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Wednesday, July 30, 2003

Malthus, Demography and the Great Transition

Brad has been museing on Malthus, demography and economic growth, and has stirred up a bit of controversy in the process:

Begin with the shape of the demographic transition since 1820, with population growth rates plotted as a function of levels of guestimates of levels of real GDP per capita (measured in Maddison's 1990 "International Dollars") for the world's various regions for six irregular (but sensible) subperiods. The figure shows how population growth rises rapidly as societies progress and grow their annual per-capita incomes from a Malthusian near-subsistence level of $400 (1990 International Dollars) per person per year up to $1,100 or so. Then population growth levels off--typically at 1.75% per year or so--as fertility restriction becomes widespread. Once societies pass $4,000 per capita a year or so, the demographic transition proper sets in, and population growth rates start to decline markedly.
Source: Semi Daily Journal

This interpretation is backed up with a very nice looking scatterplot, which makes the correlation look almost undeniable. In broad sweep Brad is obviously right here, there is an obvious association between societies with annual incomes in the range $400 -$600 pre 1800 and low population growth. There is then an undeniable 'take off' post 1800 as improvements in diet, medical care, public health etc gradually reduce infant mortality, and population starts to rise. What is not so clear is what is cause and what is effect here. This is a topic that has been argued over for years, and will doubtless continue to be argued over. One thing is, however, clear, what Malthus calls the 'preventive check' was far more widespread (and socially configured) than many contemporary economists seem to accept. Part of the problem, is I feel, a methodological one. Most contemporary economists start from the individual, and the individual decision making process and work outwards. Even in our highly individualistic modern societies this procedure is questionable, but in more traditional, and family or clan-structured societies, it seems highly illegitimate. In some sense you have to start from the social, and what reproduction there is a socially regulated reproduction. Hence the importance of ecological-system arguments. It is this that leads Brad into his most controversial and contested argument:

What held back population growth? What keeps the numbers of the human race from growing at more than 0.2% even under the most favorable pre-industrial conditions? The conclusion seems inescapable: desperate poverty. For the overwhelming bulk of recorded history, population growth rates have been kept low by poverty so dire that women's fat reserves are so low that ovulation is a hit-or-miss affair, and by poverty so dire that nutritional deficits are so great as to seriously compromise immune systems' abilities to deal with the endemic disease pool.

Here I feel I cannot do better than 'recover' a couple of the posters from the comments section:

Brad's conclusion that « desperate poverty » and chronic malnutrition held back the growth rate of the human population up to say 1800 CE becomes doubtful if you try to extend it beyond the dawn of agriculture (≈ 10 000 BP). Demographic growth rates in the long hunter-gatherer era must have varied quite a lot, first constrained by competition in Africa and expanding rapidly when skilled hunters moved in on unexploited Eurasian and American fauna, but overall they must have been modest. Still, the modern and archaeological evidence is that hunter-gatherers are pretty healthy. Their population is too low to support endemic infectious disease, and is controlled by other factors than chronic, Malthusian malnutrition: predation, accidents, intraspecies violence, infanticide, catastrophes and late weaning. I’m not sure about parasites.

Recently discovered bones of very early African humans show big frames; they had to be strong because the diet included hippos. Imagine hunting hippos with stone-tipped weapons, poor-quality ropes and nets, and shallow pit traps. If the humans won there was plenty of food to share; but many must have died trying.

I like the baby-food theory: hunter-gatherer mothers must breast-feed infants and wean them late on to a chewy mixed diet, farmer mothers can substitute some gruelly pap early and get pregnant again. The population booms, the farmers drive out the hunter-gatherers by force of numbers; but are now locked into a Malthusian trap, where their health deteriorates by loss of diversity in diet and greater susceptibility to diseases. (In fairness I should state that I tried this theory on the eminent food historian Felipe Fernandez-Armesto, who says it doesn't fit the known facts about adoption of farming.)

The Malthusian constraint is a good theory for the Era of Agriculture. It doesn't fit either the preceding Hunter-Gatherer Era or the Knowledge Era we live in.
James Wimberly

Brad DeLong writes, "[...] population growth rates have been kept low by poverty so dire that women's fat reserves are so low that ovulation is a hit-or-miss affair"

Elliot Oti responded, "Sounds unlikely to me. The increase in global population, at least in the last 200 years, has almost invariably been due to declining death rates (especially in infant and child mortality), rather than increasing birth rates."

Yes, exactly. The reason human population swelled in the 20th century was that people stopped dying like flies, not that they started breeding like rabbits. It was reductions in infant and child mortality that caused the 20th century "population explosion," not increases in birth rates.

Dr. DeLong's theory simply isn't supported by facts. Women had MORE children--more ovulations resulting in pregnancies--prior to 1820 than they have today...at least in the U.S. and other developed countries. It's just that an unbelievably high percentage of the children that were conceived prior to the 1820s never made it to the age that they could reproduce.

For example, I think it was Oliver Wendell Holmes who observed that, as of the start of the 20th century, a doctor's care was as likely to harm as it was to help. And even as late as the U.S. Civil War, sanitary practices in miliary hospitals were shockingly poor. Only 1 in 4 (!) Civil War patients could be expected to live after receiving treatment in military hospitals.

These answers (ie Brad's conclusions, Edward) are NOT even supported by the preponderance of available data, let alone an "inescapable conclusion." Dr. DeLong's "inescapable conclusions" are contradicted by:

1) Population growth was not caused by having more babies, but by having more children who children who subsequently reached reproductive age (as could be determined from birth records from the early 19th century, versus birth records for the middle 20th century), and

2) Population growth was caused by knowledge of the causes of death and disease (e.g. knowledge of microbiological foundations of improper sanitation, and communicable diseases like malaria). This knowledge became available to even the poorest people in the 20th century. For example, the populations of India and China exploded in the middle of the 20th century. But the per-capita wealth of those two countries in that period probably wasn't substantially greater than the per-capita wealth of the colonists and early 18th century U.S. citizens. What was available in India and China, that was not available to the colonists, was knowledge of the causes and preventative measures for diseases (both diseases caused by improper sanitation, and diseases like malaria, diptheria, and whooping cough).
Mark Bahner

Japan: Trouble at Corporate Mill?

From time to time, some indications trickle through that all may not be as well as the optimists think it is in corporate Japan. Today we have another example from Toshiba:

Toshiba alarmed investors and watched its share price plunge on Wednesday after the company revealed a quarterly loss almost double that of last year.

Many observers had expected the net loss at Japan's biggest chipmaker to shrink in the April to June period, but instead it grew to Y36.9bn ($309m) from Y18.8bn - a rise blamed on poor consumer demand for televisions and PCs.

In response Toshiba shares plunged 8.4 per cent, compared with a 2.8 per cent fall in the electronic machinery sub-index.

Toshiba's results announcement followed news from Fujitsu on Tuesday that it would increase its loss forecast for the half-year, and helped sour the mood surrounding results season in Japan. Operating losses at Toshiba grew to Y41.3bn from Y26.3bn last year, while revenues fell 6.2 per cent to Y1,120bn. Losses per share were Y11.45. The company maintained its full-year forecasts of a Y40bn net profit and Y170bn operating profit, but some analysts said it may struggle to meet them following the dismal start to the year. Toshiba's digital products division put in a particularly poor performance, as orders for computer systems remained weak and PC prices continued to fall. Sales of household electronics, notably televisions, were also lacklustre. Profit at its chip division, however, increased thanks to revenues lifted by demand for camera-enabled mobile phones and digital cameras.
Source: Financial Times

Institutional Impacts

Brad has another little gem buried away in his recent posts. It refers to 'institutionalism' of the Doug North variety:

Property rights. Doug North has made a career out of talking about how parliamentary government and independent courts established secure property rights in Britain, and arbitrary royal government and dependent intendents created insecure property rights in France, hence the English economy boomed while the French economy stagnated in the century and a half before the coming of the Industrial Revolution.

