Dani Rodrik's weblog

Taming financial globalization in our time

I was late to the opening session of the International Economic Association Congress, so I got to hear only the last bit of Guillermo Calvo's presidential address. But I was in time to hear his bottom line which is that financial crises can hit you regardless of whether you are a saint or a sinner. His solution to the problems of financial globalization: a global lender of last resort and more global cooperation on financial regulation and supervision to prevent a "race to the bottom."  But as he was the first to acknowledge, it is not at all clear how these ends can be achieved in a world where nation states guard their sovereignty on these matters zealously. Even the Eurozone has so far failed to harmonize national financial regulations. 

The interesting question to me is how financial globalization can be tamed in the world that we do inhabit--not the world we wished we inhabited.  And here we seem to have a real dearth of ideas. 

I am starting to believe in miracles

by a daughter who wishes to remain anonymous, impersonating her dad

OK, I am on the plane to Turkey with my two daughters and not even the incessant and loud snoring of the guy behind me can dent my excitement. I can't push the miracle that just occurred in Euro 2008 out of my densely-packed, economically-filled brain.

I had dragged my daughters to the British Airways lounge and sweet talked the attendant behind the desk with my smooth moves (my silver card lets me bring one guest only). I proceed to trek through the crowd of men in suits surrounding the TV. I find a seat on the floor, embarrassing my daughters and attracting a few odd looks in the process. I am therefore able to catch the last half of the Turkey-Croatia game, where I witness the most amazing moments of my soccer viewing career, and throughout which I add a few sound effects of my own (mostly high pitched screams, and a few yelps here and there). What a final two minutes! I am crushed when Croatia scores but my spirits are soaring when Turkey equalizes soon after in the final seconds of extension time (luckily right before I couldn't control my tears). Hugging my knees like a toddler, I rock back and forth during the penalty kicks and debate whether I should go to the restroom and not come back until it is all over. Afterwards, I cannot seem to express my joy, but obviously attempt to anyway by repeating "I just can't believe this!" over and over again for maybe, I don't know, about the next 3 hours.

And now I'm jamming out to the music on my iPhone in celebration while my daughter is coping with her crap iPod from 1923. You should see me play the air guitar.. mm hmm magic flows from my fingers. And I'm sure you can't wait to see me dance because that is, of course, the main attraction. When I start my daughters are so overjoyed that they have to step outside for a little. They tell me that it's because they don't want to be seen with me, but I know it's really to suppress their misery that this gene was not passed on to them. Well, the main point of this is to report on the victory of Turkey because soccer is the favorite sport of Americans (how 'bout them Celtics?!) and assuming that the majority of American citizens TiVo legitimately every game that takes place and watch it with teeth ground and fists clenched, I think that you will agree with me when I say: what a game, my fellow soccer fans, what a game!

Overview: On the up side, Turkey just managed another come from behind feat.  On the down side, I may be dodging a few stray bullets here and there, courtesy of celebrating Turks after today's game.

It is ba-ack!

Is the industrial policy debate back in the U.S.?  A WSJ interview with Barack Obama would suggest so:

The heart of Sen. Obama's spending program is his plan to spend $15 billion a year for 10 years on energy technology. It would be funded by revenue collected from a separate Obama proposal to cap greenhouse emissions through a system of trading pollution permits. Sen. Obama would auction those permits to producers of carbon dioxide, such as electric utilities, and figures the sales would yield about $100 billion a year. Most of that would go to consumers as rebates on utility bills, he said.

He also would fund an "infrastructure reinvestment bank" that would finance $60 billion in high-speed railways, improved energy grids and other projects over a decade. He would double spending on basic research, subsidize investment in high-speed Internet hook-ups, and offer $4,000 a year in tuition credits for students who later perform public services.

To "capture some of the nation's economic growth," he said in the interview, "and reinvest it in things we know have to be done like science, technology, research and fixing our energy policy, then that is actually going to spur productivity."

...

Sen. Obama made the case in the interview for large-scale government intervention in the energy market, saying that although venture funds are investing heavily in energy technology, there was a gap in funding that should be filled by Washington. He called it supporting the "middle stage" between innovation and commercialization. "You have this point in time when things haven't quite taken off yet and still entail huge risks," he said.

