Economics — Mutual Information

Portugal does not have the highest debt of the eurozone, nor its highest unemployment, nor did it have a real estate crash. It didn’t even have the largest budget deficit. Yet, it seems like it will be the next domino to fall.

The reason is actually pretty simple: its growth prospects are poor. Markets are forward looking, rather than backwards looking. Normally, debt and recent deficits are a good indicator of whether, going forward, the government will be able to service its debt. However, in some cases that relationship breaks down (for example, if the country just got out of a war, its future will look very different to its recent past). In Portugal’s case, the debt is not that worrisome, and its deficits are not that large, but growth has been stagnant and there is little indication it will change.

For decades now, the average yearly growth rate has been slowing down (especially if you disregard the period just before and after the 1974 revolution as exceptional). In the last decade, it has barely been above 1%.

Why? Here, unfortunately, it gets messy. It feels like a death by a thousand cuts.

1. The labour market is awful. Many are familiar with the sclerotic Spanish market and the division into overly protected cosy jobs and bad, underpaid, precarious ones. Portugal’s labour market is, in some senses, worst. A proposal to make it as liberal as Spain’s (!) is being resisted by the unions.

2. The bureaucracy of the state has improved in recent years, but it is still a drag on the productive economy. Especially at the local level, things take too long and are overly unpredictable. See this Bloomberg report for a good description. Lisbon has more vacant houses than houses where people live in! Most of the vacant houses are owned by people who have been waiting (often for many years) for permission to renovate and put them back on the market. The city does not approve them and Lisbon loses its vitality.

3. There is no large scale corruption like in Greece, nor the state-level corruption of France, but petty corruption is abundant. In general, corrupt politicians still get re-elected. A few years back, one of the social-democratic parties (there are two of them), withdrew support from its most corrupt mayors. It was a good start, but the party got rewarded by losing many seats, whilst the other social-democratic party supported their corrupt mayors and kept them. In a democracy, people get the government they deserve.

4. Since 1968, when the first programme of “democratic education” started, the population is increasingly well-educated, at least on paper. Unfortunately, during the 1980s there was a very large internal brain-drain as most of the college educated chose to work comfy jobs in the public sector rather than start new companies or modernise existing ones. This also meant that the upper middle-class that rules the country (the sort of people a journalist at an important newspaper might encounter at a dinner party) are beholden to the state. Many small private companies, on the other hand, are run by the people with the least education.

5. Speaking of education, it’s not very good. Culturally, it is still not valued enough, with parents caring more about grades themselves than whether their children are learning anything at all (for example, trying to get teacher to dumb down so that their kids get better grades by learning less is common).

6. Large corporations, even when nominally private, are, almost without exception, dependent on the good favours of the state and protected from competition. The exceptions are export-oriented, but there are not many of them.

7. The demographic situation is horrible: there are too many people retiring for the number of workers. Demographics is like a slow moving freight train: it takes forever to get to you, but, when it does, it crushes you. Social security is now partially dependent on the value-added-tax. It will not get better, more general taxes will need to be diverted for it. For as long as I remember it, the pension system is in a process of “reform” (i.e., slowly breaking its promises, slowly increasing its take in taxes). The young are increasingly called to pay more to the older generation (who, in general, have no savings). As their taxes increase, many, the more productive, opt out of the system altogether (Portuguese emigration has picked up again in recent years). Atlas is shrugging.

8. The euro needed to be much looser. Portugal simply adopted a strong currency without the cultural adaptation that revealed itself to be needed.

Frankly, I just don’t see an easy way out for this little country in the short term. The political economy is warped by the older generation which works for the state and will fight for its perceived due. The economic culture is Keynesian even as they keep pulling on the string of public works (the plan is to have 3 parallel freeways from Lisbon to Oporto!). The idea of private initiative is too tainted by the pervasive crony capitalism (while at the same time, the state’s prerogative to choose winners is unquestioned—as if the two were unrelated). Meritocracy is resisted by the mediocre who have cushy jobs (with egalitarian leftists intellectuals serving as useful fools supporting them). There will not be a catastrophe. I’d be surprised with a radical populist up-rising. Portugal just does not like radicals and there are not enough young people. Instead, at least during the next 5 to 10 years, we’ll see a muddling along.

The intervention of the IMF (which still seems inevitable) will buy the country some time, but there is too much wrong with its economy for the fix to be the miracle that some expect.

