New Economist

IMF: "Risks to financial stability have intensified"

For those hoping that credit conditions might gradually be returning to normal, today's IMF Global Financial Stability Report market update contained a stark warning:

Risks to financial stability have intensified since October 2008. Macroeconomic risks have risen as global growth has fallen precipitously alongside a sharp slowdown of global trade. Credit risks have also risen as a deterioration of economic and financial conditions have resulted in rising loan losses. At the same time, the flight from risky assets and illiquid market conditions has increased funding costs, even as risk-free rates have declined with monetary easing.

That is despite the massive bailouts, spending plans and other government interventions we have seen since the last report:

...With the help of extensive government support, market functioning toward the end of 2008 improved in a number of asset classes. However, the negative interaction between the economy and the financial sector has intensified as the credit crunch bites harder and extends globally, with confidence among financial counterparties remaining strained. Indeed, the recent shock to bank earnings and other bad economic news has put further downward pressure on bank equity prices, and the width of credit default swap spreads points to still-elevated systemic risks.

And if you think that prognosis was depressing, the sentence that follows is even worse:

Notwithstanding public injections of capital, many banks around the world may have an insufficient capital cushion to weather a deep global economic downturn.

Translation: many banks are insolvent and probably won't survive the global recession.

The credit crunch ain't over; not by a long shot.

CBO: largest growth shortfall since the Great Depression

 The Congressional Budget Office's new director, Douglas W. Elmendorf, testified on the state of the US economy before the House Budget Committee today. It makes sober reading.

An accompanying blog post summarises his three key points:

1. The economy is currently weathering a recession that started more than a year ago, and absent a change in fiscal policy, CBO projects that the shortfall in the nation’s output relative to potential levels will be the largest– in duration and depth– since the Depression of the 1930s.
   
2. Most economists agree that both significant fiscal stimulus and additional financial and monetary policy approaches are needed.
3. H.R. 1, the American Recovery and Reinvestment Act of 2009, would, in CBO’s judgment, provide a substantial boost to economic activity over the next several years relative to what would occur without the legislation.

Somehow the low key style makes these conclusions seem all the more compelling.

'Lone dove Danny' quits the MPC

Controversial Monetary Policy Commitee member and Dartmouth professor Danny Blanchflower is leaving the Bank of England, according to The Times: Man who wanted early rate cuts David Blanchflower steps down from MPC

Professor Blanchflower, who has voted to cut interest rates every month since October last year, said that he would not seek reappointment when his three-year term ends on May 31.

Once can hardly blame him. Despite being one of the first to call the economic slowdown, global recession, downside risks to inflation and upside risks to unempoyment, he has routinely been derided by City economists and market commentators - and ignored by his fellow MPC members.

His doveish voting record often put him at loggerheads with members of the committee, who refused to cut rates earlier over fears about rising inflation. Professor Blanchflower, who travelled to rate meetings from his home in the United States, maintained that the sharp economic downturn in America could be replicated here and advocated taking evasive action by cutting rates.

'Lone dove' Danny has been proven right. The rest of the MPC stubbornly refused to acknowledge the growing downside risks to UK inflation from the global credit crunch and economic downturn.

A key lesson from this is the importance to bring a global (or US0 perspective to monetary policy. In a globalised world, what happens in the United States economy and financial markets clearly has major implicatiosn for the UK. While in theory British-based MPc members ought to be aware of these developments and factor them into their thinking, danny's example shows that they don't.

It is clearly time to globalise the Monetary Policy Commitee and move away from a parochial 'little England' approach. Let's see if Treasury have learned the lesson, and appoint another US-based member as Danny's replacement.

Are emerging Asia’s reserves really too high?

Aside from China, no, according to a new IMF working paper by Marta Ruiz-Arranz and Milan Zavadjil. This is in large part an attempt to insure against a repeat of the 1997 Asian currency crisis:

The paper has presented evidence that to a large extent explains Asia’s large reserve accumulation since the 1997–98 crisis through the precautionary motive. Current reserve holdings in most of Asia (excluding China) are not seen excessive when compared with levels predicted by a simple model of optimal reserves applied to specific country and regional characteristics. By mitigating the potentially large welfare costs of crises, reserves provide benefits in terms of insurance that more than compensates economies for the
opportunity cost of holding liquid assets.

