Category: Economics

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Russia, Georgia, the Caucasus

Inspired by this piece in the FT by Martin Wolf …

“I am feared; therefore I am.” This is more than a restatement of Machiavelli’s celebrated advice that, for a ruler, it “is much safer to be feared than loved”. Vladimir Putin, the latest in the long line of autocratic Russian rulers, would agree with the Italian on that. But the war in Georgia is not just a re-assertion of Machiavelli’s principles of statecraft; it is a renewal of Russian national identity. It is yet again feared. In the eyes of its rulers, therefore, it exists.

… a friend asked why, if Georgia started this whole thing, we’re necessarily viewing Russia as the bad guys.  This was my attempted reply:

First the background. The area of the Caucasus (Georgia, Azerbaijan, Armenia and bits of southern Russia) is viewed as generally important for a few reasons:

  • Geographically, it represents the land-bridge between the Caspian sea to the east and the Black sea (which connects to the Mediterranean sea through the Bosphorus (the body of water that splits Istanbul in half)).
  • Economically, it is traditionally a very important trade route between Europe and the east. In today’s world, that means that oil pipelines run through the area (the Bosphorus is the world’s busiest stretch of water for oil (the English channel is the busiest overall)).
  • Politically, it has been a focal-point of conflict for centuries, since it represented the junction of the Russian, Ottoman (Turkish) and Persian (Iranian) empires. Since World War I for sure and arguably before, the area has been seen as Russia’s “backyard” – the equivalent of Mexico and central America to the USA.
  • Militarily, the three previous reasons join to give it enormous strategic value. Commanding the Caucasus enables you to project power all over the Middle East and eastern Europe.

All of this is complicated by the fifth point:

  • Culturally, the area is enormously diverse and filled with distrust. The various national boundaries are really pretty arbitrary and only loosely represent the various ethnic, religious and linguistic groupings. Note, in particular, that the Armenians were on the receiving end of an intensely brutal killing spree by the Turks back when the Ottoman empire was coming apart. Asking whether or not to call that event genocide is a good way to get people’s tempers from perfectly calm to screaming rage in milliseconds.

On to recent history:

Given that Russia had “owned” the area for the best part of a century, it was enormously shameful to them to lose it when the Soviet Union broke up in the early Nineties. It was, in a way, the ultimate demonstration of their descent (however temporarily) into mediocrity as a world power. Imagine if not just Cuba, but the entirety of Central America had switched to Soviet-inspired communism over the space of two or three years in the late 1980s. America would have shat itself.

From the point of view of the rest of the world, though, the move to independent statehood for the three little countries represented a victory over Soviet communism and a triumph for (hopefully democratic) liberalism. That is the backdrop to the Georgia conflict. It’s Russia-at-the-core-of-the-Soviet-death-machine that is seen as the bad guy and Putin as the ex-KGB nutjob that’s pulling the strings and taking Russia back to the Bad Old Days ™.

To a certain extent, this is partially the West’s fault. When the Soviet Union fell, we didn’t do the sportsmanlike thing of offering them our hand to help them stand up. We kicked them while they were down. The Shock Therapy that we foisted on them through the voice of Jeffery Sachs might arguably have helped the Soviet satellite states like Poland and the Czech Republic, but in Russia itself it really only served to cause massive unemployment, the dismantlement of healthcare and other forms of state aid and worst of all, the pillaging of anything of economic value by the now-infamous oligarchs. On top of that, Nato simply started marching east. Russia was admitted to the G8 only grudgingly, was ignored utterly in Kosovo and has never been recognised as a grown-up on the post-Cold War stage.

Telling Georgia that they could ultimately join Nato just after Russia had finished bludgeoning Chechnya into submission with a nail-studded bat was the equivalent of deliberately spilling red wine on Russia at a fancy dinner party and then saying loudly so everyone could hear “Oh dear, and that’s your only suit. Well, I’m sure you can scrub it out in the kitchen” before turning your back on them to talk to the Austrians about how their music was always so much more inspired than that brutish Russian peasant noise.

