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Brad DeLong's Thoughts of the Moment on Economics, and on Other Topics as Well
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November 21, 2002
The Current World Short-Run Economic Outlook
The Economist surveys the current state of short-run economic forecasts. It sounds remarkably gloomy--next to nothing about the long-run tech-led supply-side boom, next to nothing about the magic of the market. Instead, it focuses on how governments are mismanaging aggregate demand, and about all the things that could make spending even weaker:
Economist.com: ...As the OECD acknowledges, most economic upturns are uneven in the months directly after recessions have ended. But the latest report points out one unusual feature of the rather weak pick-up in activity this year: the coincident fall in share prices around the world. Equity markets have continued to weaken even as most economists concluded that the worst was over in America and Europe. In America, the drop in share prices since the recovery began at the turn of this year is the first such fall in any of the 18 economic recoveries since 1912. That is more than just another interesting statistic. Falling share prices undermine corporate and individual wealth and could in turn weaken economic activity.
Business investment is already weak—the accounting and other corporate scandals in America have done little to help there—and if consumers start to lose heart as well, recovery could stall, and might even go into reverse.
Another unusual feature of the global recovery, which follows the first worldwide downturn for more than a decade, is its apparently divergent nature. The OECD does not think this is a cyclical phenomenon—ie, simply a matter of different regions being at different stages of recovery. It reckons that structural differences explain the different pace of the upturn in different parts of the world—and that, in particular, the potential for future growth in America is considerably greater than in other parts of the world. If this analysis is right, policymakers in Europe and Japan should be worried.
They are, of course. In the case of Japan—the industrial economy facing the greatest crisis—they are both worried and, as yet, incapable of the tough decisions needed to deliver reforms that are now long overdue. In Europe, governments are slowly waking up to the challenges which face them, and realising how much time they have lost. Policymakers in the euro area find themselves constrained by the fiscal deficits that make it difficult to inject stimulus into their economies. At the same time, they are under pressure from the stability and growth pact to take action to reduce those deficits...
Still sickly
Nov 21st 2002
From The Economist Global Agenda
The Organisation for Economic Co-operation and Development sees a slow and irregular global recovery in its latest economic outlook. The risks remain on the downside. Policymakers are finding life difficult in part because they relaxed too much in the 1990s
WHAT is the world coming to? That is an unusually difficult question to answer at present, as the Organisation for Economic Co-operation and Development (OECD) implicitly acknowledges in its latest economic outlook, published on November 21st. The rich countries’ think-tank notes that the world economic recovery is “more hesitant and less widespread than expected”. More ominously, perhaps, it also notes that the risks are on the downside.
The OECD’s uncertainty is shared by other economic forecasters. The International Monetary Fund (IMF) made the same point when it published its own outlook in September, for example. Two months on, economists are no nearer to making confident predictions about the likely progress of the upturn. They think it will continue, but they worry both about it being blown off course and about the ability of policymakers to deliver the economic reforms needed to establish sustainable growth more firmly.
As the OECD acknowledges, most economic upturns are uneven in the months directly after recessions have ended. But the latest report points out one unusual feature of the rather weak pick-up in activity this year: the coincident fall in share prices around the world. Equity markets have continued to weaken even as most economists concluded that the worst was over in America and Europe. In America, the drop in share prices since the recovery began at the turn of this year is the first such fall in any of the 18 economic recoveries since 1912.
That is more than just another interesting statistic. Falling share prices undermine corporate and individual wealth and could in turn weaken economic activity. Business investment is already weak—the accounting and other corporate scandals in America have done little to help there—and if consumers start to lose heart as well, recovery could stall, and might even go into reverse.
Another unusual feature of the global recovery, which follows the first worldwide downturn for more than a decade, is its apparently divergent nature. The OECD does not think this is a cyclical phenomenon—ie, simply a matter of different regions being at different stages of recovery. It reckons that structural differences explain the different pace of the upturn in different parts of the world—and that, in particular, the potential for future growth in America is considerably greater than in other parts of the world. If this analysis is right, policymakers in Europe and Japan should be worried.
They are, of course. In the case of Japan—the industrial economy facing the greatest crisis—they are both worried and, as yet, incapable of the tough decisions needed to deliver reforms that are now long overdue. In Europe, governments are slowly waking up to the challenges which face them, and realising how much time they have lost. Policymakers in the euro area find themselves constrained by the fiscal deficits that make it difficult to inject stimulus into their economies. At the same time, they are under pressure from the stability and growth pact to take action to reduce those deficits. The OECD report gently points out that the difficulties now reflect missed opportunities to put houses in order in the boom years of the 1990s.
