Macroeconomic models – a new approach needed.

The recent David McWilliams podcast entitled Humanomics discusses how economists have struggled to make accurate decisions as Ben Bernanke’s recent report on the Bank of England’s failures show. He states that economists need to get out more and uses the example of when he worked as an economist for the Irish Government. Whilst calculating the GDP forecast for the Irish economy using all sorts of formulae a senior economist told him to look out the window at the number of cranes in the skyline as that will give you an idea of what is going on in the economy. He compares the beauty of the exactness of the formula against the truth of what is really happening in the economy.

A blind faith in mathematical precision has clouded our judgment. Humans are messy and economics is about humans, so let’s be messy.

In 1776 Scottish economist Adam Smith talked of the economy as the invisible hand. Here he emphasized the self-regulating nature of the economy as individuals, firms and companies independently seek to maximize their gain which may produce the best outcome for society as a whole. The capitalist systems seems to rely more on the relentless growth of consumer spending and, although it can lead to dramatic improvements in standard of living, it does require people to become resolutely addicted to products/services and be prepared to get into significant debt.

Today, an economy is a much more intricate machine which aims to allocate scarce resources to satisfy the utility of economic agents such as individuals, firms and government. The dominant model for many years has been “Dynamic Stochastic General Equilibrium” (DSGE) and it takes all the characteristics of an individual (this person is typically called the representative agent) which is then cloned and taken to represent the typical person in an economy.

Therefore it assumes that all individuals and firms have identical needs and wants which they pursue with total self-interest and complete knowledge of what they desire. DSGE also takes into account the impact of shocks like oil prices, technological change, interest rates, taxation etc. However a couple of areas that it doesn’t represent accurately is the financial sector and the instability of markets – booms and slumps. A new task will be to include the banking sector into the models as macroeconomists assumed it to be a screen between savers and borrowers rather than profit orientated organisations prepared to take big risks with increased leverage and sub-prime lending. For example as house prices increase banks are willing to lend more money to speculators who bid up the price above what is the fundamental value. The opposite applies if banks become more risk adverse and marginal buyers are forced out of the market causing prices to drop. By representing the financial sector in an economic model you go some way to help solve the major problem with DSGE and other models in that they are useful only if they are not unsettled by external factors like a banking crisis.

Keynes said “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”. To achieve this there needs to be structural reform in the discipline.

Agent-based modeling

An emerging field called agent-based modelling has grabbed the attention of some economists. This is where large amounts of data is collected from individuals who are unique to each other in they have different motives and actions in the market place. The behaviour of these individuals overlap and interact which generate predictions through a messy process but similar to what happens in real life, unlike DSGE and the clean old-fashioned macroeconomic models. Agent-based modeling has also shown promise in other disciplines like Physics and involve real-world problems. The example used by John Lanchester (New York Times magazine) is how Brazil nuts seem to end up towards the top of the mixed-nut package and nut research has since found real-life applications in industries such as pharmaceuticals and manufacturing.

With a better sense of what is influencing behaviour in the economy, economists might become less blinkered by their own theory, and better able to foresee the next crisis. Meanwhile, they would be wise to repeat (daily) the words: “My model is a model, not the model.”

Final thought

Macroeconomic models need to be adapted to take account of the events of the last 20 years. For so long typical macro model has been DSGE but as yet no model includes the impact of recessions and the eighty-year depressions. Economics failed to predict or prevent the GFC and this was based on conceptual faults which included a refusal to engage with the role of the banking and finance system in the economy.

Dani Rodrik of Harvard University splits economists into two camps: hedgehogs and foxes.

Hedgehogs take a single idea and apply it to every problem they come across.

Foxes have no grand vision but lots of seemingly contradictory views, as they tailor their conclusions to the situation.

Maybe more fox like behaviour is needed.

References

New York Times Magazine – The Major Blind Spots in Macroeconomics

The Economist – A less dismal science

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Brian Eno and Ha-Joon Chang in conversation

I have blogged on this before but found it very worthwhile with my classes this year. Below is a discussion between musical innovator and artist Brian Eno and award-winning author and economist Ha-Joon Chang that was screened on Al Jazeera. It is well worth listening to and they both raise interesting points about inequality, climate change, the inertia of economic policy, They talk of challenging the status quo, the development of paths to a fairer society and the lack of political leadership to challenge the economic orthodoxy. Ha-Joon Chang also talks about his latest book, Edible Economics, one ingredient at a time.