I've always had two worries about this line of argument. First, if Britain is the most successful late-early modern social formation in the world, France ranks no lower than number three. Britain, Holland, France--and behind them come all the rest, every single other nation and principality and empire in the world. To treat late-early modern Britain and France as if they are at opposite poles of success and failure may make sense if you are an eighteenth or nineteenth century British or French historian or politician. It makes no sense for anybody else. The number two superpower in any era is doing something very right.
Source: Semi Daily Journal

Brad is clearly right. The institutional argument cannot do so much of the heavy lifting. This point has relevance for economic policy in the contemporary environment. That's why I lean towards demography, technology transfer and learning by doing (which also implies cultural openness to learning).

Still Feeling Confident?

The latest set of confidence reading in the US should be read with caution. They neither confirm not discount anything. In my book they are still consistent with either reading - one step forward two steps back, or one step backwards two steps forward - of the direction of the recovery:

U.S. consumer confidence took a surprise spill in July as worries over rising unemployment took a heavy toll, the Conference Board reported on Tuesday. The result provided a muted counterpoint to cheerleading from government officials. Treasury Secretary John Snow on Tuesday took time off from a bus tour of the Midwest to tell television network CNBC the economy was "spring-loaded to go."

Not all Americans, it seems, are convinced. The private research group's monthly consumer confidence index slid to 76.6 in July from 83.5 in June. That was the lowest reading since March, when the invasion of Iraq was in full swing, and completely confounded analysts, who had looked for an improvement to 85.0.

The index that measures jobs hard-to-get rose to 33.1 percent from 31.9 percent in June, its highest level since 1994. That mirrored a jump in the national unemployment rate to 6.4 percent in June, also a nine-year peak. Job figures for July are due on Friday, and this poor survey could dent hopes that payrolls will show the first rise in five months. The labor market has stayed stubbornly depressed, even though other recent indicators have shown some signs of life are stirring in the economy.
Source: Yahoo News

The biggest worry still has to be the lack of employment growth, and the impact of this on the output gap as indicated by Bernanke in a piece I posted earlier in the week. Maybe this is a timely moment to go back to a piece's on Brad's Blog that I failed to comment on (probably due to my local obsession with the problems of Bulgaria). The issue in question, the (in the eyes of some) belated decision of the NBER business cycle dating committee to call an end to the recession. If you look through the comments you will find that the majority of the posters are only crying either 'foul' (for political manipulation), or 'stupid' (for being a bunch of tiresome professors). Neither of these perspectives cut any ice with me. I think I understand something about economic processes, and I don't consider these decisions easy. What most people seem to have missed in the more heat than light exchange, is the rather subtle point that Brad draws attention to, that in order to call and end to the recession (which might in fact seem a reasonable thing to do) they had to modify, or at least change the weighting of, their crtieria:

The NBER's Business Cycle Dating Committee has decided that the last business-cycle trough took place in November of 2001. More interesting, they seem to have dropped employment from their list of principal monthly indicators. Their report puts income first, industrial production and sales second, and refers to Macroeconomic Associates's estimates of monthly GDP..

IIRC, it used to be that employment, incomes, sales, and industrial production were more-or-less all given equal weight. It also used to be that those four series tended to have peaks and troughs that were very tightly clustered together. It is because incomes, sales, and GDP are out-of-step with industrial production and very out-of-step with employment that has led to hesitation on the part of the Business Cycle Dating Committee--hesitation that is now resolved.
Source: Semi Daily Journal

Now maybe the hesitation has now been resolved (either for better or for worse, history will be the judge) but the problem that gave rise to it hasn't. Industrial production and employment growth are tracking well below income, sales and GDP. Now this must have some significance, and part, at least, of this significance is to be found in what Roach calls the twin deficit - federal budget, and external trade. With industry busy restructuring and outsourcing to China and other locations, and services also doing what outsourcing they can, the US economy seems to be accumulating an important structural imbalance. The decline of manufacturing industry and some re-locatable services would not be a problem were the decline of these activities to be compensated by the rise of other activities which could pay for this transition. But this is just where the problem arises, what are the new activities in 'tradeables' that can pay for the transition?

Tuesday, July 29, 2003

Where Have All the Flowers Gone?

There was a time when we used to ask ourselves this question, today it is perhaps imagination we find more lacking. Firstly, many thanks to Francisco for pointing me this link to Tim O'Reilly, commenting on the latest RIAA push against file sharers. O'Reilly makes five good points. Firstly, the main effect of copyright protection is to keep things in obscurity (it is often suggested patents may be used in this way, as a form of protective defence). Secondly, so called 'piracy' functions as what O'Reilly terms progressive taxation: some famous artists lose a little (although as he stresses, even this point is not proven) whilst many, many more come to get known. Thirdly, he argues that customers want to do the right thing if they can. He backs this point up by asserting that books published by O'Reilly which are also to be found online do not lose sales. This latter point is perhaps more debateable, since perhaps people buy because they have not yet got into the habit of working 100% online. Certainly, speaking anecdotally, I have noticed that people tend to progress, initially printing material out, and then becoming more happy to work from the screen. No, I think the big factor is time and earnings. The file sharers are largely adolescents and students. People who have lots of time and little money, then when they have more money and less time they may buy. Fourthly he says, online sharing doesn't threaten book publishing, only the incumbents. And fifthly, the lower quality free service, is normally followed by a better 'paid' version (like Blogger Professional Hmm, Hmm).

I initially used to print a lot of material to read in the metro, or while having coffee, or...... Little by little, I stopped doing this. Now I read all digital material from the screen, and find I have more time for reading books (from, of course, Amazon) in the metro, having coffee,......

Also my experience of music and file sharing confirms one of O'Reilly's points. I have been buying more CD's since I started sharing. One of the most useful activities is browsing the collections of another sharer. This is were you can discover music and sample it. It is a role radio also plays, but, as is often pointed out, we hear a lot fewer complaints about 'free music' on radio. Indeed, when I was a teenager, the so-called 'pirates' had ships of-shore from the UK playing 24 hour pop music, the record indusrty has not only learned to live with this 'piracy', it has now grown rich from it. When, as the song goes, will they ever learn?

More than 100,000 books are published each year, with several million books in print, yet fewer than 10,000 of those new books have any significant sales, and only a hundred thousand or so of all the books in print are carried in even the largest stores. Most books have a few months on the shelves of the major chains, and then wait in the darkness of warehouses from which they will move only to the recycling bin. Authors think that getting a publisher will be the realization of their dreams, but for so many, it's just the start of a long disappointment.............

For all of these creative artists, most laboring in obscurity, being well-enough known to be pirated would be a crowning achievement. Piracy is a kind of progressive taxation, which may shave a few percentage points off the sales of well-known artists (and I say "may" because even that point is not proven), in exchange for massive benefits to the far greater number for whom exposure may lead to increased revenues...........

I have watched my 19 year-old daughter and her friends sample countless bands on Napster and Kazaa and, enthusiastic for their music, go out to purchase CDs. My daughter now owns more CDs than I have collected in a lifetime of less exploratory listening. What's more, she has introduced me to her favorite music, and I too have bought CDs as a result. And no, she isn't downloading Britney Spears, but forgotten bands from the 60s, 70s, 80s, and 90s, as well as their musical forebears in other genres. This is music that is difficult to find -- except online -- but, once found, leads to a focused search for CDs, records, and other artifacts. eBay is doing a nice business with much of this material, even if the RIAA fails to see the opportunity.
Source: Open P2P

Downward Mobility, a New Craze Sweeping the Planet?

Are you downwardly mobile yet? Well, if you aren't don't worry, your turn will come, you just aren't old enough yet. What am I on about? Well just read Eddies latest piece from Singapore:

Downwardly mobile: a new job reality

ABOUT a decade ago, a study by the National Research Council in Washington concluded that the time it takes to lose half a worker's skills due to changes in technology and knowledge had declined from between seven and 14 years to between three and five years. This loss of a worker's competence, of course, differs from occupation to occupation. It is, for example, particularly true for engineering. An engineering friend of mine told me that within the first five years of work, half of what he learned at university had became obsolete. And now, he cannot remember much of what was taught because he does not use it any more.

