The Irish Economy

This FT article is well worth reading. It asks a question I had been idly wondering about: is German growth just a reflection of Chinese growth? If so, then the issue of whether Chinese (or more broadly, perhaps, Asian) growth can become self-sustaining, or will continue to largely depend on sales to over-indebted American households, is a question with major implications for the European economy.

Update: I have just come across this piece by David McWilliams on similar themes. I guess the hope for Germany is that their growth is based on more, ultimately, than Chinese exports to the likes of us.

HT Calculated Risk

Barry Eichengreen and Peter Temin have written classic accounts of the Great Depression. If you haven’t read Golden Fetters, and Lessons from the Great Depression, you should.

But if you don’t have time for that, they have a piece on Vox which reprises the main conclusion of their work:

an international monetary system is .. a system in which countries on both sides of the exchange rate contribute to its smooth operation. Actions by surplus countries, and not just their deficit counterparts, have systemic implications. They cannot realistically assign all responsibility for adjustment to their deficit counterparts.

This is as true for EMU and “Bretton Woods II” as it was for Bretton Woods, or the Gold Standard, but it is a lesson that at times seems to have been completely forgotten.

Economic policy advice on reducing the risks to macroeconomic and financial stability from the housing market, restoring competitiveness and preparing to adjust in a downturn was available to the Government prior to the financial crisis.

In a research paper which I presented in the plenary session of the Annual Economic Policy Conference in Kenmare on 13 October 2006 (attended by a good number of senior civil servants), after discussing the adjustment mechanisms available to Ireland as a member of the European Economic and Monetary Union, I pointed out four main challenges facing the Irish economy and suggested a combination of policy measures to respond to these challenges. The four challenges that I identified were as follows: 

a)      maintaining a high potential output growth rate

b)      restoring competitiveness

c)      managing potential risks to macroeconomic and financial stability from the housing market

d)      adjustment to a slowdown in the United States and an expected appreciation of the euro against the dollar

 The policy measures suggested to respond to these challenges included the following:

     a)      fiscal tightening to reduce domestic demand pressures

     b)      a wage restraint in the public sector

     c)      fiscal measures to reduce the risks to macroeconomic and financial stability such as phasing out the tax relief on mortgage interest payments, a tax on imputed rents, a broader capital gains tax, or  a property tax on vacant of secondary dwellings (as options available to the Government)

    d)      limits on the use of real estate as collateral to protect the banking system against over lending and bad loans

    e)      running a large fiscal surplus during the current boom to prepare for a downturn in the world economy

The Irish Times of 14 October 2006 covered extensively my main points. The paper was published in the Quarterly Economic Commentary in March 2007.    

Martin Wolf has a really nice column here. For those of you who can’t access the article, the bottom line is that German and Asian savers have (via their banks) invested their savings in an exceptionally foolish manner — that is, by lending to the likes of us, to finance our excessive consumption habits. There is a clear possibility that they are, sooner or later, going to lose a lot of money as a result.

This brings to mind Keynes’ famous line that

“If the Grand Trunk Railway of Canada fails its shareholders by reason of legal restriction of the rates chargeable or for any other cause, we have nothing. If the underground system of London fails its shareholders, Londoners still have their underground system.”

At least 19th century Britain was investing in overseas railways, rather than in overseas housing bubbles!

One wonders whether the threat of ‘restructuring’ will eventually prompt the ants of Germany and Asia to start investing more of their savings in domestic investment projects, which might provide them with the foundations of sustainable growth.

The current issue of the New Yorker has a profile of Esther Duflo.  In the article, the views of Angus Deaton on the limitations of randomised controlled trials are assessed as wondering if “someone put sand in Angus’s toothpaste”.  Readers will find the offending substance here. 

You will undoubtedly  make your own assessment of the following direct quote from Duflo in the New Yorker piece:  “I want a baby goat” she mused.  “I’ll take good care of it”.

Given all the worries concerning the Eurozone right now, I thought it might be appropriate to post a link to this.

Paul Krugman and Robin Wells have a lengthy discussion of Reinhart and Rogoff here.

Barry and I have updated our graphs here.

