February 27, 2004
How Strong a Supporter of International Capital Mobility Can I Still Be?
How Strong a Supporter of International Capital Mobility Can I Still Be?
J. Bradford DeLong
February 27, 2004; draft 2.0; 1843 words
Fifteen years ago, I at least found that was easy to be in favor of international capital mobility. It was easy to preach for an end to the systems of controls on capital that hindered the flow of investment financing from one country to another.
Capital controls created large-scale opportunities for corruption. Whoever got the scarce permissions to borrow abroad had a good chance of becoming rich, and somehow those who got the scarce permissions to borrow abroad often turned out to be married to the niece of the vice-minister of finance. A highly corrupt society is one in which tax rates are idiosyncratically and randomly high, and cannot be a productive society. Eliminating capital controls seemed likely to be a great help in the general anti-corruption drive.
Capital controls kept the level of investment in peripheral developing countries down. This seemed to be a very bad thing. Higher investment boosts the capital stock and so directly raises labor productivity and wages. It also acts as a carrier for those important parts of technological advance that are embodied in the machines that are at the heart of so much of the productivity growth of the past two centuries.
There appeared to be four important reasons to be in favor of removing capital controls: (1) The direct boost to production and productivity to follow from the removal of this barrier to market exchange. (2) The reduction in corruption and improvement in the quality of government that we hoped would follow. (3) The fact that our social welfare function places a higher weight on the utility of the poor than does the social welfare function implicitly maximized by the market, and so we place a large positive value on the improvement in the income distribution that follows from enlarging the supply of the scarce factor--capital--in capital-poor countries. And (4) the external benefits that flow from learning-by-doing using modern machinery and from capital imports as a carrier of technological knowledge.
These four reasons seemed to me back then to make up an overwhelming case.
Today, however, it is much harder to be a supporter of untrammelled international capital mobility.
Those of us card-carrying neoliberals who pushed for large-scale opening of capital flows in the early 1990s had a particular vision of the future in our minds' eyes. We looked at how extraordinarily strongly the world's system of relative prices was tilted against the poor: how cheap were the products that they exported, and how expensive were the capital goods made in the post-industrial core that they needed to import in order to industrialize and develop. "Why not free up capital flows and so encourage large-scale lending from the world's rich countries to the world's poor countries?" we asked. Such large-scale lending might cut a generation off the time it would take economies where people were poor to converge to the industrial structures and living standards of countries where people were rich. Certainly such large-scale borrowing and lending had played a key role in the economic development of the late-nineteenth century temperate periphery of Canada, the western United States, Australia, New Zealand, Chile, Argentina, Uruguay, and South Africa more than a century ago.
But the future we saw did not come to pass.
Instead of capital flowing from rich to poor, it flowed from poor to rich--and overwhelmingly in recent years into the United States of America, whose rate of capital inflow is now the largest of any country, anytime, anywhere. Central banks that sought to keep the values of their home currencies down so that their workers could gain valuable experience in exporting manufactures to the post-industrial core, first-world investors who feared sending their money down the income and productivity gap after the crises of Mexico '95, East Asia '97, and Russia '98, techno-enthusiasts chasing the returns of the American technology boom, the third-world rich who thought a large Deutsche Bank account would be a good thing to have in case something went wrong and they suddenly had to flee the country in the rubber boat (or the Learjet)--all of these fueled the flow of money into the United States, which was thus enabled to invest much more than it managed to save. The U.S. economy became, and remains, a giant vacuum cleaner, soaking up all the world's spare investible cash. As best we can calculate, the United States has run current-account deficits averaging 2.5% of GDP over the past two decades--that's $270 billion a year at today's level of GDP. Only one-third of this can be attributed to inflows from the developing world, but $90 billion a year is still the (current exchange rate) income of the poorest 500 million people in India.
The fact that the flow of capital seemed more to go from poor to rich than from rich to poor, that capital flowed by and large to capital-abundant regions like the United States, was disturbing. International capital mobility was supposed to add to, not drain, the pool of funds financing development in peripheral countries.
Even more worrisome was the extraordinary vulnerability of peripheral countries with open capital flows to financial crises. Currency mismatch, duration mismatch, risk mismatch left Mexico, East Asia, Brazil, Turkey, and others desperately vulnerable to shocks to first-world investors' perceptions of what was going on in far-away countries of which they knew little. We advocates of mobility retreated a little: "before opening up to untrammelled international capital flows," we said, "first establish an effective system of financial regulation so that financial firms' bets do not create large amounts of systemic risk." But the U.S. does not have an easy time regulating its financial system when the salary differential between the bureaucratic regulators and the regulatees is on the order of five to one. What chance does an Indonesia, a Thailand, or a Brail have when the salary differential between the bureaucratic regulators and the regulatees is on the order of twenty to one?
Thus those of us who still wish to be card-carrying flag-waving advocates for international capital mobility are reduced to two and only two arguments. First, and most important, capital controls create the setting for large-scale corruption. People who badly want to move their capital across borders can't--unless they can find some complaisant bureaucrat. A well-functioning market economy needs to minimize the incentives and opportunities for corruption or it will turn into something worse.
Second, perhaps the inflow of capital into America was and is justified: perhaps there is something uniquely valuable about investments in America today. (But in that case, if these investment opportunities are so great, why aren't Americans themselves saving more--both privately and publicly--to take advantage of them?)
1960-85 was the era in which development was to be financed by public institutions like the World Bank because market failures and distrust of governments made it very hard for poor countries to borrow on the private market. 1985-2000 has been the era in which development was to be financed by private lending to countries that had adopted the market-friendly and market-conforming policies that were supposed to lead to high returns and rapid growth. The first era was not one of unqualified success. And looking at the reverse inflow of capital into the United States, I cannot say that the second era has been one of unqualified success either.
It is very nice that Mexican workers and entrepreneurs are gaining experience in export manufactures, and exporting enough to the U.S. to run a trade surplus. But the flip side of the trade surplus is the capital outflow. Should capital-poor Mexico really be financing a further jump in the capital intensity of the U.S. economy? In the Treasury in 1993, I naively projected that after NAFTA there would be a net capital flow of some $10 to $20 billion a year for decades to come as investors around the world built factories in low-wage Mexico that now had guaranteed tariff-free access to the largest consumer market in the world. Instead, the capital flow has gone the other way.
Now perhaps this reverse capital flow is economically efficient. Rich Mexicans certainly have the choice between investing in their own country and investing in America, and they are deciding to some degree to do the second. They are investing in America because they expect returns to be high--and the U.S. is an immensely productive, technologically inventive, and potentially fast-growing economy. And they are investing in America to diversify against both economic risks and political risks: you want to have something in America in case the rubber boat scenario comes to pass, and is there a better way to get your grandchildren the option of moving to the United States than having large investments there. A standard economic analysis might stop here: might say that it is surprising that the net flow of capital is from poor to rich and not from rich to poor, but that the market knows best, the market is efficient, and voluntary acts of economic exchange are mutually beneficial.
And I certainly agree that under the proper competitive and other preconditions, the market equilibrium attains the Pareto frontier. Or, to put it another way, the market equilibrium maximizes that Benthamite social welfare function in which each individual's utility is weighted by the inverse of their marginal utility of income. That means that if you are so very rich that your marginal utility of income is very low, that your weight in the social welfare function implicitly maximized by the market is very high. And is that the goal that we want to pursue in development policy? It is the same, in some sense, as assuming that the current distribution of income both between and within countries is the right and just distribution.
It is not possible for a card-carrying neoliberal like me to wish for any but the most minor of controls to curb the most speculative of capital flows. Capital markets can get the allocation of investment badly wrong, but governments are likely to get it even worse, and the incentives to corrupt bureaucrats do need to be kept as low as possible. But the hope for a repetition of the late nineteenth-century experience, in which core investors' money gave peripheral economies the priceless gift of cutting decades off the time needed for successful economic development, has so far proved vain. And to the extent that the case for international capital mobility hinged on the third and fourth of the reasons I mentioned at the start--on how a net flow of capital to the periphery would raise the capital-output ratio and serve as a powerful carrier of technological knowledge--it has slipped through our hands.
Posted by DeLong at February 27, 2004 09:45 AM
Administration's Budget Would Cut Heavily Into Many Areas Of Domestic Discretionary Spending After 2005 - 2/27/04
The Administration's budget would cut every area of domestic non-entitlement spending outside homeland security, except for space exploration, over the next five years, with the cuts in many areas reaching substantial levels; the budget also would impose spending caps to lock cuts of this magnitude in place.
Concentrating on the Wrong Target: Bush Cuts Would Reduce Domestic Discretionary Spending, As A Share of GDP, To Its Lowest Level in 46 Years - 2/27/04
Although increases in domestic discretionary programs (outside homeland security) are responsible for just one-twentieth of the recent fiscal deterioration, these programs are the principal focus for cuts in the Bush budget; by 2009, the proposed reductions would cause domestic discretionary spending, measured as a share of GDP, to fall to its lowest level since 1963.
A Brief Overview of State Fiscal Conditions and the Effects of Federal Policies on State Budgets - 2/27/04
During the fiscal crisis, states have closed budget gaps more by cutting spending than by raising taxes. Total state spending in FY 2004 is about $73 billion less than it would have been if real per-capita spending during 2001-2004 had continued to grow at the same rate it did during the 1990s. (During the 1990s, real per-capita spending grew about 2 percent annually, a lower rate than in previous decades.)
