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March 13, 2009

Economist's View - 8 new articles

Positive Trends in Economic Development

William Easterly:

When Will There Be Good News?, William Easterly: In the midst of the general doom and gloom, fears about how the crisis will affect poor countries, and fierce criticism of markets, states, and aid agencies, perhaps it's healthy to step back to the big picture, to recognize there has already been some very real good news. The graph below shows some overall statistics for the developing world:


This graph has a mixture of good news that all of the much-criticized triad of markets, states, and aid can take partial credit for. Markets obviously get at least some credit for the reduction in global poverty and increase of global average income. States supply public goods like education, water, and health, and there has been progress on all of these. Aid deserves some credit for successes in health, as already stressed in a previous blog post.

One group that doesn't deserve much credit is "development experts," because there is a terrible crisis of confidence in development economics now, where we all freely confess we don't really know what to advise governments on how to speed up development. ...

Yes, there is a terrible crisis now, not to mention that all of these indicators are still deeply unsatisfactory, so we all keep criticizing and holding accountable the market, state, and aid actors who fall so woefully short. But let none of us forget how much development already happened over the last half-century, which may inspire us with hope that more step-by-step improvements in markets, states, and aid could make even more development possible.

Summers at Brookings

Economic Recovery [Transcript of Entire Speech] Fiscal Solvency Education Secretary Tim Geithner

The Rodrik Roundtable

Dani Rodrik at The Economist:

A Plan B for Global Finance

My response at the Rodrik Roundtable (Other responses: Richard Baldwin, Adam Posen, Simon Johnson, Leo Tilman, The Economist: London, The Economist: New York):

Central Authority Necessary, by Mark Thoma: Dani Rodrik does not believe that global financial regulation is feasible, prudent, or desirable, and he argues for considerable regulatory autonomy for individual countries rather than a centralised regulatory authority. This is consistent with the one economics, many recipes theme he has been developing in recent years. I don't disagree with the idea of granting individual countries as much individual flexibility as possible, and most proposals recognise some role for a global institution, so the question is one of degree, i.e. how much power to give a central authority, and how much power to leave to each individual country.

There is often tension between moving quickly to resolve a crisis, and following democratic processes that allow all interests to be represented in the decision-making process. When power is concentrated, quick action is much easier, and we see this concept at work in the Federal Reserve system. The Fed, as initially conceived in 1913, was a decentralised institution with no dominant central authority. The vision was one of twelve cooperating banks, with each bank granted the power and the flexibility to respond to conditions within their districts. This is the vision Dani has for the world economy.

But the Great Depression made it clear that such an institution, while perhaps ideal for normal times, was severely limited when a crisis hits... [...continue reading...]

Failing to Bailout Lehman Brothers was a Mistake

Lately, the idea that allowing Lehman Brothers to collapse was not the big disaster many have claimed it was has been heard with increasing frequency, especially among those opposed to government bailouts of the financial industry. For example, John Taylor recently said of the "bad turn" financial markets took after Lehman Brothers failed:

Many have argued that the reason for this bad turn was the government's decision not to prevent the bankruptcy of Lehman Brothers... A study of this event suggests that the answer is more complicated and lay elsewhere.

Here's a rebuttal of this idea, and of the evidence presented by Taylor:

Why letting Lehman go did crush the financial markets, by Sam Jones: For some time now, the folks over at Clusterstock - notably John Carney - have led a challenge to a particularly virulent piece of received wisdom: that the failure of Lehman was necessarily an inflection point that took the severity of the financial crisis to a whole new level.

And with that the implication that the government's decision to let Lehman fail was, in itself, a failure.

Until now, that kind of debate might have seemed a little academic - a question for historians. But day by day; bailout by bailout, its pertinence to current events and future policy is growing: politicians and regulators are going to find themselves increasingly under pressure to account for the growing number of expensive opportunities they are being occasioned with to Save The World.

Loath as we are to turn again to the "Japanese Scenario" for appropriate lessons, it's worth bearing in mind that in Japan, it was ultimately the weight of public opinion, as much as it was economic or financial considerations, that came to shape the way the crisis played out. Distaste for spending taxpayers' money grew extreme: bailouts became taboo. The way Japan's authorities consequently pussy-footed their way around problems rather than tackling them head on drew the crisis out for nigh on a decade - dare we now even say, two.

