Krugman 2009 - a gimmicky assessment with a no-brainer solution, or an anti-globalization handbook?

Paul Krugman’s new and remastered Depression Economics from 2009 offers his critical assessment of the 2008 global financial crisis as viewed from the lens of financial economics, laid out to be a fairly easy read for people without a degree in economics. He starts with the Great Depression of the 1930 and his somewhat comical analogy of the “baby-sitting coop” and then uses that same model to lead the reader through the multiple recent crises around the world that, according to Krugman, should have been a signal to the bankers and economic policymakers worldwide that something is wrong with the system. After this very well-presented historical analysis, he offers his solution to the crisis that is neither very detailed nor complex, and should seem like a no-brainer to anyone familiar with Keynesian economics. The solution he offers also seems to be an extension of something that is commonplace in Europe, for example, and “depression economics” ends up being more of a pretty rhetoric than any sort of groundbreaking new economic theory.

Krugman identifies two main reasons for financial crises. First is the easy access to credit and moral hazard as a negative side-effect. It goes like this – first, for whatever reason, the credit starts flowing actively. Eventually, because of “easy money”, as well as insurance against risk, the people start to invest in riskier enterprises for higher yield. As a result, the whole system becomes more responsive to “self-fulfilling panics” that can get powerful enough to result in a domino effect, breaking the bubble and plunging the economy into a recession. That is when the second problem comes in – the issue present since the Great Depression in various forms, despite the changes in the financial system, the “liquidity trap”. The trap could have various reasons – an economic system based on a fixed exchange rate like the gold standard in the 30s, or the fixed dollar exchange rates in Argentina or South Asia, which lead to limitations based on the amounts of reserves available; another one would be a tight economic policy, or reaching the interest rate of zero without revitalizing the economy. This is Krugman’s “depression economics”, the situation where in is the demand side that fails the economy, and the traditional supply-side approach is unable to help (182). Krugman then proceeds to bring out the analogy from all the earlier crises to the current worldwide slump, and the role the “shadow economy” has played in it.

Now, this is a very well laid-out comparative perspective that is difficult to find holes in. In some ways, it is easy to blame Krugman for the use and abuse of the benefit of hindsight some reviews accuse him of; I would argue that a childish “told you so” is not really the main point of the book. The goal is rather to show that crises like these are easily prevented with a correct approach, and that it is possible to plan ahead based on the historical analogies to prevent the trouble before it ever happens. To be fair, the comparison that Krugman engages in is probably worth more as an insight than suggestions for future actions; still, it was quite disappointing to find such an inconclusive ending to such a great assessment. The no-brainer “exercise more control in the unregulated areas” and “use more stimulus money” suggestion may be useful, but Krugman does not bother to present them in an appealing or even asserting way. One may also see a problem with the “recovery first, reform second” approach. Here is why it may not work: for the same reasons why the IMF only has real power during crises; in short, if the recovery proceeds smoothly, the reform is likely to be overlooked. One may blame FDR for his “Roosevelt depression”, but at least it insured that a new system is installed, one that lasted for a good 60-70 years without major trouble.

Getting the credit flowing now with massive stimuli (4-6% GDP, on Krugman’s suggestion) may only further unbalance the market. First, it will stimulate even more moral hazard, the banks and companies having ever more trust in the government “bailout”. Second, will it not start yet another bubble? (Krugman seems to realize this, but not elaborate, resorting to an Onion reference instead) How long will it take till a bubble big enough to throw even a giant like US into a “Japan trap” comes around? An economy dependent on constant succession of bubbles is like a drunken man constantly staggering but not quite falling down. Shouldn’t we rather look to the root of the problem before caring to fix the short-term consequences?
Finally, Krugman’s book can be a perfect manual for the opponents of globalization. The author himself does not go much into this, but the conclusion is pretty obvious – first the Asian countries in the 90s, then the whole world today has seen economic interdependence turn what may have been minor domestic issues into a big worldwide problem. On the other hand, China, a country that tries to control globalization to fit its own interests, with its strict controls on currency exchange and overall government controls on the market economy, is about the only country to still have a significant positive GDP growth (8%), despite the global recession. If the lack of regulations and moral hazard are at fault for starting the crises, globalization is surely responsible for exacerbating them, according to Krugman.

