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Friday, September 05, 2003

On the New Productivity Paradox

Well, the latest round of revised productivity numbers certainly puts the productivity question firmly back on the agenda, and the surprise jump in job losses in August only adds to the connundrum. Interestingly Stephen Roach has a strange take on this today: US workers are both working more and less hours. The are implicity working more because 24/7 connectivity means you now carry your work round with you (does Edward never sleep?), but they are working less since repeated crashes and outages lower the available working time:

I just blew another productivity opportunity. I spent the first 45 minutes of my workday fighting the mindless edicts of the technology gods. I always remind myself not to take it personally. After all, I am only one of America’s some 83 million IT-dependent knowledge workers. I guess that’s just the point: To the extent others feel the same pain, there may well be good reason to raise serious questions about America’s widely celebrated white-collar productivity miracle................

According to the BLS, the average workweek in the financial activities sector was 35.4 hours in July 2003 - essentially unchanged from the level a decade earlier (35.6 hours in July 1993). I find that most difficult to fathom. Over the past decade, the IT-enabled knowledge worker has seen a radical transformation of work schedules. Courtesy of miniaturized and portable information appliances, together with near-ubiquitous connectivity, workdays have been extended as never before. Yet in this increasingly "24 x 7" mindset, the official data speak of unbelievably short and unchanged work weeks. What a disconnect! To me, this smacks of a classic measurement problem.

I fully realize all this is heresy. But I fear that in our rush to rationalize the wisdom of our ways, we have lost sight of the pitfalls of the Information Age.

Now come on Steven which is it? Because clearly it can't be both, or at least if it is both, then these two factors probably balance out and the argument about measurement problems has less force. The truth is, I suspect, Steven's card-carrying 'skepticism'. As he says it is heresy, he is an information age non-believer. Brad - against whom one could never ever hold this - had an interesting post recently about Robert Gordon - about whom one certainly could - and an article of his in the FT on productivity. Browsing over to Gordon's homepage I discovered that the article is based on a longer piece of research that he has recently published as an NBER working paper. Since the productivity phenomenon is really one of the most striking things about the recent US performance, and since this paper is by and large non-technical (ie I think it could in the main be read by the average economically literate blog enthusiast) it may be worth looking quite closely at the argument and the conclusions. Two other papers of interest are: Yang and Brynjolffsson, "Intangible Assets and Growth Accounting: Evidence from Computer Investments", which is cited extensively in Gordon's paper but is fairly technical ( here ), and Bart Van Ark's "Is there a productivity puzzle?" which is a comparison of the EU and the US and is pretty readable since it is in the form of a presentation ( here ). Incidentally Gordon, who previously attracted some notoriety - and in a sense became seen as a key representative of the new economy cynics - by asking whether the internet and computational revolution measured up to the big technological revolutions of the 19th century, appears to be answering his own question: "In short, the 'marriage' of computer hardware with software and communications hardware in the 1990s was as important to the development of the computer as was the development of paved roads and then superhighways to the full exploitation of the internal combustion engine." However having ventured so boldly forth he does try to redeem his former self at the end, by pointing out that he considers the ICT-internet fushion a 'first rate' but not a 'mega' invention since it has, apparently, a one time only component.

In the paper Gordon presents five 'puzzles'. Here I will focus only on two: the problem of the cyclical component in productivity, and the question of the post-2000 acceleration. His conclusion on the first point is - following Yang and Brynjolffsson - that little of the 1995 - 2000 improvement was cyclical, since it is more than likely the result of a massive long term investment in 'intangible human capital' which was being measured as a cost earlier, but which was not showing up as a benefit. Post 1995 this 'asset' has been increasingly revealing its worth, and, as the figures show, it continues to do so. If we go back to Roach's skepticism for a moment, it is worth noting that according to the BLS the US services sector lost 67,000 jobs in August alone. Yet sevices output continues to grow significantly. The question really is - and this is a complete unknown - how much more of this is there still in the pipeline? Because if there is a lot, and I suspect that there may be, and if we continue to have 'lukewarm growth', then this is going to have serious implications for the deflation problem in the US. Put simply, this rise in intangible human capital is the result of learning by doing. This learning by doing has two components: you get to do the things your were doing better, and you find new things to do. It is a dynamic process, and this brings us to Gordon's conclusion on the second puzzle. His conclusion is that the 1995 Netscape-ICT 'alchemical wedding' had a one-time-only component, hence we may be near the end of the ride. His examples for this are trivial, as incidentally were his skeptical comments about word-processor improvements in his earlier 'does the internet measure up' piece. For an example of one of the potential new productivity enhancing innovations on the horizon you could take something like grid computing (see my earlier post here ). Many many more possibilities could be mentioned, but that's what they are, possibilities. The whole point about this learning-by-doing creative-machine which we've set in motion is that we won't know till we get there. However what we could notice is that imminent-intimate fushion of Robert Gordon (who has an excellent 'productivity analysing' mind) and Ray Kurzweil (whose imagination and insight as a practising technologist are invaluable) to create a new breed of 'spiritual economists' might be just what we're in need of right now. Trouble is I'm not sure whether we should load Robert's mind into Ray's computer, or up-load Rays hard disk contents into Robert's body.

(Puzzle 1) Whatever happened to the cyclical effect? Skeptics were justified on the basis of data through the end of 1999 in their claim that part of the post-1995 productivity growth revival reflected the normal cyclical correlation between productivity and output growth. In contrast data through mid-2003 reveal only a negligible cyclical effect for 1995- 99 but rather a temporary "bubble" in 2002 that repeats similar temporary blips in three previous business cycles.

(Puzzle 2) Why did productivity growth accelerate after 2000 when the ICT investment boom was collapsing? The most persuasive argument points to "hidden" intangible investments in the late 1990s that required labor input but were not counted in measured output; after 2000 the delayed benefits of intangible investments boosted output, while much of the labor input that created them was laid off. In short, productivity growth was understated in the late 1990s but overstated since then.

Our verdict on Puzzle 1 is that little of the initial 1995-2000 productivity growth revival was cyclical, and almost all of it it represented a fundamental shift in the trend. However, the 2001-2002 "bubble" contains a temporary element that has occurred in the early stages of the recovery in previous business cycles and deserves to be called "cyclical" because of its periodic repetition. The 2001-2003 economic recovery has been substantially more "jobless" than the 1991-92 recovery that gave rise to that label, and productivity in the first few quarters after the four quarter "bubble" period has been considerably healthier than in 1993-94 relative to a much more robust trend. The U. S. economy is on track to achieving a rate of productivity growth over the decade 1995-2005 of almost three percent per year, raising deep questions about why this has occurred and why these causes have not been equally relevant in Europe.

The period 2000-2003 has been marked by a sharp downturn in ICT investment, particularly in computer hardware but also in software and communications equipment, and a rapid decline in employment. Output can grow despite a continuing decline in labor hours, because the benefits of the previous hidden investment in improved business processes and better trained employees are transmitted to production, while the workers that produced the hidden output in the late 1990s (programmers, consultants, trainers) have been laid off and are walking the streets. In a sense the U. S. economy of 2000-2003 has been getting a "free ride" from the 1995-2000 wave of investment in hidden capital.

At least one obvious question is raised...........and this is whyintangible capital did not produce a productivity growth upsurge during previous periods when the share of spending on computer hardware was growing rapidly, particularly 1972-87, the interval that led Robert Solow to utter his famous quip that later became known as the Solow "computer paradox," that "we see the computer age everywhere except in the productivity statistics". One possible answer is that the 1972-87 increase in the share of computer spending in GDP was slow and gradual, while the post-1995 upsurge was sudden and hence created a greater imbalance between measured and unmeasured ICT investment. A second possibility is that the nature of ICT innovation in the 1990s was more disruptive and required a more substantial investment in intangible capital than did earlier waves of computer innovation.

Just as complementary investments in roads and suburbs were necessary to provide the full benefits of motorcars and motor transport, so complementary innovations in software and communication technology were necessary to provide the full potential benefits of the personal computer. Windows 95 and 98 provided an intuitive interface that instantly replaced DOS, with its command lines and DOS-based programs with their arcane codes. While the replacement of DOS programs with Windows-based programs may have been little more than an annoyance for experienced DOS users in the business world, they made it possible for business firms to reduce training expenses, and also for the personal computer to penetrate the household.

But the "killer application" that powered the post-1995 productivity revival was the marriage of computer hardware and Windows-type software to communications technology that made possible the WWW. Equally important were developments in hardware power and software that made it trivial to send documents as e-mail attachments, thus eliminating the need to print out many preliminary documents and spreadsheets and to send the printed versions via fax or courier service. Cheap communications caused a revolution in business practice...........In short, the "marriage" of computer hardware with software and communications hardware in the 1990s was as important to the development of the computer as was the development of paved roads and then superhighways to the full exploitation of the internal combustion engine.

One way of assessing the likely productivity impact of near-term ICT innovation is to ask whether such innovations can break through the inherent impediments to the replacement of human beings by computers.

