Paul Krugman has a working draft that argues and models how increasing returns, in the form of localized external economies, plays a major role in explaining trade patterns even in a world of comparative advantage.
He traces the history of international trade to three parts - pre-War (export of different goods - manufactures and primary products - based on comparative advantage), post-War (trade between similar countries and similar products, driven by increasing returns due to specialization and explained using models of monopolistic competition), and post-trade liberalization of the eighties (comparative advanatage driven trade between developing and developed countries in manufactured goods based on their labor and skill intensities).
Standard trade theories have sought to explain international trade in terms of comparative advantage and increasing returns from specialization. In the past two decades, increasing returns have taken the form of localized external economies (or the concentration of specialized industries in particular localities) which has been sustained by Alfred Marshall's trinity of agglomeration effects - information spillovers (network effects in the knowledge economy), specialized suppliers, and thick labor markets.
Krugman illustrates this with the example of China's comparative advantage with abundant labor and relatively high manufacturing competence, and its high degree of industrial localization - 60% of the world’s buttons are manufactured in the small town of Qiaotou, Wenzhou produces 95% of the world’s cigarette lighters, and Yanbu is the underwear capital of the world! While comparative advantage explains the overall pattern of trade, external economies explains the national origins of industrialization based on local differentiation and specialization. He writes about the double gain from trade
"There are gains from trade due to the specialization of China in labor-intensive industries like button manufacture, but there are further gains from trade – gains that accrue to the world as a whole – from the concentration of world button production in the single small town of Qiaotou... eras in which comparative advantage seems to have ruled international trade are also the eras in which increasing returns has seemed to exert its strongest influence on intra-national economic geography... gains from localization arguably are a significant source of gains from trade, even if they don’t seem to affect the pattern of specialization."
Krugman invokes the role of external economies of local industrialization to argue that the depressing effect (arising from the Samuelson-Stolper effect) of labor intensive imports from developing countries on the real wages of less-skilled workers (who are relatively less abundant there) in developed economies may not be as large as claimed. Further, there is always the possibility that the Stolper-Samuelson reduction in wages of American workers has been covered by the TFP increases due to import competition.
Sunday, November 8, 2009
Nominal spending crash and the Great Recession
David Beckworth has two graphs that depicts the nominal spending changes in the US economy and among OECD economies for the half century since 1960, which are strikingly similar, especially in the great crash in nominal spending since the later half of 2008.
The immediate conclusion drawn from this is the apparent insufficiency of monetary expansion in recent times. Marginal Revolution feels that some inflation could give nominal spending a boost. Paul Krugman, though differs and uses the money supply-velocity equation (MV=PY) to argue that focussing on nominal spending when faced with a liquidity trap monetary policy has no traction. The equation itself tells us that "any changes in the money supply are offset one for one by changes in velocity". Further, in the real world, where Central Banks control only the monetary base (and not the money supply), money supply becomes constrained in any case when facing the liquidity trap.
See also Beckworth's response to Krugman here, where he argues that changing expectations of future inflation can make monetary policy effective and this in turn can be achieved with the Fed annoucing an explicit inflation target. Free Exchange's response is here.
The fundamental issue here is whether monetary policy will have any more steam in stimulating demand given the present circumstances. Supporters say that "if you put enough money in the hands of American consumers, then eventually they'll begin spending it" and there are many ways to do this. Opponents like Krugman say that, all this is fine under ordinary cirumstances, but when faced with the zero-bound liquidity trap, people will just save or pay-off debts and not spend the money put into their pockets. In any case, when economists and historians discuss the Great Recession in later years, this will surely be one of the most contentious issues of debate.
The immediate conclusion drawn from this is the apparent insufficiency of monetary expansion in recent times. Marginal Revolution feels that some inflation could give nominal spending a boost. Paul Krugman, though differs and uses the money supply-velocity equation (MV=PY) to argue that focussing on nominal spending when faced with a liquidity trap monetary policy has no traction. The equation itself tells us that "any changes in the money supply are offset one for one by changes in velocity". Further, in the real world, where Central Banks control only the monetary base (and not the money supply), money supply becomes constrained in any case when facing the liquidity trap.
See also Beckworth's response to Krugman here, where he argues that changing expectations of future inflation can make monetary policy effective and this in turn can be achieved with the Fed annoucing an explicit inflation target. Free Exchange's response is here.
