global economy

The New York Times: World Hunger, The Problem Left Behind

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This article originally appeared in The New York Times

The drought-induced run-up in corn prices is a reminder that we’re nowhere near solving the problem of feeding the world. The price surge, the third major international food price spike in the last five years, casts more doubt on the assumption that widespread economic development leads to corresponding gains in agriculture.

The green revolution has slowed since the early 1990s, and it has become harder to bolster crop yields, as I have discussed in my book, “An Economist Gets Lunch.” And recent research by Dani Rodrik, a professorof international political economy at Harvard, indicates that agricultural productivity improvements are among the hardest to transmit from one nation to another.

For all its importance to human well-being, agriculture seems to be one of the lagging economic sectors of the last two decades. That means the problem of hunger is flaring up again, as the World Bank and several United Nations agencies have recently warned.

Consider Africa, which is often considered to have turned a corner and to be headed toward steady growth. The expansion of the African middle class and the decline in child mortality rates are both quite real, but the advances have not been balanced — and agriculture lags behind.

In a recent address, Michael Lipton, an economist and research professor at Sussex University in Britain, offered a sobering look at Africa’s agricultural productivity. He suggests that Rwanda and Ghana are gaining, but that most of the continent is not. Production and calorie intake per capita don’t seem to be higher today than they were in the early 1960s. It remains an issue how Africa’s growing population will be fed.

One huge problem is that the price of fertilizer in Africa is often two to four times the world price. Yet African soil and rainfall make much of the continent subpar for growing food. In other words, the region that probably needs fertilizer the most also has to pay the most for it, and much of Africa doesn’t have the prosperity to make this an easy stretch. The high prices result in large part from infrastructure and trade networks that aren’t developed enough to create a low-cost and competitive market. And the problem could worsen if economic troubles in China distract it from its beneficial investments in African roads and harbors.

On top of all that, many African nations have unhelpful policies toward agriculture. Malawi, for instance, subjects corn to periodic export and import restrictions as well as to price controls, all of which thwart development of a well-functioning market. When market speculators save corn in anticipation of greater scarcity, they may be punished by law. These restrictions of market incentives exacerbate the basic supply problems.

Such bottlenecks are a challenge for the future of the African economies. For comparison, the rapid expansions of economic growth in Japan, South Korea, and Taiwan were all preceded by significant progress in agricultural productivity. In these countries, higher yields created a domestic surplus for savings and investment, encouraged small-scale entrepreneurship, fostered a sense of economic security and helped the middle class expand.

In contrast, much of Africa’s growth has come from resource wealth — such as oil, diamonds, gold and strategic minerals — and, unfortunately, resource prices are notoriously volatile. Resource wealth is less well-suited to supporting sustainable democracies, because it tends to be connected with state-backed privileges and other legally entrenched entities. The Norwegian government manages its oil wealth just fine, for example, but autocracies and fledgling democracies are more likely to be corrupted.

There is no shortage of writing — often from a locavore point of view — in support of more organic methods of farming, for both developed and developing countries. These opinions recognize that current farming methods bring serious environmental problems involving water supplies, fertilizer runoff and energy use. Yet organic farming typically involves smaller yields — 5 to 34 percent lower, as estimated in a recent studyin the journal Nature, depending on the crop and the context. For all the virtues of organic approaches, it’s hard to see how global food problems can be solved by starting with a cut in yields. Claims in this area are often based on wishful thinking rather than a hard-nosed sense of what’s practical.

WHAT to do? First, put food problems higher on the agenda. In the United States, there is no general consciousness of the precarious state of global agriculture. Even in the economics profession, the field of agricultural economics is often viewed as secondary in status.

Second, the United States government should stop subsidizing its own corn-based biofuels, mainly ethanol. Today, about 40 percent of America’s field corn goes into biofuels, thanks to a subsidy and regulatory policy dating from 2005. With virtual unanimity, experts condemn these subsidies as driving up food prices, damaging land use and costing the taxpayers money. Once the energy costs of producing the biofuels are taken into account, it doesn’t even appear that this policy helps slow climate change. It has become a form of crony capitalism, at great global expense.

Today, we have two presidential candidates who both look a bit short on grand vision and transformational change. Perhaps they could look to helping solve the food problem — and making a big dent in global hunger — as America’s next beneficial legacy.

The world is not yet in that happy situation where “what’s for dinner?” is a boring question.

The Globe and Mail: The World According to Tyler Cowen

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This article originally appeared in The Globe and Mail

He’s not as famous as Nouriel Roubini and has far fewer Twitter followers (roughly 23,000 versus 194,000 for Dr. Doom). And he hasn’t, like New York Times columnist Paul Krugman, won a Nobel prize. Yet 50-year-old Tyler Cowen is a formidable presence on the American economic landscape. Chairman of Economics at George Mason University in Virginia, he is a prolific writer and editor and blogger; his Marginal Revolution – co-written with his Canadian colleague Alex Tabarrok – is among the best read blogs in the field. His last book,The Great Stagnation, was a bestseller. His next, he told Globe and Mail reporter Michael Posner in an interview, will explore what the path out of the great stagnation will look like. Mr. Cowen will deliver a lecture Tuesday evening at Toronto’s Isabel Bader Theatre.

