False economy

Damn it. I am barely finishing reading a splendid book on the economic history of the world that another one is coming out and seems to be a must read. Well, that is the impression that I get from reading Easterly's review (in today's FT) of "False Economy: A Surprising Economic History of the World" by Alan Beattie, the FT’s world trade editor.

Easterly thinks "the book is rife with interesting conundrums: the Nile river valley is one of the most fertile places on earth, yet Egypt imports half of its wheat; Peru rather than California has captured the US asparagus market; West Africa is the perfect location and climate to produce cocaine for Europe, but coke is instead made in distant Colombia – then routed through West Africa.

Beattie’s explanations, the best parts of the book, are on his home turf: international trade. In a wonderful exposition that should make it into all undergraduate economics classes, Beattie argues that, fertile Nile or not, Egypt is not so much importing wheat as importing water. Only the Nile provides water for the mostly desert country. Wheat takes much water to grow, so the water imports are contained in the wheat imports. By importing wheat, Egypt conserves its own water for drinking and uses other countries’ water to grow wheat shipped to Egypt. This is a wonderful illustration of how trade allows countries to import scarce resources, buying in the goods that would use them, and export their abundant resources, by selling the goods that use those.

To Beattie, the surprising and sad thing is that there are so few “water” exchanges and other such beneficial trades. This is partly because special interests distort trade. For example, the US preaches free trade to Africa, but prefers to keep out African cotton and give $4bn in subsidies to 10,000 American cotton farmers instead. Why? Senators in those farming states would block any reform of the cotton subsidy.

Is importing Peruvian asparagus a happy counter-example of US free trade policy? Unfortunately not, Beattie tells us. It was part of a drug war programme to subsidise Peruvians to grow asparagus rather than coca leaves, giving them privileged access to the US market.

And the cocaine still pours out of Colombia, not West Africa, because even an illegal export needs good roads to get the coca leaves to the factory and then to the port. West Africa’s lack of good roads, Beattie points out, costs it much more in lost exports than even trade policies such as those on cotton."

I'm adding it to my shopping cart...obviously.

The Quiet Coup

In recent months it has been fascinating to observe policymakers' responses to the financial tailspin. However, according to Simon Johnson (former Chief Economist of the IMF) in this article ('The Quiet Coup', from The Atlantic Monthly) two further major responses are necessary: nationalise the banks; and break up the financial oligarchy that rules in America.

Whilst the former suggestion has been much discussed, it is the latter notion, of breaking the financial oligarchy in the US, that is perhaps Johnson's most interesting and controversial point. Drawing a parallel with his experiences with emerging markets during his IMF days, Johnson posits that there exists a 'revolving door' between Wall Street investment banks and the political establishment, to the point where a stint at Goldman Sachs is almost a prerequisite for public service at the highest level. Below an interview with Mr Johnson concerning his article:





Thus the essential message behind Johnson's article is that - like many emerging markets - the US government has been captured by the finance industry. Until the government frees itself from the influence of those whom it is supposed to be regulating, efforts at recovery will fail.

All in all, a fascinating piece from a guy who has been up close and personal with his fair share of banana republics!!!


**Thanks to Daniela Benavente for pointing me in the direction of this article!!

Inspiration Needed??

The middle of semester can often be the time when one tends to enter a bit of a funk and get disheartened about (a lack of) research progress.

In the case that you need a bit of inspiration, you should definitely watch the following video:




This is a lecture by the late Dr Randy Pausch, of Carnegie Mellon University. Diagnosed with terminal cancer and given 6 months to live, Dr Pausch gave an amazingly inspirational speech on how to achieve your childhood dreams and to get past the 'brick wall' blocking your progress. Although watching the whole thing is a bit of a time investment (circa and hour), it is well worth it if you have the time (even if you don't, watching a bit of it can give you the flavour of what he is on about).

Usually I'm a bit sceptical of these kind of motivational speeches, but I found the lecture brilliantly compelling and inspiring. Especially given his circumstances, this is quite an exceptional lecture.

Ponzi Schemes 101

One of the best explanations I have seen yet of the Bernie Madoff Scandal and Ponzi schemes:

The Formula That Shook the World

We all know how central mathematics has become to contemporary economics (and finance), but who would have thought that a (seemingly innocuous) mathematical function could be downright lethal to the world financial and economic systems??

Up until I read this article about the 'Formula That Killed Wall Street', if you had said to me that maths could be responsible for the mess we are in today, I would never have believed you. This all changed when I read about the way in which the 'Gaussian Copula' function was used by the bankers to price the risk of the assets they were acquiring (more specifically, it was used to boil default correlations down to one simple, elegant and irresistible parameter).

