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Thursday, July 10, 2003

Holding Out For a Hero

Now all the sons of warlike Greece surround
Thy destined tomb and cast a mighty mound;
High on the shore the growing hill we raise,
That wide the extended Hellespont surveys;
Where all, from age to age, who pass the coast,
May point Achilles' tomb, and hail the mighty ghost.

I'm off to Valencia tommorrow, in search of a hero, or heroine - so blogging the next few day will be 'light'. I'm going to start some research to try to discover why the hell so many well educated Bulgarians are ending up in a dreary one-horse town, in the backwoods of the Spanish province of Valencia. I say I'm looking for an early adopter, and Margy says I should call him a hero, the first to leave, the first to arrive, the one who pulls all the rest in the process of chain migration. I would call him the modern Achilles.

routine1234: Ok let's go to the project a minute. My end was going to be the networking part.
margy_joy: OK
routine1234: In the first place I want to begin to try and study how these accumulations of people occur.
margy_joy: good
margy_joy: Who is the Hero - in terms of culture and creation of new place
routine1234: Tell me more about the Hero idea
margy_joy: ok - the "Hero" this is a great emigrant ideology -
margy_joy: the first one who made Conqista - and succeeded
margy_joy: It means - who survived - to be honest, and who find the way to start network
routine1234: Yep, I really like this idea, and it reminds me of Achilles and his tomb
margy_joy: I mean - who invited his people - brother, friend and started chain migration
margy_joy: I have some data about first one in Strasburg PA - now he is Achilles
routine1234: Strasburg PA?
margy_joy: And the Hero is someone at the top of local community.... until next one is getting Rich - then they split
margy_joy: Strasburg Pensylvania, USA - my Pomacs are there between Amish people - can you imagine
routine1234: It's funny, how some cultures maintain the memory of immigration and interet it differently from others
margy_joy: yes - the mythology is the same
margy_joy: does not matter if you are Cadmus - to start a new city - or you are John and you start in Madrid

What's in a Name?

Well I certainly don't make it easy for people to pin me down. In fact a recent exchange of views with Paul (on responsible irresponsibility, what else?) elicited the following formula:

Well, for what it's worth, I am still a bit confused. But I think you're playing John R Commons to my John Maynard Keynes - basically arguing that deep institutional stuff must be understood, that there are no easy solutions, while I'm saying "push this button".

At the time - apart from wondering what the hell the R stood for - I left it at that. It does seem to sum-up the difference between us, and while I'm not saying don't push the button, I am saying it won't be enough. I do also sympathise with the difficulty of trying to understand what I am saying at times, I have the same problem myself. And John Commons seems to have been such a noble soul. However my uncle Billy, who hung out in Camden, Arkansas and was a wobbly , (in fact everyone told me as a child I took after him), was almost perpetually drunk, out of work, and with no money to feed his kids. So it seems just having your heart in the right place isn't enough.

So today I got back to thinking about the problem. And then this occured to me: why don't we change the labels a bit, why don't I play Walt Whitman to his Paul Samuelson (textbook'n all)? No, not Walt the poet, silly, Walt Whitman Rostow. Still lost, well try this:

To return to the question of theory, I have six variables which I ask my students to use. Now if you wish to characterize my work compared to conventional economics, here it is 'Conventional economics evades these six variables: population; technology and investment; relative prices, which embrace the Kondratieff cycles; business cycles, but seen as a form which growth took - not abstracted from the whole system; the stages of growth, which repeat in a sense the technological revolutions, but from a different perspective - the perspective of a single country; and the non-economic variables which affect the world economy. Among these are perfectly obvious ones like the traumatic effects of wars - the Napoleonic Wars, the Civil War, and the World Wars. But the economy is also affected, for example, by how the ruler disposes of his limited resources ... There are three directions that rulers could take: they could dispose of resources to redress old wrongs; to build up the center versus the regions; and there was the question of welfare ... It's very important to be clear about the primacy of politics, generally, notably in modem economic development...........

Milton Friedman asserted flatly in one of his books or one of his essays, that he's going to stick with his theoretical view dominated by one variable. Some people are gifted that way; some are gifted to look at the whole of reality. What I would assert is that a historian is bound, by his profession, to deal with multiple variables. In that sense, I'm a historian. But, for each of my variables, I have a theory: a theory of demographic cycles, a theory of innovations and investment. I keep saying it very politely, but the proportion of income invested isn't at all the product of a Keynesian system. It isn't at all the product of the consumption function. It's a product of how much of the backlog of technology you missed and are as a society willing to make up.

After the war the Japanese ran a 30% investment rate. After the war the Europeans ran a 22 to 24% investment rate. In the United States it hovers around 15 to 17% and the rates of growth accommodate themselves to the investment rates. Well, the Japanese were furthest be- hind. The Japanese were impoverished; they had a broken society. But they came up like a rocket. They set about acquiring every type of technology. Along the way they started with cameras. The cameras arose out of their expertise at making bomb sights, and they were very good at it. And they went right up. They planned a technological chain. They were a well-educated people. They climbed a chain right up to the present crisis. And they ran, in so doing, a 30% investment rate for most of that period, although it fell off towards the end. The Europeans also came up. They had the war damage to make up, and they hadn't had the mass automobile age or the age of consumer durables. The automobile age came in the '50s and '60s. It was interesting to see the British and the Continental factories where the bicycle racks gave way to the parking lots. They didn't have American automobiles at the time. They had smaller automobiles and they had a big tax on petrol. But they had the automobile age, and they had refrigerators, and they used oil instead of coal, and they got rid of smog. In other words, the investment rate is a function of how close you are to the technological frontier and how acquisitive your entrepreneurs are.

Why was there a split so people feel that economic history - to quote Science magazine - became a 'backwater field' in the profession?

That's simply the triumph of Samuelson and The Foundations of Economic Analysis. The triumph of that kind of economics took the whole profession out of the game.............Because the differential calculus could not deal with these factors that matter: with population, with technology and investment, with relative prices, business cycles as an aspect of growth. So economics became everything you could deal with through the calculus.

I like Samuelson. I regard him as a friend. I would never, never question his right to deal with economics his way. I wish wistfully that he'd understood not only that 'mathematics is a language' - which is a direct quote - but also the wonderful wisdom that 'nature is much more complex than could be dreamt of by a single mind', or revealed by a single technique or variable. Despite what Keynes said about bridging the gap in economics between micro- and macro-analysis of prices, he didn't bridge it. His was a Marshallian short-period analysis in The General Theory. What is missing from the way we teach economics is the sector. It's the sector in which technology comes. It's the sector you must study to understand high prices of raw materials and the low prices of raw materials. There is no theory of the sectors. Think about it.

One problem?

Yes, it worries me more than any other: the fall in the birth rate in Japan and Russia and Germany. This means that these countries will hollow themselves out. Now improvement in medical science gives, in part, an out. We can extend the length of retirement from 60-65, which is arbitrary, to 75. These people can improve the work force. We can improve the productivity of the work force, as we're doing now in the United States. We also need to improve education. Eighty percent of the people in our public school system do not go to college for four years. They must be trained for the modem work force. Higher productivity of labor will help solve the problem. But still I fear for the older industrial countries versus the younger industrial countries on demographic grounds...............But you asked me what worries me most: it's the demographic issue.

On Saving Tomorrow's Spending Now

Well I promised it was going to be Robert Shiller day at Bonobo, so I guess it's time I tried to prove I'm up to my word. But actually the protagonist here is Joerg, not me:

Here is a book to think about.

Paradoxically, I feel that the basic concept is very, very wrong-headed but one of the implementations proposed by Shiller is identical to what I would prescribe (the topic in question is "Intergenerational Social Security: Sharing risks between Young and Old"). I just cannot understand why it is so hard to grasp that the paradox of thrift also applies to the different states of the economy along the timeline. You cannot efficiently save tomorrow´s spending now other than effectively reducing investment. If all "present futures" (I am trying to translate Luhmanns "gegenwartige Zukünfte") try to ever more efficiently save, any future present ("zukünftige Gegenwart") will effectively have less to spend.

The implication of an increasing lifespan therefore is not - as Malmberg claims - inflationary: because people do anticipate the future, it is short-term deflationary. After deflation has run its course, however, investment does pick up and ensures that technical change cancels out - make that: overcompensates - the inflationary effect. Could we become richer by not investing in old people´s well-being? No. Deciding to go that route would imply to deplete those motivational resources that drive individuals to invest ever greater amounts of time in study, scientific research and business development. There will surely be at least one civilization on earth whose members are smart enough never to forget this truism.

Also look at Henry Farrell's post about L. Sprague de Camp. Maybe you should read de Camp´s novel. After all, Einstein started out trying to figure out what it would be like to ride atop a ray of light.

