February 19, 2013
Revenge of Keynes: Ecuador’s Success Story

Mark Weisbrot discusses the popular success of Ecuadorian president Rafael Correa, a Phd economist who has used “big government” economics to get his country back on its feet:

[Ecuador’s] Unemployment fell to 4.1% by the end of last year – a record low for at least 25 years. Poverty has fallen by 27% since 2006. Public spending on education has more than doubled, in real (inflation-adjusted) terms. Increased healthcare spending has expanded access to medical care, and other social spending has also increased substantially, including a vast expansion of government-subsidised housing credit.

If all that sounds like it must be unsustainable, it’s not. Interest payments on Ecuador’s public debt are less than 1% of GDP, which is quite small; and the public debt-to-GDP ratio is a modest 25%. The Economist, which doesn’t much care for any of the left governments that now govern the vast majority of South America, attributes Correa’s success to “a mixture of luck, opportunism and skill”. But it was really the skill that made the difference.

Correa may have had luck, but it wasn’t good luck: he took office in January of 2007 and the next year Ecuador was one of the hardest hit countries in the hemisphere by the international financial crisis and world recession. That’s because it was heavily dependent on remittances from abroad (eg workers in the US and Spain); and oil exports, which made up 62% of export earnings and 34% of government revenue at the time. Oil prices collapsed by 79% in 2008 and remittances also crashed. The combined effect on Ecuador’s economy was comparable to the collapse of the US housing bubble, which contributed to the Great Recession.

And Ecuador also had the bad luck of not having its own currency (it had adopted the US dollar in 2000) – which means it couldn’t use the exchange rate or the kind of monetary policy that the US Federal Reserve deployed to counteract the recession. But Ecuador navigated the storm with a mild recession that lasted three quarters; a year later it was back at its pre-recession level of output and on its way to the achievements that made Correa one of the most popular presidents in the hemisphere.

How did they do it? Perhaps most important was a large fiscal stimulus in 2009, about 5% of GDP (if only we had done that here in the US). A big part of that was construction, with the government expanding housing credit by $599m in 2009, and continuing large credits through 2011.

But the government also had to reform and re-regulate the financial system. And here it embarked on what is possibly the most comprehensive financial reform of any country in the 21st century. The government took control over the central bank, and forced it to bring back about $2bn of reserves held abroad. This was used by the public banks to make loans for infrastructure, housing, agriculture and other domestic investment.

It put taxes on money leaving the country, and required banks to keep 60% of their liquid assets inside the country. It pushed real interest rates down, while bank taxes were increased. The government renegotiated agreements with foreign oil companies when prices rose. Government revenue rose from 27% of GDP in 2006 to over 40% last year. The Correa administration also increased funding to the “popular and solidarity” part of the financial sector – co-operatives, credit unions and other member-based organisations. Co-op loans tripled in real terms between 2007 and 2012.

The end result of these and other reforms was to move the financial sector toward something that would serve the interests of the public, instead of the other way around (as in the US). To this end, the government also separated the financial sector from the media – the banks had owned most of the major media before Correa was elected – and introduced anti-trust reforms.

Weisbrot concludes by saying what’s on everybody’s mind:

[T]he conventional wisdom is that such “business-unfriendly” practice as renegotiating oil contracts, increasing the size and regulatory authority of government, increasing taxes and placing restrictions on capital movements, is a sure recipe for economic disaster. Ecuador also defaulted on a third of its foreign debt after an international commission found that portion to have been illegally contracted. And the “independence” of the central bank, which Ecuador revoked, is considered sacrosanct by most economists today. But Correa, a PhD economist, knew when it was best to ignore the majority of the profession.

Other countries have used similar “big government” policies in the past to salvage their economies. In Sweden, where government spending continues to hover around 50% of GDP and the top income tax rate is 57%, the government has been running regular surpluses since 1998.  While some are determined to credit Sweden’s success on free-market reforms, Sweden’s recent economic success over the past two decades was largely due to getting its banking industry under control in the 1990’s, and utilizing an activist Central Bank that employed an expansionary monetary policy to reduce unemployment.  Switzerland’s central bank did the same thing in 2011.  And Japan’s central bank purposefully inflated its currency in late 2011 after large Japanese manufacturers "blamed the strong Yen for hurting their profits."  

If anything, these examples demonstrate that there’s a time and a place for every economic policy.  Clearly “big government” economics are not always appropriate for every economic situation.  but in Ecuador’s case, the “big government” approach appears to have worked.  Sweden and Switzerland have also experienced economic success with central banks that intervene far more aggressively in the economies than the Federal Reserve.  And despite Sweden’s purported free-market reforms, the Swedish government continues to fund a rather robust welfare state with high income tax rates, steady economic growth, and regular budget surpluses.  Surplus-driven welfare states are not only possible, but we currently have many excellent examples of them working in different parts of the world.

