The Great Debate UK

from MacroScope:

The Law of Diminishing Greeks

The Law of Diminishing Returns  states that a continuing push towards a given goal tends to  decline in effectiveness after a certain amount of effort has been expended. If this weren't the case, Usain Bolt would be able to run the mile in  less than 2-1/2 minutes.

From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:

More than one in five Greeks is unemployed.

There are more young people without a job than with one.

The record 1.08 million people  without work in January was a  47 percent tumble  in a year.

Putting aside for the moment the question of what such a condition means for political dissent, there is now the issue of whether any of this austerity-fueled pain is actually helping the Greek economy.

Austerity mixed with the inability of euro-tied Greece to devalue its currency  means  Greece is now in its fifth year of recession. As for job-creating small and medium -sized businesses, the latest projections are that more than a net 130,000 of them will have shut down over two years by the time 2012 is over.

The biggest example of the Law of Diminishing returns, however, is the impact all this is having on what ails Greece in the first place -- its budget.

Unemployed people offer no revenue to the government in terms of income tax and far less in sales tax than they would if they were working.

from The Great Debate:

The limits of the scientific method in economics and the world

By Roger Martin The opinions expressed are his own.

This is part one of this essay. Read part two here.

As the economy teeters and the capital markets gyrate, I can’t get out of my mind the evening of May 19, 2009.  We were near the stock market nadir and fears were cresting that we were heading straight into the next Great Depression. I was invited to a dinner along with half a dozen tables of guests to hear a very prominent macroeconomist opine on the state of the economy and the path to recovery.

The economist held forth with a detailed, analytical account of what had caused the economic meltdown in the second half of 2008 and the path that he predicted recovery would take. I was struck by how scientific he was, spewing myriad statistics, employing technical terms by the boatload, and praising his econometric model. It was ‘very sophisticated’.  Given the nods and encouraged looks in the room, it seemed as though he had provided great comfort to the guests; they could go to bed confident that thanks to his science, they could trust that this man knew where we were headed.

I wasn’t quite so confident. Being the curious sort, before coming to dinner I had checked his forecast from a year earlier, mere months before the crash.  His spring 2008 forecast for the second half of 2008 was for modest positive economic growth for America.  This was not unusual; no credible economist predicted anything less rosy for the back half of 2008, although many now claim that they did.  I don’t blame or ridicule him for being cautiously optimistic mere months before the worst economic downturn in 80 years.  Economic forecasting is fraught with peril.

For me, the striking thing about the evening was that nothing changed about his models after they were shown to be hopelessly wide of the mark.  He just loaded up the equations, dumped in the latest numbers and started crunching away.  I asked him whether he had altered his models in the wake of his dreadful forecast of 2008; stunningly, he hadn’t thought of the question.

It struck me then and still does that this dinner is illustrative of a fundamental blind spot in modern science.  It has ventured far afield of its natural limits and is both creating problems and inhibiting progress.

from Ian Bremmer:

The secret to China’s boom: state capitalism

By Ian Bremmer The views expressed are his own.

One of the biggest changes we’ve seen in the world since the 2008 financial crisis can be summed up in one sentence: Security is no longer the primary driver of geopolitical developments; economics is. Think about this in terms of the United States and its shifting place as the superpower of the world. Since World War II, the U.S.’s highly developed Department of Defense has ensured the security of the country and indeed, much of the free world. The private sector was, well, the private sector. In a free market economy, companies manage their own affairs, perhaps with government regulation, but not with government direction. More than sixty years on, perhaps that’s why our military is the most technologically advanced in the world while our domestic economy fails to create enough jobs and opportunities for the U.S. population.

