Wednesday, 17 September 2014

Mechanisms for economic gains from independence #4

#4 Mean Reversion

This mechanism's perhaps a bit unfair since, if it's true, then it applies to both independence and union. If it's not true though, then conclusion must be that we expect gains from independence. In either case, the economic outlook is brighter than often painted.

In A conversation on the economics of independence, I suggested that there must be an institutional reason for the regions of the UK excluding London and its environs occupying all of the poorest places in the ranking of northern European regions which had never been communist. This contention was made because I could think of no structural or fundamental reason for these UK regions to be so disadvantaged. If this contention is correct then we should expect institutional change, such as independence, to be accompanied by economic gains.

However, there is another possibility: luck. Perhaps the regions of the UK excluding London and its environs have experienced an unfortunate series of bad outcomes. If this is the case, then we should not expect this run of bad luck to continue, and these UK regions should "revert to the mean".

Certainly Scotland's experience over the past century has been particularly poor in a European context. This can be most clearly seen from population statistics. As I discuss in Population Records, "whether economic success determines relative demographics or vice versa, these statistics clearly co-vary and looking at the outcome of relative migration can tell us about the outcome of relative economic performance. Over the 20th century, Scotland did terribly on net migration and population growth."

If this was bad luck, then we should expect to do better over 21st century because of simple mean reversion. If this was due to institutional features, then we should expect to do better by changing institutions.

Mechanisms for economic gains from independence #3

#3 Spillovers from statehood and location of central government

My own favourite mechanism for possible economic benefits from independence (relative to being a peripheral region of a larger country) is the positive externalities that may accompany the very fact of statehood.

As soon as a region is a country, international companies treat it differently. Many need to base at least a small office, with at least some local autonomy, to ensure legal compliance and appropriate marketing. The direct economic effects of this are that these international companies incur extra costs, and the new small country experiences extra private demand and public revenues from this local employment. These direct effects are likely negative in the aggregate (the company has incurred extra costs), but are likely positive within the new small country.

As soon as a region is a country, it both sends out and receives diplomatic staff. On the assumption that it sends out as many as it receives, the direct economic effects of this are zero: the government is paying salaries to the diplomatic staff that it sends out into the world, and roughly this amount extra of private demand is added to the local economy from the diplomatic staff that it receives from the rest of the world.

As soon as a region is a country, the status and responsibility of government officials and civil servants is enhanced. The Institute for Government's Robyn Munro reports in the LSE's British Politics and Policy blog that "In the event of independence the Scottish civil service would ... require ... a rebalancing of the grades and experience levels of its employees. ... UK department staff based in Scotland are drawn disproportionately from the lower grades (AA, AO and EO), with few senior civil servants." Under the assumption that fixed costs in public good provision are neglible (*), and the further assumption that the current bill paid by Scottish taxpayers funds current civil servant employment in Scotland, then on independence with the same level of public good provision, Scotland would need fewer civil servants overall, but more at senior grades. The direct economic effect of this is zero: the same government expenditures and the same private spending power.

These three changes provide no great direct overall economic boost or cost to the new small independent country. However, they are associated with indirect economic effects which should be beneficial:

# Firstly, the local offices of international companies are a source of informational feedback: local demand is more fully understood, and the company is more likely to have the capacity to respond to this information.

# Secondly, as a junior civil servant, interaction with senior colleagues within the same building rather than them being 600 miles away in London is likely to boost human capital accumulation.

# Thirdly, growing companies need to discuss their business with government - particularly with senior people who have the authority to effect any changes needed. Being able to have these discussions in Scotland means that these companies, as they grow, are more likely to stay in Scotland. If they have to go to London every time they need to have a meeting, they might as well base themselves in London. Further, growing companies need the full range of business support services. Government procurement by an independent state on advertising, legal services, research and analysis etc mean that these services are much more likely to be available locally. Gordon Young, the publisher of The Drum, describes this business ecology effect well in relation to the marketing industry.

