Institutions fail: What about it?

Over at Anti-Dismal, Paul Walker has replied to a comment I posted with a couple of posts. Now I thought I should repay the favour by writing something up :)

Update: Paul replies here.  I agree with absolutely everything he says, but ultimately I think our views on what constitutes “optimal” action still differ as a result of different value judgments.

You should definitely go read the posts, they are very good posts which cover the idea of government failure, and the limits to market failure through asymmetric information. I completely agree with all the objective parts of his posts. However, I still believe my response to “Now there may be something wrong with the price system, but there is a lot more wrong with the government system”:

That’s really your key value judgment isn’t it. I’m not sure I agree. I am not a fan of “multipliers” – but in the face of a large, sustained, market failure I find it hard to conclude that there is no role for government.

Here’s why:

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Currency manipulation: What they don’t tell you

It appears that one of President Obama’s first concerns is “currency manipulation” by China – very interesting. The administrations view seems to be:

The US has long felt that China has artificially depressed the value of its currency to boost exports – to the detriment of US business – but the Bush administration always stopped short of formally declaring China a currency manipulator.

However, I would also note who in the US it benefits: The US consumer. When China devalues their own dollar, they are making exports more cheaply for the rest of the world – including the US.

I’m all for market pricing the in the face of good information – but lets not forget that US consumers have benefited from this action.

Chinese growth slows rapidly

Given the increasing importance of China as a trading partner to New Zealand (they are our 4th largest trading partner, account for 4.5% of our exports in the year to November *) and as a major support for our main trading partner, Australia, the rapid slowdown in growth in China should be concerning.

Both Calculated Risk and Econbrowser mention that Chinese economic growth has slid to 6.8%pa in December – down from 9.0%pa in September.  According to Nouriel Roubini this indicates that Chinese economic activity was virtually unchanged between the September and December quarters (seasonally adjusted) – indicating a massive loss of momentum in the worlds fastest growing economy.

This slowdown is a lot more rapid than expected – as is illustrated by this graph from Econbrowser:

Infrastructure as stimulus?

Greg Mankiw has made an implicit call that there are long lags to infrastructural policy – and therefore such policy seems difficult to justify as a short-term stimulus (Anti-Dismal and Kiwiblog also link to this approvingly).

Now this is a very fair point, however I was initially going to criticise it on the simple ground that the government promising to invest in infrastructure increases expected future income which DOES lead to stimulus now (given that we believe that expectations and confidence are key).  Hell the government could pay people now to build things in the future.

However, that didn’t take very long.  So instead I’m going to discuss this post on a defense of infrastructural spending.

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British reject “smart stimulus”: Should we?

I noticed that the British government rejected the idea of a “wage subsidy” that was put forward by unions (who would have guessed ;) ). Now, whenever a government outright rejects an idea I usually ask myself the question “how could that idea have worked” followed by “would that idea have worked”. In this case there is definitely a how, and it might even work in the current situation.

Just before I began writing my ideas I saw this post on Econlog on a “smart stimulus”. In the post they support the idea that cutting the employers share of payroll tax would solely give money to employers (as wages are sticky). This money would both support employment by lowering the relative price of labour (which is too high given the shock to productivity), and it would incentivise “business activity” by increasing profits.

Ok, well I agree with the possibility of the idea that has been discussed at Econlog – but I need to look at it in more detail before I can say whether I would support it “in the current situation”. Lets try that:

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