...

Sen. Obama likened his proposal to a venture-capital fund, with the government seeking private investors to contribute. He lauded a Central Intelligence Agency project which helps fund technologies the CIA finds important, but which lack long-term capital.

And the predictable Republican response:

Douglas Holtz-Eakin, chief economic aide to Republican candidate Sen. John McCain, dismissed the Obama strategy as "classic industrial policy which shows a lack of faith in private markets."

Although it is difficult to be sure, Obama's comments in the interview suggest that he has thought these issues through more carefully than we are accustomed to with politicians and presidential aspirants.  I sense the outlines of a coherent and economically sensible strategy here. And it is too bad that Doug Holtz-Eakin is playing the role of party hack.

Stolper-Samuelson for the real world

(Warning: This is a long and wonkish entry, aiming at self-comprehension, and the product of one too many long plane ride.)

The Stolper-Samuelson theorem is a remarkable theorem: it says that in a world with two goods and two factors of production, where specialization remains incomplete (plus a few more technical assumptions), one of the two factors--the one that is "scarce"--must end up worse off as a result of opening up to international trade. Not in relative terms, but in absolute terms.  But the theorem is also quite limited in its applicability.  It applies only to a case with two goods and two factors, and so its real world relevance is always in question.

But there is a version of the theorem that is remarkably general and powerful. It says that regardless of the number of goods and factors, at least one factor of production must experience a decline in real income from trade as long as trade induces the relative price of some domestically produced good(s) to fall (and as long as the productivity benefits from trade are restricted to the traditional, inter-sectoral allocative efficiency improvements, about which more later).  All that this result requires is a very mild assumption, namely that goods be produced with varying factor intensities (i.e., use different combination of factors).  The stark implication is that someone will lose, even if the nation as a whole becomes richer.

(Here is the proof. Take the good whose price falls with respect to all other goods' prices in the economy. The percent change in that good's price must be a weighted average of the percent change in the prices of its inputs.  This means that there must be at least one input or factor whose price falls by more (in percentage terms) than the output price.  The owner of this particular factor must be worse off then in relation not only to that good's price, but in relation to all other prices as well.)

The theorem does not identify who exactly will lose out. The loser in question could be the wealthiest group in the land. But if the good in question is highly intensive in unskilled labor, there is a strong presumption that it is unskilled workers who will be worse off.  And before you curse economic theory, note that this is really accounting--not economics at all.

I have been thinking about this result in connection with Broda and Romalis's remarkable finding that

the rise of Chinese trade has helped reduce the relative price index of the poor by around 0.3 percentage points per year. This effect alone can offset around 30 percent of the rise in official inequality we have seen over this period.

The puzzle here, at least on the face of it, is that one would expect China's trade to have had the largest price impact on labor-intensive goods. And if so, wages of unskilled workers must have fallen even more, along the lines of the Stolper-Samuelson logic sketched out above. Can we still say that trade with China has helped reduce U.S. inequality?

The first thought that comes to mind is that Broda and Romalis are talking about consumer prices, and Stolper-Samuelson effects depend on changes in producer prices--i.e., prices of goods that are actually produced in the U.S.  If nobody in the U.S. produces the garments and toys that China exports to the U.S., then it is conceivable that the relative price of labor-intensive goods will fall without hurting real wages. 

But then this is unlikely, given substitutability between Chinese- and U.S.-made goods. And indeed another paper, by Raphael Auer and Andreas Fischer, employs a clever technique to document a sizable negative impact on U.S. producer prices from trade with China and other labor-abundant countries.  So the benign effect of Chinese exports, if any, is not due to the fact that the U.S. no longer competes head-to-head with that country in similar products.

What gives? The Auer and Fischer paper underlines another important result. What lies behind the decline in U.S. producer prices in trade-affected sectors is not wage or other input price reductions but mostly increases in total factor productivity.  So perhaps what is going is that the Stolper-Samuelson logic is defeated by increases in sectoral productivity induced by import competition.  The mechanical link between prices and factor costs--which I appealed to above in the proof of the generalized S-S theorem--breaks down whenever there is productivity change.  After all, if TFP increases, employers can afford to pay unchanged wages even if the prices they face decline.