The further acceleration of productivity growth in 2000-03 has laid the cyclical argument to rest insofar as it applies to the 1995-99 period. But another cyclical phenomenon has emerged more recently, the "early-recovery productivity bubble" that pushed up productivity growth in 2002 to incredible levels. This phenomenon is cyclical in the sense that it is periodic; similar "bubbles" occurred in 1975-76, 1982-83, and 1991-92, and in each case were followed by two or more years of productivity growth below trend. Data on productivity growth rates during 2000-03 are pushed up by the bubble phenomenon, as are estimated Hodrick-Prescott productivity trends that respond relatively rapidly to the evolution of the actual data.

Puzzle 2 was suggested by the paradox that productivity growth accelerated after the year 2000 despite the collapse in the ICT investment boom, suggesting that standard studies of growth accounting may exaggerate the causal role of ICT in achieving the first 1995-99 phase of the productivity revival. Three factors support the case for exaggeration. First, the growth accounting methodology unrealistically assumes that the full productivity benefits of ICT hardware and software are achieved at the instant of production, with no allowance for reorganization or training effects. Second, independent evidence for the retail trade sector finds that all of the rapid productivity growth in the 1990s was achieved by new establishments and none by old establishments, even though ICT investment has been made in both. Third, and most important, the boom in measured ICT investment in the late 1990s was accompanied by a boom of perhaps equal size in unmeasured or "hidden" improvements in intangible and human capital, as suggested by Yang and Brynjolfsson. The numerator of productivity omitted the creation of the intangible capital but the denominator included the labor input, artificially holding down the magnitude of the productivity growth revival. Then after 2000 productivity growth was exaggerated, because output was supported by intangible capital input that had been created before 2000, but the labor input that had created the intangible capital had declined, as programmers, consultants, and trainers were laid off. The cyclical analysis of the 2002 productivity growth "bubble" and the intangible capital argument both suggest that observed productivity growth in 2002-2003 may represent a high water mark and cannot be expected to continue.

That major source of productivity growth, capital-deepening investment, cannot occur forever without a continuous flow of innovations, and so the post-2000 crash in ICT investment raises the question as to whether the wave of innovation in the 1990s had a one-time-only component, and whether a new wave of innovations will emerge over the next few years to create a repetition of the investment boom. We classify innovations as "mega," "first-rate", "second-rate," and beyond and argue that the marriage of computer and communications hardware with software in the 1990s was a first-rate invention, but that it had a one-time-only component because the web could only be invented once, because part of the boom consisted of demand from dot.com firms which promptly went bust, because of the mismatch between hardware and software innovation, because of the timing of Y2K, and because of the overbuilding of telecom infrastructure. The main areas of ICT investment in the near future are innovations that look distinctly second-rate, the further move toward mobility with internet-enabled mobile phones and wi-fi enabled laptops that will allow e-mail, web access, Word, Excel, and Powerpoint to be accessed more conveniently, but the functions to be accessed will be the same as five years ago.

The World Bank and Replacement Migration

Back to yesterday and the World Bank economic forecast. Here is another extract on 'replacement' migration for Europe and Japan which makes it plain that they are coming round to the UN view. Bush is not the only one these days finding out he needs the UN! As they say, this alone will not solve the problem, but it will help. As they also note the objections are political not economic: so much for de-regulation.

The combined demographic effects of the baby boom that marked the immediate post-war period, the fall in fertility rates that began in OECD countries in the late 1960s, and longer life expectancy have led to a striking acceleration in population aging in virtually all advanced industrial societies. Population aging is much more marked in Europe and Japan than in North America, but all three regions will be affected. According to demographic projections by the United Nations, the populations of the European Union and Japan are expected to fall by 10 percent and 14 percent, respectively, between 2000 and 2050, representing a decline of some 55 million in all. In both Japan and the European Union, the dependency ratio (defined as the ratio of pensioners to workers) is expected to decline from five to one today to three to one in 2015.

For the United States, projections still point to an increased total population over the same period, but the dependency ratio also rises. Recent research has considered the economic and fiscal impact of these demographic trends in the OECD area (OECD 2000, 2001c, 2002; Visco 2000). Without offsetting measures, the growing dependency could place enormous strains on social security, Medicare, and pensions systems. Far-reaching decisions are required over the medium and long term to meet shifting labor demands and to safe-guard balance and equity in the systems of social protection—decisions related to the length of working life, levels of contributions and benefits, and productivity advances. One solution receiving increased consideration in several countries is to increase levels of permanent immigration to modify population structures and mitigate the social and economic costs of aging. Immigration has advantages. It can quickly increase the economically active population because new immigrants tend to be younger and more mobile. Also, fertility rates among immigrant women are often relatively high, which can help boost population growth. This has only a limited impact in the short run, however. Immigration alone cannot provide the answer to population aging, as demonstrated by simulations produced by the United Nations (2000). The simulations show that maintaining steady dependency ratios until 2050 would require an enormous increase in migration flows—for the United States and the European Union, migration balances would have to be at least 10 times the annual averages of the 1990s. Such scenarios seem implausible by historical standards, and in light of the likely political reactions.
Source: World Bank

Where the Growing is Good

Back to my demography thesis for a minute. By now it should be common knowledge that I am treating Italy as the big downside test. In other words if Italy in the next few years should mysteriously, and apparently inexplicably, find itself in a pretty tough economic corner, then I guess I'll know I'm more or less on the right lines. But since I don't want everyone to think I'm an inveterate pessimist, maybe I need one or two positive examples to help things along. Now it's is also common knowledge that I'm pretty strong on China and India. But so too are the World Bank, Brad, and a lot more who shall remain nameless. And none of these necessarily subscribe to the demographic thesis. In addition many could identify this with an Asian cultural phenomenon. So I've been thrashing around trying to come up with something better and, as I indicated last week, Turkey and Brazil to me look like two obvious candidates. Culturally very different, recent hyper inflation history, not the obvious candates. So let's keep watching, and see if my judgement is any good.

The Turkish economy is staging a remarkable recovery with no sign of overheating. The turnaround in economic activity and financial markets appears to be a startling contrast to the gloomy expectations just a few months ago. Real gross domestic product posted a seasonally adjusted annualised growth rate of 12.2% in the first quarter of this year, up from 7.9% in the last quarter of 2002, according to our computations. We believe Turkey is on an upward curve to develop into one of the fastest-growing economies in the world. However, the current economic recovery has a perplexing nature. First, increases in the rate of real GDP growth are largely driven by an extraordinary inventory accumulation. Second, the quasi-recovery has hitherto failed to improve conditions in the labour market. Nevertheless, a debate on the risk of overheating of the economy may soon emerge. In our view, such a judgement is based on a set of flawed assumptions and a misreading of underlying macroeconomic trends and structural changes.

Despite the good news on the inflation front, overheating arguments may be unavoidable. We believe markets may soon start to fear that the rate of economic growth would produce an increase in inflation by lowering the unemployment rate to a point where upward wage pressures become overwhelming. Such a line of reasoning, in our view, contains questionable presumptions. First, it is widely assumed that the sustainable level of economic growth in Turkey is just 4.5%. The dissection of this potential growth rate, which seems to be based on the average real GDP growth rate in the 1990s, shows (probably) a growth rate of 2% in the supply of labour and 2.5% productivity improvement. Second, the argument is based on the assumption that the Turkish labour market is rigid with real wage growth outpacing productivity gains.

We believe productivity growth is not only much greater than 2.5%, but will remain so for a long time. Before dissecting the country’s estimated potential growth rate, we should point out that productivity is virtually impossible to measure in the service sector and the diffusion of new technologies — Turkey is still in the midst of technological convergence — makes measurement errors worse. Nonetheless, we believe measurable productivity is growing much faster than the 2.5% “consensus” figure. Labour productivity in the manufacturing sector grew at an annual rate of 3.7% in the 1988–2001 period, and increased by 16% in the last two years. Although labour productivity is reliable in the short run, we believe total factor productivity, which is also on an improving trend, is a more dependable concept over the long run in determining the potential growth rate...........

The sustainable rate of output growth is close to 7.5%, according to our calculations. The contribution of total factor productivity to real GDP growth was 1.4% in the 1970–2002 period, and we expect it to rise to around 3% in the next 10 years. In fact, the rate of change in total factor productivity can be even much higher than our projection, if the authorities accelerate the process of economic liberalisation through increased openness of external trade and eliminating inefficiencies in the public sector that have actually become a burden on the whole economy. In particular, institutional reforms required for the EU accession would bring foreign capital, technology and know-how and thus increase the country’s total factor productivity. For the time being, our computations show that Turkey’s potential growth rate is close to 7.5% — 2.0% labour-force growth and 5.5% productivity growth...............