Unlearning information that is no longer relevant has become a real challenge. It brings to mind what Albert Einstein once said: 'Imagination is more important than education.'
The dot.com stock-market bubble may have burst three years ago, but technology's progress is relentless. Technological change is not just growing, it is growing at an accelerated pace. The rate of progress is doubling every decade. And it leaves us with a thorny question: If the worth of a worker's acquired skills is diminished within five years, what value would you place on experience? Perhaps the question is better put this way: Would you place more value on the ability of a worker to adapt, or on his years of experience? This is turning Asian values upside down. Confucian beliefs place a premium on seniority, and that forms the basis of wage structures in many East Asian countries. But in a market economy, seniority is becoming hard to justify. Even as Singapore debates the need to change its wage structure, the marketplace is already making the changes.

The gap between the minimum and maximum wage for a job has been reduced to 1.7 times, on average, over the years. It used to be as high as three times. The Government's recommendation of 1.5 times for most rank-and-file jobs is mere tinkering compared to what has already occurred. And lest we believe this is an event unique to our shores, look at what is happening in Japan, that supposedly most rigid of labour markets. In a paper two years ago, titled 'Changing Seniority-based Wages', the Ministry of Health, Labour and Welfare (MHLW) in Japan noted that about a sixth of leading Japanese companies had already revised their wage systems by expanding the portion that was determined by 'performance, ability to execute duties and by content of work'. Another fifth of companies planned to do so over the next three years.

The attitudes of workers were shifting too. More than 85 per cent of respondents in a survey commissioned by the MHLW believed that the revision of the wage system was 'unavoidable', and that in fact, 'basic revision is necessary'. JTB Corp, a leading travel agent in Japan, has introduced a new wage system which essentially stipulates that an employee's basic wage peaks when he is 35 years old. JTB launched the new system for its employees back in April 2001. Household names such as Hitachi, NEC and Fujitsu are introducing performance-based systems. Mr Hiroshi Okuda, chairman of the influential business organisation Nippon Keidanren, which groups Japan's largest companies, told The Straits Times four months ago that, from an economic standpoint, 'it is odd that wages should rise automatically'.

Yet, one can equally understand the worker's point of view. As Mr Allan Wee, 59, noted in an interview with The Straits Times last month: 'A worker who stays with a company for 20 years should count, as compared to someone else who works just two years and is always thinking about job hopping.' But there is little that can be done to compel an employer to pay older workers more if he does not choose to. The company always has the choice to pack up and go elsewhere.

This is not to deny that adaptability is necessarily harder for the older worker. There will be those more able to adjust, but for most, age, as the saying goes, catches up. The AFP wire agency carried a story recently on the diverging fortunes within the Doi family in Japan. Mr Kojiro Doi, aged 24 and with a master's degree in social psychology, had just accepted a job at one of the top management consulting firms. His starting salary: six million yen (S$88,000) a year. His 58-year-old father, Mr Kuniyoshi Doi, on the other hand, took early retirement two years ago from consumer electronics giant Matsushita. He is now employed at a Matsushita subsidiary. His pay? three million yen a year, or half of what his son is bringing home.

Ultimately, many workers will have to accept second 'downwardly mobile' careers, with lower salaries, and perhaps, worse working conditions. And it does not just stop there. As more companies restructure their wage systems, there will be a gradual impact on the economy as a whole. The consequences for the economy may have a deeper undertow that has less to do with simply misaligned wage structures than what an ageing population, faced with these wrenching wage changes, means for household expenditure.

While a company can restructure its wage system to lift the bottom line, a country finds that its workers are also its consumers, and consequently there is less demand for the goods produced. The goods may, of course, be exported. But there is no reason to expect an increase in overall spending worldwide since older workers facing reduced salaries and early retirement are a global phenomenon. What is exported comes at the expense of reducing jobs elsewhere, because consumers will only buy foreign goods by reducing their consumption of local goods. In 1992, a worker in the United Kingdom's shrinking motor-car industry was interviewed on BBC Television's 'Nine O'clock News' and the reason he gave for the industry's predicament was 'when no one's buying cars, there's no point in making them'. When you view wage restructuring from a global perspective, that just about sums up why the Singapore economy is finding it so hard to pick itself up this time round.
Source: Eddie Lee: Straits Times

Your Future in Futures

Another link from Joerg, this is rational expectations sent to the nth and ultimate degree. As they used to say 'whom the gods would destroy they first make mad'.

Pentagon Plans Futures Market for Events in Mideast

The U.S. military plans a worldwide on-line futures market to help it predict events in the Middle East. Traders could bet on the likelihood of events ranging from the overthrow of a government to the collapse of an economy or the assassination of Palestinian leader Yasser Arafat. Traders can register starting August 1; on-line trading would begin a month later, according to the program's Web site. Two Democratic U.S. senators say the market is a terrible idea and must be stopped. "Clearly, this is morally wrong,'' Oregon Senator Ron Wyden said. Senator Byron Dorgan of North Dakota called it ``the most Byzantine thing I have ever seen proposed by a federal agency.'' The Pentagon requested $3 million for the project in its fiscal 2004 budget. The Senate said no; the House said yes. The budget is now before a conference committee of both chambers. If the Pentagon doesn't shut it down, ``we have to find a way in conference,'' Dorgan said. ``This is a hare-brained scheme.'' The Policy Analysis Market is part of a Pentagon effort to anticipate terrorist attacks. The Total Information Awareness Program was restructured this year after Wyden persuaded Congress to cut its funding over concerns over privacy issues. The market is to be managed by the Pentagon's Defense Advanced Research Projects Agency, or DARPA. DARPA spokesman John Jennings wasn't immediately available for comment. The senators said their information came from the market's Web site. The site doesn't make clear the extent to which traders, geopolitical analysts or ordinary citizens actually ``bet,'' the mechanics of payment if any, and how the Pentagon plans to use the information.

"How would you feel if you were the king of Jordan and learned that the U.S. Department of Defense was creating a futures market in whether you're going to be overthrown,'' said Dorgan, a member of the Senate Appropriations Committee. The Web site for the Policy Analysis Market cites ``Overthrow of Jordanian Monarchy'' as an example of the sort of event traders might speculate on. Others include Arafat's assassination and the likelihood of a North Korea missile attack on the U.S. "PAM will focus on the economic, civil, and military futures of Egypt, Jordan, Iran, Iraq, Israel, Saudi Arabia, Syria, and Turkey and the impact of U.S. involvement with each,'' according to the ``Concept Overview'' on its Web site. "The issues represented by PAM contracts may be interrelated'' and traders can ``structure combinations of futures contracts,'' it says. The market ``will be active and accessible 24/7 and should prove as engaging as it is informative.''

The actual wagering will be conducted through a FutureMap program that provides the Defense Department ``with market-based techniques for avoiding surprise and predicting future events,'' DARPA said in a May 20 report to Congress. The intent is to ``answer predictive questions such as `Will terrorists attack Israel with bio-weapons in the next year?''' DARPA said. ``To answer this question, FutureMap would aggregate information from a variety of experts.'' The trick is to combine the disparate answers into a model useful for policy analysts, and that's where the "market'' approach comes in, DARPA said. The new approach is to set up, as it were, a `market' in two kinds of futures contracts -- one pays $1 if an attack takes place; the other pays $1 if there is no attack,'' DARPA said. "Prices and spreads signal probabilities and confidence,'' it said. ``Since markets provide incentives for good judgment and self-selection, the market will effectively aggregate information among knowledgeable participants,'' DARPA said. "This approach has proven successful in predictions concerning elections, monetary policy decisions and movie box office receipts -- DARPA is investigating its success in defense- related areas,'' it said. Dorgan didn't see it that way. ``Futures markets almost always relate to a commodity in this country,'' he said. ``There's not a commodity here. It's wagering.'' Wyden, a member of the Senate Intelligence Committee, was scornful of the project. "They have this notion about the predictive capabilities of intelligence,'' he said. "We think it's absurd; we think when you look at what happened in 9/11. You ought to go on the basis of real evidence from the real world. They have these ideas about markets and predictive capabilities which are more of fantasy land.''
Source: Bloomberg

An Unwelcome Fall in Inflation

Some extracts from, and a link to, the recent Ben Bernanke speech which has caused all the fuss. The implicit output gap argument seems sound enough to me, I also think he's right to trace the current disinflationary pressures backwards and look again at the productivity/inflation situation during the 'new economy' boom. What this effectively means is that the process of capacity expansion outstripping aggregate demand effectively started earlier. Now why was this? The conventional argument is the internet-driven bubble. But this only takes things back one more step: why was there so much liquidity swimming around?