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Economics discussion exercise – Keynes v Hayek

This year I am trying to get students to develop a deeper understanding of economic issues and to improve their evaluation skills for the written exam. The goal is that students will arrive at a collective meaning, rather than seek a “right” answer. Below is a plan of how you could structure the discussion.

Subject content – Economic schools of thought. Keynes v Hayek – this is part of Unit 9 of the CAIE A2 syllabus.

Content knowledge: Types of economies (left and right wing) covered at CAIE AS Level. The schools of thought are taught in class and questions (MCQ) and short answer are used to test student understanding of the characteristics of each. The two videos below are useful to consolidate knowledge.

Austrian economics and Keynesian economics explained in 1 minute. See below

Music (rap) video ‘Fear the boom and bust’ – Keynes v Hayek. See below

One of the challenges is to keep students on task and try and get contributions from all students. In order to overcome these issues I have developed a set of playing cards with certain statements on each. Students receive 8 playing cards with different assessment objectives/ skills/ elements of written work in economics – see photo. Students can only talk when they place a card on the table. Once a student has used up all their cards they can no longer contribute to the discussion. The link below has more detail on this method:

https://econfix.wordpress.com/2022/09/20/using-playing-cards-for-economics-discussions-2/

Tutorial preparation (outside the classroom)

Students read a media extract on the topic. Extract selection is important – not too long and must be easy to relate to core knowledge. I have picked the article by Larry Elliott in the Guardian newspaper as this is media that is different to what students tend to be exposed to.

Guardian Weekly

‘Like COVID-19, capitalism has evolved a new variant to survive’ Larry Elliott

Number of students in a group is a determining factor – 8 to a group.

Tutorial/discussion over 2 periods

Opening question – essential that this is pitched at the level appropriate to the group as the intention is for the discussion to proceed through student interactions.

The new variant of capitalism should be the dominant policy option for governments.

If this is question doesn’t engage the students you could ask some of the following questions:

• Start off with a simple question that is referenced from the text – ‘What aspects of Keynesian economics are evident in the extract?’
• Allow each student to answer the opening question – 30 seconds. Other responses can spark conversation once everyone has replied.
• Get students to continually reference the text so to keep the conversation relevant

Coaching – there may be the need to encourage deeper and more critical thinking. Need to avoid teaching by offering analysis and possible evaluations. Some questions to encourage critical thinking:

• Why was the Keynesian variant relinquished in the 1970’s?
• How did the 2008 GFC influence government policy?
• Was austerity the answer to the issues caused by the GFC?
• How did COVID-19 impact policy for left right and centre governments?

Should allow students to respond from their own perspective but must be related to the extract.

Student reflection – the hope is that students are able to develop a deeper understanding of the complexities of the subject content and read newspaper/magazine articles with a more holistic view of the how an economy works. The level of scaffolding for reflection will vary with each student but there is potential for all students to feel more confident in their knowledge and participation in future discussions.

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Can globalisation help tame inflation?

Supply chain disruptions and large fiscal deficits have been part of the cause of the inflationary problems that have been prevalent in the global economy. Increased aggregate demand from government spending accompanied by supply constraints have seen prices soar. The IMF blog looked at how we should go back on history and look at how globalisation in the past has offered an antidote to inflationary spirals.

In the 1970’s technology improved global supply chains with the introduction of the shipping container which reduced transport costs of goods. Policymakers like the former US Fed Chairman Alan Greenspan see the relationship between globalisation and innovation a transition to low inflation. This idea has been embraced by current Fed Chairman Jerome Powell who talks of not only technology but demographic factors that bring about sustained disinflation. Trade liberalisation had a part of play here with the role of the General Agreement on Tariffs and Trade (GATT) – now know as the World Trade Organisation (WTO) – providing the rules for much of world trade and presided over periods that saw some of the highest growth rates in international commerce – see graph.

Modern inflation targeting by central banks (1-3% in New Zealand) also brought inflation under control as countries established a process that would allow them to attract capital flows or to globalise further. New technologies will produce better growth and increase the potential capacity of the economy (Production Possibility Curve shifts to the right) but requires a lot of cross-border co-operation. Some countries pursue costly ‘friendshoring’ strategies of steering trade to friendly nations and regimes while attempting to hobble rivals. In particular big economies look to protect strategic vital and strategic resources thereby preventing global economic growth. All of this may seem an easy solution to tame inflation but the reality is there are many variables that influence the inflation figure within countries.

