PSA

There is a new site called Footnote, which is dedicated to translating academic work for a general audience. They asked to re-run selected blog posts written by me, and I've agreed. Here is a link to the first one. Presumably more to follow.

So far I like the site. It's clearly still growing, but it's a really good idea and they have a decent cast already assembled. Give it a look.

Does Political Science Deserve Public Funds?

If you pay any attention at all to the political science blogosphere you know that the House of Representatives recently decided to prohibit the National Science Foundation from directing $14mn roughly -- 0.2% of its budget -- to political science research. This has caused much consternation among (some) political scientists, as well as indignant blog posts from political scientists and e-mails from APSA asking us to fill in form letters and send them to our Congresspeople.

What it has not done, generally, is come up with any sort of explanation for this event that is informed by political science, nor any sort of strategy for mobilization that would ensure outcomes that benefit the discipline.

This I find ironic. Faced with an banal existential threat to its existence, political science has responded by a) acting as if social science methods do not exist, and b) acting as if it knows nothing at all about political mobilization, organization, competition, institutions, or much of anything else relevant to altering outcomes in the political sphere. The response from academics has been to whine, get defensive, and generally miss the point (which is almost surely not about whether political science is cool or interesting or even important).

In fact it's worse than simple ineptitude: rather than unifying around some strategy that will secure existing funding, the discipline has turned on itself*.

In a sense I think this goes back to broader schisms in the discipline**. Particularly in IR the past decade-plus has seen a lot of internecine battles over what is best practice for academics. Everything from "what we should study" to "how we should study it" has been debated, quite vituperatively, in journals, blogs, conference panels, graduate student seminars, letters to editors, and bitch-sessions at the tavern. The period from Perestroika to TRIPs has moved us a bit from knee-jerk anti-positivism towards "let a thousand flowers bloom", but there is another problem: the NSF.

Actual funding from the NSF is pretty paltry; getting those funds neither makes nor break political science as a discipline, and almost any NSF-funded project could be funded in other ways***. But getting an NSF grant is prestigious: it improves your application and tenure packets; it can lead to a reduction in teaching load thus increasing research output; it can help you get a full professorship or endowed chair; it boosts your status. Right now the NSF does not fund all types of political science research equally. It privileges certain types of projects, and in particular those smell that smell especially "science-y": studies that build and/or analyze large data sets. As it happens most of my research uses this kind of data set, and I certainly wish there were more of them in the world, but not everybody in political science does. In fact, most of us don't.

According to the most recent TRIPs, a majority of IR scholars consider themselves to be something other than positivists (Q. 26) and only 15% of us employ quantitative methodologies as our primary research method (Q. 28), although another 22% sometimes use them as secondary methods (Q. 29). Obviously international relations is not all of political science, and I'm sure that a greater proportion of Americanists use stats. But (I would expect) fewer comparativists do, and almost no political theorists do. To the extent that NSF funding is biased in favor of quant studies, it is biased against the majority of the discipline. Given that hiring and promotion decisions (and general prestige) are influenced by ability to attract grants from places like the NSF, this is no small thing.

This is probably why Jacqueline Stevens wants to see funding either abolished or distributed via a lottery system which would not privilege some types of work over others ex ante. To me that makes little sense, but I can see why some would prefer either outcome to the status quo ante.

Regardless of where you come down on this -- and I don't really care that much either way -- it's hard not to notice that political science has not covered itself in glory. It seemingly has no theory of politics that can help folks understand why this is happening or how to change it. Its best response to this challenge is classic rent-seeking -- we deserve this money because we do cool stuff -- but without any ability to effectively seek rents. That, in and of itself, might be reason enough to discontinue funding.

*Links to much other discussion can be found at that one. I'm too lazy right now to hyperlink them all myself.

**I'm not the first to point this out. Henry Farrell did as well, in one of the dozens of posts political scientists have dedicated to this bill.

***Phil Arena has one such proposal here, although I'm not too sure how serious he is about it. I find the fact that political scientists are not willing to fund their own research through their professional associations to be another indication that it probably doesn't deserve all that much funding. Some of his commenters suggest that public funding of political science is necessary because it generates public goods which will not be realized without government intervention. To that I say a) show me the evidence****, and b) public goods can be supplied without government intervention, particularly if there are motivated groups who can easily identify the location of those goods and organize to capture them. APSA is already organized, and presumably in a better position to find these public goods than Congress or even the NSF.

****Or even the logic. Most political science research, including NSF-funded research, is published by journals with subscription feeds that are prohibitively for individuals or even most libraries. Therefore the work is most definitely not "non-excludable"... it is excluded! So it is not a public good. But even if it were it would only be a public good in the most facile sense of "the creation and dissemination of knowledge is good" which merely begs the question: maybe, but wouldn't that money be better used in ways that spread knowledge in different ways? E.g., funding public libraries, giving laptops to low-income people, etc.

Why Has US Finance Grown? Because The World Is Not a Monad

Guesting at Noah Smith's place, Dan Murphy seeks to explain why the financial sector grew to be such a large component of the US's economy during the 2000s. He offers three possibly explanations: finance became better at "making markets" by matching buyers and sellers, the need to manage risk became more important, and that people became convinced that employing financiars would help them boost their investment portfolios. Murphy suggests that the first two are not good explanations because they are static variables unable to explain change. He doesn't seem to think the third is as well, although it seems that way to me.

I don't think this is the right way to think about this. Instead, I'd rather embed finance into the broader US economy and then embed the broader US economy into the broader global economy. What changes have been taking place in the global economy over the past decade-plus that could help explain this? Two prominent things immediately come to mind:

1. The opening of capital accounts around the world, which began in the 1990s but accelerated dramatically during the 2000s.

2. Changes in the global trading system, particularly the expansion of the GATT -- which added many new members following the end of the Cold War -- and the transition from the GATT to the WTO.

The cumulative effect of these two factors both forced encouraged the US to pursue its comparative advantage in high-skilled service labor (e.g. finance) and increased the market into which the US could sell its comparative advantage. The result is thus entirely predictable: finance becomes a bigger size of the US's economy, while comparatively disadvantaged sectors shrank. Factor in positive feedback dynamics in global financial markets and this isn't much of a mystery at all.

Potential Consequences of the EU's Proposed Regulatory Changes

The European Union is considering a dramatic revision of the current institutional arrangement concerning banking regulation and supervision. Currently, members of the EU must implement international capital standards -- the Basel accords -- but regulation of domestic financial sectors is left up to national governments. Some governments choose to have their central banks regulate, others give that authority to a separate agency; each is fine under current EU rules.

That may change. Given the instability in the EU banking markets, and the fact that EU members must allow free movement of capital within the EU, the institution is considering moving supervisory authority to the transnational level:

The leaders of France, Germany, Italy, Spain and Austria are willing to back a powerful supranational supervisor, and a decision to relinquish national control over cross-border banks is being prepared for next week’s EU summit, according to senior officials. One said the new-found political impetus was “astonishing”.

The "astonishing" political impetus has come from the fact that the EU is currently experiencing a number of bank runs, capital flight from the periphery to the core, and a general lack of trust in the solvency of many of its financial institutions. To shore up confidence, many in the EU would like to create a "banking union" that would involve continent-wide deposit insurance for EU banks. In exchange for that guarantee, states would have to give up sovereignty to a higher body, which would presumably be heavily influenced by the core European countries (in this case, Britain, Germany, and France).

What would the effect of this be? It turns out that I've done some research on that question.* That work suggests that the answer is: it depends. Specifically, it depends on who the regulator would be. The top two choices appear to be the European Central Bank and the European Banking Authority. Why does it matter?