What I don't see - in what I am now coming to call the 'Treasury view' (whether in its monetary or structural variants) - is any analysis or explanation of why we might be having this continuing weakness in aggregate demand. This, as I see it is the soft spot, or weak point in the argument.

Following Lindh and Malmberg I do have a rough back-of-the-envelope model that can handle this, based around demography, cohorts, and either (take your pick) the life cycle, or the permanent income hypothesis. Is there something I am missing?

This distinction between inflation that is positive yet too low and deflation is worth exploring for a moment. Although the Federal Reserve does not have an explicit numerical target range for measured inflation, FOMC behavior and rhetoric have suggested to many observers that the Committee does have an implicit preferred range for inflation. Most relevant here, the bottom of that preferred range clearly seems to be a value greater than zero measured inflation, at least 1 percent per year or so. Both the apparent tendency of measured inflation to overstate the true rate of price increase, as suggested by a range of studies, and the need to provide some buffer against accidental deflation serve as rationales for aiming for positive (as opposed to zero) measured inflation, both in the short run and in the long run. To the extent that one accepts the view that measured inflation should be kept some distance above zero, a very low positive measured rate of inflation (say, 1/2 percent to 1 percent per year) is undesirable and implies a need for highly accommodative monetary policy, just as would be required for outright deflation. The language of the May 6 statement encompasses the risks of both very low inflation and deflation. I suspect that for the foreseeable future, of the two, the risk of very low but positive inflation is considerably the greater. That is, inflation in the range of 1/2 percent per year in the United States in the next couple of years, though relatively unlikely, is considerably more likely than deflation of 1/2 percent per year............

A second set of circumstances in which deflation or very low inflation may pose significant problems is potentially more relevant to the current U.S. economy. That situation is one in which aggregate demand is insufficient to sustain strong growth, even when the short-term real interest rate is zero or negative. Deflation (or very low inflation) poses a potential problem when aggregate demand is insufficient because deflation places a lower limit on the real short-term interest rate that can be engineered by monetary policymakers. This limit is a consequence of the well-known zero-lower-bound constraint on nominal interest rates. For example, if prices are falling at a rate of 1 percent per year, the short-term real interest rate cannot be reduced below 1 percent, since doing so would require setting the nominal interest rate below zero, which is impossible. (Likewise, the very low inflation rate of 1/2 percent would prevent setting the real interest rate lower than minus 1/2 percent.) Thus, in a situation of insufficient aggregate demand, deflation or very low inflation might prevent the Fed from achieving full employment, at least by means of the Fed's traditional policy tool of changing the short-term nominal interest rate.........

the factor most likely to exert downward pressure on the future course of inflation in the United States is the degree of economic slack that is currently prevailing and will likely continue for some time yet. Although (according to the National Bureau of Economic Research) the U.S. economy is technically in a recovery, job losses have remained significant this year, and capacity utilization in the industrial sector (the only sector for which estimates are available) is still low, suggesting that resource utilization for the economy as a whole is well below normal. By conventional analyses, therefore, even if the pace of real activity picks up considerably this year and next, persistent slack might result in continuing disinflation.5

A highly simplified, though not quantitatively unreasonable, calculation may help. Let us suppose that economic activity does pick up in the second half of this year, by enough to bring real GDP growth in line with its long-run potential growth rate--roughly 3 percent or so, by conventional estimates. Moreover, suppose that activity strengthens further next year so, so that real GDP growth climbs to approximately 4 percent, a full percentage point above potential. What will happen to resource utilization and inflation?

Focusing first on the implications for economic slack, we note that this projected path for real GDP gap would imply no change in the output gap through the end of this year, followed by a percentage point reduction in the output gap during 2004. Given the average historical relationship between the change in the output gap and labor market conditions, known as Okun's Law, the unemployment rate would be expected to remain at about its current level of 6.4 percent through the end of the year and then decline gradually to about 6.0 percent by the end of next year. This projection is fairly close to many private-sector forecasts.

Let us turn now to the implications for inflation. From 1994 to 2002, core PCE inflation remained in a stable range while the unemployment rate averaged about 5 percent; so let us suppose, for purposes of this example, that the unemployment rate at which inflation is stable is 5 percent. (If the unemployment rate at which inflation is stable is lower than 5 percent, the disinflation problem I am discussing becomes larger.) A little arithmetic shows that this scenario involves 1.9 point-years of extra unemployment (relative to the full-employment benchmark) between now and the end of 2004. Now make the additional assumption that the sacrifice ratio (the point-years of unemployment required to reduce inflation by 1 point) is 4.0, a high value by historical standards but one in the range of many current estimates. Then the additional disinflation between now and the end of next year should be about 1.9 divided by 4, or about 0.5 percentage points. So given our assumptions about GDP growth, core PCE inflation, say, might fall from 1.2 percent currently to 0.7 percent or so by the end of 2004.

The precise figures I have used in this exercise should be taken with more than a few grains of salt. But the bottom line (which would not be much affected if we played around with the numbers) is that, even if the economy recovers smartly for the rest of this year and next, the ongoing slack in the economy may still lead to continuing disinflation. So the FOMC's May 6 statement, by indicating both balanced risks to economic growth (that is, a reasonable chance of a good recovery) and a downward risk to inflation, had no internal inconsistency.

Now, further disinflation of half a percentage point in conjunction with a significant strengthening of the real economy would not pose a significant problem. But of course, the simple scenario I just outlined has risks. If the recovery is significantly weaker than we hope, for example, the greater level and persistence of economic slack could intensify disinflationary pressures at an inopportune time. Another possibility, given the uncertainty inherent in measures of potential output, is that the amount of effective slack currently in the economy is greater than most analysts think--which, if true, would help to explain the recent pace of disinflation.

There are good reasons not to discount this possibility. For example, during the late 1990s, economists worked hard to explain the combination of an unusually low unemployment rate and stable inflation--possible evidence of a decline in the economy's sustainable unemployment rate. Factors that were thought to have contributed to a lower sustainable rate of unemployment included the maturation of the labor force (Shimer, 1998); increased numbers of people on disability insurance (Autor and Duggan, 2002) and increased rates of incarceration (Katz and Krueger, 1999), both of which tended to remove less employable individuals from the labor force; improved matching between workers and jobs, facilitated by increased access to the Internet and the rise of temporary help agencies (Katz and Krueger, 1999); and perhaps other factors as well. Many of these forces continue to operate in today's economy, conceivably with greater force than in the late 1990s.6 In addition, measured labor productivity has continued to increase rapidly since early 2001--remarkably so, considering that productivity tends to be strongly procyclical--raising the possibility that we have underestimated the degree to which innovation and better use of existing resources have increased potential output. If so, the true level of slack in the economy is higher than conventional estimates suggest, implying that incipient disinflationary pressures may be more intense............

