Brexit and austerity: they’re connected

June 27th, 2016 at 9:26 am

As I discuss in today’s WaPo, Brexit was a function of many factors:

–PM David Cameron’s reckless, opportunistic political gambit: calling for the referendum back in 2013 to assuage his far right Euro-skeptics in time for the upcoming election.

–Strong anti-immigration and anti-globalization sentiments. The unleashed xenophobia, surely linked to the refugee crisis, is to my thinking the worst part of all of this. Re globalization, UK voters (and probably US ones as well) finally had enough of elite economists and politicians lecturing them that if they only understood “comparative advantage” (the productivity-enhancing benefits of trade) and shut up about “factor price equalization” (the costs of trading with low-wage countries), they’d realize how great expanded trade has been for them.

–The stark polarization between the urban and economically dynamic parts of Britain (Remainers) and the rest (Leavers).

–Distrust of the EU given their mismanagement of the recession and the recovery, which oftentimes seemed wholly unresponsive to the people on the wrong side of their decisions, people that appeared to have little in the way of voice or democratic recourse.

And a big part of this mismanagement, one that hasn’t gotten enough attention, was fiscal austerity.

Sources: IMF, Eurostat

Sources: IMF, Eurostat

What matters next is, if the UK economy is hard hit by the fallout, whether this destructive fever breaks. Odds are, unfortunately, that it will not.

From the joint dept. of: capitalism is remarkable, and we are a very sick society

June 26th, 2016 at 2:37 pm

Today’s NYT mag has a piece about how the proliferation of mass shootings made the term “active shooter” part of our lexicon.

The piece begins by featuring a manufacturer of bullet proof office furniture. For five years, Ballistic Furniture Systems has been developing “bullet-­resistant panels that could be fitted inside chairs, cubicles and doors.”

There is no other economic/political system I know of that is unable (really, unwilling) to take action against gun violence–and to be clear, mass shootings account for a tiny fraction of US gun deaths–while simultaneously developing all sorts of new ways to make money off of it.

I can just hear the pitch: “We offer competitive salaries, a great benefit package, and complete bullet-proof protection should an active shooter show up!”

BTW, just to close this loop of dark irony, the article notes that “Among the many contractors that now offer active-shooter training is G4S, the global ­security firm that employed one Omar Mateen.”

Sorry to get dramatic and maudlin, but I’m increasingly compelled to apologize to my children for the world that “grownups” are leaving to them.

UK to EU: We Out. Scattered thoughts on Brexit

June 24th, 2016 at 11:19 am

No time to organize thoughts, so here are a few synaptic firings.

–I was disappointed by the outcome but not surprised. As I’ve written, this was in no small part a referendum on immigration, and the timing of the vote interacted with rising anger about this and other impacts of globalization.

–The structure of the EU–a common market with free flow of people and goods–has a great deal to recommend it, especially given Europe’s bellicose history. But the incomplete architecture–the absence of a fiscal and banking union–along with gross mismanagement–fiscal austerity, punitive actions by Brussels and Germany, non-management of immigrant flows–surely led “Leave” voters to discount the benefits of EU membership.

–I highly discount all the economic predictions in terms of the cost of the Brexit in terms of GDP, jobs, etc., except the following:
a) volatile financial markets over the next few days and large losses to the value of the pound, euro, and yen relative to the dollar;
b) the Fed may further flatten its “normalization” path.

–What about growth effects? The reason I discount the predictions is that such predictions must be based on the past and we’ve got no record to forecast off of. Moreover:

–The political economy of the Brexit impact is really tricky. At one level, I’d like the EU to avoid negative growth impacts by smoothly renegotiating the UK’s reentry into the common European market. But, as many pundits have argued, that would be firmly against Brussels’ interests, as it would signal to other potential leavers that leaving is costless.

–However, there’s a deeper problem than that. The UK can’t possibly get back in without accepting at least some, and likely most, of the conditions 52 percent of the voting electorate just rejected. EG, how could EU authorities possibly say, “we’ll give you back full, no-tarriff trading privileges with no requirements on freedom of movement for EU citizens?” That’s not a matter of disciplining other potential leavers; it’s part of the fundamental structure of the EU.

–I predict Scotland with be anxious to leave the UK as they will want to rejoin the EU. Look for another referendum before too long.

–Finally, I saw this WaPo headline: “Stop underestimating Trump. ‘Brexit’ vote shows why he can win.” I get–and bemoan–the Trumpian dimensions of the outcome, but here’s the thing. I believe that to the median Leave voter who might share some Trump sentiments–anti-immigration, anti-globalization, turn back the clock, insulate–the downside of leaving the EU looks a lot less scary than a Trump presidency. To be clear, I’m obviously not talking about die-hard Trump supporters. I’m talking about a US voter who’s unhappy with her choices from either party, yet she sympathizes with some of the anti-establishment sentiments fueling the Trump phenomenon. I would not assume that she views the consequences of leaving the EU as seriously potentially damaging as a Trump presidency.