We also need to focus on indicators of current labour market weakness. The unemployment rate soared to the all-time high of 12.3% of the civilian labour force in the first quarter of 2003, from 5.6% in 2000. In the last two-and-a-half years, economic troubles destroyed over 2.5 million jobs, and the recent improvement was due predominantly to a drop in the participation rate. If truth be told based on official statistics, which, in our view, underestimate the depth of worsening in the labour market, the non-farming jobless rate increased from 8.2% before the crisis to 15.1% last year, and improved slightly to 14.6% this year (see our recent report, Young, Educated and Jobless, August 28, 2003). There appears to be no shortage of the supply of labour in Turkey. The country’s labour force increased at an average rate of 1.6% in the last decade, and, more recently, expanded by 4.7%, thanks partly to increasing female participation.
Source: Morgan Stanley Global Economic Forum

BTW: Don't lose the point about labour market problems. Turkey, like the US, has a lot of young people entering the market, and is also experience a cultural change with the rise of female employment. This is going to make low unemployment difficult to achieve short term, but with growth rates in the 7% range this should not be unduly preoccupying short term.

US Economy: the Guessing Continues

In the US productivity continues to rise strongly while employment continues to lag behind. The dollar is wobbling a bit, but factory orders remain strong. All in all the game continues, with no clear outcome in sight.

Grid Computing in Medical Research

Those familiar with the arguments on my website deflation page will know that falling information costs is one of my pet themes. I have no way of evaluating if the claims made in the following article are valid, but the idea seems sound, and it does seem indicative of what I'm trying to say:

No cure for diabetes. No cure for Aids. No cure for Alzheimers or the common cold. No new drugs except those for weight or sexual performance. That is the likely outcome of 40 years of rising costs and longer times to get new drugs certified. Howard Asher, director of global life sciences for Sun Microsystems, said that when he started in the industry in 1969, it took US$6 million and eight years from discovery to bring a new drug to market. "Today it takes 17 years and US$800 million. If this continues, once it reaches 20 years and US$1 billion we are out of the business of drug innovation and drug discovery, because 20 years eliminates all worldwide patent protection and eliminates the return on investment that only blockbuster drugs would even come close to offering.

"It means in five to seven years from today, the only survivors would be generic drug companies and the only products they would have ... would be those drugs we currently have on the market." Asher says the solution is silicon. By finding new ways to harness huge amounts of computing power, the costs and time of drug testing can be reduced. Mapping the human genome has given researchers a massive amount of data which can be used to study reactions to disease and therapeutic interventions at a molecular level. "That detail is incredibly promising but it is computationally huge." He said the DNA of the animals commonly used for testing had also been mapped, meaning it should be possible to simulate tests "in silico".

Information on the way existing drugs worked on individual patients could also be collected and compared against genetic data. "We believe in 10 years we can eliminate the need for all animal studies, we can eliminate phase one and phase two clinical studies, so computationally we can model a drug or therapeutic agent in the computer against the genomic data." Asher said new tools and the development of grid computing utilities, which use broadband internet to tie together multiple computers so their CPUs can become part of a virtual supercomputer, could bring the price of getting new drugs released to under $100 million and 10 years.

Researchers need tools to sift the huge amounts of unstructured data - text information in any language or jargon - which may relate to their project. With a terabyte of textual information being published every day in medical, clinical and scientific journals, existing databases and classification systems can't cope. Asher said the tools developed by Hamilton firm Reel2 appeared to have solved the problem of finding unstructured information in any language from large databases. "What Reel2 promises is revolutionary for the life sciences and medical communities." He said Sun was tackling the problem of how life sciences researchers could amass the computing power they needed without breaking the bank. In Canada Sun was developing a computing utility. "Canada has a lot of companies with very large computers but many sit idle on evenings or weekends.
Source: New Zealand News

China Mobile's Agile Movements

While the a strong whiff of 'promo' about this Finance Asia article, the details you can find there are real enough. China Mobile is now the world's No2 carrier in terms of subscribers, and set to rocket upwards if the market potential is anything to go by. This situation could also be revealing about the pattern which may be to come as China's internal market expands.

The company's position as the second largest mobile phone operator in the world by number of subscribers was bolstered at the end of last year with the acquisition of seven mobile phone interests in China. The acquisitions were funded by a $6.6 billion share placement and a $690 million convertible bond, the largest equity issue from non-Japan Asia ever achieved. With the assistance of its financial advisers, China Mobile Hong Kong's senior management showed a stroke of genius by registering the deal in the US which meant that a lot of institutions were encouraged to participate. The convertible bond portion of the transaction was 25 times subscribed.

"China is now absolutely in the super league, one of only a handful of truly global wireless companies," commented the head of equity capital markets for Goldman Sacks, Mike Ryan, following the successful deal.

From the proceeds, China Mobile (HK) was able to acquire seven mobile communications interests from China Mobile Communications Corporation in Beijing, Shanghai, Tianjin, Liaoning, Shandong, Hebei and Guangxi. "The acquisitions have significantly expanded the subscriber base and geographical coverage of our business," says Mr Wang. "The group's network in the coastal provinces of China now covers almost half of the population in China." As a result, China Mobile (HK) services approximately 53% of all mobile subscribers in China, with subscriber numbers exceeding 45 million by the end of 2000...............

"To build our wireless data business, we have established a joint venture with Hewlett Packard and other parties." The joint venture will focus on the development of wireless data-enabling technologies and applications. This will include a standardized nationwide platform for wireless data.

China Mobile (HK) formed another strategic alliance in February when it signed a deal with Vodafone to share management expertise and human resources as well as operational expertise. It will also participate in joint research and development in key technologies, infrastructure, applications and solutions relating to the mobile phone market. Vodafone's chief executive, Chris Gent, now sits on the board of China Mobile (HK) as a non-executive director, in part to assist the company in seeking new joint ventures and equity-based strategic alliances.
Source: Finance Asia

Chip Sales on the Rise

Intel doesn't seem to be able to stop revising it's forecasts upwards these days, but look where the growth is coming from:

Intel, the world's largest semiconductor maker, on Thursday said strong microprocessor sales would enable it to reach the high end of its third-quarter sales forecast set just two weeks ago. The company said its latest revision was due to strong demand in its Intel Architecture business, which produces microprocessors for personal computers and servers. Intel said emerging markets were particularly strong..............Merrill Lynch has also upgraded its PC sales outlook on Thursday. The brokerage said PC unit sales would likely grow 7 per cent this year and 11 per cent in 2004, up from an earlier forecast of 5 per cent growth in 2003 and 10 per cent next year. Merrill also forecast that industry-wide PC sales would increase 4 per cent this year, compared with an earlier estimate calling for a 1 per cent decline.But the brokerage did not raise its outlook for Dell or Hewlett-Packard, the two largest PC makers, because growth was partly driven by "white box" PCs assembled and serviced by small generic computer companies.
Source: Financial Times

Hong Kong Government Backs Off

This one should get all the China bloggers commenting:

The Hong Kong government says it has withdrawn a controversial anti-subversion bill which sparked the territory's biggest political crisis in years. "We will consult the public again and before that we will not legislate," Chief Executive Tung Chee-hwa told reporters on Friday. Tung said the government had no timetable for re-introducing the bill, which is required by its constitution, but added there would be public consultations first. Critics have feared the planned legislation would trample on basic civil rights. Massive public demonstrations against it rocked Hong Kong's government in July and alarmed leaders in Beijing.

Postcript: I was right about the Sino-blog community. See (eg) ( here ) and ( here ).

A Question of Extremes

There's a piece in today's FT on extreme value theory which, since I am not a subscriber, I can't read. Extreme value theory is a branch of statistics dealing with the extreme deviations from the mean of probability distributions and is useful for trying to assess risk for highly unusual events, such as 100-year floods, earthquakes and the like. In fact anything with a fat tail distribution, and only a few readings in the tail - like financial market fluctuations, and business cycles. Quick-googling I did discover this research team whose leader has a very acceptable Chuck Berry Johnny B'Good bootleg for listening. This article is straigthforward and informative, while this one is more technical. So now even those of us who are locked-out of the FT premium content won't have to miss out on the fun.

It's All in the Mind

Well I always thought there was something in this line of argument, now it seems they're finding some evidence to back our intuitions up.

Brain activity linking negative emotions to a lower immune response against disease has been revealed for the first time, claim researchers. Many previous studies have shown that emotions and stress can adversely affect the immune system. But this effect had not been directly correlated with activity in the brain, says study leader Richard Davidson, at the University of Wisconsin, Madison, in the US. The part of the brain the team studied, the prefrontal cortex (PFC), is associated with depression. People who had the greatest activity in the right PFC when asked to dwell on distressing episodes in their life had a markedly lower antibody levels after an influenza vaccination. In contrast, those showing exceptional activity in the left PFC when recalling happy times developed high antibody levels. Davidson says emotions play an important role in regulating systems in the body that influence health. "This study establishes that people with a pattern of brain activity that has been associated with positive [emotions] are also the ones to show the best response to the flu vaccine." "It begins to suggest a mechanism for why subjects with a more positive emotional disposition may be healthier," he says. Janice Kiecolt-Glaser, an expert on stress and immunity at Ohio State University, told the New York Times that the study represents "some of the best evidence we've seen to date."

