Links

Voxeu explains some Eurozone central banking mechanics: http://voxeu.org/index.php?q=node/7391
At the same place, Charles Wyplosz argues for decentralised discipline: http://voxeu.org/index.php?q=node/7387

Immigration: ordure approaching fan

If the Eurozone does collapse, or if there is just a second European credit crunch, then Britain will be relatively insulated. We will still suffer a lot, but less than the Eurozone itself. However, the EU has a useful mechanism for sharing the pain: labour migration, guaranteed by freedom of movement within Europe. Although it is low compared to the US, it has still been high enough over the past decade to make immigration a big political issue in Britain. The government has pledged to cut immigration to the tens of thousands. Good luck with that when Eurozone unemployment increases above its already high level. There will be increasing pressure to pull up the drawbridges.

On the Euro crisis

Mainstream opinion seems to be as follows:

1. Creating the Euro was a mistake.
2. We should save the Euro at all costs.

“At all costs” means:

• In the short run, the ECB to buy member states' bonds, or to issue Eurobonds.
• In the long run, centralized budgetary discipline in the Eurozone...
• … and perhaps much greater transfers to provide “automatic stabilizers”

On the face of it (1) and (2) do not sit well together. The argument for combining them is that the alternative is disastrous: government default, one or more countries leaving the Euro, bank runs which governments can no longer prevent, and perhaps a second Great Depression.

Almost anything would be justified to avoid a really serious depression, because events on that scale do not just impose economic hardship – they also risk devolving into political chaos. For instance, I have heard the Great Depression and the collapse of world trade cited as a cause of World War Two, though I don't know enough history to evaluate that claim.

On the other hand, the argument is not completely obvious.

First, it isn't necessary to leave the Euro in order to default. Greece, for example, is keen to stay in the Euro. The cost of staying in the Euro is being stuck with an uncompetitive exchange rate. But countries have survived that. By defaulting they would at least rid themselves of the debt overhang that is forcing them to cut, cut, cut government spending in the midst of a recession. The cost of leaving the Euro is being stuck with a less credible currency, and probably facing bank runs as a result.

On the other hand, if countries do leave the Euro, that may not be disastrous for them. (Or why would they do it voluntarily?) Britain was forced to float its currency 20 years ago; the Conservative government was humiliated, but the economic results were actually beneficial, weren't they? There is a trade-off: chaos at exit versus increased competitiveness with your own currency afterwards.

At the very least, the economic tail is wagging the political dog. European government structures are being created as a panicked response to a crisis. These structures are likely to be less democratic, more centralized (with Germany being the centre), and also to set in stone the Eurozone's problems, as follows:

• There will still be a single currency without the integrated labour markets that would help it to work.
• There will still be the temptation to fiscal indiscipline, which will have to be prevented by centralized control.

Fans of democracy, freedom and responsible politics should not find this an appealing prospect. It would also be a national defeat for Britain, because we would be on the periphery of a large centralized Eurozone with very different economic interests and values to our own.

If the alternative is really a global economic collapse then perhaps this is the best choice of a bad bunch. My personal nightmare is different:

• Europe centralizes;
• Established parties, and elites more generally, face an ever-stronger backlash from their “angry and defrauded young”;
• A new generation of populists enters national governments. They offer fantasy solutions, play fast and loose with deficits, and fail to exercise mutual discipline at European level.
• We have a century of Argentina-style distributive politics, relative decline, and domination by a resurgent Russia.

My instinct is that failed ideas should be discarded; but if we are going to have the Euro, it seems better to have fiscal discipline and a hard budget constraint – a core condition for “market-preserving federalism”. The US has achieved this, so why can't Europe?

Perhaps I am missing something and there's an obvious reason that a default means a Euro collapse, and that Euro breakup must inevitably be an economic catastrophe. Certainly lots of people think so. However, perhaps some of the current panic comes from businessmen and bankers who naturally confuse short-term harm to themselves with the end of civilization.

Ezra Klein explains the Euro crisis

in eight graphs.

