Swapping Lemons with China

The US trade deficit with China is essentially an exchange of goods for financial assets; rather than getting an equal amount of goods in exchange for what they sell to the US, the Chinese are getting financial assets - stocks and bonds, etc. - in return. Or, in other words, the Chinese are purchasing US financial assets with their goods.

Lately, there has been much attention the fact that some of the goods we are importing from China have turned out to be unsafe - toys with lead paint, for example. As Dani Rodrik explains, the recent credit crisis has shown that many of the financial assets that we are selling to the Chinese (and other foreign investors) are also, arguably, unsafe.

Misunderestimating Growth

The Economist's Free Exchange blog examines why the transformative power of economic growth is so little appreciated.

The now-well-documented historical record suggests that economic growth has done more for the welfare of humanity than any moral creed or non-economic initiative meant to improve the dignity and quality of human life. So why is there no treatise required of all undergraduates singing growth's praises and setting it out as a moral imperative for all decent peoples?

The post discusses several explanations: (i) people do not understand compounding growth, (ii) historically speaking, sustained growth is a relatively new phenomenon, and much of our religion and philosophy predates it and (iii) we find it easier to imagine future disasters than the positive effects of growth.

An illustration of the power of growth from principles class is that Japan and Mexico both had real per capita GDP of just over $1,000 (in 1990$) in 1890. Over the next 110 years, Mexico's per capita GDP increased sevenfold (!) to $7,249, and Japan's increased twenty-one times (!!) to $21,051. Mexico's average annual growth rate over the period was 1.8%, and Japan's was 2.8% - only 1% higher, but over 110 years that is the difference between being a "rich" and a "middle income" country. [data are from the best spreadsheet ever, Angus Maddison's Historical Statistics for the World Economy: 1-2003 AD]

One person who understood compound growth was John Maynard Keynes. In his famous essay "Economic Possibilities for our Grandchildren," he foresaw growth solving the "economic problem" of scarcity and making possible dramatic social changes and liberation from social values oriented towards capital accumulation:

When the accumula­tion of wealth is no longer of high social im­portance, there will be great changes in the code of morals. We shall be able to rid our­selves of many of the pseudo‑moral principles which have hag‑ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money‑motive at its true value. The love of money as a possession ‑ as distinguished from the love of money as a means to the enjoyments and realities of life ‑ will be recognised for what it is, a some­what disgusting morbidity, one of those semi­criminal, semi‑pathological propensities which one hands over with a shudder to the specialists in mental disease.

With scarcity behind us,

for the first time since his creation man will be faced with his real, his permanent prob­lem ‑ how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.

Although Keynes understood the power of growth, it seems he underestimated our ability to create new material wants, and perhaps overestimated how quickly our value systems could change.

As for why we still fail to appreciate economic growth, I would add a fourth reason: we don't really know how to improve it. Although there is quite a bit of fascinating research being done, the improvements of "total factor productivity" that are the main driving force of growth remain elusive. Moses Abramovitz once described the Solow residual (which is how total factor productivity is measured), as a "measure of our ignorance." That still holds some truth today.

We Are All Uninsured

There are now 47 million Americans without health insurance - nearly one-sixth of the population. But as Boston University Economist Laurence Kotlikoff points out, the exposure to risk is much, much broader. In an op-ed titled "We Are All Uninsured Now," he writes:

...the rest of us with health coverage are also uninsured. We too face terrible, albeit more remote, healthcare risks -- the risk that our employer will drop our plan, that Medicare will go bust, that our plan won't cover our needs, that premiums will eat us alive, that our doctor will stop taking our insurance, that long-term care will wipe us out, and that our uninsured friends and family members will need major financial help.

If the point of insurance is to reduce individual risk by pooling it, the American "system" is failing all of us miserably. Kotlikoff offers a voucher scheme as a solution - I'm not sure its better than single-payer national insurance, but it would be an improvement on what we have now (its hard to imagine we could do worse!). (Hat tip to Economist's View).