The fundamental issue here is whether monetary policy will have any more steam in stimulating demand given the present circumstances. Supporters say that "if you put enough money in the hands of American consumers, then eventually they'll begin spending it" and there are many ways to do this. Opponents like Krugman say that, all this is fine under ordinary cirumstances, but when faced with the zero-bound liquidity trap, people will just save or pay-off debts and not spend the money put into their pockets. In any case, when economists and historians discuss the Great Recession in later years, this will surely be one of the most contentious issues of debate.
Cost of Bush tax cuts - $2.34 trillion!
When the Bush era tax cuts expire next year, they would have cost the US Government $2.34 trillion, 61.4% of which would have gone to the top quintile of Americans. When the cuts expire, the two top tax rates will move up from 33% and 35% to 36% and 39.6% respectively.
US Health Care reform plan approved in House
The US health care reform bandwagon moves one step closer with the House of Representatives passing the Affordable Health Care for America Act, that that would overhaul the health insurance system and expand coverage at a cost of $1.1 trillion over 10 years. The Bill will now be debated and voted upon in the Senate.
The Plan, paid for through new fees and taxes (income surtax on individuals earning more than $500,000 and couples earning more than $1 million), along with cuts in Medicare, would extend coverage to 36 million people now without insurance while creating a government health insurance program, significantly expand Medicaid and would offer subsidies to help moderate-income people buy insurance from private companies or from a government insurance plan. The Bill would also require most Americans to obtain health insurance or face penalties, force most employers to provide coverage or pay a tax penalty of up to 8% of their payroll, and also end insurance company practices like not covering pre-existing conditions or dropping people when they become ill. It would also set up a national insurance exchange where people could shop for coverage.
The government insurance plan (aka Public option), would offer the same benefits and comply with same insurance market reforms as those offered by private and non-profit insurance co-operatives, and would negotiate rates with doctors and hospitals to be financially self-sustaining. A comparison of different proposals with the House approved version is available here. See also this interactive graphic of the history of health care reforms in the US.
In a reflection of the power of lobby groups and the influence of individual right activists, the House Democrats had to bow down to pressures from certain conservative Democrats and limit elective abortion coverage from both private and public insurers on the exchange. The proposal will prohibit federal funds for abortion services in the public option and also prohibits individuals who receive affordability credits from purchasing a plan that provides elective abortions.
The Plan, paid for through new fees and taxes (income surtax on individuals earning more than $500,000 and couples earning more than $1 million), along with cuts in Medicare, would extend coverage to 36 million people now without insurance while creating a government health insurance program, significantly expand Medicaid and would offer subsidies to help moderate-income people buy insurance from private companies or from a government insurance plan. The Bill would also require most Americans to obtain health insurance or face penalties, force most employers to provide coverage or pay a tax penalty of up to 8% of their payroll, and also end insurance company practices like not covering pre-existing conditions or dropping people when they become ill. It would also set up a national insurance exchange where people could shop for coverage.
The government insurance plan (aka Public option), would offer the same benefits and comply with same insurance market reforms as those offered by private and non-profit insurance co-operatives, and would negotiate rates with doctors and hospitals to be financially self-sustaining. A comparison of different proposals with the House approved version is available here. See also this interactive graphic of the history of health care reforms in the US.
In a reflection of the power of lobby groups and the influence of individual right activists, the House Democrats had to bow down to pressures from certain conservative Democrats and limit elective abortion coverage from both private and public insurers on the exchange. The proposal will prohibit federal funds for abortion services in the public option and also prohibits individuals who receive affordability credits from purchasing a plan that provides elective abortions.
Saturday, November 7, 2009
Mobile phones to deliver PDS rice?
Freakonomics points attention to the World Food Program's (WFP) decision to deliver food vouchers to Iraqi refugee families in Syria through mobile phones using SMS text messaging.
The WFP will send a 22-dollar (15-euro) voucher every two months by SMS to each family (who will be provided with a special SIM card), who can then exchange the electronic voucher for rice, wheat flour, lentils, chickpeas, oil, canned fish, cheese and eggs at selected shops.
Our Public Distribution System (PDS) could take a leaf out of this and effectively target the delivery of rations under the scheme. Mobile phones can help overcome the targeting problem by SMS-ing the monthly ration vouchers directly to the consumer, who can in turn show the SMS and avail of his ration from his designated ration shop.
