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July 10, 2009

Economist's View - 7 new articles

Haiku Economics

Why the sudden popularity of Haiku Economics??? This is from Steve Ziliak:

Dear Mark:

The economic recession -- something -- is bringing increased attention to "haiku" and "Haiku Economics."

The first fundamental assumption of haiku economics is: Less is more and more is better. The idea seems to be catching on with financial traders as much as with poets and political speechwriters. The unemployed, it seems, can't resist it, and more than a few economists (heedless of Bentham) have put pens to verse.

Last week (July 2nd, 2009) brought a fine introductory article on "haiku economics," by Erica Alini, at the Real Time Economics blog of The Wall Street Journal.

In May I was interviewed -- in haiku form -- by the Chronicle of Higher Education (Steve Kolowich); there followed from the (fun to do) Chronicle interview three separate appearances on National Public Radio. Inspired by my interview, NPR issued a "recession haiku challenge."

The outpouring of hundreds of haiku about economics, written by NPR listeners, was rather shocking, even to NPR, the journalists said. News of the NPR haiku-economic explosion has spread by now to many other sites related and unrelated to public radio. For example:

  • Vinca LaFleur, a former speechwriter for Bill Clinton who now blogs at the West Wing Writers' Podium Pundits, has picked up on it.
  • On Dec. 31, 2008 The Wall Street Journal (Mary Pilon) did a page one article on the nationwide outpouring of haiku and other short verse and again my work was featured.
  • In August or September of 2008 Freakonomics/New York Times issued a haiku-economic challenge to which hundreds of economists and others responded.

By way of introduction, I first learned haiku from a friend and adopted teacher, Etheridge Knight (1931-1991), a great American and African American poet with whom I was in close contact between 1987 and 1991. This was in Indianapolis, back in the days before Robert Bly was a household name and well before Yusef Komunyaaka had been to Princeton or had won a Pulitzer Prize and so through Etheridge and his companion, the poet Elizabeth McKim, I got to know the underbelly of an important body of American poetry, haiku included. (Etheridge Knight's teacher was Gwendolyn Brooks, a U.S. Poet Laureate from Chicago. She discovered Knight while he was serving time at the Indiana State Pen, in the early 1960s.)

Etheridge used to urge me to put haiku and economics together. I told him yes, and then I went into another world - - into a Ph.D. program not in the Writers' Workshop but in Economics!

About 10 years later, in 2001, I was teaching econ at Georgia Tech in Atlanta when I began to understand how these two arts and sciences fit together, and I've been writing and teaching "haiku economics" ever since. Now, a few years on, I see that haiku and economics converge more than they collide at the level of principles, or so I argue.

Haiku economics won't solve all our aching problems. But, as I argue in my forthcoming article, haiku can and does serve as more than economic pain relief, 17 syllables at a time, plus or minus a small standard deviation!

"Are Depressions Necessary?"

Chris Hayes takes up a notion I've never been very fond of, that recessions are necessary and healthy since they clear out inefficient firms, and spur the development of new innovation during the recovery phase. (Why do I think this is unnecessary? The entry and exit of firms driven by innovation and the development of new products can be part of a full employment equilibrium, that is, cycles are not needed to clear out old firms and spur innovation. Imagine an economy where a new idea allows a slightly more productive firm to enter a market and displace a less productive firm, and the workers migrate from the old to the new firm over time. If this happens at a constant rate in aggregate over time, there won't be any cycles at all, but we still manage to clear out the inefficient firms and replace them with more innovative rivals. The displaced workers from the the innovation driven structural adjustment are part of the natural rate of unemployment in such an economy):

Are Depressions Necessary?, by Christopher Hayes, The American Prospect: ...Are economic contractions, like the one we're currently experiencing, a good thing? ... It would be career suicide for any elected official to suggest that the widespread stress, misery and heartache being wreaked by ... contraction were are a good thing. But scratch the surface a bit and you'll find a surprisingly vibrant school of thought, one that reaches back all the way back to the Great Depression, that holds precisely this view.

Famed economist Joseph Schumpeter said that "a depression is for capitalism like a good, cold douche," one that rinses off accumulated dysfunction. Robber baron Andrew Mellon (who served as Herbert Hoover's treasury secretary) welcomed the Great Depression with these infamous words: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people"

It's not hard to find this same view among bankers, financiers and sundry Wall Streeters today. ...

