Saturday, June 13, 2009


Gary Becker (link) and Richard Posner (link) discuss whether the gravity of world economy is moving from the US and the EU to emerging Asian economies.

Rapid economic growth and steady institutional transformation are the key drivers of Asia's economic rise in the global economy. While the United States and the EU will likely suffer from this year's recession and pursue a U-shaped recovery, India, China, Indonesia and Vietnam will continue to grow in 2009 with favorable midterm growth projections. Even minor short-run differences in economic growth can lead to a profound impact on long-run income per capita. For example, if China and India's long-run economic growth rate is about 5 percent, it would take 14 years to double its income per capita.

If the growth rate were 6 percent, which is more likely after taking the productivity shocks into account, it would take 12 years for income per capita to double. The medium-term forecasts by the IMF suggest that the U.S and Europe will grow between 2.5 and 3 percent. Similarly, that would take 29 years and 24 years to double the income per capita. The gap can be further estimated by the empirics of real convergence.

Rapid economic growth in Asian tigers will also induce their bargaining power in institutions such as WTO, IMF and World Bank. In particular, Asia's fast growing economies play a stronger role in world trade. Thus, the bargaining power of India and China in negotiating regional and multilateral trade agreements is growing. The central challenge, however, is whether Asian tigers will recognize that free trade promotes economic growth, welfare and peace. The rise of trade protectionism in the U.S (link) and Europe is a significant concern from a countervailing perspective. Even the area of climate change policy is a potential source of conflict between the US and the EU on one side and China and India on the other side.

Of course, I disagree with pessimistic arguments that the U.S will lose its leadership in innovation, technology and human capital. Indeed, top U.S universities will still remain world's top-notch sources of human capital and the U.S high-tech firms are unlikely to lose their world leadership. However, rapid economic growth in Asia will induce China, India, Indonesia and Vietnam to pursue free-market policies alongside economic, civil and political liberties to give up the authoritarian political climate. In fact, the transformation to free-market economy with independent economic and political institutions will, in the long run, determine the scope of Asia's economic rise in the world.

Friday, June 12, 2009


Daniel Griswold, trade economist at CATO Institute, describes (link) how American labor unions oppose the free-trade agreement between the U.S and Columbia although the U.S International Trade Commission's estimates show that the free trade agreement between the two countries would boost U.S exports by about $1 billion annually. The AFL complains that Columbia is an unworthy of an agreement because of violence levied on union members (link). This may sound politically feasible, but the background is certainly much different from what AFL complains. In fact, Daniel Griswold showed that Columbian unions are as safe as American unions against political violence (link).

Recall the basics of international trade, H-O-S theorem (link) explains that international trade occurs because of the differences in relative factor abundance, i.e. differences between labor/capital ratio. Thus, a country with relative abundance in labor shall export labor-intensive products while the second country shall export capital-intensive products and services. Consequently, relative wages in labor-abundant country are lower compared to those in capital-abudant country. Why? Because in a more developed capital-abundant country, labor is scarce and, hence, relative wage is higher.

The complete liberalization of trade between the U.S and Columbia would reward the relatively abundant factor in the U.S (capital) and reduce the real reward to less abundant factor (labor). Thus, in the short run, relative wages may decline. Note that the Columbian level of productivity is less than half of the U.S level. In the long run, however, relative wages shall not decline given a staggering difference in productivity between the U.S and Columbia.

As a interest group, AFL is protecting labor againist the short-run decline in relative wages. The hindrance of free trade, in fact, harms everyone. The U.S exporters would suffer the loss of one the key Latin American markets while the Columbian exporters wouldn't absorb the benefits of free trade. On the other hand, the greatest victims of protectionist trade policy are consumers. The consumers in the U.S would be denied the freedom of choice of Columbian imports while Columbian consumers would lose the variety of choices from the U.S at a lower price, following the abolition of tariff protection.

Wednesday, June 10, 2009


"For centuries philosophers, mathematicians, political scientists and economists have searched for the best method of voting. Fifty-eight years ago the economist Kenneth Arrow (later a Nobel laureate) decided to see whether any voting rule could avoid the problems we've illustrated. Fix them all at once, he found, and you get--a dictatorship. One voter calls the shots every time. Arrow's "impossibility theorem" demonstrates that no system of voting always gives the "right" result."

