Sunday, January 31, 2010

Obama's State of the Union Address

Like millions of others around the world, I settled down on Wednesday night last week to watch President Obama’s State of the Union address. And apart from being a little rambling, and way too long, with a rather quicker build up to the finale than we’re used to with Obama’s speeches, it was cogent, surprising in certain areas and yet conciliatory in others. A masterful speech I would say, but certainly it doesn't rank alongside his best to date.

From an economics perspective the surprises for me were: i) the lack of a proper analysis of why we need a new jobs package when the stimulus package hasn’t really started to show long-term results yet; ii) freezing of discretionary budgets along with a dropping of the “don’t ask don’t tell” military policy; iii) the emphasis on “full employment”; iv) the emphasis on export stimulus rather than protectionism; and v) the international comparisons that the President put into the speech relating to long-term growth. Let me elaborate…

First, the new jobs package. It is no mystery that some of the bigger long-term capital projects have been delayed – only late last week the high speed trains project was announced in various parts of the country – and clearly there are still others in the pipeline. So given that the economy is now growing, that the unemployment rate has stopped rising, that employment is at last showing signs that it might turn round soon ( - there was still a loss in jobs in December, 2009 – the latest figures), and that the financial system appears to have stabilized, it seems to me a little premature to do yet another stimulus. Surely some of the measures that the Obama administration wishes to pursue ( - including the $30bn fund for lending to small businesses) would do the trick rather than further increasing spending. This on top of the nervous situation about the rising deficit and mounting US debt. So from what I could gather from the speech the idea would be to set a date to quit increasing discretionary spending now, but in the meantime go for broke and increase spending now before the cap becomes law. The government spending multiplier needs some time to work – any student of macroeconomics would know that the fiscal lags inherent in any new spending take time to work their way through the economic system. [See - where this is a Jan 2009 estimate and many of the projects have taken longer than anticipated to come online.]

Second ( - and this is one reason I’m glad I didn’t post this blog immediately after the speech), military spending and “don’t ask, don’t tell”. I think it was a brilliant move on the part of the Obama administration to exempt the military from the discretionary spending freeze from next year, and announce the scrapping of “don’t ask, don’t tell” at the same time. The bad cops in the form of Pelosi and other democrats were immediately out there doing their jobs to make sure that the military understands that there are voices now on the left (see my previous post on this) favoring some trimming of military budgets. You can just imagine the conversation with the military top brass telling them that if they don’t want to scrap “don’t ask, don’t tell”, then it would be difficult to fend off the democratic calls for a military spending freeze ( - and this isn’t just a one year freeze…it goes on for 3 years). If I was top brass in the military I know what I would do!!

Third, as an economist, I was surprised to hear the term “full employment” once again being introduced into the political discourse. Most economists would use the term “natural rate of employment” given that this has become the level of employment that we use in our own academic work and one that makes a lot more sense than “full employment”. [For those of you not in the know on this see] Psychologically what it means to me is a return to the “Keynesian” stimulus economics of the 1950s, when we were not worried about the effect of inflation and we were more worried about adjusting spending to an “optimal” level. We are not currently in this situation now, as we know that inflation can occur from these actions, particularly if interest rates rise which will automatically increase the burden of the debt on government finances. Potentially this is a vicious cycle – the more debt we incur, the more likely a sudden collapse in foreign confidence ( - look at what happened in Dubai if you don’t believe me on this), and the more likely interest rates will have to rise, making recovery less likely. It is clearly important to get this balance right ( - the balance between stimulating the economy and causing alarm among our foreign lenders), and in my opinion using terms like “full employment” implies that large budget deficits will continue into the future.

Fourth, the new and welcome emphasis on export spending. This was a high point in the speech that a lot of people missed. Why? Politically, because it placed new emphasis on developing new markets and boosting exports rather than resorting to protectionism. But what about the economics? First, it recognized that the U.S., because it started the current global economic downturn, can "hitch a ride" from other countries that get out of the recession faster, as other economies suffered a "shock" transmitted from the U.S. whereas the U.S. clearly had some major systemic problems that it needs to address.  Second, it implies that the exchange rate needs to stay low if the "doubling of exports in 5 years" and the "2 million more jobs" are to happen.  If for some reason the administration has it completely right (or some other country suffers a big shock which causes investors to seek the "safe haven" that the U.S. dollar traditionally affords) and so the dollar begins to rise again, this would derail their export objective. So the Obama administration must be betting on a low or even lower dollar than we have right now to make this happen. All food for thought.

