Friday, December 25, 2009

Monday, December 21, 2009

Tuesday, December 15, 2009

STOLPER-SAMUELSON THEOREM

Dani Rodrik offers a nice insight into one of the most remarkable theorems in international trade (link).

Monday, December 14, 2009

IN MEMORIAM: PAUL A. SAMUELSON

On Sunday, December 13th, Paul A. Samuelson has died at the age of 94 (link).


He was on the economic giants of the 20th century. His ideas reshaped the economic science and revolutionized the mode of economic thinking around the world. With the mathematical rigour and analytical mastermind, his groundbreaking approach to economic analysis transfored the economic science into a dynamic problem-solving tool. In this short essay, I will present my reflections on the life and contributions of Paul A. Samuelson to the economic science.

I first came across Paul Samuelson in the year before I entered the university. In the first year of the undergraduate class, Samuelson and Nordhaus's Economics was the assigned reading for the Introductory Macroeconomics. I read the textbook back and forth and I liked it; not because of its simplicity in introducing the analytical framework of economics but rather because of the clarity, intuition and incentives to undertake a rigorous pursuit of analytical economics at the theoretical and empirical level. In addition, Samuelson penetrated the application of linear programming to economic problem-solving.

Together with Milton Friedman, Paul A. Samuelson is the economic giant of the 20th century. Hardly any economist could take the same place in the scope of influence as an economic thinker. He conducted the Neoclassical synthesis. As an interested reader can verify in his Nobel prize lecture (link), Samuelson's synthesis combined a Keynesian macroeconomics with a rigorous Marshallian microeconomics. In microeconomics, Samuelson extended the Marshallian analysis of partial equilibrium with strong mathematical articulation of demand and supply curves, cost curves and deadweight loss. On the abstract level, together with Abram Bergson, he constructed social welfare functions based on three marginal conditions and extracted from earlier work of Kaldor-Hicks-Scitovsky analysis (link). In macroeconomics, Samuelson further affirmed the dominance of Keynesian macroeconomics with a strong emphasis on the role of fiscal policy in stimulating full-employment output. In addition, he invented the term multiplier and the acceleration, the former relating to the effect of change in exogenous macro variables on endogenous variable (notably, output) and the latter referring to the partial adjustment of aggregate investment to the capital stock. Samuelson-Hansen multiplier-accelerator principles spurred the theoretical foundations of Keynesian economic policy. He also popularized Overlapping Generations Model which later became the corner stone of innovations in the modeling of aging population. In macroeconomics, Samuelson also proposed the so-called "Samuelson-Mishi condition for the efficient provision of public goods. When the condition is satisfied, it implies that further substitution of private goods provision for public goods will result in a diminishing social utility.

Assuming Pareto efficiency, Samuelson-Mishi condition satisfied the criteria for Lindahl equlibrium. The equilibrium states that when individuals are willing to pay for the provision of public goods according to marginal benefits, it will be Pareto efficient. However, such condition is not compatible with the incentive mechanism since it requires the complete knowledge of individual demand functions for particular public good which could result in the asymmetric distribution of benefits in response to relevation-principled taxation.

As a student of international economics, I came across the influential theoretical work of Paul Samuelson. Modern international economics is a combination of mathematical economics, advanced microeconomics, game theory and international finance. One of the most interesting and penetrating areas of international economics are theorems in international trade. Under particular assumptions theorem postulate axiomatic explanations based on previous statements. Back in 1941, he proposed Stolper-Samuelson theorem together with Wolfgang Stolper. The theorem quickly became a source of academic debate. In its simplest form, the theorem states the following: assuming constant returns to scale and perfect competition, a rise in the relative price of good will lead to higher return on the factor which is used more intensively in the production of the good and to the fall in the return to the other factor. Stolper and Samuelson wrote:

"Second only in political appeal to the argument that tariffs increase employment is the popular notion that the standard of living of the American worker must be protected against the ruinous competition of cheap foreign labor… In other words, whatever will happen to wages in wage good (labor intensive) industry will happen to labor as a whole. And this answer is independent of whether the wage good will be exported or imported."

The theorem showed that the international trade between two countries could lead to the opposition of international trade since the relative price of labor-abundant good in the high-wage country will be higher than the world price of that good, reflecting the relative abundance of capital or human capital. The theorem quickly became the main theoretical weapon of opponents to free trade. Even today, Stolper-Samuelson is the best explanation of why labor unions in high-wage countries oppose free trade agreements and further economic integration with low-wage countries.

