Dani Rodrik's weblog

Am I being dense?

France has threatened to walk out of the G20 summit in London if agreement is not reached on the important issues.  Bravo!

But wait.  What does France want agreement on?

"I am absolutely determined, and President Sarkozy has said it loud and clear, that we actually eradicate non-cooperative centres and tax havens," [finance minister Christine Lagarde] said.

"I know that Chancellor Merkel is very much on that line, I know that Gordon Brown has said that old tax havens have nothing to do with this new world.

"Well, we need to deliver on that and we need to be extremely united and strong."

Now can someone explain to me what offshore tax havens and financial centers have to do with our current mess?

I suppose some would say this is a tactic to divert attention from all the other important issues on which there will definitely not be an agreement on.  If they can at least agree to put the blame on offshore havens who, after all, will not be sitting around the table, France and the others can walk away claiming victory.  Will the media really be taken in?

Simon Johnson's morality tale

Simon Johnson tells a simple and compelling story: the U.S. has been afflicted by a version of the crony capitalism that has been the scourge of so many emerging markets, except that Wall Street has bought its influence and power not by bribery but by shaping the ideology of our times:

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.

Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.

The solution, to Simon, is equally clear.  Finance needs to be cut down to size.  What the U.S. needs is what the IMF would have told any country:

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

...

The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

As with any story built around clear villains easy solutions, there is something in this account that is quite unsatisfying.  For one thing, I think it puts the blame too narrowly on the bankers. Yes, there can be little doubt that banks badly misjudged the risks they were taking on.  But they were aided in all this by the broader economics and policymaking community--not because the latter thought the policies in question were good for bankers, but because they thought these would be good for the economy.  Simon himself says as much.  So why pick on the bankers? Surely the blame must be spread much more widely. 

And I find it astonishing that Simon would present the IMF as the voice of wisdom on these matters--the same IMF which until recently advocated capital-account liberalization for some of the poorest countries in the world and which was totally tone deaf when it came to the cost of fiscal stringency in countries going through similar upheavals (as during the Asian financial crisis).   

Simon's account is based on a very simple, and I believe misguided, theory of politics and economics.  It is an odd marriage of populist and technocratic visions.  Countries fail because political elites always end up in bed with economic elites.  The solution, apparently, is to let the technocrats (read the IMF) run your affairs.

Among the many lessons from the crisis we should have learned is that economists and policy advisors need greater humility.  Too many of us thought we had the right model when it turned out that we didn't.  We pushed certain policies with much greater confidence than we should have.  Over-confidence bred hubris (and the other way around). 

Do we really want to exhibit the same self-confidence and assurance now, as we struggle to devise solutions to the crisis caused by our own hubris?     

A week in Barbados

... is highly recommended to all (who can afford it--the island is frightfully expensive).  The economic success of the island immediately raises the question of why economic performance in the Caribbean has been so uneven--ranging all the way from the disaster that is Haiti (the earliest country to gain its independence, by the way) to the achievements of Barbados. Eric Williams' fascinating history of the region is a must-read.  Williams himself is a fascinating man, having acted as the long-term prime minister of Trinidad and Tobabo as well as being a distinguished historian (and the originator of the thesis that the Industrial Revolution was spawned by the riches earned through the colonial trade).  A few recent papers (see this and this) scratch the surface in terms of explaining the differences (the bequest of history and domestic policy choices made at home both make a huge difference), but there is much, much more to be done.

This is the first time I gave a talk preceded by the playing of national anthems.  Here is the powerpoint of my presentation: it is what my One Economics, Many Recipes book would look like if I were to write it today. 

The Goats of Finance

One thing leads to another.  Or in this case, everything leads back to the global financial crisis...

I was doing some reading on the Caribbean economy in preparation for this, and came across the homepage of Norman Girvan, who is one of the most thoughtful (living) economists I have never met.  I learn from his blog that Bob Mundell, a former neighbor of mine better known for other reasons, has been in Havana recently.  Where, among other things, he has identified "the five goats who contributed to the financial crisis." To see who they are, and many other thoughts besides, check this out (slide 60).