Sadly, Krugman offers little to no political commentary for the current situation in the US and worldwide. We may know of the existence of an economic remedy, and feel the dire need to implement it, but sadly economics do not always come first, even in democratic countries with market economies. The small first stimulus package (small enough to be of little use) is one great example to the politicians caring more about the short-term public response and political ideology rather than long-term economic benefit. The crisis may also change how the different countries relate to each other on the international political scene. These are just some minor (but important) side-stories worth exploring.

In the end, I think Krugman succeeds in laying out a decent framework for future research, but fails to construct an effective argument of his own. Then again, perhaps a 200-some-page book cannot really do justice to such an extensive topic in the first place.

A reason for developed countries to stop agricultural subsidies

"A global fall in agricultural research spending - other than in China - is slowing growth in farm output and will lead to higher world food prices for the first time in five decades, an economist said Tuesday" (China Daily).

If the productivity growth slows in the developed countries don't bother/can't afford to spend as much money on research in the field, maybe they should give it up all together? Comparative advantage doesn't exist for nothing. Maybe if the EU finally reforms its CAP and US drops its subsidies, and instead direct the money to developing countries in Africa to promote modernization and productivity growth in agriculture, everyone would profit - the developing countries from investment, everyone else from lower food prices. Instead, we get a lose-lose situation as described in the article, which is the complete opposite of how Stiglitz (quite convincingly) argues globalization should work.

If this were a less academically-inclined blog, I'd feel a lot less resentment from using this meme to describe my feelings:

/facepalm

PS: No, I am not making lots of blogposts just to fill a "quota" after 2 weeks of silence during midterms ^_____^

Who's to blame?

Not to steal the title from the famous work by Alexander Herzen, which, however, has very little to do with economics, but this is the question that seems to be most relevant recently in the lender-borrower relationships. Is it the investors' fault for putting money into risky projects and generating bubble economies, or is it the banks', who do not warn about the risk and care little about fund security?

Well, the wealthy Chinese investors seem to be putting the blame on the banks. While it is difficult to feel compassionate for those guys, at least they're breaking the trend of domestic investors doing nothing to protect themselves during crises while the foreign investors get away with their sins lightly. And though the issue is still up to some legal dispute (with the Chinese courts being of questionable democratic merit), the millionaire Chinese investors may well set an important precedent for the international financial community. If they effectively win this battle, not only will it encourage the major Chinese banks to adopt more cautious policies, but perhaps set a good example for other banks around the world. If not, the careless investment practices may continue to make future look grim, with yet another major financial crisis due to moral hazards by the time we get our PhDs (if Krugman's theory has some merit, that is).

Comment on: http://www.chinadaily.com.cn/metro/2009-10/27/content_8853939.htm

The front against free trade

EU agricultural policy continues to be a front against free trade and global integration. Perhaps it was a mistake for the EU to adapt protectionist policies for its agricultural sector, but it is surely making them pay dearly now. It remains to be seen whether the agriculture ministers yield to the pressure, or go through with their pretty "modernization" rhetoric.

What shows the inefficiency of the EU CAP more than anything is the source of the crisis - the price drop due to overproduction. One would think that exporting the excess would be a viable solution, except that the products will get an even lower price on the global market, if it is able to compete at all. Perhaps the Council of Ministers should go back to Econ 102 to study comparative advantage.

In response to article: http://news.bbc.co.uk/2/hi/business/8289976.stm

PS: I would NOT want to be one of the policemen holding off the crowd.

So I TRIPped over a branch in a 'patent thicket' the other day... it HURT!

If protectionism for football players is what gets Mr. Dickovick started, for me it has certainly been patent, especially in regards to software - although as Stiglitz has shown, the same issues are relevant for almost any patent, not the least in medicine and other research.

I know, throwing stones at Microsoft for their less-than legal and more-than disgusting market policies has already gotten old, but they certainly deserve every single one. No everyone may realize that just having a shiny brand on it (Microsoft, Adobe etc.) does not automatically make the product better. As a proud user of open-source technologies - from text editors and Internet browsers to video, sound, graphics processing and on to the more obscure areas - I can assure you that the free alternatives are as good as, if not superior to their pricey counterparts. The biggest irony is that while "open source" can be claimed to stop innovation (in the same way as the argument against free-flow of knowledge in scientific research that Stiglitz mentions), it does just the opposite, making things easier to use, for free. To give you a few striking examples - Open Office can work with about twice as many formats as Microsoft Office, including easy conversion from .doc to .pdf. On the other hand the M. Office, if it did anything "innovative" at all, is it sacrificed pragmatism for form, and used an ingenious mechanism to ensure that the customers will HAVE to buy their new, and in many people's opinion inferior product (some pretty monopolistic behaviour there, too). Another fun one is that Microsoft got the idea for tabbed browsing for its new IE7 and 8 from Netscape or Opera, where it has existed for years - and had they patented it, they could've made a hefty sum. So much for "protected innovation".

