Resource booms and income distribution

Via Vox Eu comes a piece looking at the distributional consequences of resource booms – using Australian data.  Their conclusion:

We need good time series data from developing countries to see whether the distributional impact is bigger there than what we find for Australia. Until then, the analysis here seems timely and relevant, not just for Australia, but for all resource-rich developing countries as the price volatility experienced by the former since the late 19th century was greater than that for the average commodity-exporting low-income country.

The distributional impact of commodity-price shocks in Australia (Canada and New Zealand) should yield important lessons for primary producers from the developmental south.

True – the idea that taxation should be more progressive the more dispersed income and wealth is is an old and widely accepted idea.  And this gives us another way to conceptualise it, with a relevant shock for the NZ and Australian context.  However, a couple of things to keep in mind when thinking about these issues are: Read more

We should never ignore the politics

An interesting paper by Acemoglu and Robinson, who have long discussed the interaction between economics and politics. The basic point is that economists cannot afford to ignore politics when they make policy prescriptions. It’s well-known that policy prescriptions based on partial equilibrium models can be risky. A&R take that a step further and point out that economic policies can affect political equilibria in unpredictable ways that may end up being counter-productive. For example,

Faced with a trade union exercising monopoly power and raising the wages of its members, most economists would advocate removing or limiting the unions’ ability to exercise this monopoly power, and this is certainly the right policy in some circumstances. But unions do not just influence the way the labor market functions; they also have important implications for the political system. Historically, unions have played a key role in the creation of democracy in many parts of the world, particularly in Western Europe; they have founded, funded and supported political parties, such as the Labour Party in Britain or the Social Democratic parties of Scandinavia, which have had large impacts on public policy and on the extent of taxation and income redistribution, often balancing the political power of established business interests and political elites. Because the higher wages that unions generate for their members are one of the main reasons why people join unions, reducing their market power is likely to foster de-unionization. But this may, by further strengthening groups and interests that were already dominant in society, also change the political equilibrium in a direction involving greater efficiency losses. This case illustrates a more general conclusion, which is the heart of our argument: even when it is possible, removing a market failure need not improve the allocation of resources because of its impact on future political equilibria.

Making policy is hard, but really important

We’ve talked a bit about the costs of unemployment recently and that discussion lead me to re-read Ken Rogoff’s letter to Joe Stiglitz from 2002. It’s clear in the letter than Rogoff is enraged with Stiglitz criticism of the IMF, but also with his arrogance and the potential consequences for vulnerable people. He’s right to be: the conduct of public policy has huge consequences for millions of people and we take on a heavy burden upon ourselves when we make policy recommendations. It should never be done lightly.

This confidence brims over in your new 282 page book. Indeed, I failed to detect a single instance where you, Joe Stiglitz, admit to having been even slightly wrong about a major real world problem.

You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn’t this a little like observing that where there are epidemics, one tends to find more doctors?

AJR vs Sachs: the conflict drags on…

Acemoglu and Robinson have proven to be extremely combative bloggers but they have, until now, refrained from engaging directly with their nemesis. Well, it seems they might have been harbouring a little bit of a grudge:

Several people asked us why we haven’t responded to Jeffrey Sachs’s review of Why Nations Fail. Well the answer was sort of in-between the lines in our response to Arvind Subramanian review: we said that thoughtful reviews deserve thoughtful answers.

Grab your popcorn and head on over for the full reply!

Cliff notes on the financial crisis

At work we are writing occasional articles for the fine people over at Rates Blog at the moment.  I’ve decided to focus on an issue that will get people irritated – an explanation of the GFC where I largely defend economists (although admiting that the mainstream missed the development of the shadow banking sector).

I’ve stuck with the view I’ve articulated in the past (as can be seen here with and with the links), but I’ve attempted to articulate it in a clearer fashion.  I’m aiming to have a related article out at some point trying to discuss why the crisis has persisted – after all in the article I’ve linked to above, if my explanation was true, the actions of the Fed and US Treasury should have led to the crisis being over by now.   My view is that policy failure in Europe put us on this darker and more persistent path.  The three other primary views are:

  1. Fed and US Treasury policies did nothing, and this is still in essence the same crisis.
  2. Financial crises, but default, are long and ardueous.
  3. This is irrelevant and monetary policy has just been too tight due to central bankers being more conservative.

I would note here that these views (including the one I posited) are not mutually exclusive, and each has a significant grain of truth to it.

Our explanation for the crisis matters right now because it determines what sort of policy response we think is right – which is the main reason why many analysts out there are purposefully “over-arguing” how confident they are about their explanation.  In truth, things are never as simple as they seem.

Note:  And before anyone starts saying that by defending economists on some level (even though I do appropriate blame on them as well) and therefore I’m being purely self serving regarding my own failure to publically warn about the crisis, I’d also note that I only started my job in 2007 – I was just starting to get used to data sources and writing about economics on a regular basis (including starting the blog) once the crisis had begun.

It would be in my interest to attack the establishment that was already in place and pretend to be a “fresh voice” – but unlike some economists around the world who seem quick to attack the rest of the discipine, and misrepresent the views of other economists to sell their own image, I’d prefer to take a bit more of a balanced view 😉 [this comment isn’t aimed at New Zealander commentators, just to make that clear].

Progress is hard to measure

Wellington Regional Council have recently published their Genuine Progress Indicator, which is intended to measure changes in regional well-being. Measuring well-being is very difficult and the technical documentation provided by the WRC shows how hard they have found it to overcome the challenges.

The GPI has been constructed by taking about 100 variables of relevance to well-being, normalising each, and averaging the 100 indices. The Council have declined to weight the aggregation because they recognise that people may disagree over the weighting. They seem to want to avoid arguments over the normative weighting decisions. Unfortunately, weighting everything equally is just as much of a value judgement as any other weighting system. For instance, the council consider the prevalence of smoking to be a negative indicator. Due to the equal weightings, a 1% decrease in smoking in the region would be as good for progress as a 1% increase in incomes, or a 1% decrease in unemployment. With other variables, from access to public transport to dairy farm soil quality, it seems unlikely that many people would agree with weighting them all equally.

There are plenty of other difficulties, too: ensuring comparability of the variables measured and selecting a baseline for normalisation, for instance. What these difficulties illustrate are the importance of value judgments in creating these GPIs, even when the architects try to steer away from making them. Each of us, given the opportunity to choose our own variables and weightings, could come up with a different result for the region’s progress. Because of that it’s hard to take the GPI seriously as a reliable measure of regional progress, except insofar as it is defined by the council’s own preferences.