to data compiled by the OECD reported in Figure 1, industry sources are financing a growing share of academic research while “core” public funding is generally shrinking. This ongoing shift from public to private sponsorship is a cause for concern because these sponsorship relationships are fundamentally different. Available evidence suggests that industry financing does not simply replace dwindling public money, but imposes additional restrictions on academic researchers. In particular, industry sponsors frequently limit disclosure of research findings, methods, or materials by delaying or banning public release.
Recent economic research highlights why public disclosure of academic research is important. Disclosure permits the stock of public knowledge to be cumulative, accessible, and reliable. It limits duplication of research efforts, allows new knowledge to be replicated and verified by professional peers, and permits access and use by other researchers which enhances opportunities for complementary research. Some work finds that greater access to ideas and materials in academic research not only increased incentives for direct follow-on research, but led to an increase in the diversity of research by increasing the number of experimental research lines. Other work, examining the theoretical conditions supporting “open science” versus “secrecy”, stressed that maintaining and growing the stock of public knowledge requires a limit on the private financial returns obtained through secrecy.
To better understand the potential implications of increased industry funding, we implemented a research project that examined the relationship between industry sponsorship and restrictions on publication disclosure using individual-level data on German academic researchers. Germany is an apt setting for examining this relationship. It has a strong tradition of public financial support for academic research and, according to the OECD, Germany experienced the most dramatic growth in its share of industry sponsorship, an 11.3 percentage point increase from 1995 to 2010 (see Figure 1).
German academic researchers were surveyed about the degree of publication disclosure restrictions experienced during research projects sponsored by government, foundations, industry, and other sources. To examine if industry sponsorship jeopardizes disclosure of academic research, we modeled the degree of restrictiveness (i.e. delay and secrecy) as a function of the researcher’s budget share financed by industry. This formulation allows us to examine two potential effects of industry sponsored research contracts. The first is an adoption effect that takes place when academic researchers commit to industry funding. The second is an intensity effect that captures how publication restrictions depend on the researcher’s exposure to greater ex post review and evaluation by industry sponsors. Our models include covariates that control for non-industry extramural sponsorship, personal characteristics, research characteristics, institutional affiliations, and scientific fields of study.
Both the descriptive and regression results show a positive relationship between the degree of publication restrictions and industry sponsorship. The percentage of respondents who reported higher secrecy (partial or full) is significantly larger for industry sponsored researchers than it is for researchers with other extramural sponsors, 41% and 7% respectively. Controlling for selection, adopting industry sponsorship more than doubles the expected probabilities of publication delay and secrecy. The intensity effect is positive and significant with a larger effect on publication secrecy than on publication delay when academic researchers become heavily supported by industrial firms. These results are robust to the possibility that researchers self-select into extramural sponsorship and to the possibility that the share of industry sponsorship is endogenous due to unobserved variables.
Based on our analysis, the shift from public to private sponsorship seen in the OECD aggregate data reflects changes in the microeconomic environment shaping incentives for disclosure by academic researchers. On average, academic researchers are willing to restrict disclosure in exchange for financial support by industry sponsors. Our results shed light on an important challenge facing policymakers. Understanding the trade-off between public and private sponsorship of academic research involves gauging the impact of disclosure restrictions on the quantity, quality, and evolution of academic research to better understand how these restrictions may ultimately influence innovation and economic growth.
On September 18, Scots will go to the polls to vote on the question “Should Scotland be an independent country?” A “yes” vote would end the political union between England and Scotland that was enacted in 1707.
The main economic reasons for independence, according to the “Yes Scotland” campaign, is that an independent Scotland would have more affordable daycare, free university tuition, more generous retirement and health benefits, less burdensome regulation, and a more sensible tax system.
As a citizen of a former British colony, it is tempting to compare the situation in Scotland with those of British colonies and protectorates that gained their independence, such as the United States, India/Pakistan, and a variety of smaller countries in Africa, Asia, and the Americas, although such a comparison is unwarranted.
Historically, independence movements have been motivated by absence of representation in the institutions of government, discrimination against the local population, and economic grievances. These arguments do not hold in the Scottish case.
