An old post with some additions... had written this from my last visit to Kerala a few weeks back and forgot to post.
One of the distinguishing features of Kerala's rural landscape is the numerous massively opulent houses (even stylish) that spring up in the most unexpected of locations. An Econ 101 analysis of these houses suggests that there is considerable room for eliminating wastage and for efficiency gains. Here are just two strands
1. I can't believe that such houses have anything to do with functional utility since they are way beyond the daily requirements of its occupants. In fact, a large number of them are virtually uninhabited, occupied as they are by the old parents (mostly confined to one or two rooms) of the first generation expatriate.
This can leave us with only one conclusion - the size of the house is a clear signaling device. It becomes a "monument" to signal the new-found wealth of the family to the neighborhood and thereby seek a status elevation.
I am inclined to believe that even assuming the obvious purpose of signaling one's new found wealth to relatives and the local community, a less conspicuous/garish approach would have sufficed. Unlike the house-owners in bigger cities, who benchmark their houses in relation to the equally big or even bigger houses of their neighbors, the owners of these mansions in Kerala's villages have no competition.
In the circummstances, Governments may have an opportunity for a Pareto improvement intervention in such spending patterns. The urge for local recognition that drives people to make massive investments in such opulent houses could be channeled to more productive avenues. One route is to incentivize people to contribute towards construction of public assets like community halls, school and hospital buildings, or even roads, in return for naming rights to those assets. This mutually beneficial arrangement will ensure that the local community gets its desired public asset and the individual gets his high-visibility local public recognition.
The house-owner could now detach the process of house construction from the pursuit of social recognition. In fact, he gains both ways, the social recognition achieved by contributing to the construction of public assets is qualitatively different and in most cases much larger than that from building large houses. Further, his investment in the house is more optimal in so far as its life-cycle costs are now minimized (maintenance and repairs are smaller).
A full-fledged policy which incentivizes people to contribe towards construction of community assets in return for fulfilling the urge for social recognition is therefore likely to yield good returns in Kerala.
2. Building large houses is certainly not unique to Malayalis. Big houses are the mark of prosperity and, as indicated earlier, a very commonplace means of signaling status. However, I am inclined towards the argument that Kerala's mansions are different from those in other places, in so far as the overwhelming majority of its owners have amassed their wealth from their wages than from some entrepreneurial or business activity.
Further, a large share of these people intend to return back and settle in their villages after a few years, when their income sources are likely to be constrained (mostly fixed deposits or some commercial activity). In the circumstances, the large and illiquid investment in houses, with their recurring maintenance costs, mean a very large, often unbearable, opportunity cost.
Update 1 (19/9/2010)
Apparently Kerala is not the only place where immigrants build massively opulent houses to signal status. "Overseas Filipino Workers" too do the same.
Monday, June 7, 2010
Sunday, June 6, 2010
The role of social theories
Superb post from Daniel Little, who draws the distinction between the relative predictability (arising from reasonably high level of conformity to the laws of nature) and simplicity (so "that we can aggregate the effects of the relevant component processes into a composite description of the whole") of natural sciences and the complex and unpredictable path and context-dependent world of social sciences. He argues that there is little "real knowledge to be gained by applying social theories to a set of empirical circumstances",
Daniel Little's post should be a must read for all social scientists who often elevate theories to a pedestal and engineer social explanations and predictions to fit the underlying theories. No where is this more ubiquituous than in the field of economics.
Social science theories should function as enabling methods of research rather than act as all encompassing and comprehensive theories. They should be employed to help find explanations for past events and help predict future ones, instead of becoming blanket explanations and predictions themselves.
