Club Troppo

One of the big mistakes responsible for the outbreak of WWI was that existing Western powers actively tried to contain the influence of emerging powers. England and France tried to hold on to all their colonies and keep Germany out of the colonial game. Conversely, Austria and Germany were wary about Russia’s growth and housed opinions that advocated war as a means of halting the growing threat. The notion of aggressively holding on to the current division of the spoils was a large factor in the outbreak of WWI. It seems a valid question to ask whether we are making the same mistake with China and India now, or whether ‘we’ have apparently learned our lesson.

Thinking about the openness of markets, the West has learned its lesson well. Export growth of China and India is hardly contained by new trade barriers at all, even surviving the recent financial crisis. Comparing this to the collapse of trade relations during the great Depression of the 1930s, one has to see this as a victory of reason. Slightly worrying is that this support for continued relatively ‘free’ international trade had to be carried by elites (governments and economists) rather than by whole populations. Lessons might have been learned, but apparently not by whole countries.

Thinking about access to resources, the question is whether the West is allowing China a growing share of overseas spheres of influence in order to secure its supply of raw materials, i.e. is China allowed to encroach upon the traditional overseas dependent territories? Here again, it has to be said that the West is not making great efforts to keep the Chinese from gaining footholds in the regions of great natural resources. The explicit Chinese program of investment in natural resource sectors of other countries has not been opposed, and the buying up of mineral deposits in Africa and Latin America of the Chinese is still proceeding relatively unopposed (for a discussion of China’s investment in Africa and Latin America see here). It is the case that the recent introduction of the resource tax effectively means we Australians have cheated the Chinese out of some of their expected profits from investing in Australian mining, but in the scheme of things this is small potatoes.

Thinking about ego-rents, it is also clear that the West is allowing both China and India their ‘place in the sun’. The Olympics were in Beijing; skilled Chinese and Indian migrants are welcomed in Australia and the US; China has a permanent veto at the UN security council; Taiwan and Tibet are not recognised as separate countries by most Western countries; thinking about the future, Taiwan will clearly be abandoned as an ally to appease the Chinese and no-one will seriously interfere in Tibet; Western governments are not talking up the threat of Chinese investments in their army; etc.

On balance, you would have to say that the West seems to be applying the main lessons of WWI when it comes to China and India. It recognises that China is the next world superpower and is letting it happen without too much fuss.

Evidence-based policy is a buzzword that conjures up images of responsible government: difficult decisions taken after a careful examination of the evidence, tailored local experiments, and then implemented using the best advice available. Sounds good, no? As a buzzword, it is a clear winner and something we all want more of.

But how much can we really expect of this buzzword and what will it actually lead to? Let’s have a look at the dangers and benefits.

The dangers and limitations

The first thing to note about the buzzword is that its main association is with rational control. In order to have evidence based policy, you must gather evidence and have a policy process. That means hiring more bureaucrats to do the gathering and the processing. Hence the buzzword is first and foremost a means for a bureaucracy to get their hands on more resources.

The buzzword also works to legitimise more power to a centralised bureaucracy: if you are going to have evidence-based policy, you must be able to implement the centrally-decided policy. Hence it is an excuse to take independent decision-making power away from local actors to the benefit of a supposedly rational centre. One might note the inherent contradiction here: with less power to local actors comes less local experimentation, meaning less policies are tried out and less possibilities for learning. Evidence-based policy is hence an engineer’s view of how an organisation learns (top-down). An alternative view could be that an organisation learns by following successful examples within the own organisations, which is a more organic but far less ‘evidence-based’ view. One might not know why something works and have no evidence that it will work in other places, but by simply following previous successful examples one can nevertheless reasonable hope to improve over time. That is how evolution works (what accidentally happens to fit its environment gets to procreate) and how many markets work: not by a rational gathering and analysing of information but by an almost blind mimicry of accidental success.

These initial thoughts mean that adopting the word ‘evidence-based’ policy implies increased bureaucracy, increased centralised control, and decreased local experimentation.