Christina Romer shifts my priors

 ... a speech on estimating the economic effects of austerity and/or expansion. Her conclusion: there is solid evidence that fiscal stimulus works, and that austerity is painful. Not something I' naturally am inclined to believe, but when the evidence is gathered so carefully, it shifts my priors.

Dodgy science

Alex Tabarrok spanks the BMJ over an article on the brain drain.

The BMJ and Lancet are publishing a lot of social science these days. The slant is usually Left-ish; more importantly, the methodology is often weak. When did social science overtake medical science in analytical rigour?

Blame the economists!

It is widely thought that the financial crisis shows up the flaws of neoclassical economists, who were so immersed in nerdy mathematical theory that they forgot about the real world.

However, many economists did predict aspects of the crisis. Not all were marginal voices, either. Some were very distinguished figures from the mainstream.

Here is Marty Feldstein in 1997 (ungated link), arguing that the Euro is an economic liability.

Here are Obstfeld and Rogoff in 2005 (ungated link), worrying about opaque networks of cross-holdings and counterparty risk (in the context of the US current account deficit).

Economists probably are not blameless, and certainly there were naïve optimists – I read a fabulous article recently, from about 2005, which said [re the strength of the dollar, but it seems to typify that era] “the markets can be wrong, but they can't be wrong for a decade”. But as a group, macroeconomists probably had a clearer and earlier sense of the dangers than anyone else. The problem is that their knowledge did not percolate to the wider public.

This seems like a growing problem. Social science has been getting better and stronger in the past two decades – we have rigorous techniques for untangling multiple causes, ever better datasets and now the possibility to integrate field and laboratory experiments into our theory. But very little of this knowledge has spread to the world in general. Popular social science (Freakonomics or The Tipping Point) has been in fashion recently, but we are still far from the point where people turn to social scientists for ideas about what is going on. For example, think of the referendum on the Alternative Vote in the UK this May. There is a lot of research on how electoral systems shape political and economic outcomes – not enough to decide definitively either way, but certainly relevant evidence. This research never got mentioned in the debate. (There was some very simple stuff, like simulations of how the 2010 election would have gone, but nothing of modern research in political economy.)

I am not sure how this could be fixed. We definitely need more Levitts and Harfords. Perhaps we need more social scientists blogging.

On the steps of St Paul's

Sitting on the steps of occupied St Paul's Cathedral. There's a funky brass band playing. Tents everywhere. Posters from anarchists, communists, loons of various descriptions. A couple of people in those masks from V. (Terrible, self-indulgent film.) There's one or two TV cameras, and a lot of tourists like me milling around.

The mood is unfocused and idealistic. The closest thing to a set of demands is posted up on the corner of the information tent. No to cuts, we won't pay for your crisis, the system is unjust and must be replaced. A lot of references to 19th-century protest. A strong non-violent vibe. Apparently all decisions are taken by a General Assembly. (By consensus, if you hadn't guessed.)

My favourite poster

Yesterday I bought The Big Short. It's a great story. If you spend a lot of time reading theorists' explanations of what caused the Global Financial Crisis – the GFC, as the jargon of my economic policy class would put it – it's good to compare them with a journalist's description of what actually happened. The Big Short focuses on the “heroes” of the GFC, if they deserve that name: the people who figured out early that the boom in house prices was unsustainable. They took large bets on this. Normally, in a market, if somebody bets against something, its price goes down. One of the puzzles in the book is that this doesn't happen. There seem to be two markets: one in which a small but growing number of smart people figure out that many US mortgage loans will not come good, and another official market in which these loans are expected, right until the end, to pay out. So, where did the buyers for the second market come from? The book never answers this very clearly except to say “idiots in Germany”.

A tent where you can meditate or pray. A notice up asking people not to drink on site, as requested by the London Fire Brigade. Inevitably, a sign offering FREE HUGS.

I'm sympathetic with these people's anger, and it's nice to see somebody in London doing something other than shopping. I think they need some coherent analysis. I'll leave them The Big Short for a start.

Shetland

Yup, the world's most Northerly ferry is on Facebook.