Herbie, the Capitalism Bug

The New Yorker recently carried a nice essay by Steven Shapin on Herbert Spencer, the 19th century British social theorist who is responsible for the idea of "Social Darwinism." Shapin writes:

Nowhere did Spencer have a larger or more enthusiastic following than in the United States, where such works as “Social Statics” and “The Data of Ethics” were celebrated as powerful justifications for laissez-faire capitalism. Competition was preordained; its result was progress; and any institution that stood in the way of individual liberties was violating the natural order. “Survival of the fittest”—a phrase that Charles Darwin took from Spencer—made free competition a social as well as a natural law. Andrew Carnegie admired Spencer enormously and attributed to him the decisive metaphysical epiphany of his life: “I remember that light came as in a flood and all was clear. . . . I had found the truth of evolution. ‘All is well since all grows better’ became my motto, my true source of comfort.” Thanks to Spencer, Victorian capitalists knew that nature was on their side.

Although Social Darwinism is no longer respectable (Shapin: "It was Spencer's misfortune to outlive his reputation" - zing!) its spirit lives on, lurking behind some of the "libertarian," "free market" and "supply side" economic ideology used to justify our new gilded age (which I discussed here).
Though I'm not a fan of his ideas, I do feel a certain connection: Spencer, the author of "Social Statics," was born in Derby. At Derby Middle School, my eighth-grade social studies teacher was a certain Mr. Spencer.

Financial Freak Out Odds and Ends

The recent problems in financial markets still fall short of a "crisis" in my mind. I'll start to worry if we see a significant drop in household consumption. But at this point, I'm inclined to agree with Ken Fisher of Fisher Wealth Management who says (via Real Time Economics) “A few months from now this will all blow over and we will wonder what the noise was all about, as is the case with all corrections.”

On Econbrowser, James Hamilton has a nice post noting a couple of interesting aspects of the situation. The yields on short-term US Treasuries, which normally aren't very volatile, have plummeted as investors try to get into the safest possible assets (as the price of a bond rises the yield falls, so this reflects increased demand for Treasuries). This does, at least, get rid of the inverted yield curve (the situation where short-term yields are higher than long-term, which sometimes presages an economic slowdown). Also, though the Fed has not lowered the target for the Fed Funds rate, it has been below the announced target of 5.25% for a while now (could this dent the Fed's credibility?).

The NY Times reports that several big banks have made a show of tapping the Fed's discount window. The banks say they don't actually need the money - this is a symbolic move to support the Fed's actions, which are also, I think, largely symbolic. Its as if the markets just need a big hug... Poor Wall Street, everything will be okay! Do you feel better now?

Via Economist's View, I see that Dean Baker has a sterner attitude: "Wall Street Welfare Wimps Keep Whining," he says.

For Those About to Optimize

We Salute You.

Some people believe Mozart makes you smarter, but does AC/DC make you more rational? This study by Robert Oxoby of the University of Calgary exposed subjects to the music of AC/DC during an economic experiment called the "ultimatum game." The outcomes were found to be less efficient when the subjects listened to AC/DC under original frontman Bon Scott than under Brian Johnson, who replaced Scott in 1980. From the conclusion:

Our analysis has direct implications for policy and organizational design: when policymakers or employers are engaging in negotiations (or setting up environments in which other parties will negotiate) and are interested in playing the music of AC/DC, they should choose from the band's Brian Johnson era discography.

Yes, its a joke. But as the Chronicle of Higher Education reports, many people, including Steven "Freakonomics" Levitt, did not recognize it as such. Hmmmm...

China's Exaggerated Rise?

The rapid growth of China's economy has aroused fear in some quarters and giddy excitement in others. Perhaps folks are getting carried away: in the NY Times, MIT's Lester Thurow argues that China's official statistics are greatly exaggerated. Based on China's electricity consumption, Thurow guesstimates an annual growth rate of 4.5-6%, which is brisk, but far short of the official reports of 10% or more.

A (Mostly) Symbolic Move by the Fed

The Fed's moves today were largely symbolic, but expectations and psychology matter in financial markets. The headline-grabber was the cut in the discount rate, the interest rate at which the Fed will make loans directly to banks. The discount rate is far less important than the Federal Funds rate - the rate at which banks loan reserves to each other - which the Fed tries to keep near an announced target level through its open-market operations.

The discount rate is somewhat of a vestigial organ of monetary policy. Back in the day when the Fed was much more secretive, changes in the discount rate were considered important as a signal of the Fed's intentions. After the Fed began announcing its targets for the Fed Funds rate in 1995, the discount rate has been much less prominent (I don't even mention it in my principles class). Borrowings from the discount window are relatively small - according to FRED, an average $132 million (that's million with an m) per month so far this year - because the Fed keeps the discount rate above the Fed Funds rate and there is somewhat of a stigma attached to it (i.e. it might be taken as a signal that a bank is having problems if it has to use the discount window).