The WFP will send a 22-dollar (15-euro) voucher every two months by SMS to each family (who will be provided with a special SIM card), who can then exchange the electronic voucher for rice, wheat flour, lentils, chickpeas, oil, canned fish, cheese and eggs at selected shops.
Our Public Distribution System (PDS) could take a leaf out of this and effectively target the delivery of rations under the scheme. Mobile phones can help overcome the targeting problem by SMS-ing the monthly ration vouchers directly to the consumer, who can in turn show the SMS and avail of his ration from his designated ration shop.
The future of auto insurance?
California announces regulations to pioneer pay-as-you-drive insurance policies that allow motorists to buy insurance based on the miles they drive. Per-mile pricing, using measuring devices like Mile Meters, are expected to incentivize consumers to optimize on their vehicle use.
Such insurance is being seen as a means "to accurately tie insurance cost to accident risk, and to provide an incentive to walk, bike or use public transportation". Incentives like higher per-mile insurance cost for those who have higher mileage would entice people to optimize on their private vehicle use.
Coupled with policies on congestion pricing, parking etc, such per-mile insurance could go a long way in increasing the efficiency in private vehicle usage, relieving traffic congestion and increasing road safety.
Such insurance is being seen as a means "to accurately tie insurance cost to accident risk, and to provide an incentive to walk, bike or use public transportation". Incentives like higher per-mile insurance cost for those who have higher mileage would entice people to optimize on their private vehicle use.
Coupled with policies on congestion pricing, parking etc, such per-mile insurance could go a long way in increasing the efficiency in private vehicle usage, relieving traffic congestion and increasing road safety.
Friday, November 6, 2009
What is wrong with development policy making?
Longish essay (more on the theoretical and abstract front), summarizing impressions on development policy making.
It is commonplace to have development experts and multi-lateral institutions venturing diagnosis of what ails a developing country and ready-to-implement prescriptions for those problems. They despair that corruption and weak governance are holding back these economies from effectively implementing these magic solutions. Is development as simple as these experts would suggest? Is it merely an issue of our not being able to translate a simple policy prescription into tangible action at the field level?
Invest in education and health care to unleash the full potential of your human resources. Reform governance institutions and processes to be transparent, responsive, and participatory. Design policies to align the incentives of the private sector with the larger economic goals. Open the economy, internally and externally, to free movement of capital, labour and technology. Put in place adequate social security and welfare cushions for the disadvantaged and the poor.
The aforementioned recipe, with small variations, is the general one-size-fits-all panacea to any developing country's ills. But as the East Asian and most impressively the Chinese and Indian examples show, these models are chasing the shadows. Decentralization, transparency, good governance, equity were all given lip-service in the Chinese success.
Accordingly, elections are foisted on institutionally deficient polities in the name of democracy, public utilities and services are privatized in the name of efficiency, welfare government role gets rolled back in the name of corruption, and the economy gets deregulated and opened up in the name of globalization and free trade. With the prescriptions implemented one would naturally expect these developing countries to prosper. But recent history of development economics is replete with numerous failed examples of such experimentation. In fact, for many decades now Latin America has been the laboratory for innumerable such experiments with all versions of the liberal free market economy. And the results are for everyone to see!
There are three major traditional explanations for the problems facing developing economies - lack of resources (and so need for massive foreign aid), lack of proper markets (so deregulation and privatization), and weak and corrupt governments (so need for better governance). All three are possible deficiencies in countries, but none of them alone are enough to explain the problems facing these countries. Any explanation requires going beyond this paradigm.
Dani Rodrik explains his approach towards development economics thus, "the right way to approach development policy is to start with the view that we actually don't know where the problems lie, to acknowledge that the key problems may differ from setting to setting, and to adopt an explicitly experimental attitude to policy selection and formulation so that you can learn about the environment in which you operate. In this approach, monitoring and evaluation are key, as you want to pull back from mistakes and improve policies over time. Indeed, you build the monitoring into the policy process itself so that learning becomes part and parcel of it - rather than something you leave to your researchers or economists."
The development contexts in developing countries exhibit spectacular diversity - racial, linguistic, economic, geographic, societal, and religious. A similar set of problems in different countries may manifest as widely varying outcomes. The same set of policy prescriptions may throw up contrary outcomes in countries with the same social contexts. The inter-play of these forces leads to the emergence of patterns of development that goes beyond the scope of any econometric model. These forces interact with each other both at the micro and the macro levels, at the individual and societal level, revealing a whole spectrum of socio-economic outcomes. There exists multiple equilibria for each socio-economic and political context.
