Consider the following numbers: $300 billion and $700 billion. Those are the approximate sizes of the US federal government budget deficit and the US annual trade deficit with the rest of the world, respectively. The total is $1 trillion annually, a number that represents approximately the amount that the US must borrow each year from the rest of the world to finance our deficits.
To say that the US is spending more than it produces is to state the obvious. To say that the US needs to reign in its spending and increase its savings is also to state the obvious. Yet, a look at current monetary and fiscal policies makes one wonder what the government and the Fed are thinking. The Fed is feverishly lowering interest rates to stimulate spending while the Federal Government has already passed a tax rebate to help people spend more as spring approaches. Of course, the reason for these moves is to presumably forestall a recession or help us to get out of one that we may already be in.
Given that consumers will not get checks until May and given that Fed policy takes 6-8 months to have any real effect, the question has to be: why are we doing this? Why is the Federal Government spending money it doesn't have and why is the Fed lowering interest rates only to set us up for the next bubble that it will create (recall the tech stock boom of the late 1990s and the housing boom most recently-both Fed caused)? The recession/slow growth will end by June/July at the latest and the economy will start to recover, regardless of the stimulus packages that the government and the Fed have concocted. Are we going back to the days of stop/start economic policies that we experienced in the 1970s/1980s? We can hope we are not, but it is beginning to look as if this is the case.
Monday, February 25, 2008
Wednesday, February 20, 2008
Possible Causes of the Industrial Revolution
I've just finished reading Greg Clark's book, A Farewell to Alms, available in Kent Library. Clark addresses a few very interesting questions. First, why did the Industrial Revolution begin in England and not Japan or China or India or somewhere else? Second, why did the great expansion in economic well-being begin around 1780 and not before? Third, what were the drivers behind the escape from the Malthusian trap where, for thousands of years, advances in technology resulted in short-term per capita income gains which were wiped out by an expansion in the population?
Clark examines the main economic growth theories and finds them all insufficient as explanations for growth. Instead, Clark argues that there were four main drivers of the Industrial Revolution that occurred over centuries. First, interest rates declined because individuals became more patient and willing to defer gratification. In an interesting section, Clark gives evidence that forager/hunter societies have very high rates of time preference (they strongly prefer current consumption to future consumption). For example, the Yanomamo of Brazil, have such a high rate of time preference that they cut the branches off berry bushes to make picking easier, even though it reduces future harvests and even kills the bush. The decline in interest rates allowed greater accumulation of capital which helped fuel growth. Second, economic growth occurred because of greater willingness to work more. People in forager societies lived at the subsistence level but worked little; on average the male Yanomamo worked between three and six hours a day, while male laborers in England worked between eight and nine hours per day, but also existed at the subsistence level. However, the longer work hours became a cultural norm and helped enhance efficiency as the world went through the demographic transition to lower population growth. Third, "literacy and numeracy went from a rarity to the norm." Numeric skills were needed to facilitate the use of money as a medium of exchange, rather than barter, and ultimately allowed technological innovation to spread. Finally, there was a decline in interpersonal violence. While Clark glosses over this driver of growth, I would argue that the decline in interpersonal violence gave rise to greater trust between individuals. Without trust, voluntary trade between strangers is more difficult resulting in a loss of the gains from specialization according to comparative advantage.
Clark provides evidence on a wide range of economic and social indicators between various hunter/gatherer societies and more industrial societies to build his case. He looks at height, fertility rates, calorie consumption, work hours, transportation costs, population, profit rates, interest rates, land rents, and wages. Clark's overall theme seems to suggest that the industrial revolution occurred in England and Europe because of cultural changes, rather than institutional changes, such as greater reliance on private property rights and markets and limited government.