Many states are cutting Medicaid costs. This will not end well for patients on Medicaid (or for those marginal workers who now have insurance, but will be dumped on Medicaid by Obamacare).

The great Scott Sumner:

Here’s how I think about jobs. First, what do we want? If those things can be provided with very few workers, don’t despair, ask what we want after we have gotten our first wish granted. And so on, until all the workers are employed.

Writes Todd Zywicki:

Who could have possibly predicted that the Credit CARD Act’s rules that limit non-interest fees and the ability to raise interest rates when a borrower’s risk changes would result in “record high” interest rates (other than me, of course, when I testified to the Senate Banking Committee in 2009 that the act would result in higher interest rates and other than the sponsor of the law, who has acknowledged that it has resulted in higher interest rates but has decided for the rest of us that higher rates is a good thing)? Even more amazing, it appears that these restrictions on risk-based pricing has hit poor credit risks even harder than less-risky consumers.

Amazing. It’s as if supply and demand continued to work even after Congress passed a law.

On the other hand, the lower-upper-middle-class (most of the policy and public opinion in the US is made by the sort of people that a NYT reporter might encounter at a dinner party) will be happy to know that (1) their rates have not gone up and (2) that pesky $30 fee that they got charged 5 years ago for over-using their card on a trip will not happen again.

The comments below made me verbalise my understanding of Cowen’s thesis in another way.

His argument is about traditional growth theory growth (capital and labour yields growth, i.e., you should invest in infra-structure), versus Romer-style growth (ideas and capital and labour yields growth, i.e., you should create knowledge and institutions).

Until the Great Stagnation, the US was undergoing Romer-style growth: new institutions, new ideas, and a lot of capital. Recently, it switched to something that is better explained by traditional growth theory: you apply more capital (having run out of extra labour to apply) and you get a bit of growth, but there are no radical new ideas. We have not been creating new intelectual infra-structure (is the thesis).

Therefore, the comments that the internet has never stopped growing strike me as not reaching the heart of the matter. Of course, email is much more valuable now that everybody is using it. However, this is traditional-growth-theory-growth (more computers, faster computers, faster connections, everything gets cheaper). There are no conceptual leaps to switching from a command line cryptic command editor to a gmail text box. Once you have email and the idea of a graphical interface (which was a true conceptual leap and was presented at mother of all demos in 1968), getting to gmail is just application of capital.

Tyler Cowen’s ebook single, The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History,Got Sick, and Will (Eventually) Feel Better just came out. I read it and here I some thoughts

1. I love the format. Much better than the traditional way of handling these books, which is to add filler text to make them 150 pages long, then print them in large type with a few illustrations and finally sell them for $15.99. I also see this text as an essay, which is geared at pushing one idea and starting a discussion rather than trying to be the final word on the matter.

2. I applaud Tyler for just confronting the GDP/wage stagnation data face on. Too many free-market economists just deny the data (you can point out its many flaws, but still accept that there is signal there). The signs of stagnation in GDP growth wages are there and need to be addressed (the other free-market economist who has done the same is Scott Sumner who points out that, yes, after the 1970s, everybody had slower growth, but relatively speaking the free-market countries still did much better).

3. The main thesis is that this is a real phenomenon: the US has grown more slowly since around 1970. This is because previous growth was support by low hanging fruit such as free land, small government, and scientific progress that ran out without being replaced. Over the last few decades, the only real new thing has been the internet.

4. Let me comment on the internet. It is the exception that Tyler gives to his general thesis. I respectfully disagree. There are very few things on the internet that are new. Most of them are simpler, more colourful, versions of functionality that existed in the 1980s or even before. Blogs were part of the original idea for the web (which was inspired in pre-existing systems). Instant messaging, email, discussion groups, all of those have always been with us. The one exception might be wikipedia (the precedents are the 1945 description of it by V. Bush and open-source software [early 1980s], but I still think that no one was predicting it would work so well if anyone could edit). What feature does today’s internet have that was not present in 1980s internal university Unix systems (which were used by many internet “innovators”)?