The difficult problem does seem to be: just how long will deflation need to run its course. Simple answer: I've no idea. I think Joerg is right here that Malmberg has got it wrong, but with good intentions. Also he doesn't consider the role of credit, and that I think is a big omission. On technical change cancelling the problem out, I'm going to duck the point till I get back from playing ethnographer (late next week) since I also have a query from Eddie along very similar lines.

Population Overshoot?

OK, it's heresy time again. I'm reading the Malmberg Four Phases piece another time, while I'm preparing something to send him. And I stopped in my tracks on this paragraph:

In recent years, students of demography have focused mainly on gross population growth, while the problem of long-term changes in the age structure hasattracted less attention. In consequence, the demographic transition model has been formulated in terms of (gross) death and birth rates. The analysis has focussed on the impact of the transition on the rate of population growth. According to this classic analysis, the rate of population growth is low as long as both birth and death rates are on a high level. When the death rate begins to fall, without any corresponding decline in the birth rate, the population starts to grow. Eventually, as the birth rate falls to the low levels typical of modern, industrialised societies, the rate of population growth is once again reduced.

OK, so what's the fuss. This is standard and obvious, now isn't it. Of course, probably that's just the point. But let's stop and think about it in terms of what we know about economic processes and financial markets: let's think leads, lags, and overshoot. Then it all becomes incredibly simple. We have a trip switch: the industrial revolution. This provides a shock to what was otherwise a more-or-less homeostatic situation. Population prior to the IR was more or less self regulating, and Malthus was only partially right. Malthus, it will be remembered, made a distinction between positive and preventive checks. The positive checks are the inevitable mortality rates produced by an excess of poulation above what the land could produce at a given level of technology.

Here Malthus was undoubtedy influenced by Godwin and Condorcet (and by, of course, Cantillon - god bless him - and the left to themselves 'they breed like mice' thesis). But of course the theory of positive checks (which of course do exist), like so many theories of its type, was based on a gross oversimplification of human affairs which was never exposed to the critical scrutiny of a 'reality check'.

Well today we are not constrained by this lack of research and evidence. In fact we now know that the 'preventive check' has been much more representative of human conduct than Malthus would ever have dreamed. (A good place to start on this would be the excellent piece On Fertile Ground
from Harvard anthropologist Peter Ellison, or another point of departure could be the work of economic historian Greg Clark). The fact is, whichever way you look at it, most societies incorporate cuturally grounded 'preventative checks'. So along comes the IR and gives things a big whallop. Mortality rates - for the reasons that you choose to offer, living standards, what Mokyr calls recipes of child care, hygiene etc - fall, and fertility drops, but only with an important lag. And this I think is the point, leads and lags in demography work on a different time scale to, for example, those to be found in the garden variety business cycle. Such lags could easily be of a century or more, Meantime what we have is overshoot, while the eco-system (in this case the eco-fertility system is 'struggling' to adapt and adjust).

Of course here there is more. There is an increase in longevity, there is an increase in child rearing time, there is an increase in child bearing age. But maybe, just maybe, the underlying problem is simply one of system overshoot. The problem meanwhile is the overshoot is sending us into a nosedive, and we don't know how to handle it.

By way of illustration of the kinds of problems such processes can produce, here is an extract from the summary of a science article by Austrian demographer Wolfgang Lutz (and colleagues):

The age composition of Europe’s population has been modified by past low birth rates to such a degree that there are fewer children today than adults of reproductive age. This phenomenon – called “negative momentum” by demographers – implies that even if women in the future should have an unexpected fertility increase to two children on average the population would (in the absence of migration and mortality changes) be destined to shrink. This new force toward population shrinking appeared in Europe around the year 2000 and will become more and more powerful the longer fertility stays at its current low levels. And these current low fertility rates are partly a result of continued delays in childbearing.

“Negative momentum has not been experienced on a large scale in world history so far. It is now like sailing against a current running toward population shrinkage and aging,” Lutz said. Two factors are responsible for Europe’s negative population momentum. The first is well known: that women are having fewer than two children, on average. The second factor, whose future impact hasn’t been addressed directly until now, the authors say, is that women’s average age at childbirth has been increasing over time. This so-called “tempo effect” matters because it reduces the number of children born in a given year, boosting the average age at which women have children. The researchers estimated how these two factors might affect Europe’s population in future decades. They found that approximately 40 percent of potential future population declines caused by low fertility were related to the postponing of births.

According to the researchers’ calculations, if women’s average age at childbirth continues to increase for another 10 to 40 years:

There will be a built-in tendency for population size to decline by 55 million to 144
million by 2100;

An additional 500 to 1500 million person-years of workers will be needed to maintain
the support ratio for the elderly population over the rest of the century.
Source: IIAS Press Release

USD Correction Entering New Phase?

MS's Stephen Len argues that the USD correction is now entering a new phase. If the first phase was characterised by a change above all in USD-euro values, and to a lesser extent USD-yen values, the next phase should centre on a correction with the remaining currencies (which depends in the end on whether or not the Chinese are prepared to play ball: this has to remain an open question). His reasoning here, the inherent weakness of the eurozone economies:

The single-most important development in the currency markets is the rapid deterioration in the outlook of the Euroland economy in the last two months, in my view. While the USD side of the story is by and large unchanged from two months ago, it is becoming increasingly clear that Euroland does not have the tolerance for a sustained overshoot in the EUR. The rally in EUR/USD was too rapid for the policy makers in Euroland to reverse their long-standing position that the EUR was grossly undervalued. However, with growing evidence of the Euroland economy in atrophy, I believe the Euroland policy makers will quietly welcome the recent correction in EUR/USD. In fact, the lack of complaints from Europe so far against the recent correction in the EUR essentially signals, in my view, that the Euroland has involuntarily joined the ‘war of competitive devaluation’. EUR/USD is no longer the ‘path of least resistance’ in the USD index sell-off. With the EUR no longer strengthening against the USD or JPY, downside pressure on the USD will be forced out via the Asian and emerging markets.

I cannot over-emphasise the importance of making a clear distinction between the USD index and EUR/USD. Some investors still, surprisingly, treat them as synonymous. Just because I’ve declared that the structural ascent in EUR/USD may be over for the year does not mean that I believe the USD correction is complete. I stress again here that I believe the correction in the USD index (measured by the Fed’s major currency index) still has some 5-10% to go by end-2004, but the adjustment against the EUR is now complete. (Compared to the expected fundamentals in 2004, the USD index is 5-10% overvalued. But compared to the current economic fundamentals, the USD index is only 2-3% overvalued. The main reason why the size of the overvaluation is so modest is because the US still commands a productivity premium over the rest of the world, which partly offsets the record size ‘twin deficits’. Those who are fixated on the US’s C/A deficit miss this important point.) The capping of EUR/USD and EUR/JPY will partially correct the skewedness of the current correction in the USD, pushing more USD downside pressure out against the JPY than the EUR. This is why I believe that, in its final phase of correction, we will see more of a rotation of leadership from the EUR to non-EUR currencies. In my view, the USD will correct mainly against (1) commodity currencies, (2) LatAm currencies, and (3) Asian currencies

But Len goes further, and in so doing locks swords with his boss, Stephen Roach. In Len's view a number of points are important: that global deflation and a US dollar crash are incompatible, that the US 'productivity advantage' still makes it a superior destination for investment and that thirdly the 'symbiotic' US-Asia relationship isn't going to change dramatically any time soon. For these reasons, and despite the existence of important structural imbalances, he argues that the conventional currency view is not applicable, and that the USD is liable to much less downside risk than many imagine. I broadly agree, indeed my feeling is that, with the euro position unsustainable and the Chinese in no hurry to float significantly upwards, the risk is if anything upwards in the mid-term.

In his Forum dispatch on Monday, titled, ‘Flashpoint?’, Steve argued that the continued expansion in the US savings deficit, and therefore the goods market imbalances, will need to be normalised through a massive and sharp decline (i.e., another 30-40%) in the value of the USD. This is an important view, one that challenges the very foundations of my view on the USD. I respond with the following points.

Point 1. Global deflation and a USD crash are mutually exclusive. The primary difference between the current situation and the mid-1980s is that we are in a synchronous global recession. At this point, fighting global deflation remains a top collective objective of global policy makers and one that is significantly more important than re-balancing global demand. Despite the widespread criticisms of the imprudence of the US consumer, no one in the world genuinely wants to see the US consumer stop consuming, as that would very likely lead to a global recession. Asia has already shown its hand in not wanting to see its currencies rally against the USD. But with the Asian currencies (not just the Chinese RMB, but also the JPY and the rest of Asia) therefore effectively pegged to the USD, a sharp crash in the USD would be extremely deflationary for the rest of the world (i.e., Europe and emerging markets). It is thus difficult for me to see how the USD can crash if the rest of the world will not let it crash. If anything, the US, Euroland, Japan, China, and the rest of Asia are already fully engaged in a war of competitive devaluation.