To recall: the red lines show what happen when governments respond to a worldwide economic crisis with monetary and fiscal stimulus. The blue lines show what happens when governments stick to monetary and fiscal orthodoxy. All very purgative and morally satisying no doubt, except that it led directly to the election of Adolf Hitler (something that I have been meaning to blog about for a while, but now I have to prepare for class..)

Not wanting to be outdone by Martin Feldstein, Laurence Kotlikoff (recently based known for his Limited Purpose Banking proposals) is the latest US-based economist to bring his analytical skills to bear on the Greece’s problems to diagnose an instant solution:

Is there some way that Greece can devalue without devaluing?

There is, indeed. The government can implement wage and price controls for, say, the next three months, with these controls covering not just the growth in wages and prices over the next three months, but also their initial levels. Specifically, the Greek government would decree that all firms must lower their nominal wages and prices by 30 per cent, effective immediately, and not change them for three months. After three months, everyone would be free to put prices and wages back up.

This is an interesting proposal. Indeed, if this decree-based approach proves to be successful, it could then be applied to other areas. For instance, in the sphere of justice, the Greek government could decree that people should obey the ten commandments. And, if it works in Greece, we should try the decree approach here. After all, we’re all in favour of evidence-based policy formulation.

The Greek situation is regularly discussed as being “a threat to the Euro” and, on this blog and elsewhere in Irish commentary, it has revived the idea that the solution to our economic problems is to leave the Euro and re-establish our own currency.

This idea is often discussed as though membership of the Euro simply involves being locked into a disadvantageous fixed exchange rate, which we can address by getting out of the Euro. In fact, the process of leaving the Euro would be far more complex than that and could have many downsides that would offset the benefit of a more competitive exchange rate. Perhaps it’s been linked to on this blog before but this paper by Barry Eichengreen provides plenty of food for thought on this issue.

Update: Thanks to Philip for pointing out that Eichengreen has a new column on Greece and the Euro. Link here.

This is a nice summary of Latvia’s recession or, perhaps more accurately, depression, which thus far has seen a decline in GDP of more than 25 percent. The Latvian example is interesting both because of its parallels with Ireland because of the fixed exchange rate with the Euro and also for its differences due to the problems associated with having a fixed but not “irrevocable” exchange rate.

I’ve been following the news stories on the proposed potential Greek bailout. However, reading articles like this, I’m struggling to find a good rationale for the agreement that’s been reached. The following questions come to mind:

1. Greece needs to address its huge fiscal problems. To do this will require putting through highly unpopular measures. How does the EU’s offer of a potential bailout help get this achieved? How does the Greek government convince its people that harsh measures are required to reduce its deficit and keep open its access to sovereign debt markets when they now know that the EU tooth fairy is waiting by to help?
2. Even if the senior figures in the leading EU countries have ultimately decided to intervene to prevent the disruptions associated with a Greek failure to roll over its debt, why not wait until that failure has happened?
3. Why would the EU wish to be associated in the Greek public’s minds with the harsh expenditure cuts and tax increases that would still have to follow even after a bailout deal?
4. Do those who advocate this policy really believe that the current Greek crisis is sui generis or are they planning to put in place a safety net for the whole Euro zone? If the latter, can such a policy really be credible?
5. Is the long-run macroeconomic stability of the Euro area better served by avoiding the dislocations associated with one its constituent members going through a sovereign debt default or should we be more concerned about the problems created by the new bailout mechanism that lets governments know that the EU will intervene if they choose not to tackle their fiscal crises?

I feel that in asking these questions, I’ve clearly been missing something. Hopefully those who thrashed out this deal have thought these issues through. My concern is that in the somewhat fevered quasi-crisis atmosphere of this week, precedents may be getting set that we will live to regret.

Update: To be honest, I probably should have linked to this hand-wringing Times editorial as a better illustration of what I’m confused about. The editorial worries about “depressing the value of the euro” (which would in fact be a good thing for the Euro area economy) and discusses how this “raises major doubts about the future of the single currency” without explaining why this is the case.  The piece ends with the dramatic note of “The European Union remains on alert and on financial standby.”  It does make one wonder a little whether this issue is being hijacked somewhat by those who see “Europe” as the solution to most ills.