Source: IMF Blog: In defense of globalisation

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Globalisation to slowbalisation – IMF

With the global economy experiencing supply chain pressures, inflationary problems, higher interest and geopolitical tensions are we seeing what the IMF call ‘slowbalisation’?

Part of this change has come about from the decoupling of the American, European and Japanese economies from China. This ultimately alters trade and investment flows around the global economy and will mean lower economic growth and less liquidity. For instance consider the restrictions on technology including complex microchips being placed by the US on China. Janet Yellen the US Treasury secretary referred to ‘friendshoring’ which means relocating production to countries that fall within the US economic sphere of influence. Apple’s announcement that it would begin sourcing sophisticated chips from North America is the signal that many global firms have been waiting for to begin reducing their exposure to China.

Furthermore as well as the impact of decoupling of trade with China, a shortage of labour will also add to production costs and will result in slower rates of growth. Labour force participation rates have dropped as less migrant workers coming into countries. This scarcity of labour will put further pressure on wages and ultimately inflation. To counteract the latter interest rates will continue to climb and this will lead to further problems:

The cost of financing economic expansion will become more expensive.
Firms that have lived off 0% interest rates and negative real rates (nominal interest rate – inflation) will face increasing problems on their balance sheets

In the medium term interest rates are determined by inflationary expectations and rates tend to move lower in periods of disinflation and higher in periods of inflation. The risk for all central banks and policymakers is if the rate of inflation goes above that of expectations there can be a further tightening cycle. Although recently we have seen a reduction in inflation, central banks need to maintain a level of tightness – high interest rates – so that inflation levels are within a country’s target range.

Phases in the graph

1. Industrialisation was prevalent in Europe and the USA and the advances in transposition reduced the costs for firms and encouraged trade.
2. WW1 and WW2 saw a very protectionist environment with trade becoming regionalised with trade barriers and the breakdown of the gold standard into currency blocs.
3. The post-war recovery and trade liberalisation encouraged growth in Europe, Japan and developing countries. The war had also stimulated a hugely expansionary fiscal and monetary policy which rendered the gold standard unsustainable. Floating exchange rates took over from those that were pegged to the US dollar.
4. In 2001 China became a member of the World Trade Organization (WTO) and there was the emergence of more free market economies with relaxed capital controls between countries. This was helped by the fall of the Berlin Wall and the integration of the former Soviet bloc.
5. “Slowbalisation” followed the global financial crisis in 2008 and the rising geopolitical tensions with protectionist policies being imposed by many countries.

Source:

IMF Blog – Charting Globalisation’s Turn to Slowbalisation After Global Financial Crisis

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Has China’s economy outgrown its economic blueprint?

Below is an excellent video from German state broadcaster Deutsche Welle (DW). It outlines the decline in China’s GDP which is now at historic lows. DW look at the problems that have been building in China as for the first time in two decades, its output fell behind that of the rest of Asia. It also addresses the history of economic rise and the mountain of debt that it has accumulated. Add to that the demographic change and international threats. Below are some points from the video:

The draconian measures to contain COVID has sapped domestic consumption crippled small businesses and kept China’s factories closed.

The Chinese government has shielded its economy for years with infrastructure projects – building roads, dams, harbours, rail networks etc. It is the latter that is a good example of excess capacity and mounting financial losses – the network keeps growing even less populated locations where there isn’t much demand and now maintenance costs and interest payments have overtaken the railway’s income.

With the working population declining it is hard to maintain dynamic growth. Less workers puts pressure on wages and for China to maintain its cheap prices it has to improve productivity. Demographic change is a long-term phenomenon so the Chinese government still has room to respond and it has already switched to a three-child policy.

Also the demand for China’s exports has decreased as the global economy goes through an economic slowdown with surging inflation. Exports declines from 36% of GDP in 2006 to 20% in 2021 – see graph. Therefore more domestic consumption is needed to maintain growth and an expansionary fiscal policy like that in western economies might be the way to go.

Business cycle or volatile booms and busts? The four stages of the bubble.

I blogged on this topic last year but below is a useful video from the Wall Street Journal (WSJ) on how bubbles are so difficult to predict with some examples from Gamestop to Tulips. A graphical explanation follows after the video.

I picked up this graphic and explanation from The Geography of Transport Systems by Jean-Paul Rodrigue (2020)

It is apparent that business cycles aren’t those smooth ups and downs as depicted in a lot of textbooks but more volatile with booms and busts. Central banks appear to play their part in this process with the low cost of borrowing feeding the boom phase of the cycle. Instead of economic stability regulated by market forces, monetary intervention creates long-term instability for the sake of short-term stability.

