End March Links

# Green Keynesianism, de-siloed

# Joachim Voth provides an interesting example of how technology and incentives can combine to lower economic output and growth: Click here

# Fantastic post by Chris Dillow in defence of property taxes

# I love this argument by example (ultimately in favour of NGDP targeting): Restaurants will pass on costs by going out of business, or Why macroeconomics matters in real life

# Interfluidity has a great series of posts (dating from way back) about what's both right and wrong with financial services. The idea is basically that complexity in finance is a way to convince investors that they are not on the hook for losses from aggregate (as opposed to idiosyncratic) shocks. There are spillovers from investment that are realised by society so we are all better off if this investment is made, but individually, none of us would contribute to this investment project if we knew the risks. The classic example of societal benefits and investor losses is the 19th century development of the railways. Complexity in finance therefore has aggregate benefits and serves a legitimate purpose. However it also provides cover for rent seeking and theft, and so the regulatory balance has to be stuck that allows this investment to occur but minimises the theft. Complexity in this light is a feature and not a bug since only with complexity will we be convinced as potential investors that we will not be on the hook: "finance as placebo. Financial systems are sugar pills by which we collectively embolden ourselves to bear economic risk. As with any good placebo, we must never understand that it is just a bit of sugar. We must believe the concoction we are taking to be the product of brilliant science, the details of which we could never understand."
It's a fascinating thesis:
   - "Opacity creates a very serious technical problem: as we allow finance to be opaque and complex, it may become difficult to police and impose good incentives. So we may, as a society, face an unpleasant tradeoff. Tolerating more opacity may help mobilize capital for useful purposes, but any benefit may be offset by a diminishment of our capacity to regulate and police. At one extreme of opacity, financial intermediaries simply steal everybody else’s wealth. That’s no good. At the other extreme, if we insist on perfect transparency (without big changes in how we organize our affairs), the result will be extreme underinvestment. Which is no good either."
   - "On capital allocation, status quo finance could do better and could do worse. Let’s call it a glass half full. But on systematic risk allocation, I think it unquestionable that status quo finance is completely terrible. When losses cease to be occasional, all that ex ante tranching turns out to be little more than prelude to continuing conflict, “tranche warfare”. In the recent crisis, the behavior of mortgage servicers — agents of banks working to avoid existentially threatening loss allocations — has been entirely perverse with respect to ex ante expectations that they would serve as agents of investors. Throughout the financial system, intermediaries and their erstwhile “clients” continue to struggle over who will bear costs. More broadly, the financial system, including its public and private elements, has by and large protected the nominal and real value of opaque “low risk” investments by shifting costs to the marginally employed (who relieve pressure on the price level by becoming unemployed) and to taxpayers (including people who hold few financial claims and those who are outright in debt). In other words, it is clear ex post that the risk of the aggregate portfolio has been borne by those who were least able to bear it (a circumstance that is unfortunately correlated with political weakness). In my view, there is no reasonable case that status quo finance did a remotely good job of allocating systemic risk to those best able to bear it in the recent crisis. And this shifting of costs to diffuse taxpayers and the marginally employed is hardly unusual. As allocators of systematic risk, opaque financial systems are very much worse than sugar pills. Opacity serves to delay and obscure conflicts, which are almost always resolved in favor of the powerful and at the expense of the weak. Status quo financial systems certainly do help us manage our idiosyncratic risks. And you can sum up the benefit of this insurance against idiosyncratic risks to argue they improve our aggregate welfare by some amount. But from a systematic perspective their main contribution is that they persuade us not to hold our wealth as canned goods and ammo. They embolden us to jump."

# An interest of mine, written about by Noah Smith: The end of growth wouldn't be the end of capitalism

  

Independence & my PhD

I finally submitted my PhD last week. I've posted links to two of the chapters before:
# A balance of questions: what can we ask of climate change economics?
# The interaction of scale economies and energy quality
and the third chapter is now available too:
# Measuring costs and benefits of independence.

This is a joint paper with my Catalan co-author, Professor Sevi Rodriguez Mora, and the country/region/entity (all loaded terms in this debate) we analyse is Catalonia. In this paper we model Catalonian independence by assuming its apparent economic integration, and trade links, with the rest of Spain, become like those of Portugal with Spain. This is done in a model in which trade is good, and so a reduction in trade is costly, in order to generate one specific cost of independence. This cost is set against the fiscal transfer that Catalonia pays to the rest of Spain, and we can compare.