# Fourthly, these three changes, as well as the increased propensity for growing companies to stay in Scotland, provides visible job opportunities at senior and high status grades. This is likely to mean that school levers and graduates in Scotland are less likely to automatically assume that London is the place to go for a high status career, and it is likely to provide the pull for increased high ability immigration. Many high status roles, leads to many high ability candidates applying for roles, which increases the chances, for a firm to find an appropriate hire, which lowers the costs of doing business. This is the beneficial effect of "thick markets". In peripheral regions with no autonomy, we find truncated talent distributions (because the talent leaves) which makes them unproductive and therefore unattractive to talent. To break this cycle you need to provide opportunities for talent.

(*) Deaner & Phillips (2013) [Section 5.1 ‘Spending by service area – how might it change?’ on page 62 and 63] do not find any evidence of scale economies when looking across Europe at the costs of providing public services in countries of different sizes.

Tuesday, 16 September 2014

Mechanisms for economic gains from independence #2

#2 Smaller is less risky and more robust, with lower costs from complexity:

From Nassim Taleb

Small is beautiful and more robust.

Most journalists are trapped in verbalistic concepts devoid of logical/empirical clarity, & are to be taken in reverse. A New York Times article claims: "big countries tend to be more resilient to shocks.", which is pure BS. 

Just look around: Singapore, Denmark, Norway, Switzerland, Dubai, compared to their neighbors. Focus on otherwise same ethnicity (Cyprus vs Greece, Lebanon vs Syria). Things are a bit more complex: it is the decision-making unit which would put federations like Germany and the US in the same group).

Articles, by people affilitated with the Extreme Risk Institute, on SIZE (by yours truly): mathematical derivation of the statement that small is MORE resilient of SILENT RISK:

Note that for small state to do well, all we need is a "pax" of an Empire, "pax Romana", "pax Ottomana", etc. Which we have with EU, US, Nato, etc.

Mechanisms for economic gains from independence #1

#1 Animal spirits:

Quoting Andrew Wilson in conversation with Derek Bateman

Scotland changes with independence. We become more focused on getting the economy motoring so that we can create the society we want. I think as responsibility increases, the economic imperative grows.

All of the fundamentals are great for Scotland. We vote with more money, more resource, more information,and more of  a platform of existing government institutions [than the other 142 countries since WWII that have become independent]. There is no country taking this choice with more going for it. People need fear nothing. Are we up to it as individuals? Do we want to lie down and sleepwalk through life or are we willing to get out of bed and give it a go? And we know in life that if you let life happen to you then you don't succeed and you don't reach your full potential. If you just set a goal for yourself and go for it, all things are possible. It's called belief.

Thursday, 11 September 2014

A conversation, between economists, on the economics of independence

Surely there are solid arguments for negative effects from being a small country relative to being a large country? Economies of scale, the existence of border effects, liquidity premia, and so on?

Yes. Economic theory has proposed many plausible mechanisms that mean that large size should be associated with greater productivity and greater wealth. Further, when attempts are made to estimate the size of these effects, they turn out to be not insignificant. For example, see my own work which suggests that if the only change on Scottish independence were that it traded with the rest of the UK in the way that Ireland seems to trade with the UK, then this should be associated with a 5.5% fall in Scottish GDP.

However, these effects apply to all countries, not just Scotland, and if this were all that was going on then we should expect to see larger countries richer than smaller countries. As shown by Rose (2006), the economic literature on this generally finds no effect of size on growth or level of income (some papers even find a negative correlation e.g. Alouini & Hubert (2010)). This null result can be explained by supposing that there are non-GDP benefits of independence and richer and more productive regions, which can afford the trade-off, choose independence. This selection effect would mask the true relationship between size and GDP.

This selection effect however does not convince me. Given the persistence of national borders, then the randomising effect of technological change on productivity of different regions over time should mean that a small productive region which made the choice to be independent several hundred years ago is expected to be no more or less productive than another region that was poor several hundred years ago and made the choice to remain as part of a large country. Given random productivities, the benefits of size should be visible. They are not.

This either means that the benefits of size are wrong (I don't believe this) or that there are countervailing effects. Perhaps small countries are better run or function at a more appropriate scale (convex costs of complexity?). Perhaps there are spillover benefits to running a country rather than being a peripheral region of a larger country like the ability to attract talent (high status government employment, and many international firms want at least a small office presence in your region) which leads to a more diverse business ecology, which involves the provision of the full range of support services that new and growing businesses require.

