Tuesday, November 24, 2009


Today's Hardtalk on BBC World News (link) discussed the political, economic and social aspects of communism versus liberal capitalism with Slavoj Zizek ,a philosopher and professor at European Graduate School.

Mr. Zizek discussed the role of liberal capitalism in the modern age. He condemned communism as a failure of the mankind and reaffirmed the liberal capitalism as the greatest invention of the mankind. The topic discussed was the future of liberal capitalism. In arguable words of Mr. Zizek, liberal capitalism, although dynamic and powerful in delivering ends of political and economic freedom, is doomed to fail and it thus requires new politico-economic alternative, divisible at the intersection of market and the state. Despite the interactive debate, I would like to add some points to the discussion which were, in my opinion, either mismatched or misinterpretated.

The evolution of liberal capitalism throughout the course of human history has been emphasized by the expansion of economic, political and human freedom. The greatest inventions in human history were not conducted under dictatorial political regimes. But they were conducted during the age of limited government and free innovation environment. Anytime the powerful wit of government was enforced, innovation and discoveries suffered. Although Mr. Zizek recognizes the failure of totalitarian regimes to stimulate intellectual creativity, his analysis of liberal capitalism inherently neglects its role.

The ability of individuals and firms to pursue their own goals in liberal capitalism is enabled not because of the design of desirable goals but because the free-market capitalism evolved as an undesigned system of ideas under strong rule of law. If liberal capitalism, as Mr. Zizek argues, would be doomed to fail, the individuals never witnessed an unparalleled increase in prosperity and in the 20th and 21st century.

What has distinguished communist political regimes from liberal democracies are the institutions of economic freedom. There is a clear and remarkably positive empirical relationship between economic freedom and standard of living. The experience has shown that political liberty is a neccesary but not sufficient condition for prosperity. Both, the neccesary and sufficient condition for the pursuit of prosperity is economic freedom. Without economic freedom, when governments replace the rule of law with the rule of man, and heavily interfere with free-enterprise activity, these countries are doomed to stagnate. Totalitarian political ideology, claiming to create heaven on earth, has always turned towards the hell on earth.

During the interview, Mr. Zizek argued several times that liberal capitalism can eat itself and fail in a similar vain as communism did. The Soviet Union and the communist block certainly hadn't failed because of the lack of technological investment, but because communist political ideology erased the system of incentives. Even today, when several politically totalitarian countries sustained high growth rates, the superiority of liberal capitalism is even more obvious. The motion behind the economic miracle of Gulf countries, such as UAE, Bahrain and Qatar, is the institutional arrangement that promotes solid economic performance under robust system of law, market economy and incentives that allocate scarce resources into the most appropriate uses. In the interview, Mr. Zizek described Dubai's miserable labor conditions as "labor concentration camps" where workers from other countries reside. Although this view sounds very compelling to Marxist philosophers and political thinkers, no government agency forced foreign workers to go to Dubai and work there.

In fact, the economy of United Arab Emirates went through a remarkable restructuring with the creation of the robust financial and service sectors. As productivity growth and capital investment soared in recent decade, wage rates in Dubai are much higher than in other Arab countries. Still in doubt? Ask foreign workers in Dubai how many of them would leave the place and returned to work in their home countries; and why they don't do that. In addition, in Mr. Zizek's home country, labor conditions for foreign physical workers mostly from ex-Yugoslavia are not the envy of the world despite the most regulated labor market in the world.

There is also a wide array of case studies from recent economic history that show how economic freedom crucially determines the wealth of nations. In 1955, Hong Kong was a miserable place flooded with refugees from the mainland China. In 1960, Hong Kong's average income per capita was 28 percent of that in Great Britain. In 1996, it rose to 137 percent of that in Britain. Neither the dictatorial political regimes led to the economic boom in Hong Kong, nor the desire to create heaven on earth. It was a set of strong rule of law of British origin, limited government spending and free markets that propelled Hong Kong to the climb up the ladder.

Mr Zizek arguably enforced the proposition that global financial crisis led to the crisis of liberal capitalism. Although the global financial crisis led to the recession, high unemployment and deflating prices, it certainly has not put the existence of liberal capitalism into doubts.

The origins of the last year's financial crisis go back to the New Deal and presidential time of Jimmy Carter and Bill Clinton whose administrations, as benevolent social engineers, enforced numerous acts to boost home ownership. Back in 1996, president Clinton signed Community Reinvestment Act which forced banks to allocate housing borrowings to low-income neighborhoods. In the aftermath, Fannie Mae and Freddie Mac securitized risky sub-prime mortgage loans to save banks from default. Meanwhile, they inflated debt-to-equity ratio to 60:1. It means that for deposit of USD, there were 60 USD behind in debt that nobody was willing to bear.