Clark examines the main economic growth theories and finds them all insufficient as explanations for growth. Instead, Clark argues that there were four main drivers of the Industrial Revolution that occurred over centuries. First, interest rates declined because individuals became more patient and willing to defer gratification. In an interesting section, Clark gives evidence that forager/hunter societies have very high rates of time preference (they strongly prefer current consumption to future consumption). For example, the Yanomamo of Brazil, have such a high rate of time preference that they cut the branches off berry bushes to make picking easier, even though it reduces future harvests and even kills the bush. The decline in interest rates allowed greater accumulation of capital which helped fuel growth. Second, economic growth occurred because of greater willingness to work more. People in forager societies lived at the subsistence level but worked little; on average the male Yanomamo worked between three and six hours a day, while male laborers in England worked between eight and nine hours per day, but also existed at the subsistence level. However, the longer work hours became a cultural norm and helped enhance efficiency as the world went through the demographic transition to lower population growth. Third, "literacy and numeracy went from a rarity to the norm." Numeric skills were needed to facilitate the use of money as a medium of exchange, rather than barter, and ultimately allowed technological innovation to spread. Finally, there was a decline in interpersonal violence. While Clark glosses over this driver of growth, I would argue that the decline in interpersonal violence gave rise to greater trust between individuals. Without trust, voluntary trade between strangers is more difficult resulting in a loss of the gains from specialization according to comparative advantage.
Clark provides evidence on a wide range of economic and social indicators between various hunter/gatherer societies and more industrial societies to build his case. He looks at height, fertility rates, calorie consumption, work hours, transportation costs, population, profit rates, interest rates, land rents, and wages. Clark's overall theme seems to suggest that the industrial revolution occurred in England and Europe because of cultural changes, rather than institutional changes, such as greater reliance on private property rights and markets and limited government.
Friday, February 8, 2008
Presidents, Economic Growth, and CO2 Emissions' Growth
Since 1960, Democratic presidents have achieved higher average annual rates of real GDP growth than Republic Presidents. As concern about global warming mounts among scientists, policy-makers, and citizens, how do the different presidents fare on CO2 emissions? Reading from left to right we have Bush II, Bush I, Nixon/Ford, Carter, Reagan, Clinton, and JFK/LBJ. Higher growth rates of real GDP per capita are strongly correlated (r=0.72) with higher growth rates of emissions. Of course, correlation does not prove causation, but it should give pause for concern about the difficult tradeoffs society faces concerning future emissions and economic growth.
The Barbarian Invasions
For foreign film aficionados, The Barbarian Invasions is good pick, as a dying French Canadian university professor is tended to by his economist/financier son. In addition to a great story, the film causes the viewer to look closely at Canada's health care system and the role of markets in bringing together the "sensual socialist" professor and his "puritanical capitalist" son. In Kent Library, IM DV 479.
Tuesday, February 5, 2008
Pretense of Knowledge in Financial Economics
A colleague called me to task for my criticism of constructivist macroeconomists at the Federal Reserve and macroeconomists in general for their persistent support of discretionary stabilization policy despite evidence indicating such policies are pro-cyclical. What Hayek called a “pretense of knowledge” and a reliance on artificial mathematical precision is also apparent among financial economists. Taleb, author of the Black Swan, argued that the pretense of understanding was even worse among financial economists. Economists are more often content to predict the direction of change while much of the financial economics, including the theory of asset and derivative pricing, presumes to predict magnitudes. Despite a preponderance of evidence indicating stock returns are non-normal much of finance theory assumes normality in returns with constant conditional variance. Accordingly, under the assumptions of a normal distribution stock market declines such as the ones in 1987 and 1997 are only supposed to happen every 500 years.
The over reliance on artificial mathematical precision may also be more apparent in financial economics. Over the last decade many Wall Street investment banking firms relied on PhDs in statistical physics to quantify risk in securitized lending such as the sub-prime secondary market despite their having little institutional understanding of how these markets operate. Clearly, many of the models perpetuated by Wall Street were wrong but you can afford to be wrong if you can rely on the Bernanke put.
The over reliance on artificial mathematical precision may also be more apparent in financial economics. Over the last decade many Wall Street investment banking firms relied on PhDs in statistical physics to quantify risk in securitized lending such as the sub-prime secondary market despite their having little institutional understanding of how these markets operate. Clearly, many of the models perpetuated by Wall Street were wrong but you can afford to be wrong if you can rely on the Bernanke put.
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