"My general inclination is to think that "applying" general social theories to specific social circumstances is not a valid way of creating new knowledge or understanding. This is because I believe that social ensembles reflect an enormous degree of plasticity and contingency; so general theories only "fit" them in the most impressionistic and non-explanatory way. We may have a pure structural theory of feudalism; but it is only the beginning of a genuinely knowledge-producing analysis of fourteenth-century French politics and economy or the Japanese samurai polity. At best the theory highlights certain issues as being salient -- the conditions of bonded labor, the nature of military dependency between lord and vassal. But the theory of feudalism does not permit us to "derive" particular features or institutions of French or Japanese society. "Feudalism" is an ideal type, a heuristic beginning for social analysis, rather than a general deductive and comprehensive theory of all feudal societies. And we certainly shouldn't expect that a general social theory will provide the template for understanding all of the empirical characteristics of a given instance of that theorized object...
allow Marxism, or Weber or Durkheim or Tilly, to function as a suggestive program of research for empirical investigation. Let it be a source of hypotheses, hunches, and avenues of inquiry. But be prepared as well for the discovery of surprising outcomes, and don't look at the theory as a prescription for the unfolding of the social reality. Most importantly, don't look to theory as a deductive basis for explaining and predicting social phenomena."
Daniel Little's post should be a must read for all social scientists who often elevate theories to a pedestal and engineer social explanations and predictions to fit the underlying theories. No where is this more ubiquituous than in the field of economics.
Social science theories should function as enabling methods of research rather than act as all encompassing and comprehensive theories. They should be employed to help find explanations for past events and help predict future ones, instead of becoming blanket explanations and predictions themselves.
Saturday, June 5, 2010
Economics of discrimination
I had blogged earlier about fve examples of that illustrate the importance of initial conditions, family and societal environment, and contextual factors in influencing outcomes in unexpected manners.
Now a Cornell University study "When Emotionality Trumps Reason" by Justin Gunnell and Stephen Ceci finds that unattractive defendants are 22% more likely to be convicted than good-looking ones, and that the unattractive also get slapped with harsher sentences - an average of 22 months longer in prison - and in case of damages more attractive people tend to receive higher rewards.
The study involved 169 Cornell psychology undergraduates who were initially classified as either rational or emotional decision-makers through an online survey and then given case studies of defendants, complete with a photograph and profile, were read jury instructions and asked to listen to the cases' closing arguments. In serious cases with strong evidence, there was little difference in the conviction rate between attractive and unattractive defendants. But in more minor cases, with ambiguous evidence, jurors were more biased toward the good-looking, confirming what the study calls a "unattractive harshness effect". Their conclusion,
Update 1 (8/7/2010)
A nation-wide record-linkage cohort study of over 950,000 Swedish men born 1950–75 with respect to attained education for up to 27 years after measurement of height at baseline age 18, finds strong co-relation between height and attained education in later life, after controlling for all other factors.
Update 2 (13/8/20010)
Freakonomics has this post with links to the various other types of discriminations.
Update 3 (9/9/2010)
Chris Dillow has links to lots of strange things that affect our earnings - looks and ugliness, height, marital status, sexual orientation, left-handedness, personality (pdf) or participation in sport, not to mention ethnicity and gender. We can add another to the list - an optimistic disposition - optimists out-perform their peers in the job market.
Update 4 (23/9/2010)
Freakonomics points to a study by Shamena Anwar, Patrick Bayer, and Randi Hjalmarsson which uses data from criminal trials and finds "strong evidence that all-white juries acquit whites more often and are less favorable to black versus white defendants when compared to juries with at least one black member".
Now a Cornell University study "When Emotionality Trumps Reason" by Justin Gunnell and Stephen Ceci finds that unattractive defendants are 22% more likely to be convicted than good-looking ones, and that the unattractive also get slapped with harsher sentences - an average of 22 months longer in prison - and in case of damages more attractive people tend to receive higher rewards.