My research, building off of some work by Copelovitch and Singer, argues that giving regulatory authority to central banks alters the policymaking incentives that central bankers face. Without getting too wonky, it incentives central banks to privilege the needs of the banking sector when choosing monetary policy, as financial instability could lead to the loss of their authority. This, in turn, incentivizes banks to behave more riskily, as they expect to receive preferential treatment from sympathetic central banks, so long as they stay above the statutory requirements. The cumulative result is a more bank-friendly monetary regime (the Copelovitch and Singer result) and a more risk-friendly banking sector (my result, supported by a ton of statistical tests). This may not be what the EU currently has in mind.

On the other hand, regulatory central banks may be better able to prevent financial instability in the first place by tailoring policy to the needs of the financial sector. I do not explicitly study this question, and I doubt it is strictly true, but central bankers have argued according to this logic in the past. Alternatively, unifying regulatory and monetary authority could reduce institutional competition and lead to better-coordinated policies. Of course, if that coordination is in a direction that rewards greater risk-taking by EU banks then that might not be the best thing.

*Currently under review so no link, but interested parties can e-mail me for a copy.

Agreeing and Disagreeing with Kindleberger (and Delong and Eichengreen)

This post is basically to point to the new preface by Brad DeLong and Barry Eichengreen to Kindleberger's The World In Depression 1929-1939. I'm glad the book is being reprinted, and I am in agreement with all of DeLong & Eichengreen's intro. Except this part:

Kindleberger’s second key lesson, closely related, is the power of contagion. At the centre of The World in Depression is the 1931 financial crisis, arguably the event that turned an already serious recession into the most severe downturn and economic catastrophe of the 20th century. The 1931 crisis began, as Kindleberger observes, in a relatively minor European financial centre, Vienna, but when left untreated leapfrogged first to Berlin and then, with even graver consequences, to London and New York. This is the 20th century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously.

I don't think this is "arguable". First things first... Creditanstalt was decidedly not a "relatively minor" institution; as Ben Bernanke has noted it was one of the largest (and most well-connected) banks in Europe. Moreover, it wasn't the first major bank to fail. To give just one example, the Bank of the United States (a private bank located in New York) failed in December, 1930 -- one of the largest bank failures in U.S. history, which occurred months before the collapse of Creditanstalt. Indeed, in his monetary history of the U.S. Milton Friedman considered the collapse of the Bank of the U.S. as the pivotal moment that tipped the U.S. from recession into depression. In general, financial instability in the U.S. seemed to precede financial instability in Europe from 1929 on.

The U.S. and much of Europe was already in depression before the collapse of Creditanstalt. Indeed, chronology suggests that Delong & Eichengreen have causality reversed: the Depression (combined with the fallout from losing WWI, including reparations) caused the collapse of Creditanstalt, not the other way around. U.S. industrial production had fallen by nearly 25% before Creditanstalt's collapse. Farms prices were down by 40%. The financial system was decimated. Trade was collapsing. The signal events occurred in 1929, not 1931. By the latter date we are talking about knock-on effects, not first causes.

My view is not particularly controversial. The collapse of Creditanstalt exacerbated a pre-existing panic, but it did not generate one sui generis.

Contagion is powerful, but it tends to operate from the center outward rather than from the periphery inward.* The best read of the collapse of Creditanstalt is that it was evidence of contagion rather than the epicenter of it.

That said, Kindleberger's book is very good in general, as is the new Delong/Eichengreen intro.

*We've blogged about this before, and we have a piece that will hopefully be forthcoming soon that makes this case explicitly. For a simplistic precis see this Foreign Policy piece that Thomas and I recently placed.

P.S. While thinking about this I stumbled across this piece from a 1952 issue of Time which gets nearly every detail wrong in its first paragraph. For starters: Creditanstalt collapsed in 1931, not 1929; it was not controlled by the Rothschilds until after that collapse; Hitler persecuted the bank during Anschluss for that reason, so it not quite fair to say that the bank "served" Hitler. The rest of the article is blocked to nonsubscribers so I (mercifully) can't read it.

Room to Move (Redux)

Layna Mosley, one of my professors at UNC, has a piece in Foreign Affairs on the European sovereign debt crisis. In a sense she's come back around to her dissertation work, in which she argued that international investors care much more about outcomes than the particular policies used to generate those outcomes, or things like the partisan composition of governments. Turns out that she was pretty much right about that, at least in the case of Europe.

She has two primary points. The first is that the composition of debt maturity matters quite a lot; a lot of short-term debt means a lot of servicing, which means a greater sensitivity to short-run developments. The second is that investors don't have nearly as much influence on government policies as most commentators ascribe to them. What influence they do have is, again, over outcomes rather than the particular decisions used to reach them. So yes, investors prefer lower debt levels, but they don't particularly care whether fiscal probity is achieved via spending reductions or taxation. Mosley previously referred to this relationship as giving governments "room to move": so long as they stay within certain parameters -- mostly relatively low/stable inflation and relatively low/stable debt levels -- governments have quite a lot of latitude to pursue other policies without being punished by investors.

It's a good piece with valuable lessons. Read it.

The Importance of Actors in Networks

(Apologies for the light posting. Real work plus a family emergency has gotten in the way. Normal posting should continue for most of the rest of the summer.)

Ben O'Laughlin recently attended a talk given by Anne-Marie Slaughter to the British Parliament that focused on how the Clinton State Department is trying to lay the groundwork for perpetuating the U.S.-led liberal order. For those who have followed Slaughter's career, both as an academic and as a former senior advisor in Clinton's State Dept, the basics should not surprise. She's a strong advocate of leveraging networks to embed the U.S. at the center of the global system. She believes that one way to do that is via "smart power", a term coined by Joe Nye* and popularized by Sec. Clinton, that emphasizes persuasion as a complement to capabilities. What I found interesting, however, was the way that the State Dept is going about this:

Slaughter began by saying that structures are being put in place whose effects won’t be visible for some years. The structures the US is building are informed by the assumption that the biggest development in international relations is not the rise of the BRICs but the rise of society – “the people” – both within individual countries and across countries. The US must build structures that harness societies as agents in the international system. Slaughter returned to Putnam’s (1988) two-level game, the proposition that it is in the interaction of international and domestic politics that governments can play constituencies off against one another to find solutions to diplomatic and policy dilemmas. Slaughter took up this framework: the US administration must see a country as comprised of both its government and its society, work with both, and enable US society to engage other countries’ governments and societies. The latter involves the US acting not as “do-er” but as “convenor”, using social media and organising face-to-face platforms for citizens, civil society groups and companies to form intra- and international networks.

Critically, these two levels are flat. This took me by surprise. At the society level, citizens, civil society groups and companies are connected horizontally. No particular group or individual is afforded a priori centrality. Why is this a surprise? Public diplomacy experts have spent the last few years trying to target ‘influencers’ in societies. Influencers are political, religious or cultural figures who are listened to by others. This idea is informed by network analysis, marketing, and the idea that State Department messages are more credible in different parts of the world when mediated and delivered by a local influential figure than by Hillary Clinton on TV. Slaughter was not convinced by reliance on influencers, empirically or normatively. She argued that all the millions marketers have spent still hasn’t generated any clear knowledge about how influencers can be identified and utilised. Not only that, but it is surely preferable to try to engage whole societies and treat all individuals equally. That would flourish a greater democratic ethos than appealing to amenable clerics, companies, journalists and intellectuals in the hope they might spread the word downwards.

The bold is added and it's the part that I'm not sure about. A few lines up Slaughter says (via O'Laughlin) that she is "not convinced" on the empirical evidence that influencers are, erm, influential. I wonder why, because it as far as I can tell it's a pretty robust finding across many differential fields that use network analysis.** In network terms, "influencers" generally have a high "degree", meaning that they are at the center of the network and many other actors in the network are linked to them. In many cases, non-central actors are not linked in any way but through the central actor. So if you want to gain influence in the network you get the most bang for the buck by influencing the influencer.