In addition, the monetary policy of the Greenspan era kept low interest rates for too long which causeed an asset bubble and led to the decrease of mortgage values It led to the federal bailout of Bear Sternes and the failure of Lehman Brothers. It also triggered innumerable quests for federal bailout of financial institutions. Thus, it would be foolish to speak about the crisis of liberal capitalism after the financial meltdown. Is liberal capitalism to blame? Of course not. It is rather the greedy political apetite for destructive policies that compromised the stability of the world economy for the sake of short-term political goals.

Mr. Zizek wisely avoided the question of the post-communist politico-economic status of Slovenia after the collapse of Tito's Yugoslavia. True, Slovenia's superior economic performance in Yugoslavia was mainly due to its export orientation and higher growth compared to the rest of Yugoslavia. At the beginning of the independence in 1991, Slovenia was, by all measures, the most developed former communist country; far ahead of countries such as Czech Republic, Slovakia and Estonia. Today, Czech Republic virtually caught-up Slovenia's level of standard of living. In 2008, Czech Republic's GDP per capita was 94 percent of that in Slovenia. In 1991, it was merely of 60 percent of that in Slovenia. The politicians, of the same "market socialist" politico-economic beliefs as Mr. Zizek, designed the statist economic policy based on high tax rates, state-owned enterprises, weak rule of law and rigid market structures. Today, Slovenia's economic and political system more closely resembles Russia's mafia state than a liberal society based on economic freedom, rule of law and limited government. In a great part, thanks to the political ideology of "market socialism."

Sunday, November 22, 2009


From Alberto Alesina and Silvia Ardagna (link):

"We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. We confirm these results with simple regression analysis"

Saturday, November 21, 2009


Douglas Holtz-Eakin, former CBO director, discussed the negative effects of the new fiscal policy in the U.S (link).


The Economist published a thorough discussion (link) of China's currency policy and reasons why yuan is unlikely to revaluate any soon.


The Economist updated the report on the Japanese economy which again suffered from monthly deflation (link). The forecasts for the end of the year forsee deflation as a structural problem of the Japanese economy and not as a short-term phenomena that would reflect temporary declines in domestic or foreign demand. True, the financial crisis and the recession depressed Japanese exports but the real cause of the deflationary persistence is to be found in the design of the monetary policy which pushed the Japanese economy in deflationary trap back in early 1990s.

The OECD's preliminary report on the Japanese economic outlook (link) suggested the Bank of Japan to keep interest rates low and immediately implement quantitative easing measures to boost the economic activity as long as the expected inflation remains firmly positive.

In 2009, the IMF's inflationary forecast is -1.1 percent. Recently, Deutsche Bank released an interesting report on the Japanese economy (link), emphasizing annual decrease in output by 7 percent country's record high public debt as well as its tearing debt scenario. Japan easily maintained high public debt because of low interest rates. In fact, most of the net value of the public debt has been denominated in yen which reduced government's interest payment risk and decreased the probability of government's debt default. Before the crisis, gross government debt stood at 172 percent of the GDP. The net debt, for instance, stood at 87.7 percent of the GDP mostly because public pension assets are counterbalanced by spending commitments.

The question is how to tackle Japan's disease of low output growth and persistent deflation that last well over the latest decade?

First, it is difficult to implement further quantitative easing for the Bank of Japan. If the Bank eventually decided to do so, the interest rate would go beyond zero ground, leading to higher future value of bond payments and, hence, higher indebtedness of the Japanese government. The Bank of Japan recently left the interest rate steady at 0.1 percent and decided to purchase government bonds to keep the monetary policy strongly accomodative.

Second, the Japanese experience with a long period of falling prices began when the Bank of Japan kept driving the expansionary monetary policy when temporary shocks in domestic and foreign demand led to lower capacity of the Japanese corporate sector. When output and prices started the recovery, excess reserves were compensated by further lowering of the central bank's policy rate. Low interest rates were not offset by the closing of the output gap so the measure to boost the aggregate private consumption, investment and exports hindered the goals of the economic policymakers. The result was a depressing decrease in the price level that couldn't be offset by quantitative easing and fiscal stimulus. The former would cause negative real interest rates while the latter would increase government spending, cause crowding-out effect and further increased the country's soaring public debt.