Point 2. The US is still a superior destination for investment. Notwithstanding all the criticisms of the US policies, the US remains one of the most flexible large economies in the world. I am not at all convinced that the expected return on assets is higher in Euroland or Japan than in the US. After 9/11 and the war in Iraq, there was also much speculation on whether the USD had lost its shine as the geopolitical hegemonic currency. It is interesting, anecdotally, that Saddam Hussein paid hired foreign combatants in US dollars, not the EUR, not the Russian RUB, and not the JPY. Even given more reserve currency diversification, in my view we have to accept the fact that the USD is still the hegemonic currency in the world, and will remain so for a long time.

Point 3. The symbiotic relationship between Asia and the US will last for a while. Asia’s recycling of its balance of payments surpluses back into US Treasuries through intervention is a reflection of a lack of confidence in letting the USD weaken against their currencies. One day Asia will find a better balance between consumption and production. In the meantime, however, Asia’s ‘lack of confidence’ and under-consumption imply that the US will be allowed to run persistent current-account deficits, with much less downside risk to the USD than a more orthodox view on currencies might suggest. LINK

Talking the Dollar Up and Down

I think I make no secret of the fact that I wouldn't by any stretch of the imagination consider myself a currency specialist. I base a lot of my opinions on arguments from Morgan Stanley's Stephen Len (see next post, remember the 'trust' factor) and when this doesn't help I either lean on my brother, or ask Eddie, or call up Kevin to try to resue me from a tight spot. But blogging is a baptism of fire, and we seem to learn a little each time we move forward. As it happens I have been arguing that the key factor in the dollar depreciation was not the market response to some 'underlying economic fundamentals' but the perception by some key participants that the IMF was calling for a dollar correction, that the US Treasury was not resisting this view, and that the US had just won a war in Iraq (and before that in Afghanistan) and was in a position to impose its view. Now, from Brad's Blog come some unexpected re-inforcements for my view. Maybe the Cardinal sent some disloyal troops:

If neither monetary nor fiscal policy can be of use, the only remaining policy lever is to try to boost exports by talking the dollar down--a very difficult, hazardous, and possibly counterproductive exercise.
Source: Semi Daily Journal

So there it is, you can have a 'dollar policy' of talking up-and-dpwn the currency, and it is on a par with monetary and fiscal policy, it is part of what Eddie calls the macro arsenal. Of course I imagine Brad's 'caveat emptor' here would be to pivot himself on the difference between the short and the long run. In the long run (apart from being dead) all the talking up-and-down may make little difference to us, but in the short run it may make a lot (and precisely for the reasons Brad explains in his collected dialogues). And the reason why the US can do this (despite those notorious 'twin deficits'): because it is perceived to have the clout to do it, something the eurozone and Japan (despite their manifestly worse 'fundamentals') are not. The error in thinking about the non-effectiveness of dollar policy stems, I think, from seeing it as a question of market intervention. What I think Brad has very nicely demonstrated this week is that by generating the right expectations you can achieve a lot by doing very little (and apply the law of minimum effort). For these very reasons I imagine the US Treasury will be extremely circumspect in what they say publicly about rinban revaluation, precisely because of the risk that the Chinese might ignore the 'friendly advice'. So we are left with a lop-sided currency 'correction', whose logic, I have to admit, escapes me. And if 'winning the peace' in Iraq should turn out to be more difficult than imagined..................

Some 'Selective' Information

In my last post I mentioned that there was a bit of information around to back the view that the 'recovery' may not be exactly what the markets are expecting. The main evidence is, of course, the employment data. But since I think we're all agreed that this may be a lagging indicator we can't read too much into this yet.

Then there's the output gap, and Brad's musings about when "real GDP will begin to grow at the 3.5% per year pace that we think is needed to keep the unemployment rate from rising, or the 4.0% per year pace that we think is necessary if unemployment is to start to decline (and even then only slowly: by perhaps 0.2 percentage points per year)".

But there are also a lot of other incidental details which may give us clues (of course these clues are selective, in the same way that all 'information' is in some sense selective).

Firstly This One

Inventories at U.S. wholesalers unexpectedly fell for a second straight month in May, the government said on Wednesday, as sales also sagged. The Commerce Department said wholesale stocks dipped 0.3 percent in the month, as inventories of durable goods -- those meant to last three or more years -- and non-durable products slipped. Wall Street economists had expected inventories to post a 0.2 percent gain after a revised 0.3 percent slide in April. Wholesale sales also slid. They fell by 0.5 percent after a revised 2.5 percent decline in April, the biggest drop in Commerce's records
Source: Yahoo News

Then This

More Americans struggled with their credit card bills in May than a year earlier, as rising job losses took a toll on cardholders' ability to meet monthly payments, Moody's Investors Service said on Wednesday. "The relatively weak economy, especially with respect to the job market, continued to make it more difficult for consumers to repay their debts," the bond rating agency said in a statement. Last week, the U.S. Labor Department said the nation's jobless rate climbed in June to 6.4 percent, the highest in nine years, from May's 6.2 percent. Moody's delinquency index on credit card payments 30 days late rose to 5.20 percent in May from 4.86 percent a year ago, but declined from 5.25 percent in April. The year-over-year delinquency rate has risen in the past four consecutive months, Moody's said.
Source: Yahoo News

And This

Demand in the United States for loans to buy homes and refinance mortgages fell in the July 4 holiday week as interest rates crept higher, an industry group reported on Wednesday. The drop in applications for mortgage loans was, in part, due to the holiday weekend that lured Americans to beaches and parks. The Mortgage Bankers Association of America said its measure of demand for refinancings, the refinancing index, fell 21.3 percent to 6,768.3, while its gauge of demand for loans to buy a home, the purchase index, fell 5.5 percent to 414.1. "We adjust as best as we can for the holiday affect. It is mostly the higher rates," said Douglas Duncan, the association's chief economist, adding that some of last week's decline in activity was also due to the July 4 U.S. Independence Day holiday. The trade group's measure of overall lending activity, the market index, fell 17.7 percent to 1,346.3 and 30-year loan contract rates rose to 5.37 percent in the July 4 week from 5.23 percent in the previous week. The record low was 4.99 percent in the June 13 week.
Source: Yahoo News

So there it is, now you go away and make up your own minds. BTW, what does it say on the reverse side of the greenback?

Will She, Won't She: the Continuing Saga of the US Recovery

With equity markets all over the planet betting heavily that the long awaited US recovery is now just over the horizon, there is only one small detail left to tidy up: is this for real? Of course the strongest argument in support of the recovery-on-the-way view is that it has failed to materialise for so long now that surely it's going to happen. But isn't there a simple probability fallacy about tossing coins that is applicable here? No, no.. you don't understand, you see there is also the business cycle, and from this we know that what goes down must come up, recovery is just a matter of time, and surely now sufficient time has elaspsed, ergo..... Well, no. Business cycle theory does enable you to predict a recovery will come one day, but it does not tell you how far down, or for how long you will go first. Nor does it tell you how pronounced the recovery will be when it does come. For all of this we need more information, a bit more theory, and some bloody good guess work.

So what does that leave us with. Well the recovery is coming because the markets are already pricing it in. But what if the markets are already pricing it in because the market participants are expecting it to come. Doesn't this then become a bit circular. I think that today, for reasons which will become clear a bit later, is going to be be Robert Shiller day here at Bonobo.

Ever since Brad's admirable sally into the world of the Socratic Dialogue I haven't been able to get away from the problem of herd behaviour , and the associated phenomenon of information cascades.

And this is where Shiller comes in, since he has an admirable paper entitled: Conversation, Information and Herd Behaviour.


Experimental evidence shows that an important reason why people tend to imitate others, to exhibit "herd behaviour," is that they assume that others have information that justifies their actions. The informational cascade models of Banerjee (1992) and Bickchandani et al (1992) are significant developments in showing some general equilibrium and welfare effects of such rational imitative behaviour. But these models as specified may be of limited applicability since they assert that differences across groups in herd behaviour can be attributed to the random decisions of the first movers. Differences across groups might be explained more often across groups in terms of different modes of interpersonal information transmission. Patterns of human conversation imply great selectivity to the kinds of information transmitted within groups.

