Yearly Archives: 2017

Mario Draghi On Settlement Of Intra-Eurosystem Claims

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Recently, Mario Draghi—in a letter responsing to questions about TARGET2 imbalances to two members of the European Parliament—says the following:

If a country were to leave the Eurosystem, its national central bank’s claims on or liabilities to the ECB would need to be settled in full.

Since many years many economists, led by Karl Whelan have refused to accept this. There has been a denial via various arguments. The main argument of this camp has been that TARGET2 assets of the ECB doesn’t really matter, presumably because central banks create money and can be capitalized using a bookkeeper’s pen. That is a strange argument because if a country were to leave the Eurosystem and cannot settle its claims to the ECB, the ECB will take a loss. It has less interest earning asset than otherwise and since the ECB’s profits ultimately get distributed to national treasuries, treasuries’ income doesn’t matter according to this argument.

Another way to see this argument is wrong is to think of the international investment position of the remaining region if a country leaves. It’s net international investment position falls. Does international investment position not matter?

Yet another argument. Suppose the day before a country leaves the Euro Area and the Eurosystem, the ECB were to buy that country’s government bonds. The leaving country’s NCBs’ liabilities to the rest of the Eurosystem will fall and its government’s liability will rise. This transaction is a purely financial account transaction in international accounts. How it is that one is debt and the other not debt? Those who claim that the intra-Eurosystem debts do not matter seem to believe that it’s not debt.

Of course, Mario Draghi’s position can be legally challenged. There’s hardly any mention in the legal documents of the Euro Area explicitly stating what happens. But since intra-Eurosystem claims (i.e., NCB TARGET2 balances) earn or pay interest, this makes the case for the settlement of the claims. In law, the reasons why they were created are sometimes used if something is not explicitly stated.

Ha-Joon Chang’s Kicking Away The Ladder Theory

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With recent political changes such as Brexit and Trump, economists have been struggling to understand what’s going on. While there’s some concession with phrases such as “inclusive globalization” (which doesn’t mean much in practice), the global elite is upping its call for free trade.

I’d argue that it’s the macroeconomics of international trade which makes Post-Keynesian economics different from the orthodox. In recent times, economists have conceded a lot about the macroeconomics of fiscal policy and money, they have become more confident about their orthodoxies on international trade. Even with the former they are returning to their orthodox opinions with the argument that heterodox ideas make sense only if the zero lower bound (ZLB) is reached. But “free trade” is the holy cow which will be difficult for orthodoxy to ever abandon.

Ha-Joon Chang is a great writer and communicator on economics. In his 2002 book Kicking Away The Ladder: Development Strategy in Historical Perspective, he argues for a fresh look at how nations developed and how they used a mix of free trade and protectionism whenever it suited them more. Once they became advanced, they want to prevent others from adopting their strategy – they are kicking away the ladder they used to climb to top.

In a shorter article Ha-Joon Chang explains:

Central to the neoliberal discourse on globalization is the conviction that free trade, more than free movements of capital or labor, is the key to global prosperity. Even many of those who are not enthusiastic about all aspects of globalization–ranging from the free-trade economist, Jagdish Bhagwati, advocating capital control to some non-governmental organizations (NGOs) accusing the developed countries for not opening up their agricultural markets–seem to agree that free trade is the most benign, or at least a less problematic, element in the progress of globalization.

Part of the conviction in free trade that the proponents of globalization possess comes from the belief that economic theory has irrefutably established the superiority of free trade, even though there are some formal models which show free trade may not be the best. However, even the builders of those models, such as Paul Krugman, argue that free trade is still the best policy because interventionist trade policies are almost certain to be politically abused. Even more powerful for the proponents of free trade, is their belief that history is on their side. After all, the defenders of free trade ask, isn’t free trade how all the world’s developed countries have become rich? What are some developing countries thinking, they wonder, when they refuse to adopt such a tried and tested recipe for economic development?

A closer look at the history of capitalism, however, reveals a very different story (Chang, 2002). As we shall establish in some detail in this paper, when they were developing countries themselves, virtually all of today’s developed countries did not practice free trade (and laissez-faire industrial policy as its domestic counterpart). Rather, they promoted their national industries through tariffs, subsidies, and other measures.

and introduces the phrase “kicking away the ladder”:

Thus seen, contrary to the popular belief, Britain ‘s technological lead that enabled this shift to a free trade regime had been achieved “behind high and long-lasting tariff barriers” (Bairoch, 1993, p. 46). And it is for this reason that Friedrich List, the nineteenth-century German economist who is mistakenly (see section 3.2 below) known as the father of modern “infant industry” theory, wrote the following passages.