Russia has been handing out Russian passports to anybody old enough to hold them in South Ossetia for years so they could declare that they were simply defending their citizens. They’ve been sort-of-almost occupying the region for a while anyway under the guise of peacekeeping, but that role was never recognised by the UN or any other country in the region. Formally, South Ossetia and Abkhazia are part of the sovereign nation of Georgia. Their declarations of independence were – it’s widely believed – to have been encouraged, if not actually orchestrated, by Russia in an attempted loose parallel to Kosovo.

The West in general and the USA in particular had told Georgia that they had their backs. Georgia had troops in Iraq fighting with the Americans. The Georgians, stupidly it turns out, thought they were genuine allies of America. When Georgian troops started going into South Ossetia and triggered this whole mess, it demonstrated two things. First, that the USA under the Shrub [*] administration had really, really dropped the ball in its international relations. That the Georgians managed to get the idea that the US would rush to direct war with Russia over the Caucasus really says that the State and Defence departments screwed up badly. Second, that Russia was staggeringly well prepared for the Georgian move. They just happened to have an enormous mass of troops just over the border waiting to leap to the Ossetian’s defence? No. This was a trap laid by Russia and Georgia walked into it.

[*] Little bush.

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Sing it from the rooftops

A bunch of serious economists have been pointing to this comment by Paul Collier. It is so good that I’m going to reproduce it in full:

The sharp increase in the world price of staple foods is an inconvenience for consumers in the rich world, but for consumers in the poorest countries, especially in Africa, it is a catastrophe. Despite the predominance of peasant agriculture, most African countries are net food importers and food accounts for over half of the budget of low-income households. This is the result of decades of agricultural stagnation combined with growing populations. Although many of the net purchasers are rural, evidently the problem is at its most intense in the urban slums. These slums are political powder kegs and so rising food prices have already triggered riots. Indeed, they sow the seeds of an ugly and destructive populist politics.

Why have food prices rocketed? Paradoxically, this squeeze on the poorest has come about as a result of the success of globalization in reducing world poverty. As China develops, helped by its massive exports to our markets, millions of Chinese households have started to eat better. Better means not just more food but more meat, the new luxury. But to produce a kilo of meat takes six kilos of grain. Livestock reared for meat to be consumed in Asia are now eating the grain that would previously have been eaten by the African poor. So what is the remedy?

The best solution to a problem is often not closely related to its cause (a proposition that that might be recognized in the climate change debate). China’s long march to prosperity is something to celebrate. The remedy to high food prices is to increase food supply, something that is entirely feasible. The most realistic way to raise global supply is to replicate the Brazilian model of large, technologically sophisticated agro-companies supplying for the world market. To give one remarkable example, the time between harvesting one crop and planting the next, in effect the downtime for land, has been reduced an astounding thirty minutes. There are still many areas of the world that have good land which could be used far more productively if it was properly managed by large companies. For example, almost 90% of Mozambique’s land, an enormous area, is idle.

Unfortunately, large-scale commercial agriculture is unromantic. We laud the production style of the peasant: environmentally sustainable and human in scale. In respect of manufacturing and services we grew out of this fantasy years ago, but in agriculture it continues to contaminate our policies. In Europe and Japan huge public resources have been devoted to propping up small farms. The best that can be said for these policies is that we can afford them. In Africa, which cannot afford them, development agencies have oriented their entire efforts on agricultural development to peasant style production. As a result, Africa has less large-scale commercial agriculture than it had fifty years ago. Unfortunately, peasant farming is generally not well-suited to innovation and investment: the result has been that African agriculture has fallen further and further behind the advancing productivity frontier of the globalized commercial model. Indeed, during the present phase of high prices the FAO is worried that African peasants are likely to reduce their production because they cannot finance the increased cost of fertilizer inputs. While there are partial solutions to this problem through subsidies and credit schemes, large scale commercial agriculture simply does not face this problem: if output prices rise by more than input prices, production will be expanded because credit lines are well-established.

Our longstanding agricultural romanticism has been compounded by our new-found environmental romanticism. In the United States fears of climate change have been manipulated by shrewd interests to produce grotesquely inefficient subsidies for bio-fuel. Around a third of American grain production has rapidly been diverted into energy production. This switch demonstrates both the superb responsiveness of the market to price signals, and the shameful power of subsidy-hunting lobby groups. Given the depth of anti-Americanism in Europe it is, of course, fashionable to criticize the American folly with bio-fuels. But Europe has its equivalent follies.