And third, Japan's unfavorable demographic trend pose a significant risk on the sustainability of government's pension system. As Japan's population is in decline, the overall private consumption decreases which leads the retail sector to cut prices to gain the market share. The rising aging population certainly endangers country's public finances, marred by budget deficits and the highest public debt in the OECD.

Japan's looming public debt and deflationary trap are the main inhibitors of country's long-term macroeconomic recovery. Pulling the economy out of deflation rate would require huge steps to reflate the prices such as charging banks for deposits at the central bank. That would raise the interest rate at the expense of decline in aggregate investment. However, the goal is not the mission impossible. What can save the Japanese economy from double D-trap is strong, persistent and high productivity growth. It would surely ease the burden of public debt, since the Japanese government's revenues would grow and thus, its borrowing abroad and raising the level of public debt were anchored. It would also allow for greater spending cuts. On the other hand, Bank of Japan could finally pursue the real credibility of the monetary policy and avoid the mismanaged quantitative easing.

Friday, November 20, 2009


Daron Acemoglu wrote a marvelous article discussing the supportive role of incentives and institutions in global poverty reduction and economic development (link):

"If we know why nations are poor, the resulting question is what can we do to help them. Our ability to impose institutions from the outside is limited, as the recent U. S. experiences in Afghanistan and Iraq demonstrate. But we are not helpless, and in many instances, there is a lot to be done. Even the most repressed citizens of the world will stand up to tyrants when given the opportunity. We saw this recently in Iran and a few years ago in Ukraine during the Orange Revolution."

Thursday, November 19, 2009


In yesterday's edition of WSJ, Johnny Munkhammar and Nima Sanandaji wrote a well-argued dissussion (link) on how Eastern Europe's advantage in terms of competitive tax rates, low tax burden and sizeable reform efforts in emerging from the crisis offer a great lesson for economic recovery of the Western counterparts.


The Economist has published two great articles on the anomalies of U.S fiscal deficit (link) (link).

Thursday, November 12, 2009

Wednesday, November 11, 2009


Yesterday, it has been 20 years since the fall of the Berlin wall and the eventual collapse of communist political and economic system in Central and Eastern Europe. However, there is still discussion about economic costs and benefits of German reunification (Wiedervereinigung). I've been motivated to open this debate by professor Becker's analysis (link) on the size of countries and by the recent article in Financial Times by the contributing German economist (link).

Economists in Germany and the rest of the world have long warned against the consequences of the unification of East and West Germany. After the unification, German central bank set the exchange rate at 1:1. Because East German workers' relative productivity level lagged far behind the West German level, East German workers migrated to West Germany in search of higher wages. When wage rates between West and East Germany were equalized in the absence of productivity catch-up in East Germany, the excess labor supply in the East led to high unemployment and slow changes in the economic structure. As the exchange rate was equalized and wages prevented from the natural adjustment to productivity growth, the unemployment soared as East German manufacturing sector couldn't employ labor anymore. The unemployed received massive transfer payments which, even more than a decade after the reunification, still present about 4 percent of total German income.

Today, the figures suggest that East German GDP per capita is roughly 70 percent of the Western German level and the unemployment rate exceeds 12 percent - more than twice the Western level. Low population density and high share of rural population are the main structural obstacle to higher productivity growth in the East. The majority of models in economic geography and urban economics suggests that agglomeration economies occur where population density is high. The latter yields significant advantages in terms of spillovers, search cost, factor mobility, know-how and economies of scale. Low population density is a major obstacle in attracting investment mostly because firms are not eager to locate at the periphery in the presence of high search costs and in the absence of high-skilled labor, agglomeration and linkages to economies of scale. In the U.S, for instance, Pittsburgh's industrial restructuring from resource-based steel industry into knowledge-intensive information technology, biotechnology and software development required agglomeration which combined high-skilled labor, human capital, access to regional and international markets as well as high population density.

In Germany, for example, Hamburg generated the highest GDP per capita (€51,000) among cities and Bavaria (Bayern) generated the highest GDP per capita (€36,000) among German states. Hamburg and Munich, as well as the linking cities located in their vacinity are among the most densely populated areas which enabled them to develop core industries, spillovers, know-how and dynamic knowledge externalities. There is an overwhelming evidence that differences in population density are a good source of growth difference between east and west Germany.

After the unification, German fiscal policymakers favored an expansive fiscal policy which directed federal expenditures into poorer regions of the East to boost the development of infrastructure. However, at an exchange rate 1:1, West German firms were reluctant to invest in East Germany mainly because of higher relative price of labor. As East German workers moved to the Western part of the country, west German firms hired eastern workers. As brain drain became widespread, the convergence of east German income per capita slowed.