The Irish Times and other media today carried a report on the publication of a new globalisation index produced by Ernst & Young which places Ireland third on the globalised states list. The EY index joins an increasingly crowded field, so what follows is a bluffer’s guide to globalisation indices. As always, a good starting point (but never more than that) is the relevant Wikipedia entry.
(more…)

Barry Eichengreen makes the case here, without having to warn about Western protectionism.

I know the parallels are not exact but this story is a reminder that our current banking situation—involving banks that don’t want to lend, governments exhorting them to do so and banks focused heavily on attempting to escape government control—is not exactly unique. Some highlights:

Bank executives say they itch to make profitable loans, as many as possible, but are struggling to find qualified borrowers. They also say that the administration is asking for increased lending even as it pursues financial reforms that will limit the ability of banks to make loans.

And, of course,

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” the president said after the meeting. “And now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.

And this:

This is the second time the president has convened bank executives to urge increased lending. The first meeting, in March, did little to slow the slide. The president said Monday that he continues to get “too many letters from small businesses who explain that they are creditworthy and banks that they’ve had a long-term relationship with are still having problems giving them loans.” But the White House on Monday defended the value of the rhetoric.

“I think that the bully pulpit can be a powerful thing,” said press secretary Robert Gibbs.

We’ll see whether asking nicely a second time works well for them.

I found this story interesting. Clearly, the underlying story is just that Ireland is being used a political stick to beat Mister Salmond with. Beyond that, though, the exchange raises some interesting questions. Why are Scottish opposition politicians so sure that an independent Scotland would pursue policies that would lead it towards fiscal troubles of the Irish variety? How could Mr. Salmond assure them that this wouldn’t occur? Do the Scottish opposition believe that the Republic would be better off economically rejoining the United Kingdom?

And what about the banks? Would those two disastrous banks with the phrase “Scotland” in their names have been defined as Scottish banks to be bailed out by the Scottish taxpayer?  Presumably not but this raises the question of how one defines the fiscal responsibility for banking measures as one negotiates one’s way out of a united country.

Proof we’re not alone on the fiscal crisis front: The UK Pre-Budget report. The UK government plans to reduce its deficit from 12.6 percent this year to 12 percent next year and then gradually to 4.4 percent in 2014-15. One highlight of the statement: An immediate 50% supertax on bankers’ bonuses paid between now and April. Bankers, apparently, are furious and were seen crying into their Dom Perignon all over the City of London.

This column was not written with an Irish audience in mind, but given its trade patterns and openness Ireland is obviously one of the countries that is most exposed to the risks it discusses.

Now that the worst seems to be over, it is time to start thinking about the next flood. Today’s piece in the Independent is a small start.

Richard Baldwin has just put together a new VoxEU Ebook on the great world trade collapse of 2008. It contains 23 short, user-friendly essays that give a great overview of what we have learned so far about the causes of this dramatic event.

Here’s a paper on “Containing Systemic Risk” which I submitted to the European Parliament’s Monetary and Economic Affairs Committee in relation to its Monetary Dialogue with ECB President Trichet.

I’m one of a panel of “experts” that briefs the committee. Here’s a link to the page that contains all the expert papers for this year. Click on 7.12.09 and you’ll see papers by other economists on the topic of systemic risk as well as some interesting papers on the Monetary Exit Strategies.

The German Council of Economic Experts - an academic body which advises the German Government and the Parliament on economic policy issues has published last week its Annual Report 2009/2010. The related Press Release can be downloaded from here.

There is an ongoing discussion on this blog about attracting foreign investment in R&D in Ireland. In a recent research paper we analysed the location decisions of foreign affilates in the R&D sector incorported in the European Union over 1999-2006. Our research results suggest that, on average the location probability increases with market potential, agglomeration economies, R&D intensity and proximity to centres of  research excellence.  The determinants of the location choice of R&D foreign affiliates vary depending on the country of origin of the foreign investor. Thus, it appears that agglomeration externalities and business R&D intensity had a higher positive effect on the propensity to locate in an EU region in the case of multinationals from North America in comparison to European based multinationals. Proximity to centres of research excellence had a positive and significant effect on the location choice for North American R&D multinationals but no significant effect in the case of  European R&D multinationals.

