Economic Dreams - Economic Nightmares

Brad Setser Argues Against the China Decoupling Thesis

Yesterday Brad Setser challenged those who cling to the China decoupling thesis. In short, Setser suggested that China's growth continues to be export led, and that domestic demand is "actually weaker than it was in 2003 and 2004". The only change is that exports are more to Europe than to the US. Setser punctuates his argument with this graph from what he calls "an excellent November 12 paper by Goldman Sachs' Hong Liang":

China: GDP v. "Domestic Demand"

Setser:

… China has decoupled to a degree from the US over the past two years. The US hasn't been the engine of demand growth globally over the past two years.The US hasn't been the engine of demand growth globally over the past two years. Net exports only subtracted 0.1% from US GDP in 2006, and they contributed 0.5-0.6% to US GDP in 07 [PDF, 14 pp.]. US import demand has slowed -- with real imports in 2007 growing more slowly than real consumption (in part due to the fall in residential investment). Europe, by contrast, has emerged as an engine of demand -- growing more rapidly than the US [$] . That has meant that China has shifted from relying on US demand to relying on European demand. Up until now, China has offset the slowdown in the pace of growth in its exports to the US with strong growth in its exports to other parts of the world.

For China to help support the global economy during a potentially rough period -- and for the world's imbalances to shrink on a sustained basis -- China needs to grow entirely on the basis of domestic demand.

It will prove interesting to see how things play forward in China as the pretty-much-guaranteed US slowdown proceeds and as continuing financial disclosures threaten to worsen the ongoing financial meltdown.

P.S. By contrast, George Soros argues in favor of the Decoupling Thesis, in The Sixty-Year Storm, while maintaining that the upcoming day of reckoning for the US will be long and deep as a sixty year cycle of euphoria unwinds.

Exports Stalling: Dreams Trending Again Toward Nightmares

After giving some of us — me — a bit of hope re: declining dollars, credit bubble problems, and import/export markets, Paul Krugman retreats from his optimism that the export market might save us. Following leads from the ever-watchful Brad Setser, Krugman points to stalling US exports. Earlier, Krugman helped us understand better why the Fed is less-than-empowered to "fix" this mess, given that the Fed's actions to pump up the now-faltering housing market lured us into the mess. Looks like were caught in a Liquidity Trap. Yes? No? Here's Krugman:

Maybe exports won’t save us, Paul Krugman, Jan. 11 I’ve pointed out that rising exports, thanks to the weak dollar, were what allowed the US to avoid slipping into recession up through 3rd quarter 2007. But Brad Setser points out that real exports have stalled over the last few months (this is monthly non-petroleum exports in 2000 dollars, seasonally adjusted):

Stalling exports

These data do bounce around, but it sure looks like export growth is stalling just when we need it to offset further declines in housing, consumer spending, and more.

Krugman on the impotence of Monetary Policy—amid housing bubble collapse:

Worries about the Fed (a wonkish post), Paul Krugman, Jan. 11 The signs point increasingly to an imminent, or perhaps already begun, recession. Ben Bernanke has in effect pledged to do whatever is necessary. But does the Fed have what it takes? … Monetary policy mainly exerts its influence through housing: high interest rates squeeze home construction, low rates encourage it. Interest rates have much less direct effect on business investment. The reason? Housing lasts much longer. …

[H]ere’s what normally happens in a recession: the Fed cuts rates, housing demand picks up, and the economy recovers.

But this time the source of the economy’s problems is a bursting housing bubble. Home prices are still way out of line with fundamentals:

CBO price-rent ratio

So: is it even possible for the Fed to cut interest rates enough to create a renewed housing boom? (The Fed can cut the overnight rate all the way to zero, but even large changes in the overnight rate can have only modest effects on mortgage interest rates, if the market perceives those changes as temporary.) If it can’t, how much can the Fed really do to help the economy?

Those aren’t rhetorical questions. I’m actually not sure how bad things will get — remember, we still have help from booming exports. But it’s not too hard to tell stories in which monetary policy doesn’t have enough mojo to deal with our current problems.

Can the Export Market Save US?

If anyone would have asked me if we could have "devalued" ourselves out of our US-led financial mess, what with the irrational exuberance of the 90s and the warmongering of the 00s, I would have said, "No Way!" But we may have done so, albeit it at a cost, i.e. an increasingly stressed working poor and middle class.