East Germany were far better off, if the country remained independent. The reunification of Germany would yield singificant economic benefits, if the unification itself were based on close economic integration with the establishment of free trade area and free movement of capital, goods and labor. If East Germany remained independent and retained its own currency without the uncovered exchange rate realignment to to West German exchange rate parity, the relative price of East German labor wouldn't increase and thus the unemployment rate would be significantly lower than it has been ever since the reunification. Thus, West German firms would easily find attractive investments in East Germany. The process would dramatically reduce disparities in population density compared to the West. Under such scenario, East Germany's macroeconomic stabilization and institutional reforms would be a lot easier and the overall economic and political transition much less painful.


Frederic Mishkin says not all bubbles are a threat to the economy (link):

"Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy..."


From The Economist (link):

"Nevertheless, it is unclear how a transatlantic row can be avoided along the lines of the spat in 2001, when a planned merger between General Electric and Honeywell caused a stink. The commission worries that a union between Oracle and Sun would reduce competition in the market for corporate databases. Oracle is the world’s biggest seller of proprietary software to run such databases, with a market share of nearly 50%. Sun is the owner of MySQL, the most widely used “open-source” database software, which already competes with Oracle’s products and could become more of a threat in the future. Neelie Kroes, Europe’s competition commissioner, spoke of her “serious concerns” that the deal would reduce choice and lead to higher prices."


Russia's recessionary contraction has been marked with several distinct features. First, capital account deteriorated significantly. In Q3:2009 it posted a $23.7 billion deficit, reflecting net capital outflows as a result of recovery uncertainties, exchange rate and oil price volatility and the inability of the Russian banking sector of debt repayment. Thus, net capital flows to the private sector decreased by 31.5 percent in Q3:2009.

During the economic crisis of 2008/2009, Russian fiscal policymakers increased government spending when the output gap was positive. Thus, from the mid-2008 onward, Russia faced high inflation rate which peaked well over 10 percent level. Even the fiscal outlook remains sluggish. In 2009, the non-oil government deficit is expected to reach between 11.0 and 12.5 percent of the GDP. The dynamics government deficit remains deteriorating until 2012. In 2010, the non-oil balance is expected at -14.20 percent of the GDP. In 2012, the balance is likely to improve by 1.40 percentage points from 2011. The decline of oil demand has rapidly eroded Russia's reserve fund earnings which decreased from 10.3 percent of the GDP in 2008 to 4.1 percent in 2009. Before the financial crisis, Russia's economic growth model was based mainly on fiscal policy reforms, confluence of high oil prices and access to external financing at low benchmark interest rates. The World Bank estimated that Russia's real GDP will return to pre-crisis level in late 2012. In the long term, Russia's growth quality will be improved only by more dynamic diversification of the economic basis, bold structural, governance and institutional reforms, trade openness, higher productivity growth and liberalized financial sector.

Russia's Macroeconomic Outlook
Source: Central Bank of Russia, Ministry of Finance, Bloomber
*denotes preliminary estimates

Economic Growth in Russia, Central and Eastern Europe and Advanced Economies

Source: IMF, World Economic Outlook, October 2009


The latest macroeconomic data from major world economies suggested that the recessionary contraction is likely to be ended in the light of positive news on GDP growth and midterm macroeconomic outlook. However, the road of the economic recovery remains uncertain. The policymakers responded to the great contraction of 2008 by decreasing interest rates close to zero rate. Massive injections of monetary stimulus boosted liquidity and attempted to accelerate credit expansion. However, monetary stimulus such as TARP in the U.S encouraged excess reserves. Thus, the banking sector published significant quarterly results as the stimulus package covered the overall losses from the credit crunch and subprime mortgage crisis of the previous year. In this brief article, I outline the economic recovery in the U.S in the ongoing year.

In Q3, the U.S economy grew by 2.4 percent despite the negative unemployment figures. While the U.S productivity grew by 6.8 percent in Q2:09 and by 9.8 percent in Q3:09, the unemployment rate is expected to reach 10.5 percent in December. The $787 billion stimulus from Obama administration to the ailing industries did little to prevent the fallout of demand and the financial difficulties of many firms. In fact, most of the stimulus has not already been spent. In spite of enormous fiscal emergency aid, the Obama administration effectively nationalized the auto industry as Detroit's auto industry declared bankruptcy. The auto industry is likely to recover gradually. Eventually, the fall of Detroit's giants was more likely a consequence of auto industry's inability to cope with high labor cost and fringe health and pension benefits.