COWEN:When I wrote The Great Stagnation, I thought it would take 20 years for us to get out of it. Now, I think it will be 10 years. I don’t think the great run of innovation is over. I just think it’s on pause. The Western world has excellent institutions. Science is still vital. But part of our problem is behavioural – getting people to be motivated. Throwing more science at things isn’t always the answer. Insofar as I’m pessimistic, it’s behavioural issues, especially in education and health care.

 

How volatile will markets be?

We’ll see levels of market volatility and stock price collapses that will be, to many people, horrifying. So the headlines a year from now – I’m very pessimistic. But if you’re asking about the real economy several years down the road, I do not think we are headed for doom.

 

What sectors will lead the next great boom?

Artificial intelligence [AI] will be a significant breakthrough. There are new developments almost every day. Cheaper fossil fuels, particularly natural gas, will spur short-run growth. And an increasing share of national income will go to capital and high productivity. It may not feel like an end to stagnation for many workers, but in terms of aggregate output, the U.S., Canada and Mexico are poised to do extremely well. Mexico will find its way around the drug problems and become more integrated into the U.S. economy. It’s the great underrated nation in the world right now.

 

Can advances in AI create great numbers of jobs?

No. A lot of people will be hurt by it. Owners of intellectual property, and capital and manufacturing plants will do very well. Output will go up a lot. But in many areas, wages will fall and jobs will disappear. So the U.S. trend – falling labour force participating rates – will continue. But people who get quality education will be better off.

 

Many economists see China as the great growth saviour. You don’t.

You can’t grow at 10 per cent per year forever. It’s already been 30 years – the greatest growth streak in history. But China is slowing down very rapidly. It’s been investing about 50 per cent of GDP [gross domestic product] for a long time. It’s very hard to do that well. And they are massively corrupt. I tend to think they will never be as wealthy per capita as Mexico. I would call that a medium-hard landing. It’s here now. The slowdown will be very bad for parts of Africa and it will hurt Canada. But Canada has other strengths and will be fine. It will hurt Brazil and other resource-rich economies. I don’t think it will hurt the U.S. I don’t adhere to apocalyptic scenarios – no riots or rebellion. I just think they will grow much more slowly. The same thing is happening in India.

 

What’s your call on the future of the euro zone?

I think multiple countries will leave, but I’m not sure that’s the pessimistic forecast. The pessimistic forecast might be they stay in forever and all get dragged down by deflation. I’m a pessimist about the euro, but not about Europe. So the southern periphery, Spain, Italy, Greece, leave – Italy might be the first to go – and the rest stay. That will work just fine. But unless they want to give up democracy, I don’t see greater fiscal union as the answer. The economies will eventually recover. There is great human capital, a lot of strengths, and mostly good institutions. Austerity is not the main problem – it’s that their banking systems are coming apart at the seams.

 

Do you play the stock market?

I’ve been heavily in cash for some time, and paying down debt. I thought stocks were overvalued in the early part of the last decade. I was right too early, but I did not suffer in the financial crisis.

 

What’s the likelihood of a major war?

I’m worried about it, especially in the Middle East. I don’t think it would be good for the U.S. economy. Energy prices would go up. There’d be a lot of uncertainty, which the world does not need more of. And the issue of nuclear weapons is not trivial. It’s hard to get a good understanding vis-à-visIran. There’s a lot of misinformation. But we seem to be on a collision course.

 

Does it matter who wins the U.S. presidency?

It’s hard to tell. As people, [Republican leader Mitt] Romney and [U.S. President Barack] Obama are not that different. Both are in bad situations, for reasons not of their own making. If Obama wins, which seems more likely, we probably get more of the same – gridlock, nastiness. If Romney wins, we have to ask, ‘Do Republicans really mean what they’ve been saying?’ I think they don’t. It’ll be like the Bush years – right-wing versions of left-wing ideas.

 

Does Obama get enough credit for saving the global economy from collapse?

George Bush doesn’t get enough credit. He basically said, ‘This is over my head, but I’m going to back [then-U.S. Treasury Secretary Henry] Paulson and [U.S. Federal Reserve Board chairman Ben] Bernanke to the hilt,’ and he did. I give most of the credit to Bernanke. He was an absolute genius.

 

What about Russia?

I see a big brain drain, too heavy a reliance on resource prices and their politics is far from settled. And they are not reinvesting in education. So I’d say I’m a pessimist.

 

What credence do you attach to the Black Swan scenario – the possibility of a completely unanticipated event having a major impact?

It’s an interesting theory, but it’s miscategorized. These so-called unpredictable events are actually the classic events of history – war, financial panic, maybe pandemic in the future. They’re unpredictable because we make mistakes. The problem is us. They’re not actually black swans – not bolts out of the blue.

 

To what extent was America’s sense of exceptionalism damaged by 9/11, the Iraq war, and the 2008 financial debacle?

We have a much stupider version of exceptionalism now. It’s less fact-based. The better version has to do with our ability to reinvent ourselves, be self-critical and, if we screw up, come back to better ways of doing things. The stupider version is jingoistic and patriotic, and gets you into mistaken wars. So our exceptionalism has been traded in for a weaker version and it’s distressing.