Do economists understand economies?

June 21st, 2016 at 6:00 am


–The economist Greg Mankiw had an essay in the NYT last week on five theories as to why growth has been so sluggish for so long (Greg’s focus was on the US, but it could have applied to Europe as well). Mankiw, a Harvard professor and writer of widely used textbooks, has long been at the top of the field. Almost a decade after a deep recession that “no one saw coming” (as is widely claimed) and seven years of a tepid recovery, he presents five different diagnoses, ranging from mismeasurement to weak demand to “policy missteps.” With honesty and candor, he concludes: “Unfortunately, I have no idea which one is right.”

–Take a look at the figure below. It is a series of forecasts of world GDP growth by IMF economists. The solid line is actual inflation-adjusted GDP growth and the dashed lines are forecasts conducted in different years. As you can see, they optimistically kept predicting GDP to turn around, failing to correct their model for persistent forecast errors. But let’s not pick on the IMF, since…

Source: Jay Shambaugh, CEA

Source: Jay Shambaugh, CEA

–…Interest rate projections by various administrations show the same pattern, as do inflation projections by the members of the Federal Reserve board (see first figure below). To their credit, however, if you look at the Fed’s predictions for 2015q4 real GDP growth starting in 2012, by June of that year they’d finally downgraded their forecast (second figure below).

Source: Fed

Source: Fed


Source: Fed

Notwithstanding the Fed’s markdown, something seems quite wrong with contemporary economics. If your car failed to accelerate, even as you hit the gas (i.e., held rates at zero for years), you’d bring it to a mechanic. And if, after seven years of weak expansion, that mechanic (along with most of his fellow mechanics) couldn’t explain the problem, you might legitimately conclude: mechanics don’t understand cars.

Could it be the case that economists don’t understand economies?

Well, there are a lot of different economists out there. Dean Baker quite clearly diagnosed and wrote extensively about the housing bubble well before it burst (so “no one saw it coming” isn’t correct). Paul Krugman long ago correctly diagnosed the crippling problem of austere fiscal policy when economies are not fully recovered and the federal funds rate is stuck at zero.

But broadly speaking, we must ask ourselves not just why we’ve underperformed around the Great Recession and recovery, but why, according to CBO numbers, we’ve been at full employment only around a third of the time since 1980. Given the damage slack labor markets do to the wages, incomes, and opportunities of middle and low-income working households, that’s a tremendous, though too rarely cited, indictment.

Here are a few thoughts about what’s gone wrong:

Old habits correlations die hard. The latest Economic Report of the President included a revealing set of figures showing that a correlation at the heart of macroeconomic analysis and a guidepost for Fed policy—that between labor market slack and inflation—has grown increasingly hard to reliably estimate. Relatedly, the ERP showed that the confidence interval around the “natural rate of unemployment” right now runs from less than zero to about six percent. That implies that economists still operating from this model are likely to get important things wrong.

That word “temporary.” I don’t think it means what you think it means. The Fed keeps talking about temporary headwinds, like the negative spike in energy prices, the strong dollar, slow growth abroad, capital inflows, and wage and price growth that have been largely unresponsive to the tightening job market. But variants of these problems have been around for years now, and the assumption that soon the model will be right again, as in the IMF figure above, is another source of the problem.

Globalization ideology. The assumption that more international trade is always a plus has led too many economists to miss problems in global macro. Most importantly, some of our trading partners suppressed their consumption, boosted their savings, and exported those savings to us such that their trade surpluses become our trade deficits. The need to offset that macro drag, in tandem with large inflows of cheap capital, led to destabilizing bubbles that were missed by most economists.

Finance is much more than an intermediary. Though we’re getting better at this one, for years, macro models treated the finance sector as an intermediary that simply distributed excess savings to its most productive uses. Thus, we mostly missed the fact that the sector was instead misallocating capital to “innovative” financial schemes that systematically underpriced the true risks they engendered, thus both undermining productivity growth and inflating bubbles.

Politically motivated bad ideas posing as economic analysis. This one has become very serious. Most Republicans, mindless budget hawks (those who are always hawkish, regardless of the timing), and anti-government ideologues pushed economic arguments about the “failed stimulus” and the need to pivot to budget austerity. Mankiw, e.g., argues that the Keynesian interventions in 2009 may have been a policy misstep (Blinder/Zandi strongly disagree). Such arguments prompted a shift to budget austerity well before the economy was ready for it. Look, for example, at the following figure from EPI’s research director Josh Bivens, showing per capita government spending (at the federal, state, and local levels) over the past six business cycles. This cycle is a clear, negative outlier which somehow gets missed by the “failed stimulus” crowd. It also brings me to the final point.

