Category Archives: Economics

Riding the Tiger

Apparently, the Republicans are going to bring up the balanced budget amendment again this fall, conveniently prior to the elections. Although I don’t really believe that this actually has any chance of passing, either now or after the election, I thought I’d make a couple comments, one purely based on political sensibility, the other on more neutral economic grounds.

I’ll start just by noting that, of course, we do need to balance the budget and reduce national debt, via both spending cuts—where appropriate—and tax increases—in some cases, significant ones. It isn’t going to happen without both. Anyone who says otherwise is most assuredly either delusional or given over entirely to mendacity.

On its face, pushing for a balanced budget amendment is not necessarily a bad thing. However,  unless properly conceived with exceptions for certain circumstances, it makes the government’s job that much more difficult when the economy or country as a whole is in duress. If we fall into a recession and tax revenues decline, does one really want the government to less able to fund “safety net” programs, or national defense, or any of a number of other items? Would it be possible for the government to, say, implement a national “rainy-day” fund to bolster federal spending during a recession? Yes, it would be possible, but how long would such an idea last before someone says, “Why should the government get to hold more of my money than it needs?” At that point, the lower-taxes-now crew would come in and propose refunds for any tax revenue that exceeds spending, and the fund would be gone.

Could we rely on people’s common sense to show them that such a fund would be in everyone’s interest? I would doubt it. Let’s look at how people think of government spending now. Many people would suggest that there are lots of things that the government could cut, but, as it turns out, we’ve been to this dance before–for the most part, people want cuts in things that we don’t spend any significant amount of money on. If people are unable or unwilling to understand what needs to go into cutting the federal budget, are they really going to understand what needs to go into supporting it during lean times? I’m not optimistic on it.

As for political sensibility, a balanced budget amendment would be quite a challenge. How would we get from the current budget to a balanced budget? Would there be a grace period, or would it come in effect in one fell swoop? Do the Republicans (and the Blue Dogs who also seem to be supporting this) really think that they can balance the budget, not raise taxes, and still get re-elected after they make either the large cuts in national defense spending or in Medicare/Medicaid/Social Security that would be required? Would there be exceptions in the case of a national emergency resulting from terrorism, or natural disaster, or war? Would certain programs be able to be supported above-budget? If any of these are true, how many exceptions are too many? At what point would such an amendment become so many meaningless words?

In the current situation of imbalance, no one wins politically by carrying through a balanced budget amendment. It is great to campaign on, because people love to hear about it, but it would be politically disastrous for the first majority party that actually has to deal with it. Thus, I’m not altogether convinced that this isn’t just campaign bluster to capitalize on our current Tea Party zeitgeist—riding the tiger of fiscal reform. If such an amendment actually passes, the riders may very well become the tiger’s lunch.

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Dubai: Fine?

So, I’ve decided to retool this a little and begin blogging again. I left up a couple old posts, but for the most part they were eliminated for one reason or another. We’ll see what sort of consistency I can arrange for postings, but I have enough ideas to write about, as some of you no doubt know. With that said, a new post.

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“Dubai and Abu Dhabi and the rest of the emirates are fine.”

This was the pronouncement of Sheikh Mohammed this past Thursday. Needless to say, it is justifiable to have some doubts about how accurate an assessment this really is. Of course, it is necessary for national leaders to act as cheerleaders for their countries in one way or another. It would not do to have one’s leader act like there will be no positive change (as people often wrongly accuse Carter of doing in the “malaise speech”). Markets, amongst other characteristics, can be extremely open to psychological manipulation—a topic within the field of behavioral economics—and the cheerleading, or message-shaping, or what-have-you that surrounds a country’s (or company’s) economic endeavors can certainly have a real and independent effect on the ultimate economic success achieved. However, Sheikh Mohammed may be playing this hand a bit too strongly, given the circumstances.

The fantastic growth of Dubai in particular depended on significant and consistent foreign investment—especially in the real estate market—and loose banking habits. A situation like the past is unlikely to emerge again soon, if only because there is simply a lot less money available out for investment purposes there than there used to be. The relatively anemic recoveries so far in the United States and Europe underscore this point. A lot of on-paper money went away over the past two years, and even as it comes back, it is likely that much more will be held onto instead of rapidly (or rashly) invested.

