Archive for April 2013


Culture; it’s not what you think

Noah Smith has a new post that quotes me saying things that I don’t believe, and that he knows (or should know) I don’t believe.  I admitted in the comment section to his critical post that I shouldn’t have called the Chinese “pragmatic.” It’s clear from this follow-up post, and the comment section where he responds, that Noah and I actually have pretty similar views on culture.)

Take two very poor countries, North Korea and Pakistan.  Then ask which one is likelier to be rich in 50 years time?  I’d say North Korea, and if you hooked Smith up to a lie detector, I imagine he’d do the same.  But why?

For me the answer would be culture, culture, culture.  But not culture in the sense that ignorant people use the term “culture.”  Rather culture as a sort of residual.  We can observe cultural differences, but don’t really know what part of the cultural differences matter for development.  The easiest way to explain all this is with a bunch of examples.

Why do I think North Korea will do much better than Pakistan?  Is it because I’ve met Koreans, and Pakistanis, and noticed some mysterious superiority in the Koreans that I have met?  Not really.  Both the Korean and South Asian people I’ve met seem highly productive.  Nothing about them would provide me with any useful information to predict North Korea will grow faster than Pakistan.

Alternatively, suppose it were the case that both Koreas were currently desperately poor, and India and Bangladesh were rich, while Pakistan was poor.  In that case I’d predict Pakistan would do much better over time, even though nothing changed in the personal characteristics of the people I happen to have met who were Korean or South Asian.  One notices cultural patterns in development, but that doesn’t mean one knows which particular cultural characteristics explain those patterns.

Here’s another example.  Back in the early 1980s I saw China moving toward a market economy.  At the same time I knew that all of the very fast-growing economies in the world, whose growth wasn’t based in resource extraction (i.e. South Korea, Taiwan, Hong Kong, Singapore, Japan, etc.), were located in East Asia.  I noticed that China was right in the middle of this group, and also shared cultural similarities.  Thus I predicted China would grow really fast, and because I was correct I’ll be able to retire early.  Yes, I know, that violates the EMH  🙂

So why fixate on “culture”?  Why not “geography?”  Because it seems like culture is the key factor.  Australia is a neighbor of New Guinea, yet has cultural similarities to Europe.  Singapore is next to Indonesia, but has cultural similarities to Taiwan and Hong Kong. Israel is next to Egypt, but has cultural similarities to Europe.  When culture and geography diverge, go with culture.

So far this seems very deterministic, but when you look closer you realize that it really isn’t.  That’s because economic development reflects many factors, and culture impacts those factors in diverse and often unpredictable ways.  A (by no means exhaustive) list includes skill at governance, skill at entrepreneurship, propensity to save, work hard, etc.  Many people assume that cultures that work hard are richer.  And yet the data shows that Germans work less hard than Greeks, for instance.  The data doesn’t match the stereotypes.

In the eastern Mediterranean there are lots of cultures that have a reputation for entrepreneurship (Greeks, Armenians, Lebanese, Jews, etc.)  When these people move to a country like the US, they often do just as well as immigrants from a country like Germany, perhaps even better.  So the stereotypes often do more to mislead than illuminate.

So maybe the Germans don’t work harder than the Greeks, but their culture led to more effective governance.  That’s certainly plausible, but the result also seems quite “fragile.”  After all, Greece is the birthplace of democracy, and Germany . . . well let’s not talk about that period.  And although a high saving propensity probably helps, the (low-saving) US is the richest big country in the world.

I think that conservatives often err in assuming culture is constant over time, and more importantly that the advantages of certain cultural attributes is stable over time.  A culture that is able to mobilize horseman to sweep across the grasslands and conquer huge regions, may not be well-suited to organizing large assembly lines that run with mindless precision.  And that latter group may not be good at service/tech industries that require lots of creativity and individual initiative. And of course there are the contingencies of history—the Cold War separated the two Koreas, the two Germanys, the three Chinas.

So with all these caveats why do I cling to culture as an important factor?  Because it obviously is.  For some reason it has become politically incorrect to talk about culture.  (Oddly, a few years back the non-culture explanations (genetics) were taboo.)  Others seem bothered by the non-scientific aspect of culture.  But I still see strong cultural correlations in economic performance.  That information seems useful, even predictive where the contingencies of history have created artificial outcomes, and so I see no reason to throw out useful information.

Interestingly, Noah Smith uses exactly the same analysis I would use to predict China might do better than his opponent assumes.  He notes that Japan, Taiwan and Korea have moved up to European levels of income.

PS.  Just be be clear, I think all cultures are capable of achieving a great deal of economic progress, and indeed going forward I expect the less developed parts of the world to grow much faster than the developed regions.  In the long run all countries will be rich, but I believe that culture plays a role in how fast they’ll get there.