First, the European Commission is now imitating the American bio-fuels policy. At present the programme is small enough to be unimportant, but we need to pull it back before it does real damage. We have surely learnt enough about European agriculture to realize how important it is to kill this incipient scam before we are engulfed by it. But the true European equivalent of America’s folly with bio-fuels is the ban on GM. Europe’s distinctive and deep-seated fears of science have been manipulated by the agricultural lobby into yet another form of protectionism. The ban on both the production and import of genetically modified crops has obviously retarded productivity growth in European agriculture: again, the best that can be said of it is that we are rich enough to afford such folly. But Europe is a major agricultural producer, so the cumulative consequence of this reduction in the growth of productivity has most surely rebounded onto world food markets. Further, and most cruelly, as an unintended side-effect the ban has terrified African governments into themselves banning genetic modification in case by growing modified crops they would permanently be shut out of selling to European markets. Africa definitely cannot afford this self-denial. It needs all the help it can possibly get from genetic modification. Not only is Africa currently being hit by rising food prices, over the longer term it will face climatic deterioration in the context of a rapidly growing population.

While the policies needed for the long term have been befuddled by romanticism, the short term global response has been pure beggar-thy-neighbour. It is easier for urban slum dwellers to riot than for farmers: riots need streets, not fields. And so, in the internal tussles between the interests of poor consumers and poor producers, the interests of consumers have prevailed. Governments in grain-exporting countries have swung prices in favour of their consumers and against their farmers by banning exports. These responses further politicize and fragment an already confused global food market. They increase the risks of investing in commercial-scale food production and drive up prices further in the food-importing countries. Unfortunately, trade in agriculture has been the main economic activity to have resisted being subject to global rules. We need stronger and fairer globalization, not less of it.

What can I say?  Just this:  Amen.

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Four techniques of public policy

Suppose you have a situation where individual choices are suboptimal, both for that individual and for the group as a whole.  Exactly why the individual makes suboptimal choices isn’t immediately relevant for the moment.  It seems to me, that there are four broad approaches to “solving” this problem: a) an engineering approach; b) a government mandate; c) economic incentives; and d) a psychological approach.  The four approaches are not mutual exclusive and can even overlap, but they each bring a different mindset to the problem.  All four approaches can be taken to an absurd extreme.

To explain each of the four, an (admittedly pretty graphic) example may be useful.  Men seem, in general, to have a habit of spillage at public urinals – pee goes on the floor instead of the urinal.  This induces both private costs (increased health risks and the ‘ick’ factor of negotiating another guy’s floor-pee) and public costs (increase cleaning costs).

  • An engineering approach would be to design a better urinal to minimise spash-back.  An extreme engineering approach would not only do this, but also include sensors to detect when urine falls outside the catchment area and then activate an automatic (i.e. robotic) cleaning system.
  • A government mandate would make it illegal to spill your pee on the floor.  How extreme this is would depend on the enforcement mechanism.  A light-handed approach would pass the law and then do nothing to enforce it, similar to jay-walking.  A heavy-handed approach would hire a cop to occasionally watch men pee and arrest them if they spill, similar to most countries’ drug policy.  An extreme approach would have a government agent hold your penis to make sure that you don’t spill, similar to the Australian government’s enforcement of mandatory superannuation.
  • An economic incentive would impose a fine on men for spilling and/or give them a bonus payment for not spilling.  How extreme this measure is would depend on the size of the fine or the bonus.  Because this also has a need for enforcement (government-implemented or government-guaranteed), this can be thought of as a market-oriented government approach.
  • A psychological approach would seek to reframe the issue to influence the way that men make their choices.  For the urinal, it could be to make use of the fact that if you paint a fly in the urinal at the spot that minimises splash-back, the visual cue will cause men to aim at it and overall spillage will fall.  My mother did something similar when I was a kid.  She had five teenage boys living under her roof and not even making us clean the toilet seemed to stop the mess, so she put a ping-pong ball in the toilet (because it’s so light, it won’t flush down) and told us to aim at it.