On average, real per-capita state spending in 2004 will be 0.7 percent lower than it was in 2003. This reduction follows cuts of 2.6 percent in 2002 and 2.2 percent in 2003. Real per-capita spending will be 5.4 percent lower in fiscal year 2004 than in 2001.
"Capital markets can get the allocation of investment badly wrong, but governments are likely to get it even worse..."
I have some fiber optic cable for sale cheap. I have some telecommunications capacity for sale cheap.I have some lovely S&L loans left over from the last go-round but one for sale cheap. I have lots of AOL stock for sale cheap. I cannot even begin to count the amount of cheap IPO e-stocks I have for sale cheap. I have a slew of drugless new pharmaceuticals for sale cheap. My inventory of bad private sector investments is big, and getting bigger every day.
I was talking to a special assets officer at a large bank outside his building one day; he told me that right at that very minute, someone in that building was doing something, and in about 18 months he and I would be looking at each other and saying: "he did what? Why on earth did that seem like a good idea?" I have made a nice living from that very fact.
I won't say that every thing that the government does is valuable, in fact, I would be offering a bunh of armaments for sale cheap but they seem to have been blown up in Iraq.
On the other hand, we get to vote the administration out, if we really think they have acted stupidly, and occasionally they figure it out for themselves (think Comanche helicopter and Crusader artillery).
When some CEO, caught up in the herd, rushes to invest shareholder money in the fad of the day, what bad thing happens to him? He walks off with his retirement and his money, and his underlings who enabled that wishful thinking, take his place, and no one cares about all the money that went down the rathole.
I think we could all use a bracing dash of Alan Abelson at Barron's, whenever we think of talking about the wisdom of the private sector.
I'm not saying that the stuff you post is completely uninteresting, but do you ever feel any attachment to the idea that the comments should relate to the original post?
Maybe you should just start your own blog.
Capital flows seems like something that can be modeled with a dynamic model or simulation. (Disclaimer: I am an engineer, not an economist). With all the academic work done in economics, surely such models must exist. Even simple simulations can often display surprising, counterintuitive behavior, often when inputs or assumptions are varied only slightly. Has such modelling been applied to capital flows, and if so, what kinds of results were there? I'm just surprised that the actual results don't seem to have been forseen as a possibility.
In the phrase
"the salary differential between the bureaucratic regulators and the regulatees is on the order of twenty to one?"
I find the chiasmus confusing: shouldn't it be
"the salary differential between the regulatees and the bureaucratic regulators is on the order of twenty to one?"
and likewise in some similar uses? (Fuss, fuss.)
Well, there are a few points that I would like to add:
* Considering what is going on with the Dollar:Euro exchange rate, we may experience a major capital outflow.
* You have ignored the possibility of malice. When you have Brazil and Argentina style crises, there are people who make a LOT of money. It's naive to suggest that there are not folks out there who are actively creating these situations for money.
* The need for foreign investment is over sold. In developing nations, the industries likely to develop are low capital high labor, like textiles, which do not require massive capital investment.
I'm a lefty mechanical engineer though, not an economist, so YMMV.
Massaccio - it would be nice if shareholders would hold CEO's accountable - but if they don't care, why should the government intervene to save them from losing their own money? Yes, we overinvested in fiber-optics. And railroads, in an earlier era. I suspect, however, that the return on investment in computer cable put down in the '90s, in the long run, but better than that returned by the Chunnel. Do publicly funded airports get good returns? I don't know, but I don't know that the return on actual investment (as opposed to stock purchases, which were definitely based on inflated speculation as to returns) was really bad. Those drugless new pharmaceutical companies? Just getting started. Most will fail. One will produce the next Paxil or Claritin, and make scads of money selling it to Merck. It is the nature of the biz. On net we will look back and say "across the industry, the investment in capital was solid. what stock buyers were thinking buying x at $y, however, I don't know." It is the nature of the biz for most start-ups to fail, in any industry. The survivors typically make it "worth it", or at least closer to it than the chunnel, the "big dig", Amtrak, Airbus, or any number of government projects get.
Getting back to capital flows - if I lived in India, and had a fair amount of money, would I invest there, or in the US? Well, if the Indian economy goes strong, I'll already get a good return off my job, whatever I got rich doing in the first place, etc. But if it tanks, I lose all that. To be safe, I'd put any spare cash I got into the US or Europe. The return may not be as good, but the inflationary and other risks are less daunting, and my portfolio is better diversified. Same reasoning behind not investing your 401k in your employer. It doesn't shock me large amounts of money are coming here. Its not like it is hurting them - if it were, India wouldn't be "stealing our jobs" would they? Capital flows should remain free, even if the benefits of it aren't the ones "neo-liberals" like Brad were expecting.
I hate to be a stickler (as I am a big JBD fan and since I agree with the general thrust of the argument) but for the sake of accuracy, it needs to be stated that Mexico is a net importer of capital. According to the IMF’s 2003 World Economic Outlook report, Mexico was the 5th largest importer of capital in the world -- though it certainly receives only the smallest fraction of the avalanche of capital that flows into the US. It looks like the earlier, ‘naïve’ JBD (the one who predicted that investors from around the world pile into Mexico)may have been right.
John Stein: You've got the basic idea of how macro is being done these days. The problem with dynamic general equilibrium is that it's pretty hard to pin down, especially when we add uncertainty. I suggest that you go to a library, find a database called EconLit, and search for this sort of thing.
The question I have is, "What if population growth rates and technical progress were the same around the world? What would happen? That is, how much of this strange current-account behavior is attributable to technical or population change, and how much of it is just strange?"
I for one would like to throw together a model to estimate this sort of thing--imagine two countries with identical rates of technical progress (this can vary), but one of them has much higher population growth than the other (say, 2% versus 0). OLG may be easier than infinite lives, or maybe not. Assume CRTS technology, Cobb-Douglas maybe. Intuition says that the low-fertility country will run chronic current-account surpluses with the high-fertility one, as the demand for capital in the latter keeps rising. (Watch out for transversality conditions!) Call our countries the US and Japan (or Europe). Do the quantitative results match the qualitative ones?
I guess I should check EconLit because it's such an obvious exercise that someone has to have done it somewhere.
From: "Legends of the New Banana Republican Plantation: Chapter Two"
"...Well children, while ol' brer Rubin, brer Krugman and brer DeLong was just polishing their alibis, fiddling with their theories, and fudging with their models, ol brer Bush, brer Cheney and brer Greenspan was BUSY little beavers.
Yes, they was. They SHORE was...
"James K. Galbraith on Global Keynesianism"
"The decline of Keynesianism that began a quarter-century ago was an ambiguous event, since the Keynesians, helped along by the economic effects of the Vietnam War, had reduced unemployment to below 4% in 1969, at an inflation cost that was both predicted and quite moderate by later standards. But during the 1970s, economists came to see economic problems that might have passed into history as mistakes of policy and external shocks, as, instead, the result of fundamental errors of theory.
They retreated from any the idea that the government's economic policies should aim at achieving full employment, adopting the view that efforts to reduce unemployment were not only futile but also likely to be inflationary -- that you would get only a temporary decrease of unemployment in return for a permanent and intractable increase of inflation. This put macro-economic policy, the manipulation of budget deficits and interest rates to achieve grand goals of employment and growth, on the sidelines. Economic policy moved from the macro to the micro, from the demand side to the supply side, from a focus on accounting aggregates to focus on individual incentives...
...The term "global Keynesianism" means only some system - a mechanism that has not yet been worked out - for managing interdependence to achieve high economic growth and employment, a common rising standard of living, and a minimum of financial instabilities attendant to higher growth.
The great economic powers -- the United States, Germany, Japan -- must stop thinking in purely national terms and start thinking of the larger community of which they are a part. They must understand that the growth of income in the countries to which they sell eventually determines the growth of income in their own countries.
We have not faced the responsibilities of interdependence since the end of the earlier Keynesian period and breakdown of the Bretton Woods system in the 1970s, perhaps not since promulgation of the Marshall Plan. We have abandoned governmental power to market forces, particularly to the global capital markets and the large financial institutions that play in them. However, market forces cannot replace governments in the functions of governance -- neither within national boundaries nor in relations between nations.
We can harbour no illusions about the difficulty of rebuilding a multinational structure dedicated to growth and employment, and of controlling the powerful private forces whose interests would be threatened by our doing so. However, this very difficulty is in one way a virtue. We have suffered because of the short shelf life of the various economic theories put forth over the last 25 years. We try one thing, if it fails to work in a few years, we throw it out.
But if our current difficulties force us to think our problem through to the end and to adopt a set of ideas that contain a vision to which the public can respond -- a vision that holds out neither pointless sacrifice nor immediate gratification but the serious possibility of positive results in a medium and long terms-- we may be able to free ourselves of the cycle of short-lived economic theories, with their false promises and perceived failures."
"THE END OF CHEAP OIL"
by Colin J. Campbell and Jean H. Laherrère,
Scientific American, March 1998
"In 1973 and 1979 a pair of sudden price increases rudely awakened the industrial world to its dependence on cheap crude oil. Prices first tripled in response to an Arab embargo and then nearly doubled again when Iran dethroned its Shah, sending the major economies sputtering into recession. Many analysts warned that these crises proved that the world would soon run out of oil. Yet they were wrong.