Of course, one could say that Europe and the United States are the past, economically-speaking. The general line of this argument holds that the major center of future foreign investment will be China. Of course, China is certainly pouring money into the Middle East, Africa, and Central Asia, trying to stake out economic claims, so to speak, while the Western countries deal with the consequences of their latest round of excesses. One problem, however, is that China is likely itself to come under increasing economic strain soon—speculation continues about the potential fallout of a collapse in the very hot real estate market in major cities; the export-obsessed economic model that has provided China its growth in the past is likely to need a retooling, which even they now admit and which will likely entail a period a reduced prosperity; and the country will soon need to ramp up its efforts to deal with an increasingly-aged population even as the country continues to develop, the consequence of initiating the one-child policy in 1979. Of course, this last issue is less relevant at the moment, but it remains something to be aware of over the next 15 years, as the aging of China becomes more acutely apparent.

So, the era of easy foreign money that enabled the incredibly rapid development of Dubai is unlikely to be encountered again in the near future. Does this mean that Dubai will be unable to get itself back on track? Not necessarily, but it does suggest that the track may have to be adjusted—the flashy real estate projects and other such investments cannot reasonably be continued in the near future. What is needed is a program to develop a domestic economy that is far more self-sustaining than the previous one was. This is a problem more or less common to all of the Gulf countries, as they are all facing the need to diversify their economies in order to make them more resilient and, thus, less reliant on the good graces (and good fortune) of external economic actors and the ups-and-downs of the oil market. Dubai needs to be able to give the world something besides man-made islands and the tallest building for sustainable economic development.

Is Dubai’s economy “fine?” I wouldn’t say so—that is too cavalier an assessment. Is it doomed? Certainly not. Rather, it is in that middle stage between falling-out and getting back on its feet, and it fortunately has a big brother around to lend it money. The current period of adjustment, financed by Abu Dhabi, will have to result in Dubai getting used to a more pedestrian lifestyle, and significant work will be needed to get the emirate back on a solid footing for future growth, but one could certainly imagine worse fates.

A follow-up to the previous post…

So, I realized that I didn’t include a pontentially useful tidbit in my previous post. This has to do with recognition of market failures, such as those which result from incomplete information. Neoclassical economists–at least, the serious ones—acknowledge that markets do have failures, but they tend to believe that markets will tend to sort themselves and that rational decisionmaking will dominate irrational decisionmaking. Unfortunately, there is no good evidence that this is the case, making it another belief. I don’t think anyone would claim that the present crisis is the result of rationality, or that the S&L crisis, particular sub-crises of the Asian financial crisis of 1997-1998 (Hong Kong in particular)…I could keep listing them, but I think the point is evident.

Of course, government is more than capable of failure, as it is another collection of people just like a market. Just to pre-empt people, I certainly do not advocate a centralized, dirigiste economy. Rather, I’m looking for reasonable controls to protect people from our collective ability to be completely irrational…

Self-restraint, Greenspan, and Beliefs

There are several issues which I tend to have with Alan Greenspan’s economic ideology, most of which center around his strong tendency to believe in things. Now, I have nothing against believing in things per se, but, when it comes to believing in things against all available evidence, then I begin to have a problem. I could write several posts about different aspects of this—which I reserve the right still to do—but for now I’ll just have a brief comment on this observation of his:

“We need not rush to reform. Private markets are imposing far greater restraint at the moment than would any of the current sets of new regulatory proposals.”

So, the justification for not rushing to reform anything is that private markets are “imposing far greater restraint” than any regulatory proposal? Okay, we should not be too hasty in assembling new regulatory schemes—I can agree with that—but is not this “far greater restraint” which the private markets are exercising simply the flip side of what got us here in the first place? We have gone from the irrational exuberance of the tail end of the Greenspan era/beginning of Bernanke and into a  time of irrational suspicion and doubt. Even though he admits that heightened regulatory rules will be necessary, Greenspan still believes that restraints on the market should be based on the assumption of a rational market controlling its own urges—this is precisely contradictory to all available evidence. Markets do not function rationally as a norm; indeed, it seems that irrationality predominates and has throughout history.