The underlying economic theory and evidence teach that massive government intervention in the economy is inefficient as if government bailout hadn't occured. In Q3:09, financial industry posted significant quarterly earnings. Monetary stimulus inflated another asset bubble which translated into highly prospective annual data and higher volatility. Morgan Stanley's annual stock return currently stands at 133.4 percent (link). On the other hand, stock markets rallied in the light of significant quarterly earnings of the banking and financial sector. In one year, Dow Jones Industrial Average grew by 18.27 percent (link), S&P 500 increased by 22.16 percent (link) while Nasdaq Composite's annual growth rate stands at 36.91 percent (link). Stock markets rallied in the light of favorable earnings projections and cost reductions.

On the macroeconomic level, the U.S economy is likely to face a long L-shaped recovery. The underlying conditions are extremely low interest rate, high unemployment rate and high quarterly productivity growth rate. Much of the confidence in fiscal stimulus and expansionary fiscal policy was based on the initial assumption that spending multipliers will exceed 1 and boost short-term output and investment to reduce the negative output gap. Nevertheless, fiscal policy outlook remains sluggish and the prevailing evidence suggests that spending multipliers are hardly positive, except for when the unemployment rate exceeds 12 percent, causing a major fallout of capacity utilization. Robert Barro and Charles Redlick recently estimated the cost of fiscal stimulus. The Obama administration has already expressed commitment to raising the marginal tax rates. Tax increases are the unfortunate midterm alternative because excessive borrowing and the estimated 9.9 percent of the GDP fiscal deficit in 2009 (link) has already downgraded sovereign U.S debt outlook. Redlick and Barro showed that one-period lagged increase in the average marginal tax rate reduces, GDP growth by 0.56 percentage point. The overall effect on consumption purchases is -0.29 and the overall effect on investment is -0.35, both statistically significant at 99 percent.

The U.S dollar further depreciated against the euro (link), increasing the U.S inflation rate above the expected target, partly as a result of the increase in short-term yield on Treasury bonds. Purchases of Treasury bonds effectively increased demand for U.S dollars and triggered short-term depreciation trend. An effective reduction of fiscal deficit in the coming years is a necessary condition for mitigating the negative effects of U.S current account deficit. As fiscal deficit raises demand for imports in the U.S, real depreciation of the real effective exchange rate raises relative prices in the tradable sector compared to non-tradable sector. The main highlights of U.S economy recovery will be focused on restrictive fiscal policy and policy interest rates. Zero interest ground is a real disadvantage in economic recovery, mainly because the negative output gap and the Fed is likely to face hard time trading-off between higher inflation if interest rates remains at historic lows while the real sector's credit demand could surge and potential output contraction in the coming quarterly periods if the Fed will raised targeted federal funds rates. In the latter scenario, the U.S economy could repeat the Japanese disease from the 1990s, being faced with long, sluggish and slow economic recovery that could last for several years.

Tuesday, November 10, 2009


David O. Meltzer and Zhuo Chen explored the relationship between minimum wage rate in the U.S and body weight (link):

"Growing consumption of increasingly less expensive food, and especially “fast food”, has been cited as a potential cause of increasing rate of obesity in the United States over the past several decades. Because the real minimum wage in the United States has declined by as much as half over 1968-2007 and because minimum wage labor is a major contributor to the cost of food away from home we hypothesized that changes in the minimum wage would be associated with changes in bodyweight over this period. To examine this, we use data from the Behavioral Risk Factor Surveillance System from 1984-2006 to test whether variation in the real minimum wage was associated with changes in body mass index (BMI). We also examine whether this association varied by gender, education and income, and used quantile regression to test whether the association varied over the BMI distribution. We also estimate the fraction of the increase in BMI since 1970 attributable to minimum wage declines. We find that a $1 decrease in the real minimum wage was associated with a 0.06 increase in BMI. This relationship was significant across gender and income groups and largest among the highest percentiles of the BMI distribution. Real minimum wage decreases can explain 10% of the change in BMI since 1970. We conclude that the declining real minimum wage rates has contributed to the increasing rate of overweight and obesity in the United States. Studies to clarify the mechanism by which minimum wages may affect obesity might help determine appropriate policy responses."


Norges Bank has recently published Monetary Policy Report 3/2009 (link) and a comprehensive list of figures and charts including major macroeconomic trends in Norway and abroad (link). Time series on unit labor cost, output gap and other macroeconomic indicators are interesting to observe, especially because Norges Bank has been the first central bank in Europe to announce a targeted increase in interest rate to mitigate midterm inflationary outlook. Here (link) is a closer look at NIBOR and monthly interest rate dynamics in Norway (link).