Their dire predictions were emotional and political reactions; even at the time, oil experts knew that they had no scientific basis. Just a few years earlier oil explorers had discovered enormous new oil provinces on the north slope of Alaska and below the North Sea off the coast of Europe. By 1973 the world had consumed, according to many experts’ best estimates, only about one eighth of its endowment of readily accessible crude oil (so-called conventional oil). The five Middle Eastern members of the Organization of Petroleum Exporting Countries (OPEC) were able to hike prices not because oil was growing scarce but because they had managed to corner 36 percent of the market. Later, when demand sagged, and the flow of fresh Alaskan and North Sea oil weakened OPEC’s economic stranglehold, prices collapsed.
The next oil crunch will not be so temporary. Our analysis of the discovery and production of oil fields around the world suggests that within the next decade, the supply of conventional oil will be unable to keep up with demand. This conclusion contradicts the picture one gets from oil industry reports, which boasted of 1,020 billion barrels of oil (Gbo) in "Proved" reserves at the start of 1998. Dividing that figure by the current production rate of about 23.6 Gbo a year might suggest that crude oil could remain plentiful and cheap for 43 more years—probably longer, because official charts show reserves growing.
Unfortunately, this appraisal makes three critical errors. First, it relies on distorted estimates of reserves. A second mistake is to pretend that production will remain constant. Third and most important, conventional wisdom erroneously assumes that the last bucket of oil can be pumped from the ground just as quickly as the barrels of oil gushing from wells today. In fact, the rate at which any well—or any country—can produce oil always rises to a maximum and then, when about half the oil is gone, begins falling gradually back to zero.
From an economic perspective, when the world runs completely out of oil is thus not directly relevant: what matters is when production begins to taper off. Beyond that point, prices will rise unless demand declines commensurately.
Using several different techniques to estimate the current reserves of conventional oil and the amount still left to be discovered, we conclude that the decline will begin before 2010..."
April 11, 2002
"US dollar hegemony has got to go"
"...The current international finance architecture is based on the US dollar as the dominant reserve currency, which now accounts for 68 percent of global currency reserves, up from 51 percent a decade ago. Yet in 2000, the US share of global exports (US$781.1 billon out of a world total of $6.2 trillion) was only 12.3 percent and its share of global imports ($1.257 trillion out of a world total of $6.65 trillion) was 18.9 percent. World merchandise exports per capita amounted to $1,094 in 2000, while 30 percent of the world's population lived on less than $1 a day, about one-third of per capita export value.
Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. The dollar, now a fiat currency, is at a 16-year trade-weighted high despite record US current-account deficits and the status of the US as the leading debtor nation. The US national debt as of April 4 was $6.021 trillion against a gross domestic product (GDP) of $9 trillion.
World trade is now a game in which the US produces dollars and the rest of the world produces things that dollars can buy. The world's interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies. To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.
By definition, dollar reserves must be invested in US assets...
...A strong-dollar policy is in the US national interest because it keeps US inflation low through low-cost imports and it makes US assets expensive for foreign investors. This arrangement, which Federal Reserve Board chairman Alan Greenspan proudly calls US financial hegemony in congressional testimony, has kept the US economy booming in the face of recurrent financial crises in the rest of the world. It has distorted globalization into a "race to the bottom" process of exploiting the lowest labor costs and the highest environmental abuse worldwide to produce items and produce for export to US markets in a quest for the almighty dollar, which has not been backed by gold since 1971, nor by economic fundamentals for more than a decade. The adverse effect of this type of globalization on the developing economies are obvious. It robs them of the meager fruits of their exports and keeps their domestic economies starved for capital, as all surplus dollars must be reinvested in US treasuries to prevent the collapse of their own domestic currencies.
The adverse effect of this type of globalization on the US economy is also becoming clear. In order to act as consumer of last resort for the whole world, the US economy has been pushed into a debt bubble that thrives on conspicuous consumption and fraudulent accounting. The unsustainable and irrational rise of US equity prices, unsupported by revenue or profit, had merely been a devaluation of the dollar. Ironically, the current fall in US equity prices reflects a trend to an even stronger dollar, as it can buy more deflated shares.
The world economy, through technological progress and non-regulated markets, has entered a stage of overcapacity in which the management of aggregate demand is the obvious solution. Yet we have a situation in which the people producing the goods cannot afford to buy them and the people receiving the profit from goods production cannot consume more of these goods. The size of the US market, large as it is, is insufficient to absorb the continuous growth of the world's new productive power. For the world economy to grow, the whole population of the world needs to be allowed to participate with its fair share of consumption. Yet economic and monetary policy makers continue to view full employment and rising fair wages as the direct cause of inflation, which is deemed a threat to sound money.
The Keynesian starting point is that full employment is the basis of good economics. It is through full employment at fair wages that all other economic inefficiencies can best be handled, through an accommodating monetary policy. Say's Law (supply creates its own demand) turns this principle upside down with its bias toward supply/production. Monetarists in support of Say's Law thus develop a phobia against inflation, claiming unemployment to be a necessary tool for fighting inflation and that in the long run, sound money produces the highest possible employment level. They call that level a "natural" rate of unemployment, the technical term being NAIRU (non-accelerating inflation rate of unemployment).
It is hard to see how sound money can ever lead to full employment when unemployment is necessary to maintain sound money. Within limits and within reason, unemployment hurts people and inflation hurts money. And if money exists to serve people, then the choice becomes obvious. Without global full employment, the theory of comparative advantage in world trade is merely Say's Law internationalized.
No single economy can profit for long at the expense of the rest of an interdependent world. There is an urgent need to restructure the global finance architecture to return to exchange rates based on purchasing-power parity, and to reorient the world trading system toward true comparative advantage based on global full employment with rising wages and living standards. The key starting point is to focus on the hegemony of the dollar.
To save the world from the path of impending disaster, we must:
* promote an awareness among policy makers globally that excessive dependence on exports merely to service dollar debt is self-destructive to any economy;
* promote a new global finance architecture away from a dollar hegemony that forces the world to export not only goods but also dollar earnings from trade to the US;
* promote the application of the State Theory of Money (which asserts that the value of money is ultimately backed by a government's authority to levy taxes) to provide needed domestic credit for sound economic development and to free developing economies from the tyranny of dependence on foreign capital;
* restructure international economic relations toward aggregate demand management away from the current overemphasis on predatory supply expansion through redundant competition; and
* restructure world trade toward true comparative advantage in the context of global full employment and global wage and environmental standards.
This is easier done than imagained. The starting point is for the major exporting nations each to unilaterally require that all its exports be payable only in its currency, so that the global finance architecture will turn into a multi-currency regime overnight. There would be no need for reserve currencies and exchange rates would reflect market fundamentals of world trade..."
"BUSH'S DEEP REASONS FOR WAR ON IRAQ: OIL, PETRODOLLARS, AND THE OPEC EURO QUESTION"
As the United States made preparations for war with Iraq, White House Press Secretary Ari Fleischer, on 2/6/03, again denied to US journalists that the projected war had "anything to do with oil." He echoed Defense Minister Donald Rumsfeld, who on 11/14/02 told CBS News that "It has nothing to do with oil, literally nothing to do with oil."
Speaking to British MPs, Prime Minister Tony Blair was just as explicit: "Let me deal with the conspiracy theory idea that this is somehow to do with oil. There is no way whatever if oil were the issue that it would not be infinitely simpler to cut a deal with Saddam...." (London Times 1/15/03).
Nor did Bush's State of the Union Message, or Colin Powell's address to the United Nations Security Council, once mention the word "oil." Instead the talk was (in the president's words) of "Iraq's illegal weapons programs, its attempts to hide those weapons from inspectors, and its links to terrorist groups."
However our leaders are not being candid with us. Oil has been a major US concern about Iraq in internal and unpublicized documents, since the start of this Administration, and indeed earlier. As Michael Renner has written in Foreign Policy in Focus, February 14, 2003, "Washington's War on Iraq is the Lynchpin to Controlling Persian Gulf Oil."
But the need to dominate oil from Iraq is also deeply intertwined with the defense of the dollar. Its current strength is supported by OPEC's requirement (secured by a secret agreement between the US and Saudi Arabia) that all OPEC oil sales be denominated in dollars. This requirement is currently threatened by the desire of some OPEC countries to allow OPEC oil sales to be paid in euros...
...Dominance of Middle Eastern oil will mean in effect maintaining dollar hegemony over the world oil economy. Given its present strategies, the US is constrained to demand no less. As I explain in this extract from my book, Drugs, Oil, and War (pp. 41-42, 53-54), the present value of the US dollar, unjustified on purely economic grounds, is maintained by political arrangements, one of the chief of which is to ensure that all OPEC oil purchases will continue to be denominated in US dollars. (This commitment of OPEC to dollar oil sales was secured in the 1970s by a secret agreement between the US and Saudi Arabia, before the two countries began to drift apart over Israel and other issues.)
The chief reason why dollars are more than pieces of green paper is that countries all over the world need them for purchases, principally of oil. This requires them in addition to maintain dollar reserves to protect their own currency; and these reserves, when invested, help maintain the current high levels of the US securities markets...."
"The Earth's life-support system is in peril"
Margot Wallström, Bert Bolin, Paul Crutzen and Will Steffen
Monday, January 19, 2004
A global crisis
BRUSSELS Our planet is changing fast. In recent decades many environmental indicators have moved outside the range in which they have varied for the past half-million years. We are altering our life support system and potentially pushing the planet into a far less hospitable state.