One more element of the model for inflation is important to mention: the error term. At the upcoming August meeting, the Board staff, as it always does, will present the FOMC with its forecasts for inflation. Based on historical experience (using actual staff forecasts for 1985-97), the staff's forecast for CPI inflation for the full year 2003 (that is, the current year) will prove fairly accurate; the confidence interval for that forecast, as measured by the root mean squared error, will be only 0.3 percentage points. However, if history is a guide, the forecast the staff provides next month for CPI inflation during 2004 will have a confidence interval of about 1.0 percentage points, a fairly wide range. This amount of uncertainty is no reason to be defeatist about trying to forecast inflation but it is a reason to be cautious. We are currently in a range where undershooting our inflation objective by 1 percentage point is more costly than overshooting by 1 percentage point. All else being equal, that fact should put us on our guard against unwanted further declines in inflation.
Source: Ben Bernanke Speech to the UCSD Economics Round Table

Feedback From Germany

Joerg From Germany with some feedback on my German post yesterday. I don't think he's quite right to be so cynical, I thinks it's worse, I think they actually believe it. Anyway, it's a promise, if the 'treasury view' turns out to be right, and we have a significant German growth spurt next year (note the careful choice of words) it's online photos of me in sackcloth, and if I'm wrong enough, the ashes too!!

I would love to get a picture of you in sack cloth.

However, let´s wait and see. If the Bartsch/Sinn/Economist expectations for Germany do materialise, this would, of course, be welcome. But it shouldn´t give anyone the idea that some substantial change took place and led to an alteration of the course of events, a shifting of paths or the like. The health care reform certainly doesn´t qualify as a major restructuring. If growth returns, we will have to attribute that to the economic cycle. The politicians themselves seem to be convinced that
they didn´t achieve anything much - so it may be Bartsch and Sinn were just tired of singing the same old tune.

Hit Me With Your Rhythm Stick

Really I haven't got much to say, except to ask: isn't there a better way of resolving all this than this one? Resorting to the strong arm of the law in this way is a sign of weakness, not of strength, businesses normaly work because they have a product people want to buy, not because they are afraid. There must be some better business model available to the RIAA. In fact my biggest preoccupation when George W came to office was not what we can actually see happening now in Iraq (of course maybe I was wrong) but that a group of people with no idea at all about the dynamics of the 'new economy sector' (read Nasdaq) were going to be incapable of coming up with the kind of imaginative policy and institutional framework to enable the US tech sector to benefit from it's inbuilt advantage. What we are seeing now, with the consolidation of incumbent interests across the board, confirms my worst fears. The real point is that this will make the US economy weaker, not stronger, long term. The digital economy is here, and building ring-fences won't work forever.

blizzard of subpoenas from the recording industry seeking the identities of people suspected of illegally swapping music is provoking fear, anger and professions of remorse as the targets of the antipiracy dragnet learn that they may soon be sued for hundreds of thousands of dollars in damages. The Recording Industry Association of America has obtained close to 1,000 such subpoenas over the last four weeks to more than a dozen Internet service providers, including Verizon, Comcast and Time Warner Cable, and several universities, including Boston College and the Massachusetts Institute of Technology, demanding the names of file swappers. Most Internet providers are notifying the unlucky subscribers by mail that they are legally required to turn over their contact information.

Those on alert include several college students, the parents of a 14-year-old boy in the Southwest, a 41-year-old Colorado health care worker and a Brooklyn woman who works in the fashion industry. "They could have used some other way to inform people than scaring the bejiminy out of them," said a mother who received a copy of the subpoena last Wednesday, listing several songs that her 14-year-old son had made available for others to copy from his computer. "If someone had sent me a letter saying `this is wrong,' you can bet your sweet potatoes that would have gotten my attention. This just seems so drastic."

The ominous letters and a list of screen names culled from court filings that is circulating on the Web underscore the unusually personal nature of the industry's latest effort to stamp out online piracy, which it blames for a 25 percent drop in sales of CD's since 1999. Under copyright law, the group can be awarded damages of $750 to $150,000 for each copyrighted song that was distributed without authorization. Some of the targeted Internet users expressed shock that they were singled out for an activity that tens of millions of Americans are believed to engage in. Others said they were unaware they were doing anything wrong. Most of those interviewed refused to be identified by name, citing privacy concerns and the potential impending legal action against them.

The mother of the 14-year-old boy said she had assumed that her son's file-swapping was all right because she knew that Napster, the company that drove the original wave of online music piracy, had been shut down after the record companies sued. Any other company whose software is used by so many of her son's friends, she reasoned, must have done something different to be allowed to continue operating. After receiving a copy of the subpoena in the mail on Wednesday, the mother said she did some research and learned that though the software itself might be legal, the way her son was using it was almost certainly not. The 150 songs her son had on his computer have been deleted, along with his computer privileges for the rest of the summer.

"We've had extensive discussions about why it was wrong, and how it's kind of like plagiarism, taking someone else's words or someone else's music and not giving them credit for it," she said. She added that her son stayed in his room all day, while her older daughter worried that her parents would not be able to pay for college next year. The notion of paying up to $150,000 for each of the eight songs that the recording industry listed on the subpoena — not to mention lawyer fees of $200 an hour should the family decide to fight a lawsuit — still boggles her mind. "Hopefully when they find out he's just a kid, they'll drop it," she said.

But not necessarily. Frustrated with the failure of warnings and educational campaigns to stem the flood of online music trading, the major music companies said on June 25 that they intended to sue hundreds of individuals as a form of deterrence. "I guess people didn't take it seriously, but we really are very serious about this," said Cary Sherman, president of the Recording Industry Association of America. "We want the message to get across to parents that what their kids are doing is illegal. We are going to file lawsuits."

The popularity of file-sharing software, which allows users to copy music, movies and other files from one another's computers, has long benefited from a sense of impunity among users. By tearing away the Internet's veil of anonymity, the record industry hopes to scare people away from using the software and crack a cultural consensus that tends to regard file-sharing as a guilt-free activity. Before pursuing individuals, the association sponsored antipiracy television and radio commercials; sent four million instant messages warning people using KaZaA, the most popular file-sharing software, that they were violating copyright law; and published an advertisement in The New York Times and Entertainment Weekly that began, "Next time you or your kids `share' music on the Internet, you may also want to download a list of attorneys."

The music industry also tried suing the makers of the software that succeeded Napster. But in April, a federal judge in Los Angeles ruled that two peer-to-peer systems, Morpheus and Grokster, were legal even though people used them to make illegal copies of music and movies. Music executives said they were left with little choice but to pursue the users themselves. As news of the subpoenas spread across the Internet in recent days, many file-swappers, who often rationalize their behavior by arguing that CD's are too expensive and the record industry does not deserve their money, responded with defiance.

A spoof cartoon was widely circulated, set to the tune of the 1980's hit "We Are the World" and with the lyrics, "Sue all the world/Sue all the children." On sites like Zeropaid .com, a hub of information for file-sharing, discussion board participants vowed to boycott major record labels and called on people outside the United States — and the restrictions of United States copyright law — to share more files. But many file-swappers also expressed alarm. Jorge Gonzalez, the founder of Zeropaid, said some who posted discussion board messages planned to stop file-trading altogether. Many rushed to check a list, initially published on TechTV's Web site, of the KaZaA screen names cited in the subpoenas filed in the Federal District Court in Washington.

Several lawyers said the record industry probably had a good legal case. "It's pretty well settled that it is infringing copyright to share files without permission of the copyright holder," said Jonathan Zittrain, a director of the Berkman Center for Internet and Society at Harvard Law School. Still, some legal experts argue that the tactic is risky, particularly if the industry appears to be concentrating on families with no resources to defend themselves. "The practice of filing thousands of lawsuits is a game of chicken, and not a sustainable model for the industry or the courts," Mr. Zittrain said. "The overall puzzle for the industry is how to truly convince the public that this is in the public interest."