Paul Krugman opened his blog this year by unveiling information as to how US exports may have buffered the worst (so far) of problems from a faltering US housing market:

Did we dodge a bullet? Paul Krugman, Jan 1: In a recent post I pointed out that up through the third quarter of 2007 rising exports had roughly offset the impact of the housing bust. Here’s the chart again. (By the way, all of the data come from the Bureau of Economic Analysis, which has fairly easy-to-use interactive data tables.)

Exports (red) versus housing (blue), % of GDP

So did the U.S. economy dodge a bullet?

Yes, it did — which is why I haven’t been as sure about a looming recession as, say, Larry Summers or Marty Feldstein, let alone Nouriel Roubini. (No, I’m not always a doom and gloom guy — only when the situation warrants, which has been pretty often lately.)

While we dodged a bullet, however, there are between one and three more bullets headed our way.

First, housing has further to fall. There’s been a further plunge in building permits and starts since the credit crunch began in August; these take a while to be reflected in construction spending, so there’s a fresh hit to GDP definitely in the pipeline. Even now, residential investment as a share of GDP is only down to its long-run average; you’d expect it to fall below that average for an extended period.

Second, there are hints of a slump in business investment, especially commercial real estate, which seems to have had a bubble of its own and is feeling the effects of the credit crunch.

Third, there are hints that consumers have finally started to cut back.

On the other hand, exports still seem to be growing fast.

So I’m actually uncertain about where things go this year.

But as Krugman points out, we are going to have to wait and see how bad the fallout is from "consumers starting to pull back," from "slumps in business investment" as folks try to navigate their way through the credit crunch, and as the US housing sector continues to falter. We do indeed live in "interesting times."

Naomi Klein on: 'Shock Doctrine' and Greenspan

{Updated 9/30}

Naomi Kleins' book, The Shock Doctrine: The Rise of Disaster Capitalism is nothing if not controversial. So is Klein. Commentary surrounding Klein's book is raising important questions as to what effect activist economists have on politics. Those familiar with Robert Heilbroner's works, e.g. The Worldly Philosophers, Behind the Veil of Economics already know well what impact the most well-known and powerful economists have on politics.

In The Shock Doctrine Klein takes on Milton Friedman and "the Chicago boys", blaming them for planting the seeds of so-called free-market capitalism in the minds of disciples, paving the way for alleged "crony capitalism" that followed. William Grieder's appraisal of Friedman is also damning. So is Joseph Stiglitz's, in his "Bleakonomics" review of Klein's The Shock Doctrine. Here's Alexander Cockburn's review , which views Friedman in a slightly less evil light. Yesterday, Klein took on Alan Greenspan:

Greenspan and the Myth of the True Believer, Naomi Klein, The Nation,Sept. 27: … Since I began touring with my book The Shock Doctrine, I have had a number of exchanges like this, revolving around the same basic question: When hard-right political leaders and their advisers apply brutal economic shock therapy, do they honestly believe the trickle-down effects will build equitable societies--or are they just deliberately creating the conditions for yet another corporate feeding frenzy? Put bluntly, Has the world been transformed over the past three decades by lofty ideology or by lowly greed?

A definitive answer would require reading the minds of men like Dick Cheney and Paul Bremer, so I tend to dodge. The ideology in question holds that self-interest is the engine that drives society to its greatest heights. Isn't pursuing their own self-interest (and that of their campaign donors) compatible with that philosophy? That's the beauty: They don't have to choose. Unfortunately, this rarely satisfies graduate students looking for deeper meaning. Thankfully I now have a new escape hatch: quoting Alan Greenspan.

His autobiography, The Age of Turbulence, has been marketed as a mystery solved: The man who bit his tongue for eighteen years as head of the Federal Reserve was finally going to tell the world what he really believed. And Greenspan has delivered, using his book and the surrounding publicity as a platform for his "libertarian Republican" ideology, chiding George W. Bush for abandoning the crusade for small government and revealing that he became a policy-maker because he thought he could advance his radical ideology more effectively "as an insider, rather than as a critical pamphleteer" on the margins. Yet what is most interesting about Greenspan's story is what it reveals about the ambiguous role of ideas in the free-market crusade. Given that Greenspan is perhaps the world's most powerful living free-market ideologue, it is significant that his commitment to ideology seems rather thin and perfunctory--less zealous belief, more convenient cover story.