In any case, if the correlation between size and income is approximately zero, then it suggests that the (GDP-related) costs and benefits of size roughly cancel out. This does not, itself, provide a case for independence or for union. It just suggests that if we value independence for other, non-GDP reasons, then there does not appear be any significant GDP cost/benefit to pay/gain in general. Of course, there may be issues specific to Scotland and the UK could lead to the expectation of GDP costs or benefits of independence.

If there is no relationship between country size and long run growth/wealth then surely this is bad for independence, given transition costs?

Usually, yes. But Scotland already has most of the infrastructure of a state. HMT's estimates of the transition costs were rubbished by the author whose research they relied upon. In any case, even if HMT's figures were appropriate, this is a one off cost which should be met by extra government borrowing and amortised over a very long period. If we, extremely pessimistically, assume £3bn cost at 5% borrowing rate, then this is an annual cost of £150m or 0.1% of GDP. This is not a big issue.

Lumping lots of disparate countries together produces this zero correlation between size and income. Would it not be more valid to consider subsets of reasonably similar polities? For example biggest is richest for Spanish-speaking Latin American countries (excluding Puerto Rico which is really part of the United States). And for English-speaking countries, the largest, the USA, stands out as the richest, in spite of the fact that it does not appear to have better institutions or national endowments per capita than Canada, Australia or New Zealand.

Interesting points. I'm glad you thought of making comparisons across countries which, other than size, have some similarities. I contend that a suitable comparison group for looking Scotland and the UK is the EU members of northern Europe which have never been communist. For these 11 countries (Ireland, UK, France, Belgium, Luxembourg, Netherlands, Germany, Austria, Denmark, Sweden, & Finland), there is a significantly negative correlation between size and income. Set against the Spanish speaking Latin American countries, or the worldwide English speaking countries, this isn't something that nails the argument - but it does show that your other two examples certainly don't nail the argument either.

More interestingly, looking at these countries allows us to make a specific point about Scotland and the UK rather than considering only the general size of countries issue. Eurostat has data that divides these countries up into 48 "NUTS1 regions" (*). These are shown in the graph below. I know of no reason to expect that 7 of the 12 UK regions should occupy the bottom 7 places in the ranking, with 11 of the 12 in the bottom half. The UK is not less fertile, it is not landlocked, nor is it lacking in natural resources (indeed it has the largest oil and gas reserves of any of these 11 countries). I contend that this is indicative of institutional problems in how the UK is run: perhaps to the benefit of London which is one of the richest regions in Europe, despite the poverty of the rest of the UK (indeed, the UK has the highest regional inequality in Europe). Are we to believe that it's luck that all the poorest regions are in the UK? Ireland had income per head of 70% of UK average when it gained independence in 1922, now it is in the top half of this ranking and would be the UK's second richest region if still in the UK. Escaping whatever causes the outcomes shown in this graph provides a clear expectation that Scotland can gain - in GDP terms - from independence. This is of course in addition to the non GDP benefits like electing political parties more closely aligned with preferences of the Scottish electorate.

(*) All NUTS1 regions of these 11 countries excluding 1 region from France: French overseas territories - not in northern Europe; and 6 regions from Germany: the East German Länder - formerly communist.

Sunday, 31 August 2014

End August Links

# Chris Dillow's Repressive Diversity makes the point that it is possible that as 'opinion-former talent' is drawn from more disparate sources (variable cultures, ethnicity, genders, and sexuality), the opinions of these opinion formers may become more homogeneous. This sounds possible to me: if you don't share some strong cultural bond with the person you're about to hire, then you're more likely to select on intellectual conformity. This contrasts with points made by Lesley Riddoch in her book, Blossom: "The exclusion of women doesn't just narrow the pool of talent available to play the existing game - it excludes the most likely game changers" - and again it's certainly true that variation in life experience will lead to variation in opinion. So there're two mechanisms going on here, one which represses and one which promotes diversity of opinions as the diversity of the talent pool rises. It would be interesting to know which mechanism is dominant.