He said there was no obvious historical analogue to the scattershot subpoenaing of individuals in copyright law enforcement, which has traditionally been aimed at businesses or people who are profiting from illegally copied material. He likened it instead to raids during Prohibition, or red-light cameras that catch drivers disobeying traffic laws when they think they are unobserved. Both have given rise to social outcry, Mr. Zittrain said, even though they were used simply to enforce the law. Citing the privacy and due process rights of its subscribers, Verizon Communications has appealed a federal court decision that compels Internet service providers to turn over subscriber information without first requiring copyright holders to file a lawsuit. The company said at least one of the subscribers it notified last week had hired a lawyer and was planning to challenge the recording industry's subpoena.

The Massachusetts Institute of Technology and Boston College have declined to comply with subpoenas they received, citing procedural concerns and their responsibility to protect student privacy under the Family Educational Rights and Privacy Act. Some lawyers who were contacted by people who received notices from their Internet providers say the cases raise many questions because of the way the software in question works. Some versions of KaZaA automatically designate certain folders on a computer as "shared," so users may not have realized their personal music files, copied from legally purchased CD's, were available to others. Daniel N. Ballard, a lawyer with McDonough, Holland & Allen in Sacramento, Calif., said he was representing a Brooklyn woman who believed she had prevented her files from being accessible to the KaZaA network. He said computer intruders may have rearranged the files on his client's hard drive without her knowledge.

Some say they were unaware that they were doing anything against the law. "My daughter would never have used her name as her e-mail address if she thought she was doing anything wrong," said Gordon Pate of Dana Point, Calif., who said an Associated Press reporter found him through the telephone directory after his 23-year-old daughter's screen name, leahpate@kazaa, appeared in the court filings last week. (Most were more along the lines of "anon39023" and "RockOn182.") But a Colorado man said he knew what he was doing was illegal; he had just not seriously considered the consequences. "I used the program," said the man, 41, who used KaZaA to find songs that included the words "happy birthday" to play for his young daughter when she woke up on her birthday, among other times. "It's cute, but look what happened," he said. "It's an expensive birthday, that's the reality."
Source: New York Times

Monday, July 28, 2003

Germany on the Brink.........of Recovery?

There has been some talk recently in Bonobo Land as to whether Wim Duisenberg should, by rights, eat his hat. One thing is clear, if the optimists are right, and the German economy does make a surpringly robust recovery, I will have to think again, and wear sackcloth and ashes for at least six months. Meantime allow me to remain the 'doubting Thomas' of the pack. First a piece from today's FT

Germany's Ifo business climate index, one of the most closely-watched economic indicators of eurozone growth, rose for a third successive month in July, further underpinning hopes for recovery in the country's feeble economy. The rise in the Ifo index followed a dramatic jump in another growth indicator, the ZEW economic institute's monthly expectations indicator earlier this month. Together, the indices provide a much-needed boost to the government, which is in the midst of pushing through an ambitious reform agenda in an effort to revive the stagnant economy. Crucially, the Ifo' s third rise - helped by recovering stock markets, the slightly weaker euro and the reform debate - signals that the real economy can be expected to follow the trend. "Based on previous experience, an improvement in the Ifo business climate three months in succession signals a coming economic upturn," Ifo president Hans-Werner Sinn commented. Unlike the ZEW, which is based on a survey of financial market analysts, the Ifo index, which is based on a survey of 7,000 companies, also provides firmer evidence that the turnaround in sentiment extends to businesses. At the same time, however, Monday's rise in Ifo's key index for western Germany was smaller than expected - to 89.2 from 88.8 in June, less than the 89.8 that had been forecast - highlighting that caution is still needed amid mixed signals from the real economy. Numerous economists, including at the IMF and Bundesbank, have revised down their expectations for German growth to near zero for this year, and 1.5 per cent for 2004, well below the government's official forecasts. With the economy still flirting with recession, and much dependent on whether the euro will again strengthen against the US dollar, the pressure remains firmly in place for chancellor Gerhard Schr?der to rapidly deliver on the "Agenda 2010" reforms he outlined in March.
Source: Financial Times

Now clearly the expectation is one of a global recovery lifting all boats. For a look at what Keynes would perhaps have called the 'treasury view' let's make a brief visit to Morgan Stanley's Elga Bartsch last Friday:

Six months ago, I published a report entitled Is Germany Doomed? (January 6, 2003), in which I argued that the German economy would be reaching a critical point this year, in terms of both the business cycle and economic policies. As I feared at the time, the economy slipped back into recession in the first half of this year and is unlikely to do anything but stagnate for the year as a whole. Nevertheless, I am now ready to give three cheers to the Chancellor on the progress he is making in pushing through his reform agenda (see German Economics: Schroeder's Masterplan, March 16, 2003).

The first cheer is for the attempt to push through structural reforms, notably on labour market regulation. On my estimates, these reforms could add 0.75% to GDP over the next few years -- a small, but not negligible, effect. The second is for trying to lower (or at least limit further increases in) social security contributions, notably by trying to contain healthcare expenditure, reduce unemployment benefits and freeze pension spending. The third cheer is for pulling forward income tax cuts of about €15 billion that were originally scheduled for 2005, to next year, thereby bringing the total tax relief in 2004 to €20 billion, or 1% of GDP.

In light of these developments, we are revising up our 2004 GDP growth forecasts from 1.7% to 2.1%. If confirmed by official data, 2004 would record the second-strongest growth rate since 1994. Only the exceptional boom year of 2000, when the German economy registered a strikingly high growth rate of 2.9%, would surpass our new 2004 GDP forecast. The upward revision to the growth outlook, which brings our numbers to the upper end of the range of available forecasts, is concentrated in domestic demand, the long-standing Achilles heel of the German economy. In particular, we are raising our forecasts for consumer spending by almost a full percentage point to 2.1%, the highest growth rate since 1999. We are also increasing our forecast for investment spending from 1.3% to 1.8%, as small and medium-sized companies, which do not pay corporate taxes but income taxes, will also benefit from the income tax reduction. To some extent, the stronger domestic demand will also translate into stronger import demand, which comes as good news for Germany's neighbours.

Even though a growth forecast of 2.1%, almost one-third above trend growth, may already seem a little vertiginous, we believe that our forecasts are still on the conservative side. In particular, we have not factored in a reduction in social security contributions implied by efforts to contain spending on healthcare, pensions and unemployment benefits. In our view, January 1, 2004, will be too early to expect a marked reduction in contributions, which are equally shared between employers and employees, because we think that the cyclical upward pressures on contribution rates are likely to prevail in the near term.

With monetary policy remaining overly restrictive for the German economy and with fiscal policy under the scrutiny of the excessive deficit procedure, bold structural reforms really seem to be the best way forward. A recent IMF report estimates that by embracing US labour market regulations, the euro-area unemployment rate could be lowered by some 3.5 percentage points and output boosted by 5.25% in the long run. This simulation assumes that the replacement ratio of unemployment benefits, employment protection legislation and labour taxes are lowered to US levels. Of these three factors, however, it is really the replacement ratio and the employment protection legislation that matter most. Both of them are at the heart of Chancellor Schroeder's reform agenda. If, in addition, euro-area product markets were as deregulated as their US counterparts, this would boost output by roughly the same amount as a change in the labour market regime (see Unemployment and Labour Market Institutions: Why Reforms Pay Off, IMF, April 2003). For an economy that has underperformed the rest of the euro area for almost a decade now, attempting to unleash additional growth potential of 10% would not be a bad move. In fact, it might be the best one.
Source: Morgan Stanley Global Economic Forum

Now as regular readers will know all too well, I am not in principle opposed to the 'labour market reforms', nor to product market deregulation, nor to pension reform, what I am not sure about is whether these measures when applied will produce the anticipated recovery. Elga convinces me of one thing, when you want to be convinced, it's not too hard to convince yourself - 10% additional growth potential, just like that, and you didn't even see my hands move! As Eddie once said, everything here is timing, timing and a broader view of the problem. Among other quaint details, I fail to see why we have to note that the monetary conditions are overrestrictive and leave matters there. If they are overrestrictive, shouldn't they be loosened? Finally, something Eddie sent in the mailbox this morning seems strangely to the point.