Such large-scale and long-term changes present major policy challenges. The Kyoto Protocol is important as an international framework for combating climate change, and yet its targets can only ever be a small first step. If we cannot develop policies to cope with the uncertainty, complexity and magnitude of global change, the consequences for society may be huge.
We have made impressive progress in the last century. Major diseases have been eradicated and life expectancy and standards of living have increased for many. But the global population has tripled since 1930 to more than six billion and will continue to grow for several decades, and the global economy has increased more than 15-fold since 1950. This progress has had a wide-ranging impact on the environment. Our activities have begun to significantly affect the planet and how it functions. Atmospheric composition, land cover, marine ecosystems, coastal zones, freshwater systems and global biological diversity have all been substantially affected.
Yet it is the magnitude and rate of human-driven change that are most alarming. For example, the human-driven increase in atmospheric carbon dioxide is nearly 100 parts per million and still growing - already equal to the entire range experienced between an ice age and a warm period such as the present. And this human-driven increase has occurred at least 10 times faster than any natural increase in the last half-million years.
Evidence of our influence extends far beyond atmospheric carbon dioxide levels and the well-documented increases in global mean temperature. During the 1990's, the average area of humid tropical forest cleared each year was equivalent to nearly half the area of England, and at current extinction rates we may well be on the way to the Earth's sixth great extinction event.
The Earth is a well-connected system. Carbon dioxide emitted in one country is rapidly mixed throughout the atmosphere, and pollutants released into the ocean in one location are transported to distant parts of the planet. Local and regional emissions create global environmental problems.
The impacts of global change are equally complex, as they combine with local and regional environmental stresses in unexpected ways. Coral reefs, for example, which were already under stress from fishing, tourism and agricultural pollutants, are now under additional pressure from changing carbonate chemistry in ocean surface waters, a result of the increase in atmospheric carbon dioxide.
Similarly, the wildfires that hit southern Europe, western Canada, California and southeastern Australia last year were a result of many factors, including land management, ignition sources and extreme local weather. However, prevailing warm and dry conditions - probably linked to climate change - amplified fire intensity and extent.
Poor access to fresh water means that more than two billion people currently live under what experts call "severe water stress." With population growth and economic expansion, this figure is expected to nearly double by 2025. Climate change would further exacerbate this situation.
Biodiversity losses, currently driven by habitat destruction associated with land-cover change, will be further exacerbated by future climate change. Beyond 2050, rapid regional climate change, as would be caused by changes in ocean circulation in the North Atlantic, and irreversible changes, such as the melting of the Greenland ice sheet and the accompanying rise in sea levels of 6 meters, or 20 feet, could have huge economic and societal consequences.
It is now clear that the Earth has entered the so-called Anthropocene Era - the geological era in which humans are a significant and sometimes dominating environmental force. Records from the geological past indicate that never before has the Earth experienced the current suite of simultaneous changes: we are sailing into planetary terra incognita.
Global environmental change challenges the political decision-making process by its uncertainty, its complexity and its magnitudes and rates of change.
Because of the uncertainties involved, decision-making will have to be based on risks that particular events will happen, or that possible scenarios will unfold. A lack of certainty does not justify inaction - the precautionary principle must be applied.
Because of its complexity, global environmental change is often gradual until critical thresholds are passed, and then far more rapid change ensues, as seen in the growth of the ozone hole. Some rapid changes - such as the potential melting of the Greenland ice sheet - would also be irreversible in any meaningful human timescale, while other changes may be unstoppable, and indeed may have already been set in motion.
Because of the magnitudes and rates of change, we are unsure of just how serious our interference with the dynamics of the Earth's system will prove to be, but we do know that there are significant risks of rapid and irreversible changes to which it would be very difficult to adapt.
The first step toward meeting the challenge presented by global change is to appreciate the complex nature of the Earth's system, the ways in which we are affecting the system, and the economic and societal consequences. Scientists and policy-makers must establish a dialogue to communicate current knowledge and to guide future research.
Real policy progress must address the need for large-scale change, technological advances and global cooperation. Incremental change will not prevent, or even significantly slow, climate change, water depletion, deforestation or biodiversity loss. Breakthroughs in technologies and natural resource management that will affect all economic sectors and the lifestyles of people are required...."
J. Michael Neal
Yep, you are right, the comments were supposed to be on an earlier post. But, the budget analyses are important in any event and being rather neglected. Thanks.
Brad, it's not immediately clear to a non-economist like me why you think capital should smear out geographically.
Perhaps you take the neoclassical assumption of no-scale benefits from investments, this should make capital smear out to optimally combine with (non-mobile) labour forces.
But the assumption of linear capital returns is there only because it yields tractability to economic models - in reality scale benefits seem huge. Hence capital optimally concentrates geographically (towns)enriching those who can move (urbanize) to where the capital stock grows, empoverishing those who can't - those who are trapped at the wrong side of 1st-3rd world country borders.
The US offers political and economic stability. Any portfolio seeks a balance of high risk-high return and low risk-more moderate returns. You are wrong that investors will invest where profit seems to be the highest. Future profit is unpredictable and the wise balance their portfolio insted of putting all their eggs in a shooting star such as Enron.
Capital flow to higher return ventures should improve if stability can be guaranteed.
"You are wrong that investors will invest where profit seems to be the highest. Future profit is unpredictable" No, no, I'm referring to a pure optimal planner's perspective in a no-risk environment. Furthermore, industries *do* appear in clusters, industrial life *is* organized in towns, economists *do* measure significant levels of above linear returns to scale from investments.
You simply don't assemble cars in small factories or ship oil across the oceans in 5.000 ton vessels, do you?
You state, "* Considering what is going on with the Dollar:Euro exchange rate, we may experience a major capital outflow."
Not if exchange rates follow any sort of random walk given interest rates. And if they don't, there are obvious opportunities for profit. The empirical record on this is pretty spotty, but you really have to take seriously the fact that changes in exchange rates are determined in a market and therefore have a lot of unpredictability about them.
"* You have ignored the possibility of malice. When you have Brazil and Argentina style crises, there are people who make a LOT of money. It's naive to suggest that there are not folks out there who are actively creating these situations for money."
Apart from George Soros, maybe, I can't think of anyone who has enough market power in currency markets to do this. A better explanation is that currency crises can be self-fulfilling, with rational herd behavior--if everybody shorts a currency, a currency peg breaks; if nobody short it, it stays. Both can happen. I think that Krugman did some good work in this, if I'm not mistaken, and it's easy enough to teach to undergrads. Basically, either everybody attacks or nobody attacks; they're both valid equilibria.
Granted, it's human nature to assume malice in bad social outcomes, and there's enough real malice out there. But any one person taking advantage of Argentina's unsustainable peg is not malicious--no one person caused the crisis, but lots of people did in the aggregate, because one bad policy gave them the opportunity. Now only if the Argentines had floated sooner, stabilized their macroeconomy, and avoided the whole mess--the benefits of hindsight....
"* The need for foreign investment is over sold. In developing nations, the industries likely to develop are low capital high labor, like textiles, which do not require massive capital investment."
Textiles don't require massive capital investment?! Have you ever seen a textile plant? It sure uses a lot more capital than subsistence farming, and the capital has to come from somewhere. Foreign investment may not be absolutely necessary over the very long run if you believe the Solow converegence story, but it sure speeds up this capital deepening process. It takes a really, really long time for subsistence farmers on the edge of starvation to build up capital. Even the Japanese after WWII took a long time to do this after their capital stock had basically burned to the ground. They shunned foreign investment. The Germans didn't even though Germany was even more thoroughly destroyed. Who recovered more quickly?
I'm in no mood to read long paragraphs but I glanced through them -- cause I SHORE liked the first paragraph 'bout "brers" -- chuckle!
Question: You feel like Kerry would pursue even one tenth along the lines you favor? I think you guys need to do somethin quick to put Edwards ahead of Kerry. I think Kerry has less of a chance than Edwards of ousting Bush and even if Kerry does win, I don't think it would make helluva difference in policy!
"The US offers political and economic stability. ...Capital flow to higher return ventures should improve if stability can be guaranteed." Exactly, and this is only another display of super-linear returns, in this case above the industrial scale. US and 1st world stability is there because capital is there, and vice versa.
And sometimes there are rushes of capital to emerging markets in expectation that more captial will follow to create the scales needed. When these expectations for some reason are abandoned, capital flows quickly reverse. 3rd world high risk is in this perspective yet another evidence of super-linear returns even on nation-wide levels.
The super-linear returns are on quite a lot of places, except in the foundations of neoclassical theory?
Don't worry about Michael Neal - keep posting your clips. I read all of them and am glad to have someone go sift through the chaff of economic reports to find and post a few kernals of wheat.
Good article, and quite reasonable. If more people viewed government interference with the economy as a last resort rather than a preferred method, we'd be doing better.
"Second, perhaps the inflow of capital into America was and is justified: perhaps there is something uniquely valuable about investments in America today. (But in that case, if these investment opportunities are so great, why aren't Americans themselves saving more--both privately and publicly--to take advantage of them?)"
In 1980 about six percent of American households owned mutual funds. That was up to 44 percent in 1998. I don't have more recent data on hand--and would appreciate any links to such data--but I doubt it's down by much. One of the problems with the standard class-warfare techniques is that a hell of a lot more Americans have their fingers in Wall Street than they used to.