May 5, 2012
"Owe your banker 1,000 pounds and you are at his mercy; owe him one million pounds and the position is reversed."

John Maynard Keynes, 1945

March 2, 2012
"Now if only conservatives can admit that if Friedman was alive, he would support having the Federal Reserve be much more active in working to speed up the economic recovery."

Frum (via huskerred)

LTMC: Friedman understood that monetary policy holds a unique place in the structure of an economy, and that more goes into debauching a currency than simply printing more money.  His thoughts on Japan’s lost decade were completely spot-on: zero percent interest rates are a symptom of overly tight monetary policy.  The solution, all else being equal, is more liquidity.  Ben Bernanke wrote an article in 1999 that came to the same conclusion. Greg Mankiw (a right-leaning economics professor from Harvard), went so far as to author an open memo in 1999 entitled "Memo to Japan, lower taxes, print money."  Tyler Cowen, an economics professor at George Mason University, recommended back in 2010 that the Fed should move its inflation target from 2% to 3% to incentivize higher velocity.  Note that these three economists have very different ideological positions on a range of issues pertaining to economics.  But they all seem to agree on the need for expansionary monetary policy during a recession accompanied by a liquidity trap.

Meanwhile, Chinese economists predicting a slowdown last December advocated ”slow monetary loosening” to ease the effects of growth reduction. And the central banks of both Switzerland and Sweden have already demonstrated that increasing liquidity during a recession does far more to lift the country out of recession than it does to debauch a nation’s currency.  Along the same lines, those who believe that inflation is universally bad should see Switzerland’s and Japan’s attempts to inflate their currencies to shore up exports, which would have had negative economic consequences for both countries.

Friedman understood that economic actors demand money the same as any other good; but he also understood that money is unique because it is the only economic unit that people demand solely for its utility as an exchange proxy for all other goods and services.  As a result, trying to figure out what the correct price of money should be is not necessarily intuitive, and is quite often co-relative, as demonstrated by the LIBOR index collusion fiasco.  Friedman understood that this creates a unique relationship between a nation’s economy and its monetary policy.  And while Frum is perhaps oversimplifying Friedman, I think the thrust of his observation is correct.  Friedman advised against self-induced paralysis in 2000, and I have no doubt he would do the same now.

(via jgreendc)

February 4, 2012

[S]tandard Keynesian models, open-economy version, tell a very clear story about what happens when a country pegs its exchange rate at a level that leaves its industry uncompetitive. The country doesn’t stay depressed forever: high unemployment leads to actual or at least relative deflation, which gradually improves cost-competitiveness, which leads to rising net exports and gradual expansion. In the long run, full employment is restored; it’s just that in the long run we’re all, well, you get the picture.

That was Keynes’s whole point in ‘The Economic Consequences of Mr. Churchill’ — not that the return to gold at too high a parity would mean depression forever, but that it would subject Britain to years of unnecessary suffering.


Paul Krugman

January 12, 2012
Romney’s Bain Problem, Ctd: Alien Invaders

The more I read about Bain Capital, the more I get the impression that this company essentially behaved like a predatory, carnivorous alien species, hopping from planet to planet and sucking it dry of bio-mass before moving on to the next hapless spherical body unfortunate enough to catch the alien fleets’ attention:

Romney’s private equity firm, Bain Capital, bought companies and often increased short-term earnings so those businesses could then borrow enormous amounts of money. That borrowed money was used to pay Bain dividends. Then those businesses needed to maintain that high level of earnings to pay their debts…

* Bain in 1988 put $5 million down to buy Stage Stores, and in the mid-’90s took it public, collecting $100 million from stock offerings. Stage filed for bankruptcy in 2000.

* Bain in 1992 bought American Pad & Paper (AMPAD), investing $5 million, and collected $100 million from dividends. The business filed for bankruptcy in 2000.

* Bain in 1993 invested $60 million when buying GS Industries, and received $65 million from dividends. GS filed for bankruptcy in 2001.

* Bain in 1997 invested $46 million when buying Details, and made $93 million from stock offerings. The company filed for bankruptcy in 2003.

Romney’s Bain invested 22 percent of the money it raised from 1987-95 in these five businesses, making a $578 million profit.

They essentially purchased companies, leveraged the $%#& out of them, paid out dividends to their invaders investors with the leveraging proceeds, and then left the companies to wallow in the inevitably unsustainable debt, leading directly to bankruptcy and the loss of jobs, wages, benefits, and pensions for the people employed by the company.

This is exactly the type of predatory capitalism that has incited so much populist rage in the present hour.  Yes, the proceeds from those investments will probably be invested or spent elsewhere in the economy, eventually resulting in some form of equilibrium.  But human beings are not as fungible as capital.  A person who trained and worked their whole life as an accountant will not suddenly become an expert in jewelcutting when Bain investors purchase diamond-coated seat-covers for their Murcielago P640.  The economy might be organic, but it is not an amoeba.  This conduct can be as disruptive as it is profitable, on a macroeconomic scale.