Then, let us consider the limits of ‘evidence’. New events that have no clear precedent but to which one must react are clearly outside the scope of evidence. What is one supposed to do then, wait until evidence is gathered? For instance, the recent Global Financial Crisis had no clear known precedence. It only vaguely resembled previous recessions. Should this then mean that all kinds of policies that were not implemented before and for which there was no evidence should not have been implemented? Should there have been no fee for the bank guarantee? Should we have stopped migration? Should we have started government work programmes (which were deemed so successful during the Great depression)? Or should we have done nothing for 50 years during which we gather more evidence?

It is clear that in the case of new major shocks hence, evidence-based policy has no meaning. We react to these based on vague rules-of-thumb and a vague understanding of how the whole economic system behaves. Such vague knowledge, based on vague historical evidence, can hardly be called evidence-based, but it is all we have to go on in such situations.

Then, onto the plus side:

(Continued)

Following the efforts of James Farrell as to the many different things meant by lay folk and professionals by the word ‘belief’, I wanted to try to tackle the question from an economics points of view. Given that the methods and mindsets of economists are an amalgam of other scientists, we firstly need to review how different stereotypical scientists from various disciplines would answer this question. Before getting to the perspective of economists, this medium-sized essay will therefore first present the view of a mathematician, a statistician, and a modern cognitive psychologist (or at least how I think of them).

(Continued)

In May of this year, the Australian government announced a tax increase on the mining company whereby all profits over the long-run bond rate would be taxed at 40%, with off-sets for losses. This tax on the rent created by the boom in mineral prices was spent on reductions in the company tax rate and on various overall subsidies. Following a fairly extensive campaign by the big mining companies and their representatives such as the Minerals Council Australia, the government in July negotiated directly with the three major mining companies and reduced the planned tax increases in return for the explicit promise to stop campaigning. If we compare the revenues the tax would have gotten (under the revised price estimates) with the current expected revenue, it seems radio silence has come at a cost close to 5 billion dollars per year. In terms of discounted values, every dollar spent on campaigning by the mining industry seems to have paid off (ball park figure) something like a thousand dollars in less tax.
Elsewhere, I have talked about how the media campaign was made up of false arguments and wild exaggerations. Essentially, jobs and investments in mining were never truly at stake and it was a straightforward fight over money with on the one hand a few dozen billionaires who stood to lose and on the other hand millions of small businesses and consumers who stood to gain but of whom a fairly large slice was scared into thinking they were going to lose.
Observations:
1. One lesson from this saga is that negative campaigning works, particularly in an election year. The basic recipe for protecting privilege has been applied here: muddle the argument; roll out experts with minor doubts and represent those doubts as sincere opposition; get the masses to believe something unfair is happening and they have something to lose; and never once talk about money. Not once did the media blitz even try to run the argument that it is fair for billionaires to make more money out of Australia’s mineral resources. The eventual outcome, 5 billion dollar less taxes for the mining industry per year, was never put forward as the goal of the campaign. Will the mining companies give this bonanza to charity? Don’t count on it.

2. The super-wealthy stood fairly united. As I remarked in an earlier blog, other wealthy organisations who make their money from rents, like property developers, banks, and most financial institutions, could have expected to be the next in line for tax increases. This is clearly the whole idea of the Henry Tax review. Probably as a result of this, Business Councils did not line up behind the tax even though all non-mining businesses clearly won out because of the reduced company tax rates.

3. Nothing is secret when this amount of money is involved. The mining industry had clearly prepared for this campaign long in advance, even though the Treasury tried to keep the exact plans secret.

4. The dip in Rudd’s popularity was used to settle old scores within his party and his administration. They must have really hated his guts.

5. The media seems to have been a victim in all this, being fed stories about Rudd from within his own circles, being fed all kinds of storylines by the mining interests, and being bombarded with opinions from all and sundry. No wonder the mainstream media had no idea what to believe.

Lessons:

(Continued)

With Gillard as our new PM, a compromise has been done on the RSPT, rewarding the big mining companies for their negative campaigning. In this first post-mortem, I have some mopping up to do regarding two as yet undiscussed ‘reports’ brought out on the old RSPT, one by Ernst and Young and one directly brought out by BHP.