Just a few comments on Brad's essay.
First, I've been shaking my head too about the direction of capital flows. Could it have anything to do with the fact that, under free trade between rich and poor countries, the rich countries specialize in relatively capital intensive industries? Somebody above referenced that.
In the case of a country like China, for example, all they really need is a ready market to accept unlimited quantities of what they decide to make, and the next thing you know they've got a spot that is turning out six billion pairs of shoes a year (as I understand is actually the case). Suddenly you've got tens of millions of peasants entering the money economy for the first time, and a society with a 40% savings rate that can actually afford to leave half of its profits overseas -- for a rainy day maybe, or because the government wants to bring tens of millions of additional peasants into the money economy making some other kind of widget, and needs those low exchange rates to be sure it can do so. These are just guesses, because I really don't know the answer.
Second, being a flag-waving member of any club is not a good idea for anyone who wants to maintain their intellectual independence. There's too much group think and peer pressure on the left as well as the right. (I would make an exception for the club in favor of "the greatest happiness for the greatest number" or "liberty and justice for all" -- but those are ends not means. Dogma about means is a formula for disaster, as witness the dogma of free trade in the economics profession itself.
Third, any reference to Pareto always makes my blood run cold. As soon as I realized that a society could be "Pareto optimal" even if one man had everything and everybody else had nothing, I knew it was time to throw that concept out the window, where it might reside with other concepts like "value-free economics" and undesirability of making "interpersonal utility comparisons.
For the purposes of our democracy why not just adopt the maxim that, other things being equal, a dollar is worth more to a poor man than a rich one. And as a subsidiary, that we should never sacrifice the welfare of the home folk for those overseas.
This subsidiary maxim, by the way, is being violated by our current trade policy, because our trade theorists have decided to ignore the principle of compensation, accepting that it is good enough that such compensation could take in principle, rather than insuring that it does take place in practice. Bhagwati, btw, admitted as much to me in personal conversation -- in fact he brought it up -- but it didn't change the way he talks in public.
The post are too long and have too many points to comment on.
But I would like to comment on oil.
In the 1970s, as you said the marginal supply of oil was the North Slope and North Sea. so we knew that by hook or by crook the price of oil had to rise to the point that would make developing those fields economic. it was somewhere around $30
but one of the most productive economic sectors over the last 20 years has been oil drilling.
The advances in the use of computers in making oil exploration cheaper has been fantastic.
I always list Schlumberger as my candidate for the best managered company in the world.
Now, all the oil the world could want for the next 25 years can be brought on line for under
$20. the marginal price of oil is under $20.
Oil reserves, should be thought of as short run inventories. It only pays oil companies to develop the enough reserves to match a few years supply. As long as proven reserves are at that level the oil companies do not bother to do much exploration.
I remember many of the same types of studies in the 1970s that said we were running out of oil and raw materials. But the truth was simply that demand had just outpaced supply on a short run basis. We are probably in a similiar situation now because we underinvested in oil and basic materials in the 1990s, partially because we underestimated Chinese demand.
but free markets are working as they should.
Profits in oil and raw materials are up sharply and those stocks are leading the stock market.
With a lag this will lead to an investment boom in oil and raw materials that will create more supply than needed. At that point prices will fall
and another cycle will start. but in the meantime overweigth oil and basic industries in your stock portfolio.
the worse thing we do in economics is teach the perfectly competitive model so that people think that free markets are efficient. they are highly inefficient as they lurch from one extreme to another. They are just better than any thing else we have tried.
For years I have believed the success of the marshall plan led thinkers,planners and economists down the long path.
In post war europe the human capital and organizational ability to run an advanced
industrial economy already existed. But
they faced a bottleneck of foreign exchange
because the capital equipment had to come from the US. the marshall plan solved that bottleneck
problem but that is about all it did.
But for years economists looked at the success of the marshall Plan and draw the conclusion that
the problem was a lack of foreign capital.
They ignored the problem that most of the poor countries lacked the human capital and organizational structure to develop. Foreign capital bottlenecks was not the problem.
One of the biggest advantages of direct foreign investment is that it is also accompanied by transfers of institutional knowledge that you do not get with indirect capital flows.
The field of economic development now knows this, but for decades after WW II it was ignored.
If you should ever manage to pull yourself away from the Democratic Presidential "horserace" long enough to count YOUR 'winnings', AND if you should THEN happen to find yourself in a "serious as a heart attack" mood, take the time glance through one or two of these long paragraphs:
Interim Report: Notes on the U.S. Trade and Balance of Payments Deficits
1. The United States has a balance of payments deficit worth nearly 4 percent of GDP and negative net foreign assets (or foreign debt) worth nearly 20 percent of GDP. If U.S. growth is sustained in the medium term, it is quite likely that the balance of trade in goods and services will not improve. The United States is the only major country, or country "bloc," to have a substantial trade deficit and this is proving of great advantage to the rest of the world.
2. If the balance of trade does not improve, there is a danger that over a period of time the United States will find itself in a "debt trap," with an accelerating deterioration both in its net foreign asset position and in its overall current balance of payments (as net income paid abroad starts to explode). Such a trap would call imperatively for corrective action if it is not at some stage to unravel chaotically.
3. The emergence of a debt trap is put forward as a possibility that must be taken seriously rather than as a forecast of what is most likely to happen. Policymakers are advised to ensure that adequate instruments are available should things start getting out of hand...
Power to the people
Sunday April 29, 2001
When it comes to rebellion on the streets, I must confess a prejudice. In a pitched battle between children armed with banners and spray paint against highly trained police and military personnel with a large array of deadly weapons, I tend to side with the kids.
As a child, I was taught about an instance of property destruction known as the Boston Tea Party and it made a positive impression on me.
At recent street protests in Quebec and in the late-1999 Seattle protests against the World Trade Organisation, this 50-year-old was out on the streets with the young people. I was very impressed by their analysis, their courage, their creativity and their heartfelt desire to protect other species from the human onslaught.
Why would these young people be rebellious? Maybe it's due to things such as seeing the major biological systems of the planet collapsing while an oil company cowboy in the White House pulls the US government out of the mild Kyoto Accords because it might disrupt the profits of his benefactors. Contrary to media suggestion, the youth-led movement for global economic transformation is not 'anti-globalisation'.
There are really two varieties of globalisation: élite globalisation (which we oppose) and grassroots globalisation (which we promote). The top-down globalisation is characterised by a constant drive to maximise profits for globe-spanning corporations. It forces countries to 'open up' their national economies to large corporations, reduce social services, privatise state functions, deregulate the economy, be 'efficient' and competitive, and submit everything and everyone to the rule of 'market forces'. Because markets move resources only in the direction of those with money, social inequality has reached grotesque levels..."
U.S. Budget Deficit Threatens World Economy, IMF Warns
Thursday, January 8, 2004
A rising U.S. budget deficit and trade imbalance may create such a burden of foreign debt that it could cause financial instability in the United States and the rest of the world, a report released yesterday by the International Monetary Fund says.
According to the report, the U.S. budget deficit last year reached $374 billion, a record in dollar terms, and it is expected to exceed $400 billion this year. In a few years, the report says, the United States could have a foreign debt equal to 40 percent of its total economy — "an unprecedented level of external debt for a large industrial country."
The U.S. situation would affect the rest of the world because global interest rates would go up, slowing global investment and economic growth (Becker/Andrews, New York Times, Jan. 8).
The Wall Street Journal reports that the higher the interest rates, the less the population is likely to spend on such goods as houses and cars, resulting in a weak cash flow and weakened economic growth (Greg Ip, Wall Street Journal, Jan. 8).
According to the Times, White House officials have dismissed the IMF report, saying that U.S. President George W. Bush expects to reduce the budget deficit by half over the next five years.
Some economists, however, said they agree with the IMF's concerns.
"The IMF is right," said the director of the Institute for International Economics in Washington, C. Fred Bergsten. "If those twin deficits — of the federal budget and the trade deficit — continue to grow you are increasing the risk of a day of reckoning when things can get pretty nasty" (Becker/Andrews, New York Times)..."
Trade Deficit Swells 17.1% To Record $489 Bil In '03
Tue Feb 17,10:21 AM ET
By Jed Graham
The U.S. trade deficit widened more than expected to a near-record $42.5 billion in December, bringing the full-year total to a record $489.4 billion, the Commerce Department (news - web sites) said Friday.
The trade gap expanded by $4.1 billion, or 10.8%, from November's 13-month low of $38.4 billion. December's deficit was the second biggest ever, behind the $42.9 billion gap last March.
For the year, the deficit rose $71.3 billion, or 17%, from the old record of $418 billion in 2002.
The goods deficit with China swelled to a record $124 billion in 2003 from $103 billion in 2002..."
International capital mobility was supposed to add to, not drain, the pool of funds financing development in peripheral countries.
You were a idiot
"Benthamite social welfare function ...[where if you are very rich] your weight in the social welfare function implicitly maximized by the market is very high.
Major religions and democratic traditions treat all people as of equal value before God or the law. So a quadraplegic woman is entitled to as much moral value as a rich man. I once asked one of my econ professors (re a discussion of Pareto optimization), "What if you could increase the utility of many poor people, by taking a little away from a very rich person". At the time, he replied that the Pareto concept didn't deal with that question. So the pareto allocation was all we could talk about. I wonder if professor Delong or some one else could point me to some answer.