Scotland is an integral part of the United Kingdom. It is represented in the British Parliament in Westminster, where it holds 9% of the seats—fair representation, considering that Scotland’s population is a bit less than 8.5% of total UK population.
Scots do not seem to have been systematically discriminated against. At least eight prime ministers since 1900, including recent ex-PMs Tony Blair and Gordon Brown, were either born in Scotland or had significant Scottish connections.
Scotland is about as prosperous as the rest of the UK, with output per capita greater than those of Wales, Northern Ireland, and England outside of London (see figure).
Because the referendum asks only whether Scotland should become independent and contains no further details on how the break-up with the UK would be managed, it is important to consider some key economic issues that will need to be tackled should Scotland declare its independence.
Since Scotland already has a parliament that makes many spending and taxing decisions, we know something about Scottish fiscal policy. According to the World Bank figures, excluding oil (a resource that is expected to decline in importance in coming decades), Scotland’s budget deficit as a share of gross domestic product already exceeds those of fiscally troubled neighbors Greece, Spain, Ireland, Portugal, and Italy. Given the “Yes” campaign’s promise to make Scotland’s welfare system even more generous, the fiscal sustainability of an independent Scotland’s is unclear.
As in any divorce, the parties would need to divide their assets and liabilities.
The largest component of UK liabilities are represented by the British national debt, recently calculated at around £1.4 trillion ($2.4 trillion), or about 90 percent of UK GDP. What share of this would an independent Scotland “acquire” in the break-up?
Assets would also have to be divided. One of the greatest assets—North Sea oil—may be more straightforward to divide given that the legislation establishing the Scottish Parliament also established a maritime boundary between England and Scotland, although this may be subject to negotiation. But what about infrastructure in England funded by Scottish taxes and Scottish infrastructure paid for with English taxes?
An even more contentious item is the currency that would be used by an independent Scotland. The pro-independence camp insists that an independent Scotland would remain in a monetary union with the rest of the UK and continue to use the British pound. And, in fact, there is no reason why an independent Scotland could not declare the UK pound legal tender. Or the euro. Or the US dollar, for that matter.
The problem is that the “owner” of the pound, the Bank of England, would be under no obligation to undertake monetary policy actions to benefit Scotland. If a sluggish Scottish economy is in need of loose monetary policy while the rest of the UK is more concerned about inflation, the Bank of England would no doubt carry out policy aimed at the best interests of the UK—not Scotland.
If a Scottish financial institution was on the point of failure, would the Bank of England feel duty-bound to lend pounds? As lender of last resort in England, the Bank has an obligation to supervise—and assist, via the extension of credit—troubled English financial institutions. It seems unlikely that an independent Scotland would allow its financial institutions to be supervised and regulated by a foreign power—nor would that power be morally or legally required to extend the UK financial safety net to Scotland.
At the time of this writing (the second half of August), the smart money (and they do bet on these things in Britain) is on Scotland saying no to independence, although poll results released on August 18 found a surge in pro-independence sentiment. Whatever the polls indicate, no one is taking any chances. Several Scottish-based financial companies are establishing themselves as corporations in England so that, in the case of independence they will not be at a foreigner’s disadvantage vis-à-vis their English clients. Given the economic uncertainty generated by the vote, the sooner September 18 comes, the better for both Scotland and the UK.
Headline image credit: Scottish Parliament building, by Jamieli. Public domain via Wikimedia Commons.
Quite abruptly income inequality has returned to the political agenda as a prominent societal issue. At least part of this can be attributed to Piketty’s provoking premise of rising concentration at the top end of the income and wealth distribution in Capital in the Twenty-First Century (2014), providing some academic ground for the ‘We are the 99 percent’ Occupy movement slogan. Yet, this revitalisation of inequality is based on broader concerns than the concentration at the very top alone. There is growing evidence that earnings in the bottom and the middle of the distribution have hardly risen, if at all, during the last 20 years or so. Incomes are becoming more dispersed not only at the top, but also more generally within developed countries.
We should distinguish between increasing concentration at the top and the rise of inequality across the entire population. Even though both developments might take place simultaneously, the causes, consequences, and possible policy responses differ.