The problem which interests Shiller in this paper is not whether or not herding behaviour exists, he obviously takes it as read that it does, but how the decisions of the 'first movers' spread to the rest of the herd. And here he gets rather interesting because he attempts to use a communicational model to explain differences in receptivity across groups. We might consider that the phenomenon of the IT early adopter, and the differing ways this unfolds across societies, could well be a case in point. What determines how many 'first movers' - those who, by definition, do not trust the judgement of others to form their own - exist in any given society? (Here's one for you Maynard on the 'malleability' of cultures). Trust, and the forms of communication and social networks associated with it within different societies, would seem to be a crucial concept here. (Come to think of it, and entirely on the fly, this should have some implications for how we interpret our 'confidence' indices). And what determines the velocity of propagation, from first mover to herd? Well these are really questions rather than answers, but sometimes the questions themselves point us towards the answers. Shiller's conclusion is as follows:

Groups may differ in complicated ways in terms of what may be called informational cascade facilitators. For example, some groups may observe others in relation to certain kinds of information more often than other groups, or have different theories than other groups about the relevance of other group members' decisions to their own decision problem. Conversation patterns may also vary across groups in terms of habits of revealing sources of information. A seemingly inessential group tendency to reveal or not reveal wher one heard an improbable story may make an important difference in the kind of informational cascades that develop in conversation. If one knows that a more reliable person believed the story enough to tell it, then one would more logically have more tendency to believe it and tell it . Much research could be done documenting differences across groups in such dimensions.

The key expression in the final part is 'a more reliable person'. This is what I mean by trust and how it operates. So, to sum up, and return to where we started, since I am one of those people who congenitally has difficulty trusting the judgement of others to form my own, I am a recovery doubter. My reasons, a bit of information (see next post) a bit of theory (see website) and some bloody guesswork!

Wednesday, July 09, 2003

Now It's Labour Reforms in Mexico

David Hale is arguing that Mexico is now too expensive for it's own good. Solutions: among other things labour market reforms. Germans, are you ready for another round?

The point of my irony is not that some labour market reforms which improve mobility, flexibility and efficiency may not indeed be welcome and necessary, but that we need to look very carefully at what lies in the small print of all this. Simply setting the wage rate in China as a standard, and moving the whole world towards it, is not a reasonable policy for anything. So we need to take a second look at growth, how to achieve it, and why we may be having difficulty doing so, and not simply fall into universal mantras. This, I think, is my point.

The shock that may help to break prolonged political gridlock is the rise of China. There is now a widespread fear among Mexico's elite that China will soon displace it as America's second largest trading partner. For this reason, Mexico was the last country to approve China's entry into the World Trade Organisation in 2001.

Mexican concerns about China are legitimate. The manufacturing companies in the maquiladora assembly zone have lost more than 200,000 jobs since 2000, in part because of companies transferring production to Asia. Mexican labour costs are three to four times as high as China's. Mexico's electricity costs twice as much because of a lack of foreign investment in the energy sector. Mexico depends heavily on exports of traditional cyclical goods, such as cars and television sets, while Taiwanese companies are rapidly expanding China's high technology exports. Foreign direct investment into Mexico amounts to $12bn-$14bn a year. China's FDI is now running at nearly $55bn a year, with $16bn in the information technology industry alone. A growing number of Japanese, US and European companies now regard China as an attractive manufacturing base for global exports, not just a robust market for domestic consumption. They will ensure that China continues to expand its share of world trade at the expense of other countries.

The question for Mexico is whether China will precipitate as dramatic a change in economic policy as Mr Salinas' trip to Davos. He was able to promote Nafta at home because Mexico was still a one-party state. But today the PAN, the PRI and the leftwing Democratic Revolutionary party (PRD) must find common ground on electricity privatisation, tax reform and labour market deregulation in order to reduce Mexico's manufacturing costs. If they fail, not only will Mexico lose market share in the US but there will also be a continuing exodus of manufacturing jobs and rising unemployment.
Source: David Hale, Financial Times

China and the Malleability of Culture

Maynard is asking me whether I have read The Chinese. The answer is no, but I will do. He raises some interesting points, especially the one about just how serious is the China growth phenomenon. I think we have to be careful here. The world of 'China watching' seems polarised into two camps the way the world of Japan-watching used to be. (I think now the Japan watchers have all collapsed into one camp: it's a mess). There are those like Stephen Roach, and Andy Xie who hail the dawn of a new era of global growth in China. Then there are those (charactarised in the present case by Jasper Becker) who seem to see everything as a sham, right down to the latest growth statistics. I try to steer perilously between these poles, but I am definitely in the Xie-Roach camp. It's not only about looking at official numbers, it's also about talking to people (and listening) and I find whether it's talking with Xiaomeng in Hangzhou or T-Salon (who incidentally has some interesting material on the recent protests in Hong Kong, which are, after all pretty relevant to what Maynard is talking about) or my Chinese friends in Barcelona, or Eddie in Singapore the feeling is the same: there is a very important growth process taking place across the coastal area (the interior is another question). So whether those GDP number are dodgy or not, something important is happening. You can even see it in the US employment stats I think.

On the other hand you have a political leadership who far from front-running are probably behind the curve, and who are struggling to hold together a process which may in the end be just too powerful for them. I don't know. What Maynard regards as a 4,000 year old tradition of illiberalism (although this may be stretching a thin point a bit too far, there have been 'more' and 'less' enlightened dynasties, there have been 'openings' and 'closings') may indeed continue (I think I commented at the time of the SARS issue that I found Andy Xie's faith in the capacity of the bureaucracy to reform way too optimistic). What I do know is that information is still tightly controlled in China, and that the Hong Kong issue suggests that the intention is it's going to stay that way. This is one of the reasons why China will not be a leader in the information revolution (and why that role may naturally fall to India with different tradtions and a different culture). But China as the industrial hub, this is another matter. I would say that's already a 'done deal'.

Are cultures malleable? Not as malleable as we like to think. (Parenthesis here: even though it is not very fashionable to ask about it, this point would also apply to contemporary US culture - which could be thought to be suffering from some form of institutional lock-in. To survive as a world leader the US may need to change. Is US culture capable of this change? We don't know. Of course the 'naturalistic attitude' of US culture, which assumes it is the logical end-point for all other cultures to evolve-to may be precisely the obstacle which makes such a reflection imposssible. We Europeans at least know we all have 'cultures').

But China has a cultural tradition of hard work, sacrifice and a love of business, so in the present context maybe it doesn't need to be that malleable. Even at the height of the cultural revolution China was different from many of the Eastern European state run economies (maybe Hungary here is an exception, I seem to remember back in the 70's in London there were lots of Hungarians around busy doing 'business' despite an outwardly unfavourable attitude on the part of the official regime at home). As one of my Chinese friends here says: 'we are very strong, we can resist a lot, then, later, we control the business'. I've a feeling she may turn out to be right.

have you read the book "The Chinese" by Jasper Becker. This was published in 2000; the author was a journalist at the South China Morning Post. I've almost finished it. It's a fascinating read---a collection of barely linked chapters dealing with separate segments of society --- minorities, the army, the bureaucracy, teachers, doctors etc.

What I find striking is that it pretty much confirms the idea I've had for a few years, that China's leaders, regardless of whether you like or loathe them, feel themselves to be desperately trying to hold together a collection of elements that's just waiting to blow; that far from being as all-powerful as they're made out to be by outsiders (eg
India explaining why their economic results have apparently not been as spectacular), they're clinging on for dear life and straining mercilessly the few items that are under their control while accepting those that are not, in the hope that each year they manage to sustain things makes it a little easier for them to develop towards a more normal state. I can't help but believe that at times like Tiananmen the discussions had nothing to do with democracy or even really about maintaining party power, but were essentially technical discussions about an end that both sides agreed upon --- what course of action is most likely to maintain stability.

The other thing that's striking is his general pessimism about the country, compared with what one sees everywhere today. Most of what he says is the familiar stuff --- the statistics are all lies, the masses of poor are not getting any better off, the Chinese fooled everyone in the West about how great things were in the 70s and they're doing the same thing again, the culture/bureaucracy/party has been authoritarian and illiberal for 4000 yrs and isn't going to change now. However most commentators gloss over that to believe that this time things really are different. If there's one thing we learned from the 90's, it's that business writers appear remarkably able to buy into hype. I guess ultimately this gets back to what has long been a buggaboo of mine --- just how malleable is "culture". I still don't have an answer, and I still haven't found an author who even thinks the question is worth posing.

Researching Net Use

Via Brad, a link to Eszter Hargittai's interesting web log. The post in question refers to Google and Eszter's research into internet use. I absolutely agree with her that the social divide in the net is enormous. My anecdotal 'participant observation' in the locutorios of Barcelona made this abundantly evident to me. Indeed the 'walled-garden offensive' is much more extensive than people seem to imagine, especially in non-english speaking cultures. (Incidentally, on the topic of participant observation, I went shopping this morning, an activity I hate, but I did get some new sandals, shorts and, and a small cassette recorder complete with tapes. On Friday I'm off to begin my ethnographic career. It will be interesting to see where all this leads, because the more I think about it the more applications I can see for the methodology I am learning. And meanwhile back in the office one of my fantastic colleagues (Mari Paz) will be working busily away on a qualitative data analysis programme called Atlas-ti with which she is a real whizz).