The stakes for this argument are very high: if steep economic contractions are like forest fires, a necessary part of the system's self-calibration, we should more or less let them burn. If they are more like five-alarms raging through dense city neighborhoods, we should call in the fire department.

Newsweek and Washington Post columnist Robert Samuelson is perhaps the most prominent and outspoken Mellonist writing today...

Paul Krugman, to put it mildly, disagrees. ... What animated much of this advice was not just a rigid and dogmatic economic consensus, but also the puritanical normative assessment that a wicked economy must now pay its penance. (Of course said penance was never paid by those who caused the crisis: It was paid out of the pockets of the starving, the poor and working class.)

It's exactly this notion that Krugman seeks, above all, to dispel. ...

"...The ... business cycle may have little or nothing to do with your more fundamental economic strengths and weaknesses. [B]ad things ... can happen to good economies."

...More broadly, Krugman's point is that, contra Samuelson, recessions, and depressions and assorted downturns are not useful, cleansing opportunities to "purge the rottenness out of the system," but more often vicious cycles, auto-catalytic processes that result in massive amounts of human suffering, and waste human capital and an economy's productive capacity. More like the forest fire caused by a careless camper than the natural cleansings produced by mother nature.

The technical implication of this view for crisis management is that when an economy is stuck in a deep recession, like the one in which we are now mired, normal bromides of Chicago-style economics, those to which Samuelson clings so closely, cease to apply. ... Krugman ...[believes] deft and active management is necessary. Suffering is no badge or courage, but a sign of failure. ...

As Krugman persuasively argues, economies need management and policy to ... be saved from their own tendency to spiral into disaster, to cycle through booms and busts... Samuelson and those of the Mellonist school have an innate distrust of politics; meddlesome and vulgar and prone to demagoguery. Lately the political system as seemed to be working over-time to confirm their worst fears.

But ultimately there is not economics without politics, and as terrifying as this may be, economists can't save us from this crisis. Only politicians can.

Are Small Banks the Answer for Developing Countries?

This week at The Economist:

Justin Lin, the World Bank's chief economist,... in his guest Economics focus column ... argues that developing countries should base their financial systems on small, local banks:

The size and sophistication of financial institutions and markets in the developed world are not appropriate in low-income markets. Small local banks are the best entities for providing financial services to the enterprises and households that are most important in terms of comparative advantage—be they asparagus farmers in Peru, cut-flower companies in Kenya or garment factories in Bangladesh. The experiences of countries such as Japan, South Korea and China are telling. Those countries managed to avoid financial crises for long stretches of their development as they evolved from low-income to middle- and high-income countries. It helped greatly that they adhered to simple banking systems (rather than rushing to develop their stock markets and integrate into international financial networks) and did not liberalise their capital accounts until they became more advanced.

Mr Lin concludes:

Leave the developed markets to worry about how to reform their highly evolved financial systems. To make sustained progress in lifting the weight of the extreme poverty that will remain after the crisis has subsided, low-income countries need to make their financial institutions small and simple.

Over the course of the next week, we will devote this blog to a discussion of Mr Lin's column, posting responses from our correspondents, invited experts from the academic and policy worlds, and our commenters. We'll be collecting the entire series of posts here. Do stop by and contribute to the debate.

Here is the lead Essay: Walk, Don't Run by Justin Lin

Here are the responses so far (more to come):

Here is my response:

Small banks need help, by Mark Thoma: I agree with many of the points in the article regarding the potential that small and simple banks provide. But while small and simple banks can help to overcome many problems, by themselves they may not be enough fully serve the financial needs within developing countries.

There are two issues here. The first is to determine the types of financial products that best suit the needs of people and businesses within developing countries, and the second is how to best deliver those products to the people and businesses who could benefit from using them.

Small banks and microfinance of the type emphasised in the article can meet many of the financial needs in developing countries, for example the need that farmers have to borrow funds to purchase seed and fertiliser, and then repay the loans at harvest, can be met in this way. But other needs require more sophisticated financial products. The ability to hedge price risk through futures markets, the need for insurance against crop failure, the need to purchase farm equipment through pooling arrangements that share the costs among end users, and the problems brought about by seasonality require more sophisticated products and arrangements. The point is that not all of the financial needs in agricultural, small scale manufacturing, and services are simple, even in developing countries.

Can these more complex financial needs be satisfied, or are there important barriers within developing countries that prevent these products from being used?