Large currency reserves have the added benefit of lowering borrowing costs:

Furthermore, the benefits of reserves in terms of reduced spreads on privately held external debt, and thus borrowing costs, further justifies most of the observed growth in reserves. The paper finds that a majority of economies in Asia continue to benefit from reduced spreads, as evidenced by the high estimated threshold levels beyond which no further gains are realized.

Nonethless, the authors consider that current reserves "are close to or have recently reached optimal
reserves levels", and "a slowdown in the pace of accumulation in Asia is now desirable."

China, meanwhile, remains an anomaly. These models "cannot fully explain the large stock of reserves in China" - a subject to be explored in future research.

Austan Goolsbee

The September/October 2008 edition of the MIT Technology Review has a feature by Mark Williams on Obama's senior economic advisor, Austan Goolsbee: Obama's Geek Economist No earth shattering insights, but another reminder of just how Chicago-ist an Obama presidency could be.

The credit crunch: what happened?

While Ken 'worst is yet to come' Rogoff is trying his level best to scare global financial markets about the credit crunch, research is now starting to filter through about just what happened last year. A new IMF working paper by Nathaniel Frank, Brenda González-Hermosillo and Heiko Hesse, Transmission of Liquidity Shocks: Evidence from the 2007 Subprime Crisis, does some of the spadework. As they explain, liquidity crisis soon segued into a solvency crisis (think Northern Rock, Bear Sterns):

It is found that the interaction between market and funding illiquidity increased sharply during the recent period of financial turbulence, and that bank solvency became important. ...What started out as a liquidity crisis, turned into a solvency issue.

It wasn't simply credit that dried up, it was trust - the whole basis of interbank money markets. Banks were unwilling to trust the disclosures or assurances of their counterparties. As a result central banks had to pump hundreds of billions into financial markets to address the liquidity spiral and to ensure the solvency of key financial institutions.

So why did these interactions and correlations spike when the sub-prime crisis hit?

The analysis presented here suggests that increasing financial integration and innovation can make market and funding liquidity pressures readily turn into issues of insolvency.

The easy answer would be to blame the quants and financial engineers. But the real culprit was greed, reinforced by the lousy risk management and lax prudential standards of most major banks (and their clients, many of whom bought products they did not understand). While the money kept rolling in the door, senior managers were quite happy to avert their eyes to the ever-mounting risks.

I was not surprised by the sub-prime crisis; it was an accident waiting to happen. But I didn't expect the credit crunch to have been protracted, particularly once central banks interviened with such gusto.

Rogoff is probably right to say that we are only about half-way through the crisis. But the key issue for me is not whether another major bank goes bust (some of them clearly deserve to). It is whether the risk of US recession is now receding (a U-shaped downturn), or whether we are instead facing a 'W'-shaped downturn, with another growth dip looming. So far my controversial call of no US recession this year has held up, and I still think I am odds on to be proved correct. But the outlook for 2009 has becoming bleaker; there are now too many uncertainties to rule out an eventual recession.

Back again

The very welcome return of Dave Altig's Macroblog last week has prompted me to consider posting again too.

Apologies for the protracted absence. My non-virtual life has been rather hectic in recent months. Now that things have settled down a little, I hope to return to semi-regular postings again.

It's good to be back.

Skilled migration boosts innovation

A recent paper by McGill University's Jennifer Hunt to an NBER labour studies programme conference asks whether the increase in foreign-born college graduates has contributed to innovation in the United States. Her paper, How Much Does Immigration Boost Innovation? (PDF), finds that it does:

In this paper I have demonstrated the important boost to innovation per capita provided by skilled immigration to the United States in 1950-2000. A calculation of the effect of immigration in the 1990-2000 period puts the magnitudes of the effects in context.

The 1990-2000 increase from 2.2% to 3.5% in the share of the population composed of immigrant college graduates increased patenting by at least 81:3 = 10:4%, and perhaps by as much as 18%. The increase in the share of post-college immigrants from 0.9% to 1.6% increased patenting by at least 10.5% and perhaps by as much as 24%. The increase from 0.30% to 0.55% in the share of workers who are immigrant scientists and engineers increased patenting by at least 13% but probably by less than 23%.