The study involved 169 Cornell psychology undergraduates who were initially classified as either rational or emotional decision-makers through an online survey and then given case studies of defendants, complete with a photograph and profile, were read jury instructions and asked to listen to the cases' closing arguments. In serious cases with strong evidence, there was little difference in the conviction rate between attractive and unattractive defendants. But in more minor cases, with ambiguous evidence, jurors were more biased toward the good-looking, confirming what the study calls a "unattractive harshness effect". Their conclusion,
"Information processing can proceed through two pathways, a rational one and an experiential one. The former is characterized by an emphasis on analysis, fact and logical argument, whereas the latter is characterized by emotional and personal experience... Our hypothesis was that if we identify the two groups, then the experiential people are more likely to focus on extralegal factors (like attractiveness), which shouldn’t have any bearing on the legal process".
Update 1 (8/7/2010)
A nation-wide record-linkage cohort study of over 950,000 Swedish men born 1950–75 with respect to attained education for up to 27 years after measurement of height at baseline age 18, finds strong co-relation between height and attained education in later life, after controlling for all other factors.
Update 2 (13/8/20010)
Freakonomics has this post with links to the various other types of discriminations.
Update 3 (9/9/2010)
Chris Dillow has links to lots of strange things that affect our earnings - looks and ugliness, height, marital status, sexual orientation, left-handedness, personality (pdf) or participation in sport, not to mention ethnicity and gender. We can add another to the list - an optimistic disposition - optimists out-perform their peers in the job market.
Update 4 (23/9/2010)
Freakonomics points to a study by Shamena Anwar, Patrick Bayer, and Randi Hjalmarsson which uses data from criminal trials and finds "strong evidence that all-white juries acquit whites more often and are less favorable to black versus white defendants when compared to juries with at least one black member".
Friday, June 4, 2010
Why tax cuts are still not the remedy?
Nomura economist, Richard Koo had argued that currently we are passing through a "balance sheet deflation", wherein businesses and households have battered balance sheets which can be repaired only with fiscal policy (especially when monetary policy has lost traction). The magnitude of this cycle has been amplified by the fact that majority of the balance sheets were inflated by the valuations of assets which were in the first instancee purchased with unsustainable levels of debt. Once the bubble burst and the balance sheets exploded, forcing margin calls, defaults started, thereby amplifying the problem manifold.
Mark Thoma argues that in "balance sheet recessions" like the current one - where household (and business) balance sheets have been devastated by plunging asset (equity and homes) values - tax cuts can play an important role in repairing household balance sheets. This assumes importance in view of the fact that household spending, which is fundamental towards boosting aggregate demand, will get back to normal only when the debt holes in household balance sheets are refilled.
Ultimately, as Econ 101 teaches us, economic growth has to come by way of increased aggregate demand. For this to happen, repaired balance sheets help in so far as it encourages consumers to spend and businesses to invest. However, this indirect approach comes up against some pitfalls.
Taking households alone, the two major sources of balance sheet crisis are those arising from plunging asset values (and resultant "income-loss effect" which stunts consumption expenditure and causes a rise in effective mortgage values) and unemployment generated through lay-offs.
In the present case, the damage inflicted on balance sheets through the sub-prime meltdown and declines in asset values are too large, a few trillions of dollars, to be compensated with a few billions of dollars of tax cuts. For sure, these tax cuts, if properly targeted, will go into repairing balance sheets. But its impact is not likely to be much, unless it is relying on a vain hope that asset prices and market confidence will rebound adequately and in quick time and thereby repair the balance sheets. In the circumstances, one-off tax cuts, like the Bush tax rebate of Spring of 2008, will end up getting saved (and/or repay debts) and making limted impact on consumption.
Further, the damage caused by the largest post-war increase in unemployment rate cannot be repaired in any meaningful manner with one-off tax cuts. It can be argued that unemployment insurance is itself a form of targeted monthly/weekly income tax credit. However, as economists like Paul Krugman have been arguing, it is impossible to provide any significant boost to aggregate demand on a sustainable basis without quickly bringing down the record unemployment rates. Unfortunately, as Brad DeLong recently pointed out, unemployment appears far removed from the concerns of policymakers in the US.