Moreover, once established influencers tend to remain influential. This is because they are already influential. And influencers tend to become influential because of some intrinsic quality. Let's take an example. Bill Gates became influential because of his ability to make personal computing user-friendly and accessible, an intrinsic attribute. But once he gained an initial influence advantage he was able to gain even greater influence simply because he was already influential. This is not an intrinsic attribute of Gates', but rather what is called a "network externality". That is, one advantage of using Gates' products is that many other people are using Gates' products. So Gates attracts new followers largely because he has already attracted followers. In fact, Gates has been able to continue doing this despite the fact that his new products have arguably been inferior, relative to its competitors' products, than his early products. At this point Gates' position as an influencer is almost solely due to his position as an incumbent influencer.

How does this relate to Slaughter's program? It's all fine and good to engage everyone in the world with the U.S.'s message, to encourage everyone to think like stakeholders, and to try to build large coalitions that are broadly supportive of the U.S.'s interests (or at least are not reflexively against them). But this is a very high-cost, low-yield strategy. As O'Laughlin goes on to note, this is a very long-term plan with no guarantee of success. I'd add that if the U.S. cannot simultaneously get the influencers on its side then it is very likely not to succeed in buttressing the liberal order. And if the U.S. can get the influencers on its side then it is very likely to succeed whether it appeals directly to each individual in the world or not.

There's no reason not to do both, but a tactical change from targeting influencers to targeting everyone is misguided, in my view.

What I find interesting about this is contrasting Slaughter's approach with someone like John Ikenberry's. They have both spent their careers theorizing about the liberal order and the U.S.'s hegemonic relationship with it, and have co-authored a bunch of pieces on the subject, but seem now to have diverged in what they think about what needs to be done for it to persist. Ikenberry continues to stress the importance of international institutions, particularly formal institutions. Slaughter has also emphasized formal institutions in the past, particularly legal institutions, but seems not to be shifting focus. There is nothing contradictory about the contemporary work of Ikenberry and Slaughter, but they have diverged a bit in the points they've chosen to emphasize.

*I can use the diminutive because I met him once. That's all it takes, right?

**For one recent study in international relations relating specifically to advocacy networks, see this piece by Charli Carpenter.

A Financial Story IPE Folks Should Love

Because it reinforces our priors:

Its membership in the euro currency union hanging in the balance, Greece continues to receive billions of euros in emergency assistance from a so-called troika of lenders overseeing its bailout.

But almost none of the money is going to the Greek government to pay for vital public services. Instead, it is flowing directly back into the troika’s pockets. ...

If that seems to make little sense economically, it has a certain logic in the politics of euro-finance. After all, the money dispensed by the troika — the European Central Bank, the International Monetary Fund and the European Commission — comes from European taxpayers, many of whom are increasingly wary of the political disarray that has afflicted Athens and clouded the future of the euro zone.

More here. I have said for awhile now that the story in the eurozone is that the north would keep the south liquid until the north's banks were sufficiently capitalized to handle a default, at which point the money would stop flowing. I thought that would be sometime in 2013 (I think I wrote a post saying that, but can't find it now), but now I think it could be this year.

Why should IPE folks like this story? Because this is the type of tale we tell all the time: "bailout" funds are used to bail out the donor, not the recipient. Just like "aid" funds to the developing world are often tied to certain types of disbursement and are thus a form of subsidy for corporations in the developed world.

There are parallels here (of course) to the Latin American debt crises of the 1980s, where much of the debt was owed to commercial banks in the U.S. The U.S. Treasury pushed for IMF intervention, mostly so U.S. banks could get their money back without the federal government having to officially bail them out. (The story is even more nuanced -- Congress understood what was happening and demanded new regulations of the banking sector, which led to the creation of the first Basel accord -- as Thomas argues here.)

Annals of Silly(?) Policymaking: Procyclical Financial Regulations During a Bank Run Edition

This (via @dandrezer) does not seem smart:

Banks must raise their core tier one capital ratios to 9pc by the end of this month or face the risk of partial nationalisation. The global Basel III rules are also pressuring banks to retrench.  

The International Monetary Fund said banks will have to slash their balance sheets by $2 trillion (£1.6 trillion) by the end of next year even in a "best-case scenario".

That is only within the European Union, and it came about due to panic over Greece last month. Basically, this means that EU banks have to increase their capital cushions by over 200% by the end of this month. What does that mean?

The Bank for International Settlements (BIS) said cross-border loans fell by $799bn (£520bn) in the fourth quarter of 2011, led by a broad retreat from Italy, Spain and the eurozone periphery.

Note that this just in Europe. But it made me wonder (on Twitter): why do this now? After all, it was Germany that insisted on a longer phase-in period for Basel III during negotiations, while the US/UK/Switzerland wanted that stricter capital requirements. Now the EU is doing a rapid phase-in and tougher capital limits years before they are required to by Basel. And they're doing it in the middle of a bank run during a continent-wide recession. What gives? A few things.

1. Banks do have to get to 9% tier 1 capital by the end of the month, but they don't have to come fully into compliance yet. That is, a lot of junk capital that is prohibited by Basel III -- but was allowed under Basels I and II -- will still be allowed. (ht to @Procyclicality for this point)

2. Nevertheless, this is still a big boost to minimum capital standards. So how will banks come into compliance? Two quick and easy ways are to:

a. Hold more cash.

b. Buy more sovereign debt.

The first of these is contractionary -- it's basically hoarding more cash rather than lending it out -- although the ECB can facilitate it if they want to pump eurozone banks full of cash. Non-euro EU central banks, such as the Bank of England, can do the same thing if they want and the US Federal Reserve has injected a bunch of liquidity into foreign banks when needed in the past as well. As a zero-risk instrument, cash has a zero risk weight, so adding more of it to your portfolio brings your overall capital ratio up.

The second of these is expansionary. OECD sovereign debt also carries a zero risk weight under Basel III, as it did under Basels I and II. This might seem bizarre at first, but remember who's making these rules: OECD governments. And OECD governments want to pay low interest on their debt. To do that, they rig the regulatory rules to make it more attractive for financial institutions to buy that debt. Hence, a zero risk weight in Basel.

So what does that mean? If banks need to boost their capital stock, there are two ways to do it: by raising more capital (e.g. by selling equity) or by shifting their risk portfolio. The former latter will be often preferred to the latter former, so banks are essentially being encouraged to buy sovereign debt (and other zero risk weight instruments) in order to come into regulatory compliance.

Was this the point of this policy? I don't know. Probably it was mostly a freak-out after runs started on Greece and then Spain. But I imagine it was part of the calculus, or at least has become so since. In practice this will likely be a transfer of private funding for public funding. Given that the ECB cannot provide liquidity directly to eurozone governments, but can accept sovereign debt as collateral when lending to banks, this could be part of a stealth bailout program that began when Mario Draghi took over as ECB chief from Jean-Claude Trichet last year. Call it "bailout by regulatory arbitrage".

Will it work? I don't know.