I am also positive that the people who grew up in the 80s (and in some countries even 90s) would be sad if Sony Corp v. Universal City Studios were decided the other way. And I am sure, had the Supreme Court ruled the VHS recorder as infringing on copyright, the DVD players and recorders, iPods and many other 'no-brainer' everyday entertainment technologies would have been a lot more difficult to get hands on, if they ever were invented in the first place.

Of course, a VHS player is not as critical to the word development as malaria drugs, but perhaps such examples are necessary to get the people in the developed countries understand the problem. If you don't allow free flow of water, it stagnates; knowledge and information are much the same. And now, as I proudly close my Opera browser, I will let you think whether (and how) we need to pick up our verbal flamethrowers to take those nasty 'thickets' down.

P.S. When I saw that phrase in Stiglitz, I literally went "Aha!" in my head. Way to feed my blog more opportunities for obscure metaphors.

Hats off to President Lula of Brazil

While I do not necessarily approve of Lula's harsh approach to international politics (since it does destroy the possibility of a constructive dialogue from the get-go), but I do commend him for standing up for his country and his ideals. The global crisis did indeed give a reason for the developing countries to take the IMF and WB's directives for development with a grain of salt, openly. It is also an opportunity for the developing countries to take the initiative and make globalization work for them and not just the "rich", as President Lula refers to G8, since globalization "by developing countries for developing countries" may well be the best tactic. One can but hope that he finds more support around the globe, to perhaps help transform the international arena from "rule by elites" and into a more democratic relationship.

Courtesy of BBC World: http://news.bbc.co.uk/2/hi/business/8253318.stm

Lack of Trust in the Global Jungle (Intro)

Working to understand and improve political economy has never been easy, and even now, with all the positive effects of globalization, there are a number of difficult hurdles to overcome – improving living standards in the developing countries, transcending the political barriers in favor of open markets (if that is the current goal for further development) – and many others that also depend on the perspective of the speaker. Defining the priorities is surely the key to successful globalization process, but who do you identify as the “leading actors” in the process? This is probably the more important question, because it affects the answers to all others. For example, if G8 are those “actors” then perhaps the challenge is to overcome the global financial crisis, and to establish the accepted free-market system in the developing part of the world. If, however, we take a different perspective and choose the developing countries as the defining element (be it the BRIC countries, or even the less-developed Africa), the challenges may be different, if not directly opposite, like to win back the freedom to decide how the economical and political system should work, or how to establish symmetric beneficial relationships with the bigger economic and political powers. All of these are, however, but examples of specific problems; a general question like this should have a more general answer. That answer would be the lack of trust between the players in the international relations.

Whether one takes a “pro-globalization” view that there is too little of it, or the “anti-globalization” view that it is poorly managed, the lack of trust and constant verbal skirmishes between different thinkers and governments. If anything, Stiglitz is the most correct out of them all, at least in that it is political mismanagement and not economic miscalculations that can and will cause problems. Poor decisions come from violent disagreements, and people tend to disagree when there is lack of trust – the developed countries patronizing the developing ones because the first don’t trust the second to make the right decisions, and create unstable, unfitting systems as a result (some African countries, CEE, Middle East all serve as great examples); EU facing its ‘fatigue’ period because it is crumbling under the weight of all the lengthy, incomprehensible laws and provisions that arise because the politicians cannot find a common ground; millions spent on military and security rather than used towards well-being and development of the people because governments do not trust each other, etc. One could write a book just listing all the examples, but these few are enough to show that promoting open dialogue and increasing transparency in the international relationships still stands as the biggest challenge, as well as a key to success of globalization or any other program. As the recent economic crisis has proven, the “rich” countries are not always right, and perhaps need to learn to listen to other opinions, not only preach their own doctrine for world development and prosperity. The problem is that most political actors like to avoid the topic, and much less do anything to solve the problem. I am sure the world could only get better when we start cutting down the political “jungle” of IR, and many will be surprised about how much we can improve.