The recent “global recession” might well have seen the fastest progress in all of human history.  Here are a few snippets from The Economist:

National campaigning will start after various state-assembly elections in November. Observers expect a more presidential style of contest than usual. So television will especially matter: at the last election in 2009, 460m people [in India] had a box at home. Next year nearer 800m will.

And from the same issue:

Mr Webb estimates that since 1994 rural income per person has risen at an annual average rate of 7.2% in real terms (compared with 2.8% for urban incomes). Between them, the rise in income and better connections add up to a radical transformation in rural Peru. The study suggests the two are closely related. It points to the wisdom of boosting investment in infrastructure in the poorer rural parts of Latin America: Andean roads are vulnerable to rains and mudslides and need active maintenance, and there is scope to slash journey times further. Clearly, peasant farmers respond as creatively as anyone else to the opportunities that come from being connected to the market economy.

For most of my life I’ve thought of the world as being overwhelmingly poor and rural. But just in the past few years things are changing fast.  We’ve suddenly gone from most people not having telephones and TVs to most people having them.  From most people living in rural areas to most living in urban areas.  The impact on governance, and indeed culture, will be huge.  Look for India’s caste system to gradually break down.

Market monetarist influence? (butterflies, hurricanes, etc.)

James of London sent me the following:

“4.2 Nominal GDP
The incoming Governor of the Bank of England has talked about the merits of targeting nominal GDP (i.e. GDP at current market prices) instead of inflation as the anchor for monetary policy, which led some commentators to point out that potential barriers to such a policy are the timeliness and periodicity (quarterly) of nominal GDP figures, and the extent to which they are revised.

In the March 2013 budget, the Chancellor of the Exchequer announced an updated remit for the Monetary Policy Committee. Although this signalled no shift from the existing 2% CPI inflation target, it opened up the possibility of a more flexible approach, including the use of intermediate thresholds such as nominal GDP, in exceptional circumstances. The Chancellor asked the MPC to produce an assessment of the merits of using intermediate thresholds in its August 2013 Inflation Report.

In response to this, ONS has recently published an analysis of revisions to nominal GDP (as outlined in section 3.4) and, in the light of this, will be considering possible improvements to the timeliness and quality of nominal GDP estimates to meet the increased user interest. This will enable ONS to respond to the MPC’s assessment in August.”

Remember all that discussion of NGDP in 2008?  Neither do I.

PS.  Larry Kudlow did a piece last night on CNBC, discussing who should replace Bernanke at the Fed.  He mentioned six possible names, and, well . . . . you’ll have to see it for yourself.  BTW, I agree with Hilsenrath that Greg Mankiw would be an excellent choice if Obama opts for a Republican.

PPS.  I understand that people are having trouble processing the idea of me being in charge of the US economy, but stranger things have happened.

The real problem with Rogoff-Reinhart

I’ve stayed out of the R&R kerfuffle.  This is partly because I haven’t read their paper, partly because James Hamilton points out that the mistakes were fairly minor, and partly because Matt Yglesias points out that the real issue is causality, which R&R’s study doesn’t resolve.

While I’ve ignored the R&R study on public debt, I’ve had issues with their claim that financial crises tend to be followed by slow recoveries.  That’s probably true, but we need to be careful before assuming any causal relationship.  I’m inclined to think that most financial crises are caused by a sharp drop in expected GDP growth.  If the shock is nominal, as in the US in 1930s and in Argentina in the 1998-2001 period, then monetary stimulus can trigger fast RGDP growth.  If the shock is real (say Indonesia in 1998), then a slow recovery is almost inevitable.  Expectations of slow NGDP growth can easily trigger a financial crisis, so causation can go in either direction.  Indeed the EMH implies that a sharp fall in asset prices will accompany the early stages of a deep and prolonged and unexpected slump in GDP growth.  Unfortunately, the R&R study led to excessive pessimism about the prospects for monetary stimulus leading to a fast US recovery, and many pundits missed the fact that our case was more like the US in 1933 and Argentina in 2001, than Indonesia in 1998.

James Hamilton recently noted that Paul Krugman is (was?) a huge admirer of R&R’s research.  Here’s Krugman in 2010:

Regular readers will know that I’m a huge admirer of Ken’s work, both theoretical and empirical. Obstfeld and Rogoff is the definitive work on New Keynesian open-economy macro; Reinhart and Rogoff the definitive empirical history of financial crises and their aftermath. It was largely thanks to my study of Obstfeld-Rogoff that I realized, from the get-go, that many of the arguments we were hearing about how modern macro had proved Keynesianism wrong were just ignorant; it was largely thanks to my reading of Reinhart-Rogoff that I realized, early in the game, that this was going to be a prolonged slump rather than a V-shaped recovery.