It is in this context that the role of the multiplier assumes significance. Assuming a large enough multiplier for direct government spending, especially during recessions with the macroeconomic environment like now (and there is a very large and growing body of research to add credence to this claim), the arguement against tax cuts gains strength.
The other important objection against supply-side policies like tax cuts comes from the current macroeconomic environment. Despite widely expressed fears of impending inflationary spiral, all major indicators appears to inform that it is deflation and not inflation that should be the cause for concern for policymakers.
A cursory reading of the classic AS-AD curve indicates that when the supply increases without a commensurate increase in the AD (and from the aforementioned evidences, especially at a time like now, it is most likely that a major share of the tax cuts will not go into increasing AD), the prices will fall. In other words, tax cuts in a depressed economic environment like now, are likely to generate deflationary pressures.
In the final analysis, given the precarious fiscal position in most advanced economies, the priority should be on funneling resources into policies that deliver the greatest bang for the buck. In an ideal world, where resources are plentiful, all instruments of fiscal policy - tax cuts, infrastructure spending, and welfare measures - should be deployed.
However, when faced with a macroeconomic environment like now, policies than can directly boost the aggregate demand and generate plus-one multiplier are surely more attractive than ones that work their way slowly by repairing household and firm balance sheets. Moreover, policy makers should hope that they get a helping hand in repairing the balance sheets from the continuing expansionary monetary policy and a resurgence in the asset markets.
Mark Thoma argues that in "balance sheet recessions" like the current one - where household (and business) balance sheets have been devastated by plunging asset (equity and homes) values - tax cuts can play an important role in repairing household balance sheets. This assumes importance in view of the fact that household spending, which is fundamental towards boosting aggregate demand, will get back to normal only when the debt holes in household balance sheets are refilled.
Ultimately, as Econ 101 teaches us, economic growth has to come by way of increased aggregate demand. For this to happen, repaired balance sheets help in so far as it encourages consumers to spend and businesses to invest. However, this indirect approach comes up against some pitfalls.
Taking households alone, the two major sources of balance sheet crisis are those arising from plunging asset values (and resultant "income-loss effect" which stunts consumption expenditure and causes a rise in effective mortgage values) and unemployment generated through lay-offs.
In the present case, the damage inflicted on balance sheets through the sub-prime meltdown and declines in asset values are too large, a few trillions of dollars, to be compensated with a few billions of dollars of tax cuts. For sure, these tax cuts, if properly targeted, will go into repairing balance sheets. But its impact is not likely to be much, unless it is relying on a vain hope that asset prices and market confidence will rebound adequately and in quick time and thereby repair the balance sheets. In the circumstances, one-off tax cuts, like the Bush tax rebate of Spring of 2008, will end up getting saved (and/or repay debts) and making limted impact on consumption.
Further, the damage caused by the largest post-war increase in unemployment rate cannot be repaired in any meaningful manner with one-off tax cuts. It can be argued that unemployment insurance is itself a form of targeted monthly/weekly income tax credit. However, as economists like Paul Krugman have been arguing, it is impossible to provide any significant boost to aggregate demand on a sustainable basis without quickly bringing down the record unemployment rates. Unfortunately, as Brad DeLong recently pointed out, unemployment appears far removed from the concerns of policymakers in the US.
It is in this context that the role of the multiplier assumes significance. Assuming a large enough multiplier for direct government spending, especially during recessions with the macroeconomic environment like now (and there is a very large and growing body of research to add credence to this claim), the arguement against tax cuts gains strength.
The other important objection against supply-side policies like tax cuts comes from the current macroeconomic environment. Despite widely expressed fears of impending inflationary spiral, all major indicators appears to inform that it is deflation and not inflation that should be the cause for concern for policymakers.
A cursory reading of the classic AS-AD curve indicates that when the supply increases without a commensurate increase in the AD (and from the aforementioned evidences, especially at a time like now, it is most likely that a major share of the tax cuts will not go into increasing AD), the prices will fall. In other words, tax cuts in a depressed economic environment like now, are likely to generate deflationary pressures.