Sevi has publicised this work in Catalonia and in Spain: Portugal, Spain & Catalonia: friends for life [which then provoked a response from Havard economist Pol Antras: The nasty (but erroneous) arithmetic of independence to which Sevi again responded: The unpleasant independence logic]. All interesting stuff (so long as you can bear google translate), and it's easy for me to be an impartial academic: it's not my country. I do want to extend my research to Scotland though, and I plan to discuss this in several posts following this one, which introduces this research agenda.

I have said in the past, and Prof John Kay said pretty much the same on Good Morning Scotland on 9th March, that the short run position for Scotland is basically neutral (oil revenues essentially pay for the larger public sector and lower, non-oil, tax base) and so the interesting questions are to do with the long run. The Catalonia paper outlines A cost (and in Catalonia's case, A benefit), of independence. I believe that there are gains from trade, and we can see in the data that trade between locations within a nation state is higher than trade between locations in independent countries. Therefore, I do think that our work captures an important mechanism: any frictions that cause the UK single market to become less open will be associated with productivity falls. I am happy to proclaim that this is a cost associated with independence.

The model we use is not capable of generating any benefits of independence (other than fiscal transfers which, whilst significant for Catalonia, or not significant [in the short run] for Scotland). Taken to its logical conclusion, using trade models to study optimal economic integration would lead us to recommend one world government, since there can only be economic costs associated with less than full integration. There are some issues (climate change springs to mind) for which one world government is appropriate, but I do not believe (and apparently many vociferous opponents of Scottish independence also do not believe) that a single world polity is the appropriate model for general governance. Given this, what is the optimal scale of government and the optimal size of countries?

This is a general question, and to apply to a specific case like the question before us in the 2014 referendum will involve heavy qualification, but both the general question and its specific application to Scotland are fascinating. I have in the past signed the Yes Scotland Declaration and I'm instinctively sympathetic to the Yes campaign - but for political rather that economic reasons (*). The research question is an economic one: do we have any reason to believe that an independent Scotland would lead to improved factor allocations, improved factor accumulation or improved aggregate output, relative to a Scotland governed within the UK framework? The first mechanism considered, trade impacts, suggests (and provides a framework to quantify) a negative contribution to output. I will outline other mechanisms for research in follow up posts.

Finally, I'd like to link to this post from Robin Hansen: Ask Questions that Matter on academic research. Hopefully I'm asking a question that I want to know the answer to rather than a question with an answer that I want to promote. I want to define my "focus in terms of a question, rather than an answer, and ... bother to think about what questions actually matter."

(*) Read "distribution of income" rather than "level of income".

End February Links

# The "Nation's Finances" - this annoys me too.
# Is it cos wur Scots
# More on long term slow growth or stagnation from Acemoglu & Robinson: The end of low hanging fruit, and a response from Tyler Cowan. This article is related, and brilliant: Be afraid, very afraid, of the tech crisis, and this has some great charts: Is economic growth really ending?
# Discussion of helicopter money: Simon Wren-Lewis, Martin Wolf, Chris Dillow and Macroeconomic Resilience. I do not accept the helicopter money is equivalent to money financed fiscal expansion, as a matter of definition. Money financed fiscal expansion sounds good: we're in a depression so let's print money and use it for low carbon infrastructure investment. Great, I'm all for it. But that's not helicopter money. Helicopter money is more akin to money financed tax give-aways: print some money and give to the government, who can then cut taxes by an equivalent amount. But unless it's lump sum taxes that are cut (and we don't have any of those to cut) then distributional issues make helicopter money different. Helicopter money, at least as far as it's defined in my head, is money printing which is distributed on a per capita basis. This is much better than money printing that is used to fund an income tax holiday, which necessarily gives more to those on high incomes.
# I really like this back of the fag packet macro plan that solves all society's problems 
# I'd love to spend the time to get into heterodox macro (e.g. Robert Vienneau and Steve Keen), and pin down exactly what I agree and disgree with. I won't have this time in the near future but meanwhile I can fully understand what Noah Smith says, I instinctively agree with it (as a naive criticism of the potential for forecasting using e.g. Steve Keen's Minsky model), and I record this link as something useful to maybe come back to: Is the business cycle a cycle?
# Andy Wightman's submission in support of LVT to replace business rates quotes extensively from `Mirrlees Review' of taxation. The January 2013 issue of the Royal Economic Society newsletter (these newsletters only appear to be available online with a huge timelag) also discusses this review. Whilst the RES discussion is perfectly interesting, they don't focus on the LVT recommendations at all, which kind of makes the point from the review that Andy highlights: "The economic case for a land value tax is simple, and almost undeniable. Why, then, do we not have one already? Why, indeed, is the possibility of such a tax barely part of the mainstream political debate, with proponents considered marginal and unconventional?"
# The final verdict on George Osborne as Chancellor