Last, the international comparisons on long-term economic growth that the President mentioned in his speech. He specifically mentioned China and Germany and the stimulus measures that they have adopted that also enhance long-term growth prospects. It was refreshing to hear this use of “best practice” to justify new economic policy in the US. This was a hallmark of the UK Blair administration, who looked at what had been tried elsewhere to get the best ideas about policymaking, and it has clearly taken root in the current administration’s economic thinking. On a side note, although Fed Chairman Bernanke’s expertise is on the Great Depression, I would argue that we also need to understand what went wrong in Japan in the 1990s and 2000s to get it right in the U.S., as our situation much more closely mirrors what happened there. More on this next time…

Tuesday, January 26, 2010

Avatar – Some Economic Observations

Avatar is an exceptional movie – it is the culmination of 5 years of work on the part of director James Cameron and it features new filming techniques including 3D Fusion Camera System as well as “Full performance capture” as the actors in the Na’vi sequences had to wear hoods which allowed computers to simulate the facial features and movement of the actors.

The first thing that struck me was the fact that ultimately a foreign culture and what appeared to be a hostile environment came to dominate and vanquish the alliance of a quasi US military and money. Strictly speaking Cameron made it very clear in the movie that this wasn’t the US military, but it bore a remarkable resemblance to what one might expect the US military to look like sometime in the future. In essence the traditional American heroes with all their technology lost, and the winners here were the foreigners who spoke a different language, had strange beliefs and customs, and looked odd to us humans. What went through my mind towards the end of the movie was that perhaps this marks a turning point in the American view of it’s military and foreign cultures? Or maybe Cameron is just part of an enlightened minority? The movie did put a disabled (and retired?) marine who crossed over to the Na’vi in the hero’s role underlining that it’s the people in the military who matter, not the institution itself. Nevertheless, given the above, I can quite understand why Cameron found it hard to get funding for this movie!

Setting aside all the technical wizardry involved in the film-making, there are quite a few themes and noteworthy aspects of the movie that made this economist sit up and think. Of course there were the small things like expressing all distances in kilometers – clearly by whenever this is supposed to be in the future, the implication is that we will have agreed to use the metric system to measure distances rather than miles ( - obviously a concession that America is going to have to make at some point in the future), and there was also the greed aspect to the movie which pitted culture and tradition of foreign peoples against the generation of corporate profits.

I hope I don’t spoil things here for people that haven’t seen it, but the environmental and international economics implications of the movie were to me quite stark, whether intentional or not. The fact that the Na’vi win in the end implies that although technology and military muscle are formidable obstacles to preserving cultures and the environment, they will not necessarily prevail. It also implies that as we continue to exploit the Earth’s resources we need to always try to ascertain the damage done on foreign cultures and the environment so as to take these concerns into account, otherwise they will come back to haunt us. What the film says is that this requires us trying to put ourselves in the situation of others before acting, and to get to understand what is important to these foreign cultures, and how to best negotiate and dialogue with them. Notice that this also plays into the “short run” vs “long run” distinction in economics, as it implies that in the short run if we’re too concerned with quarterly profits and possession of resources we could end up destroying cultures and the environment and in a much worse situation than we started in. Yes, it’s a variation on “time inconsistency” again!!

Lastly, watching the final credits ( - a monumental list of people and organizations) after most people had already left the movie theater, I quickly realized that this movie was clearly a global effort in terms of farming out the work to many many different countries, with much of the filming in New Zealand, but a sizeable part of the special effects done in France, and of course the US heavily involved. The film premiered in London, England and has a lead actor from Australia. So I guess the movie industry is finally getting around to adopting the principle of comparative advantage - well at least this film did!

Saturday, January 16, 2010

Economics as a Science

I want to start off by saying that I like Greg Mankiw’s intermediate economics textbook – that should be self-evident otherwise I wouldn’t have adopted it for the intermediate economics course I’m teaching this semester. But every time I start this course and look at the title of Chapter 1 (“The Science of Macroeconomics”) I feel immediately revulsion: I even went to the trouble of changing my powerpoint slides and calling the chapter “Introduction to Macroeconomics” as I couldn’t bear to look at that title!!  And Greg Mankiw's textbook isn't the only one that claims that economics is a science, it just happens to be the text I'm using this semeseter.