The next question inquiring minds will want to know is how and why this TFP improvement comes about.  The available economic theory on the impact of market competition on firm-level efficiency is notoriously inconclusive and ambiguous.  (Profit-maximizing firms should want to minimize costs regardless of how tough competition is.) Perhaps what is happening is a kind of industry rationalization--exit of the least efficient firms--in which case we should see this restructuring and the associated layoffs in the data as well.  Moreover, labor does not exactly come out unharmed in this case either.  It is after all job loss, and the threat thereof, that workers complain about. 

But if this line of reasoning is correct, the main threat to workers is not a Stolper-Samuelson type permanent compression in wages, but the more temporary (and limited) wage losses incurred by displaced workers.  This is the kind of problem that wage insurance is ideally suited for.

Stay tuned--if you managed to read this far...

Turkish Czech mate

I outsource today's post to Murat Iyigun, who expresses my feelings best. 

The question is, when will Turkey's luck--after two come from behind victories that did not seem all that well deserved--run out?

"Just the facts, professor"

I have never had much luck with fact checkers. I remember in particular an experience about ten years ago, when a fact checker from The New Yorker called to ask me if a forthcoming article's description of me as "a young economist at Harvard" was correct.  I told him that I was indeed an economist and that I was employed by Harvard.  As for being young, I just told him my age. When the article was published, I had become just "an economist at Harvard."  I took this quite hard--remember this was a decade ago!--until someone reminded me that anyone above 30 is likely to seem "old" to a person of the average age of fact checkers at The New Yorker.

So when I got a call from a fact checker at the New York Times magazine last week who wanted to confirm, among other things, that I was not "antitrade," I did not take it as a good omen.  The answer was, "that is correct, I am not antitrade." I could have tried to explain how meaningless this characterization is: You can be anti-WTO, anti-trade agreements, anti-free trade, but anti-trade?  I don't know of a single soul who wants to move the U.S. to autarky.  But I was talking to a fact checker, and the discussion would have been pointless. She wanted to know "just the facts."

In any case, you can judge the result yourself.

Ian McEwan the game theorist

Ian McEwan is one of my favorite novelists, and when I picked up a copy of his Enduring Love in Heathrow on a recent transatlantic flight, I thought at first it was a new book. It turns out that it was published in 1997, with a film version in 2004. It is a beautiful book. I don't know if McEwan knows much about or is into game theory, but the book's first chapter is as vivid and enthralling a description of multi-player positive-sum games as you will ever encounter.

The setting is a picnic which the author and his girlfriend are about to enjoy, when the two of them witness a freak accident.  It is a windy day and a hot-air balloon has gone out of control. The pilot has lost his footing and is being dragged along by the moving balloon, which contains a 10-year old boy in its basket.  The author and four other bystanders are nearby, and they all run towards the balloon to help stabilize the balloon and save the child.  The trouble is that by this time the balloon has moved close to the edge of a slope. If they cannot bring the balloon to ground, it will be all that difficult to hold on to it.

Ian McEwan describes with great precision a sequence of two games. The first is a coordination game. When the five strangers reach the balloon, which is edging dangerously towards the slope, they need to quickly decide what to do. They can try to reach inside the balloon to get the child out. They can try to pull the balloon down and anchor it. They can push it away from the slope. But in the panic of the moment, there is no time to settle on any one of the strategies and confusion reigns. The pilot is screaming instructions, but no-one can make out what he is saying. "There may have been a vague commonality of purpose, but we were never a team...  No one was in charge -- or everyone was... Any leader, any firm plan would have been preferable to none"  McEwan's character recalls.  

Before the group is able to bring the balloon firmly to ground and fetch the child out, (mother) nature makes its move. A sudden gust of wind lifts the balloon up in the air and knocks down one of the rescuers (the heaviest among them). Now there is four of them hanging on to the ropes of the balloon, which is a few feet up in the air and moving in the direction of the slope.  If they all hold on, there is a good chance they will be able to bring the balloon down when the wind subsides. But each of the strangers realizes that the ground beneath them is receding the longer they hang on to the rope. "Every fraction of a second that passed increased the drop, and the point must come when to let go would be impossible of fatal....  I didn't know, nor have I ever discovered, who let go first. I'm not prepared to accept that it was me." It is a classic prisoner's dilemma. Except that one of the rescuers does hang on. Without the weight of the others, the balloon keeps rising, and the man eventually has to release his grip and falls to his death.