It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him. In this lies the secret of the cosmopolitical doctrine of Adam Smith, and of the cosmopolitical tendencies of his great contemporary William Pitt, and of all his successors in the British Government administrations.

Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth [italics added] (List, 1885, pp. 295–6).

Barack Obama On The Trillion-Dollar Platinum Coin

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Axios reports that Barack Obama gave his last interview to Pod Save America. He recalls his experience with the trillion dollar platinum coin – the idea invented by Carlos Mucha. When he was asked, “When were you most scared in the White House, what was your scariest moment” he said it was the debt ceiling crisis on 2013:

There were all kinds of wacky ideas about how potentially you could have this massive coin I mean… it was like some primitive — it was like out of the stone age or something. And I pictured rolling in some coin … It gets pretty technical, but there was this theory that I had the authority to just issue … through the mint… this massive trillion dollar coin… and that on that basis we could try to pay off our U.S. treasuries. … It was a very realistic possibility that we couldn’t get the votes for that and that we couldn’t get those debts rolled over … and at that point you were in uncharted territory.

The audio mp3 file is available here and the above discussion starts around 27m00s

Of course the President was misinformed because the coin needn’t be “massive”. But it’s nice to know that he seriously considered this possibility.

Xi Jingping And Free Trade As A Not-So-Subtle Form Of Mercantilism

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Xi Jingping, the President of the People’s Republic of China spoke today at the World Economic Forum at Davos.

click the picture to see the video on YouTube. Transcript here

In his speech, he argues for globalization, although also points out the negatives. He says:

We must remain committed to developing global free trade and investment, promote trade and investment liberalization and facilitation through opening-up and say no to protectionism. Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside, that dark room will also block light and air. No one will emerge as a winner in a trade war.

The timing of this speech is not surprising because it comes at a time when Donald Trump is going to become the President of the United States and is threatening to take action on China. Although economists and policy wonks have kept denying it, the Chinese government’s trade practices have been highly damaging to the United States’ economy. For China, “free trade” has been highly advantageous. By keeping its exchange rate at a highly devalued level, the government of China has made large gains for its economy at the expense of the rest of the world. But this “currency manipulation” is not the only unfair practice. Producers in China do what’s called predatory pricing in which prices of their products are kept low in the international markets to gain market share and harm competitors.

It’s an irony of our times that Donald Trump, a right-wing leader is insistent on taking action on China via protectionism, i.e., by setting large tariffs on Chinese exports to the US. It’s even more ironic that China is communist and is declaring free trade to be good.

China’s Mercantalism reminds us of a quote by Joan Robinson. In her 1977 essay What Are The Questions?, she says:

From a long-run point of view, export-led growth is the basis of success. A country that has a competitive advantage in industrial production can maintain a high level of home investment, without fear of being checked by a balance-of-payments crisis. Capital accumulation and technical improvements then progressively enhance its competitive advantage. Employment is high and real-wage rates rising so that “labor trouble” is kept at bay. Its financial position is strong. If it prefers an extra rise of home consumption to acquiring foreign assets, it can allow its exchange rate to appreciate and turn the terms of trade in its own favor. In all these respects, a country in a weak competitive position suffers the corresponding disadvantages.

When Ricardo set out the case against protection, he was supporting British economic interests. Free trade ruined Portuguese industry. Free trade for others is in the interests of the strongest competitor in world markets, and a sufficiently strong competitor has no need for protection at home. Free trade doctrine, in practice, is a more subtle form of Mercantilism. When Britain was the workshop of the world, universal free trade suited her interests. When (with the aid of protection) rival industries developed in Germany and the United States, she was still able to preserve free trade for her own exports in the Empire. The historical tradition of attachment to free trade doctrine is so strong in England that even now, in her weakness, the idea of protectionism is considered shocking.

[boldening: mine]

In her article she was talking about how free trade is a subtle form of mercantilism. What she was imagining was a nation typically not seen as mercantilist but pro-free-trade but that the latter is a subtle form of the former. In the present case, China is seen more as Mercantlist (although the establishment economists deny it) and it’s promoting free trade now. So these two ideologies have a lot in common. Jinping’s speech makes this obvious. Free trade is now a not-so-subtle form of mercantilism.

What Is “Crowding Out”?