Source: John Mark Hansen, Allen R. Sanderson, The Olympics of Voting, Forbes, June 3, 2009 (link)


As seen by The Economist (here and here):

"...a recent study by McKinsey, a consultancy. It looked into five sectors of the Russian economy and found that, although productivity has improved over the past decade, it is still only 26% of American levels. Bureaucracy and corruption are stifling it. It takes six times as long to obtain construction permits in Russia as in Sweden and, despite cheaper labour and land, the cost of building a distribution centre is a third more expensive than in London, according to McKinsey. When profit margins were 25%, construction firms could afford to pay off bureaucrats. Now they cannot..."


The Economist observes that a growing public debt and exploding fiscal deficit is the foremost macroeconomic enemy of the U.S economy (link). Interestingly, Douglas W. Elmendorf, the head of CBO delivered a brilliant testimony (link) on the state of the economy, emphasizing the interest rate spread, the macroeconomic effects of financial crisis and the deflationary outlook for 2010. Below is a time series and the long-term projection of the U.S public debt in the percentage share of the GDP under three scenarios.

Source: Congressional Budget Office (link)


Today, Bloomberg reported (link) that April's trade deficit in the U.S increased by 2.2 percent. The recession in major trading partner sharply reduced external demand for U.S exports. As trade deficit has continued to grow, the U.S experienced significant investment inflows due to Fed's and external demand for Treasury bonds by which Chinese central bank accumulated massive foreign currency reserves. Consequently, the U.S dollar depreciated against the yuan, pushing up trade deficit. In the last three months, the yuan appreciated by 0.3 percent. In spite of the recession, the Chinese economy is set to expand by 7.5 percent annually in 2009. Thus, it is hard to understand why some U.S politicians repeatedly say that the yuan is overvalued.

Tuesday, June 09, 2009


Earlier this morning I was informed by Bloomberg (link) that Slovenia officially entered the recession for the first time in the last 16 years. The information has not been surprising since major economic forecasts predicted a significant downturn in the light of deteriorating exports and investment. The data pointed out to a significant economic decline. Gross capital formation shrank by an astonishing 32.3 percent. On the other hand, private household consumption grew slightly by 0.1 percent while government spending grew by 3.8 percent.

The outbreak of the financial crisis led economic policymakers to pursue a robust fiscal stimulus to compensate the decline of investment and consumption spending. Before entering the EMU, Slovenia had to comply with Maastricht criteria, including anchoring the budget deficit at the maximum level of 3 percent of the GDP. This year, the budget deficit soared over 6 percent of the GDP, suggesting a growing pressure on public debt. Earlier this month, John Taylor, a professor of economics at Stanford, wrote a great article in FT discussing the hidden dangers of a growing government debt (link). When credit rating agencies downgraded the sovereign debt outlook for the United Kingdom from "stable" to "negative", it should be obvious to economic policymakers that fiscal stimulus failed the cost-benefit analysis and hardly consolidated the midterm economic outlook and recovery.

Recently, Donald Kohn, the vice president of the Fed expressed concerns about fiscal deficit regarding inflationary outlook (link). The reaction of the fiscal policy included a typical fine-tuning infusion of government spending which produced little effect. Of course, it should be noted that a rather drastic expansion of public debt is not only a consequence of an expansionary fiscal policy but also of significant bailout loans from IMF. IMF's $2.4 billion bailout loan raised Latvia's public debt from 9 percent to 15.2 percent of the GDP in 2008 (link). By 2010, it is estimated to go up to 46 percent (link) of the GDP. The explosion of public debt is a particular concern and an obvious consequence of economy's overheating. The IMF recently reported that overall bank credit to private sector settled at 95 percent of the GDP. Complementary, external indebtedness rose to 130 percent of the GDP (link). Clearly, Bank of Latvia failed to act as a lender of the last resort with unbuilt foreign reserves basis and a balance sheet that couldn't sustain the bailout of the financial sector.

Iceland, definitely one of the biggest victims of the financial crisis has recently been downgraded on sovereign debt by Moody. The assets by the outward-oriented banking sector, fuelled by a stunning interest rate differential and carry trading against uncovered interest parity, skipped the size of the economy by 900 percent. The Moody predicted that Icelandic public debt will reach 145.3 percent in 2009 and shall decline slowly and gradually.