The Fed is also temporarily changing the rules - this may be more important than the rate cut itself and lead to more use of the discount window. From the press release:

The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets.

Real Time Economics has a roundup of the Wall Street reaction. Perhaps more important was this announcement from the FOMC, which suggests a cut in the Fed Funds rate may be in the offing:

Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

NB: The Fed Funds Rate target is set by the FOMC, while the discount rate is set by the Federal Reserve Board.
Update: Charles Wyplosz says the Fed's move is "innovative and shrewd." However, Willem Buiter and Anne Sibert believe the Fed has missed an opportunity.

Capitalism, Jesus and Academic Freedom

I may have underestimated the threat to academic freedom in economics in my post yesterday. I am a bit more concerned about it today. The Rocky Mountain News reports:

What would Jesus teach about capitalism, and what would be on His assigned reading list?

That's the issue dividing Colorado Christian University, where the dismissal of a professor has sparked lively student and alumni chatter on the Internet.

The dispute at the usually tranquil Lakewood campus pits Andrew Paquin, head of a religious charity that aids poor people in Africa, against former U.S. Sen. William Armstrong, R-Colo., president of Colorado Christian and a pillar of the religious right.

Armstrong fired Paquin from a position teaching global studies at the end of the spring semester amid concerns that his lessons were too radical and undermined the school's commitment to the free enterprise system.

The goings on at a small religious college are pretty distant from my academic world, but its disturbing to see this anywhere. The irony is that there is a real tension between Christianity and capitalism. From the Bible, Matthew (19:24):

And again I say unto you, It is easier for a camel to go through the eye of a needle, than for a rich man to enter into the kingdom of God.

Inside Higher Ed's story quoted Paquin's blog:

My stance on capitalism is this ... it is obviously a very efficient and pragmatic economic system that has produced the largest and wealthiest country the world has ever seen. It also can be exploitative, lead to human greed, and leave vast populations behind in its wake. It can turn citizens into consumers. Adam Smith writes that the common good is served by the individual pursuit of self-interest. Excuse me if I believe that the pursuit of my own self-interest might be in contrast to the life of Christ that exemplifies the pursuit of the interest of others. This is my tension.

I would think that a Christian college would encourage students and faculty to grapple with issues like this. But perhaps I'm naive to believe the point of a college is to encourage its students to think. Incidentally, further down in the Rocky Mountain News story,

In a letter of dismissal, Armstrong expressed respect for Paquin's religious faith. "God may be calling you to a full-time ministry with 10/10," Armstrong wrote.

So that's how a "Christian" fires someone - tell them "God may be calling you" somewhere else [10/10 is Paquin's microlending project].

Word of the Day

Agnotology, which I discovered reading this article in Inside Higher Ed (with possibly the best headline since "Headless Body In Topless Bar") on a discussion of academic freedom at the American Sociological Association meetings. The worry is that political pressure is causing academics to avoid certain topics, or at least disguise what they are doing:

...Epstein cited the work of Robert Proctor, a Stanford University historian of science, who studies “agnotology” — the production of ignorance, or a field to contrast with epistemology. “What we are seeing is the construction of non-knowledge,” Epstein said.

There are those who just move into other research areas. But Epstein also asked about those who leave certain words out of their projects’ names or descriptions. “If you leave out the key words, people may not find your work,” he said, and more non-knowledge may have been created.

So far, I haven't had any problems with social conservatives objecting to my work on adjustment costs and exchange rate volatility. Though I don't see the same problems with academic freedom in economics as the sociologists are having (yet) - there seems to be plenty of agnotology going on in economic policy discussions. The first example that comes to mind is the persistent lie that tax cuts increase tax revenues - on this subject, see Matthew Yglesias on Giuliani and the press and this post at Economist's View. If I was feeling "fair and balanced" I could no doubt easily find some example left-wing economic agnotology, too (perhaps an exaggerated analysis of the "job losses" from free trade, for example).

The problem is that there are plenty of people with vested interests in promoting bad, intellectually dishonest "economic analysis," to support their political positions. Unfortunately, it sometimes seems easy to fool - or at least confuse - the public and the press. This is where academics have a role to play by (i) helping our students become more critical consumers of information and (ii) putting forward honest, rigorous and objective research which can be the basis for better policy choices.