So what’s my point?  Just this:  most people tend to focus on just one of the four approaches and think that it is the best way to solve every problem, when the truth is that different problems call for different responses and that the best strategy will usually employ several approaches.  In the case of spilling urine, the best strategy is probably a combination of an engineering and psychology, but in others a different combination may be optimal.  Don’t always think that your favourate approach is the best or only one.

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Farm subsidies promote terrorism

Well, maybe not directly, but it bears thinking about. It’s not a new idea, either, but I thought I’d put it out there anyway …

US and European farm subsidies artificially suppress world crop prices by causing American and European farmers to produce more than they profitably otherwise could. By the World Bank’s estimates, the prices of course grains, rice and wheat would rise by between 4% and 7% relative to other prices if all subsidies and other impediments to trade were removed (hat tip: Dani Rodrik).

That means that farmers in places like Afghanistan turn to other crops like poppies (for heroin). Since drugs are illegal, the farmers can only sell their crops through black (well, in Afghanistan, grey) markets that are controlled, America tells us, by people who support and funnel profits to the Taliban and al-Qa’ida.

Those Afghani farmers don’t really care what they grow. They just want to make a profit, like anybody else. How do we know this? Because when the price of crops goes up for other reasons, they happily started switching to planting wheat:

In parts of Helmand Afghan farmers are this year sowing wheat instead of poppy – not because they have suddenly been converted to the argument that producing heroin is not in the national interest.

Market forces have been the deciding factor – with wheat prices doubling in the past year, and the street price of heroin falling, it is now more cost effective to grow wheat.

So there you have it. If America was serious about fighting drugs and terrorism, it would cut it’s farm subsidies.

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On the indispensability of (investment) banks

As might be expected, there’s a fair amount of questioning about the finance system as a whole going on.

The claim is that the market is best able to distribute this cash to the most worthy of projects, but at what point is their judgement questioned? How are these bastards allowed to be indispensable?

It’s true that the purpose of the finance industry is to, as efficiently as possible, allocate capital (i.e. savings), risk and returns; or, as the Economist puts it, to write, to “write, manage and trade claims on future cashflows for the rest of the economy.” In that regard, the industry as a whole plays a vital role in the economy. But that on its own doesn’t necessitate the indispensability of individual banks. That comes from a variety of inter-related factors:

  • There are banks and there are banks. Ceteris paribus, nobody cares if a Small-Town Bank (STB) goes bust because it is provincial: nobody other than its direct debtors and creditors are affected. Investment banks are (effectively, sort of) where the STB goes to borrow money, though. If they go down, so do all the little commercial banks that depend on them. To use a cheap analogy from The Wheel of Time series of fantasy novels, one might think of the central bank as the True Source, the investment banks as Rand al’Thor using one of those artefacts and all the little banks as power-wielders that are vastly powerful compared to civilians but insects next to Rand. Rand channels the hundreds of little power-wielders and adds his own enormous ability to suck down the juice in order to draw massively on the true source. If somebody were to kick Rand in his privates while he’s doing his thing, half the planet gets ripped asunder. Therefore, the protection of Rand while he’s doing his thing is paramount. He is genuinely indispensable. This analogy neatly explains why you don’t actually want a single investment bank, btw. Having a single, semi-god-like character that’s able to channel the über-load of the True Source is great in a novel, but bloody stupid in real life. Redundancy is key. You want several investment banks that are competing with each other so that if one goes belly-up, the others can take over.
  • Real innovation is rare, so when somebody has an idea, all the banks leap on it at once. That’s nominally fine in itself, but it unfortunately means that the actions of the (investment) banks are highly correlated, which makes for fantastic profits when it all works and a world of pain when it doesn’t. In essence, even though they’re are several investment banks competing with each other, since they all offer the same services at the same prices using the same strategies, they’re acting as though they’re a single investment bank.
  • The latest round of innovations has served to tie a lot of financial institutions together from the perspective of policy makers. This point really comes in two parts:
    • Securitisation and the splitting of those securities into tranches of risk exposure, in principle, allow financial institutions to spread and share individual risk between themselves so that if a Bad Event happens, they all lose a little rather than just one of them losing a lot.
    • There has been a general move away from transparency, with most of these securities being held off balance sheets and being traded in private sales instead of on open markets.