Ernst and Young, paid by the Chambers of Minerals and Energy of Western Australia, put out a report in June by two relatively unknown American economists that is completely devoid of any new calculations on the RSPT but nevertheless talks loudly about potential job losses in mining. Its main point is that the RSPT reduces the pay-off on mining projects and that this might mean mining companies put greater priority on other investment projects overseas. Even if this were true, it would merely mean that the projects would be postponed, not cancelled, but it is in any case an empirical question relating to how profitable future projects actually are.

The KPMG reports from May, using data on actual projects obtained from the Mining Council, basically finds that with a properly implemented RSPT, nearly all currently planned Australian mining projects remain too profitable to walk away from.

BHP wielded out a short paper by Professor Jerry Hausman, an econometrician from MIT. Professor Hausman also doesn’t calculate anything new, but nevertheless calls for adjustments to the implementation of the RSPT. Professor Hausman does not take a stand on whether he thinks the RSPT is going to lead to more or less mining activity, but wants to make the RSPT far more complicated by taking account of ‘option values’. Professor Hausman essentially recycles an old 1997 paper of his on the optimal taxation of profits that has been roundly ignored in policy circles.

What is Professor Hausman on about and are there any merits to what he says?

(Continued)

Last week, the Minerals Council Australia (MCA) came up with a KPMG report (download here) that suggested that the newly introduced Resource Super-Profit Tax (RSPT) would lead to many future mining projects being non-viable. This is of course a cornerstone in their scare-campaign about this tax and I had a look at the report to see what they did.

A preamble to this is that the timing and source of this report raises an eye-brow. I first presumed that KPMG must have some very fast modelers in order to be able to come up with a whole report on the effects of a new tax on new mines within weeks of the budget announcement of this new tax. It would be a testimony to how fast markets can generate research if there is a quick dollar on offer for it. However, this appears not to be a case of fast modeling. The research was commissioned way in advance of the budget. This is somewhat extra surprising if you reflect on the fact that KPMG also modeled the long-term consequences of the RSPT for the Treasury, as part of the Henry Review! At the same time, in the last months of 2009, they were apparently already modeling extensions of their RSPT models on behest of the Minerals Council Australia. Large sections of the report are hence devoted to explaining the differences which read a little forced to me. You can smell the guilt.

I doubt any formal codes of conduct were broken in terms of conflicts of interest, but I find it a little dubious that the same modelers are able to sell the advise to the Treasury that the RSPT will have no adverse long-term consequences whilst simultaneously selling advise to the MCA that there might be some negative short-run consequences. It is hard to see how you can conscientiously serve two masters at once.

I have the following quick comments to make about the content before turning to the main issue:

- The report nowhere gives you the actual models and codes used for the calculations. I could not find the code books either on the KPMG website, linked to within the report, or on the website of the MCA. It is hence very much a ‘trust me, I know what I am doing’ piece. Since these were the same guys as that did the calculations for the Treasury, they probably did know what they were doing, but it would be nice to have independent access to the data and models, and I gather from the introduction that the MCA could give this information out if it wanted to.

- The report is highly selective in terms of what it chooses to calculate and highlight. It doesn’t tell us what the RSPT would do to the Net Present Values (NPVs) of all possible future projects, but only talks about the NPV of the second quartile of profitable projects. This is of course because the first quartile will go ahead anyway and the third quartile will probably see increases in NPVs due to the cost-sharing in the RSPT. It loads the dice towards the negative to focus on only 25% of all considered future projects.

- The report leaves out the effects of all existing projects, at least in its headline treatment. As Chris Richardson pointed out in his presentation on June 3^rd to the Minerals Council, existing projects will probably start to see more intensive mining activity because of the reduction in output-taxes associated with the RSPT increases the incentives to produce more at existing mines. This is also implicit in the KPMG report, but the finding that in the next 2 years mining activity should increase is not highlighted at all.