 

Canadian exceptionalism often focuses on the virtues of our health-care and banking systems. Justified?

Canada has done extremely well in controlling health care costs. The question is how much is that because the system is better, and how much because health care doesn’t matter – Canadians are just healthier behaviourally. As for the banks, I’d say that when you have two countries next to each other, you’re best off if they’re run on different principles, say with respect to of risk aversion, as Canada and the U.S are. The banking systems are thus complementary. On our side, it’s not clear we’ve done anything to corral the banks. It’s not clear we will. I think we’re in denial. This is very worrying. As in the auto industry, where there is still excess capacity, the underlying problems have not gone away.

Arabic Knowledge@Wharton: An Arab Spring Economics Recipe: Add High Food Prices to Trade Barriers, Get Revolutions

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This article originally appeared in Arabic Knowledge@Wharton

Tyler Cowen, an economics professor at George Mason University, has recently published a book called An Economist Gets Lunch: New Rules for Everyday Foodies about how you can apply basic theories of economics to get the best meal for your money.

On a serious note, he tells Arabic Knowledge@Wharton, most people don’t realize there is not a shortage of food, but rather too many poor people unable to pay for it. Cowen also discusses how food prices and trade barriers in the Middle East helped drive the Arab revolutions.

An edited transcript of the conversation follows:

Arabic Knowledge@Wharton: You state that food is a result of capitalist supply and demand. It seems logical and simple, but people don’t think about food in those terms. How did you come up with that?

Cowen: I grew up as a kid reading classical economic works by Adam Smith, David Ricardo and James Mill. Those are the origins of economics, as we all know. For obvious reasons, they’re obsessed with food. That’s almost all they write about because that’s what the economy was about back then. If you have a background in classical economics, the notion that economics is about food comes very naturally. Maybe the world has forgotten that somewhat.

Arabic Knowledge@Wharton: In the Middle East, eating a more Westernized diet is a sign of worldliness but it may not be as healthy as eating traditional meals. How did the idea of local eating transform into a lower-status symbol?

Cowen: There’s a class division in a lot of those societies. You either do things that are Western to show you have money, but it’s not necessarily healthy. I think if they became a little more obsessed with, say Indian or Chinese food, they’ll do better. There are issues with diabetes and obesity in many of these wealthier Gulf nations. They also tend not to be physically active because that also has a stigma. So it’s one thing to eat if you’re physically active, you can get away with doing so much more.

Also, they have servants, and they import labor. A lot of people are just not working; they don’t have to work. That’s a lethal combination. And the idea of, “Oh, I’m going to go to the gym,” like they say in America, it’s not the same there. It’s too much like work.

Arabic Knowledge@Wharton: You point out that there is no shortage of food in the world. But there is a shortage of money for poor people to buy the food. It seems almost ironic. What are the factors that affect this polar phenomenon?

Cowen: If you look at wheat and rice, there have been price spikes over the last five years and they’ve made food a lot harder for poor people to afford. The so-called “Green Revolution” has somewhat slowed down. This is an unreported story. Crop yields are stagnant. It isn’t a problem we can solve overnight but it’s really one of the biggest problems in the world. It hardly gets any publicity. But for poor people in India, the Middle East and parts of Africa, it really matters.

Some of the problems are we don’t have enough trade. It could be either legal barriers or just costly to transport or trade things. If there could be a shortage of rice in one place, it actually not that easy to ship a lot of rice in there because of bad roads and so on.

Arabic Knowledge@Wharton: So if countries worked on improving the transportation infrastructure, that would lower food prices in some parts of the world?

Cowen: Exactly, that would do a lot to feed people. Again, it sounds much more mundane but it’s more important than what people in the food world usually talk about.

Arabic Knowledge@Wharton: So when companies like Wal-Mart bring their logistics ability to Africa, it actually could be a good thing for the poor people of Africa?

Cowen: It’s exactly what we need more of. Yes.

Arabic Knowledge@Wharton: Yet there’s a fear Wal-Mart will put the smaller stores out of business.

Cowen: Yes, they do so sometimes, but they do so by charging lower prices. It makes it more accessible and more reliable. It’s not just the pricing at any one point and time. It’s what happens in the very worst periods. Companies like Wal-Mart are very, very good at keeping up supply and being regular.

Arabic Knowledge@Wharton: Are there other things that people can do to feed the poor people in the Middle East, especially in the Arab nations that have undergone revolutions?

Cowen: Well, they have very bad economic policies; it’s hard to know where to start. They tend to have bad energy and bad water policies. They overuse energy and they overuse water and protect their domestic farmers. It creates an unholy triad of subsidies with water, food and energy in a way that’s environmentally unsustainable. They should rely more on free trade. They tend not to trust it and I understand why, given their histories. But what they’re doing now isn’t really working.

Arabic Knowledge@Wharton: Do you think people recognize that when they’re forming the new governments?

Cowen: I think very often they do. There are a lot of sophisticated people in the governments. But that doesn’t mean they have the power to set things straight.