However, the study could not explain exactly how having a positive attitude boosts the immune system. The researchers say some evidence exists to suggest a link between the PFC and the immune system via a complex hormonal system governed by the hypothalamic, pituitary and adrenal glands. Another study by Italian and UK researchers, also published on Monday, reveals that depressed elderly people have fewer lymphocytes and T-cells - white blood cells crucial for fighting disease. This study is published in Psychotherapy and Psychosomatics (vol 72, p 253).

Thursday, September 04, 2003

Whiter than White

I was about to close down blogger for the day, but I can't resist this. Isn't this the guy Krugman was after and Cheney defended. Look what he's saying now . I think Krugman even had to apologise at one point. So who was right in the end? Why not ask Bill Cheney.

Chirac's Tax Cut

So the French have finally decided to go the whole hog. It's cut and be damned. Of course Chirac's cut is very different from the Bush one. This is short term expediency, in the French context it may even help. But it sure puts the stability pact in a tight corner. And if the growth doesn't materialise as anticipated next year? It would also have been nice if the euro-group ministers could have reached some agreement about it first, instead of France simply going it alone. This could be short term effective and long term damaging in another sense, that of euro-cohesion. It will be interesting to see whether this has any impact on the Swedish vote.

France confirmed its status as the rogue nation of the eurozone's public finances on Thursday after prime minister Jean-Pierre Raffarin decreed a 3 per cent cut in income taxes that will put further pressure on the country's budget deficit. The decision reflects the fact that French president Jacques Chirac, who promised to slash income tax by 30 per cent over five years in his 2002 election campaign, has been lobbying his government for the largest possible cut in order to "return some oxygen" to the economy. Despite the fact that a further clash with Brussels is now inevitable and that even his own finance ministry officials had warned that a one per cent cut in income tax was the most the public purse could afford, Mr Raffarin has rallied to the position of the French president.
Source: Financial Times

Job-Loss Recoveries

Brad has an extremely useful piece about the current recovery. It seems Okun's law doesn't work too well these days:

We used to have considerable confidence in Okun's law: that an extra one percentage point rise (or fall) in the unemployment rate over a year would reduce (or boost) that real GDP growth by an extra 2.5 percent over that year because a rising (or falling) unemployment rate would also be accompanied by a falling (rising) share of the population in the labor force and by falling (rapidly rising) productivity. Productivity would fall when the unemployment rate rose for two reasons: first, even when factories are not running at full capacity they still incur substantial setup and maintenance costs; second, even when there isn't enough work for them to do firms would rather hold onto skilled workers than watch them drift away and have to pay to train their replacements the next time the wheel of the business cycle turns.

Things have been different, however, in this recession (and to a lesser extent in the preceding early-1990s recession. The standard relationship between output growth and hours worked has gone substantially awry.............The fact that falling hours have been accompanied by rapidly-rising productivity is what has given us not a jobless recovery but a massive job-loss recovery. The normal pattern we would expect from the past two years' output growth would be that employment and hours would have been nearly flat. Why the different pattern this time? We think that it is because firms are no longer "hoarding labor" when times are slack because the industries losing jobs no longer expect employment to bounce back. This means that we no longer have any confidence that we understand the cyclical pattern of productivity growth--which means that we have little ability to translate the (high) productivity growth numbers we see into information about what the underlying long-run trend growth rate of the economy is.
Source: Semi Daily Journal

To elaborate on why this might be Brad picks up a piece from Erica Groshen and Simon Potter of the New York Federal Reserve Bank:

The divergent paths of output and employment in 1991-92 and 2002-03 suggest the emergence of a new kind of recovery, one driven mostly by productivity increases rather than payroll gains. The fact that no influx of new workers occurred in the two most recent recoveries means that output grew because workers were producing more. Although one might speculate that output increased because workers were putting in longer days, average hours worked by employees actually changed little during this and the previous jobless recovery.

Recessions mix cyclical and structural adjustments. Cyclical adjustments are reversible responses to lulls in demand, while structural adjustments transform a firm or industry by relocating workers and capital. The job losses associated with cyclical shocks are temporary: at the end of the recession, industries rebound and laid-off workers are recalled to their old firms or readily find comparable employment with another firm. Job losses that stem from structural changes, however, are permanent: as industries decline, jobs are eliminated, compelling workers to switch industries, sectors, locations, or skills in order to find a new job.

A preponderance of structural--as opposed to cyclical--adjustments during the most recent recession would help to explain why employment has languished during the re-covery. If job growth now depends on the creation of new positions in different firms and industries, then we would expect a long lag before employment rebounded. Employers incur risks in creating new jobs, and require additional time to establish and fill positions....

The difference from the pattern of the early 1980s is quite stark: now, the industries cluster heavily in the two structural quadrants. Most of the industries that lost jobs during the recession—for example, communications, electronic equipment, and securities and commodities brokers—are still losing jobs. Balancing the structural losses of these industries, however, are the structural gains of others. For example, nondepository financial institutions, an industry grouping that includes mortgage brokers, added jobs during both the recession and the recovery. The trend revealed in Chart 4 is one in which jobs are relocated from some industries to others, not reclaimed by the same industries that had lost them earlier. The chart provides persuasive evidence that structural change predominated in the most recent recession...
Source:Has Structural Change Contributed to a Jobless Recovery?: Erica Groshen and Simon Potter NY Federal Reserve

Now the interesting, really interesting, thing in all this is what is happening on the structurl side. It is here were we will find that much longed for 'new sector' which can square the numbers and fulfill Brad's long-term dream. Unfortunately the only sector I can see (and you need to go over to Brad's place and look at the diagram for this) is what they call non-depository financial institutions, which seems to be heavily oriented towards mortgage brokers. This could lead us to the only sector with positive structural growth during this downturn was one whose principal business activity was facilitating that US citizens get into even greater debt. I'm not convinced that this is the recipe for the future we're all looking for.

On the Advantages of International Labour Migration

Today I don't feel so alone. This is not because the girl in the flat above me is playing Spanish pop music at full blast. No, the World Bank has seen fit to dedicate a full chapter to labour migration. Even if they are far more tentative than I would be, and even though they place a lot more emphasis on temporary migration than I would, what they say is largely sound sense. Incidentally, what is clear is that what they call TMNP (temporary movement of natural persons) seems to be becoming the next big thing in connection with Mode 4 and GATS (all of this in a subsequent post). What it boils down to is 'services are on the move'. You know, try as I might, I just can't think of a single economic argument against international labour mobility, but few economists seem to recognise this. Surprising, isn't it.

With globalization—the dramatic expansion of cross-border trade and investment—has come an upsurge in international labor mobility. Falling costs of transportation and communication have reduced the distances between peoples, and the drive for better lives has motivated workers to move to areas where jobs are more plentiful and pay is better. Foreign-born persons now account for 10 percent of the total population in the United States, 5 percent in Europe, and 1 percent in Japan. In Canada and Australia, foreign-born persons represent 17 and 24 percent of the total population, respectively. Even so, today’s movement of people is still well below levels experienced in the late nineteenth century, and migration rates, now hampered by restrictive policies, are well below cross-border flow of goods and investment. By 2000, according to the United Nations, 175 million persons were living outside their country of birth—about 3 percent of the world’s population. By contrast, global exports of goods reached almost a third of GDP, and financial flows were well above 10 percent. While long term and settlement migration are still predominant in most developed countries, migrant flows are now more diverse and complex, with migrants moving back and forth more readily and rapidly. Temporary movement, in particular by highly skilled workers, has seen the largest growth in the past decade.

Both developed and developing countries have much to gain from an increased flow of workers. Rich countries benefit because they gain workers whose skills are in short supply. Also, as demographics drive up the average age in rich countries, migration allows an influx of younger workers who contribute to pension systems that would otherwise be actuarially unviable. Poor countries gain from higher wages as well as from the remittances that accrue from migration. In 2001, worker remittances alone provided some $70 billion to developing countries, nearly 40 percent more than all development assistance and significantly more than net debt flows to developing countries. Returning workers also often bring new skills back to the sending country. To be sure, there are costs to both receiving and sending countries: labor markets and social services may be strained in the rich countries, and developing countries may lose skilled workers who have been educated with public resources. Nonetheless, if a temporary visa system were introduced in rich countries permitting movement of labor up to 3 percent of the total labor force, world incomes would rise by nearly $160 billion (Walmsley and Winters 2002).

The shrinking share of young adults in the developed countries, particularly in Japan and Western Europe, and the rising share of young people in South Asia, Africa, and other parts of the world are complementary drivers of labor movement. Growing numbers of young people in the developing world have acquired the education and training needed to assume skilled positions in developed economies. And as the numbers of the foreign-born grow in developed countries, their presence makes it easier and more attractive for newcomers to join them (Hutton and Williamson 2002).

Newer factors are compounding the more familiar drivers of migration. The developing world’s rising share of educated workers—those who have completed secondary education— has jumped from one-third to nearly one-half over the past three decades. Increasingly, the growing pool of skilled developing-country labor is meeting industrial-country shortages, as the marketplace for skills widens to encompass the entire globe. Meanwhile, continued declines in transportation and communication costs and thus greater access to information on migration opportunities via global media, the Internet, and diaspora networks in receiving countries are breaking down barriers to migration(Nielson 2002).