Our research results suggest a number of policy implications. First, policy aiming at increasing the R&D intensity of regions are likely to foster the attractiveness of regions to R&D foreign investment. Second, positive externalities from clustering of R&D foreign affiliates outweigh competition effects. Third, given the heterogeneous behaviour of foreign investors, differentiated policy depending on target partner countries can increase the success of such policies.

Kevin’s comparison of the trajectory of trade in the Great Depression and the current depression (which I think was stimulated by a post on this blog) gets good coverage in the Financial Times today.

The communiqué for the latest G20 summit is available here. It contains lots of the usual waffle about co-operation on this that and the other, but I think the most important element of the discussions relates to the reform of banking regulation.

(more…)

Lots of explanations have been advanced as to why world trade fell so rapidly during 2008-9 — far more rapidly than at the start of the Great Depression. Problems associated with trade finance, and the vertical disintegration of modern manufacturing production, are the two that come up most frequently.

I’d like to offer another, more banal explanation: the composition of world trade is very different today than 80 years ago. In 1929, just 44 per cent of world merchandise trade involved manufactured goods. That proportion increased to 70 per cent in 2007. The reason this matters is that manufacturing is more volatile than the rest of the economy, and it was the output of and trade in manufactures, rather than primary products, which collapsed during the Great Depression.

Between 1929 and 1930, the volume of world trade in manufactures fell almost 15%, while trade in non-manufactures actually increased by 1% (I have to say I wonder about that, but this what what my source says). Weighting these two indices by the shares of manufactures and non-manufactures in total world trade, you get an implied fall in total world trade of 6 per cent in 1930 versus the 7.5 per cent actually experienced. Repeating the exercise, but this time using 2007 weights rather than 1929 weights, yields a counterfactual decline in world trade of 10 per cent in 1930 — equal to the decline the WTO is predicting for 2009. The changing composition of world trade can thus explain a lot, it seems.

An implication is that whenever the world economy recovers, world trade will recover with it, unless a surge of protectionism occurs in the meantime.

Colm McCarthy’s suggestion that an inquiry into what went wrong is gaining some level of support in political circles.  While there is plenty of material to digest in terms of what went wrong locally, there is also a lot of interest in understanding what went wrong in the international financial system.  Part of the debate concerns the role of economists, especially in terms of forecasting such crises.

A reader recommends this blog post which is critical of mainstream macroeconomic models.  Of course, Willem Buiter of the LSE issued a notorious critique a while back.

More recently,  a group associated with the British Academy wrote a letter to the Queen to answer her question to Luis Garicano of the LSE as to “if these things are so large, how come everyone missed it?”, while Robert Lucas defended mainstream macroeconomics in the Economist magazine in this article.

An important dimension of this debate is the relative roles of economists in policy organisations, the financial sector and academia in assessing the risks of a crisis and speaking out on these risks. While some of the debate has focused on the role of academic economists, it is maybe more difficult to evaluate from the outside the performance of economists in policy organisations in providing risk assessment, since their advice is often confidential.   In this regard,  the external evaluations of the performance of the IMF in previous international crises sets an interesting precedent, with the Independent Evaluation Office now playing this role on a regular basis.

In relation to Ireland,  the testimony of Kevin Cardiff of the Department of Finance at a recent Oireachtas Committee hearing is quite interesting in explaining the evolution of the thinking of the Department in the run up to the crisis.  You can read the transcript here.

In recent months, several analysts have argued that the unprecedented trade collapse the world is currently experiencing is linked to the vertical disintegration of production. Every time the US buys one fewer Barbie doll, trade declines not only by the value of the finished doll, but by the value of all the intermediate trade flows that went into creating it.

Not being a theorist, I have been puzzled by the argument for a while, but I now think I may understand.

(more…)

This speech given by Fed Governor Elizabeth Duke and its accompanying charts are the most useful summary I have seen yet of the various interventions taken by the Federal Reserve and their effects on financial markets.