In the final analysis, given the precarious fiscal position in most advanced economies, the priority should be on funneling resources into policies that deliver the greatest bang for the buck. In an ideal world, where resources are plentiful, all instruments of fiscal policy - tax cuts, infrastructure spending, and welfare measures - should be deployed.
However, when faced with a macroeconomic environment like now, policies than can directly boost the aggregate demand and generate plus-one multiplier are surely more attractive than ones that work their way slowly by repairing household and firm balance sheets. Moreover, policy makers should hope that they get a helping hand in repairing the balance sheets from the continuing expansionary monetary policy and a resurgence in the asset markets.
Wednesday, June 2, 2010
More on the Chinese economic growth model
Tyler Cowen's post highlighting the fact that 21 of the 22 Chinese corporations listed on the Fortune Global 500 list are controlled by its central government or state-run banks, has ignited an interesting debate (the remaining one is run by a local government) on the Chinese model of economic development.
Matthew Yglesias makes the point that the success of countries like China and France over a long enough time period, calls to question the prevailing neo-liberal policy consensus in the US, which would have consigned countries following these policies as basket-cases. Ezra Klein has this to say about China's success
Tyler Cowen responds by attributing the success of China (and France) to a few specific characteristics. One, the high status associated with government bureaucrats means that it attracts the most talented individuals and thereby ensures that the government is manned by professionally competent individuals, atleast at the higher levels. Second, unlike the erstwhile Soviet Union, the Chinese government is dedicated towards the country's growth. Third, the Chinese government has ensured that its state-controlled enterprises compete (both among themselves and with multi-nationals) in a commercial environment. Fourth, "China is grabbing the low-hanging fruit by moving smart, hard-working individuals from rural jobs to highly productive jobs". However, this will invariably come up against the "you ought to shut down" constraint and the successes of state ownership "decays" with time. Finally, the overarching control exercised by the Communist Party ensures discipline to the inter-play of the market forces.
I am inclined to disagree with Tyler for the following point-to-point reasons
1. Bureaucrats enjoy very high prestige in India and entrance to the highest echelons of Indian bureaucracy are among the most prized of career options. Despite attracting the best and the brightest, its professional competence (over the life-cycle of a bureaucrat) is questionable. There are clearly other ingredients (uniquely Chinese or French) in the bureaucratic milieu that enables the bureaucracy to maintain high standards.
2. The claim that the Chinese government is committed to the country's growth is only a reaffirmation of the importance of the role of governments to a country's growth prospects.
3. The success of the Chinese government in creating competition among state-owned firms only clarifies that what is important is not who are competing (private or government firms), but that they are made to compete (and improve) and not collude (and stagnate). In fact, the deficiency of adequate level of competition among the big Wall Street firms was surely an important contributor to the recent spectacular failure of the financial markets. Competition is a function of government policies.
4. If there are enough low-hanging fruits to be grabbed for more than three decades, and it cannot be denied that the Chinese (and East Asian, in general) model has been overwhelmingly successful in grabbing them (more than any other), then bring it on! As the "constraints" start to kick in or the "decays" increase, the governments can calibrate their policies to suit the changing circumstances. And this is precisely what China appears to be doing.
5. The Great Recession and financial market meltdown that followed the bursting of the sub-prime bubble only highlights the disastrous consequences of the absence of adequate government control (read regulatory oversight) and the unfrettered play of market forces. If the Communist Party's iron-hand has had the effect of retaining strong government oversight and disciplining market forces, then it needs to be welcomed.
None of this is meant to defend the Chinese government. Far from it. In fact, the failures of the Chinese government are on a different scale and have highly disruptive long-term consequences - suppression of human rights, environmental devastation, rampant corruption, massive wastage (manifested in over-capacity and generous corporatee handouts and concessions), mis-allocation of resources across sectors (infrastructure spending against consumption), skewed regional development (hinterland Vs coast), disruptive and painful population transfers in the name of development etc. It is possible to contain many of these failings with a governance which is more open and democratic. However, it is undeniable that the Chinese government has been very conservative with its adherence to the norms of openness and democracy.