Remittances from foreign workers, both permanent and temporary, are the second-largest source of external funding for developing countries, after foreign direct investment (FDI). In 2001, workers’ remittances to developing countries stood at $72.3 billion, considerably higher than total official development assistance and private non-FDI flows, and 42 percent of total FDI flows to developing countries that year (table 4.2). For most of the 1990s, remittance receipts exceeded official development assistance (World Bank 2003).

While the temporary movement of workers is not likely to unduly disrupt the sending country’s labor market, the potential effects of such mobility on segments of the receiving country’s labor market may at times be more significant. There, the concern arises that mobile foreign workers may be in direct competition with nationals of the host country working permanently in the same occupations. Even if the migrant’s stay is temporary, the growing number of foreign workers and the continuous influx of workers over different time horizons under contract-based flows could increase competition in the labor market (OECD 2002d). From this angle it is easy to see why immigration can be controversial in receiving countries. There is evidence that unskilled migration reduces the relative wages of unskilled workers in industrial countries (Borjas, Freeman, and Katz 1997).

An inflow of unskilled workers from the South will benefit highly skilled workers in the North. Their jobs are not threatened by the latter, and the presence of immigrants will lower prices for many goods and services consumed by the skilled workers. But the same inflow will reduce real wages of unskilled northern workers (World Bank 2001), and over time contribute to a deterioration in income distribution. Against this latter trend, however, demographic and educational trends in affluent countries will combine in the coming decades to raise the relative wages of unskilled labor in the absence of migration. As these demographic effects will likely be large, scope may therefore exist for increased flows of unskilled labor in an environment of relative wage stability. Despite the acknowledged benefits of temporary migration, the norm in receiving countries is to continue to impede the movement of low-skilled or unskilled workers through various restrictions. Such restrictions can contribute to the recent sharp rise observed in undocumented low-skilled workers throughout the OECD area.

US: Debtor of the Last Resort?

Here's another one from the world bank: the US as the world's savings consumer. Roach is dead right when he talks about this kind of global imbalance. And note another detail, the shift in the form of financing, from equity to debt.

Finally, the U.S. current account deficit is surpassing historic levels. During 2002, U.S. external financing needs claimed 10.3 percent of the savings of the rest of the world—more than double the levels of 1998. Moreover, the composition of finance also shifted toward short-term flows: net FDI flows were negative by almost $100 billion; U.S. banks’ overseas lending had ceased; andforeign official inflows (most from East Asia) increased to nearly $100 billion, from $5 billion in 2001. A sudden reversal in these shortterm flows could undercut U.S. and world growth............

But the form of financing (that is, the composition of the net foreign-asset flow) has changed dramatically over just the last three years, while the region of origin of the inflow has shifted as well. The underlying nature of the capital inflow can, as demonstrated aptly in recent years, lead to questions of medium-term sustainability of the external deficit; while shifts in origin of flows can influence market expectations for adjustment in the value of the dollar against its major partner currencies. During 2000, the final year of the boom, the United States required net inflows of some $457 billion to cover its current account deficit. Financing was readily available, through increased mergers-andacquisitions activity that yielded net purchases of corporate bonds of $281 billion; complemented by strong $160 billion in FDI flows and some $85 billion attracted to 45 percent gains in NASDAQ. Together the equity component of flows (FDI and stocks) accounted for more than 50 percent of requirements—a strong fundamental position. The onset of recession in the United States during 2001 was clearly a transition year for investor perceptions. The fall of equity markets (NASDAQ down 50 percent) forced a compression of the highly diversified flows of 2000, as equity and FDI dropped to negligible
amounts and investors flocked into debt instruments. Long-term debt-related securities almost covered the U.S. requirement of some $420 billion in the year. The transition in composition of inflows evolved more fully in the difficult environment of 2002. FDI recorded net outflow of almost $100 billion; purchases of Treasuries by risk-averse investors
increased by $100 billion; a virtual cessation in overseas lending by U.S. banks yielded a net buildup in bank liabilities of $70 billion; and foreign official assets (largely East Asian) increased by $90 billion from an inflow of $5 billion during the previous year.LINK

Deficits: Part of the Problem or Part of the Solution?

The World Bank Global Economic Prospects 2004 is now available. Of particular note is the spotlight put on China and India, who are significanty out-performing the rest of the world in economic growth this year, their economies are expected to grow at up to 8 percent and 6 percent respectively this year. Today I will post a few extracts. Here's one on the deficit situation:

But the scope for substantial further macroeconomic stimulus is rapidly dissipating. Fiscal deficits threaten to become part of the problem instead of part of the solution, especially since a quick reversal of the deficit is not anticipated. The U.S. general government budget position (including Social Security), for example, shifted dramatically from a surplus of 2.3 percent of GDP in 2000 to a deficit of 3.2 percent as of the first quarter of 2003. The Congressional Budget Office projects that the budget position is unlikely to return to surplus until 2012. In Europe, several large countries have breached the 3-percent-of-GDP fiscal deficit limits embedded in the Maastricht criteria for the common currency. And Japan has limited fiscal scope, given persistent deficits in the 6–7 percent range. Interest rates have been brought down sharply in the United States as well as in Japan, where they stand at an effective rate of zero. Following the recent 50-basis point cut in rates, Europe still has modest headroom for monetary easing should the European Central Bank choose to relax its inflation target. In fact, downward price trends in the United States and Europe have triggered concerns of possible deflation.

On Kindness and Fureai Kippu

Joerg has sent me an extract of an interview with 'alternative money' guru Bernard Lietaer about Fureai Kippu. Fureai Kippu, as Joerg notes, is Japanese, and seems to mean 'caring relationship tickets'. The essential idea is that you give your care services now in return for pay-back services, either in another time or in another place.

"For example, there are about 300 or 400 private currency systems in Japan to pay for any care for the elderly that isn't covered by the national health insurance. They are called "fureai kippu" (caring relationship tickets). Here's how they work: let's say that on my street lives an elderly gentleman who is handicapped and cannot go shopping for himself. I do the shopping for him. I help him with food preparation. I help him with the ritual bath, which is very important in Japan. For this help, I get credits. I put those credits in a savings account, and when I'm sick, I can have other people provide such services for me. Or I can electronically send my credits to my mother, who lives on the other side of the country, and somebody takes care of her. Here is an agreement within a community to use as medium of payment something other than national currencies, to solve a social problem. And it makes it possible for hundreds of thousands of people to stay in their homes much longer than they otherwise could. Otherwise, you'd have to put most of these people into a home for seniors, which costs an arm and a leg to society, and they're unhappy there. So nobody's winning. In contrast, Japan has created a currency for elderly care. In the United States, Florida is the only state that has the same density of elderly people as Japan does -- 18 percent of the population is more than 65 years old. But Florida is a model for our collective future. Colorado will be there in 2020. Germany will be there in 2006, France in 2008, Britain in 2012. Partly because of the baby boom generation, and partly because of the fact that health care has improved and people live longer. If you put all of these elderly in homes for seniors, you'd go bankrupt. Japan has been looking for another way, and has found it by introducing a monetary innovation."

This is a beautiful argument, beautiful that is except for the fact that it's flawed in just the same way our PAYGO pension system is flawed. It's a pyramid and the pyramid has inverted, so what we pay now collectively, we won't get back as individuals later. In each generation there will be less who are able to give in relation to those, from the previous generation, who are waiting to receive. Toshiharu Kato , the originator of one widely used eco-money sytem in Japan, was quoted by Japan Today as saying he:

is confident that there are plenty of people willing to create such communities, especially among businesspeople in their 50s and 60s who have retired or been laid off due to corporate restructuring. "I'm counting on the thousands of men who have another 30 years or so to live and who could contribute so much to improving their neighborhood," he said. "I may be a dreamer, but I'm hoping that ecomoney communities will flourish all over Japan and serve as an ideal model for other fast-aging countries."
Source: Japan Today

Now I think it's important to say that I have no objection whatsoever to this kind of scheme, nor indeed to the whole idea of voluntary activity. I love the idea of the 'gift economy', and just in case you hadn't noticed we bloggers may be among the most active participants.

What I can't buy, however, is the idea that these schemes will help overcome the deflationary problems associated with ageing societies. Again it could be noted, I am not averse to the idea that our societies are too 'hooked on growth', and that this addiction may have exacerbated the pyramid-type problems we are now about to have. But when you're hooked, you can't just come off like that. You need some methodone-type substitute to help. The idea that we can simply throw our recent growth history to the winds seems to me to be an extremely dangerous one.

So where does growth come from? Well, in one sense there is no great mystery. A large part of modern economic growth has come from the systematic introduction of a larger and larger population into the money economy, and the transferring of this population from lower value activities like agriculture, to higher value ones like industry, to then higher value ones like ICT based services. (Of course, capital is involved, but capital comes from saving, and with more people working, more people are earning and saving, so, of course, the growth of available capital is tied in some indirect fashion to the growth of the labour force). In another sense there is a mystery, the mystery of productivity and what is known as TFP, but let's leave this one for another day.