But my biggest preoccupation is that the internet use problem may be as much conceptual as social. I have the horrible feeling that there is what Maynard calls a 'point-of-view-switch' involved. It is just not evident to many people what, for example, the difference between a search engine and a browser is (of course at bottom the answer may be none, but it is also true that some infinities are longer than others, but to get to grips with this you need to start with some simple building blocks). What I am saying is that the whole situation may be conceptually confusing for many people, especially those not familiar with level changes, and meta languages. This may need more than simple training, but obviously use rather than theory classes is what helps. I can still remember the first time my reader friend Xiaomeng from China came to chat with me over the messenger. The first feeling was profoundly disorienting, then exciting, and finally, but only finally, comfortable.

BTW, I was chatting with Eddie in Singapore last night when at one stage he said: 'time for bed'. It was only then I thought to ask: 'but what time is it there'. 1:30 am was the answer. My God, I said, you'd better go now. Disorienting isn't the word.

Results from a study I conducted on average users’ ability to find information on the Web suggest that there is great variance in whether people can locate different types of content online and their efficiency in doing so. These findings imply that simply offering an Internet connection to those without access will not alleviate differences or the so-called “digital divide”. Rather, providing training is a necessary component of making the medium a useful tool for everyone.

Referring to Google has become the high-culture status symbol of Web use. When presented with an information-seeking task, the supposed savvy searcher quickly suggests the use of Google. However, just like simply referring to the latest opera at the Met should not be equated with expertise in the genre, a throwaway comment about Google should not make us think that people know how to find information online.

Knowing about Google does not equal knowing how to use Google – or any other search engine for that matter – effectively. Today’s search engines are not evolved enough to guess what we mean when we type in a single-word search query while looking for answers to complex questions. Yet research has shown that the majority of users employ such limited strategies when using search engines.

Moreover, although it may be hard to believe, many people do not know about Google and even some of those who do never use it. The good news for the "Googleless" is that you do not need to use any one search engine to make the most of the Web. Results from my study suggest that the particular strategies people employ to look for content is a more important predictor of their ability to find material than whether they use Google. As long as users know to include more than one word in a query or add quotation marks around some of the terms in certain cases, they will be likely to find a match regardless of the search engine.

But to assume that anyone anywhere has the Web savvy to do this is misleading. The rhetorical shift to the Web being everything to everyone perpetuates the idea promoted by the Administration a year and a half ago that the US is a Nation Online. The reality is that even among those who do use the Web on a daily basis, some are more online than others.
Source: Eszter's Blog

New Kids on the Blog

Well it seems it isn't only M&A time on Wall Street. It appears that the scale advantages of merging are making themselves felt in Blogland too. I'm referring to the newly created Crooked Timber which is a fusion of the efforts of various old-hand bloggers including Henry and Maria the deady farrell-blogger duo. The name is undoubtedly a tribute to the late lamented Isaiah Berlin, while the quote is also indirectly a hommage to Immanuel Kant.

Whether this attempt at creative fusion works, or whether it will be another Vivendi-Bertelssman I do not know. My own view is that blogging is an intensely personal activity - even a struggle to find identity - and that they may become victims of their own split personality. Or worse, they could become another example of the 'tragedy of the commons'. Blogging is, I feel, a post-ideological activity, where the personal finds its head over the intellectual (and certainly over the dogmatic). My vision of blogging is inheretly pluralist. However, much as our intrepid friends would cling to the life raft (let's hope the timber is at least sound) in a vain attempt to avoid the perilous alternative of swimming in the open sea, I do not abandon all hope. In addition, there is some interesting reading there. Take the following for example:

A common device in the broad-canvassed social-realist novel is to have events throw together people who don’t seem to belong in the same universe, in such a way as to reveal the deeper social reality. Bonfire of the Vanities is a good modern example (why was the film so bad?). Such a real-life even occurred yesterday when an express train hit a minibus in central England. On the train were the Bishop of Hereford and a Tory MP, in the minibus were men variously described as arabs and as Iraqi Kurds. Several of those in the bus were killed and the TV news thought the incident sufficiently serious to send crews to the scene. They interviewed some young women who had east European accents and probably came from Poland or the Baltics.

These people had all been drawn to Worcestershire by the promise of work. The agribusiness that hired them obtained their labour from gangmasters based in cities like Birmingham. Perhaps some of the shoppers who bought their broccoli or cabbages did so because they had a preference for “English produce” over the sugar-snap peas flown from Zambia. Who knows? Anyway, those fields are not tilled by cap-tipping yokels with pieces of straw between their teeth living in tied cottages.
Source: Crooked Timber

The similarity of this situation with my Valencian Bulgarians lead me to make this extensive comment:

Despite the apparent naivety of the premiss (that this situation is hidden: seems like we’re back with the ‘purloined letter’), this post is rather interesting. So this is happening in the UK too. I had imagined that extensive use of undocumented workers was efectively a mediterranean phenomenon - since the arrival of the euro has pushed up ‘official’ labour costs enormously (the so-called harrod-samuelson-balassa effect, god forbid) many mainstream economic activities only continue to survive using undocumented labour.

The textile industry is a case in point. A chinese friend of mine tells me there are about 15,000 undocumented chinese workers in the Barcelona industrial belt. She knows this because she is asked by the courts to work as an interpreter whenever one of the workers has problems with the law. Note that these problems NEVER relate to work. Here there is no control.

Roughly the same is true of a Pakistani community of about 10,000 just off Las Ramblas. We have numbers for all this since the current spanish law gives undocumented workers access to health (for everyone) and education (for children) if you register with the town hall.

I have been studying the same process with the arrival of Bulgarian workers in rural Spain.

It was fashionable in the 80’s in the UK to talk of de-industrialisation. In the case of Bulgaria this has taken a new twist. What we have are highly educated people - schoolteachers, dentists, engineers etc. - coming to work picking peppers and oranges. The reason, in Bulgaria a schoolteacher earns 120 euros a month, while picking peppers on an undocumented basis they can earn 500 euros a month - working ten hours a day in the blazing sun.

Another important detail, this migration is also partly provoked by an important pension reform - pensions are now 50 euros a month - which means they have to come out to send money home. Look out Germany!!!

What seems to me to be important is to understand that this process is not simply incidental. Krugman recently asked why indentured servitude was not being re-intoduced, I argued here that it effectively already has been. One of my blog readers (Joerg) astutely made the point that in the absence of a gold standard, what we effectively have - via the globalisation of labour market reforms - is a ‘labour standard’. And we are about to make all the same mistakes as were made in the inter-war years with gold.

I've Seen the Future Mum, I Wonder if it Works?

Nanotechnology keeps promising, it looks like one day soon it could be delivering:

Nanotechnology May Create New Organs

Scientists have built a minute, functioning vascular system - the branching network of blood vessels which supply nutrients and oxygen to tissues - in a significant step towards building whole organs. Conventional tissue engineering methods have successfully grown structural tissues such as skin and cartilage in the lab. But not being able to create the supporting vascular system has proved a major stumbling block preventing scientists from creating large functioning organs such as liver or kidneys. Now, researchers from Massachusetts Institute of Technology and Harvard Medical School have used computers to design branching networks of venous and arterial capillaries, which start at three millimetres wide and reach a fineness of just 10 microns.

"We used living vessels as a guide to model factors such as the angle and size ratio between branching vessels. But we optimised our design to improve it," said lead researcher Mohammad Kaazempur-Mofrad, from MIT¹s department of mechanical engineering and division of biological engineering. The networks were etched on to 15 centimetre-wide silicon wafers and the paths were then used as a mould to set a layer of biodegradable polymer. Two of these were then sealed together with a microporous membrane sandwiched between them, producing a mini artificial vascular system.

Endothelial cells - which are flat cells lining the walls of blood vessels in a single layer - were injected into the network on one side of the membrane and either liver or kidney cells were injected on the other side. The endothelial cells coated the inside of the polymer nanotubes. These nanotubes biodegraded to leave a living shell of vessels similar to a natural vascular network. This method would provide an efficient means of supplying the liver or kidney cells with enough oxygen and nutrients to survive. The one-layer systems of kidney and liver cells were successfully implanted into rats for two weeks ­ 95 per cent of the cells survived.

"The next step is to work on bigger animals, such as a pig or rabbit, using more layers," Kaazempur-Mofrad told New Scientist. "Eventually, we want to be able to replace whole organs with several layers of these constructs. The critical mass for liver is one-third, probably 30 to 50 stacked layers." "So in the next 10-15 years, we will hopefully have reached a point where we can do this procedure clinically in human patients," Kaazempur-Mofrad added.The research was presented at the American Society for Microbiology Conference on Bio-, Micro-, and Nanosystems, in New York City on Tuesday.
Source: New Scientist

Tuesday, July 08, 2003

On Front Running and the Herd Instinct

Brad is in Platonic mood today, and has a couple of dialogues that seem to be worthy of the old master himself. Firstly on 'understanding' Greenspan, and the mystery of the quarter point strategy:

Socrates: So it would seem that you have proved that restricting yourself to quarter-point moves in monetary policy makes asset prices more, not less, volatile, and thus is more likely, not less likely, to generate situations in which the financial system creeps close to the point at which the safety and soundness of the financial system.