The most widely accepted explanation for rising inequality across the entire population is so-called skill-biased technological change. Current technological developments are particularly suited for replacing routine jobs, which disproportionally lie in the middle of the income distribution. In addition, low- and middle-skilled manufacturing jobs are gradually being outsourced to low-wage countries (see for instance Autor et al., 2013). Decreasing influence of trade unions and more decentralised levels of wage coordination are also likely to play a role in creating more dispersed earnings patterns.
Increased globalisation or technological change are not likely to be main drivers of rising top income shares, though the larger size of markets allows for higher rewards at the top. Since the rise of top income shares was especially an Anglo-Saxon phenomenon, and as the majority of the top 1 per cent in these countries comes from the financial sector, executive compensation practices play a role. Marginal top tax cuts implemented in these countries and inherited wealth are potentially important as well.
So should we care about these larger income differences? At the end of the day this remains a normative question. Yet, whether higher levels of inequality have negative effects on the size of our total wealth is a more technical issue, albeit not a less contested one in political economy. Again, we should differentiate between effects of increasing concentration at the top and the broader higher levels of inequality. To start with the latter, higher dispersion could incite people to put forth additional effort, as the rewards will be higher as well. Yet, when inequality of income disequalises opportunities, there will be an economic cost as Krugman also argues. Investment in human capital for instance will be lower as Standard & Poor’s notes for the US.
High top income shares do not lead to suboptimal human capital investment, but will disrupt growth if the rich use their wealth for rent-seeking activities. Stiglitz and Hacker and Pierson in Winner-Take All Politics (2010) argue that this indeed takes place in the US. On the other hand, a concentration of wealth could facilitate large and risky investments with positive externalities.
If large income differences indeed come at the price of lower total economic output, then the solution seems simple: redistribute income from the rich to the poor. Yet, both means-tested transfers and progressive taxes based on economic outcomes such as income will negatively affect economic growth as they lower the incentives to gain additional wealth. It might thus be that ‘the cure is worse than the disease’, as the IMF phrases this dilemma. Nevertheless, there can be benefits of redistribution in addition to lessening any negative effects of inequality on growth. The provision of public insurance could have stimulating effects by allowing individuals to take risks to generate income.
How to leave from here? First of all, examining whether inequality or redistribution affects growth requires data that makes a clean distinction between inequality before and after redistribution across countries over time. There are interesting academic endeavours trying to decompose inequality into a part resulting from differences in effort and a part due to fixed circumstances, such as gender, race, or educational level of parents. This can help our understanding which ‘types’ of inequality negatively affect growth and which might boost it. Moreover, redistribution itself can be achieved through multiple means, some of which, such as higher heritage taxes, are likely to be more pro-growth than others, such as higher income tax rates.
All things considered, whether inequality or redistribution hampers growth is too broad of a question. Inequality at which part of the distribution, due to what economic factors, and how the state intervenes all matter a great deal for total growth.
Innovation is a primary driver of economic growth and of the rise in living standards, and a substantial body of research has been devoted to documenting the welfare benefits from it (an example being Trajtenberg’s 1989 study). Few areas have experienced more rapid innovation than the Personal Computers (PC) industry, with much of this progress being associated with a particular component, the Central Processing Unit (CPU). The past few decades had seen a consistent process of CPU innovation, in line with Moore’s Law: the observation that the number of transistors on an integrated circuit doubles every 18-24 months (see figure below). This remarkable innovation process has clearly benefitted society in many, profound ways.
A notable feature of this innovation process is that a new PC is often considered “obsolete” within a very short period of time, leading to the rapid elimination of non-frontier products from the shelf. This happens despite the heterogeneity of PC consumers: while some (e.g., engineers or gamers) have a high willingness-to-pay for cutting edge PCs, many consumers perform only basic computing tasks, such as word processing and Web browsing, that require modest computing power. A PC that used to be on the shelf, say, three years ago, would still adequately perform such basic tasks today. The fact that such PCs are no longer available (except via a secondary market for used PCs which remains largely undeveloped) raises a natural question: is there something inefficient about the massive elimination of products that can still meet the needs of large masses of consumers?