Now the problem with the eco-money schemes, is that they take people out of the normal open economic system, and send them back into a relatively-closed non-monetary one. This may be great for their feeling of worth as human beings, but it is definitely negative for growth. So instead of getting all those positive feedback effects we had on the way up as more and more people enter the economy (eg women in the second half of the 20th century) we may now get negative feedback as people leave on the ride down. Note that those Kato has in mind are businesspeople in their 50s and 60s, the very people most governments hope to win back into the money economy in order to pay the pensions. This is very different from Irving Fisher's proposal for stamp scrip money in the context of the 1930's deflation. Fisher's problem was a liquidity drought. Japan is swimming in liquidity, the problem is to get people to use it and spend!

CD Prices on the Way Down?

Returning to a theme I posted on earlier in the week, now it seems the price of CD's is coming down. About time, but there may be more to come, and, in the long run, the physical may be dead here:

attered by online piracy, the Universal Music Group, the world's largest record company, said yesterday that it would cut prices on compact discs by as much as 30 percent in an aggressive attempt to lure consumers back into record stores. The deep price cut — the only one to apply to new CD's since the format was introduced in the early 1980's — represents a gamble by Universal that more consumers will buy more CD's once the price dips below $13. It also reflects the profound degree to which Internet file-trading has managed to undermine the music business, Universal executives said.

"We are in the middle of a terrible situation where our music is being stolen," said Doug Morris, chairman of Universal, which includes labels like A&M and Island Def Jam and artists like Eminem, Elton John and U2. "We need to invigorate the market, and as an industry leader we felt we had to be bold and make a move." Under the new pricing scheme, Universal would lower its wholesale price on a CD to $9.09 from $12.02. The company said it expected retail stores to lower CD prices to $12.98, from the $16.98 to $18.98 they now charge, and perhaps to as low as $10. When CD's first arrived on the market they cost $15.98, and have climbed from there.

The result could be a broadening of the music market, which has contracted as prices have increased. Music consumers have complained for years that CD prices are too high, and many people who copy music online without paying for it cite high prices as the main reason. "Music is not supposed to be an elitist product," said Josh Bernoff, an analyst at Forrester Research. "We're not talking about Lexus here. It's better to have more people buying music at a lower price than to have it priced out of the market."
Source: New York Times

The Legal Niceties of Being Illegal

The debate about California's 'quasi-illegal' immigrants continues. Clearly the political postures are fairly predictable. It may not be unreasonable to suggest, for eg, that Davis sees votes in this one. On the other hand the security argument seems spurious, since registering - even for DL purposes - those who are in the country but unregistered should help not hinder security. Here in Spain the practice of giving a free health card to all who apply, regardless of status, means that the government has near-perfect statistics on undocumented immigrants. Indeed all of this does lead to an incredibly stupid bureaucratic tangle. One Bulgarian I know in Valencia - a dentist who lives by picking peppers and oranges - has the health card and is on the municipal register. He has no work or residence permit. When stopped by the local Guardia Civil they showed no interest in these latter details, but were simply concerned with why, after evidently having been in the country for over six months he had not changed his driving licence. For their pains he received a 500 euro fine, which represents about a months salary for him. A salary, of course, which he officially doesn't have. (BTW Spain does find itself, as we say here, between the sword and the wall on all this. The employers are well able to maintain a lot of otherwise uncompetitive activities with cheap (illegal) labour, while the government needs them (and the employers) to start paying social security contributions to keep the pensions system afloat.

A bill giving an estimated 2 million undocumented immigrants the ability to drive legally is on its way to Gov. Gray Davis after two days of legislative debate that showed the deep political rifts over illegal immigration. Opponents of the bill, approved 23-15 by the Senate on Wednesday and 43-30 by the Assembly late Tuesday, alleged it would help terrorists, while supporters accused its critics of racism. Although he has twice vetoed earlier versions of the bill, Davis has said he intends to sign this one, which returns the state to its pre-1994 practice of giving drivers' licenses to California residents without verifying that they are in the country legally. Davis aides have said the governor wanted to sign the bill all along, and that state law enforcement officials have grown more comfortable with it.

Many among California's growing Hispanic population have embraced the bill, and some critics say Davis changed his mind to pander to Hispanic voters for their support in the Oct. 7 recall election. One state senator, Republican Dennis Hollingsworth, said the bill would increase the nation's security risks "for a crass political purpose, to save a failed governor." Arnold Schwarzenegger, the actor turned Republican candidate for governor in the recall election, said in a statement that he opposes the bill. "The federal government has expressed security concerns over this measure, and in a time of heightened national security, we should not undermine our nation's immigration laws," said Schwarzenegger, an Austrian immigrant.
Source: Kansas City Star

'Sexing' is not Just a Problem With Poultry

'Sexing up' it seems is not just a problem with chickens: not a good day yesterday for the Blair government at the Kelly enquiry.

Experts working for Britain's defense intelligence agency complained last September that the government was exaggerating a public dossier on the threat posed by weapons of mass destruction in Iraq, a Defense Ministry official testified today. Chief among the experts' concerns was the reliability of the claim that Iraq could deploy chemical and biological weapons within 45 minutes' notice, according to Brian Jones, a retired senior official with the defense intelligence analysis staff. He said his staff of experts was wary of the fact that the claim was secondhand -- one unnamed Iraqi source quoting another unnamed senior military source; that it did not differentiate between chemical and biological weapons; and that there was no collateral intelligence to back it up. "We had not seen the weapons being produced," Jones told a public inquiry into the death of David Kelly, a British weapons expert caught up in the controversy over Britain's participation in the Iraq war. "We had no evidence of any recent testing or field trials and things like that. So that all cast some doubts in our mind on that particular piece of intelligence." Jones, along with an unnamed witness, questioned other parts of the dossier as well, including the claim that Iraq was still developing chemical weapons after U.N. weapons inspectors left the country in 1998. While the experts believed such development was occurring, they saw no conclusive proof to back the claim, he said. There was a tendency, Jones told the inquiry, to "shall we say, over-egg certain assessments in relation particularly to the production of [chemical warfare] agents and weapons since 1998 -- the difference between making a judgment that the production of CW agent had taken place as opposed to that judgment being that it had probably taken place or even possibly taken place."
Source: Washington Post

'Calpundit' Kevin Drum has a fairly reasonable take on all this:

It appears that Gilligan used information from a single source that he says he had reason to trust, he tweaked the wording to make it sound a bit more ominous than it was, and in the end it turned out that his specific charges were probably untrue. But regarding the infamous 45-minute claim, Tony Blair's dossier also used information from a single source that British intelligence says they had reason to trust, they tweaked the wording to make it sound a bit more ominous than it was, and in the end it turned out that their specific charges were untrue. This leads to a pretty obvious question for both sides: why is it OK for your guy to do this but not the other guy?

But then why am I so naive and dumb as to imagine the world might like to be a reasonable place?

Wednesday, September 03, 2003

Rogoff on Global Disinflation

The Jackson Hole papers have now been posted . Among them is a highly relevant and interesting one by Ken Rogoff about global disinflation and globalisation. As Rogoff indicates the last decade has seen an enormous reduction in the level and volatility of inflation almost across the board. The million dollar question is why. Clearly improvement in cenral bank policies and fiscal strategies may form part of the picture, but they alone certainly can't do sufficient heavy lifting to provide an adequate explanation. Rogoff's solution: globalisation and deregulation have reduced the effect of monopoly pricing, leading to reduced inflationary pressure. I think Rogoff has something here, but I don't think this is the whole picture, not by a long stretch. In particular there is the dificulty in assessing the impact of price reductions and increased competition in the traded sector on prices and productivity in non-tradeables. Still, the evidence of a long wave tendency towards historically low levels of inflation (or, of course, deflation) is compelling indeed. (BTW if the hard work was being done here by improved monetary policy, then inflation targeting - using the same effective central bank devices - should prevent deflation. So if it doesn't...........).

In recent years, inflation around the world has dropped to levels that, only two decades ago, seemed frustratingly unattainable. If one takes into account technical biases in the construction of the CPI and central banks’ desire to maintain a small amount of padding to facilitate relative price adjustment and help avoid deflation, then disinflation in most industrialized countries has already run its full course. Even in the developing world, if current trends persist, inflation will be tamed (if not virtually eradicated) within a decade. What factors explain this extraordinary shift?

Has the inflation process changed fundamentally? This paper argues that any explanation of the recent episode of disinflation has to take a global perspective, and recognize the near universality of the phenomenon. The story in the advanced countries is well known and has been widely discussed: inflation averaged 9% in the first half of the 1980s, versus 2% since the beginning of this decade. But the performance of the developing countries is even more remarkable, with inflation falling from a 1980-84 average of 31% to an average of under 6% for 2000-03. From 1990-94, inflation in Latin America averaged over 230%, over 360% in the Transition economies, and roughly 40% in Africa. For 2003, all three regions are projected to have inflation around 10%.