Glaucon: It would seem so, Socrates...

Socrates: "Seem"?!

Admetos: Only this, Socrates. We're monetary economics professors. Alan Greenspan may be the best central banker the world has ever seen. We are confident that we would have done a much worse job than he has done over the past decade and a half had either one of us been in his chair.

Glaucon: And so there is a good chance that he knows something that we do not: that our analysis of the situation is partial, incomplete, and flawed.

Socrates: What could that flaw be?

Glaucon: We have no idea.
Source: Semi Daily Journal

And a second one which touches on a topic dear to my heart: the herd instinct, and the operation of financial markets.

Glaucon: So you are telling me that when the central bank takes steps to alter the gross composition of the private sector's asset portfolio by five-ten-thousands of one percent--and to alter the net composition by much less, for these assets are very close substitutes--this shakes the entire intertemporal price system? That supply and demand elasticities are such that the future one year hence drops in price relative to the present by one-tenth of one percent? Doesn't that imply a cross-elasticity of demand for liquid spending power one year hence of 200? Even in the case when a $1 billion intervention is required, that's a cross-elasticity of 20. And when there is no intervention required, the cross-elasticity is infinite... Aren't these numbers a little... high?

Admetos: But if everyone expects today's open market operation to be followed by a whole sequence of operations in the same direction in the future...

Glaucon: But they don't, do they?

Admetos: But if everybody expects the Federal Reserve to do what it needs to do to make its policy effective...

Glaucon: They will front-run in advance to try to profit, and so change their own desired portfolios. But we no longer have a well-defined private-sector asset demand curve as a function of risk, return, and asset quantities, do we? Instead we have herd behavior coordinated by a single large actor in the marketplace, don't we?

Admetos: It would seem so...

Glaucon: Is this what we teach our students?

Admetos: No...
Source: Semi Daily Journal

And for those who wish to delve a little deeper into this labyrinthine topic, here's a paper that gives a bit of background:


Recent research has shown that institutional herding is a relevant phenomenon in stock markets. Do institutional investors also follow each other in bond markets? This paper focuses on the German bond market and uses data from 57 German mutual funds that invest mainly in DM-denominated bonds, which represents 71% of the total market volume. Due to the variety and large number of bonds that exist, we do not expect mutual funds to herd with regard to separate bonds. We believe instead that bonds with the same characteristics such as interest rate, maturity, collateral, or issuer are considered to be equivalent by institutional investors. Consequently, we construct "bond groups" consisting of similar bonds and analyze herding at a "bond group" level. Our results indicate that there is strong evidence of herding, albeit it is weaker than in stock markets. Further analysis suggests that mutual funds do not place an equal weight on different bond characteristics. Nominal interest rates appear to be most important in the bond selection process.
Source: Institutional Herding in Bond Markets Andreas Oehler and George Goeth-Chi Chao

No Plaza Accord This Time Round

Despite the fact that I find the conclusions far too optimistic, an interesting analysis of where we are in the currnecy game right now. The interesting problem is what will happen if the anticipated global expansion does not materialise as envisaged. The dollar is considered to be 20% overvalued, but the euro clearly can't take much more pounding.

Is Asia holding up global economic adjustment? With a current account deficit already more than 5 per cent of gross domestic product, rapidly increasing net external debt and a marked shift in deficit financing from stable long-term inflows to short-term "hot" money, the US economy is under unprecedented pressure. There are two ways out: either the dollar weakens, raising the competitiveness of domestically produced goods and services; or overall US demand must grow at a much slower pace than elsewhere - which in the current anaemic global economy would probably involve a protracted recession.

Most analysts conclude that a further drop of 15-20 per cent is needed to bring the US current account back to sustainable levels in the medium term. Asia, which accounts for nearly a third of US trade and has strongly undervalued currencies, should be a key part of that adjustment. However, while the euro, the pound and virtually every other non-Asian currency have strengthened against the dollar in the past 12 months, Asian central banks have been intervening to prevent currency appreciation, purchasing nearly $500bn in foreign exchange reserves since the beginning of 2001 and sterilising the resulting extra liquidity at home.

This is not sustainable. European economies are weak. There is a big risk that a stronger euro will overshoot, further weakening growth and spurring a destabilising backlash. Asia is facing pressure to adjust exchange rate polices. Japanese leaders have been leading the charge against China's de facto renminbi peg, and sluggish growth in the US has made policymakers take a hard look at China and Japan. Demand will surely grow for a new Plaza accord, aimed at convincing Asian countries to let currencies strengthen in a multilateral context.

Unfortunately, a new accord is unlikely to come about. Conditions are different from the mid-1980s Plaza accord era. First, US imbalances are no longer so visibly an Asian problem. In the first half of the 1980s the US trade deficit ballooned from 0.9-3.2 per cent of GDP, with a worsening bilateral balance with Asia accounting for more than two-thirds of that change. By contrast, in the past decade Asia accounted for 0.8 percentage points of the 3.5 per cent of GDP decline in the US trade balance. The main culprits were Europe, Canada and Mexico.

Second, the number of important Asian players has grown, making agreement more difficult to reach. Japan was the only Asian country that mattered in the 1985-87 adjustment process, accounting for more than 80 per cent of Asia's total current account surplus. Now that share has fallen to well under half. Despite its enormous surplus with the US, China's overall current surplus is only one-eighth of the total.

Third, economic conditions in Asia are much worse than in the mid-1980s. Between 1985-1987 the US, EU and Japan grew at an average annual rate of 5 per cent. Last year the major developed economies barely expanded at all, and growth may not exceed 1.5 per cent in the next two years. Asian exporters are still struggling to regain pre-2000 capacity utilisation levels while domestic investment has never been lower as a share of income.

Finally, the one country that could easily digest a stronger currency is unlikely to play ball. The Chinese economy is strong, with solid export growth, substantial net capital inflows and rapid bank credit expansion. However, Chinese policymakers are focused on the domestic agenda and are mistrustful of exchange rate volatility and a co-ordinated revaluation. They may hold to their long-term goal of a flexible exchange regime, but there will only be a small and gradual widening of renminbi trading bands - far too little to have any immediate impact on China's external balance.
Source: Jonathan Anderson, Financial Times

Thailand is not Singapore

In the mailbox, a short note from Eddie about Singapore and Thailand. Interesting argument, now could the differing population structures (as Eddie notes) tell us something about why there is this apparent difference?

You made a point about Asia’s weakness being the lack of domestic demand. It does seems to be the stumbling block of their development. An inability to emerge from their export-oriented, first stage development. Economic success is still very much judged by the ability to attract foreign investments and to export. But if everybody wants to export, who’s to import?

To some extent, the difference between Thailand and Spore is interesting. Thailand chose to support domestic demand. Spore did little (we raised the value added tax by 1%, Thailand cut theirs). The virtuous domestic circle always seems to start once there’s positive feedback with the property market. But I’m more than amazed by their results so far. GDP grew almost 7% in the first quarter. Manufacturing production AND exports are growing around 20% now.

Even before the Asia crisis, the talk was always that China posed a greater threat to mid-ladder economies like Thailand / Malaysia than top of the ladder Singapore. Thailand was the middle of nowhere economy. Yet here we are, not just Thai production, but Thai exports are outpacing Singapore. Nobody in S’pore, of course, remembers and think it of any significance.

We’ll see whether Thailand can manage to safely navigate their recovery through the stormy seas. Investors are catching on it as apparently the Thai stock market is the best performing so far this year. I’m betting Malaysia will do fairly well too. If nothing else, Malaysia has a median age of 25 or so. Spore has little going for it, except its past

Oh. I attended a seminar given by Spore’s team on the recently concluded FTA with the US. Negotiations took
3 years And for what? Tariff savings, on average, amount to 0.1% or so. That was of course wiped out in a day by the depreciation of the USD. But they are touting it as a future growth driver.

In Defence of Alan Greenspan

I'm a 'party liner' for no man (or woman), and certainly not for Alan Greenspan, but there are certain kinds of argument that I think are so worthless that I just can't stop myself from climbing onto the soap box. Take the article posted below for example. Now regular readers here will be aware that I am a critic of the whole monetarist approach to the deflation problem. This includes Ben Bernanke, and of course Sir Alan, but I think it's also important to have a little perspective here.

The important thing to realise is that these problems we are facing are new. (Tired old dogmatists who want to tell us that everything is an eternal re-run of the same beware!). And when you face new problems, there are no ready made pointers. Of course history can be a guide, but as things unfold history has a nasty habit of appearing in a new light, of being 're-interpreted'. History, of course, hasn't changed, but our angle of interest has.