Of course, America too has seen its public finances deteriorate—those projections of huge budget surpluses far into the future that President George Bush inherited when he took office in 2001 have long disappeared. They have been replaced by deficits almost as far as the eye can see: Mr Bush’s tax cut, the jump in military spending and the economic downturn have all played their part. The rising deficits have also provided a big fiscal stimulus for America’s economy, though. And at the same time, the Federal Reserve has been slashing interest rates to keep monetary policy as loose as possible. In passing, the OECD comments that upward risks—and with them, the possibility of higher inflation—should not be completely ignored after such a monetary (and fiscal) relaxation.
The European Central Bank (ECB) has been much slower to cut interest rates, in part because the tough inflation target it was set has proved difficult to meet. Nevertheless, the OECD reckons that the sluggish, even slowing pace of recovery in some of the bigger European economies—Germany above all—will lead the ECB to cut rates by a further half a percentage point in the near future. There was further confirmation of the extent of Germany’s problems on November 21st, when figures showed that GDP grew by only 0.3% in the third quarter of the year, compared with the previous three months.
The latest forecast for economic growth reveals some big downward revisions from that made by the OECD in June. For America, the OECD—often at the optimistic end of forecasting ranges—is now marginally more pessimistic than The Economist’s own poll of private forecasters. When it comes to Europe, the OECD has slashed its forecast; nonetheless, it is a shade more optimistic than The Economist’s poll.
Ultimately, though, such numerical forecasts are little more than best guesses. They often include assumptions about policymakers’ behaviour which turn out to be wrong. Politicians are usually reluctant to make tough and unpopular decisions. Germany, for instance, has been slow to accept the need for drastic reforms to its labour market. Without fundamental changes, though, the country’s capacity for future growth is likely to remain heavily constrained—something that is gradually dawning on the government.
The loudest message from the latest OECD report is that short-term problems cannot be tackled effectively if long-term reforms are ignored. As the room for manoeuvre in fiscal and monetary policy becomes more restricted, the importance of tackling fundamental economic weakness grows. It’s an uncomfortable but important thought.
Posted by DeLong at November 21, 2002 10:53 AM
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A friend of mine used to claim that The Economist believed that there were three causes for almost everything . . . . . except for the really complicated stuff that always had four causes.
Fair to observe here that this is not their best work. For example, The Economist tells us that "More ominously, perhaps, [the OECD outlook] also notes that the risks are on the downside." ALL THE RISKS ON THE DOWNSIDE? Well, they ARE gloomy-gus economists at heart, what did you expect? As Professor DeLong points out, U.S. productivity growth has been relatively good DESPITE the weak economy. Won't THAT factor spurt further when the economy really picks up?
This point in particular demands elaboration: "The latest forecast for economic growth reveals some big downward revisions from that made by the OECD in June." So, in other words, much of this article is based on the assumed accuracy of the OECD's expert forecast - made by precisely the same experts that only 5 months ago were forecasting much stronger growth?
Last, this sentence pretty much gives it all away: "They often include assumptions about policymakers’ behaviour which turn out to be wrong. Politicians are usually reluctant to make tough and unpopular decisions." If only, IF ONLY, policymakers would stop ignoring the OECD assumptions and make tough and unpopular decisions, then we'd get back on the great growth track? Oh please. Have these people ever heard of RATEX? Are individuals in all these economies just little ants that march around in precisely predictable endless loops? Worst of all, there's no reference to the egregious policy errors contributing to the slow growth. Did West Germany really have to use a 1-1 exchange rate with East Germany? Could that have something to do with their huge structural deficits? Does France have to keep subsidizing their farmers? Does one currency and one monetary policy make any sense at all for a region as diverse in languages and cultures as the EU? I digress . . . 'scuse me while I go torment the wall for a while.
Fortunately we live in several democracies. Economic policy is not made by OECD fiats, rather it is made in the confines of our political systems. France really does have to keep subsidizing their farmers, after all America subsidizes its farmers and is not going to stop any time soon.
The major economies are growing too slowly at present and there is need for stimulus packages that correspond to their several political realities. But there is no general crisis apparent to me, only a subtle need for stimulus.
Once we are back to a rapid growth period, perhaps we can begin to more earnestly tackle the structural problems of health care in America, unemployment in Germany, an antiquated middle distribution system in Japan.
When I read this comment about "Once we are back to a rapid growth period, perhaps we can begin.." my mind immediately jumped uncontrollably to the oil patch bumper sticker, "Oh Lord, please give me just ONE more boom, and this time I promise not to piss it all away!"
"France really does have to keep subsidizing their farmers, after all America subsidizes its farmers and is not going to stop any time soon."
The United States is indeed guilty of protecting its farmers, but not to the degree provided by the French government. American farmers are still thankfully going out of business and finding more sensible employment. Less than 3% of the American population depends on farming.
The French still hesitate to gradually pull the plug. Schumpeter's creative destruction dogma cannot be ignored if you truly desire a wealthy country.