Plus, it depends on which country in the Middle East you’re talking about. So Tunisia is better run than most places. Lebanon has a saner agricultural policy than most places. Yemen is a total disaster. Algeria and Egypt have not gone so well. So there’s a lot of variety within the Middle East. If you think of a model like Turkey, which isn’t technically in the Middle East, they’ve liberalized and encouraged agribusiness. Turks are much better fed than 20 years ago. When you ask a country like Iran, what should we do? It’s hard to know even where to start.

Arabic Knowledge@Wharton: As you said, Egypt hasn’t gone well. And Egypt is in the beginnings of forming a new government, it sounds like they have a very big uphill battle.

Cowen: Yes, I think it’ll get worse before it gets better. They’re prevailing on economic policy based on mercantilism — powerful, bad, old-fashioned mercantilism in the greediest way. It doesn’t work. Mercantilism backed by military rule not a good idea.

Arabic Knowledge@Wharton: You point out that the Middle East imports about half of the wheat they use, which is needed for bread and other staples. This system of importing a food staple contributes to high food prices, which is one of the reasons for the political unrest and an impetus for the Arab revolutions. What can the Middle East do to reverse this trend?

Cowen: Well, it’s not just up to the Middle East. One reason that wheat prices and other prices have gone up is because the world as a whole has slacked off in research and development in agricultural productivity. I don’t think the Middle East can solve that problem on its own.

Arabic Knowledge@Wharton: Why has the world slacked off in such research and development?

Cowen: I don’t know. It’s a bigger public policy question. In a lot of areas, we’re spending more on short-term consumption and less on long-term investment. And I think that’s our fault. It’s a general trend and you see it in a lot of different countries.

Somehow, our time horizons are shortening. But most Middle Eastern countries do not have free trade in food. And if they did have free trade in food and didn’t protect their domestic farmers with subsidies, they would have cheaper food. So they treat their domestic farmers as a lobby that should be catered to when they should not. I wouldn’t suggest that would solve all their food problems. It wouldn’t.

Arabic Knowledge@Wharton: The domestic farmers would argue they would be put out of business.

Cowen: Sure, but should Saudi Arabia be growing bananas and paying for all that water in the desert? It’s crazy. There’s a long history in many of these countries, trying to be self-sufficient with fairly outrageous water and farm subsidies, which raises prices. It costs a lot of money in the budget. It’s not really a successful path forward but it does buy the support of some interest groups of course. That’s why they do it.

But the notion of saying something simple like “Well, Lebanon has more water than we do so we should just stop subsidizing water and buy it from them.” Those countries would be much better off.

Arabic Knowledge@Wharton: So if some of these countries just traded across borders?

Cowen: Yes. I don’t mean to get into politics but Israel has the highest agricultural productivity in the Middle East. And they use technology much better. But a lot of countries are very reluctant to trade with Israel. Even share information and have any dealings at all. That’s another mistake they make and that’s part of the problem.

Arabic Knowledge@Wharton: While water is scarce in some regional countries, like Yemen, it’s actually abundant in Syria, Lebanon and Turkey. Can you explain more about the water inequality problem in the Middle East?

Cowen: Typically, the Gulf has the worst problem with water. I’m not even sure Yemen is even a viable country because there’s some chance, they will literally run out of water in the next 20 years in a lot of parts of the country. At this point, I don’t know what they can do. Saudi Arabia is a lot wealthier and they’ve returned to some sanity. Every now and then, the price of oil dips and they decide they can’t afford to be as they used to be, so they cut back on their subsidies for the better. They ought to just say their domestic farmers have to pay the market price for their water. And if they can’t produce food at that price, we’ll buy from Lebanon, Turkey, Israel or wherever else.

Arabic Knowledge@Wharton: So to buy water and food products from other nations?

Cowen: Often how you buy water is to buy it in the product. If you buy a tomato, one way to think of that transaction is you are buying water. It’s called virtual water, so yes.

Arabic Knowledge@Wharton: In India, the economy is growing at 8 to 9% but agriculture is growing at 3% because agribusiness is not allowed. Can you explain the problem and discuss some of the solutions required?

Cowen: India has slowed down since the book came out. India is now at the 6% range. They have a climate that’s very hostile to agribusiness. They don’t want to let in Wal-Mart. They don’t let in generally consolidated land holdings. Agriculturally, they’re one of the least efficient countries. Half of the children under five are malnourished. And half of the workforce is in agriculture.

Arabic Knowledge@Wharton: Why doesn’t India let agribusiness grow?

Cowen: They protect their own small farmers. The result of that is massive malnutrition, which have terrible consequences, not just for the kids, but for the whole country. People grow up and have inferior opportunities. One thing the world does know how to do, even in non-ideal countries, is to raise agricultural productivity. Turkey has done it. Most of South America has done it. But India has not been willing to take that step. It’s a huge, huge problem for them. Millions of people suffer in a very serious way.

Arabic Knowledge@Wharton: Can you explain how the European fear for GMO’s (genetically modified organisms) is affecting Africa’s agricultural economy?

Cowen: There are a few reasons African countries are reluctant to use GMOs. Some of them do, mostly South Africa. But partly they don’t have the infrastructure to do it at all. And some are afraid that if they do, they can’t export to the European Union, which is their main market and more important than the United States. So they’ve held back on investing.