Contrast the U.S. and its free market economy with China’s system.  For years now, that country has experienced double digit growth. Many observers would say that China’s embrace of capitalism since 1978, and especially since joining the World Trade Organization in 2001, has been responsible for its boom. They would be mostly wrong. In fact, a new study prepared for the U.S. government says it’s not capitalism that’s powering China, but state capitalism -- China’s massive, centrally directed industrial policy, where the government positions huge amounts of capital and labor in economic sectors it intends to nurture. The study, prepared by consultants Capital Trade for the U.S.-China Economic and Security Review Commission, reads in part:

In a world in which central planning has been so utterly discredited, it would be natural to conclude that the Chinese government and, by extension, the Chinese Communist Party have been abandoning the institutions associated with the communist economic system, such as reliance on state‐owned enterprises (SOEs), as fast as possible. Such conclusion would be wrong.

In a G-zero world where no country can claim the mantle of international leadership, China has pulled an accomplished head fake. While the media focuses on China’s special economic zones, like Hong Kong and Macau, and the rise of the banker class and Chinese tech industry, state directed spending is the real engine of growth.  Capital invested in infrastructure like factories, heavy industry, roadways, and high speed trains continues to power annual double digit growth in GDP. Reliable data from 2004 shows that 76% of Chinese non-financial firms are classified as State Owned Enterprises (firms with government ownership of greater than 10%).

In short, while the U.S. has spent decades and vast treasure building up its defense system (and yes, by extension, the sectors of the economy that service it), China has spent its time and money building up control over the broad direction of its entire economy. In today’s world, where the first sentence of this essay rings true, which country currently looks better positioned to, pardon the pun, capitalize, in the years ahead?

During last week’s euro zone bailout talks, French President Nicolas Sarkozy went hat in hand to China, painting a stark picture of China’s still-growing economic importance internationally. Never mind that the phone call didn’t result in any particular action; the mere act raised Chinese President Hu’s profile going into the G-20 talks in France this week. Not only that, the entreaty by Sarkozy made plain that China has nothing to hide about the economic path it’s chosen for itself. After decades of hectoring from the West, the tables are perhaps about to turn. After all, what economic model should China emulate? Europe’s? The United States’? “With all due respect,” you can almost hear President Hu saying, “we like the way our system is working, thanks.”

from MacroScope:

Give me liberty and give me cash!

Come back Mr Fukuyama, all is forgiven.

In his 1992 book "The End of History and the Last Man", American political scientist Francis Fukuyama famously argued that all states were moving inexorably towards liberal democracy. His thesis that democracy is the pinnacle of political evolution has since been challenged by the violent eruption of radical Islam as well as the economic success of authoritarian countries such as China and Russia.

Now a study by Russian investment bank Renaissance Capital into the link between economic wealth and democracy seems to back Fukuyama.

Looking at 150 countries and over 60 years of history, RenCap found that countries are likely to become more democratic as they enjoyed rising levels of income with democracy virtually 'immortal' in countries with a GDP per capita above $10,000.

" Only five democracies above the $6,000 income level have died. Even democracies above the $6,000 level have a 99 percent chance of sustaining their political system each year. The only exceptions were the military coups in Greece in 1967 ($9,800), Argentina in 1976 ($8,180) and Thailand in 2006 ($7,440), and the events in Venezuela in 2009 ($9,115), as well as Iran in 2004 ($8,475)," RenCap global chief economist Charles Robertson writes.

The $6,000 per capita GDP seems to be a crucial level, marking the point where a country is likely to shift to democracy. Tunisia, which early this year triggered the wave of uprisings against autocracy across the Arab world, recently crossed that threshold.

Conversely, democracy is most fragile at the lowest income levels and when incomes are shrinking. The world's populous democracy, India, is a notable exception as its per capita income was under $800 from 1950-1967, and only exceeded $2,000 in 2003.

from MacroScope:

The iPod – the iCon of Chinese capitalism

Walking past Apple's sleek shop along London's Regent Street on Sunday, my wife asked me what I wanted for Father's Day.

"An iPad?" I ventured, half-jokingly.

"Are you sure you want one? Don't you care how they're made?" came her disapproving reply.

She was, of course, referring to the rash of suicides among Chinese workers at Foxconn, the Taiwanese manufacturer of Apple's much desired iPads and iPhones.

The deaths prompted the company to raise salaries and cut working hours but lingering concerns over conditions for its over 1 million workers in China were underscored by a plant explosion last month that killed at least 3 people.