To its credit, China has benefitted from a government that has remained fairly close to the example of the Platonic "benevolent dictatorship". It is surely unrealistic to make national economic success dependent on such low probability variables (and history shows that such governments are outliers). Sure, the Chinese government has so far remained firmly committed towards achieving its growth objectives. But that can change any moment and in this uncertainty lies the great danger.
But at the other extreme, a full-fledged democracy, as the example of India shows, is likely to create policy paralysis and seriously constrain the growth path. So, in many respects, the gordian knot of being able to traverse the ideal middle-path, is to strike the right balance between open-ness (of a free-market) and discipline (of a strong government). In the real world, striking this balance becomes a formidable, even impossible, challenge. Either countries over-shoot on the side of open-ness (like India) or on the side of discipline (like China). On the balance of evidence so far (from across all of East Asia), the Chinese model concusively appears to be more successful than the India's approach.
In reply to Tyler's question about the desirability of other developing countries copying the Chinese model, I am (for the aforementioned reasons) inclined to argue that there are several important elements of it that are worthy of emulation, especially for countries with enough low-hanging fruits to be plucked. But the central ingredient that has held together the Chinese model - its reasonably disciplined and committed government - is not readily available elsewhere. In its absence, will the Chinese model deliver the desired results?
About the low hanging fruits, see this famous The Myth of Asia's Miracle article by Paul Krugman, which attributed its success to the simple process of adding inputs and shifting labor out of low-productivity sectors like farming into higher productivity sectors like factory labor. Matt Yglesias points to this and this.
Matthew Yglesias makes the point that the success of countries like China and France over a long enough time period, calls to question the prevailing neo-liberal policy consensus in the US, which would have consigned countries following these policies as basket-cases. Ezra Klein has this to say about China's success
"China's approach has been to marry market planning with state control. It brings in private companies and then uses the government's power to build the infrastructure they ask for. It lets private banks purchase up to 20 percent of state banks so that it gets private-sector expertise without relinquishing the public sector's control. It lets people buy shares of their financial institutions so it can get the oversight of the market, but it doesn't ever hand the market the reins. It uses the market to help plan, but it uses the state to act on those plans far faster and more decisively than the market ever could."
Tyler Cowen responds by attributing the success of China (and France) to a few specific characteristics. One, the high status associated with government bureaucrats means that it attracts the most talented individuals and thereby ensures that the government is manned by professionally competent individuals, atleast at the higher levels. Second, unlike the erstwhile Soviet Union, the Chinese government is dedicated towards the country's growth. Third, the Chinese government has ensured that its state-controlled enterprises compete (both among themselves and with multi-nationals) in a commercial environment. Fourth, "China is grabbing the low-hanging fruit by moving smart, hard-working individuals from rural jobs to highly productive jobs". However, this will invariably come up against the "you ought to shut down" constraint and the successes of state ownership "decays" with time. Finally, the overarching control exercised by the Communist Party ensures discipline to the inter-play of the market forces.
I am inclined to disagree with Tyler for the following point-to-point reasons
1. Bureaucrats enjoy very high prestige in India and entrance to the highest echelons of Indian bureaucracy are among the most prized of career options. Despite attracting the best and the brightest, its professional competence (over the life-cycle of a bureaucrat) is questionable. There are clearly other ingredients (uniquely Chinese or French) in the bureaucratic milieu that enables the bureaucracy to maintain high standards.
2. The claim that the Chinese government is committed to the country's growth is only a reaffirmation of the importance of the role of governments to a country's growth prospects.
3. The success of the Chinese government in creating competition among state-owned firms only clarifies that what is important is not who are competing (private or government firms), but that they are made to compete (and improve) and not collude (and stagnate). In fact, the deficiency of adequate level of competition among the big Wall Street firms was surely an important contributor to the recent spectacular failure of the financial markets. Competition is a function of government policies.