All these forces play themselves out in an even more complex and unstable social and political setting, which intimately and immediately influences the final outcomes of this game. Unfortunately, these models give no place for social and political forces and the need to accomodate them in any reform process. It presumed that these forces will be swept away in the remorseless march of the reform process and a new political alignment and equilibrium would develop. In many ways, it is ironical that neo-classical economics is advocating such a transformation, more revolutionary than anything even Marx had advocated, in the political system.
The over-riding concern with institutional weakness, governance deficiencies and corruption has led to an atmosphere of distrust of government and its institutions in developing countries. Standard development models have no place for existing government systems and clamour for wholesale institutional and process transplants. These models see little prospect of any success without such wholesale reforms. It can be said, there is either a best practice/policy/model or there is no hope!
A traditional economist scrutinizes any development policy through a looking glass which focusses on increasing aggregate demand, efficient allocation of resources, least distortionary incentives, and distributive justice. The standard prescriptions include good governance, strong institutions, decentralization, open markets, flexible labor policies, deregulation, privatization etc. There are also specific sets of prescriptions to achieve each of these objectives.
A linear and incremental outlook towards policies and their implementation and movement of societal forces, is not the most ideal way forward. Addressing development challenges in complex settings like in many Asian and African countries often requires a two-track, heterodox approach, straddling contradictory platforms - orthodox and unorthodox, public and private, open and closed, legal and informal. Thus regulation has to co-exist with free markets, legal and extra-legal have to go hand in hand. Phasing and sequencing of reforms vary across societies and economies.
There is no single "optimal reform trajectory", which can be emulated by all nations and societies. What is suitable for one developing country may not be so for another. The same development strategies and reforms may throw up contrasting outcomes in different societies. Finding out what is most appropriate for any country or society is more an exercise in experimentation than any theoretical analysis. Ex post rationalizations are more likely to be successful than ex ante analyses.
As Dani Rodrik says, it is not that economic principles work differently in different places, or need to be tailored to local conditions, but their institutional embodiments vary. He writes,
Development requires all or some of the aforementioned conventional prescriptions and much more. It is essential to embrace the more unconventional and innovative context-specific approaches, besides exploring, analyzing and drawing from the micro-foundations of development challenges/problems (as is being done by experimenters through RCTs etc). Accordingly, a kaleidoscope of policy alternatives may have to be applied depending on the socio-economic and political contexts.
It is commonplace to have development experts and multi-lateral institutions venturing diagnosis of what ails a developing country and ready-to-implement prescriptions for those problems. They despair that corruption and weak governance are holding back these economies from effectively implementing these magic solutions. Is development as simple as these experts would suggest? Is it merely an issue of our not being able to translate a simple policy prescription into tangible action at the field level?
Invest in education and health care to unleash the full potential of your human resources. Reform governance institutions and processes to be transparent, responsive, and participatory. Design policies to align the incentives of the private sector with the larger economic goals. Open the economy, internally and externally, to free movement of capital, labour and technology. Put in place adequate social security and welfare cushions for the disadvantaged and the poor.
The aforementioned recipe, with small variations, is the general one-size-fits-all panacea to any developing country's ills. But as the East Asian and most impressively the Chinese and Indian examples show, these models are chasing the shadows. Decentralization, transparency, good governance, equity were all given lip-service in the Chinese success.
Accordingly, elections are foisted on institutionally deficient polities in the name of democracy, public utilities and services are privatized in the name of efficiency, welfare government role gets rolled back in the name of corruption, and the economy gets deregulated and opened up in the name of globalization and free trade. With the prescriptions implemented one would naturally expect these developing countries to prosper. But recent history of development economics is replete with numerous failed examples of such experimentation. In fact, for many decades now Latin America has been the laboratory for innumerable such experiments with all versions of the liberal free market economy. And the results are for everyone to see!
There are three major traditional explanations for the problems facing developing economies - lack of resources (and so need for massive foreign aid), lack of proper markets (so deregulation and privatization), and weak and corrupt governments (so need for better governance). All three are possible deficiencies in countries, but none of them alone are enough to explain the problems facing these countries. Any explanation requires going beyond this paradigm.