While I find evidence for the crowding-out of natives in the short run, in the long run there is evidence for the reverse: that skilled natives are attracted to states or occupations with skilled immigrants. The results hint that skilled immigrants innovate more than their native counterparts, especially if they are scientists or engineers. If correct, the result could reflect higher education of immigrants within skill categories, or positive selection of immigrants in terms of ability to innovate. However, the effect of natives is not as well identified econometrically as the effect of immigrants.

These findings suggest there are clear merits in adopting policies to both attract foreign students and to retain them once they have completed their studies (as the UK and Australia, among others, currently do).

How rural villages have gained from China's great migration

Inter-county migration in China - mostly rural migrants moving to urban areas - increased four-fold during the 1990s, from just over 20 million in 1990 to 79 million by 2000. With what effect?

Co-authors Alan de Brauw from the International Food Policy Research Institute and Michigan State University's John Giles examine the impacts this great tide of migration has had on China's rural villages. Their paper, Migrant Labor Markets and the Welfare of Rural Households in the Developing World: Evidence from China (PDF), finds that rural out-migration has boosted per capita consumption and reduced inequality:

We find that increased migration from rural villages leads to signicant increases in consumption per capita, and that this effect is stronger for poorer households within villages. Household income per capita and non-durable consumption per capita both increase with out-migration, and increase more for poorer households.

Villages with the fastest growth in out-migration have seen the largest reductions in village poverty headcount and the strongest growth in average consumption levels. Out-migration has also reduced inequality - "expanded migration is associated with decreasing inequality within villages", as poorer households "supply more labor to productive activities and experience more rapid income growth".

There are mixed effects on rural investment - new earnings from urban jobs have largely been spent on better homes and durable goods:

A second important finding relates to the impact of migration on investment in rural areas. Increases in migration from rural China are associated with increased accumulation of housing wealth and consumer durables, but we do not find evidence of a significant relationship between migration and investment in productive assets.

While none of these findings are particularly unexepected, they help unpack China's economic story. And they show that it is not just international migration that brings benefits.

Why people emigrate

Semi-regular blogging service resumes this week with a few posts on migration - still a very topical issue on both sides of the Atlantic.

The first paper I'd like to highlight is by the University of Chicago's Jeffrey Grogger, and UCSD's Gordon H. Hanson. Their recent NBER Working Paper No. 13821, Income Maximization and the Selection and Sorting of International Migrants, seeks to explain to what extent selection and sorting account for international migration flows using data on emigrant stocks by schooling level and source country in OECD destinations. As the authors conclude, a simple model can explain a lot:

Two dominant features of international labor movements are positive selection of individuals into migration and positive sorting of migrants across destinations. We show that a simple model of income maximization can account for both phenomena.

The more educated are more likely to emigrate; and more-educated migrants are more likely to settle in destination countries with higher rewards to skill. As the authors explain:

In our selection regression, we find that migrants for a source-destination pair are more educated relative to non-migrants, the larger is the skill-related difference in earnings between the destination country and the source. That is, positive selectivity is stronger where the reward to skill in the destination is relatively large. This result obtains for wage differences expressed in levels, but not in logs.

...Positive sorting is a general prediction of income maximization. In our sorting regression, the relative stock of more-educated migrants in a destination is increasing in the level earnings difference between high and low-skilled workers. This correlation is stronger when wage differences are adjusted for taxes, implying that migrants weigh post-tax earnings when choosing a destination. The U.S. and Canada enjoy relatively large post-tax skill-related wage differences, which largely account for their ability to attract more educated migrants relative to other OECD countries.

Other factors are also at work:

Our analysis also shows that language, history, and policy affect migration. English-speaking destinations draw higher-skilled immigrants than other destinations, whereas former colonial powers draw lower-skilled immigrants from their former colonies than from other source countries. Destinations with liberal refugee and asylum policies draw relatively low-skilled immigrants, all else equal.

An ungated version of the paper is available here or here.

The trouble with Joe

Ever been to a concert or play where the rest of the audience were in raptures, but you weren't? That's been my experience every time I've gone to hear Joseph Stiglitz speak on globalisation in London. Each time I've come away wondering how such a first rate economist can offer up such populist tropes, sloppy reasoning and pessimistic interpretation of the facts.