Bubbles (financial manias) unfold in several stages, an observation that is backed up by 500 years of economic history. Each mania is obviously different, but there are always similarities; simplistically, four phases can be identified:

• Stealth – emerging opportunity for future prize appreciations of investments. Investors have better access to information and understand the wider economic context that would trigger asset inflation. Prices tend to increase but are unnoticed by the general public.
• Awareness – many investors start to notice the momentum so money starts to push prices higher. There can be sell-offs but the smart money takes this opportunity to reinforce its existing positions. The media start to notice that this boom benefits the economy.
• Mania – the public see prices going up and see this a great opportunity to invest with the expectations about future appreciation. This stage is not so much about reasoning but psychology as money pours into the market creating greater expectations and pushing prices up. Unbiased opinion about the fundamentals becomes increasingly difficult to find as many players are heavily invested and have every interest to keep asset inflation going. At some point, statements are made about entirely new fundamentals implying that a “permanent high plateau” has been reached to justify future price increases; the bubble is about to collapse.
• Blow-off – everyone roughly at the same time realises that the situation has changed. Confidence and expectations encounter a paradigm shift, not without a phase of denial where many try to reassure the public that this is just a temporary setback. Many try to unload their assets, but takers are few; everyone is expecting further price declines. Prices plummet at a rate much faster than the one that inflated the bubble. Many over-leveraged asset owners go bankrupt, triggering additional waves of sales. This is the time when the smart money starts acquiring assets at low prices.

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Transition of East Germany and the level of happiness

With the fall of the Berlin Wall in October 1990 there was the predictable euphoria amongst the population in eastern block countries and although you can change a political system overnight, an economic system takes many years. That is why economies in the transition phase usually use this period of happiness amongst the population to implement economic policies which will be very unpopular in the short-term but potentially have long-term benefits for the economy. However were East Germans happier after this freshly regained freedom in 1990?

Research has shown that is took over 25 years after transition for the level of happiness to be higher than in a June 1990 survey taken when East Germany was still a socialist state. Happiness declined sharply from 1990 to 1991 as unification occurred and recovered to about where it was before the transition to capitalism began. The decline in satisfaction was accompanied by a decline in output equating to about one-third of GDP with high levels of unemployment as numerous firms go bankrupt. Unemployment reduces happiness but also impacts those in employment as the threat of losing their job increases. In East Germany the unemployment rate was 14.8% in 1994 and it peak at 18.4 in 2004 – see graph below.

As well as unemployment the social safety net was a factor that influenced the level of happiness in East Germany. Satisfaction with health care, childcare and work were all surveyed from 1990 onwards, and all decline noticeably in the transition to capitalism. Under socialism jobs tended to be assured and employers provided sufficient childcare and financed comprehensive healthcare. With the shift to the capitalist systems a lot of these benefits disappeared. An East German respondent to a survey commented that:

The unification process is costuming me personally DM400 each month. I include in this higher rental and transport costs, as well as social costs. There are problems at all levels: traffic, crime, rent refugees, health care, social security. For me personally it is a vast and serious problem. People have lost old structures and certainties, and don’t know how to cope. I know that we here in the East have to go through a transition process, but it is difficult and for many no longer makes sense.

When asked about their level of happiness people focus on their immediate personal circumstances rather than the political environment. This includes having a job, making a living, caring for their family and ensuring good health. Only around 1 person in 25 members broad systemic issues such as the form of government or political and civil rights.

Many economists assumed that the transition of East Germany to capitalism would make everyone vastly happier. Pre-transition conditions in East Germany show that to increase people’s level of happiness, job security and a strong social welfare system were paramount. Happiness in most Eastern European countries has been on the increase but it is still likely to be short of where it had been prior to transition. However it is not just policies in socialist countries that increase the level of happiness, capitalist countries can achieve similar results.

Source: An Economist’s Lessons on Happiness. Farewell Dismal Science by Richard A. Easterlin (2021)

Interest rates and controlling inflation

Excellent video from The Economist. It goes through the impact of raising interest rates in an economy – mortgages, spending patterns, inflationary expectations. Also looks at when interest rates in the US went to 19.5% during the 1980’s. There is a fine line between increasing interest rates too quickly and tipping the economy into a recession or being too slow with the tightening process and letting inflation spiral upwards. The video discusses all these points – great revision for the Inflation topic at NCEA, IB and CIE.