Democracy and Development

Xavier Marquez has a very interesting series of posts on the relationship between democracy and economic growth since the end of WWII:

The basics of this relationship in the post-WWII era seem pretty well understood: basically, the richer the country, the more “democratic” it appears to be (in the sense I’ve discussed here and here, where democracy is conceived as a system of normatively regulated competition for control of states including the usual paraphernalia of elections, freedoms of speech and assembly, etc.), though the reasons for why this is the case remain disputed, and there are obvious and significant exceptions to this pattern. Conversely, the academic literature suggests that democratic regimes have a slight and indirect long-term development advantage, though the evidence for this claim is much more controversial, and there is no consensus on how this particular advantage operates, if it exists at all

There are links to literature describing all of these assertions in the original post. Marquez then runs down some simple data (and presents it very well) and notes:

The median income of democratic regimes has been higher than the median income of both hybrid and fully authoritarian regimes since at least the 1950s, and the gap has in general widened, not narrowed, even as the number of democratic countries has increased. (From this graph we cannot tell, however, whether the gap has widened because democratic countries have grown faster, or because non-democratic countries that grew fast turned into democracies; from the graphs below, we may infer that it was a mixture of both). The gap was highest during “peak authoritarianism” in the late 1970s and early 1980s, when most poor and newly independent countries were either hybrid regimes or dictatorships, but it stopped growing after the end of the cold war, when a number of relatively poor countries became democratic. ...

What about growth? Is any particular regime type consistently associated with economic growth? ...

The answer is "not really" or at least "not very much". Dictatorships and hybrid regimes have more variability -- some grow very quickly, at least for awhile, but also go bust more frequently -- but averaging across regime types shows very little difference in central tendency:

To the extent that we can ignore these confidence intervals and focus only on the trend performance, democracies have not always done better than these other regimes. In the early post-war era it seems that dictatorships did better (though most did about as well as democracies), but then decolonization came along and the growth performance of dictatorships basically cratered. Indeed, the 80s, when the so-called “third wave” of democratization began, was also (not coincidentally perhaps?) the time when the “growth gap” between democracies and hybrid and dictatorial regimes was at its widest. Ominously, the last decade has seen a reversal of this pattern, which explains much of the (not very well thought out) commentary about the rise of the “Chinese model.”

He has a very cool motion chart at his blog (that I can't find the embed code for) that maps out the null effect, so click through to watch it.

More on Cowen on Europe

In his op-ed, Tyler Cowen raises a concern about a euro-collapse that I haven't much seen previously:

We thus face the danger that the euro, the world’s No. 2 reserve currency, could implode. Such an event wouldn’t be just another depreciation or collapse of a currency peg; instead, it would mean that one of the world’s major economic units doesn’t work as currently constituted.

There are a lot of claims -- some implicit -- in here. I'll take them in turn.

1. Does an exit of several peripheral countries from the eurozone constitue an implosion of a reserve currency? I don't think so. The status of the euro as a reserve currency does not depend on Greece's membership, it depends on Germany's management of it. If the alternatives are to jettison Greece -- or even several of the GIPSIs -- or to devalue the currency to keep them in, the euro's status as a reserve currency might actually be improved by a smaller membership of weak countries.

2. How important is the euro as a reserve currency? Roughly as important as the German mark was pre-euro, perhaps in combination with the the franc. The euro has not advanced much above the mark+franc status as a global reserve currency, if any at all, since its introduction in 1999. So the global economy as a whole does not appear to be very dependent on the euro; it is dependent on the US and, to a lesser extent, Germany, Britain, and Japan.

3. Would a euro-exit be more severe than a collapse of a currency peg? It conceivably could, but again: what matters most is Germany, and markets' belief in Germany's credibility to maintain a valuable currency. Germany's economy is not on the verge of collapse, nor does it depend on Greece, and German policymakers have repeatedly chosen to maintain policy credibility over possibly saving peripheral members. How much do markets care about Greece? I'll return to that below.

4. Would a euro-exit signal that one of the world's major economic units doesn't work? No. Greece is not one of the world's major economic units. A euro-exit would signal that one of the world's major political units doesn't work, but I'm not sure that this is new information nor am I sure that markets care all that much. The the extent that markets prefer stability over instability any resolution may be preferable to continued uncertainty.

Let's look at some data. Has the euro has significantly weakened as the crisis has grown more severe?

A bit. But if we zoom out and look at a longer time series we see that the euro is now trading at historical levels:

If Greece leaves will the value of the euro hold? Considering that Greece is by far its weakest link I would think so. Indeed, the fewer non-German members in the euro the more credibility it has! Germany does not need to devalue.

Anyway, just how important is the euro? At the end of last year global dollar holdings were nearly 250% higher than euro holdings. Or consider the exchange market. The introduction of the euro did nothing to reduce the world's reliance on the dollar, as I discuss (and graph) here. The euro is used in roughly the same percentage of the world's Forex as was the mark + franc. The global economy survived the end of those currencies.

There is only one truly important global currency -- the dollar.

Perhaps most distressingly, Cowen seemingly misunderstands the arguments of Kindleberger that he references in the paragraph immediately following the quoted one above:

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences. For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States. (But when it comes to the euro zone, the United States is on the sidelines.)

I said a bit about that in my post yesterday, and I'll say more about it in another post (this is plenty long already), but if the hegemon is most important than we should really only be concerned about the US (the global hegemon) and Germany (the regional hegemon), not Europe's southern periphery. And the role of the hegemon is to stabilize the system, not necessarily to guarantee good outcomes for every constituent within it.

Think about it this way: if Germany left the euro and re-issued the mark, do you think it would be stronger or weaker than the Germany-less euro? Do you think the new mark would be used more as a reserve currency than the euro or less?

So why should we think that a Greek exit would be much worse than "another depreciation or collapse of a currency peg"?

The World's Central Banker, Yet Again

Tyler Cowen summons his inner Kindleberger and gets pessimistic:

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences. For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States. (But when it comes to the euro zone, the United States is on the sidelines.)

It depends on what he means by "on the sidelines". The US Congress is certainly not doing anything about Europe. Short of a Marshall Plan for the GIPSIs I'm not sure what they could do, and there's no way that's happening. But that doesn't mean that the US government as a whole is showing no hegemonic leadership. I've written a number of posts arguing that Bernanke has been acting as the world's central banker during the crisis -- opening swap lines with every major central bank in the world, extending liquidity financing to foreign firms, not provoking currency wars that lead to competitive devaluations, etc. -- and that this has stabilized the core of the global financial system.

I'm not going to re-write all those posts here, but please click through and read them. The Fed has been engaged in hegemonic leadership, and has done pretty well so far. Its job is not to put out every fire everywhere; its job is to keep the center of the system intact. So far, at least, its actions have been sufficient.

Note that in the op-ed Cowen more than once sounds a lot like an IPE scholar who has read no IPE literature. That is, he's asking the right questions but fumbles for answers to them. I have other things to write about the piece, but I'm going to break them up into pieces over the next day or two. Consider this a teaser.

When Did the Dollar Become the World's Reserve Currency?

New research from Livia Chitu, Barry Eichengreen, Arnaud J. Mehl. The abstract:

This paper offers new evidence on the emergence of the dollar as the leading international currency, focusing on its role as currency of denomination in global bond markets. We show that the dollar overtook sterling much earlier than commonly supposed, as early as in 1929. Financial market development appears to have been the main factor helping the dollar to surmount sterling’s head start. The finding that a shift from a unipolar to a multipolar international monetary and financial system has happened before suggests that it can happen again. That the shift occurred earlier than commonly believed suggests that the advantages of incumbency are not all they are cracked up to be. And that financial deepening was a key determinant of the dollar’s emergence points to the challenges facing currencies aspiring to international status.

I haven't read it yet, but I'm predisposed to disagree with the conclusion.

Asymmetry in Global Markets

Some argue that we understate the significance of the Asian crisis. So, here are three graphs of equity market correlations in moments of rather severe crisis. The unit in each is 12 month percent change.

1. Black Monday, October 1987. Biggest Single Day Correction in US History. Notice that the FTSE and Hang Seng follow the US down. Notice the correlation 10 years prior to the 1997 Asian crisis.