H.G. Wells, London, and the failure of summits

As we get closer to the G20 summit in April, it is worth remembering another London conference that took place in rather similar circumstances.

In 1933, representatives of all the leading nations met in London to find a coordinated way out of the Great Depression engulfing the world economy.  H.G. Wells' description of the ill-fated conference, especially of Roosevelt and his entourage makes for remarkable reading in light of some of the parallels:

[For] some months at least before and after his election as American President and the holding of the London Conference there was again a whispering hope in the world that a real “Man” had arisen, who would see simply and clearly, who would speak plainly to all mankind and liberate the world from the dire obsessions and ineptitudes under which it suffered and to which it seemed magically enslaved. ...

Drawing wisdom from Wilson’s personal failure, [Roosevelt] did not come to London and expose himself and his conversation to too close a scrutiny. He preferred to deal with the fluctuating crises in London from his yacht, Amberjack II, in Nantucket Harbour, through intermittent messages and through more or less completely authorized intermediaries.

Everywhere as the Conference drew near men were enquiring about this possible new leader for them. “Is this at last the Messiah we seek, or shall we look for another?” Every bookshop in Europe proffered his newly published book of utterances, Looking Forward, to gauge what manner of mind they had to deal with. It proved rather disconcerting reading for their anxious minds. Plainly the man was firm, honest and amiable, as the frontispiece portrait with its clear frank eyes and large resolute face showed, but the text of the book was a politician’s text, saturated indeed with good will, seasoned with much vague modernity, but vague and wanting in intellectual grip. “He’s good,” they said, “but is this good enough?”

President Obama will be there in person, of course, not aboard the presidential yacht. So count this one in his favor.  Next, read what Wells has to say about Roosevelt's advisors.

Nevertheless hope fought a stout fight. There was no other personality visible who even promised to exorcize the spell that lay upon the economic life of the race. It was Roosevelt’s Conference or nothing. And in spite of that disappointing book there remained some sound reasons for hope. In particular the President, it was asserted, had a “Brain Trust”. A number of indisputably able and modern-minded men were his associates, such men as Professors Tugwell, Moley and Dickinson, men whose later work played a significant part in that reconstruction of legal and political method which was America’s particular contribution to Modern State ideas. This “last hope of mankind”, it was credibly reported, called these intimates by their Christian names and they called him “Guv’nor.” He was said to have the modesty and greatness to defer to their studied and matured opinions. Observers, still hopeful, felt that if he listened to these advisors things might not go so badly after all. He was at any rate one point better than the European politicians and heads of States who listened only to bankers and big-business men.

But was he listening? Did he grasp the threefold nature of the problem in hand? He understood, it seemed, the need for monetary inflation to reduce the burthen of debt and over-capitalization; he was apparently alive to the need for a progressive expansion of public employment; and so far he was sound. ... But was he sound upon the necessity that these measures should be world-wide or practically world-wide? He made some unexpected changes of attitude in these respects. Were these changes inconstancies or were they tactical manoeuvres veiling a profoundly consistent and resolute purpose? Was it wise to be tactical when all the world was in need of plain speech and simple directive ideas? His treatment took on a disconcertingly various quality. He listened, it seemed, to his advisors; but was he not also listening to everybody?

As it turned out, Roosevelt had little hope or use for the London conference, as he did not want to be diverted from his own national plan of recovery, based on getting off gold and reflating the economy.  With Roosevelt not on board (literally and figuratively), the conference collapsed. 

The problem with the London conference then was that its agenda focused on an outdated goal--restoring the rules of the classical gold standard--when the world economy required massive monetary reflation.  Will the April London summit face a similar problem of irrelevance?  

