Dani Rodrik's weblog

More One Economics

I see that the February 2009 issue of the Economic Journal has a set of reviews of One Economics, Many Recipes by three of my favorite economists, Jim Robinson, Rob Feenstra, and Jonathan Temple.  OK, maybe I should have told them that they are among my favorite economists before they set out to write their reviews.

Seriously, I have little to complain about.  All three reviews are extremely thoughtful, and when they give me a hard time, they do so fairly.  Jim Robinson thinks I take welfare (second-best) economics too seriously and political economy not nearly seriously enough--and therefore place too much faith on the ability of governments to get things right.  Rob Feenstra finds me glib and unconvincing in my critique of the free-trade orthodoxy and WTO rules.  And Jon Temple frets that growth diagnostics needs to incorporate considerations of robustness before it can be applied usefully.

Happily, all say that there is some useful stuff in the book.

(I don't know if there are ungated versions of these reviews, so cannot provide direct links.)

P.S.  Andres Rodriguez-Clare (another favorite economist!) has a review also in the February 2009 issue of the Journal of International Economics. 

A global survey of stimulus plans

by Kevin P. Gallagher, guest blogger

The G-20 issued a November 2008 call for a coordinated set of national responses to the global financial crisis and pledged that such responses would not be pro-cyclical in nature. With my graduate students at Boston University I conducted a survey of national stimulus packages and IMF rescue plans to examine whether these promises have been fulfilled. It seems they have not.

Our central findings:

· There have been a relatively small number of stimulus packages thus far and they don’t amount to much. The sum of these packages is a very small fraction of global GDP. Just over 20 countries have earmarked approximately $3 trillion (USD) or 0.5 5.5 percent of global GDP.

· The composition within the plans is fairly varied. Some focus infrastructure spending and tax cuts, others include attempts to save a currency or auto bailouts.

· Stimulus packages, with a few exceptions, have mostly occurred in the developed world or in larger developing countries.

· Every stimulus package identified is clearly expansionary, yet IMF packages are starkly contractionary and have a high degree of conditionality.

We link here to a spreadsheet that lists the various stimuli and IMF rescue plans in whole dollars, in terms of GDP, and provide a short description and link to each plan. We also juxtapose this information with data regarding each nation’s budget and current account deficits/surpluses in terms of GDP.

This effort is far from exhaustive we are sure. In your comments please point out and provide links to other efforts that we have overlooked. We will be updating this spreadsheet as the year goes on.

More importantly this survey raises real questions:

1) Is this an adequate global response to the crisis?

2) What about the poorer nations of the world?

3) Is the IMF prescribing the wrong policies?

(UPDATE:  See important update to these numbers here. --DR)

What do Philippe Aghion and Dean Baker have in common?

Jeff Sachs and Bob Pollin?  Peter Temin and Mark Thoma?  Brad De Long and James Galbraith?  Ken Arrow and Bob Solow (besides the fact that they have both won the you-know-what)?  Or for that matter, Jagdish Bhagwati and I? 

We all support this.

In praise of the ATM

A while back, I asked about concrete examples of financial innovation that had made a real difference--a positive one!--to our lives.  Paul Volcker has come up with the best answer I have yet heard, but it is not quite what you may have thought:

Volcker .. mocked the argument that "financial innovation," a code word for risky securities, brought any great benefits to society. For most people, he said, the advent of the ATM machine was more crucial than any asset-backed bond.

I feel much better with him having some say in this administration's financial policies.  I would love to be a fly on the wall when he and Larry Summers get to hash it out in front of the President.

Coming soon to a theater near you: capitalism 3.0

Capitalism is in the throes of its most severe crisis in many decades. A combination of deep recession, global economic dislocations, and effective nationalization of large swathes of the financial sector in the world’s advanced economies has deeply unsettled the balance between markets and states.

But don't fret about the future of capitalism, which after all has an almost unlimited capacity to reinvent itself. The real question is not whether capitalism can survive — it can — but whether world leaders will demonstrate the leadership needed to take it to its next phase as we emerge from our current predicament.

Read the rest of my latest Project Syndicate column here.

Is more effective international regulation the answer?

No, it is not.

I am prompted to write this by a piece in today's NYT, which centers around my colleague Ken Rogoff's views on financial globalization and its pitfalls. I think Ken is quite correct in his diagnosis of the problem, but I disagree with him on the policy implications that he draws.

This crisis has shown the Achilles’ heel of a globalized financial system to be a lack of high-quality, and consistent, regulation to prevent overconfident bankers from taking irresponsible risks. A year and a half ago, when it appeared to be a subprime mortgage issue for the United States, most countries thought they could glide past it. But it turned out that everyone in that globalized system was vulnerable to the collapse that began at the center.

“I believe we need a global financial regulator with real teeth,” Mr. Rogoff said this week, “to prevent the lowest common denominator problem.” Before this crisis, capital flowed to the place where it was least regulated, and some countries competed to be that place. It is worth remembering that the Bush administration was trying to use the threat of overseas competition to relax regulation before the financial system blew up.