December 12, 2011

Has the dollar lost value under Bernanke and Obama? No. The usual measure for the strength of the dollar is called “trade-weighted value.” In July 2008, just before the financial crisis erupted in earnest, the greenback’s value stood at 95.4. As I’m writing this in mid-September, it has gone up, then down, and is currently sitting at 96.1.Taking a longer view, the dollar lost value under Reagan and Bush I, gained value under Clinton, lost value under Bush II, and has mostly stayed steady under Obama. There’s just no basis to the claim that Obama and Bernanke have debased the currency.

And that’s unfortunate. As economist Dean Baker is fond of pointing out, if we want to get our national savings rate up and our long-term budget deficit down, there’s only one way to do it: by fixing our massive trade deficit. We have to import less and export more, and one way to make that happen is with a weaker dollar. A weaker dollar makes foreign goods more expensive, so we’ll buy less of them, and makes American goods cheaper, so others will buy more of them.

The truth is that we’d be better off if we ditched the loaded “strong/weak” terminology and just talked about an “export dollar” (weak) and an “import dollar” (strong). Sometimes one is good, and sometimes the other is. The Chinese, for example, have done well for decades with an export yuan. Likewise, an export dollar would be our friend right now.


Kevin Drum

November 19, 2011
Should We "End the Fed"?

The U.S. Federal Reserve System [the Fed’s primary functions are carried out by a system of 12 regional Federal Reserve Banks] is a study in obfuscation. It appears in the organization chart of the U.S. government and presents itself to the world as an independent government body, but its highly complex governance structure assures its operations are in fact controlled by the big banks whose interests it faithfully serves. It piously reports that its accounts are subject to extensive internal and external audit, but only the special one-time audit ordered by the U.S. Congress in the Dodd-Frank financial reform bill signed into law by President Obama on July 21, 2010 under vigorous Fed protest revealed the amount and the beneficiaries of its $16 trillion post-crash handouts.

There are angry calls from both left and right to shut down the Fed. The anger is justified. The call to shut it down, however, ignores the reality that a national money/banking system requires oversight and management by a central bank or its institutional equivalent. The choices center on that institution’s degree of transparency, to whom it will be accountable, and what its priorities will be.

(Source: azspot)

November 19, 2011
Do minimum wages drive industrialization?

Big Push models suggest that local product demand can create multiple labor market equilibria: one featuring high wages, formalization, and high demand and one with low wages, informality, and low demand. I demonstrate that minimum wages may coordinate development at the high wage equilibrium.

…formal employment increases and informal employment decreases in response to the minimum wage. Local product demand also increases, and this formalization occurs only in the non-tradable, industrializable industries.

This is good, but what it lacks is an analysis of the relationship of the minimum wage to the theoretical natural market clearance price for unskilled labor.  A minimum wage that is too high in relationship to the theoretical clearance price will just increase unemployment.  But a minimum wage that is not too divorced from the theoretical market clearance price of unskilled labor will have a negligible effect on unemployment, generally speaking.  For example: many employers already pay higher than federal minimum wage for their entry level workers.  This suggests that our minimum wage is pretty close to the aggregate market clearance rate of unskilled labor; meaning that any effect on unemployment would be negligible.

See also this paper from the comments, wherein Gavin Wright argues that something similar happened in the U.S. South as a result of New Deal farm programs and Labor law changes.

(Source: azspot)

November 13, 2011
Galbraith On Keynes And Occupy Wall Street

Friedrich August von Hayek was a charming and gracious man who accepted my invitation to lunch in Salzburg when I was 23 years old.  But even Milton Friedman called his price theory “very flawed” and his capital theory “unreadable.”  He was denied a post in economics at the University of Chicago, and his reputation today rests largely on The Road to Serfdom,  a warning against Soviet-style central planning with which Keynes felt free to declare “deeply moved agreement.”