On the annual basis, Slovenia's small and open economy declined by 8.3 percent which is one of the most significant declines in the EU after Baltic tigers and Ireland. The European Commission predicts 3.4 percent decline in output by 2009. Exports are expected to decline by 11.8 percent. Small and open economies are vulnerable to economic crises and external shocks, particularly because its trade-to-GDP ratio stands at 60 percent of the GDP and beyond.

This year's quite striking decline has much to do with Slovenia's main macroeconomic backbones. The inflation rate, which grew significantly during the 2007 economic expansion when GDP growth stood at 6.8 percent annually, has not increased. That is because Slovenia, as other EMU members, experiences the recessionary output gap and also because there were no inflationary shocks from the oil market. The third frontier of explanation for a deflating pressure on economic activity in Slovenia is that during the recession spillovers from the tradeable sector strongly affected domestic retail and service sector. In March 2009, the unemployment rate stood at 8.4 percent. The combination of a weak labor market and significant downturn of private consumption spending weakened the bargaining power of unions over wage determination, although wages in the public sector recently grew by double-digit rates (link). In May, the monthly rate of inflation reached 0.6 percent respectively (link). The industrial production, one of the keenest signals of economic activity, for instance, declined by 20 percent in March 2009 (link). The lack of productivity shocks such as restructuring and innovation further worsened the outlook of industrial production.

In a Keynesian spinning turn, Slovenian government pursued a dramatic fiscal expansion coupled with an easy money policy from the ECB's lowest baseline interest rate since early 2000s. In addition to horrible state of public finance, the government enforced a set of measures to protect the major banks from the failure. After the failure of Lehman brothers, it became obvious that the credit flow to state-owned companies for purposes of acquisitions and oligpolistic consolidation will inevitably decrease significantly as the banks' balance sheets were too soft and, of course, too small to secure loans to the real sector. Not surprisingly, the banks performed dismally at the stock market. SBI20, Slovenia's headline stock market index shrank by an astonishing 68 percent between 2008 and 2009 (link), suggesting that P/E ratios and earnings forecasts were mostly overvalued and distorted by the insider information and inadequate and unreliable signals.

The recent staff report by the IMF on Slovenia (link) suggested the immediate enforcement of structural reforms to boost economic recovery. The historical track record of macroeconomic and structural reforms is quite sluggish. During the financial and economic crisis of 2008/2009, the Slovenian government raised government spending and tax burden.

Additionally, it further regulated the labor market by preventing firings through wage guarantees to temporary unemployed whom employers are obligated to reemploy as the economic recovery goes further. Is this a reminder that a totalitarian political economy is still alive? Yes. It seems that economic policymakers ignored the overwhelming regulatory burden in the business environment (link), extremely regulated, inflexible and costly labor market (link), the lack of scale to develop sound capital and financial markets (link) (link), unfinished privatization, high tax wedge and the lack of judicial enforcement in defending the rule of law and the protection of property rights.

These structural and macroeconomic reforms would strengthen the midterm growth outlook and significantly boost the economic recovery. Nonetheless, these reforms would not inhibit the economic growth in the long-run. The IMF's World Economic Outlook predicts weak growth in 2010 and a consecutive recovery until 2014 when the economic activity is expected to increase by 3.5 percent. However, the economic growth in Eastern tigers is expected to go steadily beyond 4 percent by 2012. By 2012-2014, Estonia's economic growth is expected to set up between 4 and 4.5 percent. Nonetheless, Slovakia, which smoothly matured in macroeconomic stability by entering the EMU in 2008, is set to expand 5.2 percent in 2011 and experience moderate growth ranging between 4 and 4.5 percent until 2014. Even a minor difference in economic growth has a significant long-term effect.

If Estonia and Slovakia steadily experienced 4.5 percent economic growth rate, it would take 16 years to double its GDP per capita. On the other hand, if Slovenia steadily experienced 3.5 percent economic growth rate, its GDP per capita would double in about 21 years. In my workshop on real convergence, I estimated that Estonia and Slovakia shall catch-up with Slovenian level of the GDP in about 12 to 16 years. In 1991, the catch-up gap between Slovenia and Estonia was between 45 and 50 years respectively.

Thus, without bold and strong economic reforms, the future of Slovenia shall be nothing more than a story of a slowly-growing and gradually stagnating economy with close and unfortunate similarities to Italy and France rather than to Singapore or Australia.