Now poor Alan Greenspan has had the bad luck to face two new and important developments in rapid succession, one damn thing after the other as they say. First it was the 'new economy' of the ninetees, and make no mistake about it, there was something new. The tired old hacks never stopped repeating the mantra that 'it's all hype', and probably saw their argument confirmed when after the boom came the dot-com crash. But this would be an extremely superficial way of looking at things. Apart from the obvious impact of the internet, and the 'death of distance', the 90's also saw what is obviously the most extensive globalisation process in history, the awakening of what is bound to become the biggest economy in the history of the planet (China), and the growing tendency for 'increasing returns' dynamics to play a leading role in economic processes. (Small parenthesis: the internet is obviously the biggest 'big thing' ever, China is the biggest economy ever to have industrialised, this globalisation process is the biggest one to date. Now what does this tell us: that each time the tide rises one level higher - it's not saying anything special to say that this wave of technological, socio-economic and demographic changes is the biggest to date, it's just obvious, it would be wouldn't it, simply because it's the most recent. And if you don't believe me have a look at some of Kurzweil's exponential curves. The interesting question is whether or not this process can touch a limit - here it may be helpful to think of Per Bak and How Nature Works , or as Dylan would say: 'every grain of sand can change the mountain'. This has to do with emergence, self organising criticality, and topics for another day. But it is worth noting that both the pessimists and the optimists have one thing in common, they are forever telling us that the critical limit has just been reached!).

Going back to Greenspan, he at least recognised that something new was happening, and tried to 'ride the tiger'. That he rode and failed should not be taken as evidence for anything very special, except that it is another case of 'to err is human'. But this is uncomfortable for us since we like our central bankers to be gods, which they plainly can't be. Now if you examine most of the critics of the Greenspan of the ninetees (and here I have to include Krugman and Roach even though I respect them a lot) you will find that the root of much of the criticism is a strong dose of cynicism about 'new economy' type processes. This is fine, and coherent, but I don't accept the premise. Something new did happen, and we are still living with the consequences. You will find a lot less 'Greenspan bashing' from those who accept this point.

Now fast forward five years to the dot-com crash. What is the new problem increasingly on the agenda: deflation. And who is in the forefront of keeping the world aware of the ever-present danger. Why Alan Greenspan, of course. I repeat, I would differ with the remedy, but at least give the man credit for seeing the problem.

Now if we come to Duisenberg, I think the best policy is to say nothing. On neither of these topics has he had anything memorable to say. Sorry, I'll correct that: the only memorable comments are memorable for their crass stupidity. In addition he has a monumental and pathological communication problem. Two left feet as we say in the UK. So summing up: both men may be considered to have been challenged and found wanting. But one of them has been a man of his times, and has been there where the issues were, while the other.............

BTW on the substantive point of the 25bp cut. I think it was a difficult call. Maybe he did the best thing available and maybe he didn't. Only time will tell, it depends in part if the US recovery really is coming, in which case he needs to try to take some heat out of the housing market now to avoid problems later. Of course if, as I suspect, the recovery may be much weaker than the equity markets anticipate, then choking the bond markets may prove to have been an important error. But it's always easy to be right after the event.

In pulling the rug out from under global bond markets, Alan Greenspan, chairman of the Federal Reserve, has done Wim Duisenberg, his counterpart at the European Central Bank, a big favour. He has undermined the popular myth that it is Mr Duisenberg and the ECB that have problems communicating with markets - unlike the Fed, which is a paragon of virtue and effectiveness when it comes to getting its message across. But who could fairly criticise the ECB now that the Fed has misled investors so badly and caused financial carnage by cutting only a quarter of a percentage point off interest rates at its June meeting - after sending numerous signals to the markets that a half-point cut was in the offing? Who could argue that the ECB has the monopoly on poor communications, given the Fed's subsequent communiqué - a badly worded and confusing text apparently intended to clarify and explain the Fed's stance on the economy? This is not the first time Mr Greenspan's credibility has come into question. To his critics he is the "double bubble" man. First, Mr Greenspan egged on the stock market to bubble proportions with incessant happy talk about the alleged limitless capabilities of US productivity. That story did not have a happy ending, as we all know.

Some Europeans may take comfort from the Fed's troubles but this is not a situation in which bad news for the US is good news for Europe. The US economy must recover in order for Europe to do so, and the Fed's loss of credibility may well slow down the US recovery. Still, the frequent attacks on the ECB and Mr Duisenberg in both the markets and the media have often had as their implicit assumption the view that the Fed would do it better. This was always unfair. But now we know that it was untrue as well. Mr Greenspan is the "double bubble" man - not Mr Duisenberg. The Fed's fall from grace is valuable if only for putting the achievements - and shortcomings - of the ECB and Mr Duisenberg into proper perspective.
Source: Melvyn Krauss, Financial Times

How Nature Works

Monday, July 07, 2003

A Story of Arithmetic

Flashpoint on the way? This at least is Stephen Roach's latest warning. And the root of the problem, a US national savings rate fast approaching zero. The reason for this is in Roach's words the fact that: "most of America’s national saving now shows up in the form of depreciation -- funds that are earmarked for the replacement of worn-out physical assets". Now this way of putting things has a rather quaint air about it. It conveys an impression of a lot of worn down to breaking point machinery. If we say depreciated by the winds of creative destruction we might well be nearer the mark, especially since with the under-utilisation of productive capacity that has characterised US economic activity in the last couple of years it's hard to see too many things getting worn out in the classic physical sense. The rise in depreciation therefore may well be the result of an increasing obsolesence rate, a shorter turnround time on technology (which is probably more or less the same thing) and an increase in the scrapping of capital assetts associated with outsourcing to China (or Mexico, or wherever....). This is my hunch at any rate. And if I'm right, then this is also an indication of the difficulties associated with the attempt to hoard value for the future. Getting it right in major technological decisions is going to be more and more important, and it is important to bear in mind that this process is destructive of as well as productive of values. Playing the omniscient and omnipotent god seems to be getting more difficult by the day, and, as I indicated last week, it always was an impossible task.

There’s little concern about the mounting imbalances of a saving-short US economy. Nor are there any serious worries about the perils of a US-centric world. At least that’s the verdict that I take away from my recent discussions with investors, businesspeople, and policy makers around the world. That could be a dangerous oversight. The United States is rapidly approaching an ominous threshold -- a net national saving rate that is about to go negative. Could that be the flashpoint that sends a wake-up call to world financial markets?

This is a story of arithmetic. The accounting identity is often the most powerful of economic constraints. Such a framework is not subject to theoretical interpretations -- the identities simply have to add up, year in and year out. For any nation, saving must always equal investment. Unfortunately, America’s national saving rate is plunging into the danger zone. In the first quarter of 2003, gross national saving -- households, businesses, and government units, combined -- fell to 14.0% of gross national product; that’s down 1.5 percentage points from the year-earlier rate and fully 4.8 percentage points below the post-1960 norm of 18.8%. But that’s only the tip of the iceberg.

The problem is that most of America’s national saving now shows up in the form of depreciation -- funds that are earmarked for the replacement of worn-out physical assets. In the first quarter of 2003, such depreciation accounted for fully 94% of total saving. That means that the net national saving rate -- that portion of national saving that is available to fund the actual expansion of productive capacity -- fell to a record low of 0.7% of gross national product in the first period of this year. That’s off sharply from the year-earlier reading of 2.3% and is well short of the nearly 5% average of the 1990s and the 11% norm of the 1960s. There are few macro gauges that tell us more about an economy’s internally generated growth capacity. Sadly, America has all but depleted its reservoir of net saving -- the sustenance of longer-term economic growth.

This problem has profound implications for the US and the rest of the world. Lacking in domestically generated net saving, America has had to import surplus saving from abroad in order to grow its economy. In the parlance of the accounting framework noted above, the US saving-investment identity has been finessed by the willingness of the rest of the world to provide the funding. In order to attract that capital from abroad, America has had to run massive trade and current-account deficits. In the first quarter of 2003, the US current-account deficit hit a record 5.1% of GDP, or $545 billion (at an annual rate) -- an annualized shortfall that must be financed by capital inflows of slightly in excess of $2 billion per business day. Never before has the world had to finance an external imbalance of that magnitude.
Source: Morgan Stanley Global Economic Forum

What a Difference an Index Makes

Some months ago Brad asked me about how the HICP (the harmonised price index) was determined, and I answered something to the effect that: with difficulty. This difficulty precisely arises from the lack of harmony in methodology used in determining price values in the different countries. So we have something like an average derived from 6 apples, 5 pears, and 8 pinneapples: not as illuminating as it should be for the importance that has been placed on this number. But there is another dimension to HICP, and that is what is included and what is excluded in the index. This becomes important since the UK still uses its old RPIX, and this gives a different reading to the HICP when applied to the UK, not because of methodologies, but because of composition questions. The RPIX was running at 2.9% for the year to May (ie no big deflation scare) while the HICP came in at 1.2% (and with interest rates at 3.75%, ie deflation risk and tight monetary conditions). The principle difference here is in the inclusion of house price depreciation linked to housing prices and local taxes in the RPIX. Without housing the RPIX would be running at around 1.8%. As MS's Joachim Fels & Melanie Baker inform us:

The remaining gap of some 0.5 percentage point between HICP and RPIX inflation is explained mainly by the way in which raw prices for individual goods and services are aggregated at the micro level. The RPIX uses simple averages to combine prices, while the HICP uses a geometric average to combine the same prices, with the latter method producing lower inflation rates than the former. In its May Inflation Report, the Bank of England estimated that this had accounted for an average divergence of around 0.5 percentage point between the two inflation measures, mostly concentrated in clothing and footwear and household goods. Thus, once the differences in coverage (housing costs) and aggregation methods are taken into account, RPIX and HICP inflation rates are virtually the same.