Re: the question of financial instability. Could these effects be so great that they swamp the efficiency arguments. Some of the countries that have grown most quickly have capital controls, e.g. China, India?, Malaysia. And isn't this something Stiglitz makes a big point about.
Re: the efficiency of investing in the U.S. How much of this capital inflow is investment in real assets (plant and equipment, intellectual property) as opposed to buying financial assets (stocks and bonds). Isn't most stock market investment, just recycling pieces of paper with a theoretical claim on underlying cashflows. Most U.S. companies meet their investment needs from retained earnings, not new stock offerings. I know I'm missing something here. So if this argument is off base, someone please let me know.
Capital mobility is probably fine as long as you have labor mobility to match it. Perhaps one could imagine a process like the 1st world's urbanisation - population concentrates to match capital concentrations - but on a larger scale?
More Mexicans in the US, Algerians in France, Maroccoans in Spain, Estonians in Sweden...
" real assets (plant and equipment, intellectual property) as opposed to buying financial assets (stocks and bonds). Isn't most stock market investment, just recycling pieces of paper with a theoretical claim on underlying cashflows."
OMG! Just try to ignore your morgage or credit card payments to see how "theoretical" financial claims are!
"You were a idiot"
I'm sorry; I just had to point out the irony.
"An" idiot. :)
Ethan: "'I just had to point out the irony."
Demonstrating thereby that you are currently a idiot.
I was just observing that buying a stock or an already issued bond for say $100, doesn't necessarily result in a $100 investment in real assets. Moreover, many stocks pay little or no dividends, so there is no promised cashflow. Of course you are right that the issuer of the Bond must make his promised coupon payments. But if I buy an already issued bond, have I increased the amount of investment in underlying assets? I'm not sure.
If you're going to pick on public spending as wasteful and inefficient in comparison with the allocations of private capital markets, then it is best to be careful in choosing your examples. I don't know exactly what is wrong with the "Chunnel"- that's a bit far afield for me and I haven't read anything about it pro or con-, but Boeing is currently in a good deal of trouble with respect to the commercial aviation market because it has been outcompeted by Airbus.
It's good that Prof. DeLong finally got back to this issue after his previous post a while back on it was swallowed up by some computer/moveable type troubles. I was not the only one requesting a repeat at the time, as it is a large and important issue, well deserving of full discussion, as well as, of course, the airing of the usual biases.
My only small contribution to the matter is to ask: if foreign financial capital were to flow to "developing" countries, just whom exactly would it be loaned or transferred to? Perhaps those self-same local ruling elites who manage to run such corrupt governments? Or to multi-national corporations setting up production platforms variously to arbitrage cheap labor. Sure, these latter might pay somewhat higher wages than otherwise available, and offer employment in the face of massive surplus unemployment, but chances are they run highly rationalized production systems, importing much of their standardized inputs, and otherwise interacting little with the local economy. In other words, the impact on the local economy of corporate FDI may be much less in terms of multiplier effects and positive externalities than one might prima facie expect. In both cases though, the main orientation is toward extracting maximal gains from the deployment of cheap labor rather than toward the broader distribution of benefits, so it is not entirely surprising the profits so extracted might tend to get re-exported rather than re-invested locally, though I am not so naive as to correlate intentional orientations with systematic effects. At any rate, the neo-liberal theory emphasised entirely export-led growth. What ever happened to the older notion that the key to endogenous economic development and "take-off" was the development of internal and more internally differentiated markets? At any rate, while the import of foreign financial capital flows, currency risk and all, may be tantamount to a necessary condition of economic development for under-developed nations, it is perhaps not a sufficient condition for the right policy mix and perhaps should not have been so regarded. And the assumption that development should be export-led, since it is the wealthy industrial nations that have the demand capacity to absorb imports, ignores the problem of the "terms of trade" in capturing the gains from comparative advantage, as well as, the fact that developed nations overwhelmingly tend to trade with each other.
I might add the the examples listed from the late 19th century all have a context. It's called "the British Empire."
"The US offers political and economic stability."
Really? Haven't Krugman and Brad been bitching for ages and at tedious length that America no longer enjoys economic stability - indeed it has the projected finances of a banana republic? And hasn't it just been through a stockmarket boom and slump? The massive capital inflows have come at the same time as America's fiscal position has experienced its biggest deterioration in peacetime history (I think).
Surely the main reason that the capital inflows have been so large is that central banks, mostly in Asia, have been happy to build up gigantic dollar assets, for reasons unknown, but perhaps to avoid exchange rate appreciations, which will hurt politically sensitive sectors? Or maybe as a piggy bank against future crises? This may be a silly judgement, but it is one that they have the right, as independent sovereign states, to make.
rvman: I was trying to make two points: a) that government investments in infrastructure are no less likely that private sector investments in other stuff to be quite useful; and b) that we can change politicians, but we cannot change management of large important corporations.
Let me expand on that last point. Many people do not like the way Michael Eisner has managed Disney. There is a campaign to withhold votes for him in the current proxy campaign. http://www.nytimes.com/2004/02/27/business/media/27DISN.html Nothing the sharelholders do will make a difference. Eisner has things wired so that even if the shareholders get rid of him, they will wind up with the bill. Democracy offers a realistic chance of dealing with people who make a mess of things.
Consider Enron. Many people, including those who post here, seem to think that the market acted just fine in dealing with that fraudulent empire. Sure, after losing billions and billions of other people's money, some people from Enron got punished, and the rest kept their money. There are any number of similar examples.
So, why do people keep on talking about the brilliant private sector and the stupid incompetent government? I say there is plenty of stupid to go around, and at least we have some minimal control of the government, and at least it is transparent.
Very nice essay. I especially admire the intellectual honesty. Everyone makes mistakes but few have the courage and integrity to admit them.
Is there a lesson in this story?
Perhaps it suggests that we ought to be very cautious and circumspect in our policy proscriptions and forecasts. The best economic minds were not able to correctly predict even the sign (forget the magnitude) of international capital flows when this flow was deregulated ( one can't blame them; it probably was unpredictable).
It leads one to wonder how much confidence should we have in other policies that economists are now confidently promoting.
I just wanted to thank you for posting this. At one point I got so angry with reflexive free-trade mantra I posted a nasty comment about outsourcing economics professorships, on a post about hawks.
As in: "if an economics professor is so well paid to look out his window to see hawks flying around perhaps it's a sign his job should be vulnerable to outsourcing."
Jeanne D'arc says it much better today, about Thomas Freedman's silly op-ed piece.
The goal of a liberal free trader should not be Freedman's "golden straight-jacket" in which all the world's labor is in a fratricidal competition. That's the route of: "workers of the world unite! You have nothing to lose but your chains!"
But it's the other side of the coin of mercantilism: if capital is flowing out of the united states in a trade imbalance, it has to flow back *somehow*. And so it does, as foreign investment.
Googling and browsing some - it seems from this one:
that I've been more or less along the lines of Nicholas Kaldor on increasing returns and international trade. Brad's use of rubber-boats and learjets seems a rather ad hoc attempt at defending neoclassics against ideas labled "new growth theory" and "new trade theory".
Maybe some economists out there could help this uninformed internet-addict on these things?
"I was just observing that buying a stock or an already issued bond for say $100, doesn't necessarily result in a $100 investment in real assets." So, if there were no secondary market, do you really think people would be active in the primary market? If seller of mortgage and credit card institute's debt couldn't find buyers in the secondary market - you don't think this would affect your ability to buy a bigger house, better car, or even your ability to keep the debt you already have?
Three (or four) more "for the record"
If you think the economic current situation is 'incomprehensible', 'unprecedented' and/or 'hopeless' think again:
The Economic Consequences of the Peace
Main Causes of the Great Depression
If you have trouble wrapping your moral imagination around the economic jargon, you'll find a very interesting discussion of the the current situation AND some impressive pictures here:
Tour of the US Income Distribution: "The L-Curve"
If you, too, are disgusted by what passes for 'courage' and 'vision' among run of the mill professional economists, spend some time here:
The Divine Right Of Capital: Dethroning the Corporate Aristocracy
"So, if there were no secondary market, do you really think people would be active in the primary market? "
No. Thanks for pointing that out. So $100 of foreign capital invested in the secondary market for stocks, means what for investment in real productive assets in the U.S.? How much of that winds up in real investment? How much is paper speculation on future returns. Or is the proper question how much does investment in the secondary market lower the cost of raising capital in the primary market. I wonder if we are talking past one another here. If so I appologize for not getting your point.
On reflection I shouldn't have used the term "theoretical claim" on underlying cashflows. I should have said "various legal claims" on cashflows. I think I was subconciously thinking about the shareholder's legal but inneffective right to ownership and control of the enterprise.
"What if you could increase the utility of many poor people, by taking a little away from a very rich person". At the time, he replied that the Pareto concept didn't deal with that question. So the pareto allocation was all we could talk about. I wonder if professor Delong or some one else could point me to some answer."
Your professor was right - the change you describe would not be Pareto improving (but neither Pareto, um, worsening). The criteria of
Pareto optimality just basically says more or
less that there's no "free stuff" (valued by someone) sitting around that nobody's using.
Your question was about distribution. In general
the Pareto set is just that - a set, of distributions without free stuff laying around. If you make further assumptions on what constitutes social justice, or fairness through
a Social Welfare Function (or on a specific way to aggregate individual preferences into social preferences), then you can pick a point out of that set which will give you a distribution which is efficient and "just" according to the criteria you assumed.