The data are even more stunning when one looks at individual countries. In the 1970s, 1980s and 1990s, high inflation and hyperinflation countries abounded, especially in Latin America, Africa and the Transition economies. Argentina’s price level has increased a 100 trillion times since 1970, Brazil’s a quadrillion (thousand trillion), and the Democratic Republic of the Congo’s almost 10 quadrillion.2 Today, of the IMF’s 184 member states, only 11 are projected to have inflation over 20% in 2003, and only 6 over 30%. If one takes the 40% inflation threshold that some researchers have argued is particularly damaging to economic growth3, only Mynamar (40%) Angola (over 75%) and Zimbabwe (over 400%) seem reach or exceed this level in 2003..............

The global economy now appears immersed in a long wave of low inflation, but experience suggests that many factors, notably heightened conflict that reverses globalization, can bring it to an end.............

There is little controversy about the fact that improved central bank design has been a major factor in improved inflation outcomes, and I will not try to parse the different elements (greater independence, better communication strategies, improved techniques, etc.) here. My main focus is on whether other factors such as more prudent fiscal policies, higher productivity growth, deregulation, and increased globalization may have also contributed to make disinflation both less painful and more successful than would otherwise have been the case. Has the success of global monetary authorities in engineering lower inflation had anything to do with having the wind at their backs?

I shall argue that the most important and most universal factor supporting world-wide disinflation has been the mutually reinforcing mix of deregulation and globalization, and the consequent significant reduction in monopoly pricing power. This increased competitiveness lowers the gains a central bank can reap via unanticipated inflation because it reduces the gap between the economy’s monopolistically competitive equilibrium and the socially desirable competitive equilibrium..................

One view of the past fifty years is that the monetary authorities just got bamboozled by bad Keynesian theories in the 1960s and 70s. The great inflation of the 1970s and 1980s was the by-product of macroeconomic teaching malpractice. Once the world’s central bankers started coming to their senses in the 1980s, ending inflation was just a matter of communication and technique. Perhaps, but this interpretation probably gives too little credit to previous generations of policymakers, and too much credit to modern day monetary authorities, not to mention 1980s monetary theory. The global nature of modern disinflation suggests looking elsewhere..............

There are, of course, several examples of countries where inflation has been coming down despite rising deficits and debt ratios. India has been recording general government deficits of roughly 10% of GDP for almost half a dozen years now, yet inflation has declined. Recession-ridden post-1980s-bubble Japan, with sustained deficits of 6-7% of GDP and a debt/GDP ratio exceeding 150%, is actually experiencing deflation. More generally, as Reinhart, Rogoff, and Savastano (2003) document, many emerging market and developing country economies have seen a substantial buildup in market-based debt over the past fifteen years, due to various factors including financial liberalization (e.g., paying market interest on debt formally forced on banks at sub-market interest), lower tariffs and, in some cases, higher government budget deficits. Yet most of these economies have succeeded in lowering inflation.

Unexpected productivity growth at least temporarily reduces pressure on the central bank to inflate.........True, the productivity story works well for the United States since the latter half of the 1990s. However, in its simplest form, the productivity hypothesis falls far short as an explanation for global disinflation. In the case of Europe, for instance, the simple correlation goes the wrong way, with inflation falling through most of the period, yet trend productivity
growth declining as well. Indeed............amongst the largest European economies, productivity growth slowed substantially in the second half of the 1990s, continuing the trend decline in the largest continental economies. In the developing world, productivity – especially in traded goods – probably has been a factor in many cases, though it is hard to separate it from globalization.......

There is little question that in many economies, the mutually reinforcing effects of globalization, deregulation and widespread reduction of the role of government, have sharply increased competition, and lowered “quasi-rents” to monopolistic firms and unions. Blanchard and Philippon (2003), drawing on results from a broader OECD study of deregulation (Nicoletti et. al., 2000, 2001), argue that quasi-rents in the OECD have fallen steadily since the 1970s.

A reduction in monopoly pricing power per force leads to lower real prices, holding monetary policy constant. Monetary authorities can, of course, offset the nominal price level effects of this impulse by suitably adjusting monetary policy to stabilize inflation. As I elaborate below, however, they will generally choose to let some of the effects pass on to lower inflation......

Trade with emerging Asia has certainly put downward pressure on the real cost of goods, that is, workers in most countries can now buy more with a given income than prior to globalization. Although China alone accounts for 5% of world trade, emerging Asia combined accounts for almost 20%. The exact quantitative impact of Emerging Asia’s growing trade on global prices, however, is difficult to estimate, in part because there are large indirect effects in addition to the direct effects. For example, even though traded goods arguably only constitute at most 20-25% of US GDP (Obstfeld and Rogoff, 2000), sharp reductions in traded goods prices almost surely have spillover effects to other sectors. Many traded goods are intermediate goods (e.g., computers), and also there is some degree of substitution between various traded and non-traded goods.

Crooked Logic

Last week I posted a short piece about the Californian Democrat politician Cruz Bustamante. I said the follwing: "While everyone esle seems worried about where big Arny would take the golden state, deap seated changes which seem to revolve around the rise of the Chicano vote, do seem to be on the horizon. Tacitus's question about just why Bustamante hasn't renounced this part of his past seems a perfectly reasonable and legitimate one". Well yesterday I trolled over to the normally ultra-reasonable Kevin Drum to find that a new member of the 'crooked crew' - Ted Barlow - had a long takedown of the absurd MEChA baiting recently invented by desperate right wingers afraid that Cruz Bustamante might win the recall election . My god, I thought, I've put my foot in it, I've been doing some 'absurd Mecha baiting' and now I'll have to pay for my sins. (I'm not especially desperate, and I certainly don't consider myself to be 'right wing' - although I have defended Alan Greenspan, Marty Feldstein and Greg Mankiw, so I guess in some peoples little books that makes me as good as).

So off I went to see this 'long takedown' and frankly I was appauled by what I found. What we have from Barlow is a piece which is long on invective - the term bullshit is one of his favourites and (as Juan Non-Volokh and Tacitus have shown) short on fact - including the incredibile detail that he googled in English for his MEChA research. Rather than addressing the question of why Bustamante stayed silent for so long, what Barlow does is try to suggest there is nothing to worry about. Except that there is this awkward little phrase 'por la raza todo', which may have sounded just fine at a time when the Black Panthers and Malcolm X were all the rage, but somehow doesn't seem to fit in in the new multi-cultural, diversity-open US of A. (Incidentally check out the official Bustamante disavowal of his past and see if you are convinced). Both Lionel Jospin and Joschka Fisher have had to take a lot heat for opinions they once held, and their political careers have continued, I don't see why the case of Bustamante should be any different. We all love poking fun at Big Arny and his apparently sexist past, but surely what is sauce for the goose is also sauce for the gander.

Is all this a 'typical example of the tendency of blogland to get bogged down in trivia'? I don't think so. I have no idea who will make the best governor of California (I don't even know if it would be Davis), what concerns me are political standards, and even-handedness in criticism, and that the Barlow approach applies just the same 'guilt by association' technique to Tacitus (who after all originated the story) as he suggests Tacitus applies to Bustamante. In conclusion, una de cal y una de arena, as we say in Spanish. First Tacitus's own explanation - which I agree with, and don't dare miss the Sims link - and a piece I fished from the comments section of CT. The latter makes a point which needs to be made, the Chicanos had one hell of a rough time and deserve all our respect and consideration (I was busy listening to Arlo Guthrie, Pete Seeger and Joan Baez at the time in question) but this is no reason to adjust downwards our standards of debate.

First Tacitus

In answer to your question, Matthew, the issue is not whether Bustamante is personally racist, nor whether "the nation is threatened by a rising tide of Latino fascism." The former is probably not true, and the latter is almost definitely not true. I took care to disassociate myself from the wacky theories of Lowell Ponte and the nutball American Patrol from the get-go, and I still do.

The problem with Bustamante's affiliation with MEChA is that the group itself does indeed espouse and abet sentiments and principles that may be justly described as racist or secessionist. Source documents and citations in the posts above. A common rebuttal to this is that most Mechistas don't actually act on these sentiments or principles; however, this is not a moral defense, but an argument from efficacy. I'd assume that wrong is wrong whether it works or not. (Certainly that was the just basis for the condemnation of Dave Sims .)

Bustamante's unwillingness or inability to disassociate himself from MEChA over those concerns -- or even to acknowledge that those concerns exist -- is deeply disappointing. It shows, at best, a lack of comprehension on his part. At worst, it shows a lack of character. As a Republican who denounces neo-Confederates, it would be hypocritical of me to not apply the same standards to Cruz Bustamante.