On policy matters Hayek was no extremist and often aligned with Keynes.  As Professor Walter Block points out in the Journal of Libertarian Studies, he agreed that central banks should fight unemployment, he favored fair labor standards and “an extensive system of social services;” also antitrust and policing against fraud and deception and state-sponsored health insurance; what we might call a “public option.”  All of this drove Professor Block to declare in despair that Bill and Hillary Clinton should have cited him in their campaign for health care reforms. None of this came from Hayek’s own economics:  as Block wrote, the Hayek of 1944 “stands condemned by the Hayek of 1931 and 1933.”  The contrast between Hayek’s economic ideas and his policy views is for our friends on the other side to explain if they can…

Keynes favored deficit spending – “loan-expenditure” — to fight unemployment, and he denounced the pernicious doctrine of the natural rate of unemployment in 1929, almost forty years before our friend Professor Edmund Phelps is credited with inventing it:

The Conservative belief that there is some law of nature …that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his brain fuddled with nonsense for years and years…”

Keynes’s greatest policy polemic was his first, The immortal Economic Consequences of the Peace.  His message was that debts that cannot be paid will not be paid, and the attempt to squeeze blood from stones brings disaster.  As Nicholas Wapshott tells, Keynes was a hero to Hayek and his friends in 1919 Vienna for this.   “Europe is solid with herself,” he wrote. “If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also, being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds.”   So it is today with Germany and France and Holland and Finland on one side and Greece, Portugal, Ireland, Spain and Italy on the other.

In each of these areas:  jobs, banks, and international debt, we can read Keynes with direct relevance to our present miseries.  Against this, today’s followers of Hayek tell us to accept those miseries and not to relieve them.  

Well, Hayek would say that attempting to relieve those miseries with counter-cyclical government spending will just make them worse in aggregate (i.e. you may relieve the current miseries, but the imbalances created by government spending in the market will just lead to later corrections that wouldn’t otherwise have occurred).  

Obviously Keynes would disagree; though any cosmopolitan economist knows that virtually anything is possible in terms of policy correctness assuming the correct combination of fundamentals (e.g. idle/mobilized resources, monetary policy, tax rates, debt-to-gdp ratio, liquidity, business risk aversion, investor confidence, and so forth).  That’s part of the reason why Economist Bruce Bartlett believed it was smart to support Reagan’s economic policies in 1980, but that those same policies are not appropriate today because the problems facing our economy are much different. 

To wit, there are certainly economic situations in which Austrian solutions are 100% appropriate.  But I am hard-pressed to believe that the same critical mass of human action which Austrians tell us is too complex to interfere with beneficially is simultaneously not complex enough to create situations in which un-checked incentives lead to bad results.  The process of regulating those incentives may be subject to inherently human flaws, but letting the perfect be the enemy of the good in this case is to leave a one-legged man without a crutch, on the basis that the crutch is not a well-fitted prosthetic.  An inefficiently enforced regulation that still gets good results is not a bad regulation by any means.

h/t AZSpot

November 6, 2011
Did a Harvard Economics Class Cause the Financial Crisis?

Harvard grads frequently go on to highly influential jobs on Wall Street, at think tanks, and in government. Did the principles they learned in their alma mater’s most popular class cause America’s financial crisis and growing wealth gap? That’s the view of a group of approximately 70 students who walked out of professor N. Gregory Mankiw’s Economics 10 class this week in solidarity with the Occupy protests happening coast-to-coast. The students say the conservative slant of the economic theories taught by the prominent professor are driving policies that create inequality. According to their open letter to Mankiw—who advised President George W. Bush and now Mitt Romney—the free market, laissez faire capitalism he teaches to nearly 700 students every semester deprives students of “an analytic understanding of economics as part of a quality liberal arts education.”Mankiw’s academic influence also extends well beyond Harvard. His textbook, Principles of Economics, is widely used in introduction to economics classes nationwide.

This is interesting, if far-fetched.  I disagree with Mankiw on quite a few points of economic policy, but he’s hardly an extremist.  He wrote an article for the New York Times in 2008 in which he essentially came as close as one can to advocating a Keynesian counter-cyclical approach to recession-busting; he stopped short, however, because he believed our current deficits render Keynesian solutions impractical at present.  He believed our public debt is already so large that the present liability is too grave to implement a Keynesian package of sufficient size to boost aggregate demand without jeopardizing public finances.  An arguable, but certainly not unreasonable position to take.

Mankiw goes on in the article to say that the Fed can “set a target for longer-term interest rates. It can commit itself to keeping interest rates low for a sustained period. Most important, it can try to manage expectations and assure markets that it will do whatever it takes to avoid prolonged deflation. The Fed’s decision last week to start buying mortgage debt shows its willingness to act creatively.”

These are hardly the words of an skeptical Austrian School disciple.  I’d say he’s closer to the Chicago school, if anything.  But neither is he diametrically opposed to Keynesian solutions.  He’s actually a fairly nuanced thinker in that respect.  I’d definitely put him to the Left of Milton Friedman; and Friedman was in many ways the primary crown jewel in the Chicago School’s crown.

With these considerations in mind, I think the Harvard students are actually in the wrong here.  If they’d bothered to read Mankiw’s work in more depth, they’d probably discover that he’s a more nuanced economist than they realize.  As I said earlier, I think he’s wrong on a lot of economic questions.  But the guy knows economics, and he certainly not a “laissez-faire” purist who eschews all government involvement in the economy.

(Source: sunrec, via socialuprooting)

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