2. The Asian Crisis, 1997. Notice the separation. Hong Kong falls sharply. The US and UK give back a few gains but then recover very quickly. No banks failed in the US as a result of this crisis. And I note that this Asian crisis was probably the most severe to occur prior to 2008. And yet

3. US Subprime, 2007-09. The rest of the world follows the US down.

So, is Greece more like Thailand, or is Greece more like the United States? We think Greece is more like Thailand.

Being Relatively Unconcerned About Concerning Things

Blogging has been non-existent the past few days because more pressing work has taken precedence. One such thing was an essay (with Thomas) for ForeignPolicy.com on why we should all be more blase about the Greek situation. It's very counter to the sort of convention wisdom that you can find here (other examples cited in our article).You can read it here. Our central claim:

Further economic and financial deterioration in Greece would certainly have negative impacts there and might adversely affect Greece's southern European neighbors, who are facing similar circumstances. But financial weakness in Greece is unlikely to spark a global crisis analogous to the one triggered by Lehman Brothers' collapse in September 2008 -- even if economic woes eventually force Greece to exit the monetary union. Instead, the global consequences of southern Europe's debt crisis are more likely to resemble the Latin American sovereign debt crises of the early 1980s, the East Asian crises of 1997-1998, and Argentina's crisis at the turn of the millennium. Each of these had significant local effects -- widespread bank failures, sharp increases in unemployment, large exchange-rate devaluations, deep recessions -- that were not transmitted globally. Indeed, in each of these cases the global economy continued to grow, major world equity markets held their value, and world trade expanded. None had the dramatic global consequences sparked by Lehman's collapse.

We're already getting some pushback -- as we have from the underlying research that informed this piece -- such as this from Dan Drezner:

I think you understated the global impact of the 1997 East Asian crisis. I'd rather avoid another one of those.

On the one hand, I agree: I'd rather avoid another one of those, although I don't know how that's possible. On the other, I don't think we understate the global impact of the E. Asia crisis. I think many people dramatically overstate it. The period during which the E. Asian crisis occurred -- the late 1990s -- is associated with one of the largest periods of global economic growth ever. These days we look back on it with nostalgia, and wonder how we can do it again. The E. Asian crisis was a crisis for E. Asia, but not so much for everyone else. I think it's likely that the S. European crisis will be the same. Actually, given the slow-motion nature of the thing, I think it's likely that the S. European crisis will be even less of an event.

We may soon see. I hope we don't. 

Brinksmanship and Grexit

Henry Farrell re-ups his view of the eurozone as being a game of brinksmanship between Germany and Greece. I objected to this characterization back in February, and I still don't think it's the best. Take this:

If there weren’t any possible resolution, there wouldn’t be any incentive to engage in crisis bargaining. What we’re seeing suggests that the players on both sides think that there is a real chance of catastrophe, but also a real chance of a deal.

Whether or not there is a possible resolution is most likely private information. (Or, more accurately, neither side knows the truth.) Let's look at this from Germany's perspective. Who are they negotiating with? For all intents and purposes Greece does not have a government that is capable of negotiating. Any future Greek government also has an inability to make a credible commitment to uphold any negotiated settlement in the future, which is why Germany had previously asked for all political parties in Greece -- whether in the government or not -- to approve of the previous bailout program. It is not clear right now who "Greece" is, much less what it is willing to accept.

Nor is it necessarily clear (to me) that Germany believes that there is a real chance of catastrophe for them if Greece exits. Perhaps there is, but it's probably not an economic catastrophe. At this point it might be cheaper to shore up the banks than to keep funding Greece indefinitely. Remember that Greece's creditors have already taken very large haircuts. Remember that European banks have had years to prepare for this, and European regulators have (presumably) been forcing them to do so. Euro governments, the ECB, and the EFSF would lose something on the order of €200bn from a full Greek default, of which €75bn would come from Germany. This is not nothing -- about 3% of Germany's GDP -- but it isn't enough to sink Germany either.

More likely Germany is worried about the political ramifications of a break-up of the eurozone, but in that case they should be interested in ensuring that they are not blamed when that happens. This implies that they will engage in negotiations right up until the end, and perhaps even after it, to demonstrate that they made a good faith effort to keep the monetary union intact even if they believe that there is no possible resolution that actually keeps the monetary union intact.

Farrell:

At a guess, Greece has considerably more bargaining leverage than it might seem to at first. One useful index of bargaining strength is relative levels of sensitivity to breakdown/catastrophe/failure to reach a deal. It’s plausible that Greece is relatively indifferent to breakdown at this point – years of grinding austerity inside EMU seem barely preferable to the costs of exiting the euro. In contrast, Germany could see the collapse of the euro (and consequent very serious economic costs) if a Greek exit leads to the collapse of confidence in Spanish, Irish, and worst of all, Italian banks. If I were to lay a bet on which side is likely to fold first, I’d be putting my money on the Germans.

Again, it's not clear who "Greece" is or what their bargaining position is. As Daniel Davies says in comments on Farrell's post, there is no reason to think that Greece is indifferent between staying in or getting out. Something like 80% of Greeks say that they want to stay in. Even Tsipras has stated no intention to exit. The best case scenario of leaving -- probably Argentina -- is not very good, and I wouldn't be optimistic about the best case scenario obtaining in this case. So how much leverage does that really give Greek leadership? If their citizens want to stay in, and the costs of leaving are extreme, then Germany can demand quite a lot.

Nor is it clear that a Greek exit would lead to a collapse in Spain, much less Italy, or that such a thing could be avoided even if Greece stays in. The fundamentals are crap either way. It's not clear that a collapse in these countries would be devastating for Germany. They've maintained economic growth thus far, and capital flight from the GIPSIs would likely move into Germany, giving them further fiscal flexibility to deal with their banks and macroeconomy.

Right now the political dynamic in Europe is about who gets the blame for a Greek exit. If blame cannot be assigned in a politically satisfying way then they will continue to muddle through. However the greater the costs associated with keeping Greece in, the more likely the blame will shift away from Germany and the more likely that Germany will refuse to pay on any terms that are acceptable to Greek leaders.

Edward Hugh writes of the choices:

Right now there are two, and only two, options on the table: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn’t allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment – and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.

The second of those is not palatable. It would wreck what remains of the political integrity of the Euro project, which has already been corrupted by the less-than-democratic approach to the bailout. Political integrity is not about keeping Greece in on whatever terms... moral hazard is a real risk and the original institutions designed to combat moral hazard (eg Stability and Growth Pact) have been obliterated as has the independence of the ECB. In other words, it's not clear what political integrity Germany would really be fighting for. The entire EU social contract has to be re-written anyway, at least implicitly.

Given that, Germany may wish to re-write it on more stable terms.

There is a very real chance that over a medium term time horizon Germany would be better off with Greece out of the eurozone. If that's the case then this isn't a brinksmanship game.

Good Sense and Critical Intelligence

Following up on my post below, here's how our elected leaders view social science:

“We’re spending $70 per person to fill out [The American Community Survey]. That’s just not cost effective,” [Rep. Daniel Webster] continued, “especially since in the end this is not a scientific survey. It’s a random survey.”

I hope you can spot the egregious error at the end.

We've been doing the American Community Survey since 1850, and it is used to learn about the demography and needs of the citizenry as a way to guide spending programs in a more sensible way:

It is the largest (and only) data set of its kind and is used across the federal government in formulas that determine how much funding states and communities get for things like education and public health.

The House of Representatives has already voted to abolish it.

Via all the poli sci grad students in my Facebook feed.

Defending Social Science Against Those Who Would Prefer to Know Nothing

Earlier this week PM included this line in defense of NSF funding for political science at DoM:

Indeed, the alternative to good social science is not no social science but bad social science.