    The securitisation and tranching may have gone too far over the last few years, but that on its own isn’t the problem. The problem is that it was combined with a lack of transparency, meaning that it has become enormously difficult to pick apart the pieces when somebody falls.  To quote the Economist again, “Bear Stearns may not have been too big to fail, but it was too entangled.”  While they could have let Bear Stearns fall rather than be swallowed by JP Morgan, doing so would have required the careful unpicking of all of Bear Stearn’s positions, which would have taken months.  That would then have fed into the final point …

  • People are nervous lemmings. Even if the investment banks were properly competitive and transparent and each employed different strategies so that if one fell, there wasn’t so much risk of the others falling, a major bank collapse is still a problem because we’re all idiots. We panic. Then we see each other panicking, which helps us justify our own panicking and makes us wonder if maybe we’re not panicking enough.  The panic can then develop a momentum of its own, causing other banks to collapse when they otherwise didn’t need to.

So … that’s why they’re indispensable. But that doesn’t mean that we should be paying them the way we do.  Judgement of bankers’ performance is really only measurable after we pay them, which is stupid.  I’ve written briefly on bankers’ pay before here.  It is worth noting, though, that calls for bankers’ pay to be made in the form of stock have to face up to the fact that many employees of Bear Stearns had a huge share of their savings invested in Bear Stearns stock.

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Paul Krugman: Hanrahan of the Econ-Blogosphere

I’ve got a lot of time for Paul Krugman. People just love to hate the guy, or at least dismiss him as a crank and wonder what he’s going to do when Mr. Bush moves back to Texas, but the man was – for years! – practically the lone beacon of criticism of the Whitehouse in a country that seems to want to beatify its presidents. You can debate the good and bad points of the W. Bush presidency all you like, but the fact remains that America is a country that doesn’t like dissing their sitting president. It seems to make them feel dirty or “unAmerican” or something.  Try asking the Poms to lay off their P.M. for a week.

Anyway, this latest piece by Prof. Krugman got me thinking:

But the plunge in consumer confidence in recent weeks is pretty startling. The chart below shows the University of Michigan index; consumer confidence is now lower than it ever was during the 2001 recession and aftermath, and close to its worst levels during the early 90s, when the unemployment rate went well above 7 percent.

Bit by bit, the evidence is mounting that the wheels are coming off this economy.

I don’t want to dispute the facts of the brief post, just the sentiment. The “wheels are coming off”? Come on. The U.S. is probably entering, if it hasn’t already entered, a recession. That is not the wheels coming off the economy. That is a perfectly normal phenomenon and Professor Krugman knows it. It’s also arguably a necessary phenomenon and I’d be stunned if Professor Krugman didn’t know those arguments. If you want an example of an economy with the wheels off, look at Zimbabwe. Now that, to mix our tired metaphors, is a train wreck.

All of which reminded me of a famous (in Australia, anyway) poem by Patrick Hartigan (1878-1952) writing under the pseudonym of John O’Brien:

Said Hanrahan

“We’ll all be rooned,” said Hanrahan,
In accents most forlorn,
Outside the church, ere Mass began,
One frosty Sunday morn.

The congregation stood about,
Coat-collars to the ears,
And talked of stock, and crops, and drought,
As it had done for years.

“It’s looking crook,” said Daniel Croke;
“Bedad, it’s cruke, me lad,
For never since the banks went broke
Has seasons been so bad.”

“It’s dry, all right,” said young O’Neil,
With which astute remark
He squatted down upon his heel
And chewed a piece of bark.

And so around the chorus ran
“It’s keepin’ dry, no doubt.”
“We’ll all be rooned,” said Hanrahan,
“Before the year is out.”

“The crops are done; ye’ll have your work
To save one bag of grain;
From here way out to Back-o’-Bourke
They’re singin’ out for rain.