Rstudio plug

For a few years I've been searching for a GUI for the statistics program R. Now I think we have a winner: Rstudio. It doesn't bother providing menu items for graphs or regressions, instead focusing on a great script editor and command line (features like command line syntax highlighting and multiline entry), plus integrated plot, history, variable and help file display. It's really one of the best programming editors I've seen for any language.

Mobility and democracy

If you graph UK economic performance over 1979-2007 – these look like the natural breaks nowadays – then we do pretty well:

Real GDP per capita 1979-2007 (WDI via Google; log scale)

But at the end of this period, there was increasing immigration to the UK, from Eastern Europe as well as from traditional sources like South Asia. This immigration resulted in growing political dissatisfaction, which came firmly on to the agenda in the 2010 election.

Population growth rate 1979-2007 (WDI via google)

The two great areas of democracy in the world today, the US and the EU, are also areas of free mobility. The US was a frontier society until 1890: dissatisfied employees could move West and find a homestead.

Wagons heading West

Today, it remains a decentralized country – the United States – and the states have been called “laboratories of democracy”. The EU even more so: written into its founding charter are the principles that member states must be democratic, and that labour, like other goods and services, must be free to move between them.

There are many reasons why democracy and mobility might go together. It's no coincidence that dictatorships like North Korea and Cuba are prison states that try to stop their subjects leaving. Mobility might protect you from the tyranny of the majority: political scientists like Carles Boix have argued that democratization is more likely when wealth is mobile, so that the rich no longer fear being expropriated by a poor majority.

On the other hand, mobility brings with it certain problems for systems where good governance depends on the wisdom of the citizenry.

First, intelligent policy-making is always a public good – something that benefits everyone in a community, no matter who pays for it. But freedom of movement makes good governance a public good between communities, as well as within them. Suppose, choosing two countries at random, that Spain is worse governed than France, and therefore a poorer and less pleasant place to live. Without free movement, the citizens of Spain have a strong incentive to do something about that, for example by voting for policies that work better. With freedom of movement, they have a simple alternative: pop across the border. Under the (very idealized) assumption that mobility is free and frictionless, they will continue to do so until “utilities are equalized”: that is, until France and Spain are equally un/pleasant, perhaps because of all the migrants moving into France and using public services.

Of course, that politics is a public good means that self-interested people will never provide enough of it. But existing national communities are organized in ways to get round this problem: they have newspapers which keep people informed and encourage them to participate, national parties to link politicians with an active citizenry, patriotism as a source of willingness to work for the community, and so forth. The political collective action problem within nations is hardly solved, but it is mitigated. That is much less true for the collective action problem between nations.

Another problem for democracies comes from the same source. People are politically ignorant: this is one of the best-established empirical generalizations in political science. It, too, is probably a result of the public good aspect of politics: when you have little influence over something, ignorance is rational. The most reliable knowledge we have about our politicians' performance is not the information we seek out – which is often schematic, sketchy and biased towards our pre-existing beliefs – but what we learn “by accident” in everyday life. If you lose your job, then you can assume the economy is not going very well, and you can (and will) blame the government.

But again, free mobility makes that signal noisier. If your child waits a long time for healthcare, do you blame the government's handling of the NHS? Or do you blame the increased demands placed on the system by more people using it? (Some local authorities have blamed poor performance on immigration in the past.) If free mobility equalizes utility between countries, then good and bad governance are no longer distinguishable.

A final problem with mobility is the issue of fairness between different groups, such as the old and the young. European welfare states are built on intergenerational compacts, and these national compacts vary from country to country. Mobility allows people to arbitrage these differences. Young singles turn up to work in London's vibrant freemarket economy; couples with children can move to take advantage of Holland's education system. These problems are known in America, where there is talk of a “race to the bottom” between states in welfare provision; though at least America has a big-spending federal government to iron out these differences.

None of these arguments make me long for the return of border controls in Europe. But they do show there is some tension between the ideals of democracy and freedom of movement. As long as European countries remain widely divergent in wealth and standards of public services, this tension is likely to stay prominent. Denmark's recent decision to impose border controls even within the Schengen area is one example.