The implication from that is not that all social science is good but that it strives to be, is useful when it is, and in aggregate has improved the stock of human knowledge. Enough has been written about the battle over NSF funding that I feel no need to weigh in, but I must object to this ridiculous post by Gary Gutting at the NYT (via The Monkey Cage). It's titled "How Reliable Are the Social Sciences?" and it argues, I guess, "not enough for it to influence policy". Or in the authors words:

How much authority should we give to such work in our policy decisions? The question is important because media reports often seem to assume that any result presented as “scientific” has a claim to our serious attention. But this is hardly a reasonable view. There is considerable distance between, say, the confidence we should place in astronomers’ calculations of eclipses and a small marketing study suggesting that consumers prefer laundry soap in blue boxes.

He then goes on to make a nearly uncountable number of false assertions, misplaced blames, understatements of the usefulness of the social sciences, and overstatements of the development of the natural sciences. It's hard to know where to begin. Take the above quote for starters: The first sentence asks about policy decisions. The concluding sentences reference two potential avenues for inquiry that, so far as I can tell, have nothing whatsoever to do with policy.

Or take this:

But often, as I have pointed out for the case of biomedical research, popular reports often do not make clear the limited value of a journalistically exciting result. Good headlines can make for bad reporting.

Biomedical research may have implications for policy -- e.g. what treatments should be covered in insurance plans or something -- but it is not a social science. Additionally, if journalists misread research findings that is an indictment of journalists, not researchers.

In the next paragraph:

Second, and even more important, there is our overall assessment of work in a given science in comparison with other sciences. The core natural sciences (e.g., physics, chemistry, biology) are so well established that we readily accept their best-supported conclusions as definitive. (No one, for example, was concerned about the validity of the fundamental physics on which our space program was based.) Even the best-developed social sciences like economics have nothing like this status.

Are the core sciences so settled? I'm no expert in any of them, but my impression is that they are filled with hotly-contested debates concerning almost all of their "definitive" conclusions. Do we exist in a multiverse? Does evolution operate at the level of the genotype or phenotype? Can a universe (or multiverse) arise from nothing, and if so what is the definition of "nothing"? Is consciousness a biological function, and if so how did it arise and to what species does it extend?

Should we accept the validity of bodies of work based only on their perceived "status"? As determined by who, exactly? 40% of Americans don't believe that evolution occurred. Despite clear evidence, only 60% of Americans believe that climate change is happening at all, and a majority believe that humans do not play a major role in altering the climate. Granted, those polls are examples of social science so Gutting would likely give them no credence but even then the question remains: where does this status come from, and why should it matter?

Perhaps more pointedly, everyone should well be concerned about the "validity of the fundamental physics on which our space program was based" considering the impressive number of boondoggles and outright tragedies that resulted from it.

There are many questions of policy relevance that social scientists have not yet answered sufficiently well to base policy on them. There are also many questions with policy relevance that are more or less "settled" by social scientists, in that they have coherent theoretical explanations that are supported by multiple empirical studies. There's no point in running down a list, which could only be illustrative in any case, but one example might be that if you pay people to put silly arguments into print under their own name then they will be more likely to do it than if they were taxed for it.

A bit further down:

Is there any work on the effectiveness of teaching that is solidly enough established to support major policy decisions?

The case for a negative answer lies in the predictive power of the core natural sciences compared with even the most highly developed social sciences. Social sciences may be surrounded by the “paraphernalia” of the natural sciences, such as technical terminology, mathematical equations, empirical data and even carefully designed experiments. But when it comes to generating reliable scientific knowledge, there is nothing more important than frequent and detailed predictions of future events. We may have a theory that explains all the known data, but that may be just the result of our having fitted the theory to that data. The strongest support for a theory comes from its ability to correctly predict data that it was not designed to explain.

This is both true and one of the weaknesses of the social sciences. But refer to the quote from PM with which I began this post, and consider the relative youth of social scientific inquiry that has employed the "paraphernalia" of the natural sciences. In some cases we've only been doing it for a decade or several, mostly with pretty poor data and not much sophistication. But these problems are being corrected with time and experience -- as science should do -- and even the flawed efforts of the past are better, in aggregate, than their alternative: setting policy according to how Thomas Friedman's (or Gary Gutting's) gut feels about it.

Gutting then goes on to suggest that social science's problem is that it cannot do randomized controlled experiments on its subjects and therefore cannot make "detailed and precise predictions". Setting aside the fact that, in many cases, neither can astrophysicists or evolutionary biologists, this is a) changing in the social sciences; b) not a panacea in any science, social or otherwise; c) RCTs are about testing hypotheses (or, sometimes, just seeing what happens) not generating them; d) the analysis of observational data has always been considered a valid way to examine the rightness of theories in the sciences. Should Galileo not have been trusted because he couldn't perform a randomized controlled experiment on the earth's orbit around the sun? Had Darwin no insight on natural selection because he could not perform a trial to determine why the beaks of finches in different places varied in thickness?

Even more absurdly Gutting then writes:

Without a strong track record of experiments leading to successful predictions, there is seldom a basis for taking social scientific results as definitive.

True. True not because social science findings are so unreliable as to make them useless. True because all findings in all sciences are provisional. That is the hallmark of science. To criticize science for not being definitive is like criticizing philosophers for asking questions.

Having painted himself into such a corner Gutting has no choice but to conclude:

Given the limited predictive success and the lack of consensus in social sciences, their conclusions can seldom be primary guides to setting policy. At best, they can supplement the general knowledge, practical experience, good sense and critical intelligence that we can only hope our political leaders will have. 

Well then God help us all.

More seriously, perhaps we should use research to influence policy decisions when the research is relevant and when there is strong empirical support from multiple research programs, while recognizing that changed circumstances or new information may cause us to modify these programs later. I'm not suggesting that ever will quite happen -- if they notice it all opportunistic leaders will cherrypick findings that support their preferences and disregard the rest -- but surely that's a better goal than relying on the "good sense and critical intelligence" our overlords do not possess to solve our problems.

And when our leaders stray, or when they set policy cynically, it is the role of intellectuals to use every faculty at their disposal to point out the emperor's nakedness. That is easier done with the arsenal of social science at one's disposal than with intuition or impression alone.

Gutting is a professor of philosophy at Notre Dame. It's worrying to see him so dismissive of his colleagues in the academy. Perhaps he should give them some more of his time.

Poking Macroeconomists with a Stick

In one small part of a longer discussion Scott Sumner says something interesting:

Macroeconomics is the study of policy failure. Once an issue goes away the field loses interest.

Leave aside for now whether or not that is strictly true, or whether it was inadvertent. When I read the first of those sentences I immediately thought "then why not study why the policies fail, dammit!" After a bit of reflection I've realized that macroeconomists think that's what they're doing. They have models, to which they are wedded ideologically and/or reputationally, which are internally coherent but externally invalid.* When they try to explain why they are invalid they claim that policymakers aren't doing what the models tell them they should do. That's what Sumner means by "policy failure". And they explain why policymakers aren't doing what the models tell them they should do by either demonizing them, calling them ignorant, or claiming that they are members of cults believing in confidence fairies, bond vigilantes, the hive mind of the Borg, or some discredited or otherwise objectionable ideology.

The assumption here is that policymakers are, or should be, utilitarian Philosopher Kings whose goal is to maximize output and employment while minimizing inflation. But maybe, just maybe, that assumption is false. If we get rid of it then we don't have to appeal to superstition or metaethics to explain the behavior of policymakers. Instead we can treat policymakers as being interested in gaining or retaining office, and that the best way to do that is not necessarily to bring unemployment down to its natural rate as quickly as possible.

In other words, we can treat macroeconomic outcomes not as "policy success" or "policy failure", but as things that benefit some groups of people and harm others. From the viewpoint of a policymaker a policy success is one in which the policymaker retains office, and a policy failure is one in which she does not. To remain in office she must appease some number of people (what we often call a "minimum winning coalition") and that's all. In advanced democracies that coalition is largely comprised of relatively affluent people who own some type of equity whose value is more sensitive to inflation than whether the marginal unemployed worker gets her job back. So when policymakers set policy to win over that person it isn't a "failure"... it's the whole purpose.