People have a problem with Pareto for two reasons.
The first is based on a misunderstanding - they ask the criteria of Pareto efficiency to do what it was not designed to do, that is to make social welfare comparisons. The second one is more legitimate and it is basically an annoyance at the disproportionate attention that the Pareto criteria receives in modern economics, rather than say Social Welfare Theory, which is a legitimate criticism except that....
...Social Welfare Theory was (partly) aneasthesized by Arrow's Impossiblity Theorem in the 1960's, but that's another can of worms.
"I for one would like to throw together a model to estimate this sort of thing--imagine two countries with identical rates of technical progress (this can vary), but one of them has much higher population growth than the other (say, 2% versus 0). OLG may be easier than infinite lives, or maybe not. Assume CRTS technology, Cobb-Douglas maybe. Intuition says that the low-fertility country will run chronic current-account surpluses with the high-fertility one, as the demand for capital in the latter keeps rising. (Watch out for transversality conditions!) Call our countries the US and Japan (or Europe). Do the quantitative results match the qualitative ones?"
This sounds like a simple extension of the standard models. In fact for the infinite-horizon version see chapter 3 of Barro and Sala-i-Martin's "Economic Growth". The problem though is that with free capital mobility the speed of convergence is infinite or one country ends up owning everything, so you need to put in some friction in the model - Barro and SiM use either, credit constraints, finite horizons or capital adjustment costs.
They allow countries to have different rates of impatiance however and when solving the model assume equal pop and tech growth. I suspect that you could assume same impatiance rates and get similar results by letting pop growth rate differ.
At the same time I don't know if anyone has empirically estimated or calibrated this model which might be a very useful excercise as you indicate.
"And I certainly agree that under the proper competitive and other preconditions, the market equilibrium attains the Pareto frontier. Or, to put it another way, the market equilibrium maximizes that Benthamite social welfare function in which each individual's utility is weighted by the inverse of their marginal utility of income."
Brad, I'm surprised you posted that. I'd thought you were a sensible economist.
There is no such thing as a market equilibrium maximizing the social utility function, that idea was disproved decades ago. The structure of individual preferences does not, mathematically speaking, allow you to say anything about the intersection of the supply and demand curves of society as a whole.
The microeconomic proof of a "socially optimal" market equilibrium relies on the assumption that society basically consists of a society of totally identical clones each of whom have exactly the same utility function. If you assume that different people have different desires, then the structure of the social utility function is arbitrary and you can't say anything about it without empirically cataloging everyone's desires.
"Granted, it's human nature to assume malice in bad social outcomes, and there's enough real malice out there. But any one person taking advantage of Argentina's unsustainable peg is not malicious--no one person caused the crisis, but lots of people did in the aggregate, because one bad policy gave them the opportunity. Now only if the Argentines had floated sooner, stabilized their macroeconomy, and avoided the whole mess--the benefits of hindsight...."
IIRC, the Argentine currency peg was supposed to stabilize things, and help them. Of course, that was before the collapse...
Again IIRC, Krugman did a column suggesting that, in the end, a currency peg didn't lend that much fiscal credibility, because Argentina could always go off of the peg, in a crisis. So investors fled the Argentine currency, and, sure enough, a crisis happened.
Would it kill the third world to have short-run controls on volatility? The US somehow gets away with it in our stock market.
My short take on this is from Samuel Bowles new book on microeconomics: Microeconomics : Behavior, Institutions, and Evolution
On p 499 or 500 Bowles brings up that nasty second-best problem and how it plays havoc with the simplistic idea that opening up more markets and/or allowing more trade/financial flows must automatically make things better. Unless you are sure that all (well, OK, enough) things are optimally configured (via market equilibria, I suppose) in other sectors, then you DO NOT know at all whether opening up a market in another sector will make things better. Even in the sense of making more pie for everyone to share (regardless of whether everyone gets or not).
For obvious reasons market oreinted economists hate lipsey-lancaster second best stuff with a passion. But I have not seen them do much other than bad-mouth it.
So why all the hand-wringing? Just say you don't know and look around for funny stuff that might make things different in current poor countries versus nineteenth century US and Ausralia.
Bowles presents what he thinks are some interesting examples of institutional problems in currently poor countries that might explain their lack of development. Not all of them friendly to lefties like me, either.
Even if capital investment flows cancel out current account balance deficits, there is still the issue of capital flight in the form of ownership. Another country that subsidizes its exports then can convert these proceeds into purchases of financial instruments of ownership or credit. The capital then works for them in other words. The returns on the instruments of ownership and credit then increase the wealth of the other nations. This effectively dampens the real ROI on US capital investments. Does that seem obscure?
Suppose a rich Westerner takes his money and invests it into a poor third world country. He is not doing this to enrich that country. Suppose his investment makes a return. Surely he wishes to repatriate his returns. The point afterall is to make him rich. Just because his assets happen to lie in a foreign country, because the ownership and therefore right to profits belongs to him.
Now reverse this and apply it to foreign investors investing in the United States. The capital investment flow from abroad is not a fair swap / substitution for buying our exports instead.
spencer: "In post war europe the human capital and organizational ability to run an advanced
industrial economy already existed."
This is not to contradict your post: It's because the Central-European countries (plus Great Britain) were developed industrial (and largely democratic!) societies before WWII. They suffered greatly from the war, but it takes quite a bit to destroy a technological infrastructure including all the people involved.
If you travel around in Europe, you will see that in a large number of places they are still using electromechanical equipment from Germany and other countries installed during the '20s or '30s, like elevators, cable cars, pre-WWII manufacturing equipment, etc. In Mediterranean and Arabic countries British and French equipment from similar times is probably dominant, but German equipment can be found. Look at manufacturer's logos and plates affixed to machines, vehicles, building parts, etc.
Brad: Not to repeat others, but this sounds to me like the confession of a repenting sinner. :-) Good stuff though.
No offense, as always.
'I might add the the examples listed from the late 19th century all have a context. It's called "the British Empire."'
John C. Halasz cuts through all the fog and gets to the bottom of the matter. When Brittania ruled the world, investors could invest in the most far off places with the assurance that their funds wouldn't be siphoned off to Switzerland or Liechtenstein. The British Empire *did* have its good points.
Uh, that should have been "Britannia", not "Brittania".
Capital flows from poor to rich countries because the risk return tradeoff from investment in the poor countries are inferior than that of the rich countries. Often, capital flight is a result of the pent-up flight from the lifting of capital controls. The currencies are just trying to find their own natural level. Just as often, you will find the flight of human capital from the same countries.
As someone who once was an emerging market investment specialist, I can attest that capital flight is a sign that you don't want to invest in that country. One of the signs that you want to "buy" into a country is when the locals bring their money back from abroad. An even worse sign is when there is a brain drain...
At lot of this can be attributed to the poor countries pursuing wrongheaded developmental policies. For some insights, read Jane Jacobs' numerous works, or Michael Porter's "The Competitive Advantage of Nations".
The real tragedy of development, of course, is the tariff barrier that rich countries put up against the products of poor countries (e.g. textiles, Vietnamese catfish, etc.).
My question to Brad is: "If you were in favor of capital controls, would you put controls on human capital as well?"
"Today, however, it is much harder to be a supporter of untrammelled international capital mobility."
My reply: When one is up close, it is hard to see the forest for the trees. From a distance, "untrammelled international capital mobility" is nothing part and parcel of free trade. Your statement just proves that both a wacky ideas.
From a distance you even explain why. Trade is dependent upon governments arriving a trade agreements that work. Yet, as you often point out, government doesn't work. It naturally follows that free trade doesn't work, principally because all that any trade agreement equals is the sum of X, being who lacks political power and can be screwed (which up to now has been blue collar workers, not college professors and agribusiness) and Y, being the bad the bad government factor.
"In the Treasury in 1993, I naively projected that after NAFTA there would be a net capital flow of some $10 to $20 billion a year for decades to come as investors around the world built factories in low-wage Mexico that now had guaranteed tariff-free access to the largest consumer market in the world. Instead, the capital flow has gone the other way."
Question: What makes you think you are any less naive, today? You remember the old saw about experience. Doe you 1 years experience, or just 1 week, repeated 52 times.
From your posts on free trade, to this objective observer you are still naive and have not learned much about international trade and finance in 15 years.
You constantly attack Bush, and rightly so, for being off the wall in making policy. However, you are no better. No read MoneyBall and learn that none of us are that much better than most other players (Rubin was a once in a lifetime exception, when it came to the deficit and bond markets).
The American public, as Roach understands, has a far better understanding of the issues than you and any 20 other economists. The Cajun almost got it right; instead of the economy, stupid, he should have said, "Because in the long run we are all dead, It's the economy stupid."
American's still have some sense of a social contract. You don't close a factory in Topeka and put people out of work, if for no other reason than these people, or their fathers or sons fought our wars, defended our freedom, paid the taxes that built your school and funded your salary.
Given that we are at the height of our military power, now is the time to reward friends and punish enemies. Cut off trade, close the boarders, and plunge the world into depression.
Economist always think that "economic growth and prosperity" is the answer to the World's problems. It's not, for such alone carries with it no moral hazzard.