5. A few weeks ago, I read another book, Coders at Work, which has a long interview with Bernie Cosell. He describes a system at a hospital in Boston where doctors and nurses use electronic prescriptions and medical records so that every time a patient walks into another part of the hospital the data is already there (your doctor prescribes an exam, you just go to the exam room and they already know what you’re coming for). Compared to the top university hospital I have the most interaction with (UPMC, here in Pittsburgh), where everything is still on paper and you need to check in everytime you cross a hallway and talk to several different people, this sounds like a marvel of efficiency. The amazing part is that this was the job that B. Cosell had before he went on to develop the first internet routers. This was a live, running, system in the early 1960s! There are other examples of regression (rail service in the US is another good example: it doesn’t run nearly as fast as it did 100 years ago—the US does not need 2011 trains as much as 1911 ones).

6. Interestingly, much of the thesis of Great Stagnation is contradicted by another of T. Cowen’s books, Create Your Own Economy. In it, Tyler had glorified the non-measured wealth of variety and small intelectual pleasures.

7. The discussion of the current crisis I felt as the weakest part of the book. I think it commits from the Junker Fallacy when it argues that too many resources were diverted to finance (maybe a few people would have been better employed doing something else, but you cannot measure it by dollars). It is fine to disregard this whole discussion as it is ancillary to the main argument of the book. The crisis is still too recent for anyone to be able to say where it fits with more secular trends.

8. As a scientist, I support the call to give more status to scientists.

One of the most widely reproduced results in psychology is that replacing an internal motivation by an external one may lead to perverse results. For example, if you pay young kids (probably in candy rather than money) to do their homework, they end up less interested in school.

I feel something analogous happened in the Euro zone with the 3% rule. That was the rule that said that euro states needed to keep their budget deficit below 3% (another rule said that overall debt should be below 60% of GDP).

A weak rule with weak incentives (if you don’t do your homework, we won’t let you watch your favourite TV show) can mask a strong incentive: if you don’t do your homework, you’ll fail in school and that will destroy a lot of your life prospects.

Or, for Euro states, if you let debt get out of control, you will get a nasty letter from the European Commission. This is the weak incentive: a bit of public humiliation which you can even turn to your advantage by tugging at populist nationalism (“how dare some Brussels bureaucrat tell the great nation of Brokeistan that they are spending too much?”). However, there is a real incentive too: if your debt gets out of hand, you won’t be able to get a loan from private markets any more.

*

During the last 10 or 15 years, even the fiscal conservatives in Portugal argued that the debt should be kept under control because otherwise the European Commission might be upset and Portugal was under treaty obligations to comply with this rule. Wishing to fulfil treaty obligations is a noble sentiment, but I used to stare in disbelief at the television that this was the best that fiscal conservatives came up with. Never mentioning that a real debt crisis could eventually happen, their arguments were much weaker than they needed to be and were consistently undercut by

(1) appeals to national pride, even outright jingoism,
(2) the fact that the penalties, when they came, were really very weak (the minutes of a meeting in Brussels, mention your country negatively in page 47), and
(3) the fact that other countries also broke treaty rules.

Finally, it legitimised all of the budget games that masked the problem. Portugal never engaged in the illegal manipulation that Greece performed, but successive governments used legal loop-holes to rename debt to something else. Of course, these accounting schemes do not change the underlying situation; but if the game is to keep the European Commission happy, it all seemed fair as long as it was legal.

*

Even after the Greek crisis, some people were still writing as if it was all about getting the European Commission’s approval! Some people are still operating under a faulty mental model where this is a fight between EU factions. It is still an unlikely path, but not an absurd one, that this might lead to a real confrontation if there is an enterprising politician, particularly in a larger country like Spain, who picks up the anti-free-trade, anti-foreigner, anti-market, anti-German, (anti-Jewish,) platform.

The more likely path, is still a muddling through, with a lot of anger that comes from cognitive dissonance as people think (and vote) under a mental model where the problem is not that nobody is willing to lend Portugal any money at modest interest rates, but that somehow big countries are using their political power to get away with something (breaking the 3% rule) that small countries cannot do.

*

(There is a more serious, informed, argument about how the interest rates favoured by the Northern countries and the Southern countries differ and how the ECB is more responsive to the Northern views. This is not what I am writing about.)

Tyler Cowen tries to explain France. The question (from a reader) is the following:

By which I mean this: relying solely on prejudice and snippets of information, it would seem to me that France should be an economic backwater. The rate of taxation, cost of labor, early pension age, large public sector, high welfare payments, etc., none of this suggests a highly dynamic and performative economy fit for the 21st century.