- Trying to make the argument that the RSPT leads to high overall taxes by international standards, the report compares effective tax rates under the new regime with existing tax rates elsewhere. The crucial questions are of course which commodities the comparisons are made to. In choosing comparison commodities, the report leaves out oil which is more heavily taxed than the mining industry would be under these changes (but where production and investment in oil exploration haven’t suffered in the slightest despite these high taxes!), but leaves it to a side-note on page 30 to mention this. Since mineral production is becoming more profitable, it is not at all strange to compare the future of mining with the present treatment of oil, since both involve exploration, investment, and production phases.

- The report itself mentions that long-term effects of the RSPT should be positive for mining activity (a similar point is made by Richardson).

- Computed internal rates of return look very healthy for all types of mining under the RSPT, something given little attention to.

- All these highly selective choices already make it clear that the report, and in particular the summary, is indeed not an objective appraisal but a piece of propaganda that was bought for a reason. The newspaper headlines ‘KPMG report shows miners are going to be ok the next 2 years and in the long-run’ clearly is not what the MCA wanted others to get from this report, even though such headlines would be warranted by it.

Then, to the true matters of substance.

(Continued)

Well, the Israelis have been at it again. Boarding a humanitarian flotilla that was bringing humanitarian supplies to a besieged population on the Gaza strip, the Israeli military shot at least 9 people dead and once again displayed a worrying degree of disdain for UN resolutions and basic human decency. It has been roundly condemned in the Western media.

Yet, similar things happen elsewhere in the world with much less media attention given to it. UN humanitarian convoys in Africa are ambushed frequently without making the international headlines. By the standards of that region in recent times, the behaviour of the Israelis shows immense restraint and civility. So I ask myself why Israelis are held to higher moral standards than others; who are we to make any judgments on the Israeli-Palestinian conflict at all; and why should we care at all? As Australians we seem to be outsiders to this conflict, have limited understanding of the history of the conflict, and little political power in the world to influence these events. By what moral code should we then judge the actions in that little corner of the world?

The first moral lens we can use to look at the conflict is a selfish historical one: the bigger the conflict and the more directly Australians are affected, the more it should matter to us and the more entitled we are to a moralising opinion, even if that opinion is uninformed. Through this lens we should be unconcerned by the conflict.  The conflict seems to have little, if any, historical importance at all to us, since we live far away with very few Jews and Palestinians within our borders. So we must be concerned by it because of other moral lenses.

(Continued)

The recently announced Resource Profit Tax is in principle a profit grab, taking from those who owns large mines, and handing this out to those that dont. Obviously this makes mining executives angry and the noise they are creating at the moment is deafening, with all sorts of nonsense bandied about in the media about how this tax will mean the end of the world as we know it. Leaving the noise from a few super-rich to one side, it is useful to think of who belongs to the winners and the losers of the proposed tax.

A difficulty in making that assessment is that no-one yet knows how this tax will be carried out. Part of the difficulty is that the tax is meant to replace the existing royalty system in individual states, but these individual states are unlikely to simply agree to such changes in their tax raising activities. Also, definitions of ‘costs’, ‘rents’, and just exactly what constitutes a ‘mining project’ are yet to be worked out, so we can at the moment do no more than give a best guess. Let’s presume that the tax gets implemented in the way it designed, meaning that the profits of all current and future mining projects will be taxed at 40%, whereby the initial costs and losses count as a kind of tax-offset.

At the moment, the government’s plan includes the possibility that mining firms that made a loss on a project get part of that loss reimbursed, but exactly how that will work out is not clear (what happens in the case of bankruptcy?), so let’s presume that costs and initial losses will be treated as tax off-sets, which is what they will be for most of the big mining companies. Since a profitable project now remains a profitable project in the future, the long-run effect of this tax is that at least as many projects will go ahead as without this tax. Indeed, more will go ahead because the tax replaces existing royalty taxes which tax all mining activity and do discourage all mining activity. Hence, in the long-run more mining will take place under this new tax, implying higher levels of investments. The beauty of the tax is that the underlying assets (minerals in the ground) cannot run away and hence the tax cannot be avoided by mining somewhere else.  It is just not credible for any company to pretend they will refuse to make money and not dig up and sell the minerals that are there. All talk of capital flight, sovereign risk, and other forms of saber rattling are just not credible.