Dani Rodrik explains his approach towards development economics thus, "the right way to approach development policy is to start with the view that we actually don't know where the problems lie, to acknowledge that the key problems may differ from setting to setting, and to adopt an explicitly experimental attitude to policy selection and formulation so that you can learn about the environment in which you operate. In this approach, monitoring and evaluation are key, as you want to pull back from mistakes and improve policies over time. Indeed, you build the monitoring into the policy process itself so that learning becomes part and parcel of it - rather than something you leave to your researchers or economists."
The development contexts in developing countries exhibit spectacular diversity - racial, linguistic, economic, geographic, societal, and religious. A similar set of problems in different countries may manifest as widely varying outcomes. The same set of policy prescriptions may throw up contrary outcomes in countries with the same social contexts. The inter-play of these forces leads to the emergence of patterns of development that goes beyond the scope of any econometric model. These forces interact with each other both at the micro and the macro levels, at the individual and societal level, revealing a whole spectrum of socio-economic outcomes. There exists multiple equilibria for each socio-economic and political context.
All these forces play themselves out in an even more complex and unstable social and political setting, which intimately and immediately influences the final outcomes of this game. Unfortunately, these models give no place for social and political forces and the need to accomodate them in any reform process. It presumed that these forces will be swept away in the remorseless march of the reform process and a new political alignment and equilibrium would develop. In many ways, it is ironical that neo-classical economics is advocating such a transformation, more revolutionary than anything even Marx had advocated, in the political system.
The over-riding concern with institutional weakness, governance deficiencies and corruption has led to an atmosphere of distrust of government and its institutions in developing countries. Standard development models have no place for existing government systems and clamour for wholesale institutional and process transplants. These models see little prospect of any success without such wholesale reforms. It can be said, there is either a best practice/policy/model or there is no hope!
A traditional economist scrutinizes any development policy through a looking glass which focusses on increasing aggregate demand, efficient allocation of resources, least distortionary incentives, and distributive justice. The standard prescriptions include good governance, strong institutions, decentralization, open markets, flexible labor policies, deregulation, privatization etc. There are also specific sets of prescriptions to achieve each of these objectives.
A linear and incremental outlook towards policies and their implementation and movement of societal forces, is not the most ideal way forward. Addressing development challenges in complex settings like in many Asian and African countries often requires a two-track, heterodox approach, straddling contradictory platforms - orthodox and unorthodox, public and private, open and closed, legal and informal. Thus regulation has to co-exist with free markets, legal and extra-legal have to go hand in hand. Phasing and sequencing of reforms vary across societies and economies.
There is no single "optimal reform trajectory", which can be emulated by all nations and societies. What is suitable for one developing country may not be so for another. The same development strategies and reforms may throw up contrasting outcomes in different societies. Finding out what is most appropriate for any country or society is more an exercise in experimentation than any theoretical analysis. Ex post rationalizations are more likely to be successful than ex ante analyses.
As Dani Rodrik says, it is not that economic principles work differently in different places, or need to be tailored to local conditions, but their institutional embodiments vary. He writes,
"Incentives, competition, hard-budget constraints, sound money, fiscal sustainability, property rights are central to the ways in which economists think about policy and its reform. But these principles do not demand specific institutional solutions. Property rights can be implemented through common law, civil law, or, for that matter, Chinese-style socialism. Competition can be maintained by a combination of free entry and laissez-faire, or by a well-functioning regulatory authority. Macroeconomic stability can be achieved under a variety of fiscal institutions." Economic principles should be implemented through formal and informal institutions that have been suitably adaped to meet local demands and requirements.
Quite often the success of NGOs in social and economic development enggineering is presented as proof of the failure of government in addressing development issues. This euphoria invariably overlooks the important fact that such success stories are most often isolated and one-off examples. These examples present interesting challenges of scalability and are excellent examples of the inherent limitations of the very model that achieved the success story.
History is replete with examples of the failed grand development narratives. We can make a better start this time by acknowledging that there can be no grand narrative in development economics in the first place. Only a series of smaller narratives, which emerge through the routine exercise of trial and error, and not as part of a grand policy or design. The challenge is to smoothen this process of trial and error, so as to minimize costs and expedite the process."
Development requires all or some of the aforementioned conventional prescriptions and much more. It is essential to embrace the more unconventional and innovative context-specific approaches, besides exploring, analyzing and drawing from the micro-foundations of development challenges/problems (as is being done by experimenters through RCTs etc). Accordingly, a kaleidoscope of policy alternatives may have to be applied depending on the socio-economic and political contexts.
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