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How Roman Abramovich bought Chelsea Football Club.

I can recommend listening/subscribing to the David McWilliams podcast – an Irish economist who popularises economics and explains quite complex issues in understandable language. I might be a bit bias here being Irish. He recently held a live podcast to a sold out audience of 1,200 in the 3Olympia theatre in Dublin. This theatre is more used to rock concerts, plays etc so for an economist to have a sold-out gig is quite impressive. Colin Peacock of Radio New Zealand recently interviewed him on Radio New Zealand

A recent podcast looked at Russia and how the oligarchs got their money – he used the example of Chelsea Football Club owned by Russian Oligarch Roman Abramovich. Below is a mind map and a timeline of events.

• 1990 – Germany reunites – fall of Berlin Wall
• 1991 – Yeltsin – first president of Russian Federation
• 1992 – ‘Shock therapy’ economic reforms – spiralling inflation
• 1992 – Massive privatisation programme of state assets- every citizen 10,000 ruble voucher
• 1993 – Oligarchs bought vouchers off confused public – very cheap
• 1996 – Yeltsin offers oligarchs (22 individuals) key state assets (40% of country) for media support and financing re-election
• 1997 – Government tries to curtail ‘sweetheart deals’ with oligarchs
• 1997 – Oligarchs get money out of Russia – buy yachts, property, companies, football teams etc
• 1999 – Yeltsin steps down and Putin becomes prime minister – the rest is history

Estimates of oligarchs worth outside Russia

• $920bn of net private Russian wealth located offshore
• $2bn stake in the London property market
• $11bn in Swiss bank accounts500
• Russian multimillionaires living in the UK

2020 report from the Atlantic Council on Russian dark money, Vladimir Putin and his closest associates control around one-quarter of the estimated $1 trillion worth of assets stashed away in the West and beyond Russia’s borders. Source: David McWilliams Podcast

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Global Stagflation and the threat to democracy.

In my economics classes this week one cannot get away from what is happening in Ukraine and the impact of that geopolitics will have on the global economy. Already I wrote a blog post on Russian interest rates and the collapse of the rouble but what are the challenges ahead for the global economy?

Before the invasion central banks worldwide were tightening monetary policy (interest rates) to reduce the increasing inflation pressure in their economy’s. The price of oil has increased to over US$105 adding to the inflationary problem as policy makers still have to deal with the slow recovery from the COVID pandemic. However the US Federal Reserve (US Central Bank) and the European Central Bank (ECB) have indicated that they intend to continue with their tightening policy of 25 basis points (0.25%) increase in interest rates this month but may have to be less aggressive in their future tightening. Their major concern now is that the war in Ukraine has increased the chances of a period of stagflation – stagnation and inflation at the same time. Therefore it is important that central banks are more sensitive to tightening their monetary policy as adding the Ukrainian crisis (with higher oil and food prices) to the present supply chain issues would increase the chances of stagflation and a significant downturn in the global economy.

Stagflation
In economic textbooks there are two main cause of inflation – Demand Pull and Cost Push (see graph below).

Source: Eleareconomics

The inflation that New Zealand is mainly experiencing is of a cost push nature especially when you look at the recent CPI figure of 5.9%. The major driver of this inflation is:

• 30.5% rise in the cost of petrol
• 15.7% rise in the associated cost in buying a new dwelling.
• 4.1% increase in the food group

What you notice from the graph is that when the AS curve shifts left not only does inflation increase but also output and employment decrease. The last major stagflationary period was during the oil crisis years of 1973 (oil price up 400%) and 1979 (up 200%) – see video below from the Philadelphia Fed.

But when will these cost pressures ease in New Zealand? With a 5.9% inflation rate employees will put significant pressure on employers for wage increases and this is when there is already a very tight labour market (3.2% unemployment).

Final thought
2022 is going to be a very difficult year for the economy with both demand and supply issues:
Demand: higher inflation will mean a tightening of interest rates which will reduce spending and increase the debt burden.
Supply: higher energy costs, supply chain problems, increase in material costs and availability of parts for industry.

Add to this the war in Ukraine and we are in for a rocky ride. However the possible suffering is necessary if it nullifies the threat on global democracy.

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COVID-19 and the Universal Basic Income debate.