While I normally appreciate Tyler Cowen’s ability to see beyond the confines of the US, I do not think his answers are very on point this time. So let me try:

1. The assumption seems to be that France is sort of the anti-US. But France is more similar to the US than either is to Congo, or Bolivia, or, for that matter, Greece. I could talk about their similar cultural vices (the insularity, the political correctness, &c), but even on the matter of economics, the differences are not that large. The French never had a single payer health care system, for example.

2. More importantly, the differences were historically even smaller. You could probably argue that for 30 years after the war, American policies were often to the left of French policies. In France, the discourse is dominated by the Left and the extreme-Left is fashionable. However, they have only have had one president after the second world war which identified himself as a (in American terms) liberal: F. Mitterrand. Yes, the French Rightwing is economically more statist than Obama, but definitely less so than Nixon was. It is note-worthy that Mitterrand was elected at the same time as Reagan and Thatcher.

4. The French are very patriotic. Sometimes, it renders them laughable, but often serves them well, in particular in the civil service. I don’t know if the civil servant ethos is stable to the modern pressures (where the pay is lower than the private sector and the prestige is not so great anymore), but it sill survives to a large extent. The same is true in most of the US too—American public services are not that as bad as people imagine them.

3. The most egregious anti-market actions in France are the labour laws. Not surprisingly, their labour market is where things are the worst: unemployment, especially of the young and unqualified, is a major social issue. After all, a good, hip designer or marketer will certainly not be affected by the ridiculously high minimum wage and other such obstacles. So businesses that depend on cool, hip designers or savy marketing do well.

5. A note on the educational system. It is a bizarre mix of extreme competition at the top and a mediocre egalitarianism for everyone else. It is very good at giving the elites an excellent education in a competitive environment. The grands écoles (Ivy League equivalent) are the most well known example. But even before that pupils are ranked by academic merit from a young age. At least, until very recently (the 90s), it was still the case that pupils would be often seated in order of GPA. No egalitarianism here (just imagine what the American left would cry if you suggested something like this).

6. In fact, France is not a very egalitarian society at all. Germany and the Nordic countries are much more egalitarian. So are some regions of the US.

The answer to the readers question is that most of the confusion was in his head: if he can explain how high-tax, high regulation New York City is so rich, then France will be easy.

The US government is dependent on the Chinese central bank for credit. Without the support of China, interest rates on US Treasury would be much higher than they are now. Also, the Chinese government, if it were to start dumping its bonds on the markets, could make it as difficult as it wanted for the US government to continue borrowing. Put it another way, the Chinese government has veto power over most US government spending (unless Congress were to clean up its act, of course, but that would take things like health care reform out of the picture for the next few years).

Until recently, it was always argued that the Chinese central bank would never abuse its position vis a vis the US because a US fiscal crisis would become a US economic crisis and that would hurt China through its export dependency. Mutual Assured Economic Destruction.

It turns out that China has, to a larger extent than previously appreciated, decoupled from the US. It’s not so export-dependent. A crisis can be pretty nasty in the US while China chugs along. So, MAED is not true. China could probably punish the US much more than it hurts itself.

I guess that people in Washington and Beijing have already started taking this into account in China-US relationships, but I haven’t seen it mentioned in public too often.

Bond Holder was walking down the street when he was approached by a strange fellow.

“Give me your wallet” the fellow said.

“No” said the Bond Holder.

“Alright, I’m going to be reasonable. Give me half.”

And still the Bond Holder refused.

He was being unreasonable. After all, the other stake holder in the conversation had already compromised and was willing to take only half of what he had asked for in the beginning (a mighty sacrifice, you must agree).

Besides, the Bond Holder might not really deserve the money. Maybe he cheats on his wife. Maybe he serves over cooked pasta to guests. Who knows what sins he committed in the past.

Entries Tagged 'Economics' ↓

What’s Wrong With Portugal?

Medicaid Cuts

Where will all the jobs come from?

Who could have predicted it?

Battle of the Pauls: Samuelson vs. Romer

Review of The Great Stagnation

The Euro, the 3% Rule, and the Internal/External Incentive Effects

On France

End of MAED (Mutually Assured Economic Destruction)

Parable of the Bond-holders

Search

Archives

Recent Comments

Blogroll

@luispedrocoelho on twitter

About Me

Unknown Feed