Much of the debate around Greenspan's legacy has revolved around the matter of hypocrisy, of a man preaching laissez-faire who repeatedly intervened in the market to save the wealthiest players. The economy that is Greenspan's legacy hardly fits the definition of a libertarian market but looks very much like another phenomenon described in his book: "When a government's leaders routinely seek out private-sector individuals or businesses and, in exchange for political support, bestow favors on them, the society is said to be in the grip of 'crony capitalism.'" He was talking about Indonesia under Suharto, but my mind went straight to Iraq under Halliburton. Greenspan is currently warning the world about a dangerous looming backlash against capitalism. Apparently, this has nothing at all to do with the policies of negligent deregulation that were his trademark. Nothing to do with stagnant wages due to free trade and weakened unions, nor with pensions lost to Enron or the dot-com crash, or homes seized in the subprime mortgage crisis. According to Greenspan, rampant inequality is caused by lousy high schools (which also has nothing to do with his ideology's war on the public sphere). I debated Greenspan on Democracy Now! recently and was stunned that this man who preaches the doctrine of personal responsibility refuses to take any at all.

Yet ideological contradictions are only relevant if Greenspan really is a true believer. I'm not convinced. Greenspan writes that as a student he had no interest in big ideas. Unlike his classmates who were in the thrall of Keynesianism with its promise of building a better world, Greenspan was simply good at math. He started doing research for powerful corporations; it was profitable, but Greenspan made no claims to a higher social contribution.

Then he discovered Ayn Rand. "What she did…was to make me think why capitalism is not only efficient and practical, but also moral," he said in 1974.

Rand's ideas about the "utopia of greed" allowed Greenspan to keep doing what he was doing but infused his corporate service with a powerful new sense of mission: Making money wasn't just good for him; it was good for society as a whole. Of course, the flip side of this is the cruel disregard for those left behind. "Undeviating purpose and rationality achieve joy and fulfillment," Greenspan wrote as a zealous new convert. "Parasites who persistently avoid either purpose or reason perish as they should." Was it this mindset that served him well as he supported shock therapy in Russia (72 million impoverished) and in East Asia after the 1997 economic crisis (24 million pushed into unemployment)?

Rand has played this role of greed-enabler for countless disciples. According to the New York Times, Atlas Shrugged, her novel that ends with the hero tracing a dollar sign in the air like a benediction, stands as "one of the most influential business books ever written." Since Rand is simply pulped-up Adam Smith, her influence on men like Greenspan suggests an interesting possibility. Perhaps the true purpose of the entire literature of trickle-down theory is to liberate entrepreneurs to pursue their narrowest advantage while claiming global altruistic motives--not so much an economic philosophy as an elaborate, retroactive rationale.

What Greenspan teaches us is that trickle-down isn't really an ideology after all. It's more like the friend we call after some embarrassing excess so that they will tell us, "Don't beat yourself up: You deserve it."

For more Shock Doctrine (and commentary) see:

The Guardian, Shock Doctrine minisite

Joseph Stiglitz's NY Times review, "Bleakonomics",Sept 30:

… Some readers may see Klein's findings as evidence of a giant conspiracy, a conclusion she explicitly disavows. It’s not the conspiracies that wreck the world but the series of wrong turns, failed policies, and little and big unfairnesses that add up. Still, those decisions are guided by larger mind-sets. Market fundamentalists never really appreciated the institutions required to make an economy function well, let alone the broader social fabric that civilizations require to prosper and flourish. Klein ends on a hopeful note, describing nongovernmental organizations and activists around the world who are trying to make a difference. After 500 pages of "The Shock Doctrine," it's clear they have their work cut out for them.

It's Managed Trade, Not Free Trade

Yves Smith recently spotlighted so-called 'Free Trade' that puts a mask on the reality of 'Managed Trade' in our political economy. It's worth a look, as are embedded reference materials. Via Naked Capitalism:

The Truth about Free Trade: Small Net Gain, Big Redistribution, Yves Smith, Sept 17: Consider the ironies in the discussion of free trade. It's widely depicted by economists to be a good thing, and anyone who opposed it is considered to be economically illiterate. Yet the system we have deviates considerably from the free trade ideal and is more accurately called managed trade. And in this system of managed trade, other countries seem to do a better job of protecting their labor markets and achieving trade surpluses than we do.

In particular, Harvard's Dani Rodrik has shed a good deal of light on this topic. In one post, he set forth the conditions that have to be in place for trade liberalization to enhance economic performance (short answer, a lot); in another, he reviewed the analyses that claimed that our current trading system produced large economic gains and found the logic to be badly flawed.