Source: Bivens

Source: Bivens

Demand, demand, demand. In response to Mankiw, Dean writes, “…there’s not much complicated about the story. We lost a huge amount of demand when the housing bubble collapsed and there is nothing to replace it.” Bivens, Krugman, Summers and many others agree. Greg talks about this under the rubric of “secular stagnation: a persistent inability of the economy to generate sufficient demand to maintain full employment.” One can see it in interest rates that are hitting historic lows across advanced economies and in persistently low inflation. We’re still, seven years into an expansion, nursing a sizable output gap and elevated underemployment. Wage trends, the most reliable—maybe the only reliable—measure of labor market slack, are strengthening a bit but remain well below target growth levels.

So I think Dean’s right and I don’t really understand why that isn’t obvious (though, to be clear, I respect Mankiw’s uncertainty, which is much better than confidence in an incorrect diagnosis). That could be my own limitation and intellectual blinders, but it strikes me as a simple diagnosis with strong evidence to support it, and one with straightforward prescriptions. We need to create more demand through, for example, infrastructure investment, patience on interest rates, and trade policy focused on lowering the trade deficit.

If I’m right, it’s very important to move on these issues. Because most economists have been having such difficulty spotting bubbles or convincingly diagnosing what’s wrong with the economy and prescribing effective solutions, we’ve lost credibility to the point where Trump’s walls and tariffs, Brexit, supply-side tax giveaways to the wealthy, and congressional attempts to control Fed policy are all gaining traction.

And that is all very dangerous.

Read this now: Clyde Prestowitz’s masterful history of the political economy of trade in the US

June 16th, 2016 at 8:42 am

In this election cycle, the politics of trade have surfaced as a major issue, and the usual establishment position—more “free” trade agreements are always in our interest—held by both sides, is seriously on the ropes. I’ve tried to tap this opportunity to explain the nuances as I see them:

–Do not conflate globalization and trade agreements. The former is a both here to stay and a potential force for good if it is shaped by smart policies representative of all stakeholders. The latter has been largely co-opted by a narrow, unrepresentative group of corporate stakeholders.

–The idea that more trade is always win-win for everybody is unquestionably wrong in theory and practice.

–Selling trade deals as job creators is a fabrication inconsistent with theory and evidence. Oftentimes, such tactics are just a stalking horse for geopolitical goals.

–The idea that the benefits of trade are diffuse and the costs narrow is also wrong. While some groups and communities feel the costs much more acutely, they are widespread among non-college educated workers.

–Expanded trade carries many potential benefits, both for consumers here and those in emerging economies who can raise their living standards through trade with wealthy economies. But the fact that the US has steadily run economically significant trade deficits since the 1970s is a symptom of imbalanced trade that hurts and distorts growth. Moreover, this imbalance is not benign but is the result of currency manipulation, mercantilist practices fueled by savings gluts, the dollar as the dominant reserve currency, and an unwillingness of US policymakers to do much about any of the above.

–It is essential that we develop a new set of trade policies that reflect all of these insights. Trump’s 45 percent tariffs ain’t it. An end to the current spate of trade agreements, like TPP, is a start, but it is only that. We must better manage globalization from the perspective of working people as opposed to corporate and political elites.

I’ve not read a better history of the evolution of all of the above than this one by Clyde Prestowitz, in the current issue of Washington Monthly. Prestowitz has a lot going for him: he’s a long-time DC insider on trade policy, having sat at many important negotiating tables over the years. He knows the economics and where the theories have gone right and wrong, and he’s got his feet solidly planted in the reality of how imbalanced trade has hurt real people.

Prestowitz covers every one of the issues I raise, including the folly of Trump’s “solutions” in this space. His ideas for a new set of policies involve a much more interventionist stance, pushing back on currency management, beggar-thy-neighbor export-led strategies, dumping of commodities (e.g., Chinese steel), and excessive trade surpluses, which are all sound. I thought he went off a bit here: “[The new trade policy agenda] needs to have as its central aim the replacement of the U.S.’s unilateral role as buyer of last resort with new arrangements that accomplish the same goal of providing demand, especially at moments when global recessions loom, but in a more equitable and sustainable way,” but only in that I don’t see a way to do that which doesn’t exacerbate the imbalances that have hurt us for decades.

That’s a minor critique in a must-read essay. We can’t prescribe the most effective cure without an accurate diagnosis, which is precisely what we have here.