Consider, for example, a consumer whose currently-owned, four-year old laptop PC must be replaced since it was severely damaged. Suppose that this consumer has modest computing-power needs, and would have been perfectly happy to keep using the old laptop, had it remained functional. This consumer cannot purchase the old model since it has long vanished from the shelf. Instead, she must purchase a new laptop model, and pay for much more computing power than she actually needs. Could it be, then, that some consumers are actually hurt by innovation?
A natural response to this concern might be that the elimination of older PC models from the shelves likely indicates that demand for them is low. After all, if we believe in markets, we may think that high levels of demand for something would provide ample incentives for firms to offer it. This intuition, however, is problematic: as shown in seminal theoretical work by Nobel Prize laureate Michael Spence, the set of products offered in an oligopoly equilibrium need not be efficient due to the misalignment of private and social incentives. The possibility that yesterday’s PCs vanish from the shelf “too fast” cannot, therefore, be ruled out by economic theory alone, motivating empirical research.
A recent article addresses this question by applying a retrospective analysis of the U.S. Home Personal Computer market during the years 2001-2004. Data analysis is used to explore the nature of consumers’ demand for PCs, and firms’ incentives to offer different types of products. Product obsolescence is found to be a real issue: the average household’s willingness-to-pay for a given PC model is estimated to drop by 257 $US as the model ages by one year. Nonetheless, substantial heterogeneity is detected: some consumers’ valuation of a PC drops at a much faster rate, while from the perspective of other consumers, PCs becomes “obsolete” at a much lower pace.
The paper focuses on a leading innovation: Intel’s introduction of its Pentium M® chip, widely considered as a landmark in mobile computing. This innovation is found to have crowded out laptops based on older Intel technologies, such as the Pentium III® and Pentium 4®. It is also found to have made a substantial contribution to the aggregate consumer surplus, boosting it by 3.2%- 6.3%.
These substantial aggregatebenefits were, however, far from being uniform across different consumer types: the bulk of the benefits were enjoyed by the 20% least price-sensitive households, while the benefits to the remaining 80% were small and sometimes negligible. The analysis also shows that the benefits from innovation could have “trickled down” to the masses of price-sensitive households, had the older laptop models been allowed to remain on the shelf, alongside the cutting-edge ones. This would have happened since the presence of the new models would have exerted a downward pressure on the prices of older models. In the market equilibrium, this channel is shut down, since the older laptops promptly disappear.
Importantly, while the analysis shows that some consumers benefit from innovation much more than others, no consumers were found to be actually hurt by it. Moreover, the elimination of the older laptops was not found to be inefficient: the social benefits from keeping such laptops on the shelf would have been largely offset by fixed supplier costs.
So what do we make of this analysis? The main takeaway is that one has to go beyond aggregate benefits and consider the heterogeneous effects of innovation on different consumer types, and the possibility that rapid elimination of basic configurations prevents the benefits from trickling down to price-sensitive consumers. Just the same, the paper’s analysis is constrained by its focus on short-run benefits. In particular, it misses certain long-term benefits from innovation, such as complementary innovations in software that are likely to trickle down to all consumer types. Additional research is, therefore, needed in order to fully appreciate the dramatic contribution of innovation in personal computing to economic growth and welfare.
China has all but overtaken the United States based on GDP at newly-computed purchasing power parity (PPP) exchange rates, twenty years after Paul Krugman predicted: “Although China is still a very poor country, its population is so huge that it will become a major economic power if it achieves even a fraction of Western productivity levels.” But will it eclipse the United States, as Arvind Subramanian has claimed, with the yuan eventually vying with the dollar for international reserve currency status?
Not unless China battles three economic foes. One is well-known: diminishing marginal returns to capital. Two others have received less attention. The first is Carlos Diaz-Alejandro. Not the man, but the results uncovered by his research on the Southern Cone following the opening up of its capital account that culminated in a sovereign debt crisis and contributed to Latin America’s lost 1980s. If the capital account is liberalized before the domestic financial system is ready, the country sets itself up for a fall: goodbye financial repression, hello financial crash. The second is the “reality of transition”: rejuvenating growth requires hard budgets and competition to improve resource allocation and stimulate innovation, counterbalanced with a more competitive real exchange rate. This is the principal insight from the transition in Central and Eastern Europe (CEE), which was far simpler than anything China faces.