Back now, though, to the specifics of Lehman's collapse. ... [...continue reading...] ...

links for 2009-03-12

When to Take Cover

In 1999, John Kenneth Galbraith explained how to spot speculative excess:

Notable and Quotable, WSJ: From an address given by John Kenneth Galbraith at the London School of Economics in June 1999 called "The Unfinished Business of the Century":

We have far more people selling derivatives, index funds and mutual funds (as we call them) than there is intelligence for the task. I am cautious about prediction; I discovered years ago that my correct predictions are forgotten, the others meticulously remembered. But some things are definite; when you hear it being said that we have entered a new economy of permanent prosperity with prices of financial instruments reflecting that happy fact, you should take cover. This has been the standard justification of speculative excess for several centuries -- for a good part of the millennium. My one-time Harvard colleague Joseph Schumpeter thought inevitable and even beneficial what he called "creative destruction" -- the cyclical process by which the system eliminates the people and institutions which are mentally too vulnerable for useful economic service. Unfortunately the process has larger and less benign effects, including the possibility of painful recession or depression.

Jim Cramer Interview

[Part 1]
[Part 2] [Part 3]

"The Ponzi Paradigm"

Paul Krugman on March 12, 2000:

The Ponzi Paradigm, by Paul Krugman, Commentary, NY Times, March 12, 2000: Charles Ponzi wasn't the first to try it, but he has joined Dr. Bowdler and Captain Boycott among those whose names will forever be terms of abuse. And the classic scam that bears his name -- using money from new investors to pay off old investors, creating the illusion of a successful business -- shows no sign of losing its effectiveness.

Robert Shiller's terrific new book, "Irrational Exuberance," contains a brief primer on how to concoct a Ponzi scheme. The first step is to come up with a plausible-sounding but complicated profit opportunity, one that is difficult to evaluate. Ponzi's purported business involved international postage reply coupons. In a more recent example, Albanian scammers convinced investors that they had a profitable money-laundering business.

From that point on it's all a matter of timing and publicity. An initial group of investors must be pulled in, large enough to attract attention but not too large; then a larger second group, whose investments can be used to pay off the first, a still larger third group, and so on. If all goes well, stories about how much early investors have made will spread, attracting ever more people, and the continuing success of the company will silence or drown out the skeptics.

In the United States, regulators -- who know very well just how effective such scams often are -- do their best to stop them before they get started. So you might think that Ponzi schemes are mainly a historical curiosity. But Mr. Shiller is not interested in history for its own sake; he uses Ponzi schemes as a model for something much more important.

Imagine, just hypothetically, that a new set of technologies -- technologies that are really, truly, deeply fabulous -- has just emerged. And suppose also that a number of companies have been created to exploit these new technologies, in the entirely honest -- but very hard to assess -- belief that they will eventually be able to earn huge profits. For the time being they earn little if any money; even if they make an accounting profit, they must continually raise more cash to pay for equipment, acquisitions and so on. Still, as the evidence for a true technological revolution mounts, the prices of their stocks keep rising, producing huge capital gains for early investors. And this attracts ever more investors, pushing the prices still higher.

If the process goes on long enough -- and there is no reason it cannot go on for years -- the doubters will start to look like fools, and the bears will go into hibernation. Everyone (well, almost everyone) may be completely sincere; nonetheless, in effect you get a Ponzi scheme without a Ponzi, a scam with no scammer.

Given the title of Mr. Shiller's book, you can guess the punch line. He makes a powerful case that the soaring stock market of recent years is a huge, accidental Ponzi scheme in progress, one that will come to a very bad end. The book actually focuses on the market broadly defined (most numbers are for the S.&P. 500), but it reads even better as a tale of the tech stocks. It's a book that I hope many people will read; but I doubt that many will be persuaded.

You see, right now bears have an extra credibility problem. Not long ago many people were skeptical not only about the prospects for today's technology companies but about the importance of the technology itself. (I plead guilty.) And every new statistic showing soaring productivity and earnings growth shows how wrong they were. As a matter of logic you can concede the reality of a technological revolution, even while asserting that the valuations of many technology companies are crazy; but who will listen?

It's also true that savvy investors (at least they seem savvy) are following the Levi Strauss strategy: Let others get caught up in the gold rush, we'll sell them the supplies. It is quite possible that the valuations of companies that sell Internet infrastructure make sense even if those of the dot-coms do not.

Still, as you watch those who missed out on the first few thousand points of the Nasdaq's rise feverishly try to make up for lost time, you have to wonder. Will people 80 years from now talk, without quite knowing where the term comes from, about being bezosified or qualcommed?

[Follow-up column: "When things are going well there is a strong tendency to suppose that financial markets can take care of themselves. Well, they can't."]

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