Not only is this article is fascinating in terms of shedding light on the detailed mathematical mechanism behind the calamity we are currently involved in, but it also raises a broader, more philosophical question about science and the eventual responsbilities of those engaged in scientific activities for the consequences of their inventions. That is, whilst the inventor of the formula, a math whiz kid by the name of David X. Li (it was Li's paper which pioneered the use of the Gaussian copula function), isn't quoted directly in the article, some mention that Li himself shouldn't be blamed for the way in which his invention was (ab)used by the bankers, and therefore should escape blame for the world's problems. On the other hand, the bankers might say that they, acting in good faith, trusted the formula to be correct in its pricing of risk and therefore should be absolved of their actions.

This article therefore raises an interesting question - to what extent do those involved in scientific endeavours, such as ourselves, bear responsibility for the later consequences of the use of our research? For example, Einstein came to regret the way in which his theory was used in the development of the atomic bomb (although he was not directly involved in the Manhattan Project himself, - he only coauthored a letter urging Roosevelt to commission the project - his theoretical advances were used by his colleagues to develop nuclear weapons and wreak havoc on the world).

So should we as scientists bear any responsbility for the way in which people use our research advances, or is it up to those who twist our research for their own ends to bear the blame?

Interested in your thoughts!!

Larry Summers

We had the chance to see Summers in person last year when he came for a speech at HEI...I wonder how much the school paid him for his speech.
According to Financial disclosure forms released by the White House Summers was paid more than $2.7 million last year in speaking fees by several troubled Wall Street firms and other organizations. He also collected roughly $5.2 million in compensation from hedge fund D.E. Shaw and made $586,996 in salary from Harvard University...The article mentioning this in the Washington Post is here.

Does this make him a bad guy? Not yet I guess. But I did notice something weird about him...I've never seen him smile or make a joke here and there...Beware of people that never smile.

Animal spirits

It's funny that no one mentioned the new book by Akerlof and Schiller during yesterday's debate on macroeconomics. Animal spirits is discussed in this week's economics focus and i really feel like reading it...The Economist write that "Macroeconomists need to apply some new lessons and relearn some old ones!"

Five classes of spririts to take into accout
"Akerlof and Shiller spin five classes of spirit. First and closest to the original is confidence. This goes beyond a rational estimate of next week’s share price, or the price in ten years’ time of what a new factory might produce. And confidence, or the lack of it, builds on itself—in a way similar to Keynes’s multiplier, but defying easy quantification. Second is fairness. Even if economists know that fairness matters, too little of their work reflects it [as I had explained here] . Third is corruption, or bad faith: what explains a Charles Ponzi or an Enron? Fourth is money illusion: economists have come to assume that people see through inflation, but they don’t, especially when it is low. The fifth they call “stories”. Economists are loth to suppose that people are irrational enough to latch onto plausible tales and forecasts—for example, that house prices will never go down. So their models won’t spot the consequences of misplaced belief until it is too late."

Does anybody think this is not gonna be a good book?

Moyo's book - Sexism and twisted incentives

I read Dead Aid and I liked it a lot, almost as if I had written it. Not only does she explains clearly the multiple mechanisms through which aid causes underdevelopment (Easterly doesn't), half of her book is devoted to explaining how new ways of financing Africa's development, that do not involve aid, like government bonds, microfinance, remittances, and the Chinese can be the solution. She explains convincingly how ending aid(except humanitarian and emergency aid) in the next 5 years could work .

And now I'm reading how most of the reviews (collected here) are discrediting her ideas, including The Economist, who was so nice with Calderisi's "The trouble with Africa" whose suggestion was to limit aid to 5 countries, or with Collier or Easterly. Everyone (except Easterly) gives her shit for a lack of objectivity and selectivity that is true of any book and is never mentioned in reviews of books written by men…This is sexism big time.

But the worst review comes from Roodman at the Center for Global development. He says that "the book is sporadically footnoted, selective in its use of facts, sloppy, simplistic, illogical, and stunningly naive" and that he has "probably done more than anyone to challenge studies showing that aid “works” on average." Really? What does he know about development except the blah blah he hears in DC and reads on the internet and writes in papers using xtabond2 to show that aid works?

A huge part of the negaitive reaction from the development community is also explained in her book and here by Ross Levine. In the aid industry, incentives to keep the lending money flowing trumps any incentive to get the advice right on important issues.

So do read her book.

Stimulating consumption

What about a negative VAT? Like a 10% reimbursement on everything you buy. The measure would be temporary and funded the same way as the stimulus bill. And unlike tax cuts the income would not be saved but spent for sure since it is only after consuming that you get your money back. Could it work?