# This series on welfare economics from Interfluidity was great. From the 5th in the series:
"You might, think, then, that I’d advocate abandoning those diagrams entirely. I don’t. All I want is a set of caveats added. The diagrams are redeemable if we assume that all individuals have similar wealth, that they share the similar indirect utility with respect to wealth while their detailed consumption preferences might differ, and the value of the goods being transacted is small relative to the size of market participants’ overall budget. Under these assumptions (and only under these assumptions), if we interpret indirect utilities as summable welfare functions, consumer and producer surplus become (approximately) commensurable across individuals, and the usual Econ 101 catechism holds. Students should learn that the economics they are taught is a special case — the economics of a middle class society. They should understand that an equitable distribution is prerequisite to the version of capitalism they are learning, that the conclusions and intuitions they develop become dangerously unreliable as the dispersion of wealth and income increases."

# Simon Jenkins in the Guardian says that Northern cities need more than 'powerhouse' rhetoric: "... lively group of local executives.... Their obsession was simple, how to stop their brighter employees, not to mention their own children, vanishing to the bright lights of London. Their problem was not industry, it was image.... An English provincial revival will never lie in pre-election promises of half-hearted localism. The wealth and subsidy gap between London and the rest is now ludicrous and impossible to defend. The cliche, implied again by Miliband today, that the provinces make widgets while London makes money, will not close it.... These places must acquire some of the glamour that is attached to York, Oxford, Winchester and Brighton, cultural magnets for young and old. Cities must fizz or die. That means big government should move itself out of town. Big art should disperse if it wants subsidy. Big media should become geographically pluralist."

Sir Harry Burns says Yes vote could be 'positive' for health - but how do I put that in an economic model!!

Dinner with No Voters or “What I wanted to say before the Pudding hit the fan” - this is the best description of the politics of independence that I've seen

# This is maybe an issue which doesn't translate well across the Atlantic: How The Public Funding Of Elections Increases Candidate Polarization at Marginal Revolution. Tyler Cowan seems to be suggesting that proponents of public funding of political parties say that it would reduce the political distance between the parties, and that this is a good thing (divergence causing gridlock in American politics). Whereas the evidence seems to show that public funding increases the polarisation, and so public funding is a bad thing. My British view of this is that the evidence is unsurprising - I'd expect it to promote polarisation - and that therefore public funding is likely to be a good thing if it means that the two main parties who fight it out (in England) don't attempt to occupy the same ideological ground.

# Interesting: A marriage made in hell: Housing and foreign demand

# I have a mention in Full Fact's article on Scotland’s international trade under independence

# I entirely agree with de Zeeuw & van der Ploeg, Climate tipping requires precautionary accumulation of capital and an additional price for carbon emissions, but in the context of this I do get a bit annoyed that no-one would publish my A Balance of Questions: what can we ask of climate change economics? paper!

# A great simple description by Noah Smith, Chris House on stimulus spending, of why it is highly likely that increased government investment is a better form of fiscal stimulus than tax cuts.

# Also from Noah Smith, a description of two papers, RBC models we can believe in, in which network effects and a complex economy, mean that local idiosyncratic shocks combine to produce aggregate fluctuations (rather than cancelling in a law of large numbers type way). My interest is not so much on how complexity underlies the business cycle, but rather the impact such complexity has on issues of optimal size and scale. However, these papers do sound like something I should know about.

# Paul Cairney, from a completely different perspective, also discusses complexity: Scottish Independence: Will Anything Really Change? In particular, this is about the tension between the "inescapable trade-off between a desire to harmonise national policies and to encourage local discretion."

# Paul Krugman reports that "Vox has a great explanation of the Roman Empire in 40 maps". Like Krugman, I love this sort of stuff.

Citizens are happier in countries where the government intervenes more frequently in the economy

38 maps that explain the global economy

Friday, 22 August 2014

"Borders" Workshop materials

The SIRE ‘Country Size and Border Effects in a Globalised World’ workshop keynote speaker presentations are available:

Keynote Lecture 1: JAMES E. ANDERSON (Boston College) – "Border Effects: Canada-US Lessons"

Keynote Lecture 2: ENRICO SPOLAORE (Tufts University) – “The Political Economy of National Borders”