The Chambers English Dictionary defines science as “knowledge ascertained by observation and experiment, critically tested, systematized and brought under general principles, especially in relation to the physical world”. And yes, scientists use the scientific method, which comes from Karl Popper’s work. Karl Popper, the British/Austrian scientist came up with the framework for deciding what is, and what is not science – to quote from Wikipedia:

“Logically, no number of positive outcomes at the level of experimental testing can confirm a scientific theory, but a single counterexample is logically decisive: it shows the theory, from which the implication is derived, to be false. Popper's account of the logical asymmetry between verification and falsifiability lies at the heart of his philosophy of science. It also inspired him to take falsifiability as his criterion of demarcation between what is and is not genuinely scientific: a theory should be considered scientific if and only if it is falsifiable.”

So in other words, if you can show that something is false, then that something can be tested to see if it is false, and therefore you can use the scientific method. So this means that any economic theory that has data (or potentially has data) should be testable if economics were to be classified as a science. Now a lot of economics does have data that it is either already collected or could be collected in the future. But a lot of economics does not lend itself to the scientific method or falsifiability. Take the 2nd welfare theorem or the optimal currency area theory. These are not verifiable given that economics operates on the basis of human behaviour.  Even when things are verifiable, economists like to think that general rules are "laws".  Take the "law" of demand for example - it is clearly not a "law" in the physical science sense of the word, but economists abuse it by attaching it to human behaviour in the face of changing the price of a product, which depending on the type of product can actually lead to an increase in demand (Thorstein Veblen's "conspicuous consumption", for example).

And there lies the rub. I know this might sound semantic, but calling economics a science is to my way of thinking calling it a “physical science”, or at least something on a par with physical sciences. Economics deals with human behaviour, either individually or collectively, so in no way does it constitute being called a “physical science”; but rather fulfills the criteria for being a valued “social science”. Some economists would say that economics uses way more mathematics and statistics than other social sciences so that it is more like a “physical science”. Well sure, the methods we use can get quite technical at times, but that shouldn’t detract from the core issue of what we’re studying, not how we’re studying it.

Certainly in most Universities the Faculty of Science doesn’t contain the economics department ( - although Dalhousie University in Halifax, Nova Scotia is the exception to the rule here), and it is put in the Faculty of Arts and Humanities or the Faculty of Social Sciences or the Business School or Faculty. Why is this? Well one of the strengths of economics is that it is not easily categorized – it contains logic from philosophy, math from science, imaginative theories ( - which almost demand an artistic mind), and “touchy-feely” policymaking from public policy.

So, to sum up…is economics a science? Yes, it is in the sense of being a “social science”. Is it a science in the sense of being always falsifiable, which can be claimed for all physical sciences? The answer here is no.

Wednesday, January 6, 2010

The Economics of New Years Resolutions

Most people wouldn’t connect making New Year’s resolutions and economics. But in fact economists talk a lot about commitment and the circumstances in which commitment doesn’t happen and the circumstances when it does. In particular, in macroeconomics commitment comes up in terms of what economists call “credibility” and how commitment mechanisms can enhance credibility.

So what insights can we gain from economics regarding New Year’s resolutions? First, the concept of “time inconsistency” is an important contribution that economics can make here. What “time inconsistency” (or what is sometimes called “dynamic inconsistency”) says is that what seems like a good thing in the long term might not seem such a good thing in the short term, so you decide not to do what is best in the long term to get short term gains when you know that what matters is the long term and not the short term. Once you succumb to the short term benefits you’re back at square one, and not getting the long term benefits.

A great example of this is quitting smoking. In the long term you know that quitting smoking is good for you – it extends your life and reduces your chances of getting all sorts of life-threatening medical conditions, plus costs quite a bit of money when you add up the costs of cigarettes over time. In the short term though having that one smoke will give you short term benefits that you think will outweigh the costs, but of course this is inconsistent with your long term goals and obvious benefits. This is a perfect example of “time inconsistency”. There are other very obvious examples of “time inconsistency” likely in all our New Years resolutions – things like losing weight, getting fit, and saving more money.

The nearest analogy to the “time inconsistency” problem of quitting smoking or losing weight for an economist is for an inflation-prone central bank to quit printing or creating money when they’ve been used to doing this, perhaps for political reasons. The solution in economics is to create inflation targets, which act as a commitment mechanism, make the central bank independent of the political process and/or to appoint a central banker who is extremely conservative.