This is what Steve Waldman was driving at in his "choosing depressions" posts. This is the dynamic that I blog about in almost every post. This is what I was writing about in a prior post, "The Problem with Macroeconomics Is the Macroeconomists". If the world doesn't work the way that macroeconomists think it should, then maybe that's because macroeconomists don't understand how the world works.

That doesn't mean that macroeconomists, or anyone else, can't have their own preferences. Krugman's blog and associated book is titled Conscience of a Liberal, not Explaining How the World Works. But that's quite a different thing from saying that "macroeconomics is the study of policy failure". To acknowledge that different groups have different preferences over outcomes is to acknowledge that the definition of "policy failure" is a not a constant but a variable, and macroeconomics has nothing to say about that.

That's why we need political economists.

*Of course they will all protest that their pet model is not externally invalid, only everyone else's is. However no macro models have performed very well in this crisis. No macro models can explain the global nature of this crisis, why countries with similar characteristics have had vastly divergent outcomes, etc. The best argument that most macroeconomists can put forward in support of their preferred model isn't "it worked" but "it hasn't been sufficiently tried".

There Is No Technocracy: China Central Banking Edition

David Daokui Li -- former member of the Bank of China's Monetary Policy Committee -- has an op-ed in the FT in which he says that central bankers are subject to political constraints:

First, central bank independence is an unhelpful superstition. In theory, independence is a good defence against pressures from politicians facing re-election. The PBoC is under the control of the state council, and not run under by autonomous bank staff. This may suggest that Chinese officials are subject to strong political whims. ... 

Knowing this, I was nevertheless shocked when the Chinese premier recently said that only two factors had the potential to undermine his government: corruption and inflation. He does, of course, have some influence over these factors.

No surprise to regular readers of this blog, I hope, but this is even more interesting in light of the fact that China's government is supposedly comprised of wise bureaucrats whose insulation from political pressures allows them to pursue optimal policy.

Guess not.

Austerity v. Drudgery

I recently posted on Twitter something to the effect of "what does 'austerity' mean when every country practicing it is running massive deficits?" It was meant to be provocative -- I know full well that deficits can come from a decrease in revenue as well as an increase in spending -- and led to an interesting but brief exchange with @dandrezner. My point is that different countries face different constraints, have different institutions, and have responded to the crisis in different ways. Describing them all as practicing austerity therefore doesn't seem appropriate. My takeaway from the exchange was that we don't have a good definition of what austerity is. We used to associate it with Washington Consensus policies enacted under duress in the midst of financial crises in exchange for emergency finance. That definition works alright for Europeriphery countries today, but not the U.S. and U.K. which were a) already following most of the Washington Consensus principles; b) not subject to external pressures from financiers; c) not really significantly altering fiscal policies in a contractionary way at all at least to this point.*

But people still use the term, often to denote something to the effect of "not enough Keynesian/monetarist stimulus". It seems to me that that is a different thing from austerity, and implies a different political interaction. As Steve Waldman notes, we're choosing our depression, and we're doing it in a way that prolongs the recovery but does not choke it off. This is being done for political reasons, but the reasons are very different than those that currently obtain in Greece, e.g. Greece is practicing true austerity -- or at least something closer to it... they keep agreeing to austerity but then missing their targets -- under duress; the U.S. is simply choosing to accept the risk of a slow recovery over the risk of higher inflation.

So why do we use the same work to refer to these two different things. I suspect there is an ideological component to it in many cases, but that's not satisfying enough. This sort of thing from Krugman** -- arguing that austerity is happening everywhere -- does not compute:

For the fact is that you can’t just look at spending levels to ask what is happening to spending programs. Here in the United States spending on unemployment insurance and food stamps has risen sharply, not because the welfare state has expanded, but because a lot more people are unemployed and poor. Similar effects are at work in European countries, which have stronger safety nets than we do. 

Right, but cutting social spending programs is pretty much the definition of austerity, at least as it used to be defined in relation to the implementation of the Washington Consensus during crisis periods. In fact, Krugman refers specifically to spending cuts elsewhere in the same post. So if we're doing the opposite of that how is it we're practicing austerity as well?

Mark Blyth has been working on a book (due out next year) detailing the history of austerity as a policy idea, so perhaps he can give us a better definition. In the video above, he describes austerity as paying down public debt through the slashing of social services. But if we're not doing that in the US (and some other countries) -- if automatic stabilizers have kicked in -- then are we really practicing austerity? If so, only on the margins and not in aggregate.

I was thankful to see Tyler Cowen considering the same question and coming to a similar conclusion. He notes that for some, it seems like "doing less than the Keynesian optimum is always a form of austerity". But does the "Keynesian optimum" really apply to countries like Greece where the bond vigilantes have already shown up? Once we start talking about cross-national transfers we're well outside of the world of the General Theory.***

I think this is important because it implies different political logics. This is what Waldman was writing about. The political logic of "austerity as penalty for emergency finance", usually to prevent moral hazard and/or force through politically unpopular reforms, is quite different from "tolerate slower recovery because of concern about future inflation".

To give one example: both the Tea Party and the Occupy Wall Street movements arose out of protest over the policy responses to the financial crisis and recession. One of them is more or less explicitly anti-inflation and also espouses principles of laissez-faire. The Tea Party movement began in 2007 during Ron Paul's presidential campaign, but really took hold in early 2009, right after the bailouts and as the stimulus fight was being played out. This was a direct response to significant government intervention into the economy via bailouts and stimulus spending. This group wanted austerity, in large part because of fears of future taxation and inflation (which they often view as a form of taxation).

Occupy Wall Street, on the other hand, is not ideologically opposed to government intervention. That movement did not form until 2011, when it became clear that the economic recovery was going to be slow overall but that the banks had recovered relatively quickly. OWS opposed the types of intervention that we, pace Waldman, chose. This group wasn't professing opposition to austerity... they were protesting expansionary fiscal policies! They opposed the distributional nature of those expansionary fiscal policies. In some cases they too wanted austerity, but via tax increases on corporations and wealthy individuals rather than cuts in spending.

The Greeks, meanwhile, are protesting the slashing of pensions and raising of taxes. These are very different movements, animated by opposition to different sets of policies. Lumping all of those policies together as "austerity" doesn't capture that. Given that, and given the loaded nature of the term, I think we need another word to describe the U.S. experience as distinct from the Greece experience. For the latter "austerity" works fine. For the former I propose "drudgery".

*Is c) true? Maybe in the eye of the beholder. In my view, the U.S.'s bailouts of Wall St/GM + extension of tax cuts + new tax cuts + automatic stabilizers + increase in nominal government spending + stimulus > the miniscule cuts that have been imposed since 2008. In which case... is that really austerity?

**Picking on him again out of laziness... I had this link at hand already.

***At least I think we are. It's been awhile since I've read it.

Am I Reading This Wrong?

Krugman reproduces the above graph and writes:

[T]his recent survey paper (pdf) on teen births, which are much higher in America than in other advanced countries. The authors find evidence suggesting that inequality and lack of mobility are central, another sign that Wilkinson-type views about the corrosive effects of inequality are going seriously mainstream. ... [I]nteresting stuff — and more evidence that we are gradually poisoning our society with inequity. 