“They’re singin’ out for rain,” he said,
“And all the tanks are dry.”
The congregation scratched its head,
And gazed around the sky.

“There won’t be grass, in any case,
Enough to feed an ass;
There’s not a blade on Casey’s place
As I came down to Mass.”

“If rain don’t come this month,” said Dan,
And cleared his throat to speak —
“We’ll all be rooned,” said Hanrahan,
“If rain don’t come this week.”

A heavy silence seemed to steal
On all at this remark;
And each man squatted on his heel,
And chewed a piece of bark.

“We want an inch of rain, we do,”
O’Neil observed at last;
But Croke “maintained” we wanted two
To put the danger past.

“If we don’t get three inches, man,
Or four to break this drought,
We’ll all be rooned,” said Hanrahan,
“Before the year is out.”

In God’s good time down came the rain;
And all the afternoon
On iron roof and window-pane
It drummed a homely tune.

And through the night it pattered still,
And lightsome, gladsome elves
On dripping spout and window-sill
Kept talking to themselves.

It pelted, pelted all day long,
A-singing at its work,
Till every heart took up the song
Way out to Back-o’-Bourke.

And every creek a banker ran,
And dams filled overtop;
“We’ll all be rooned,” said Hanrahan,
“If this rain doesn’t stop.”

And stop it did, in God’s good time;
And spring came in to fold
A mantle o’er the hills sublime
Of green and pink and gold.

And days went by on dancing feet,
With harvest-hopes immense,
And laughing eyes beheld the wheat
Nid-nodding o’er the fence.

And, oh, the smiles on every face,
As happy lad and lass
Through grass knee-deep on Casey’s place
Went riding down to Mass.

While round the church in clothes genteel
Discoursed the men of mark,
And each man squatted on his heel,
And chewed his piece of bark.

“There’ll be bush-fires for sure, me man,
There will, without a doubt;
We’ll all be rooned,” said Hanrahan,
“Before the year is out.”

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Why is the US Fed lowering interest rates?

Continuing on from my previous wondering about how panic-driven and effective current US (monetary) policy is, I notice these two posts from Paul Krugman …

Ben Bernanke has cut interest rates a lot since last summer. But can he make a difference? Or is he just, as the old line has it, pushing on a string?

Here’s the Fed funds target rate (red line) — which is what the Fed actually controls — versus the interest rate on Baa corporate bonds (blue line), which is probably a better guide to what matters for actual business spending.

It’s pretty grim. Basically, deteriorating credit conditions have offset everything the Fed has done. Doubleplus ungood.

INSERT DESCRIPTION

… and Brad DeLong …

Further cuts in the federal funds rate are on the way. Ben Bernanke is talking about how we are in a slow-moving financial crisis of DeLong Type II: one in which large financial institutions are insolvent–“pressure on bank balance sheets”–and in which lower short-term interest rates and a steeper yield curve are a way of providing institutions with the life jackets they need to paddle to shore.

Larry Meyers has pointed out that the BBB yield is no lower than it was in July–that all the easing has had no effect on the cost of capital that the financial markets feed to the “real economy,” and hence that Fed policy today is no more stimulative than it was last summer.

I’m more inclined to agree with Brad’s assessment than Paul’s implicit prediction of gloom, although it depends on what you think the Fed should be looking at.  Paul is clearly hoping for a decrease in long-term rates so-as to stimulate the real economy, while Brad is simply noting that steeper yield curves, manifested here through a drop in base rates and no movement in longer-term paper, are pumping up banks’ profit flows, which will help them deal with the hideous losses from the sub-prime mess, the monoline insurer implosion and all the other nasties out there.

This seems like pretty clear “Bernanke put” behaviour to me.  The banks need the short-term increase in profit flows in order to stay solvent in the medium-term.  Whether Mr Bernanke is pushing down the base rate because the banks can’t lift the yields on long-term debt or because he doesn’t want them to (since that would hit the real economy) is a moot point.

This doesn’t change the fact that Bernanke is slopping out the good times to save the industry from its own mistakes.  It’s probably safe to say that there’ll be no more knuckles rapped (except maybe those of the ratings agencies), so the real question is whether they’ll be allowed to make the same mistakes again …