China was able to raise total factor productivity (TFP) growth as an offset to diminishing marginal returns to capital, especially after joining the World Trade Organization (WTO) in 2001, and faster growth was accompanied by a rising savings rate. But TFP growth is hard to sustain. Any developing country targeting growth above the steady state level given by the sum of human capital growth, TFP growth and population growth (the latter two falling rapidly in China) will find that its investment rates need to continually increase unless it can rejuvenate TFP growth. China’s investment rates have risen from around 42% of GDP over 2005-7 (prior to the global crisis) to 48% in recent years even as growth has dropped from the 12% to the 7.5% range. Savings rates have hovered around 50%, reducing current account surpluses (numbers drawn from IMF 2010 and 2014 Article IV reports).
This configuration has forced China to choose between either investing even more, or lowering growth targets. It has chosen the latter, with its leaders espousing anti-corruption, deleveraging, environmental improvement and structural reform to achieve higher quality growth. The central bank, People’s Bank of China (PBoC), has reaffirmed its goal of internationalizing the yuan and liberalizing the capital account.
China’s proposed antidote is to “rebalance” from investment and exports to domestic consumption. But growth arithmetic would require consumption to grow at unrealistic rates, given the relative shares of investment and private consumption in GDP, even to meet scaled-down growth targets. Besides, households need better social benefits and market interest rates on bank deposits to save less and consume more. Hukou reform alone, or placing social benefits received by rural migrants on a par with their urban counterparts, could easily cost 3% of GDP a year for the next seven years as some 150 million additional people gain access to such benefits—quite apart from the public investment needed to upgrade urban infrastructure, according to calculations shared by Xinxin Li of the Observatory Group. And the failure to liberalize bank deposit rates has led to the rise of “wealth management products” in the shadow banking system. These “WMPs” offer higher returns but are poorly regulated and more risky.
Indeed, total social financing, a broad measure of credit, has soared from 125% to 200% of GDP over the five years 2009-2013 (Figure 2 in the July 2014 IMF Article IV report, with Box 5 warning that such a rapid trajectory usually ends in tears). Local government debt was estimated at 32% of GDP in mid-2013, much of it short-term and used to fund infrastructure projects and social housing with long paybacks. Housing prices show the signs of a bubble, especially away from the four major cities. Corporate credit is 115% of GDP, about half of it collateralized by land or property. While the focus recently has been on risks from shadow banking, it is hard to separate the shadow from the core. Besides, WMPs have become intertwined with the booming real estate market, a major engine of growth yet the centre of a “web of vulnerabilities” (to quote the IMF) encompassing banks, shadow banks, and local government finances. A real estate shock would ripple through the system, lowering growth and forcing bailouts. The gross cost of the bank workout at the end of the 1990s was 15% of GDP in a much simpler world!
2014 began with fears of a hard landing and an impending default by a bankrupt coal mine on a $500 million WMP-funded loan intermediated by a mega-bank. The government eventually intervened rather than let investors take a hit and risk a confidence crisis. And starting in April, stimulus packages were launched to meet the 7.5% growth target, a tacit admission that rebalancing is not working. But concerns persist around real estate. Besides, stimulus will help only temporarily and China is likely to be facing the same questions about growth and financial vulnerability by the end of the year.
With rebalancing infeasible, and investing even more prohibitively costly, virtually the only remaining option is to spur total factor productivity growth: China is still far from the global technological frontier. This calls for a package that cleans up the financial sector and implements hard budgets and genuine competition, especially for the state-owned enterprises (SOEs), while keeping real exchange rates competitive. The real appreciation of the past few years may have been offset by rising productivity, but continued appreciation will make it harder for the domestic economy to restructure and create 12 million jobs a year to absorb new graduates and displaced SOE workers.
In sum, China must heed Diaz-Alejandro. No one knows what the non-performing loans ratio is in China and few believe the official rate of 1%. If the cornerstone of a financial system is confidence and transparency, China is severely deficient. This must first be fixed and market-determined interest rates adopted before entertaining hopes of internationalizing the currency. China must also accept the reality of transition; the formidable remaining agenda in the fiscal, financial, social, and SOE sectors reminds us that China is still in transition to a full-fledged market economy.