Now Tanglebum from the comments section

I don’t know anything about Bustamante’s politics. I think the odds are pretty high he did some deals along the way. He endorses Lieberman. But he is hispanic, Latino, Mexican. Mestizo the way a lot of Californianos use it means the Indian Spanish mix. But if you look at most of the ‘Mexicans’ washing dishes banging nails running leaf blowers, they’re Indians. With Spanish surnames. I remember a labor bus hit by a train back in the 60’s. Those guys were working for next to nothing, then they were gone. The Salinas valley press treated it like a truck load of chickens spilled on the highway. There’s no historical record of what it was really like, it’s all in the memories of people who were there. Then they get old and the history’s gone. Talking about it is reliving it. So it isn’t there in the minds of the young, in the minds of the sheltered and privileged who never saw it when it was happening. It’s off topic I know. But really that’s what we mean when we say racism. It’s been bowdlerized to mean you couldn’t get a job, or a nice house. But it was much much worse than that.

Escaping From Global Deflation

There is nothing especially fresh in the link you will find below. In fact I'm looking around for material on deflation and I came across this piece from Rogoff back in July. However it does have the virtue that he tries to address the problem of general deflation, recognises that collective devaluation won't work, and suggests a strategy of collaboration between the three principal central banks to implement generalised monetary easing. He also notes the balance sheet consequences for the government of the central bank buying treasury bonds, stating that focussing on the consolidated government balance sheet (rather than taking each part separately) " explains why it is nonsense for the public to worry excessively when the Bank of Japan suffers capital losses on its holdings of long-term government bonds. The Bank's loss is the Ministry of Finance's gain, and both are ultimately owned in full by the Japanese taxpayer".

He does however rather let the cat out of the bag when he deals with the dangers of precipitating major inflation: "inflation might temporarily spike, but as soon as it does, interest rates will shoot up above zero, the BOJ will be out of its liquidity trap, and will once again be able to use standard monetary policy tools". This assumption that the central bank will rapidly adjust rates once the economy emerges from deflation is precisely what makes it difficult to convince market participants of the reliability - working backwards from looking forwards - of central bank 'irresponsibility', and hence what makes it so hard to get out of the liquidity trap right now in Japan.

So how to get out of global deflation in the unlikely scenario that it happens? For Japan—where despite recent developments, the IMF reports warning that deflation could easily still worsen remain valid—many observers believe that only way out of its deflation is through yen depreciation. At some level this must be right. Whatever route the Bank of Japan ultimately takes to conquer deflationary expectations—whether it be buying stocks, JGBs, or foreign exchange—the yen will likely fall sharply. Such action may be seen as manipulating the exchange rate in beggar-thy-neighbor fashion. After five years of deflation, however, the rest of the world—and certainly the IMF—should not complain too much about such a policy.

But if all the major regions were mired in deflation, they cannot all simultaneously depreciate their exchange rates, so this door out is closed. Would this be fatal? No, it should not be. A clear communication strategy that all three major central banks are deeply committed to restoring positive inflation, would go a long ways towards putting a floor under deflation expectations. It is not necessary to adopt any narrowly-construed version of inflation targeting—indeed escaping from deflation is sufficiently tricky it would be very hard to deliver on a target. But central banks can and should specify their long-term (five- to ten-year) inflation objectives. Aggressive quantitative easing worked in the 1930s, when those countries that abandoned the shackles of the gold standard and inflated their economies were largely far more successful than those that clung to gold. If all three major central banks acted in concert, there would not have to be dramatic exchange rate movements, although admittedly the yen might still depreciate since Japan is now in the deepest hole.

I admit that the central banks of the world would have a hard time calibrating their escape from deflation. Quantitative easing does eventually lead to inflation, but the relationship is not nearly as smooth or reliable as economists such as Milton Friedman once believed. Modern central banks rightly prefer to work with interest rates. Of course, as interest rates approach zero, this method begins to fail. Printing piles of currency will surely end deflation: the problem is how to avoid overshooting and ending up locked in high inflation. Should people in Japan worry that an overly aggressive exit from deflation will lead to the kind of horrific inflation levels that Japan suffered after the War? I don't see it, especially given the large output gap. Inflation might temporarily spike, but as soon as it does, interest rates will shoot up above zero, the BOJ will be out of its liquidity trap, and will once again be able to use standard monetary policy tools. Any inflation overshoot should be fairly temporary and relatively manageable. One has to acknowledge there are many risks to this strategy. However, there may be even greater risks to trying to live with deflation indefinitely.

The Immigration 'Palliative'

In the mailbox, Hans is puzzled:

if I understand what I read these days the following is happening: in the U.S. insider stock sales are at a historical high, the Asian stock boom is largely due to foreign investors and Asian central banks buy treasuries to prop up the dollar.

I think he's got the picture just about straight. Confusing isn't it. So much for perfect information. Maybe it is more a case of 'the grass is always greener'.....BTW: the Chinese are going to offer to buy more US treasuries to try and keep Snow happy.

Hans also sent me this point when I was away on holiday:

Have you ever checked the Swiss picture ? I remember (maybe falsely) that the first immigrant generation already adapts perfectly to the native birth rate.

I don't know too much about Swiss demographics, but it is on my hitlist of countries who could suffer deflation in the not too distant future. The point about changing migrant fertility seems in harmony with other data I have. In the final analysis fertility is dropping across the whole planet (although, there are of course some extreme outliers). The rapid rise in population has more to do with declining mortality these days. So logically the 'spread' will reduce.

On the other hand Hans may be saying that since immigrants in Switzerland adapt their fertility rapidly to the 'domestic' model, immigration won't work as a 'solution' to ageing and deflation. Long run I'm sure he is right, but in the short run we have two problems to contend with, the ageing process itself, and the 'generational gift' made when setting up the modern pension funds. This gift assumed permanent population growth. Now we have to adapt to an ageing society, to get the young people to start setting funds aside for paying their own pensions, and find a way to give pensions to those - over 50 say - who have already paid for the pensions of others.

It is as a 'paliative', to help sustain growth and buy time to make the generational transition that I am proposing systematic immigration for Europe. It is only a way of postponing the inevitable, but this postponement might make the process less painful. I certainly hope so, and I don't see any other realistic proposals on the table.

What New Sector?

Barry over at Big Picture has got the message - "Employment remains the biggest sore spot in this economy. Outsourcing, globalization, improving productivity, and declining manufacturing base continue to pressure employment numbers. When manufacturing jobs moved overseas, workers were able to retrain in new economy/service jobs. As those jobs migrate to the lowest cost provider, it’s not yet apparent what new sector will step up to absorb these newly idled workers." He also has a good resume of the dynamic problems facing the US economy.

More on The Idea of 'World GDP'

Ever since Dave raised the question of Stephen Roach's problematic use of the idea of world GDP (and here ) I haven't been able to get the thing out of my head. Yesterday it came back again:

In all my years in this business, I’ve never come across such a worrisome and potentially lethal confluence of imbalances. For starters, they are global in scope. A lopsided world economy has never been so dependent on one growth engine — the United States. Over the seven-year 1995 to 2002 interval, revised figures now indicate that the US accounted for fully 96% of the cumulative increase in world GDP (at market exchange rates); that’s nearly three times America’s 33% share in the global economy.

In other words, outside of the United States, the rest of the world accounted for only 4% of the cumulative increase in global GDP over the seven years ending in 2002. While the strength of the dollar has exaggerated America’s contribution to world GDP growth over this period, there can be no mistaking the extraordinarily narrow base of this US-centric global growth dynamic.
Source: Morgan Stanley Global Economic Forum

Now that I am alerted to it, there is clearly something wrong here. The US responsible for 96% of global growth, this is absurd. The problem I think lies with the dubious use of the market exchange rates concept of World GDP (again see here). But the more I look the more I find problems. Take the following, for example:

In a US-centric world, export support is the rule not the exception. The more economies suffer from a deficiency of domestic demand, the more dependent they become on external support from world trade and on the currency underpinnings of such a growth dynamic. Make no mistake — this is a global phenomenon. Over the 1995 to 2002 period, worldwide growth of exports (goods and services) accounted for fully 50% of the cumulative increase in global GDP.

This seems fine? Well think about it for a moment. Apparently, collectively, economies suffer from a deficiency of domestic demand, yet manage to export. How is this possible? If we are all short on demand, how can we sell to the others, who also lack domestic demand? Well the answer is pretty obvious really: globalisation. The globalisation process means that export/import penetration is becoming more important in each and every economy. But that is why esport lead growth is becoming more and more important: because your exports must be someone else's domestic demand. So what Roach is really saying is that we are becoming more and more dependent on the extension of globalisation to drive growth and increasing economic welfare. Fine, then let's say that and not something else. Am I too much of a stickler here? I don't know. I'm a Roach admirer, but I think we should have the highest - not the lowest - standards with those we admire. The real problem is that Roach is good on instinct, but short on theory and explanation. As he says, if he feels the way he does, it's because he's a 'card carrying skeptic'. The global growth slowdown is real, but he hasn't got through to the explanation yet. Europe and Japan are getting stuck in the mud but what exactly are the "reforms that are needed to unshackle domestic demand". China and India will eventually bring about a 'global rebalancing', but this, alas, may not take the form which Roach himself is anticipating.