Here Martin Sandbu of the FT  discusses the UBI as part of his Free Lunch on Film – taking unorthodox economic ideas that he likes and putting them to the test. He looks at both sides of the UBI argument with examples from Alaska and Finland where results showed that there was little reduction in working hours when people received the UBI. Good discussion and well presented.

Why has the UBI become such a popular talking point?

• The coronavirus pandemic has seen wage subsidies – a no-strings attached regular cash transfers to just about everyone in the economy.
• The automation of a lot of jobs has left people very concerned about redundancy.
• The modern economy can’t be expected to provide jobs for everyone
• The UBI is easy to administer and it avoids paternalism of social-welfare programmes that tell people what they can and can’t do with the money they receive from the government.
  

Concerns

• Potentially drives up wages and employees will compare their wages with the UBI.
• Easier for people to take risks with their job knowing there is the UBI to fall back on.
• It takes away the incentive to work and lowers GDP
• UBI – not cheap to administer and would likely cost 13% of GDP in the US

Positives

• In the Canadian province of Manitoba where the UBI was trialled, working hours for men dropped by just 1%.
• The UBI would make it easier for people to think twice about taking unrewarding jobs which is a good consequence.
• In the developing world direct-cash grant programs are used very effectively – Columbian economist Chris Blattman.
• In New Jersey young people with UBI were more likely to stay in education

If the U.B.I. comes to be seen as a kind of insurance against a radically changing job market, rather than simply as a handout, the politics around it will change. When this happens, it’s easy to imagine a basic income going overnight from completely improbable to totally necessary. 

James Surowiecki – New Yorker – 20th June 2016

Instant Economics – the takeaway option.

The Economist recently had their Briefing article (October 23rd edition) on how economics is changing with ‘high frequency data’ and that there is a ‘Third-wave’ evident. They mention three changes to economic research.

• It accesses data that is abundant and relevant to real-world problems.
• Economists using the data are eager in influence government policy
• There is little theory involved as the data/evidence says it all

1970s – more than half of economics papers focused on theory alone,
2011 – purely theoretical papers accounted for only 19% of publications.

There were hints of an economics third wave before the pandemic. Some economists were finding new, extremely detailed streams of data, such as Visa and Square (free business expense card) record spending patterns, Apple and Google track movements, anonymous tax records, location information from mobile phones etc. Of the 20 economists with the most cited new work during the pandemic, three run industrial labs.

The Economist divided economists into three groups:

• lone wolves – who publish with less than one unique co-author per paper on average;
• collaborators – those who tend to work with more than one unique co-author per paper, usually two to four people; and
• lab leaders” – researchers who run a large team of dedicated assistants.

During the pandemic new economic papers increased markedly from 2019 – 2020 from the collaborators whilst the lone wolves were least evident. Large data sets benefit from the division of labour and the research was focused on the usefulness to business. Three of the top four authors during the pandemic compared with the year before—are all “collaborators” and use daily newspaper data to study markets. The concern about macro-economic research over the past few decades is that it has been too theoretical.

The downside is that consumers of fast-food academic research often treat it as if it is as rigorous as the slow-cooked sort—papers which comply with the old-fashioned publication process involving endless seminars and peer review.

Source: The Economist – ‘The real-time revolution’ – October 23rd 2021

AS Economics Revision – Transition Economies

With the CIE AS essay paper on Monday next week here are some notes on the issues confronting transition economies – this topic is in Unit 1 of the syllabus. What have been the formidable challenges facing eastern European countries (command) embracing capitalism? Here are some thoughts as well as an informative video from the IMF:

• In planned some goods are provided free but not in a market economy
• Corruption – widespread in communist countries in eastern Europe – Oligarchs
• Inflation ↑ – privatised firms began to charge prices that reflected high costs
• Lack of entrepreneurial experience
• Rising unemployment as owners of businesses try to make them more efficient.
• Labour relations – Poor as workers are in a new environment – Job security?
• Consumer sovereignty – some industries decline/expand
• Resources – surplus and shortage
• Self-Interest – fewer merit goods and more demerit goods
• Time Gap before framework of government controls can be developed
• Expansion of industry – potentially for greater externalities
• Old/disabled – vulnerable with the change of government role
• Welfare system – limited support for unemployed etc. will take time to develop
• Provision of public services – disruption to police and other public services
• Moral Hazard – the state insure workers against risks of losing their job

Brexit – no longer ‘Mind the CAP’

After 47 years the UK has now left the EU and with it the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector.