Markets are collections of people, all of whom are acting without coordination, with incomplete information, and with a distinct preference for maximizing personal gain. None of the preceeding is meant as a value judgment. Rather, it is a simple definiton which leads to some distinct conclusions. The orthodox/neoclassical economics to which Greenspan subscribes requires that rational decisions be the result of this mix—I would question why anyone would come to such a conclusion. Without complete information, one is at best approximating rationality when one makes a decision—one cannot know that it is rational without knowing the entirety of the situation. Without coordination, people can make individually rational decisions but are unable to control the actions of others. To use a basic example, you may have the perfect information required to know that your bank is illiquid but solvent, but you cannot stop everyone else from engaging in a run which breaks the bank. In the neoclassical world, bank runs on solvent institutions would never occur—but they have in our world (in order to pre-empt such irrational actions, the FDIC was created, because it was understood that people would not tend towards rationality).

If irrational behavior is present in even very simple situations like the one just illustrated, it boggles the mind to imagine that highly educated, intelligent people can believe that rationality predominates in far more complex situations. This is where we return to the issue of belief—neoclassical economics has a very strong belief  in the rationality of actors in the market and thus in the market itself tending towards rationality. Designing a regulatory system based on this assumption, which Greenspan prefers, is foolish.

Instead, what is needed is an assumption of irrationality with which to guide our development of new regulations—whether that leads to attempts to provide information and coordination abilities to enhance the possibility of rational decisionmaking or whether it leads to tight constraints on the complexity and independence of the market from control, it will have a better end result than a regulatory scheme which has as its basis a patently false assumption.

How big is big? – or – A trillion here, a trillion there, and soon you’re talking real money…

So, we’ve all been hearing about the various fiscal stimulus packages which governments around the world have been putting together. Most economists—indeed, virtually all of them except for the outer fringes—believe that such stimuli are necessary to restoring the global economy to some semblance of order. The debate now is largely over how large these packages will be and how much spending will be required to restore that sought-after order.

If I recall correctly, President Obama will be meeting with Congress today–a phrase which two years ago I didn’t expect I’d be writing—to discuss the fiscal stimulus package. As it stands, the package involves $825 billion, of which $550 billion is spending (the balance is tax cuts). This is in addition to the $700 billion accorded to the EESA/TARP bill. Ignoring the other expenditures made—because I cannot find them all in the short amount of time I want to write this—this amounts to $1.25 trillion in spending. Certainly appears large, doesn’t it?

Now consider that the estimated GDP of the United States is $14.85 trillion (from the CIA World Factbook). The $1.25 trillion (or $1.525 trillion to count the total cost to the government’s coffers) makes up a “mere” 8.4% ( or 10.3% for the larger figure) of GDP. Now, I am not a professional economist, but some quick examination of past financial crises would seem to indicate that we will be very lucky indeed if this is all we have to spend. A World Bank paper by Caprio and Klingebiel (available here) lists a significant number of financial crises which have occured around the world since the 1970s. Most of them were only resolved with expenditures significantly over ~10% of GDP. Of course, many also involved the deadly “twin” crises of currency and financial collapse, which the US almost certainly will not face. However, many did not have significant twin crisis effects–indeed, to take the example of the US savings and loan crisis, which was vastly smaller than the present crisis we are in, one can see that expenditures of 3% of GDP ultimately proved necessary to restore health to the economy. Then, 3% of GDP was $180 billion; now, it is $446 billion, so expenditures up to that amount shouldn’t even have been in doubt (recall the massive controversy over the $700 billion TARP).

Ultimately, this is all to say that, in my at least mildly-educated opinion, we will be lucky to escape with spending totalling only $1-to-2 trillion over the whole extent of the crisis.  We had a lot of money going into this, and it will take a lot of money to get us out.