Complicated isn't it? The issue is given added piquance by Gordon Brown's June 9th announcement of his intention to change the Bank of England's remit from targeting RPIX inflation to targeting HICP inflation in November. Apart from the detail that by November house prices may be falling in the UK, this does raise the question of what measure we have of deflation? On some measures the German economy may already be in deflation, but how do we really know. I would say here that the behavioural indicators may well be the best ones. Deflation is problematic since it induces certain patterns of behaviour and expectations in individuals and enterprises. When we can observe those patterns of activity, and identify the relevant expectations (look at Japan's 30 year interest rates for eg) then I think we can say that deflation has arrived. What preoccupies me is that it is precicesly this behavioural and expectational shift which may be occuring right now in Germany.

When it comes to assessing which countries are most likely to enter deflation territory, the UK is hardly ever mentioned. Rightly so, you may say. Consumer prices as measured by the RPIX increased by 2.9% in the year to May and the GDP deflator was up 2.7% on the year in 1Q. Polls such as the quarterly NOP survey on public attitudes to inflation conducted for the Bank of England (BoE) show that the public expects inflation to be around 2.5% in a year's time -- the highest expected rate since the survey started in 1999. Similarly, long-term inflation expectations in the bond market, as measured by the difference between nominal gilt yields and the real yield on index-linked gilts, are hovering around the same level. Annual house price inflation, while slowing, is still running at close to 20%, and the depreciation of sterling against the euro is mitigating the impact of global deflationary pressures on import prices. If push comes to shove, UK economic policy would still have ample room for manoeuvre to respond to deflationary shocks.

The story would have ended here if it weren't for that strange European creature called the HICP -- the Harmonized Index of Consumer Prices -- which is a measure of average prices produced by all EU countries according to a common methodology and used by the ECB to target price stability. On this gauge, UK consumer price inflation plunged to only 1.2%Y in May, the latest available month of data. Thus, current harmonised inflation in the UK is, and has been for a long time, well below the current euro-area-wide 2.0% inflation rate and is only marginally higher than Germany's harmonised 1.0% rate for June. So, if Germany is already in or at least close to deflation, as most pundits claim, the UK appears to be fairly close to the deflation danger zone too, according to the HICP gauge.

Source: Morgan Stanley Global Economic Forum

Productivity and Ageing

OK, one more little piece on age and efficiency, and I promise I'll give this a miss for a while. This time it's from the EU Paper on the economic and financial market consequences of ageing. The paper doesn't examine the problme of age and productivity in any detail, but what little there is seems intuitively obvious to me:

While the central scenario for the EU assumes no change in the contribution of TFP to growth over the simulation period compared with the historical pattern, nevertheless it is important to underline the possibility that productivity growth could be adversely affected. These productivity concerns reflect the significantly weaker investment performance described earlier; evidence from income-age profiles which suggests that the marginal productivity of workers tends to start to decline in their early to mid 50’s; and worries that enthusiasm for reform and overall levels of dynamism and innovation in an economy may be detrimentally affected by having an ageing labour force.

This view is corroborated on the basis of results from the London Business School’s “Global Entrepreneurship Monitor” which covers 29 countries around the world (2 ½ billion people in total) and suggests that older societies tend to be less entrepreneurial, with evidence that the majority of “entrepreneurially active adults” are aged between 25 and 44.

The 'Lucky' Generation

A snippet from my brother in the mailbox, and then a related piece from Polly Toynbee.

You may have read about the corporate retirement plans crisis with some pension funds being £200 billion in the red. Secondly the UK housing stock is worth £2560 billion only 23% of which is mortgaged. It is estimated that UK housing wealth will peak at £7 trillion in 2020 and that the value of the present UK residential hosing market has jumped by 78% since 1998. The Centre for Economic & Business Research also says that after another record year of mortgage equity withdrawal household residential property will have increased in value by £256 billion against an increase in borrowing secured against housing of around £86 billion. This year mortgage equity withdrawal will be worth 7.7% of consumer spending and even in 2005 we expect it to be worth 5.9%.

Now it doesn’t take much to work out that the government are going to try to cut some deal so that unmortgaged housing equity can be used to supplement retirement income. I am staggered that the amount mortgaged is so low as a % and I would be interested to know what the US and Pan-European situation is since this may affect your deflation/demography calculations. It will of course all end in tears!

A couple of points before we move on to Polly. Firtly my defaltion/dmography thesis is not based on calculations, it is based on observing phenomena (Japan, Hong Kong, Singapore, now Germany etc) looking for similarities and differences and trying to understand what is happening. ie this is not about futurism, and about how marvellous/unpleasant things will be 20 years from now (I don't engage in that kind of speculation. I have no idea, but since this is the first time for all of us I don't imagine anyone else really has either), but about what is, or is not, happening now. Secondly, it is important to realise that these are book values, as assessed at the height of a boom. What could be the real to market value of much of this property in none boom conditions and with a lot of property coming on line at the same time is an entirely different topic. It is interesting to note that the Japanese property boom was driven by trading involving approximately 10% of the stock, and that book values are now 40% down over the peak. Meanwhile the mortgages are real, and remain real even as the value of the underlying assett deflates.

Now for Polly Toynbee. I may prefer to say things in a different way (and obviously she is much more inclined to the new law than I am), but I very much agree with the sentiment: we have been the 'luckiest' generation in history. What a tragedy it would be if now, having had so much, we should become so selfish and inward looking as to forget that the generation to come may not be so lucky, and simply try to 'flexibilise' them in order to pay our pensions, or so un-generous as to be unable to salute and greet those newly arriving third world countries about to have their 'lucky generations'.

Here we go! The golden generation gets its greedy way again. I long ago predicted that when we, the great postwar boomers (vulgarly known as bulge babies for demographic not fattist reasons), reached retirement, we would refuse to give up what we've got. We would have anti-age discrimination laws so that no one could ever force us out of our jobs. So here we go! Or rather, here we stay forever.

Talking about my generation, of course we didn't die before we got old. We lived on and we had it all. There never was a more fortunate time to be born in the west than just after the second world war. Consider how doors opened for us: the national health was created in 1948 for us to be born into, the Butler education act made sure we had universal education. Comprehensives followed: I went to the sixth form of one of the first, full of hope and modernity.

The Robbins report opened up a swathe of gleaming new plate-glass universities for us, making Keele, York or Essex newly cool, while the Open University caught late-starters. With our new buying power, 1960s youth stamped our tastes on everything: when we were young, the whole world had to be young with us.

Growing up, we lived through the greatest upward mobility ever known within a generation. Born some 70% into manual working families, by the time we married and had children society had reshaped itself radically: now two-thirds of us are middle class, with home-owning as good a class indicator as any. The nation's wealth and average incomes have more than doubled since we left university.

Our pensions may have staggered badly in the crash, but after years of hefty tax breaks that form the unseen middle-class welfare state, most people will still retire better off than our parents ever dreamed. We are also the first generation where many will inherit significant sums from home-owning parents - a windfall in late middle age that is hardly taxed for most - money to secure our children's wealth or to blow on old-age boozing and cruising................

Size matters in generations. We, the outsize generation, always had the buying and the voting power to impose our will and tastes on all who come after: Brian Matthew's Sounds of the Sixties (SOTS to aficionados) will still be playing Radio 2's prime time Saturday morning slot when we are 90 (and Brian Matthew is about 110). When we need care, we will divert more public money to the best home care or care homes.

The weaker generations that come after us have not had it so good. They have had a more competitive exam-driven education: the more people who take exams, the greater the penalty for failure. In our time, when only one in seven went to university, many more could still make their own way upwards without qualifications: now exams are the only ladder up. The young work harder than we did, the colossal weight of ever higher mortgages falling harder on them.
Source: The Guardian