The economics behind CAP intervention price
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

• It encourages an increase in European production. Consequently, output is raised to 0Qs1.
• At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
• In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
• There is a contraction in domestic consumption to 0Qd1Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

CAP and the UK

At considerable cost to the taxpayer the CAP has subsidised intensive farming methods that have impacted the British countryside and also increased the price of land making it harder to get into farming – since 2003 the price of land has risen from £4,500per hectare to £16,500 today. Subsidies also encourage farmers to develop land which is not suitable for farming and thus supports unproductive farms. The average English farm made a profit of just £6,200 in the tax year 2018-19 and being propped up by the subsidies has led to inertia and little or no innovation. Sheep farmers have especially struggled, in particular the 30% that are located in areas that are not conducive to farming – the Lake District, the Peak District, Exmoor and Dartmoor – but are seen by the public as picturesque walking areas. The issue being that farm income for grazing livestock in 2018-19 was approximately -£5,000 (lowland) and -£19,000 (upland) – see graph below.

Source: FT

New Zealand experience

New Zealand went through the process of removing the subsidies for farmers and in 1984 the Labour government ended all farm subsidies under the Lange Government and by 1990 the agricultural industry became the most deregulated sector in New Zealand. In the short-term there was considerable pain amongst the farming community and land values collapsed, inefficient farms went bust and the service sector that supports the industry. However to stay competitive in the heavily subsidised European and US markets New Zealand farmers had to increase efficiency, became more innovative and export-orientated – 95% of Fonterra’s produce (dairy) is exported. Compared to the UK, New Zealand does have a lower population density, weaker environmental standards and a different climate.

Post-CAP and the UK

In the Post-Brexit environment the UK government have pledged to keep overall subsidy levels although they will be replaced by the Environmentally Land Management Scheme (Elms) which is expected to be rolled out nationally by 2024 – the old subsidies will end in 2027. The Elms focuses on environmental benefits, such as flood mitigation and fostering wildflowers. Payments under Elms will initially be calculated on the basis of so-called “income foregone”, or what farmers could have otherwise made from farming on the same land, plus the estimated costs of the environmental work. The issue here is that a lot of this subsidy with go to the farmers who are already well off.

Agricultural support from the UK government is now focused on ‘public goods’ such as better air and water quality, thriving wildlife, soil health, or measures to reduce flooding and tackle climate change.

The Supercycle and MMT

I listened to a very good interview on the David McWilliams podcast in which he talks with Dario Perkins the super cycle and the end of neoliberalism. A lot of the discussion was around the paper that Dario Perkins had written – A New Supercycle Running on MMT – in which he sees MMT as delivering a superior fiscal-monetary mix.
The fact that fiscal policy must take over from monetary policy has been the apparent with the range of policies that were implemented after the GFC. Since the late-19th century the super cycle can be placed into three phases of Capitalism influenced by macro-financial-political regimes – see chart below. MMT could provide the intellectual rationale for a new form of capitalism – Capitalism 4.0. Over the last century the pendulum has swung between extreme fiscal and extreme monetary policy with the global economy primed for another change.

1920’s – Monetary policy dominated but ineffective during the Great Depression
1930’s – Fiscal policy dominated as there was a need for government intervention to get the economy moving after the Great Depression
1940’s – 1960’s – Fiscal Policy – with the 2nd World War and the recovery process post-war.
1970’s – Stagflation and fiscal policy is no longer effective and Keynesian economics as government spending just causes higher inflation and higher unemployment.
1980’s – Monetary policy gains traction and inflation is brought under control. Central Banks become independent and fiscal policy and government intervention is seen as a restriction to growth. With Reagan and Thatcher Neoliberalism was the ideology of the day

Source: A New Supercycle Running on MMT

Have we reached a new regime – Capitalism 4.0?
The GFC was a warning that capitalism in its present form was not working and there was potential for a new regime change. However governments adopted austerity and QE which made inequality worse. The issue was that there was no alternative to the neoliberalism Capitalism 3.0 but with the arrival of COVID-19 governments have been forced to spend up large and there is a belief that the old system doesn’t work and that maintaining Capitalism 3.0 will not make the situation any better. Stephanie Kelton, author of The Deficit Myth, argues that we need to rethink our attitudes towards government spending.