Another clear effect of this tax is that it will give mining companies (like Xstrata and BHP Billiton) an incentive to increase the costs, just like any tax-offset increases people’s incentive to use those offsets. This means that one should see increased job security, higher wages, and increases in other cost factors like transport. Indeed, the tax office will have a tricky time in deciding whether all the costs mining companies will start putting on their books are really costs associated with mining activities. Mining companies can for instance try to hide profits by paying excessive amounts to transport companies for transporting the minerals if these transport companies are owned by the same parent companies. All kinds of tax-avoidance games can be played. However, let’s presume the tax office will do a reasonable job and manage to keep the increase in ‘fake costs’ to acceptable levels. Even then, anything that is essentially a cost to mining (like employment, wages, and inputs) should get an easier time in negotiations with mining bosses because the government now effectively pays some of those costs.

Who, then, are the winners of this tax?

(Continued)

Anzac day is when Australians and New Zealanders remember their casualties of the first World War and other conflicts. It has become a defining event for the sense of nationhood of the Australians and solemn commemorations are held all over the country. Sharing the same background (some ancestors on the English side of my family fought alongside the Anzacs on the Western front), I find it a great tradition to remember the horrors of that war. It is also an event that is fascinating as a social scientist. Some observations:

1. A lot of the commemorations are state-sponsored via the Department of Veteran affairs. This department is running out of veterans to take care of, but has over the years increased its budget for commemorative services. It is actually quite hard to figure out just how many of the various ‘budget posts’ should be counted as commemorative, but at best guess we’re talking about half a billion dollars and rising. One of the reasons why Anzac day appears to become a bigger and bigger event as time goes by might quite simply be that it is a way for an existing ministry to spend surplus resources on its budget.
2. The ‘message of Anzac day’ has changed within Australia over the decades to suit the morals of the day. I was at the Anzac celebration of the school of my kids, with military commanders giving the assembled quiet and disciplined kids the supposed reasons for why so many young men died in WWI. The story these kids were told was that the Anzacs died ‘for tolerance’, ‘mateship’, ‘standing up to bullies’, and more of those values we hold dear today. The kids were basically told to follow the social norms of current day Australia as a means of honouring the memory of the fallen of previous wars. I don’t have an inherent problem with this, but do note as a social scientist that such statements take liberties with the truth. At the time of WWI, appeals were made on the basis of ‘God, King, and Country’. In the intervening century, God and King have been axed from the moral appeal, but ‘the Country’ is still there. Also, tolerance and anti-bullying were not really a big thing in the 1910s when Australia was still a very ethnically ‘pure’ country and bullying was an institutionalised accepted reality in schools. Anzac day is hence a bit like going to church on a Sunday: every generation reinterprets the book of yesterday to suit the moral code of today.
3. The ability of kids to imagine themselves part of a group that extends over the centuries but that they are not objectively part of is quite remarkable. At a guess, maybe 25% of the kids at the school commemoration will have had actual Australian ancestors involved in WWI, but they all somehow identified with ‘the Australians that went to war’, even if both parents were Chinese or African. It is simply an amazing thing how easily kids adopt stories of cultural continuity as their own even if that story has no real bearing on their actual personal histories. This imaginative capacity is not in any economic model I know, but clearly underlies our sense of identity and hence underlies important economic variables too, such as our willingness to pay taxes for ‘this country’.
4. The ‘message of Anzac day’ is different in different countries. Where I grew up, i.e. Western Europe, a big message of similar commemorations was the pacifist spirit of ‘J’accuse!’, which was the historic quote from Emile Zola that was also the title of a French film in 1919. It means ‘I accuse’ and one of the characters in that film explains it to mean ‘accusing the war… accusing men… accusing universal stupidity’. We were told as kids that WWI was one of history’s most stupid mistakes started by leaders who get themselves into a mess because their pride wouldn’t allow them to back down, and fought by gullible enthousiastic populations who thought of war as something exciting. The message we were told was that people should not blindly follow their leaders, but should think for themselves and question the logic of going into conflicts just because the conflict exists. Interestingly, there is almost none of this pacifist message left in Australia, though perhaps it was there and has simply been lost over the decades. Indeed, the kids at the school I went to for Anzac day were told to be silent, obedient, and to take it on faith that Australian men lost their lives in droves for a good cause. There is hardly any mention in Australian commemorations that it lost the flower of its nation to a pointless mistake on the other side of the world, lead by foreign commanders (such as Winston Churchill) and not even by one of their own. I must say that I find it curious that Australians are not far more critical about the leaders they blindly followed into WWI (as well as later on) but make excuses to exonerate the mistakes of those leaders and allies, even when the populations of those allies themselves are far less forgiving.