One big barrier is, as noted in the article, the lack of information on the financial history and worthiness of potential borrowers. This information takes time to develop and that is where small banks can play an important role. First, they can develop relationships within the community that overcome this informational barrier. Local knowledge allows the bank to assess credit risk more accurately, and to more efficiently serve the needs of the community. Second, as small banks gain information about the credit histories and worthiness of people and businesses within their local areas, that information must be preserved and made available system wide so that more comprehensive systems can emerge (the article has good suggestions about how to begin this process).

There is a third way in which local banks can help, and that is for the small banks to be embedded within a larger financial system so that the small banks can make available products that local banks cannot provide on their own. It is not clear, for example, how price hedging and crop insurance can be provided solely through small local banks, hence the need for small banks to be part of a more comprehensive system.

Importantly, linking local banks to financial markets more generally does not require that the local banks give up the stability cited in the article as a reason for developing countries to prefer the small bank approach. The 7,630 community banks in the U.S. used as examples of the stability small banks can provide are fully integrated into the global financial system, but they have, quoting from the article, "so far been only mildly affected by the financial crisis as they continue to deal with the same small local clients that they have for years". Finally, a fourth advantage of embedding small banks in this way is that it also helps to set the stage for the development of more comprehensive and sophisticated financial markets as the countries develop over time.

But simply providing a link to larger financial markets with more diverse products is not enough. These products are complex, and borrowers must be able to trust that the lenders will not take advantage of their superior information about the characteristics and risks of these products.

While I believe that lenders will manage to overcome their asymmetric information problem and successfully determine who is, and who is not a good credit risk within the local communities they serve, I am less confident that borrowers can overcome their asymmetric information problem regarding the use of sophisticated financial services. I don't mean to imply that people within developing countries are less able to understand how complicated financial products work, or less able to understand how to use them safely than people in developed countries. But in many cases the knowledge of and experience with these products is fairly limited, and in any case the recent financial crisis in the U.S. shows that consumers in advanced countries often lack the information they need to fully understand the characteristics of some products such as mortgages. So this is a general problem.

The response in the U.S. has been to develop a Financial Products Safety Commission, and to take other steps to provide consumers of these products with the information they need to make good decisions. Developing countries need a small scale version of this, i.e. someone or some institution that people within the local community can trust to give them the advice and information they need to make informed decisions. Ideally, that would be the local bank acting as the conduit to these products, e.g. the bank or some other financial institution would pool local resources and purchase the required products in an agency relationship, but there is reason to doubt that the bank would act in the investors' best interests.

This is an area where, I think, information and coordination problem among small farmers and producers is severe enough so as to require some type of government or outside agency intervention to help. I agree that complex financial products can be problematic in the wrong hands, and that many people who could benefit from these products lack the information they need to use them safely, but I don't believe that this means people in developing countries should not have access to products that can expand their investment opportunities and limit risk. They should not be limited to only those products that small, independent banks can provide on their own. But small farmers, manufacturers, and service providers cannot overcome the failures that cause these markets to malfunction without help. Therefore, it is up to outside agencies or the government to either step in and create optimal market conditions through regulation and other means, which would likely be difficult given the severity of the problems that must be overcome, or to provide substitutes for the financial products the market cannot provide effectively, e.g. government price guarantees and government provided insurance against catastrophic crop failure, which shouldn't be as difficult. I don't mean that these activities shouldn't be guarded and cautious, but small and simple banks cannot, by themselves, fully meet the needs of the communities they serve.

Paul Krugman: The Stimulus Trap

Everybody makes mistakes. But not everyone can admit their mistakes, and then take the steps needed to overcome them:

The Stimulus Trap, by Paul Krugman, Commentary, NY Times: As soon as the Obama administration-in-waiting announced its stimulus plan — this was before Inauguration Day — some of us worried that the plan would prove inadequate. ...

The bad employment report for June made it clear that the stimulus was, indeed, too small. But it also damaged the credibility of the administration's economic stewardship. There's now a real risk that President Obama will find himself caught in a political-economic trap.

I'll talk about that trap, and how he can escape it, in a moment. First, however, let me ... ask how concerned citizens should be reacting to the disappointing economic news. Should we be patient, and give the Obama plan time to work? Should we call for bigger, bolder actions? Or should we declare the plan a failure and demand that the administration call the whole thing off? ...

When there's an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. ... Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work; if the economy is still weak, the cutting resumes. ...

Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve. They should give existing policies time to work, but they should also consider making those policies stronger.

And that's what the Obama administration should be doing..., stay calm in the face of disappointing early results,... the plan will take time to deliver its full benefit. But ... be prepared to add to the stimulus now that it's clear that the first round wasn't big enough.