The miserable lot of humanity that hasn't learned from the "End of History" will be swept away. I know you think this is horrible, but I am just using Brad DeLong free trade thinking. You laugh at the factory worker whose life and family is destroyed when the mill closes, because he is a dumb uneducated fool. He can find solace is being retrained to flip hamburgers or greet at Wal-Marts. I laugh, for the very same reasons, at the poor throughout the world who have known for two centuries how to build a great nation but have not been willing to sacrifice for such. You forget, so easily, that American's died to get where we are. It was "capital" that built America is was the blood pouring out to the ground a thousand times at horrible places like Shiloh and Cold Harbor. I could go on, but I am sure you get the point.
With the depression this time, we need to stay at home and let Japan, Europe and Russia figure it out.
As a citizen of one of the examples of 19th century development and 21th century collapse (Uruguay), I think one of the points is that in the 19th century we could export a high priced commodity and now we can't. Capital will not flow here unless we are able to offer extremely high returns, and quite simply we can't. Our labor is not cheap enough, our commodities aren't expensive enough and we don't have enough technology. To produce export oriented growth you need something to export, something that can't be produced elsewhere easily, something whose price doesn't fall, etc. Maybe the key to the different outcome was the developed world need for commodities then and now.
It's good of Brad to realize and admit his mistakes here, but I still think he's way off base.
The people who designed the policies that freed up International Capital Controls were not surprised by what happened. It was their goal, and it was motivated by malice and greed. The people in the developing nations were not surprised either. Meet the new boss, same as the old boss. The only people who were genuinely surprised were the liberal economists.
I knew it when I protested against the WTO in 1999. Huge numbers of people knew it when they protested the IMF in 2000.
Free Trade needs to start with food and move eventually to derivitives markets. Neoliberal ideology is instituting the reverse and niether Brad, Bush, nor Kerrey want to do a thing about it.
Again, Stiglitz's book _Globalisation and its Discontents_ is the gold standard on this question. There are solutions to these problems, but Americans won't like them.
"Massaccio - it would be nice if shareholders would hold CEO's accountable"
See The Modern Coporation and Private Property for a detailed refutation of this old duck.
"It is not possible for a card-carrying liberal like me to ..."
I didn't know there was such a thing as a full-fledged liberal anymore, let alone one who had a card to match the liberal. Is it in color or black and white?
See what happens when you don't make sure that adequate amounts of dough are allocated toward big-time family parties like graduation parties? If you start getting more positive feedback on items like this, then you'll know you're on the right track.
I've got lots of point by point replies, so I'll break it into several posts. Here goes.
Masaccio writes: "Consider Enron. Many people, including those who post here, seem to think that the market acted just fine....So, why do people keep on talking about the brilliant private sector and the stupid incompetent government?" Because in our portfolios we can diversify out the effects of individual companies doing stupid things because some will do brilliant things; we can't diversify the bad effects of governmental mistakes. The stakes are higher.
Mats writes about the increasing-returns literature. In fact, this is considered to be part of neoclassical theory and is pretty orthodox; we're pretty sure that there are increasing returns or else there wouldn't be things like cities. Constant returns, however, is easiest to teach to an undergrad. The problem is identifying particular reasons for increasing returns in real life and what policy can do to help things rather than hinder them--industry-picking doesn't seem to work too well, and neither does import substitution. Also at what level do IRTS operate--globally (say, by having a diverse range of inputs), locally (say, fixed costs for infrastructure), technologically (Romer and "new growth theory")--and how much of it is there? This is one of those subfields where our theory exceeds our knowledge.
Radek nicely discusses the issues with social welfare theory. Strictly, it isn't possible; you basically have to project your own preferences onto outcomes to see what is "socially optimal." The Pareto set is pretty big--it's a weak condition that nearly everone can agree on. Someone's idea of social optimality had better be contained within that set; this is basically a no-sadism condition. Also, thanks for the reference; I'll have to check it out once I get back to campus and my library.
Barry writes: "IIRC, the Argentine currency peg was supposed to stabilize things, and help them. Of course, that was before the collapse..." Argentina was basically in a heck of a mess since it did have a real credibility problem with hyperinflation. Not that the cure proved any better than the disease.
"Again IIRC, Krugman did a column suggesting that, in the end, a currency peg didn't lend that much fiscal credibility, because Argentina could always go off of the peg, in a crisis. So investors fled the Argentine currency, and, sure enough, a crisis happened." Exactly. This is a pretty good indication that pegging a currency to gain credibility is a dangerous game. It's just inviting a perfectly rational attack, no malice.
Jml writes: "For obvious reasons market oreinted economists hate lipsey-lancaster second best stuff with a passion. But I have not seen them do much other than bad-mouth it." Whenever someone says that economists obviously believe something the statement that follows is usually off the wall. This is one of those cases. Electricity deregulation comes to mind where economists proposed either flexible pricing or continued regulation, which are first-best and second-best, respectively; it's the political system that came up with the worst-of-both-worlds approach. Trusting the political system to find a second-best is an act of faith, at best.
Too bad about Stiglitz. He's very bright but he knows it. Maybe if he spent less time attacking Ken Rogoff or reminding people about his Nobel and more time explaining economics to the masses, he'd be an effective popularizer, like Krugman a decade ago. He makes everybody in the profession seem like opinionated jerks, and he feeds the preconceptions of people who ignore economists ostensibly for this reason. Economics is about moving beyond preconceptions, something that biztheclown and MiddleAmerica in their attacks above do not realize. If you want dogma, that's what church is for.
I think you make a very good point about the rich of the third world investing in the rich world partly as a security for the rubber boat scenario. I have always been a very strong advocate of free movement not only of goods but of people. In fact, people should probably come before goods. If the immigration aspect were allowed than the percapita investment in between rich and poor world would likely more in a more positive direction.
Where do things currently stand in regards to Saudi Arabia?
I know two big things wrong with all that capital mobility:-
- When you "invest" using a fiat reserve currency to do it, that's not investment, that's wealth transfer (in proportion to the deficit going on, and with wealth not necessarily being transferred to the "investor"); it's material even when it's small, since it's cumulative. It's worse for primary producer countries; they suffer more from the resultant absentee ownership, since they don't claw anything back from the value chain they feed into.
- When "productivity increases" are driven by market imperfections in the countries concerned, e.g. by turning subsistence land over to cash crop use by privatising and/or consolidating it, you marginalise people who weren't in the cash economy. Indeed, notional increases in cash incomes happen to people who are driven into sweatshops, and this looks good to simplistic readings of Dollar and Kraay style surveys. Everything is really much worse than it looks, because of survivor bias.
All these things have precedents in the history of European progress. It's not news.
Chris: yes, you are correct, I shouldn't have said that all market oriented economists make fun of second-best theory. I am guilty of off-the-wall-ness via overgeneralization.
But then you go to do exactly what I was overgeneralizing about. So, OK, letting the government solve the second best problems is an act of faith. But so is letting the market solve it, if there is reason to believe that there is a serious second best problem.
So was what I said so off the wall, all in all? Your statement that trusting the govt is an act of faith is a dodge and a pose, it is not a serious scientific response to the problem. If you have an argument that an unregulated market will deal with a serious second best problem better than the government, let us hear it. If you want to leave it where you left it, then you should admit that an economist's faith (or gut feeling, or subjective professional judgement, or whatever) is not a scientific argument, and allow others to have their faiths as well.
It would be interesting to find out what differences where might be in postwar capital transfer regimes (that supposedly have not worked as anticipated) and previous regimes.
I am not a specialist in this, and most of my thinking has come from just having finished the Bowles book. But one example Bowles gives is differences in bankruptcy laws and land tenure in North American versus Sout Asia. It was much easier to get out of dept, and much easier for small individual producers to retain surplus of production and acquire real property in North America. Could this have made the difference? Suppose inability of of producers in South Asia to retain surplus retarded development of domestic aggregate demand, and that might have kept the "risk-return" profile of local investment unfavorable. Just what domestic market was being developed that was so attractive to produce for, or invest in, if most people stayed poor serfs?
It would be interesting to try to figure out how much of international financial capital flows went to finance what at different times and different countries. How much for currency speculation? How much for large scale top-down projects (whether governmental social invesment schemes, or large-scale international industrial projects)? How much of 19th century international capital flows went to purposes in North America that would be considered micro-finance today? Anyone know of any sources on this?
Following up on Bowles observation on promoting ability of small fry to retain surplus of their production, the 19th century US paid a lot of attention to that. Whether it made any difference or not is another question. But there were lots of regulators and government inspection men who were trying to make sure that land grant regulations were followed, and the appropriate % of land opened up by RR in the west went to individual farmers and businessmen. And of course there were armies of front men and operators trying to beat the system and keep the land under control of Southern and Western Pacific. Anyway, that is what I read in Billington's Westward Expansion, and (I think) Hughes' economic history of the US. I wasn't there, so I just know what I read in books.
But whether it worked or not, it is a different picture than most third world countries, where you can argue that most of the effort was in the opposite direction.
This is an anecdote, but this effort to allow small timers to gain control of assests made a huge difference in the case of my own ancestors.
Final note to Chris: suppose that there is something to Bowles observation that a whole system of land tenure and debt regulation embedded in a capitalist system is responsible for differences in development. Where does that leave your argument about the relative risk of small private versus large public experiments? Would any collection of small private experiments solve that problem?
By the way, I am enough of a market oriented economist to also be leery of capital transfer controls. And I would want a well worked out explanation of why a control was desirable before I would be friendly to it.