African agriculture has a lot of problems. But the biggest problem is simpler than GMOs. Africa has terrible roads. In Africa, it takes four to six time times to transport a product, which is crazy. It’s such a poor place. It’s relatively dry so they really need fertilizer. And to think an African farmer has to pay four to six times more than what an African farmer has to pay for fertilizer? A lot of that is because they have bad roads.

But not doing GMOs is part of a bigger, broader set of problems and it could make their agriculture more productive. I’m not sure injecting GMOs and doing nothing else will make a huge difference. If there’s no road to bring your crop to market, it doesn’t matter what you do to your crop. But it’s part of a series of big, interrelated problems.

Arabic Knowledge@Wharton: This fear of GMOs is more of a European fear than an American fear?

Cowen: Yes, that’s right. There’s a very small minority of Americans who worry about this kind of thing. In terms of law and public policy debate, it’s pretty much taken for granted. People have been eating GMO products for 20 years and there’s really no evidence of ill effects. Why is it this way in Europe? I don’t know. To me, it’s a bit like the right wing, climate change, etc. People start obsessing over it in a bad way and they’re not willing to face up to the evidence.

Arabic Knowledge@Wharton: In your book you point out New Zealand lamb. Its two biggest consumers are the U.S. and the Arab World. If segments of the U.S. population decided to boycott New Zealand lamb due to transportation not being environmentally friendly, how would that effect prices in the Arab World?

Cowen: In that example, I just tried to point out that boycotts are often not very effective. They make people feel good. If you get a lot of people to boycott, people somewhere else will just buy more of it. There’s a system-wide effect. In general, I tend to be skeptical of boycotts as a way to change the world. Sometimes they work but more often than not, they don’t.


The Washington Post: Can “Eurobonds” Fix Europe?

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This article originally appeared in The Washington Post

Lately, there’s been lots of debate in Europe over whether the broken euro zone needs some sort of “eurobond” to alleviate the continent’s debt woes. French president Francois Hollande has made this one of his top priorities. Yet the most recent E.U. summit ended without much progress on the topic. So whatare eurobonds? And would they actually work?

Probably not talking about eurobonds. (JUAN MEDINA – REUTERS)The Guardian has a handy primer on the concept. The basic idea is that, right now, lenders and investors are nervous that a bunch of individual countries on the euro — from Spain to Portugal to Greece — might not repay their debts. So the cost of borrowing money for those countries has been spiking at various points. (Spain is the latest casualty.) That, in turn, makes their debt crises even worse, which raises the risk of a horrible death spiral, and so on.

The logic behind eurobonds is that, rather than individual countries trying to borrow money on their own, the entire continent would borrow money together, as a unit. Spain and Greece would, in effect, pay the same interest rates on their debts as France and Germany do. Since the euro zone as a whole is large and rich, that would calm the panic over individual countries. And troubled nations would get a bailout. If Portugal only had to pay the average interest rate of euro members, its annual debt payments would fall by €15 billion, or 9 percent of its GDP.

Not surprisingly, German politicians aren’t tickled by this idea. Germany can already borrow money at breathtakingly cheap rates. If it had to pool its debts with, say, Spain and Portugal, then Germany would have to pay more to borrow — by some estimates, up to €50 billion per year more, or 2 percent of its GDP. What’s more, some German leaders fear that some nations would use the eurobond as an excuse to behave irresponsibly. After all, if Italy’s borrowing costs are going to be subsidized by Germany, there’s less need to worry about racking up debt.

One recent alternative, floated by the European think tank Bruegel, is to offer up two types of bonds. Basically, if countries behave “responsibly,” they get access to the safe, continent-wide eurobonds. But if countries rack up further debt beyond a certain point, they have to pay for it on their own. A euro-wide commission — led by Germany — would determine which countries are behaving responsibly and irresponsibly.

But would any of this fix Europe’s woes? Tyler Cowen points out a few hitches. For one, new eurobonds would do little to address the slow, inexorable run on European banks — savers in places like Greece and Spain are gradually taking their euros out of local banks and sending them to Germany, which could end up depleting the banking systems in periphery countries. (As if on cue, the Spanish government just had to bail out its second-biggest bank, Bankia, which was hit hard by the housing bust.) “The key is guaranteeing the banks and their deposits, at reasonable cross-border cost,” Cowen notes. “This [eurobond proposal] doesn’t accomplish that.”

It’s also worth noting that, even with eurobonds, individual countries like Greece would still face years of grinding unemployment and remain uncompetitive as long as they’re tethered to the same currency as richer neighbors. As the Guardian’s Philip Inman notes, “They could help to calm the market panic and ease the immediate budgetary crisis of some countries, including Italy and Spain. But a eurobond would do nothing to reduce overall levels of debt, let alone tackle the underlying structural problem.”

Still, even if eurobonds, on their own, can’t bring Europe back to full health, many analysts think they’ll have to be a major part of the treatment course. And Germany may not be able to oppose the idea forever. As Ana Nicolaci da Costa of Reuters explains, if Greece exits the euro and defaults on its debts, then the entire continent will be faced with hefty losses that may have to be shared across Europe. That could make some sort of shared bond inevitable.