So why do his speeches (and books) make me so queasy? It's not that I disagree with most of his policy prescriptions. Like Stiglitz, I was shocked by the incompetence with which the IMF dealt with the Asian currency crisis a decade ago. And like Stiglitz, I would like to see western governments pay greater attention to those among their constituents who most stand to lose from globalisation.

Robert Skidelsky's review of Stiglitz' latest book, Making Globalization Work, makes the case more eloquently than I ever could. Writing in the New York Review of Books, he concludes:

My final criticism is that Stiglitz's book is carelessly written. Stiglitz was—and perhaps still is—an outstanding economic theorist. But he has been producing big, loosely argued books. The laudable aim behind them is to inform a broader audience about economic policies that could make the world a better place, certainly with better lives for the poor, and such advocacy has its place in moving people to action. But he lacks the eloquence, urgency, and passion of the preacher, while he has too often abandoned the rigor of the scientist. In my view, he has not yet found a style suitable to the popular exposition of his economic ideas.

Based on my readings, that's a fair cop. More rigour please Joe.

Should we kill the king?

Are autocratic leaders an impediment to democratisation? An intriguing question, which some economists have recently sought to answer.

A year ago a JPE article by Harvard's Ben Olken on corruption in Indonesia attracted attention for its innovative appproach. The American magazine has a profile of him by Michael Moynihan, Graft Paper, discussing this and other research, including a paper co-written with Northwestern's Ben Jones, Hit or Miss? The Effect of Assassinations on Institutions and War (PDF). Moynihan summarises it thus:

Olken and Jones looked at the effects of political assassination, using a strict empirical methodology that takes into account economic conditions at the time of the killing and what Olken calls a “novel data set” of assas­sination attempts, successful and unsuccessful, between 1875 and 2004.

Olken and Jones discovered that a country was “more likely to see democratization follow­ing the assassination of an autocratic leader,” but found no substantial “effect following assassinations—or assassination attempts—on democratic leaders.” They concluded that “on average, successful assassinations of autocrats produce sustained moves toward democracy.” The researchers also found that assassinations have no effect on the inauguration of wars, a result that “suggests that World War I might have begun regardless of whether or not the attempt on the life of Archduke Franz Ferdinand in 1914 had succeeded or failed.”

The whole article is worth a read - as are Olken's other papers.

How China thinks

We know a lot about the Chinese economy - but how do the Chinese think? What do they discuss? Are they all Maoist automatons, or is there a lively debate occurring which Western observors are barely aware of? Veteran think tanker Mark Leonard favours the latter view, which he puts forward at some length in his new book, What does China think?

This is also the lead story in the March 2008 issue of Prospect magazine. Leonard makes some inteersting points in his cover piece, China's new intelligentsia. He documents the shift away from Deng's 'growth at any price' approach, as 'new left' views gain ground. Here are some excerpts from the article:

I had imagined that China's intellectual life consisted of a few unbending ideologues in the back rooms of the Communist party or the country's top universities. Instead, I stumbled on a hidden world of intellectuals, think-tankers and activists, all engaged in intense debate about the future of their country. I soon realised that it would take more than a few visits to Beijing and Shanghai to grasp the scale and ambition of China's internal debates. Even on that first trip my mind was made up—I wanted to devote the next few years of my life to understanding the living history that was unfolding before me.

Over a three-year period, I have spoken with dozens of Chinese thinkers, watching their views develop in line with the breathtaking changes in their country. Some were party members; others were outside the party and suffering from a more awkward relationship with the authorities. Yet to some degree, they are all insiders. They have chosen to live and work in mainland China, and thus to cope with the often capricious demands of the one-party state.

We are used to China's growing influence on the world economy—but could it also reshape our ideas about politics and power? This story of China's intellectual awakening is less well documented. We closely follow the twists and turns in America's intellectual life, but how many of us can name a contemporary Chinese writer or thinker? Inside China—in party forums, but also in universities, in semi-independent think tanks, in journals and on the internet—debate rages about the direction of the country: "new left" economists argue with the "new right" about inequality; political theorists argue about the relative importance of elections and the rule of law; and in the foreign policy realm, China's neocons argue with liberal internationalists about grand strategy. Chinese thinkers are trying to reconcile competing goals, exploring how they can enjoy the benefits of global markets while protecting China from the creative destruction they could unleash in its political and economic system. Some others are trying to challenge the flat world of US globalisation with a "walled world" Chinese version.