Workers like those who live and work in Foxconn's sprawling Chinese facilities have long been the backbone of the country's vast manufacturing sector which churns out a torrent of consumer goods for export.

But the recent labour unrest that has erupted in parts of China suggests that this low-cost export-fuelled growth model may be wheezing towards its expiry date.

Superstar economics: It’s all showbiz now

By Laurence Copeland. The opinions expressed are his own.

It seems barely a week goes by without another shock report about the ever-widening gap between those at the top of the earnings distribution and the rest of us. The facts are by now well-established. Throughout the Western world, but most noticeably in Britain and America, the earnings of the top one or two percent are accelerating into the stratosphere, leaving the middle class a long way behind, and the working class completely out of sight. How can one explain this global phenomenon?

Academic economics seems to be taking a surprisingly long time to reach a definitive answer, but I suspect there will turn out to be two long term trends at work here.

First, globalisation has doubled or tripled the supply of unskilled and semi-skilled labour. As long as China remained locked in Maoist isolation and the Indian economy had to carry the full burden of the Licence Raj, their respective workforces were shut off from the global labour market. The fact that products could theoretically be manufactured far cheaper in those countries was unimportant, because in practice Western firms could never take advantage of their rock-bottom labour costs.

Now that they have opened up and it is possible to outsource manufacturing to China and the paperwork to India, there is less and less left for our workers and middle-managers to do – unless, of course, they are willing to work for more competitive (i.e. lower) wages.

Moreover, the second phase of this transition is well underway, as the emerging economies start to exploit their vast pools of underemployed (and often excellent) graduates to move up the value chain, where they increasingly compete with our engineers, programmers, and even lawyers and doctors.

All over Europe and North America, people are asking: where will it all end?

from Felix Salmon:

Greenspan squanders his final reserve of credibility

Thank you, internet: Henry Farrell and his commenters have all the snark so desperately required in response to Alan Greenspan's ludicrous op-ed in the FT. And they're not alone: as Alex Eichler notes, "everyone is laughing at Alan Greenspan today". Greenspan could hardly have made himself look like more of an idiot if he'd tried, not only because the "notably rare exceptions" construction is so inherently snarkworthy, but also because it's so boneheadedly stupid. Anything which normally makes money is a good idea if you ignore the times that it doesn't work.

That said, it's worth looking in a bit more detail at Greenspan's nutty ramblings, because scarily they're actually representative of what much of the financial sector believes these days. (And Clive Crook, too.) The context is the GOP-controlled Congress, which has the ability to hobble or even abolish key parts of Dodd-Frank. And Greenspan is urging them on, saying that the early consequences of Dodd-Frank "do not bode well". In order to do this, he first sets up a straw man, saying that Dodd-Frank was designed to "readily address" the causes of the financial crisis. It wasn't, of course, but Greenspan pretends it does, and proceeds to give five examples of how it fails to do so, helpfully delineated with bullet points.

The first is that the credit rating agencies didn't like the idea that they should take responsibility for their ratings. Well of course they didn't like that idea -- but the SEC was so captured that it happily waived the relevant bit of Dodd-Frank. Is it true, pace Greenspan, that the SEC's supine reaction could not have been "readily anticipated"? Maybe. But the point here is that the unintended consequence of Dodd-Frank was a significant weakening of Dodd-Frank. Greenspan should be happy about this one! It's the intended consequence of Dodd-Frank that he didn't like.

Greenspan's second point is that banks "contend" that they won't afford to be able to issue debt cards if the Durbin amendment to Dodd-Frank goes through. This contention is silly, of course: no one's going to stop issuing debit cards at all. But Greenspan believes them, maybe because his entire career was based on trusting whatever he was told by the banks, since banks are always going to do what's best for their shareholders, and what's good for bank shareholders is good for America. Or something along those lines, anyway.

Back in 2008, Greenspan admitted that there was "a flaw" in that reasoning, and that he was "very distressed by that fact". But he's clearly got over his distress at this point, and is back to his old tricks of simply parroting the spin of the very entities he was purportedly regulating. "Concerns are growing," he writes, "that without immediate exemption from Dodd-Frank, a significant proportion of the foreign exchange derivatives market would leave the US."