I hence like the idea of Anzac day, but miss the pacifist message that WWI was one of the biggest f-ups of the last century and that we should think for ourselves and question the wisdom of following leaders blindly into battle.

Kopenhagen is currently witnessing two comic relief shows. One is regularly seen in the amusement area known as Tivoli, and the other is the climate change conference. The core element of pure humour in the second circus is that the actions of many governments are diametrically opposed to their words, mainly for the benefit of a watching population that wants tough words but no real action. It is like watching one clown after the other pretending to be sad whilst laughing if the rest of the clowns backs are turned.

Let us over the fold once more review the core elements of the actions and the words in this debate, and let us start at home.

(Continued)

Suppose you believed the world was getting warmer due to humanity’s greenhouse gas emissions and you worried about it but you cant get yourself to believe that the 200-odd countries in the world are ever going to agree to drastically reduce their emissions via some joint scheme, partially because it is too hard to measure many emissions, partially because it might take a world dictatorship to actually enforce such a deal, and partially because some countries are most likely going to be much better off if the world warms up and hence are going to sabotage any joint plan. You would find yourself backed up in this opinion by a lot of auxiliary data on the difficulties of letting go of the growth fetish, ranging from the known miniscule effect that the ETS schemes currently on the table would have even if they were agreed upon, to the factoid that China is building two coal powered stations a week, to the factoid that in nearly every election politicians promise their electorate more economic growth (read: bigger cars, more holidays to far-away places, more gadgets running on energy, etc.), to the factoid that even the European countries who have been calling for reductions in emissions for over 2 decades have themselves been happily burning the midnight oil.
For people like this, which includes me, geo-engineering seems the only realistic way forward, i.e. some kind of technological fix that can be implemented by a single worried country or a sub-set of countries desperate enough to try unproven technology to cool the planet down. No world dictatorship or elusive coalition needed, hence much less of a free-rider problem. How serious are good scientists thinking about such technological fixes, what are the front runners, and are the front runners indeed things a sub-set of countries could implement?
It turns out that the possibility of geo-engineering is taken much more seriously in the academic community than youd ever think from reading the newspapers. English scientists in particular seem to have adopted the idea that they should look for technical fixes, just in case the world coalition on CO2 emission reduction doesnt quite live up to the dreams of its adherents. The Royal Society for instance advocated research in geo-engineering quite openly (see here) making it clear sensible people are thinking about this option seriously. Find over the fold a basic breakdown in basic options and their characteristics.

(Continued)

Some things seem to need no explanation, but are not obvious at all on reflection and, if you wonder about them, suggest something of interest about the economic system. Consider the question of why the informal economy is so small, leading to the question of how much more productive the formal economy must be than the informal economy to make sense of how little informal economic activityy there is. See over the fold for the full argument.
(Continued)

In a post a few weeks back, I raised the question of what additional production factor one would have to include into the current production function framework in order to have a plausible story about the recent crisis.

That post included a set of conditions any candidate would have to pass in order to fit the current crisis and be interpretable as a true factor of production. From the ensuing reactions, two main candidates emerged: a mystery factor that gives a role to lines of credit (suggested by James A); and input and output linkages (suggested by doctorpat, Ian King, and, implicitly, _Tel).

Let us now add more information to this question and see whether the proposed production factors have something to say about other major economic crises that we have known in relatively recent economic history. The hope is that we need only one factor to generate a reasonable story for several major downturns. If wed need a very different new factor to explain each different major economic downturn, then the exercise of looking for new production factors becomes more futile because there is then less hope that having a good explanation for each of the previous downturns will say anything of much use to inform us about what to do to prevent or cope with the next one.