It seems to me that people tend to think one-sided. When they talk about structural problems like rigid labour markets, they think supply side. Remove the disincentives to work and flexibilise labour markets. People forget the demand side effects (which become larger, as they are a function of the demographics?)

And when you talk about determination of monetary aggregates for example, a large part of the reason why central banks are having less of an impact must be they are having less of an influence on the relationship between banks & their clients – the reason being the changing demograhics (non-linearity over the age curve?)

While the underlying causes are different, the deflation we get is always Keynesian - insufficient demand. But because of the differences again, much of which is where we are on the age curve, the cures, I agree, would have to be a lot more creative than standard Keynesian remedies.

My sense is that many people out there (particularly policymakers) think all we need to do is get the costing correct. I guess it’s essentially neo-classical thinking? They think micro and not macro.

The Benefits of Homeschooling?

A piece in the mailbox from Francisco about homeschooling .

I see that a lot of your blog revolves around "can old people adapt" and "young people take longer to (finish college, although you don't say that)" and "people have less children because they are expensive". I think that, for a different view on the subject, you should incorporate into your frame of reference the fact that homeschooling is growing very fast (specially in the US), and that it, combined with what's called attachment parenting makes for a wholly different outlook on children that renders all the first 3 points moot -i.e. children are not that expensive anymore, people who homeschool tend to have more of them, and they (the children) learn adaptability from the get-go, start working much earlier and not necessarily go to college, and are very well positioned to change careers a few times in life-. They way I see it, it's getting to critical mass (in the US at least) and could well offer the "next or different avenue we need to find".

Many thanks to Francisco for introducing me to these two interesting concepts. Where this will lead I do not know, whether such movements will, as Francisco suggests, gain 'critical mass' is hard to see. Whether the family environment needs to be a complete substitute for the social life to be found in the school I also do not know, but that we need to be much more flexible in our approaches, of this I am sure. That school was the great socialiser in the 'mass' industrial age is clear, whether things always need to be this way, as we, and our societies, change, is much less clear. Peer group contact has, as many parents know to their cost, become a double edged sword. Technology and social structures are changing, and we can and should be imaginative. Meantime here is my reply to Francisco:

Just to clarify things a bit, my argument doesn't especially hang on children being expensive. I think I am trying to look at it from the point of view of our (complex) reproductive ecology. There was a form of dynamic equilibrium, with slow growth up to the 18 century, then the system received a (technologically driven) shock which opened another dynamic, where we have population explosion. The system then gradually restabilises - during about 200 years in the european case, much more rapidly now in the case of some third world countries - only, as in the case of many dynamic systems, we have 'overshoot'. ie the population falls below reproduction rate. At some stage we will probably find a new equilibrium, but I suspect that this is an example of a complex adaptive system, and that government policies (whether those of Berlusconi or any other) have limited impact. More technological change, of the 'sci-fi' variety will also clearly impact: artificially aided reproduction, genetic engineering, Kurzweil's 'non-intrusive' implants and the imminent, intimate fushion of artificial and biological intelligence. But I am not a futurologist, and I do not wish to speculate, so I try and stick to what we can actually see happening in the here and now.

There is obviously a lot of work still to do in understanding this process, I am far from clear on many aspects, but from an economic point of view it is important since fertility, in the final analysis, is a major determinant of the labour supply, and of the relative cost of labour and capital, and of the structure of demand, investment and saving, and of many other things.

I am only professionally interested, I suppose, in childhood and ageing as tangential phenomena (although personally, of course, I have a lot of interest in both these processes). The topics which emerge in Bonobo are related to my research interests/obsessions, and as such tend to change with the focus of my interests.

Your point about 'homeschool' is interesting. It is in line with Mokyr's argument about the changing relations between home and work in the information age (the factory, and factory office, as the dominant paradigm seem to be uniquely characteristic of industrial society). The home can become much more the focus for all kinds of activity, and of course, the arrival of the internet always was going to have an impact on the institutional structure of learning. This is especially relevant to the universities. As I have said on a previous occasion , you can probably learn economics better these days downloading at home the material from the best courses of your choice which are normally (at least in the US case) freely available on line.

Mind the Gap, One More Time

I don't know whether I'd go so far as Stephen Roach, who titles his latest MSGEF piece 'long live the output gap', since it's the existence of this gap that gives the strongest indication of the disinflationary pressure facing the US economy (perhaps I prefer the infamous 'mind the gap' of the London Tube). But quibbles aside, this piece from Roach is very timely and to the point:

Macro certainly has its moments in captivating financial markets. I suspect another one of those moments is now at hand. The debate over deflation has been given a new lease on life by Federal Reserve Governor Ben Bernanke. He has now set the risks of deflation squarely in the context of an “output gap” framework -- long a central tenet of macroeconomic analysis (see his July 23, 2003, speech, “An Unwelcome Fall in Inflation?” available on the Fed’s website). Using this macro construct, Bernanke has conclud?ed that even if the US economy now enters a period of solid recovery, the risks of deflation are going to be with us for some time to come. I couldn’t agree more.

Like most concepts in economics, the output gap is a complex restatement of a very simple premise -- the inflationary consequences of disparities between aggregate supply and demand. Alas, what always sounds simple in macro rarely is. Economists attempt to get at the notion of aggregate supply by assessing the growth of “potential” output (GDP) -- defined broadly as the sum of labor force growth and trend productivity. In essence, the output gap is then calculated as the difference between an economy’s growth potential and its actual level of aggregate a?ctivity. When output gaps are at “zero,” it’s the best of all worlds -- supply and demand are in perfect balance and, at least theoretically, the economy is at full employment and able to enjoy the luxury of a stable inflation rate. When demand exceeds potential -- a positive output gap -- inflation can be expected to accelerate. Conversely, shortfalls from potential -- a negative output gap -- are invariably associated with falling inflation; they reflect excess slack that gives rise to a phenomenon referred to as “disinflation.” As such, recessions are generally depicted as disinflationary macro events, while recoveries are thought to be inflationary.

As presented in this fashion, the output gap is all about levels of aggregate activity. This stands in contrast to the growth rates that color most of our impressions about the performance of economies. This is a critical distinction. An economy can be growing at, or even above, its potential growth rate and still have ample margins of slack capacity in labor and product markets; disinflationary pressures would prevail in such instances. Conversely, a fully employed economy growing slower than its potential growth rate would still be biased toward an inflationary outcome. In other words, initial conditions matter. An economy’s growth speed is not enough, in and of itself, to Idetermine the ups and downs of the inflation cycle. The verdict is critically sensitive to the state of resource utilization.

Which takes us to the case in point. In his latest speech, Fed Governor Bernanke has used this framework to make some important inferences about the economic and policy outlook for the United States. His most salient conclusion, in my view, is the premise that America’s output gap is likely to remain wide even in the face of a fairly vigorous recovery in the US economy. Bernanke comes to that conclusion by inserting a few key numbers into the o1995t gap framework. Operating under the premise that America’s potential growth rate is around 3%, he points out that even a 4% growth outcome in 2004 will not close the output gap for an underemployed US economy. In that context, a further deceleration in inflation can be expected. Inasmuch as inflation is already quite low -- averaging 0.9% for the core CPIU in the first six months of 2003 -- it’s that next leg of disinflation that becomes so problematic. While Bernanke celebrates America’s achievement of what he calls “the de facto equivalent of price stability,” that may not be a reason to jump for joy. In fact, it doesn’t take much of an imagination to envision what lurks on the downside of this threshold. On that basis alone, the Fed has good reason to remain vigilant in the fight against deflation -- even if the US economy now moves into a solid recovery mode, as the central bank and most other forecasters expect. And that, of course, is exactly the key conclusion that points to a protracted period of monetary accommodation.