Another important contribution of professor Samuelson is the so called Ballasa-Samuelson effect which states that higher growth productivity growth rate in tradable goods relative to non-tradables will lead to the real exchange rate appreciation. Balassa-Samuelson effect also went through numerous time-series regression. The effect has been tested 60 times in 98 countries. Cross-section regression studies of Ballasa-Samuelson effect were analyzed in 142 countries. In a vast majority, the empirical evidence of Ballasa-Samuelson hypothesis was supported. The main empirical findings emphasize that productivity differential between tradeable and non-tradable sector is positively correlated with differences in relative prices. The empirical evidence also supported Samuelson's initial proposition that productivity differentials translate into higher purchasing power parity through real exchange rate appreciation.

In finance, Paul Samuelson penetrated the analytical aspects of lifetime portfolio selection. In 1972 he published The Mathematics of a Speculative Price which later became the ground of option pricing. Based on discoveries of Bachelier's pioneering work, he laid the foundations of stohastic price movements and random forecasting matches. His pioneering work in financial theory of speculation and random walk (stohastic) movements in stock prices became the underlying theoretical foundation in the emerging financial industry. In an article entitled Probability, Utility and the Independence Axiom (Econometrica, 1952), he discussed the role of probability models in measuring the overall utility. In this sense, he relied on Keynesian defence of subjective theory of probability and argued that thesubjective perception of probability does not inhibit the proper functioning of financial markets. In 1965, he published A Proof that Properly Anticipated Prices Fluctuate Randomly where he provided the foundation of the efficient market hypothesis that has been further developed by Eugene Fama and other scholars. For a detailed discussion of Paul Samuelson's contribution to financial economics, see Merton Miller's contribution in Britannica (link).

In addition to his theoretical and empirical work, he is the founding member of the Econometric Society and its president in 1951. In 1961, he was the president of American Economic Association. In the political sense, Paul A. Samuelson influenced the economic policy of the Kennedy Administration. In 1960, the U.S headed for the recession. President Kennedy, following Samuelson's advice, enacted tax cuts and a balanced budget. In 1964, when Kennedy tax cuts were enacted, top marginal tax rate was reduced from 91 percent to 70 percent. The economic reasoning behind tax reductions was firmly laid in the Keynesian multiplier (1/(1+c)(1+t)). Paul Samuelson and Walter Heller (Chairman of Council of Economic Advisers during Kennedy Administration) argued that lower tax rate would stimulate consumption spending and boosted output and employment. Throughout the 1960s, the U.S economy experienced one of the longest periods of stable economic growth, favorable employment outlook and balanced federal budget. Here is how JFK, following Samuelson's advice, supported the tax reduction (link). Also, David Greenberg's article on Kennedy tax reduction is a worthy source of further information on that topic (link).

On Sunday, the economic titan passed away. He not only revolutionized the field of economic science but also spurred the interest for economics and popularized it in a manner that turned dismal science into a problem-solving science based on theoretical foundations and empirical verification of theoretical postulates. His approach to economic analysis combined Marshallian microeconomics and Keynesian macroeconomics which he joined together after the WW2 in a Neoclassical synthesis. Compared to other economic thinkers, he knew how to formulate theoretical postulates in a manner that stimulates the research interest for further investigation.

He will be missed and remembered as the giant of the economic thought and a titan of economic theory.

Monday, December 07, 2009

MACROECONOMICS READING CLUB

For those of you who study macroeconomics and finance, here are some interesting articles on macroeconomic issues:

Menzie Chinn, The Employment Situation in the Graphs, Econobrowser, December 4, 2009 (link)

Menzie Chinn, Debt and Interest Rates; Some Empirical Evidence, November 23, 2009 (link)

Olivier Blanchard, Marianna Riggi, The Price of Oil and the Macroeconomy, Vox, December 7, 2009 (link)

Roel Beetsma, Massimo Guliodori, The Macroeconomic Costs and Benefits of the Economic and Monetary Union, Vox, November 27, 2009 (link)

THE CASE FOR CARBON TAX

Ted Gayer of the Brookings Institution testified before the U.S Senate, discussing the economic benefits of carbon tax over cap-and-trade (link)

Thursday, December 03, 2009

Tuesday, December 01, 2009

AUSTRALIA'S INFLATION, RECOVERY AND INTEREST RATE

Reserve Bank of Australia decided to continue the increase in benchmark interest rates by 25 basis points to 3.75 percent in the light of short-term inflationary expectations (link). Here (link) is a brief macroeconomic outlook of Australia.

DEFLATION - JAPAN'S FIRST BIG "D"

The Economist discussed the return of deflation in Japan (link). Meanwhile, the Bank of Japan has published an interesting publication of macroeconomic overview of the Japanese economy (link).