So what are the analogous solutions an economist would suggest for quitting smoking or losing weight? Commitment mechanisms are rules that cause you to commit to doing certain things – for example, having rules to avoid triggers to smoke ( - cut down on coffee or drink tea instead) or to avoid bars or things that are complimentary to cigarettes. The analogous action to making the central bank independent of government might be to only associate with other people who don’t smoke, as this will also likely increase the likelihood of quitting for good. There is no direct equivalent for appointing a conservative central banker, but I would suggest that the nearest equivalent would be to continue to focus on the long-term gains and try and remove any thought of the short-term pleasure of smoking, so here perhaps make a log for each day that you’re still on track to meet your long term goals. Of course there are also those anti-smoking drugs such as Xyban or Chantix which can help if taken for a period of time.

But in fact the best way to actually achieve whatever your New Year’s resolutions are is to keep on reminding yourself of the long-term benefits of what you’re trying to achieve. Write your resolutions on a sticky note and put them on your bathroom mirror, and keep on reminding yourself of the logic that you laid out when originally making those resolutions. That way you remind yourself of the long term gains and are less tempted to be derailed by the short term temptations.

At any rate good luck on those resolutions!!

Friday, January 1, 2010

South Africa and the FIFA World Cup

South Africans are really gearing up for the FIFA World Cup soccer championship, which will be held in an African country for the first time in the event’s history. There is a lot of speculation that the event will draw a lot of foreign visitors to the country to see the matches and support their national squads, plus of course the new infrastructure which would add to the nation’s capital stock and also help to spur more South Africans to play soccer and focus all the nation’s ethnic groups on a single sport (for a change).

But as any sports economist will tell you, economic benefits from building new stadia or hosting sports events in the long term are usually marginal to say the least. Montreal’s massive debt due to the construction of the Olympic Village in the east end in order to host the 1976 Olympics, plus the demolition of 6 of the 10 stadia that were constructed by Japan and South Korea to host the 2002 World Cup are regularly trotted out as examples to demonstrate that hosting an international sporting tournament doesn’t necessarily having lasting effects in terms of productive new infrastructure.

But here I think the cynics are wrong. South Africa these days is a dynamic place – developing rapidly despite the high unemployment and wrenching poverty in parts – and has always had large numbers of sports fanatics in proportion to the total population, perhaps not on a par with Australia but still well up there. So I believe that the capital investment will pay off down the road, and especially as South Africa is a developing country with need for new infrastructure that other developed countries who have hosted these contests really didn’t need.

Here in South Africa though, all the attention is on the short-term benefits of hosting the event. I think these will be minimal and for several reasons. First, South Africa is not exactly next door to any other regular World Cup participating countries, and most other African countries tend to be poorer than South Africa. This is not the case in Europe, was not the case in Asia, and was not the case in South America either. Airline ticket prices will be high for most avid soccer fans in terms of getting to South Africa, and as any economist knows, price and quantity demanded are inversely related, so less foreigners should be expected than would otherwise be the case. This is already in evidence with the ticket sales made so far – over ¾ are to South Africans, the US has the second highest ticket sales, followed by the UK.

Second, most of the world is still not in a mood to spend large amounts of money on international travel – what might seem like fun and would result in minimal cause for dismissal in good times might not seem like such a good idea in a down economy with lots of unemployed workers eager to replace existing workers.

Third, it is the winter in South Africa – one of the nicest things about coming out here is to escape the northern hemisphere’s winter chill – winter in South Africa is not quite snow and ice, but it is hardly hot and humid in July in South Africa, so this will tend to lead to shorter visits by those “in the know” and perhaps even shorter visits by those “not in the know”. Of course I could well be wrong here, and those "not in the know" might end up boosting clothing sales in July!!

OK, I don’t wish to sound like a killjoy, and really I hope the economic boost from hosting the World Cup is significant, but what with prices being quite high in South Africa because of the strong Rand, plus the above reasons, I wouldn’t want to oversell the short term stimulus from the event.

Of course the long run is a different matter. If South Africa mounts a successful event, and people around the world get to see what a great place this is, I think it could really put the country on the map as far as international tourism goes, and mark a turning point in the views of international investors in the stability and maturity of the country. Here the knock-on effects ( - or externalities as economists call them) could be significant.

Go Bafana Bafana ( - the name of South Africa’s national soccer team)!!

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