The New York Times: A Power Vacuum Is Killing the Euro Zone

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This article originally appeared in The New York Times

As problems mount in the euro zone, it’s increasingly evident that we’ve been witnessing an institutional failure of monumental proportions.

What is to be done about Greece? Simply keeping it in the euro zone won’t help much, even if it’s possible.  The continuing crisis has sapped confidence in banks not only in Greece, but also in Spain, Italy, Portugal and Ireland, though to varying degrees.  Unless there are explicit guarantees to these banks soon, the market will likely take a further turn for the worse.

An absence of guarantees could prompt a broader chain reaction of capital flight and bank collapses across several countries.

The basic problem is that many people won’t keep their euros in a Greek bank, and perhaps not in a Spanish bank, either, when those euros can be moved to Germany or some other haven.

Yet German citizens do not appear ready to guarantee Spanish banks or, by extension, the whole credit system of Spain and the other periphery nations. Guarantees of that scope are probably impossible and may also require constitutional changes in some nations.

We thus face the danger that the euro, the world’s No. 2 reserve currency, could implode.  Such an event wouldn’t be just another depreciation or collapse of a currency peg; instead, it would mean that one of the world’s major economic units doesn’t work as currently constituted.

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences.  For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States.  (But when it comes to the euro zone, the United States is on the sidelines.)

There appears to be a power vacuum, and the implications are alarming. We may be entering a new world where international cooperative arrangements, in environmental areas as well as finance, are commonly recognized as impossible.  If the core European nations cannot coordinate effectively, what can we expect in dealings with China, Russia and other countries that have less of a common background and understanding?

In the euro zone, we are seeing two refusals to cooperate: Germany won’t renew financial pledges to Greece without Greek compliance on previous agreements, and Greece doesn’t want Germany to control its national budget.  Both seem reasonable positions, and maybe they are, but reasonable positions can apparently destroy an international agreement rather easily.

Is there a way out?  To seek a binge of pro-growth government spending, in the hope of stimulating economies, is to assume what already stands in doubt. The crisis has reached a head partly because the market already lacks trust in the periphery governments to invest money for sustainable economic growth.

There is also talk of forming a true fiscal union, but that seems to be doubling down on a bad idea.  If the euro zone cannot summon enough cooperation now, how is any union requiring tighter cooperation supposed to work?  How would national budgets be set and approved?  A credit collapse remains a real possibility.

Is it too late for monetary policy to make a difference?  The other euro-zone nations might allow Greece to leave, while guaranteeing payments for food and fuel, both of which Greece imports, for a reasonable period.  Higher price inflation might then depreciate the euro, limit the need for difficult downward wage adjustments, and help Spain and Italy improve their competitiveness.  The inflation could come through central bank bond purchases from the troubled nations, thus easing their debt problems.  That may be the only useful option still on the table.

But that’s also not easy.  First, economically healthier nations may be reluctant to accept the inflation, which would represent a rather direct, continuing redistribution of wealth to the troubled debtor countries.

The second problem is that some of the banking systems in the periphery nations may be too broken for monetary policy to take hold.  Imagine the European Central Bank trying to infuse new money and credit into Spain, while bank deposits move quickly to Germany, Switzerland and other safer places.  Again, why would anyone want to keep money in the bank of a fiscally troubled nation?  That loss of confidence will not be easily repaired.

Since December, the European Central Bank has lent more than a trillion euros to euro-zone banks, but that has bought no more than a few months of peace.  It isn’t clear how much more can be done.  It probably is about time to judge the euro zone as a failed idea — and rarely is it wise to double down on failed ideas.

What is most disturbing is that the euro-zone nations are democratic, protective of basic liberties, and have advanced intellectual and research communities. The final lesson of this debacle is that smart nations with noble motives can make very big mistakes.  And that should concern us all.

Never Mind Europe. Worry About India

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This article was originally published in The New York Times

The economic slowdown in India is one of the world’s biggest economic stories, but it is commanding only a modicum of attention in the United States.

It may not even look like a slowdown because by developed standards, India’s growth — estimated by the International Monetary Fund at 6.9 percent for 2012 — is still strong. But a slowdown it is: the economy has decelerated from projected rates of more than 8 percent, and negative momentum may bring a further decline. The government reported year-over-year growth in the October-through-December quarter of only 6.1 percent.

What is disturbing is that much of the decline in the growth rate is distributed unevenly, with the greatest burden falling on the poor. If the slower rate continues or worsens, many millions of Indians, for another generation, will fail to rise above extreme penury and want. The problems of the euro zone are a pittance by comparison.

China commands more attention, but Scott B. Sumner, the Bentley College economist, has pointed out it is India that is likely to end up as the world’s largest economy by the next century. China’s population is likely to peak relatively soon while India’s will continue to grow, so under even modestly optimistic projections the Indian economy will be No. 1 in terms of total size.

India also is a potential force for energizing the economies of Bangladesh, Nepal and, perhaps someday, Pakistan and Myanmar. The losses from a poorer India go far beyond the country’s borders; furthermore, the wealthier India becomes, the stronger the allure of democracy in the region.