The blue line shows the Great Depression, in which case the 0 point on the X-axis denotes 1929; the red line shows the collapse of the Russian economy after the changes in 1990; and the green line shows the Indonesian collapse after the Asian Financial Crisis of 1997. In each case, GDP is normalised to be 100 at the start of the crisis and time is re-set to 0 at the start.

The first striking observation is that these three crises are far bigger in magnitude than the current crisis. Indeed, the Russian collapse was so spectacular that I have long wondered how it is possible that our macro-textbooks are not full of insights gained during such a spectacular macro-event. Stiglitz already noted in the 90s that the Russian collapse shouldnt have occurred under the conditions we still teach as good descriptions of the aggregate economy, but it clearly hasnt mattered for Western textbooks that a large economy on the periphery did something interesting.

The main question to briefly consider though, is whether the two candidate factors X are known to have been involved in these downturns too? Lines of credit were certainly important in the Russian case (as in the whole of the former USSR), where firms had large amounts of outstanding debt with other firms and the unwinding was a tricky business. Lines of credit were also important in Indonesia and the Great Depression. Hence credit lines can at least potentially fit, though it should still be worked out via which actual production factor they affect sold production.

Linkages are clearly of relevance in the Russian case where the whole central coordination mechanism fell away and the ensuing disorganisation (a phrase used by Blanchard and Kremer 1997) created many firms who had no suppliers and no clients. Campos and Coricelli in their 2002 Journal of Economic Literature article also point to within-sector reorganisation of links as a probable factor in the collapse.

Whilst linkages are probably relevant in the Asian Financial crisis, it is not well-documented how they might have played a role. We know many city labourers went back to the countryside, however exact numbers are unknown because most people who originally came from the country to find urban employment are unregistered and therefore not included in unemployment and migration data etc (an explanation paraphrased from a paper by Tran Tho Dat).

We also know that the capital embedded in collapsing firms was not quickly re-used by others, but theres no specific account I know of that discusses the collapse in terms of broken linkages. For the Great Depression, on which acres have been written, I also do not know of anyone looking at it through the lens of links.

One might say it is implicitly there when people talk about the issue of bankruptcy, as bankruptcy to a perfect market economist merely means the freeing up of previously inefficiently used production factors. From a link point of view, the importance of bankruptcy is that people and capital are idle for quite a while before they are re-linked.

Any ideas on how we should think of disruptions in lines of credit and its impact on the real economy via a production factor in these three crises? Any anecdotes on links?

(cross-posted with Core Economics)

There has been much talk in the last 12 months about the relationship between macro-economic theory and explanations of the current recession. Krugman essentially dismissed most current macro theory as being delusional about the workings of major recessions. His major argument (which goes back at least to Stiglitz in the mid 1990s) is that, within Real Business Cycle theories, major recessions are at their core viewed as mass holidays.

The holiday view of recessions essentially arises from the fact that most macro-models take a perfect-market view of the aggregate economy and boil down the complicated machinery of GDP creation into a smooth production function which usually only includes Labour, Human capital, Physical capital, and Technology. As soon as you realise that the factories have not been bombed, that no-one has shot the workers or de-educated them and that people havent forgotten how to use the internet, then you are by necessity forced to say that any large reduction in production must have been because workers decided to go on holiday. Of course, you can redefine any of these basic production factors to mean the rest in which case you can tautologically say changes in it explain everything, but that kind of window dressing is ultimately useless.

In this blog I simply want to pose the question of which additional production factor we would have to think of to augment our models with, such that we get a more palatable story of what happens in major recessions, whilst still remaining within the confines of a production function view of the economy. Lets look at what must roughly be true of this mystery production factor X:

• It must be easy to destroy X and hard to build up. If it wasnt true that X was easy to destroy, then one couldnt have a major reduction in GDP because the other production factors dont really take a hit during recessions. If it was easy to build up again, then recessions should be over very quickly and one should be able to return the aggregate economy back to the path it was on previously. We know this is not true and that it has, for instance, been argued that the Great Recession of the 1930s really only ended in the Second World War (see here for support and here for a paper with a contrary view).
• X must have something to do with the utilisation of labour. This is because we know that the utilisation of labour quite closely follows the downturn and subsequent upturn, just as in this recession the GDP downturn was very quickly translated into losses of jobs and losses in labour participation. In the latest recession for instance, the US Department of Labor estimated the gross job losses totalled 7.4 million in the first quarter of 2008, whilst the US Department of Labor figures showed a loss of 533 000 jobs in the month following October 2008, the biggest drop since December 1974. For more, see here.
• X must have an element of a negative externality about it. If this werent true, then one would be forced to arrive at the absurd conclusion that people knowingly destroyed their own X and accepted the huge loss of income stream associated with it. There is no believable story that would make individuals inflict the kind of income loss that we see in recessions on themselves. Hence, to some degree, the reduction in X must be due to the actions of others and the destruction of the X of others might well be due to our actions. X must therefore be two-sided in that it is not something that would arise in a Robinson Crusoe economy.
• If we take the stylised story of this financial crisis at face value and accept that things like banks can be too big and integrated to be allowed to fail, then X has to have something to do with the other production factors being integrated. It must also be relatively easy to make up stories that tie the making or destructing of X to what happens in the financial sector.
• X must make internal sense as a production factor. This means it must cost resources to build up, that investments into it are in some sense visible (even if they are not yet measured by statistical agencies), and it must actually be associated with production. Hence things like trust or confidence do not qualify because they dont actually directly involve the production and sale of goods. A lack of trust makes it hard to organise production and sales, but is not itself a production factor. Trust might be involved in the cost of building X, but it doesnt make sense to call it a direct production factor in itself. In a pure command-and-control economy for instance one, in principle, needs no trust between people at all to have a reasonably high GDP. This of course does not preclude the possibility that the start of a recession is a dramatic change in things like trust which might affect the costs of making or breaking X.

Is it worth saving the production function approach at all, you might ask? Shouldnt we simply give it up as a bad job? I think it is worth saving, because the production function approach is the most obvious way to interpret GDP and growth regressions, and forms a logical basis for expanding the set of economic macro-variables the statistical agencies look for. It is also the easiest way to teach students about the macro-economy because it is nice and compact. What is hence wanted are reasonable candidates for X and a model that convinces the profession it forms a palatable answer. We need an X to save the production function approach to macro. Any ideas?

The monthly RePec rankings for Australia are in again. Always an exiting moment for the professional economists in Australia to see whether their latest publications have already been spotted by the automatic search routines, whether they have been cited as often as they deserve, and whether having their mum download all their papers every day has made a difference. The top 20 in Australia for this month looks as follows, where I should mention that I have kicked out some fractional foreigners who propped up the rankings of some institutions (see below):

1. Adrian Pagan, QUT/ UNSW
2. Michael Keane, UTS
3. Alison Booth, RSSS ANU
4. John Quiggin, UQ
5. Paul Miller, UWA
6. Warwick McKibbin, ANU
7. Murray Kemp, MacQuarie
8. Timothy Hatton, RSSS ANU
9. Paul Frijters, QUT
10. Yew-Kwang Ng, Monash
11. Carl Chiarella, UTS
12. Harry Paasch, Uni Melbourne
13. Kym Anderson, Adelaide
14. Joshua Gans, Uni Melbourne
15. Guy Debelle, Reserve Bank
16. Fabrice Collard, Adelaide
17. Benno Torgler, QUT
18. Alan Woodland, UNSW
19. Trevor Breusch, Crawford ANU
20. Michael Shields, Uni Melbourne

These rankings are based on an amalgam of research output, including the number of pages published weighted by impact, the sheer volume of work, the number of downloads in the last year, the number of citations, etc. For a full explanation of these rankings, see here. There is of course some bickering about these rankings, but they form a nice blend of aspects that favour those who are visible (like downloads), those who publish in the best journals (impact weighted number of pages), those who have impacted upon academics (citations) and those who are productive (volume). Though flawed, the RePec rankings are now probably considered the most authoritative rankings we have.

What are some of the salient points that come out of these rankings? Lets first talk about general aspects before we talk about names.
(Continued)