I've only skimmed the paper -- which was published in the Journal of Economic Perspectives -- but I don't read it the same way at all, nor do I see it from that graph. What I see is that the discrepancy is mostly driven by whether the mother is well-educated or not. As far as I know whether or not students graduate from high school is not a function of inequality, but of poverty and other socioeconomic and cultural factors. Indeed, that is what the authors of the report conclude:

We believe that the high rate of teen childbearing in the United States matters because it is a marker of a social problem, rather than the underlying social problem itself. If a teenager has a baby because her life chances seem so limited that her life will not be any better if she delays childbearing, then teen childbearing is unlikely to be causing much of a detrimental effect. Our review of the evidence is consistent with this position.

At times the authors seem to think that poverty, social mobility, and income inequality are the same thing. I would be more likely to attribute all of them to common underlying causes that has been transforming the global political economy over the past 20+ years. In any case, the authors argue that improving economic opportunities is the way to improve this statistic. In fact, they explicitly rule out increased income inequality as playing a causal role in recent trends, noting that teen childbearing has been going down over the past generation (implying a negative correlation with income inequality if there's any relationship at all):

One thing that we have not done is explain the dramatic decline in teen childbearing in the United States over the past 20 years. Although we believe that inequality and lack of opportunity explains a substantial share of the geographic variation in teen childbearing, it is not a candidate explanation for the downward trend in the United States over the past two decades, primarily because the 50/10 ratio that we rely on as a measure of inequality has not changed much during this period (although our results are insensitive to the specific measure used).

So what on earth did Krugman read? If teen childbearing has been going down at the same time that inequality has been going up that would seem like prima facie evidence that income inequality is not causing teen childbearing.

There Is No Technocracy: Partisan Bias at the Fed

These are a few months old now, but Christopher Gandrud -- a recent LSE PhD -- has a cool project going. It's spread out over several posts [1, 2, 3] but here's the gist:

So, I have two questions:

1. Have Fed inflation forecast errors been different during Democratic and Republican presidencies?
2. Are Fed inflation forecast errors different for election periods and non-election periods? ...
Question 1: The Fed did tend to overestimate inflation during Democratic presidencies and underestimate it during Republican presidencies (an Error/Actual score of 0 means that the forecasters perfectly predicted actual inflation). Admittedly we have a pretty small sample of Democratic presidencies (only Carter and Clinton), but it is striking how all of the big underestimates were during Republican presidencies and almost all of the big overestimates were when Democrats had power.

Maybe, Federal Reserve staff anticipate--to an incorrect degree--that Democratic presidents will pursue expansionary policies and vice versa.

Question 2: It is not as clear that forecasts systematically differ in election periods as opposed to non-election periods. Though the spread of the errors across parties does shrink very close to the election. I wonder why this might be?

And:

The partisan effect is less obvious than in the earlier graph, but is is clear that during this time period the big over estimations are during Democratic presidencies and the big (actually almost all) underestimations are during Republican ones. The effect would be even stronger if we took out the end of Reagan's first term and his second one, where Fed staff may not have fully adjusted their forecasting to reflect the Volker-Greenspan era of moderate inflation.

Rules vs. Principles in Regulation

Matt Yglesias:

This gets to the heart of the difference between rules-based and principles-based regulation. You could have a version of the Volcker Rule that functions by empowering a set of bank regulators to implement the principle behind the rule. Sloan agrees that "the principle sounds wonderful and simple -- don't let banks use federally insured deposits for risky trades" so you could tell the regulators just that, with no further details or clarification. A college dorm that has a rule against loud noise or music after 10PM on weeknights isn't going to follow that up with a detailed regulatory definitions of "loud", "noise", and "music" that you can then try to find loopholes in. The issue is that if the RA decides you're being too noisy, he tells you to quiet down. 

The problem with principles-based regulation in this context is that you might fear that banks will use their political influence to get regulators to engage in a lot of forebearance. The problem with rules-based regulation in this context is that it's really hard to turn a principle into a rule.

That's not "the" problem. That's "a" problem. Another problem is that regulators will never be given one task. They'll be given multiple tasks. One might be "don't let banks use federally insured deposits for risky trades" and another might be "don't restrict our financial sector so much that foreign firms take market share". Or maybe "force banks to make safe investments" but also "lend to certain interest groups -- e.g. governments -- at privileged rates". Or maybe "regulate the banking sector" and also "manage the macroeconomy". Many of these tasks are contradictory at some margin, and that margin is precisely what is being exposed by the time we get to crisis.

Another question is "what's a risky trade"? I've been watching the Frontline documentary on the financial crisis, and one thing is clear: everybody thought that securitization was reducing risk, not concentrating it. At least at first. When I say "everybody" I mean it. Other than Brooksley Born the regulators, firm managers, journalists, academics... everybody thought this stuff was making the financial system more stable. Some people started calling this into question by the mid-2000s but at that point it was already too late. So a discretionary principle of "reduce risk" -- which is more or less what we had during the 1990s and 2000s, combined with pretty lax capital requirements -- would likely not have led to a reduction in the activity that culminated in crisis and may even have exacerbated it.

This isn't as simple as a dorm RA telling people to turn down their music after 10 pm.

Soapbox

What follows is prompted by the news that the Justice Department has filed suit against Joe Arpaio, Sheriff of Maricopa County, AZ, alleging that he has violated the civil "rights of Hispanic inmates and suspects." 

Every semester when I teach I find 5 or 10 minutes to deliver a rant. It's the only rant on an overtly normative topic that I consistently give, and no component of my students' grade is contingent upon how they respond to it. It's not much, and I'm sure it has no effect. Nevertheless, I feel compelled to give it. It's about immigration, and how bollocksed-up both our public policy and ideological orientation is to immigration. I try to attack on several fronts at once:

1. If you express faith in the utilitarian value of free markets, then you can't be selective. If capital and goods markets are to be free, then labor markets should be as well.

2. If you express concern about development and the plight of the poor, then you can't be selective. If we want to reduce poverty, then we need to encourage things that reduce poverty. Freer immigration is near the top of that list.

3. If you think that corporation are -- on balance -- a force for good in the world, then you should favor things that help corporations form and prosper. Access to an eager labor force is attractive to corporations, as they have repeatedly made clear.

4. If you wish to emancipate the tired, the poor, the huddled masses yearning to breathe free then you should let them breathe free. Let them escape the rule of the corrupt and capricious. Let them engage in the pursuit of happiness. In other words, if the word "solidarity" means anything to you, then show solidarity.

5. If you are not a nativist, nor any other sort of bigot, then you should support policies that are anti-nativist and anti-bigot.

6. If you are concerned about demographic changes, the fiscal balance, the state of the economies of most advanced industrial nations, then you should support actions that will bring young workers into the population, who will pay taxes and help bring the economy and public balance sheet back into a sustainable equilibrium.

7. If you care about the rights of humans, then surely the rights of freedom of movement and association are at the top of your list.

I feel like this little rant gives little room for dissenters to move. They can't be make a market-based argument. They can't make an anti-market-based argument. They can't make a liberty-based argument. Slight objections -- such as "national security" -- are very easily slapped away by both statistics and simple logic.* All that remains is some form of bigotry, either soft or not-so-soft, and these are not restricted to either side of the left-right political spectrum.

There is no good moral, ethical, economic, or pragmatic reason for continuing the horrible immigration policies we currently enforce in the U.S. and throughout the developed world. There are very good reasons to support liberalizing human movement from all over the ideological political spectrum, from the internationalist left to the corporatist right. There are no very good reasons to oppose it other than nativism, which is both ugly and incoherent. This is equally true whether it comes from the left or the right.

In my opinion this is the greatest civil rights issue of our time. And we're failing.

*Statistically, so far as I can tell, almost no immigrants are terrorists or otherwise threaten the integrity of their host countries. It's not even clear that immigration increases rates of crime -- setting aside the abhorrent fact that walking across an imaginary line is a crime in and of itself -- despite the fact that most immigrants are young and poor, which are (statistically) the most likely groups to resort to crime.