Modern Monetary Theory (MMT)
MMT states that a government that can create its own money therefore:Cannot default on debt denominated in its own currency;

• Can pay for goods, services, and financial assets without a need to collect money in the form of taxes or debt issuance in advance of such purchases;
• Is limited in its money creation and purchases by inflation, which accelerates once the economic resources (i.e., labor and capital) of the economy are utilised at full employment;
• Can control inflation by taxation and bond issuance, which remove excess money from circulation, although the political will to do so may not always exist;
• Does not need to compete with the private sector for scarce savings by issuing bonds.
• Within this model the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.

It will be interesting to see if MMT can enjoy the same presence in economic policy that monetarism and Milton Friedman experienced in the post-stagflation time period. Back then there was a political revolution primed to embrace monetarism and neoliberal ideas and an electorate that had experienced a serious economic crisis – stagflation. Subsequently the influence of MMT will come down to politics.

Joe Biden seems to have embarked on a more radical macro-economic policy which has various instruments that are found in MMT. Will there be other political leaders who embrace this paradigm like Reagan and Thatcher in the 1980’s with Friedman and monetarism?

Source: A New Supercycle Running on MMT

David McWilliams podcast – The end of neoliberalism?

Below is a link to a David McWilliams podcast which I recommend – excellent for macro policy.

130 – The end of Neo-Liberalism & economic super-cycles explained with Dario Perkins

There is mention of the collapse of the European Super League and that this could be that defining moment when the irresistible force of a once all-conquering ideology came crashing into the immovable object of a new reality, with devastating consequences.

The interview with Dario Perkins – 20 minutes in – is particularly worth listening to. They talk about Modern Monetary Theory (MMT) and that we shouldn’t worry where the money comes from as the central bank can just print it – spend first and tax later. It’s fiscal policy that will decide whether central banks can meet their inflation targets.

Joe Biden – the world’s most unlikely radical – is a convert to MMT. He is to MMT what Ronald Reagan was to monetarism. Biden’s agenda is to compress inequalities, rip the economy away from Wall Street and give it back to the man on the street by using government spending as an arm not just of economics but democracy underpinned by fairness. Biden wants to reverse the past 30 years and lead us into a new macroeconomic supercycle, which might also last decades.

Brexit and “Yes Minister”

With the UK having now left the European Union here is a very amusing clip from the BBC series “Yes Minister” (1982) in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.

Financial Crisis and Political Upheaval in Nazi Germany

A recent paper by Sebastian Doerr, Stefan Gissler, José-Luis Peydró and Hans-Joachim Voth investigates the role that a financial crisis in Germany played in the Nazis coming to power. They show how financial distress can lead to radical voting when accompanied by a convergence of cultural and economic factors. In less than four years, the Nazis went from capturing 2.6% to 37.3% of the popular vote. The authors identified the failure of one bank as being significant in growing the support of the nazis – Danatbank.

Danatbank and Dresdner Bank
Danatbank (the second largest bank in Germany) was widely seen as responsible for causing the financial crisis, and it was headed by the well-known Jewish manager Jakob Goldschmidt, a favourite target of Nazi propaganda. Its collapse in 1931 saw a surge of support for Hitler. Dresdner Bank, Germany’s third-largest lender, failed as well. Exposure to Dresdner Bank had a similar negative effect on city incomes as exposure to Danat, but had almost no effect on support for the Nazis. By contrast, Dresdner Bank was not the key target for Nazi propaganda – even if it had numerous Jews occupying leading positions like most German banks. While the economic impact of the two bank failures was almost identical, only exposure to Danat had a significant effect on Nazi voting. By 1932 Danatbank and Dresdner Bank merged.

Note: The shaded area indicates the period of the 1931 banking crisis, from the beginning of troubles at Austrian Creditanstalt to the merger between Danatbank and Dresdner Bank. Blue vertical lines show: (A) beginning troubles at Austrian Creditanstalt (May 1931), (B) Nordwolle accounting irregularities discovered and Hoover Moratorium established (June 1931), (C) failure of Danatbank and ensuing bank holidays (July 1931), and (D) forced merger of Danatbank and Dresdner Bank. 

The Depression enabled the Nazis’ rise to power, but the financial collapse of 1931 thus lent seeming plausibility to a key Nazi hate narrative, helping to bring a large part of the German middle class round to the party’s world view.

Wall Street and Main Street – the disconnect.

Excellent video from The Economist regarding the disconnect between Wall Street and Main Street i.e. Stock Market and the Economy. The S&P 500 is up 38% since the middle of March this year when the US economy has been going through one of its worst recessions. The US Federal Reserve had a role here by providing aid packages so the increase in the S&P was seen as a Fed rally and not from normal fundamentals.