Hamilton also noted that R&R have been far more accurate in their predictions of the eurozone debt crisis than Krugman, who pooh-poohed the notion of a widespread sovereign debt crisis in 2009.  I notice that Krugman has now begun using phrases like “garbage-in, garbage out” to describe the quality of Rogoff and Reinhart’s empirical research.  (OK, he doesn’t mention their name, but does anyone doubt which paper he is referring to.

PS.  Yes, I will eventually do a post without mentioning the Great White Whale.  But not just yet.

PPS.  I disagree with Hamilton and agree with Krugman on one point—US interest rates are likely to stay very low for longer than most people realize.

The Evans Rule needs to be symmetrical

Last December the Fed adopted a so-called “Evans Rule,” which calls for near-zero interest rates (at least) until one of the following two boundaries are hit:

1.  Core PCE inflation is expected to exceed 2.5% on a sustained basis.

2.  Unemployment falls below 6.5%

This brought some welcome transparency to the monetary policy process, but falls well short of what’s needed.  The basic problem is that the boundaries are in one direction only—markers for when to tighten policy.  There are no boundaries provided as to when monetary policy needs to be made more expansionary.

Suppose it took 1000 years for the US to reach either of the 2 boundary conditions.  The Fed could still claim that it had adhered to the Evans Rule, yet no one would regard the policy as a success.  Indeed something like this was occurring in Japan, until the recent policy change (and it’s unclear as to whether they will hit their 2% inflation target.)

Michael Darda recently sent me data showing that the PCE is up only 1.0% over the past 12 months, and the more important core PCE is up only 1.1%.  The obvious solution is to make the Evans rule symmetrical around 2%.  Thus if more than 2.5% core PCE inflation triggers tighter money, then less than 1.5% inflation triggers easier money.

Interestingly, this proposal seems more “dovish” than the Evans Rule, and it is, and yet it’s still too hawkish to fit the Fed’s dual mandate, as it’s equivalent to a 2% inflation target with no weight on employment.  That’s right, my dovish reform proposal is still too hawkish to be legal.  Just one more indication of how far monetary policy has drifted from the golden age of the Great Moderation.  But even small blessings would be welcomed.

I could extend this idea to the unemployment boundary, but I’m not really a fan of targeting unemployment. Obviously I’d prefer a 5% NGDP target path, with 4% and 6% boundaries, if the Fed wants to actually adhere to its dual mandate.  (In a few years we could gradually reduce that growth rate, if we opt for level targeting.)

We can discuss what additional stimulus would be adopted when inflation falls below 1.5%.  It might be lower IOR, but additional QE is more likely.  I’ve argued that QE should increase by 20% per month, until we are out of the zero rate bound, or the Fed owns planet Earth, whichever comes first.  Whatever the Fed decides, they need to be more aggressive.  Although nominal growth has been pretty stable in recent years, despite increasing austerity, it’s also been below the Fed’s forecasts, and below their policy target.

The Fed hopes things will pick up soon.  But hope is not a plan.

Get nominal! (Never reason from a RGDP change)

One of the most disturbing aspects of modern Keynesianism is the tendency for Keynesian pundits to use RGDP data as evidence of aggregate demand changes.  And I don’t mean just occasionally, I mean 98.6% of the time.

In fact, RGDP can be affected by either demand or supply shocks.  If one uses RGDP changes as evidence of demand shocks, then the Keynesian model becomes close to tautological.  RGDP weakness must be caused by demand-side problems, because poor RGDP data is defined as a demand-side problem!  Thus you have the absurdity of people like Noah Smith proclaiming Paul Krugman as some sort of superhero, because he predicted that fiscal austerity would reduce AD in Britain.  When British RGDP does poorly this is trumpeted as “proof” that the Keynesian model is correct, even though supply-side problems explain at least 75% of the RGDP slump, and perhaps even more.

Of course there’s a much better way—use NGDP data as evidence of demand-side problems.  If Keynesians would do this they’d find lots of evidence of demand shortfalls, even in Britain.  But they also might find that the rest of us take their views more seriously.  Right now non-Keynesians simply tune out everything they say;  “Oh there they ago again, blaming all the problems of the world on demand shortfalls.”

You often hear people say “Get real.”  Keynesians need to get nominal.

PS.  On occasion a Keynesian will point to low inflation numbers as evidence of demand-side weakness.  For instance, Mike Konczal did so in this recent column.  Can someone please find all the cases where Konczal, Krugman, or any other Keynesian pointed to the unusually high inflation in Britain since 2008 as evidence excessively high AD?

PPS.  One other advantage.  Krugman complains that Lucas, Cochrane, Barro, Fama, etc, are spouting nonsense.  I guarantee that if Krugman had made his argument in NGDP terms (i.e. too little M*V) then the Chicago group would have had a much better idea of what the Keynesians were trying to argue.  As it is the two groups were just talking past each other.