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we've been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger.

Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration's ability to respond effectively. ... The question is what the president and his economic team should do now.

It's perfectly O.K. for the administration to defend what it's done so far. ... It's also reasonable for administration economists to call for patience...

But there's a difference between defending what you've done so far and being defensive. It was disturbing when President Obama walked back Mr. Biden's admission that the administration "misread" the economy, declaring that "there's nothing we would have done differently." There was a whiff of the Bush infallibility complex in that remark, a hint that the current administration might share some of its predecessor's inability to admit mistakes. And that's an attitude neither Mr. Obama nor the country can afford.

What Mr. Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try. He needs to remind the country that he's trying to steer the country through a severe economic storm, and that some course adjustments — including, quite possibly, another round of stimulus — may be necessary.

What he needs, in short, is to do for economic policy what he's already done for race relations and foreign policy — talk to Americans like adults.

Don't Expect a Quick Recovery

One of the reasons I've argued this recovery will be slow is that we cannot simply bounce back to where we were before the problems started as we could in some past recessions. We need to move resources out of housing, out of finance, and out of autos, and those resources need to find productive employment elsewhere in new or growing industries, and that is not very likely until things improve. Consumers need to save more and consume less, as they are starting to do, and this too will require adjustment. So does this mean we should expect a U-shaped recovery instead of a V-shaped recovery? Robert Reich says it's neither, this is an X-recovery:

When Will The Recovery Begin? Never., by Robert Reich: The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. ... That's where the more sober U-shapers come in. They predict a more gradual recovery...

Personally, I don't buy into either camp. In a recession this deep, recovery ... depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. ... Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down...

Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. ...

"Cities and Stimulus"

Did cities receive too little of the federal transportation stimulus money?:

Lisa Schweitzer on Cities and the Stimulus, by Richard Greene: From her blog:

One of my fantastic students from Virginia Tech, Eric Howard, posted this piece from today's New York Times on Facebook. The NYT author argues that:

Two-thirds of the country lives in large metropolitan areas, home to the nation's worst traffic jams and some of its oldest roads and bridges. But cities and their surrounding regions are getting far less than two-thirds of federal transportation stimulus money.

The reporter goes on to quote outrage from mayors. They also get information from one of my favorite experts, Rob Puentes at Brookings. As usual, Rob has a very good point here: this package isn't just about business as usual revenue allocation–which has always had a strong rural bias due to the structure of the Federal representative system (as Owen D. Gutfreund points out). This rural strength made way more sense 150 years ago than it does now. So, of course all of these smart people are right in that cities aren't treated very well in the stimulus, as they aren't treated very well in Federal politics in general.

However, we have to ask ourselves: would it really be sensible to hand out this money on a per capita basis either?

The main argument for cities and against suburbs and small towns is an economy of scale argument. Those arguments underpin the "costs of sprawl" research. Urbanization and density of human settlement lower the cost of providing infrastructure because of all the sharing we city folk do: the same sidewalk can serve thousands per day instead of a handful of people per day, as in a low-density settlement. Thus, cities should somewhat expect to receive less per person than other places. The key point is just how much less per person should we expect urban infrastructure to cost, given all this sharing. The problem with sharing, of course, is that sharing leads to congestion after a certain point in population growth, thereby raising costs for everybody and requiring either dispersal of population or additional infrastructure. While planning and planners are hard-wired to think in terms of increasing density, building duplicate systems (ie increasing capacity) in congested areas is only one means of cost sharing: the other, more macro-scale approach is to direct more growth to areas with excess capacity or price congested facilities and shift more of the revenue generation burden back onto users instead of looking for Federal funds.

This latter approach is, I think, where we are ultimately heading with infrastructure finance in the new urban world. Do we have compelling arguments for why the Federal government should be involved in urban infrastructure if all they going to do is return revenues to source (the per capita/population distribution argument). Anti-federalists can and do make strong arguments for local funding of intracity systems, like metro rail systems, while Federal dollars should go to intercity and interstate projects. So while the NYT and urban mayors are probably right in that this distribution of funding is skewed, they haven't really told us what the right distribution would look like, other than to say that cities are important and they need more money. Of course they are and they do, but it isn't as though some of the poorest places in this country aren't places like the Central Valley rather than places like Los Angeles, and it's not as though Boston doesn't depend on connectivity between rural Florida and Boston for all parts of the freight and US food system.

[For more on this, see Ryan Avent.]

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