Who has these concerns? Greenspan doesn't say, but I'll let you into a secret: it's bankers. They like trading derivatives because trading derivatives makes them lots of money. Does it help the broader economy, or create a significant number of jobs? That doesn't really matter, and neither does any specificity as to what the word "significant" might mean in this context. This isn't argument, it's inchoate scaremongering.

Greenspan then moves on to the Volcker Rule, complaining that it puts US banks at a competitive disadvantage. Well, yes. If you have a central bank which takes its regulatory function seriously, then less fettered banks are likely to be at a competitive advantage to your own. Ask Canada. Which is feeling pretty smug, these days, about putting its banks at a competitive disadvantage.

from MacroScope:

The IMF to turn on the rich

The latest International Monetary Fund meeting ended with emerging market powers getting a pledge from the organisation for stronger and "more even-handed" scrutiny of what is going on in large advanced economies.

As Reuters correspondents Lesley Wroughton and Emily Kaiser report here, the decision is a response to long-running frustrations among emerging economies, which reckon the Fund has  not been tough enough on its biggest shareholders, led by the United States.

The move reflects a number of things. First, it shows the growing clout of emerging economies within international institutions. The G-20, for example, is arguably now more influential than the old , richer G7. Secondly, it graphically underlines the current world-turned-upside-down state of the global economy, in which profligate rich economies are struggling to keep above water while supposedly poorer and less-developed ones enjoy solid growth and relatively stable finances. This graph makes the point:

One question  that has been raised, meanwhile, is whether the IMF is capable of taking rich countries -- its primary paymasters -- to task.  A comment from a craigbhill on the Reuters story encapsulates the issue:

This is like the bankers to the Mafia being politely asked to "give scrutiny" to the Mafia.

A bit harsh. But valid?

from MacroScope:

Will China make the world green?

Joschka Fischer was never one to mince words when he was Germany's foreign minister in the late '90s and early noughts. So it is not overly surprising that he has painted a picture in a new post of a world with only two powers -- the United States and China -- and an ineffective and divided Europe on the sidelines.

More controversial, however, is his view that China will not only grow into the world's most important market over the coming years, but will determine what the world produces and consumes -- and that that will be green.

Fischer, who was leader of  Germany's Green Party, reckons that due to its sheer size and needed GDP growth, China will have to pursue a green economy. Without that, he writes in his Project Syndicate post, China will quickly reach limits to growth with disastrous ecological and, as a result, political consequences.

This will have serious consequences on the the way the West lives.

Consider the transition from the traditional automobile to electric transport. Despite European illusions to the contrary, this will be decided in China, not in the West. All that will be decided by the West’s globally dominant automobile industry is whether it will adapt and have a chance to survive or go the way of other old Western industries: to the developing world.

This is not the usual view of China. Many greens have long feared the impact of a huge leap in Chinese growth on the global environment -- refrigerators in a billion homes, cars in a billion garages etc.

from MacroScope:

Who will win this year’s Nobel Prize for Economics?

And the Nobel laureate for economics in 2010 is?

Thomson Reuters expert David Pendlebury might have an idea. At least one of the picks from his annual predictions of winners (economics, chemisty, and so on) has won a Nobel prize over the years. Here is his short-list for economics this year.

* Alberto Alesina of Harvard University in Massachusetts for research on the relationship between politics and macroeconomics, especially politico-economic cycles.

* Nobuhiro Kiyotaki of Princeton University and John Moore of Britain's University of Edinburgh and the London School of Economics for their Kiyotaki-Moore model, which describes how small shocks to an economy may lead to a cycle of lower output. It described Japan's real-estate crisis in the 1990s and could describe some of the causes of the recent U.S. recession.

* Kevin Murphy of the University of Chicago for research in social economics, including wage inequality and labor demand, unemployment, and how medical research pays off.

But what are your views? Who do you think deserves the prize for 2010 on October 11?