Why is India’s economic growth slowing? The causes are varied. They include a less than optimal attitude toward foreign business and investment: recall the Indian government’s reversal of its previous willingness to let Wal-Mart enter the retailing sector. The government also has been assessing retroactive taxation on foreign businesses years after incomes are earned and reported. Another problem is the country’s energy infrastructure, which has not geared up to meet industrial demand. Coal mining is dominated by an inefficient state-owned company and there are various price controls on both coal and natural gas. Over all, the country does not seem headed toward further liberalization and market-oriented reforms.

These problems can be solved. More troubling are the causes that have no easy fix.

Agriculture employs about half of India’s work force, for example, yet the agricultural revolution that flourished in the 1970s has slowed. Crop yields remain stubbornly low, transport and water infrastructure is poor, and the legal system is hostile to foreign investment in basic agriculture and to modern agribusiness. Note that the earlier general growth bursts of Japan, South Korea and Taiwan were all preceded by significant gains in agricultural productivity.

For all of India’s economic progress, it is hard to find comparable stirrings in Indian agriculture today. It is estimated that half of all Indian children under the age of 5 suffer from malnutrition.

Another worry is that India’s services-based growth spurt may have run much of its course. Call centers, for example, have succeeded by building their own infrastructure and they often function as self-contained, walled minicities. It’s impressive that those achievements have been possible, but these economically segregated islands of higher productivity suggest that success is achieved by separating oneself from the broader Indian economy, not by integrating with it.

India also has one of the world’s most unwieldy legal systems, and one that seems particularly hard to reform. On the World Bank’s Doing Business Index, the country ranks 132 out of 183 listed countries and regions, behind Honduras and the West Bank and Gaza, and just ahead of Nigeria and Syria. One undercurrent of talk is that the days of “the license Raj” have returned, referring to the country’s earlier subpar economic performance under a regime of heavy government regulation.

On the positive side of the ledger, the country retains a population with remarkable talent, energy and entrepreneurship. It has worldwide networks of trade and migration, and world-class achievements in entertainment and design, among numerous other strengths. Nonetheless, the previous pace of progress no longer seems guaranteed.

India may not be alone in this slowdown. There is a more general worry that the grouping of disparate giants known as the BRIC nations — Brazil, Russia, India and China — has, for some reason, lost much of its previous momentum. Last year Brazil grew at only a 2.7 percent rate, down from 7.5 percent, and Chinese and Russian G.D.P. growth are slowing too, to an unknown extent and duration. In the past, many countries engaged in catch-up growth have suddenly slowed and hit plateaus, although economists do not have firmly established theories as to when and why this happened. In any case it remains a real danger.

In the short run, we often focus on headlines, elections and fights between personalities and political parties. But the world is shaped by deeper structural forces, such as resources, technologies, demographics and economic growth rates. We ignore India’s troubling trends at our peril.

Dangers of an Overheated China

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This article was originally published in The New York Times

President Obama’s recent trip to China reflects a symbiotic relationship at the heart of the global economy: China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector. Yet this arrangement may unravel in a dangerous way, and if it does, the most likely culprit will be Chinese economic overcapacity.

Several hundred million Chinese peasants have moved from the countryside to the cities over the last 30 years, in one of the largest, most rapid migrations in history.

To help make this work, the Chinese government has subsidized its exporters by pegging the renminbi at an unnaturally low rate to the dollar. This has supported relatively high-paying export jobs; additional subsidies have included direct credit allocation and preferential treatment for coastal enterprises.

These aren’t the recommended policies you would find in a basic economics text, but it’s hard to argue with success. Most important, it has given many more Chinese a stake in the future of their society.

Those same subsidies, however, have spurred excess capacity and created a dangerous political dynamic in which these investments have to be propped up at all cost.

China has been building factories and production capacity in virtually every sector of its economy, but it’s not clear that the latest round of investments will be profitable anytime soon. Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. In Shanghai, the central business district appears to have high vacancy rates, yet building continues.

Chinese planners now talk of the need to restrict investment in sectors that are overflowing with unsold products. The global market is no longer strong, and domestic demand was never enough in the first place.

Regional officials have an incentive to prop up local enterprises and production statistics, even if that means supporting projects or accounting practices that are not sustainable. For an individual business, the standard way to get more capital resources is to put forward a plan for growth. Because few sectors are mature, and growth has been so widespread, everyone can promise to be profitable in the future.

Over all, there is a lack of transparency. China’s statistics on its gross domestic product are based more on recorded production activity than on what is actually sold. Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.

Put all of this together and there is a very real possibility of trouble.

China has had a 30-year run of stellar economic growth. But it’s only human nature for such expansion to breed too much optimism, overextending an entire economy. Americans have found this out the hard way in their own financial crisis.

History has shown that no major economy has grown into maturity without bubbles, crises and possibly even civil strife or civil wars along the way. Is China exempt from this broader pattern?

The notions of excess capacity and malinvestment were common in business-cycle theory of the 19th and early 20th centuries, when growing Western economies had frequent crashes of this kind. Numerous writers, from the Rev. Thomas Malthus to the Austrian economist Friedrich A. von Hayek, warned about the overextension of unprofitable capital deployments and the pain from the inevitable crashes. These writers may well end up being a guide for understanding China today.