If that doesn’t happen, then the most rational thing for many countries may be to insulate themselves from the globalized economy. “Countries will feel required to put on more capital controls so they are not exposed to countries that are taking risks,” Mr. Rogoff said.

That is absolutely right.  But Ken's preference for a "global financial regulator with real teeth" overlooks three major problems. Global financial regulation is a bad idea because it is neither desirable, nor prudent, nor feasible.  

It is not desirable because countries at different levels of development and with different national preferences with regard to how much risk they want to encourage as the price of financial innovation will want to select quite different national regulatory regimes.  There is a large element of a "local public good" in the financial system, and you need to recognize the heterogeneity of national preferences. 

It is not prudent, because a common global regulator will require global harmonization of rules. What if we converge on the wrong ones?  That was one of the points brought out by Katharina Pistor recently.   

Finally, it is not politically feasible because I just do not see that major countries will surrender national sovereignty to a global regulator with teeth. There is not enough political convergence globally for this to happen.  But the major principled objections are the previous two, rather than this one.

What is the alternative?  Ken is right that the only real alternative is a system of capital controls.  But viewed in the context of the arguments I just made, it is not at all clear that a system that allows and legitimizes capital-account management would not dominate a futile and undesirable effort to set up a global regulator.  In fact, the danger is that we will obsess on getting international regulation right with no plan B, and in doing so will simply prepare the groundwork for the next crisis.

But if we create a world of nationally segmented finance, won't we give up the benefits of global financial integration? Please.   

Domestic Blinders

Sorry, couldn't keep my self from the pun, but it illustrates how the best minds talking about stimulus are excessively focused on the domestic situation and not thinking enough about the international connection.  Why wouldn't Blinder add to his wish list international coordination on fiscal stimulus?

Why don't we hear a lot more about SDRs?

This one seems a no-brainer to me.  The easiest and quickest way to create global liquidity and enable credit-starved emerging and developing countries to increase their spending is for the IMF to engineer a vast new SDR allocation.  It can be done at the stroke of a pen, and it does not require the IMF to negotiate a program for every country that needs a loan.

Let's remember some basic facts. The U.S. fiscal stimulus will be a lot less effective if it is not accompanied by similar fiscal action elsewhere. Developing nations are severely limited in what they can do in this respect because they have little room for domestic borrowing. Serious fiscal stimulus requires that they have resort to external resources, of which there is a severe shortage at the moment (both because of the flight to quality and the borrowing that is going on in the developed world).  The existing swap lines and the IMF's new short-term lending facility have had few takers, in part because no country wants to signal that they are (or may be) in trouble and running out of resources.  A generalized SDR allocation--in return for a commitment to spend a share of these resources in pursuit of a globally coordinated fiscal stimulus--would give countries the cover needed to do what is good for them and for the rest of the world without suffering a reputational penalty.

The main objection to the creation of SDRs has always been that this would be inflationary.  In the current environment, this is a plus rather than a minus.  Inflationary, you say? Pile it on! That is exactly what the doctor ordered.

So if you want to reduce protectionist pressures in the U.S. and elsewhere while helping the developing countries get over a crisis that is not their doing, SDRs can be a large part of the solution.  So I repeat my question: why don't we hear more about this? 

UPDATE:  I see that Montek Ahluwahlia has also called for an issue of SDRs, as has a group of economists around the University of Massachusetts at Amherst.  Martin Wolf's otherwise excellent column today is mysteriously silent on this obvious remedy which would do much to advance his recommendations.

More on international regulatory reform

Over at VoxEU.org, the debate on how to save the world continues.  One of the best recent commentaries--by which I mean one that I wish I had written--comes from Katharina Pistor.  The title says it all: "Reforming the Financial System: Beyond Standardization on “Best Practice” Models."

Most of the current approaches presume that we will have to have more financial regulation at the international level. This in turn presumes that there will be some convergence on what the "right" models of regulation are. As Katharina points out, this is neither necessary nor desirable.

The idea that effective market regulation can be achieved by standardizing rules and regulations on the most successful model at the time is deeply flawed for the following reasons. First, it treats legal institutions as endowments and ignores the need for maintenance and adaptation not only to local conditions, but also to future change. Second, it creates the illusion that a given market is institutionally sound and thereby disguises problems that may trigger future crises.

An alternative strategy to financial market regulation should make room for experimentation:

Experimentation with alternative regulatory approaches is more likely to produce solutions to new problems than standardizing rules on a single, but potentially flawed, model. Assessments of regulatory regimes could follow a “comply or explain” strategy as an alternative to benchmarking. Moreover, policy makers should play a greater role in disseminating alternative models and explaining their trade-offs rather than endorsing a single one.   

The big question when you allow countries to adopt different regulatory regimes, and the one Katharina does not tackle, is how you prevent financial institutions from arbitraging these differences away by locating themselves and their activities in jurisdictions that impose the lowest immediate cost on their operations.  In other words, can you run such systems without also allowing a certain amount of capital controls?  I don't think so.