Ben Bernanke is hardly alone in reaching these conclusions. Analysts at the OECD have come to the same realization. In their June 2003 assessment of the global economic outlook, OECD economists estimate that America’s output gap will hit 2.1% of potential GDP in 2003 -- the widest such shortfall in the US economy since 1991, when it rose to an nestimated 2.5%. Moreover, over the four-year period, 2001-04, the OECD estimates that the United States will record a cumulative output gap of 5.9% of potential GDP. That’s two full percentage points larger than the 3.9% widening of slack expected in the euro area and only fractionally below the 6.0% cumulative output gap expected in Japan, the land of deflation. Nor can the OECD be accused of sounding the “output-gap alarm” on the basis of an overly pessimistic growth forecast for the US economy. Their current prognosis calls for a 4.0% increase in real GDP in 2004 -- not unlike the outcome Bernanke has built into his stylized depiction of deflation risks. In other words, among the major economies of the industrial world, America is expected to be right at the top of the charts in feeling the full force of disinflationary pressures through the end of 2004. That’s obviously a new role for the unquestioned engine of the global economy.

Having said all that, it pays to take a deep breath and remember that this is macro -- not nuclear physics. The output gap analysis hardly provides an ironclad guarantee of deflation risk and the policies required to cope with such risks. As has long been noted, it is based on a number of heroic assumptions -- including, but not limited to, assessments of trend productivity, the inflation-stable? unemployment rate, and implied rates of full-employment capacity utilization. Moreover, the output gap construct is largely a “closed” macro model -- driven mainly by domestic considerations. In this era of globalization, macro models must be more “open” -- allowing for the possibility that aggregate supply curves are now global in scope. Not only is that true for tradable goods, in the form of Chinese-based outsourcing platforms, but it is now increasingly true in once non-tradable services, as exemplified by Indian-based IT-enabled service exports. In his latest speech, Bernanke concedes that the output gap could be considerably wider if aggregate supply curves were underestimated; in that case, disinflationary pressures would be even more intense as a result. The ever-increasing pace of globalization of goods and services suggests that is hardly idle conjecture.

Notwithstanding these important caveats, I think it pays to take the output gap seriously in assessing the risks of deflation. While the framework is hardly perfect, it provides a reasonably good assessment of the balance between aggregate supply and demand in the US economy. If anything, globalization tells us that the risks to this macro construct are tilted more toward an understatement of slack rather than the opposite. That points to a potential underestimation of theê intensity of disinflation, suggesting that it will take a lot more than a year or so of vigorous growth in the 4% vicinity in 2004 to end the current deflation scare for a low-inflation US economy. Conversely, it follows that any setback in the pace of recovery from the desired 4% trajectory would only widen the output gap even further -- intensifying the disinflationary pressures already bearing down on the US. Either way, the output gap is not about to disappear into thin air. And the longer it persists, there’s no escaping the bottom line for a low-inflation US economy -- the greater risk of deflation.
Source: Morgan Stanley Global Economic Forum

On the Difficulties of 'Nation Building'

This article from the FT about the CSIS report seems to make a number of points which are surprisingly obvious, and should have been obvious many months ago, what seems far from obvious is why so little thought appears to have been given to them.

Five US soldiers were killed over the weekend in a spate of attacks by Iraqi militants, as a new study warned that the US may soon find itself in the midst of "a third Gulf war against the Iraqi people". On Saturday, three soldiers were killed in a grenade attack while guarding a children's hospital in the city of Baquba, and a fourth was killed in an attack on a convoy west of Baghdad. On Sunday, the fifth was killed by a grenade attack south of Baghdad near the city of Hilla.

Forty-nine coalition troops have been killed by militants in Iraq since the beginning of May, and attacks average 10 to 20 a day throughout the country. General John Abizaid, the new commander of Centcom, on July 16 became the first senior US official to acknowledge that what the coalition faces in Iraq is a "classical guerrilla campaign". A study on guerrilla warfare in Iraq by the Center for Strategic and International Studies (CSIS), a Washington think-tank, blames bad planning by the US administration and the low priority given to "conflict termination" and nation-building strategies by the Pentagon.

CSIS military specialist Anthony Cordesman says the US has not learned the lessons of past conflicts, that "even the best military victories cannot win the peace". He writes: "Unless this situation changes soon, and radically, the United States may end up fighting a third Gulf war against the Iraqi people . . . It is far from clear that the United States can win this kind of asymmetric war." The study is likely to be a further blow to the US administration, already facing mounting criticism for chaotic reconstruction efforts in the country.

Mr Cordesman offers a grim assessment of the future of the Iraqi conflict: "The most likely case still seems to be a mixed and poorly co-ordinated US nation-building effort that does just enough to put Iraq on a better political and economic path, but does so in a climate of constant low-level security threats and serious Iraqi ethnic and sectarian tensions." The Pentagon's policymakers saw the Clinton administration's focus on nation-building as a waste of resources, the report says.

US policymakers say the Iraq war ended too suddenly for an effective postwar strategy to be launched. Mr Cordesman credits the coalition with avoiding many of the worst-case postwar scenarios, such as massive refugee crisis and wholesale destruction of energy infrastructure. But Mr Cordesman offers a detailed critique of the planning and analysis that went into the war - 26 "avoidable problems" ranging from failure to introduce a police force to assuming that toppling Saddam Hussein would have won "hearts and minds". In confused and angry scenes in the Shia holy city of Kerbala on Sunday US troops opened fire as Iraqis protested over Marines killing a man the day before, Reuters reports from Kerbala.
Source: Financial Times

And just in case the point needed emphasising, here is the Reuters report the FT refers to. (My impression - and it's only an impression since I have no special expertise here, is that the internal dynamic in Iraq is so complicated that possibly the Kurds are the only group which is really content, and that the Kurds being content is also probably a source of unease for the other groups, both internally, and (in the case of Turkey) externally. Living in Spain, and seeing how live the historic internal conflicts involving Basques and Catalans with the dominant 'Castillan' group actually are, despite all the economic progress, it is difficult to see an easy resolution of Iraq's internal rivalries).

An Iraqi man was killed and three wounded in the Shi'ite holy city of Kerbala on Sunday when protesters clashed with U.S. troops and Iraqi police, witnesses and hospital workers said. Marines said two Kalashnikov rifle shots were fired during the protest and they returned fire. Reuters journalists saw troops fire in the air to try to disperse stone-throwers angry at the killing of another man by U.S. troops on Saturday. Doctors at a hospital in the city, home to one of Shi'ite Islam's holiest shrines, said the man killed in Sunday's protest had been shot and showed the wound to a Reuters correspondent. One of the wounded, Shaer Abbas, said he had been hit with an electric cattle prod. "During the protest, two rounds were fired from a building," a Marine officer told Reuters. "They were fired from an AK-47. We're investigating to make sure the firing has stopped."

Residents said unrest began on Saturday when locals accused U.S. troops of encroaching on the grounds of the revered Imam Hussein mosque. In resulting clashes, they said, an Iraqi died. The Marine officer said the Iraqi killed on Saturday had been shot by troops because he was armed and posed a threat. The death sparked Sunday's protest, with hundreds of men marching from the famed, gold-domed mosque waving banners and shouting anti-American slogans. As gunshots rang out, Marines dived for cover behind walls and many Iraqi police fled.

Soldiers arrested several protesters. At least one of the detained Iraqis was carrying a Kalashnikov AK-47 assault rifle. In angry confrontations, Marines threw several protesters to the ground and pointed their weapons at the crowd. The funeral of the Iraqi killed on Sunday was due to take place at 5 p.m. (9 a.m. EDT) on Sunday afternoon, and was expected to be another potential flashpoint in the tense city.

Violence directed against U.S. troops in Iraq has been concentrated in Sunni Muslim areas, the heartland of support for Saddam Hussein. But recent protests and attacks elsewhere are a sign of anger among the country's majority Shi'ites too. U.S. troops have generally stayed out of mosques in the holy Shi'ite cities of Najaf and Kerbala to avoid offending locals. Last weekend thousands of people protested in Najaf to show their support for a radical Shi'ite leader.
Source: Reuters