The combination of a financial clean up and the policy trio of hard budgets, competition, and a competitive real exchange rate will improve resource allocation and force innovation, boosting total factor productivity growth. But doing this is hard—that’s the essence of the “middle-income trap”. Huge vested interests will be encountered, evoking Raghuram Rajan’s description of the middle-income trap as one “where crony capitalism creates oligarchies that slow down growth”. Dealing with this agenda is the Chinese leadership’s biggest challenge.
The era of cheap China is ending, while the ability of the government to virtually decree the growth rate has fallen victim to diminishing returns to capital. Diaz-Alejandro and the reality of transition are no less important as China seeks a way forward.
Headline image credit: The Great Wall in fall, by Canary Wu. CC-BY-SA-2.0 via Wikimedia Commons.
A landmark achievement by Naomi Klein, This Changes Everything is essential reading on the ways climate change creates opportunities for us to reexamine our entire free market system — and will hopefully provoke us into lasting, significant action. Books mentioned in this post This Changes Everything: Capitalism... Naomi Klein Sale Hardcover $21.00
Dystopias are trending in contemporary popular culture. Novels and movies abound that deal with fictional societies within which humans, individually and collectively, have to cope with repressive, technologically powerful states that do not usually care for the well-being or safety of their citizens, but instead focus on their control and extortion. The latest resounding dystopian success is The Hunger Games—a box-office hit located in a nation known as Panem, which consists of 12 poor districts, starved for resources, under the absolute control of a wealthy centre called the Capitol. In the story, competitive struggle is carried to its brutal extreme, as poor young adults in a reality TV show must fight to death in an outdoor arena controlled by an authoritarian Gamemaker, until only one individual remains. The poverty and starvation, combined with terror, create an atmosphere of fear and helplessness that pre-empts any resistance based on hope for a better world.
We fear that part of the popularity of this science fiction action-drama, in Europe at least, lies in the fact that it has a real-life analogue: the Spectacle—in Debord’s (1967) meaning of the term—of the current ‘competitiveness game’ in which the Eurozone economies are fighting for their survival. Its Gamemaker is the European Central Bank (ECB), which—completely stuck to Berlin’s hard line that fiscal profligacy in combination with rigid, over-regulated labour markets has created a deep crisis of labour cost competitiveness—has been keeping the pressure on Eurozone countries so as to let them pay for their alleged fiscal sins. The ECB insists that there will be ‘no gain without pain’ and that the more one is prepared to suffer, the more one is expected to prosper later on.
The contestants in the game are the Eurozone members—each one trying to bootstrap its economy out of the throes of the most severe crisis in living memory. The audience judging each country’s performance is not made up of reality TV watchers but of financial (bond) markets and credit rating agencies, whose supposedly rational views can make or break any economy. The name of the game is boosting cost-competitiveness and exports—and its rules are carved into stone in March 2011 in a Euro Plus ‘Competitiveness Pact’ (Gros, 2011).
Raising competitiveness here means reducing costs, and more specifically cutting labour costs, which means lowering the wage share by means of reducing employment protection, lowering minimum wages, raising retirement ages, lowering pensions and, last but not least, cutting real wages. Economic inequality, poverty and social exclusion will all initially increase, but don’t worry: structural reforms hurt in the beginning, but their negative effects will be offset over time by changes in ‘confidence,’ boosting spending and exports. But it will not work, and the damage done by austerity and structural reforms is enormous; sadly, most of it was and is avoidable. The wrong policies follow from ‘design faults’ built into the Euro project right from the start—the creation of an ‘independent’ European Central Bank being the biggest ‘fault’, as it precluded the necessary co-ordination of fiscal and monetary policy and disabled the central banking system from providing support to national governments (Arestis and Sawyer, 2011). But as Palma (2009) reminds us, it is wrong to think about these ‘faults’ as being caused by perpetual incompetence—the monetarist Euro project should instead be read as a purposeful ‘technology of power’ to transform capitalism into a rentiers’ paradise. This way, one can understand why policy makers persist in abandoning the unemployed.