Globalisation: good for jobs?

Chris Giles summarises a new report on globalisation by the Ifo-affiliated European Economic Advisory Group in today's Financial Times: Globalisation ‘a blessing’ for west Europe

Increased trade, outsourcing and offshoring do not create unemployment but boost the number of jobs in advanced economies, a study of European labour markets says on Tuesday. The European Economic Advisory Group...argues that although globalisation can lead to a fall in demand for certain types of skill, it also tends to sweep away job-destroying rigidities in labour markets.

The evidence from the group’s work suggests the positive effects of globalisation outweigh the negative effects. Although the group concedes that its statistical work remains “crude”, the report concludes that globalisation is likely, if anything, to lead to long-term rises in employment. “If so, globalisation will not be a curse for employment in western Europe, it could instead turn out to be a blessing,” the report says.

The report in question is Chapter 3 of the EEAG's seventh report on the European Economy, Europe in a Globalised World, launched today in Brussels. It warns of "dark clouds" in the US, but no recession in Europe. The chapter, The effect of globalisation on Western European jobs: curse or blessing? (PDF 2.9Mb), comes to more qualified and tentative conclusions than the FT article suggests:

Our basic message is that we probably should not expect globalisation to have adverse effects on overall employment in Western Europe in the long run if one takes all effects into account. It is true that trade integration and factor mobility vis-à-vis low-wage economies are likely to cause unemployment if European labour markets remain rigid. But there is a good chance that globalisation will help reduce these rigidities. Politicians in some countries may try to swim against the tide and uphold or even strengthen regulations in the labour market, such as Germany is currently doing. But in the end, globalisation is likely to strengthen the incentives to deregulate. Therefore, the net result could be that employment is promoted.

If globalisation does not hurt employment, it will produce aggregate gains. There is a possibility that globalisation could eventually benefit almost everyone, although some will gain more than others. However, there is also a fair amount of evidence that economic integration with low-wage economies reduces the relative demand for less-skilled workers and their relative compensation. So, it is also possible that there could be a large group of losers.

But maybe that's the wrong way of looking at it? The authors suggest we should examine how effectively our institutions handle a more global world:

It makes more sense to recast the issue in the following way: are our labour market institutions and our welfare states designed well enough so that the gains from trade reform will be broadly shared? Or are they likely to breed opposition to these reforms?

The 34 page chapter ends with a useful discussion of the possible components of schemes to compensate the potential losers from the globalisation process. A thoughtful piece, deserving a wide readership.

Winning American Idol: try to be last

If you are appearing on American Idol or the X-Factor, try to be one of the last to sing. That's the conclusion from a new paper presented at a University of Westminster seminar today. Lionel Page and Katie Page look at an important topic - the evaluation of a sequential order of performances. Their paper, Biases in sequential performance evaluation, a field study on the Idol series (PDF), drew on a large dataset based on the ranking of contestants in live pop Idol shows in 8 countries (Australia, Brazil, Canada, Germany, India, Netherlands, UK, USA). That's 1,522 performances from over 165 shows. They found two main biases which influenced overall sequential performance ratings:

Our results suggest that the two mechanisms, memory and direct comparison, both play a role in the order bias. With respect to memory it appears that both primacy and recency effects are implicated when sequentially evaluating performance. Irrespective of ability, contestants who perform first are more likely to be positively evaluated than those who come in second and third positions, which provides evidence of a primacy effect. Contestants who perform in the later serial positions (particularly last position) have the largest advantage with respect to positive evaluations, implying a strong recency effect.p>

...The second bias we demonstrate is a direct comparison effect with the previous contestant. Specifically, one's performance evaluation is influenced by the evaluation of the previous contestant. If you perform after a weak contestant there is a bias such that you are more likely to be evaluated poorly than if you perform after a strong contestant. Therefore, we find evidence for an assimilation effect with respect to sequential judgments.

...Overall, we show that these two effects both operate and are important explanatory mechanisms in the evaluation of sequential performance.

Something to ponder when you go speed dating, or get a call to say you've been shortlisted for a job interview and are asked what slot you'd like.

UPDATE:

WSJ's Matt Phillips has obviously read my post, writing about the paper at the Journal's real Time Economics blog: Last Shall Be First in Idol Economics