You have to read the book (or at least the first chapter) to fully appreciate McEwan's masterful portrayal of the strategic and ethical issues raised by these coordination and prisoner's dilemma games. The film version compresses the sequence of events, so does not do full justice to it (when did a movie ever do justice to a good book?).  You can watch a clip of the balloon sequence at YouTube (unless that is you are in Turkey, where you cannot access YouTube (unless that is you have an iPhone and a wireless connection)).  Search under "Amor perdurable."

PS. Gametheory.net has a description of the prisoner's dilemma scene, but not of the coordination game.

The Economist evaluates the randomized evaluators

One of the bon mots I remember from The Economist, from the days when I used to read it, is their definition of a radical: "someone we disagree with." Well, by that standard, I am less and less of a radical with almost every issue of the magazine.

The magazine's latest Economics Focus column reports on the Brookings development conference that I had to miss, but to which I contributed a paper. Their bottom line on the contribution (and limitations) of randomized field experiments follows the arguments in my paper fairly closely--down to the example of anti-malaria bed nets that I used in my paper to illustrate the problems of extending results in one specific setting (Western Kenya) to others.

The article quotes Abhijit Banerjee, who says

"the quality of the evidence that informs much of the macro-growth debates is significantly worse than the quality of the data that bears on many of the micro-policy questions”. He adds: “The beauty of randomised evaluations is that the results are what they are.” In other words, they provide hard evidence, resting on a solid empirical base.

The trouble is that the moment you take the experiment from Western Kenya and want to use it to inform policy in another setting, you need to make all kind of additional, not rigorously tested assumptions (about how similar or dissimilar the settings are and how these affect the likely outcomes).  By the time the evidence is used, it has become as "soft" as many other kinds of evidence that development economists traditionally rely on.

(And before someone writes to ask how I know about this article if I do not read The Economist, the reason is that I was asked by the author to check on a quote prior to publication. Plus, I regularly Google myself of course...)

A Washington Consensus I can live with

My newest column for Project Syndicate discusses the Spence Commission report on growth, and places it in the context of a new intellectual climate which, I argue, departs significantly from the strictures of the old Washington Consensus.

The Spence report represents a watershed for development policy — as much for what it says as for what it leaves out. Gone are confident assertions about the virtues of liberalisation, deregulation, privatisation, and free markets. Also gone are the cookie cutter policy recommendations unaffected by contextual differences. Instead, the Spence report adopts an approach that recognises the limits of what we know, emphasises pragmatism and gradualism, and encourages governments to be experimental.

Yes, successful economies have many things in common: they all engage in the global economy, maintain macroeconomic stability, stimulate saving and investment, provide market-oriented incentives, and are reasonably well governed. It is useful to keep an eye on these commonalities, because they frame the conduct of appropriate economic policies. Saying that context matters does not mean that anything goes. But there is no universal rulebook; different countries achieve these ends differently.

The Spence report reflects a broader intellectual shift within the development profession, a shift that encompasses not just growth strategies but also health, education, and other social policies. The traditional policy framework, which the new thinking is gradually replacing, is presumptive rather than diagnostic .

It starts with strong preconceptions about the nature of the problem: too much (or too little) government regulation, too poor governance, too little public spending on health and education, and so on. Moreover, its recommendations take the form of the proverbial "laundry list" of reforms, and emphasise their complementary nature — the imperative to undertake them all simultaneously — rather than their sequencing and prioritisation. And it is biased toward universal recipes — "model" institutional arrangements, "best practices," rules of thumb, and so forth.

By contrast, the new policy mindset starts with relative agnosticism about what works. Its hypothesis is that there is a great deal of "slack" in poor countries, so simple changes can make a big difference. As a result, it is explicitly diagnostic and focuses on the most significant economic bottlenecks and constraints. Rather than comprehensive reform, it emphasises policy experimentation and relatively narrowly targeted initiatives in order to discover local solutions, and it calls for monitoring and evaluation in order to learn which experiments work.