There have been many booms and there will be many more. Though the economy is growing slowly, there is a housing boom just now. Whether or not the economist is grumpy, we can take advantage of market conditions. There was a bond market boom by spring of 2000. Nice. We took advantage of bonds. We took advantage of the housing boom. Hong Kong is in the midst of 48 months of deflation, but our friends there are taking advantage of the boom in mainland China. I wish things were better for all, I wish we had a more sensible fiscal policy, but there are still lots of opportunities and more booms to look to.
Time to sell bonds. Sell'em all and run for the hills. Well, corporate high yield might do OK as the unprecedentedly wide spreads narrow, but the treasury curve is going up. Deficits as far as the eye can see, maybe a cyclical low in inflation and who ever made money buying bonds in the middle of a war anyway?
The Gulf War? Oh THAT one. So there was one time, on my watch too. But not this time.
The risk: deflation, but definitely not Japan's deflation. Japan has financial, structural and demographic issues. We don't. BUT the world we live in has got issues. Did you know you can export deflation but not inflation? Oops, gotta hop on out and bring home a pizza for Andrea.
I'm going to get a lot of flack for this, but France's farm protection is not like ours. Theirs go primarily to small farms which are, in effect, protecting their countryside. Our protections go to huge agribusinesses which destroy our topsoil and pollute our environment. I'd be happy to subsidize our small farms and take away the subsidies going to agribusiness. And I don't think that would have as much of a free trade impact.
Michael makes a very important point. I think that completely free trade without any subsidies may be a very serious stategic mistake for many countries. Just to give one example: let's take farming in Japan.
Japan is obviously not a great country for agriculture, so from the point of view of free enterprise and free markets, it might seem that they should just concentrate on what they are good at---manufacturing cars, and eliminate all their farms. They can import all the food they need from elsewhere using the profits from car sales.
However, that is potentially a colossal mistake. What if the bottom drops out of the market for cars (perhaps because of gasoline shortages)? What if the country that they import food from stops exporting it (perhaps because of crop failure, or war, or something)? Perhaps at that point, Japan should just return to farming, but that may longer be possible: the fertile fields may have all been paved over to build parking lots for factory workers.
Pure free trade encourages putting all your eggs in the most profitable basket, which would be fine except for the fact that a country can't turn on a dime. It takes time to develop an industry such as farming or steel production, and in a crisis time is what you don't have.
I'm not saying that strategic concerns are what drives farm subsidies, but I do think that there can legitimately be reasons not to let the free market completely determine a country's industries.
Yes. Yes.
The French do subsidize small farmers, and I sure wish we did the same.
"The French do subsidize small farmers, and I sure wish we did the same."
The result of carrying out such a policy would be disastrous to the country. Keeping afloat inefficient small farms would add enormous costs to the average family budget.
I have a question to ask: where did you receive your education regarding economic matters? Your teachers obviously failed in their mission.
“Perhaps at that point, Japan should just return to farming, but that may longer be possible: the fertile fields may have all been paved over to build parking lots for factory workers.”
And yes, I could also be hit by a meteor when I leave my house. Shaq O’Neal might beg me for mercy if I went one on one with him on a basketball court. Alas, human beings should make decisions based on probabilities, not on a scenario that is statistically unlikely. A nation should pursue economic policies which promote greater efficiency---in other words, those embracing the dogma of creative destruction. Might this cost some short term pain? Indeed, it most certainly will but this price must be paid.
"I'm going to get a lot of flack for this, but France's farm protection is not like ours. Theirs go primarily to small farms which are, in effect, protecting their countryside."
"Protecting their countryside" from what? Marauding McDonald's?
Daryl McCullough writes, "Japan is obviously not a great country for agriculture, so from the point of view of free enterprise and free markets, it might seem that they should just concentrate on what they are good at---manufacturing cars, and eliminate all their farms. They can import all the food they need from elsewhere using the profits from car sales."
"However, that is potentially a colossal mistake. What if the bottom drops out of the market for cars (perhaps because of gasoline shortages)? What if the country that they import food from stops exporting it (perhaps because of crop failure, or war, or something)? Perhaps at that point, Japan should just return to farming, but that may longer be possible: the fertile fields may have all been paved over to build parking lots for factory workers."
So, instead, the government should pay farmers to grow things that that can't compete in the world marketplace? In other words, continuously make a mistake, so that the country can avoid a "colossal mistake" in some unknown future?
Why not simply let everyone do what they want to do? Most of the farmers will then go out of business. But presumably a few--those with you vision of possibly-very-expensive food--will stay in business, to make big profits in the future. If the future arrives, they're rich. If not, they're poor.