There are two things that can make a real difference to the world economy in the short run: (a) coordinated fiscal stimulus, and (b) massive increase in credit or liquidity facilities for the developing nations.  European obstinacy has taken off the table the first of these. And it is not at all clear that the second is being pushed hard enough by any of the rich countries (although the US proposal on the enlargement of the IMF is considerably more generous than what the Europeans have offered so far). 

What will a future H.G. Wells say of the London summit?     

English accent envy

I suffered through four years of English middle school in Istanbul; alas, this is not me talking.  It is the audio version of my guest Economics Focus piece in The Economist, courtesy of the folks who put out the audio edition of The Economist magazine.  Here is the roundtable discussion on it.

The sorry state of (macro)economics

The failures of contemporary macro theory remind me of the time we were interviewing a highly touted graduate student on the academic job market (I believe he was from the University of Minnesota, but I am not totally sure).  We asked him how he would teach macro to public policy students at the Kennedy School.  He thought for a while, and said: "I guess I would do it all using the overlapping-generations model, and since this is an introductory course, I wouldn't bring money in at all."  Enough said.

The good news is that the problem, in my view, is confined largely to macroeconomics.  The rest of economics is in good shape, even if, as I argue here, economists haven't done a good a job of putting to use what they know (or should know, from their own models). 

The bad news is the world could really use some practical, relevant macroeconomic theory at the moment.  Brad DeLong and Paul Krugman are doing a superb job of reminding us of the continued relevance of Keynesian thinking.  But they are hampered by the absence of micro-founded models that plausibly deliver the Keynesian remedies they advocate.  The economics profession doesn't take an argument seriously until the argument can be laid out with a well-specified model that respects accepted standards of modeling--an attitude that Krugman himself has vociferously defended in another context.  Maybe the problem is with those standards of modeling, but other fields within economics have been much more willing to adapt themselves to behavioral thinking, or the fact of missing markets, or the role of market failures.   

So what is wrong with macroeconomists?

P.S.  Peter Dougherty reminds me that I should have mentioned the excellent new book by Akerlof and Shiller, which introduces behavioral economics into macro.  I should have also mentioned Frydman, Goldberg and Phelps' work on "Imperfect Knowledge Economics".  Perhaps things aren't as dire for macro as I made it out to be.  

Willem Buiter is on a roll

See his proposals on financial regulation.  He says it is better to err on the side of over-regulation, and that it is better to do it quickly, even if we do not get it quite right, because the political window of opportunity may soon disappear if we wait too long. 

What he says on cross-border finance is worth quoting in full:

Since central banks, supervision/regulation, and taxation are almost everywhere national, there is an inherent tension with global financial markets and border-crossing financial institutions. We can expect to see the following:

• There will be a repatriation of border-crossing banks and other financial intermediaries, partly driven by market forces and partly by regulatory and other official interventions. This cross-border deleveraging can already be seen at work, especially where banks get tax payer support (at the national level) and commit themselves in return to lend to domestic households and enterprises.
• Cross-border branches (supervised and regulated by the country of the parent bank), with lender of last resort (LLR) and market maker of last resort (MMLR) access (if any) only through the parent bank in the home country, and with fiscal back-up (if any) only through the home country, will be a thing of the past.
• Even as regards subsidiaries, there will only independently capitalised, ring-fenced, autonomous cross-border subsidiaries, with regulation and supervision by host country, with LLR and MMLR support (if any) from the host country central bank and fiscal support (if any) from the host country Treasury.

Buiter leaves it unclear as to whether he regards this a sad, but necessary state of affairs, or, in view of the inherent imperfections of financial markets, an adequate second-best solution--in fact, the best that we can have if we want to avoid the mistakes of the past.  I am very much of the second view.

Non-sequitur of the day

... comes from Michael Boskin (with a little help from the WSJ editors):

A financial crisis is the worst time to change the foundations of American capitalism.

Complete markets anyone?

Here is the best line ever on the folly of assuming complete markets:

If any market takes a finite amount of resources (however small) to function, complete markets would exhaust the resources of the universe.

It comes from Willem Buiter, whose complaints about modern macro are well worth a read.