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J.W. Mason has a nice article What Does Crowding Out Even Mean? on his site The Slackwire. I agree with some aspects of it not all.

Let me offer a slightly different (but similar) perspective. First the definition. When an economist—typically a new consensus economist—uses the phrase “crowding out”, he/she means that if government expenditure rises, private expenditure falls without output rising.

That’s it: rising government expenditure will lead to a fall in private expenditure with no positive effect on output according to this. And since new consensus economists also talk of government expenditures as less efficient, it also means that they are saying that real output will fall – a proposition that follows.

But this is a highly unlikely scenario.

There are various mechanisms that are claimed by the new consensus economists which will lead to this. The most basic mechanism is based on the assumption of an exogenous stock of money which is incorrect. There are other mechanisms highlighted: such as the central bank raising interest rates following a rise in demand.

Now suppose there is a rise in government expenditure leading to a rise in output and it follows with a central bank rate increase. Private expenditure will be affected, although this effect is not as strong as economists claim. But I won’t call this crowding out. Private expenditure may fall but compared to the counterfactual of no rate increase. Private expenditure in the future is likely to be higher than in present. So it’s not crowding out. Also output has risen in this scenario.

Also new consensus economists’ description around such issue is that the central bank’s interest rate rises endogenously but in reality it is in control of the authorities and it’s not as if interest rates rise naturally as the new consensus economists make it look.

In reality, there is only one extreme case where I can see crowding out happening in my definition. Suppose the economy is running under full capacity and the government raises its expenditures without changing the tax rate. Imagine the government is interested in some construction and does this via an auction to constructors. Since by assumption, the economy is under full capacity, a constructor working for the government means its project for a private firm needs to be postponed. So a rise in government expenditure has led to a fall in private expenditure with no effect on output.

But the above scenario is rather extreme and is unlikely to happen in most economies.

But, interest rates hikes in the US economy to say 5% in one year because of the Federal Reserve raising the short term rates in response to rising demand and output, whether justified or not, is not really crowding out.

Paul Krugman Flip-Flops

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In two recent posts, I had mentioned how economists are shifting their positions because of politics:

  1. Opposing Principles Of Political Economy Just Because Donald Trump Supports It,
  2. The Soon-To-Be Conventional Wisdom: “Fiscal Policy Is Not So Good”.

Thanks to Kevin Glass on Twitter, I came across two headlines highlighting this.

Headline 1, post-election (click for the link)

Headline 2, pre-election (click for the link)

I am sure an apologist would go, “Can you read beyond the headline?”. Well, yes and the two articles mean precisely what the headlines imply.

Krugman says,

This diagnosis — shared by most professional economists — didn’t come out of thin air; it was based on well-established macroeconomic principles. Furthermore, the predictions that came out of those principles held up very well. In the depressed economy that prevailed for years after the financial crisis, government borrowing didn’t drive up interest rates, money creation by the Fed didn’t cause inflation, and nations that tried to slash budget deficits experienced severe recessions.

…

What changes once we’re close to full employment? Basically, government borrowing once again competes with the private sector for a limited amount of money. This means that deficit spending no longer provides much if any economic boost, because it drives up interest rates and “crowds out” private investment.

There are several things wrong with this:

  1. Krugman is trying to argue that fiscal expansion makes sense only in limited scenarios
  2. We are not really close to full employment. There are enough people unemployed, and underemployed. Even if the US economy were close to full employment, a fiscal expansion will raise production and hence productivity via the Kaldor-Verdoorn mechanism. So it’s not like supply-side constraints are exogenously given.
  3. “limited amount of money” is Monetarism. Paul Krugman claims that he is no longer a follower of Milton Friedman but that’s not really the case.
  4. “Crowd out” is just like “patriotism is the last refuge of the scoundrel”. Krugman himself debunked it:

    There is, however, a somewhat related doctrine — call it the doctrine of immaculate crowding out — which has now, I’d argued, achieved true zombiehood. That is, it keeps coming back no matter how many times you kill it.

But Krugman is not the only one. Simon Wren-Lewis is echoing him and so is Ben Bernanke.

Bernanke says:

There is still a case for fiscal policy action today, but to increase output without unduly increasing inflation the focus should be on improving productivity and aggregate supply—for example, through improved public infrastructure that makes our economy more efficient or tax reforms that promote private capital investment.

ignoring the fact that rise in production can lead to a rise in productivity.

It’s sad that all this happened. Orthodoxy needs to be fought harder.