4. If there are enough low-hanging fruits to be grabbed for more than three decades, and it cannot be denied that the Chinese (and East Asian, in general) model has been overwhelmingly successful in grabbing them (more than any other), then bring it on! As the "constraints" start to kick in or the "decays" increase, the governments can calibrate their policies to suit the changing circumstances. And this is precisely what China appears to be doing.
5. The Great Recession and financial market meltdown that followed the bursting of the sub-prime bubble only highlights the disastrous consequences of the absence of adequate government control (read regulatory oversight) and the unfrettered play of market forces. If the Communist Party's iron-hand has had the effect of retaining strong government oversight and disciplining market forces, then it needs to be welcomed.
None of this is meant to defend the Chinese government. Far from it. In fact, the failures of the Chinese government are on a different scale and have highly disruptive long-term consequences - suppression of human rights, environmental devastation, rampant corruption, massive wastage (manifested in over-capacity and generous corporatee handouts and concessions), mis-allocation of resources across sectors (infrastructure spending against consumption), skewed regional development (hinterland Vs coast), disruptive and painful population transfers in the name of development etc. It is possible to contain many of these failings with a governance which is more open and democratic. However, it is undeniable that the Chinese government has been very conservative with its adherence to the norms of openness and democracy.
To its credit, China has benefitted from a government that has remained fairly close to the example of the Platonic "benevolent dictatorship". It is surely unrealistic to make national economic success dependent on such low probability variables (and history shows that such governments are outliers). Sure, the Chinese government has so far remained firmly committed towards achieving its growth objectives. But that can change any moment and in this uncertainty lies the great danger.
But at the other extreme, a full-fledged democracy, as the example of India shows, is likely to create policy paralysis and seriously constrain the growth path. So, in many respects, the gordian knot of being able to traverse the ideal middle-path, is to strike the right balance between open-ness (of a free-market) and discipline (of a strong government). In the real world, striking this balance becomes a formidable, even impossible, challenge. Either countries over-shoot on the side of open-ness (like India) or on the side of discipline (like China). On the balance of evidence so far (from across all of East Asia), the Chinese model concusively appears to be more successful than the India's approach.
In reply to Tyler's question about the desirability of other developing countries copying the Chinese model, I am (for the aforementioned reasons) inclined to argue that there are several important elements of it that are worthy of emulation, especially for countries with enough low-hanging fruits to be plucked. But the central ingredient that has held together the Chinese model - its reasonably disciplined and committed government - is not readily available elsewhere. In its absence, will the Chinese model deliver the desired results?
About the low hanging fruits, see this famous The Myth of Asia's Miracle article by Paul Krugman, which attributed its success to the simple process of adding inputs and shifting labor out of low-productivity sectors like farming into higher productivity sectors like factory labor. Matt Yglesias points to this and this.
Tuesday, June 1, 2010
Defunct consultant!
John Maynard Keynes said this about economic policy making between the wars
It could easily be re-phrased as...
... to describe the state of administration in many important sectors.
"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."
It could easily be re-phrased as...
"The ideas of consultants and experts, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Politicians and bureaucrats, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct consultant or self-proclaimed development expert."
... to describe the state of administration in many important sectors.
Growth, stabilization and recovery policies
Mark Thoma has two interesting posts that differentiate between macroeconomic policies that are pursued to promote economic growth (policy that attempts to maximize the long-run growth rate) and stabilize growth (keeping the economy as close as possible to the long-run growth path).
Since the early 1980s, coinciding with the period of "The Great Moderation", pursuing the stabilization policy using the prevailing New Keynesian model involved "targeting an interest rate with a Taylor rule that responds to output and inflation, where the response to inflation was more than one to one". The remarkable, two-decade long stability (in growth and inflation) gave the impression that the business cycle had been conquered (and optimal stabilization policy achieved) using monetary policy. It was now felt that all other macroeconomic policy levers, including fiscal policy, could now be deployed to pursue the maximum growth objective.