Centralized planning, which is what Mr. McCullough is suggesting, works if the government is extradinarily smart and/or extraordinarily lucky. But the history of the 20th century (and the 19 centuries preceding it) don't indicate that governments are typically smart and/or lucky.
Mr. McCullough might find Lester Thurow's "Head to Head" interesting. The book is about the economic systems of Japan, Europe, and the United States--the United States' system being the one in which government is least involved in the economy. (Frightening thought, but true.) Which system is better for economic growth? The answer to date appears to be in favor of the U.S....at least over the last 20 years.
>>Once we are back to a rapid growth period<<
This may not be as obvious as it seems. The last fifty years have seen sustained growth and a mild inflationary climate thanks to steadily growing labour forces as a percentage of the population - the dreaded 'participation rates' - in all OECD economies. Now we have switchback, declining dependency ratios and deflationary tendencies across the OECD. Sure the labour productivity is going up, but not necessarily the per capita income, hence the output-gap problem.
This one has no easy answer. Would that it were only a question of 'silly' politicians.
>>Japan is obviously not a great country for agriculture......it might seem that they should just concentrate on what they are good at---manufacturing cars...<<
The problem is economically speaking it isn't altogether clear what the Japanese are good at these days. Technically, of course, they are superb. But manufacturing cars at a profit, not that I know of. They call them strategic 'torrential-rain' exports. Anyone in doubt on this should check out:
Mikuni and Murphy: Japan's Policy Trap and get a glimpse of what might be to come.
(http://www.amazon.com/exec/obidos/ASIN/0815702221/qid%3D1038210767/sr%3D11-1/ref%3Dsr%5F11%5F1/103-5737867-7800606)
And yes, I could also be hit by a meteor when I leave my house. Shaq O’Neal might beg me for mercy if I went one on one with him on a basketball court. Alas, human beings should make decisions based on probabilities, not on a scenario that is statistically unlikely.
I'm afraid this is not quite right. You also have to take into account the risk you are willing to bear. For instance, usually you can sell out-of-the-money puts on equity indices where the expected return is positive. People still don't do it massively, because at some point the risk is too great - if the Crash really is tomorrow, they would go bankrupt.
To put it another way, England in the 19th century made exactly the calculation you're talking about. When it came around to WWI, it was incapable of growing its own food, and was in danger of being starved to death, except that the Royal Navy managed to defeat Germany's. If England had realized the risk it had been taking, I'm not sure it would have made the same decision.
The United States is indeed guilty of protecting its farmers, but not to the degree provided by the French government.
Do you have any facts to back up your statement? (I don't know whether you're right or not, but I think it likely you don't know either.)
"The French do subsidize small farmers, and I sure wish we did the same."
The result of carrying out such a policy would be disastrous to the country. Keeping afloat inefficient small farms would add enormous costs to the average family budget.
Is this a criticism of the Republicans? Weren't they the ones who voted through the last farm bill? (PS - I think the French are right on this one.)
Mark Bahner writes: "Centralized planning, which is what Mr. McCullough is suggesting"
No, I'm not. I'm suggesting government policies encouraging diversity, at the cost of some efficiency. Overspecialization leads to extinction, in species as well as societies.
You also note that "the United States' system being the one in which government is least involved in the economy. (Frightening thought, but true.) Which system is better for economic growth? The answer to date appears to be in favor of the U.S....at least over the last 20 years."
I was arguing that economic growth should not be the sole goal for public industrial/agricultural policy.
Daryl McCullough writes, "No, I'm not (suggesting central planning). I'm suggesting government policies encouraging diversity, at the cost of some efficiency."
You're suggesting federal government policies that fashion the economy in a way that *you* think is most appropriate. I call federal government "policies" that attempt to fashion economies in a certain way, "planning." Either way, it's government getting involved in the economy of a country, with deliberate goals in mind.
Once again, I recommend you read "Head To Head" by Lester Thurow. In it, he critiques the U.S. as not having a plan--or policy, if you prefer--as contrasted with the Japanese and Europeans. But the evidence of the last 20 years is that the U.S. lack of policies produces the highest growth rate.
"I was arguing that economic growth should not be the sole goal for public industrial/agricultural policy."
Yes, you're advocating instead, that central government officials should make decisions to address possible outcomes that you forsee. The trouble with that is that it isn't only those government officials that pay when they make mistakes. The whole country pays. (Obviously, the whole country also benefits when these people in the central government guess right. The question is, do the central government people guess right more than the people in the general economy?)
'To put it another way, England in the 19th century made exactly the calculation you're talking about. When it came around to WWI, it was incapable of growing its own food, and was in danger of being starved to death, except that the Royal Navy managed to defeat Germany's. If England had realized the risk it had been taking, I'm not sure it would have made the same decision.'
Could England and Japan feed themselves if they tried? At a massive cut in real income, maybe, but I'm not sure if they can do it at all.