The advocates of more open trade are particularly upset at the growing backlash against globalization, which they see as retrograde and self-destructive (funny how the same citizens who are viewed as savvy economic actors when they function as consumers are regarded as morons as far as their labor market attitudes are concerned). But if you are, say, an auto worker, being against more open trade is a perfectly sensible position.

The trade liberalization advocates would say that anti-trade auto worker and call center employees are simply selfish. Yes, they wind up as losers, but the collective gains outweigh the losses. But since there are not mechanisms to make sure the gains are shared, the losers have legitimate concerns.

Dani Rodrik turns to this topic via comments on a new paper by Robert Driskill, "Deconstructing the Argument for Free Trade." Driskill finds the arguments for more open trade to be doctrinaire and dismissive of the impact of redistribution. As Rodrik tells us:

Driskill is a distinguished economist who knows the theory of comparative advantage as well as anyone else. And his argument is not against trade per se, but about the manner in which economists present their arguments in public and in their textbooks. His main argument is that the standard renditions

gloss over a key issue the resolution of which is anything but obvious: What does it mean for a change in economic circumstances to be "good for the nation as a whole", even when some members of that nation are hurt by the change?

In other words, instead of sticking to what they are good at—analyzing trade-offs—economists typically engage in amateur normative political theorizing about what is good for society.

Driskill also makes a more fundamental point:…

My point is not that the economics profession is not on the side of angels in the policy debate over trade liberalization—although I will argue that a more careful argument should lead to a more nuanced view—but that the argument is poorly made. This reflects negatively on the credibility of the economics profession as a whole: critical thinkers might believe all economic arguments are as poorly supported as is the one in support of free trade; others might believe economists are mere propagandists and handmaidens in service of some philosophical or political goal. Furthermore, it obscures some key ideas that should be part of a persuasive argument in support of free trade. And finally, it has confused many people into false beliefs about what economic analysis really says about the effects of international trade.

A pervasive such false belief, for example, is that trade necessarily benefits more people than it hurts.

Driskill illustrates his arguments by drawing on the writings of a range of economists, from Deirdre McCloskey to Paul Krugman. …

{Update 4:06 PM} Related:

Introducing this Blog, Paul Krugman, 09/18/07

Democracy - Not "The Free Market" - Will Save America's Middle Class, Thom Hartmann, 03/12/04

Snip from Krugman, via DeLong:

… [L]et me start this blog off with a chart that’s central to how I think about the big picture, the underlying story of what’s really going on in this country. The chart shows the share of the richest 10 percent of the American population in total income – an indicator that closely tracks many other measures of economic inequality – over the past 90 years, as estimated by the economists Thomas Piketty and Emmanuel Saez….

The Long Gilded Age:… In many important ways, though, the Gilded Age continued right through to the New Deal…. Public policy did little to limit extremes of wealth and poverty... working Americans were divided by racial, religious, and cultural issues…. The Great Compression: The middle-class society I grew up in… was created, in a remarkably short period of time, by FDR and the New Deal…. [I]ncome inequality declined drastically from the late 1930s to the mid 1940s…. Middle class America: That’s the country I grew up in… a society without extremes of wealth or poverty… of broadly shared prosperity, partly because strong unions, a high minimum wage, and a progressive tax system helped limit inequality… a society in which political bipartisanship meant something… in spite of the sinister machinations of Nixon and his henchmen…. The great divergence: Since the late 1970s the America I knew has unraveled. We’re no longer a middle-class society, in which the benefits of economic growth are widely shared: between 1979 and 2005 the real income of the median household rose only 13 percent, but the income of the richest 0.1% of Americans rose 296 percent.

Most people assume that this rise in inequality was the result of impersonal forces, like technological change and globalization. But the great reduction of inequality that created middle-class America between 1935 and 1945 was driven by political change; I believe that politics has also played an important role in rising inequality since the 1970s…. no other advanced economy has seen a comparable surge in inequality – even the rising inequality of Thatcherite Britain was a faint echo of trends here.

On the political side, you might have expected rising inequality to produce a populist backlash. Instead, however, the era of rising inequality has also been the era of “movement conservatism,” the term both supporters and opponents use for the highly cohesive set of interlocking institutions that brought Ronald Reagan and Newt Gingrich to power, and reached its culmination, taking control of all three branches of the federal government, under George W. Bush… taxes on the rich have fallen, and the holes in the safety net have gotten bigger, even as inequality has soared. And the rise of movement conservatism is also at the heart of the bitter partisanship that characterizes politics today….