This conventional wisdom meant that even when the world economy entered the Great Recession, policy-makers were interested in pursuing policies like tax cuts and infrastructure spending that were skewed more towards long-run economic growth instead of stabilization. He writes,
In another article, Mark Thoma examines the policies required to stabilize the economy by effectively managing an economic recovery. Primarily, given the uncertainty surrounding the nature of the recovery (V, U, L, W-shaped) and the persistance of high unemployment rate, he argues that any exit from the expansionary fiscal and monetary stimuluses may be premature. Given the clear lag between economic recovery, the magnitude of the job losses, and the extent and duration of growth required to reach normalcy in the labor markets, specific policies aimed at adding jobs would be essential to make any meaningful dent on the unemployment situation even on the medium-term.
The emergence of structural unemployment due to the shake-ups in the housing and financial sectors and general business re-organization in response to the recession, means that millions of workers may have to re-equip themselves with newer skills. Passively relying on economic growth and the dynamics of the markets is only likely to create the conditions for a painful and slow recovery path. Aggressive government intervention in the form of specifically tailored job-creation policies is a necessity. Mark Thoma also advocates support for state and local governments, whose forced contractionary policies, have the potential to off-set the beneficial effects of any centrally managed stimulus programs.
See earlier posts here, here, and here which talk specifically about job-creation policies.
Since the early 1980s, coinciding with the period of "The Great Moderation", pursuing the stabilization policy using the prevailing New Keynesian model involved "targeting an interest rate with a Taylor rule that responds to output and inflation, where the response to inflation was more than one to one". The remarkable, two-decade long stability (in growth and inflation) gave the impression that the business cycle had been conquered (and optimal stabilization policy achieved) using monetary policy. It was now felt that all other macroeconomic policy levers, including fiscal policy, could now be deployed to pursue the maximum growth objective.
This conventional wisdom meant that even when the world economy entered the Great Recession, policy-makers were interested in pursuing policies like tax cuts and infrastructure spending that were skewed more towards long-run economic growth instead of stabilization. He writes,
"Other types of spending, the types that get money into people’s hands and puts people to work right away, might have worked faster and had a greater benefit in terms of moving the economy closer to trend, but since these policies were harder to justify in terms of their contribution to long-run growth, they could not find the support they needed...
The policies that maximize growth are different from the polices that stabilize the economy, and insistence that all policies can be justified by their contribution to long-run growth causes us to sacrifice economic stability. The policies we put into place should pay attention to both goals, but I believe we have paid far too much attention to growth in formulating recent policy, and not nearly enough to stability... we have to realize that stabilization is an important policy goal, and that it does not always lead to the same policies that are needed to maximize growth."
In another article, Mark Thoma examines the policies required to stabilize the economy by effectively managing an economic recovery. Primarily, given the uncertainty surrounding the nature of the recovery (V, U, L, W-shaped) and the persistance of high unemployment rate, he argues that any exit from the expansionary fiscal and monetary stimuluses may be premature. Given the clear lag between economic recovery, the magnitude of the job losses, and the extent and duration of growth required to reach normalcy in the labor markets, specific policies aimed at adding jobs would be essential to make any meaningful dent on the unemployment situation even on the medium-term.
The emergence of structural unemployment due to the shake-ups in the housing and financial sectors and general business re-organization in response to the recession, means that millions of workers may have to re-equip themselves with newer skills. Passively relying on economic growth and the dynamics of the markets is only likely to create the conditions for a painful and slow recovery path. Aggressive government intervention in the form of specifically tailored job-creation policies is a necessity. Mark Thoma also advocates support for state and local governments, whose forced contractionary policies, have the potential to off-set the beneficial effects of any centrally managed stimulus programs.
See earlier posts here, here, and here which talk specifically about job-creation policies.
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