The new approach is suspicious of universal remedies. Instead, it searches for policy innovations that provide a shortcut around local economic or political complications. This approach is greatly influenced by China's experimental gradualism since 1978 — the most spectacular episode of economic growth and poverty reduction the world has ever seen.

... 

It is to Spence's credit that the report manages to avoid both market fundamentalism and institutional fundamentalism. Rather than offering facile answers such as "just let markets work" or "just get governance right," it rightly emphasises that each country must devise its own mix of remedies. Foreign economists and aid agencies can supply some of the ingredients, but only the country itself can provide the recipe.

If there is a new Washington consensus, it is that the rulebook must be written at home, not in Washington. And that is real progress.

Globalization anxiety as mass hysteria?

Those who are puzzled by globalization anxiety and attribute it to collective irrationality (see Tyler Cowen's piece in the NYT) overlook a fundamental aspect of markets--their "embeddedness."  What I am referring to is the idea that successful markets need to be embedded in a larger set of man-made rules and governance structures.  Markets need regulation, stabilization, and legitimation because they are not self-regulating, self-stabilizing, or self-legitimizing. The success of modern capitalism is due as much to the institutions that govern markets--political democracy above all--as it is to the power of markets themselves. 

It is important to understand this because it provides an important clue as to why domestic and international trade are different.  Domestic trade takes place within thoroughly embedded markets; there are clear rules and they apply to all transactions equally. International trade, on the other hand, is conducted in only weakly embedded markets: the rules either do not exist or apply unevenly.  I believe this is the fundamental reason why their consequences are often perceived so differently.

Let me make this concrete. If Harvard fires me and hires Tyler Cowen instead, I would feel bad for sure. But I would not blame Tyler or Harvard, because I would assume that the decision was made on fair grounds: we compete under the same ground rules, and if Tyler beat me to it, it must be because he deserves it. 

But suppose instead that Harvard hires John Plagiarizer, who has a much longer vita and larger citation counts than either one of us, because... well because he is a flagrant plagiarizer. I think I would have pretty good reason to feel cheated.

An extreme example? Let me make it less so.  Suppose that I am an experimental psychologist instead of an economist and the person Harvard hires in my place is someone who has accumulated a long vita by virtue of not having to abide by human subjects review standards. (You can find out a lot about human behavior through torture.)  Would I not feel treated unfairly? You bet I would.   

The international trade counterpart of this hypothetical is the worker who loses his job because his company decides to move to a country where, say, labor rights are routinely violated. So the "us" and "them" characterization that Tyler attributes to irrational nativism perhaps has more to do with the absence of a common set of international rules on labor standards, environment, consumer safety, and so on. 

By overlooking the problems created by trade in instances where regulatory arbitrage does play an important role, we miss the opportunity to celebrate the kind of globalization where such arbitrage doesn't play a role.  The latter type of trade probably constitutes the bulk of world trade. But because economists do not make this important distinction, they have no language or ability with which they can respond appropriately to the uneasiness out there--except for calling it irrational. 

And by the way, Harvard cannot fire me because I have tenure (as does Tyler). Which makes any pontification on our part about job anxiety a very poor guide to reality. 

UPDATE: Tyler Cowen responds, but frankly I am not quite sure I follow it, as it seems to have been written in haste.  He concludes thus:

The bottom line is that most people support their countries to a highly irrational degree in most international questions or disputes.  That's just obvious -- watch the World Cup -- and yes Jonathan Swift understood that too.

I have no trouble with this, except that I did not think this was what the argument was about. I thought Tyler was trying to explain why opposition to globalization had increased and become more salient in recent years and why many intellectuals were going soft in their role as cheerleaders for globalization.  I don't think a constant (nativism) can explain a change. I do think an important part of the explanation is that regulatory arbitrage has become a much bigger issue now.

And by the way, some readers may want to be informed by real research as to what drives protectionist sentiment around the world. Here is where you can start (Non-gated version here).