What will the consequences be for the United States if and when the Chinese economic miracle encounters a major stumble? A lot of Chinese business ventures will stop being profitable, and layoffs and unrest will most likely rise. The Chinese government may crack down further on dissent. The Chinese public may wonder whether its future lies with capitalism after all, and foreign investors in China will become more nervous.

In economic terms, the prices of Chinese exports will probably fall, as overextended businesses compete to justify their capital investments and recoup their losses. American businesses will find it harder to compete with Chinese companies, and there will be deflationary pressures in both countries. And even if the Chinese are selling more at lower prices, they may be taking in less money over all, so they may have less to lend to the United States government.

In any case, China may end up using more of its reserve funds to address domestic problems or placate domestic interest groups. The United States will face higher borrowing costs, and its fiscal position may very quickly become unsustainable.

That’s not so much a prediction as a very possible contingency, and we should be prepared for it. For now, we should avoid two big mistakes. The first would be to assume that just because borrowing costs are now low, we can postpone fiscal responsibility and keep running up the tab — with the aid of Chinese lending, of course. The history of financial crises shows that turning points can come swiftly and without much warning.

The second mistake would be to demand too many concessions from the Chinese. What we see in the numbers today are a growing China and a somewhat ailing America. Yet there’s a real chance that, soon enough, Chinese economic weakness will be a bigger problem than was Chinese economic strength.

Economic View; So, We Thought. But Then Again…

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This article was originally published in The New York Times

Harry Struman once said he wanted to talk to a one-armed economist, ”so that the guy could never make a statement and then say: ‘on the other hand.’<0>” Yet economic knowledge continues to progress in unexpected ways. Here are a few of the things we learned in the last 12 months:

REVISING THE CHINESE ECONOMY

Many of the prices in China had not been accurately measured since the late 1980s; in 2007, new data indicated that food, rent and other items had become a lot more expensive than had been accounted for in official measurements. Higher prices, of course, mean lower Chinese real wages and a smaller size for the Chinese real economy.

China is much further from world economic leadership than we may have thought. Furthermore, poverty in China remains severe; the data revisions imply that China has 300 million workers — about the size of the entire United States population — earning less than a dollar a day. Given these weaknesses in the Chinese economy, the yuan may not be so undervalued after all.

IT’S NOT JUST THE LENDERS

There has been plenty of talk about ”predatory lending,” but ”predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.

Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter.

In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years.

IN MUSIC, HARDWARE RULES

In 2007, album sales fell 15.3 percent, compared with 2006, itself a slow year. Even if sales of 10 singles are counted as one album, sales were still down 9.5 percent.

Economists hadn’t known whether digitization would help or hurt music markets; many thought that greater exposure to music and the ease of online access might lead people to buy more. But in 2007 the outcome became clear: people tend to buy their favorite song from an album, online, rather than buy the whole album. More digital singles are being sold, but that doesn’t mean higher profits for the artists or the music companies. There are lower prices for music (99 cents a song on iTunes) and more of the profits are captured by the makers of hardware, most of all Apple with its iPod.

When it comes to piracy, illegal file-sharing on computer networks is not the main problem; instead, computer users, especially teenagers, burn CDs for one another. The music companies don’t have a good business model for making money from this.

Music company profits may not recover until other hardware manufacturers compete more successfully with Apple, which is selling songs very cheaply, knowing that the music will fuel demand for iPods. A more competitive hardware market would mean lower prices for the music players and eventually higher prices for music, as Apple would be less keen to sell the music so cheaply.

LETHAL COLD FRONTS

Spells of extreme cold kill over 27,000 Americans each year, or about 700 people each very cold day. Heat waves may receive more publicity, but it turns out that cold periods — days with an average temperature below 30 degrees –have more significant and longer-lasting effects on human mortality. More people die in cold periods than in homicides.

Extreme cold brings cardiovascular stress as human bodies struggle to adjust to the temperature; many of the deaths in these periods come through heart attacks. Heat waves tend to kill people who were already weakened and would have died soon anyway; cold periods bring additional people to the verge of death.

When retired people move to a warmer state, their life expectancy rises dramatically. In fact, 8 to 15 percent of the increase in American life expectancy over the last 30 years comes from people moving to warmer climates, according to research done by two economics professors, Olivier Deschenes at the University of California, Santa Barbara, and Enrico Moretti, at the University of California, Berkeley.

The common thread in these various discoveries is a careful use of data and an interest in real-world problems and puzzles. In accord with the trend in the profession since the 1990s, there haven’t been many significant advances in pure theory over the last 12 months.

Many major debates of economics remain unsettled. We’re still not sure what is driving the increase in income inequality. It is common to cite globalization and the ability to sell to the entire world, but the surge in top incomes does not seem to be coming in the most globalized sectors. We’re also not sure whether 2008 will bring a recession or slow but continued growth.

Knowledge is a wonderful thing, but sometimes simply knowing what we don’t know is a form of understanding. So beware the one-armed economist; sometimes a good economist could use two or even three arms or more.