Thought du Jour

Recently, I was asked by the organisers of the IIASA conference to mark the 20th anniversary of the beginning of economic reforms in Eastern Europe and former Soviet Union to comment on the lessons of transition. …. [H]ere is my top-seven list.

First …. Economic transformation takes time.

Second, … have faith – capitalism really does work.

Third, … a reformer should fear not populism but capture of politics by the new elites.

Fourth, … do not over-plan the move to markets, but, more importantly, do not delay in the hope of having a tidier reform later.

Fifth, … you cannot teach an old dog new tricks, even with incentives.

Sixth, … do not panic about crises; they blow over fast.

Seventh, … middle-income countries eventually slouch toward democracy, but not nearly in as direct or consistent a way as they move toward capitalism.

Andrei Shleifer, “Seven things I learned about transition from communism“, VoxEU, 5 February 2012.

IIASA is the International Institute for Applied Systems Analysis, based in Laxenburg, Austria.

Russian-American economist Andrei Shleifer (born 1961) teaches in Harvard’s department of economics.

University of St. Gallen (Switzerland) economist Samia Costa measures the effect of government repression on mortality from natural disasters and finds it to be an inverted U. Countries at each end of the repression distribution suffer fewer casualties. Countries whose citizens are mildly repressed experience greater mortality from natural disasters.

Natural disasters have been a major cause of human suffering. Countries with higher income, lower inequality, lower corruption, and more democratic regimes have been found to experience less casualties from disasters. Government repression, however, could also play a role in disaster preparedness. ….

I empirically test whether countries whose governments are deemed to be repressive (and which hence may not expect to receive assistance) experience less disasters and lower mortality rates from natural disasters. I find that overall, countries with worse human rights records are no less likely to experience a natural disaster, but that they suffer higher casualties than countries with better human rights records. However, the relationship between repression and fatalities is an inverted U-shaped, so that countries at either end of the human rights distribution have lower casualties. ….

[To control for effects of other variables on death tolls, the estimated models] include the number of disasters, the log of GDP per capita, the percent of the population living in urban areas, population density, the log of population, the log of development aid, a democracy indicator, corruption, the log of land area, and the absolute value of latitude, as well as a time trend.

Samia Costa, “Government Repression and the Death Toll from Natural Disasters“, CESifo Working Paper No. 3703 (January 2012).

Partitioning the full sample into two groups – low- and high-income countries – Ms Costa reports that the relationship between repression and fatalities is linear rather than inverted U-shaped. For low-income countries, the relationship is positive, whereas for high-income countries the relationship is negative.

This finding is surprising to me. The author does not provide the partitioned regression results, nor an explanation for them, but I think that I might have one. Is it not possible that the relationship between fatalities and “log of GDP per capita” variable is U-shaped rather than linear? Testing the full-sample equations by inserting the square of “log of GDP per capita” would be an interesting exercise. Would the relationship between fatalities and repression continue to be nonlinear? Perhaps. Perhaps not. I would love to find out. Perhaps the author has already examined and discarded this possibility.

US journalist Christopher Caldwell looks at President Barack Obama’s call for a minimum 30% tax on those earning more than $1m a year.

Mitt Romney, a Republican candidate for US president, released his tax returns this week. They showed that he had paid just $3m on his 2010 income of $21.6m, which is just the tip of his quarter-billion-dollar iceberg of wealth. Mr Romney, in other words, is paying taxes at a lower rate than most of the middle-class Americans he seeks to rule. And this inequity is made possible in part by a special rule on “carried interest” that taxes the earnings of managers of private equity, such as Mr Romney, at the super-low capital gains rate of 15 per cent. ….

When Mr Obama and his fellow Democrats held the presidency, the House and a filibuster-proof majority in the Senate, they could have eliminated the carried interest accounting rule in a single afternoon. It remains in the tax code because Mr Obama’s party – which, let us not forget, holds the allegiance of 19 of the richest 20 postcodes in the US – wanted it there.

Christopher Caldwell “Class warfare need not be taxing“, Financial Times, 28 January 2012.

Mr Caldwell (born 1962) is a senior editor at The Weekly Standard, a neoconservative opinion magazine.

Alan Greenspan’s contribution to the FT series “Capitalism in Crisis” is a spirited defence of free-market capitalism. This comes as no surprise, since he is a follower of Russian-American novelist and philosopher Ayn Rand (1905–1982). Ms Rand was a fervent advocate of laissez-faire capitalism.

Greenspan, correctly in my opinion, attributes the economic success of countries in the past century to competitive markets. He fails, however, to defend capitalism from the charge that, unfettered, it produces a very unequal distribution of income. He touches on inequality only briefly, in two paragraphs:

During the past century …, competitive-market-driven economic growth created resources far in excess of those required to maintain subsistence. That surplus, even in the most aggressively competitive economies such as America’s, has been mainly employed to improve the quality of life: advances in health, greater longevity and pension systems that go with it, a universal system of education and vastly improved conditions of work. We have used much of the substantial increases in wealth generated by our market-driven economies to purchase what most would view as greater civility. ….

The often-assailed greed and avarice associated with capitalism are in fact characteristics of human nature, not of market capitalism, and affect all economic regimes. The legitimate concern of increasing inequality of incomes reflects globalisation and innovation, not capitalism. But an additional contributor to inequality in America is our immigration law, which “protects” many high earners from skilled migrant competitors. The American H1B programme is in effect a subsidy for the wealthy, a policy that is anathema to the supporters of capitalism.

Alan Greenspan, “Meddle with the market at your peril“, Financial Times, 26 January 2012.

I will restrict myself to just a few comments. Economic growth improves quality of life for those with rising incomes, but government action is necessary if everyone is to enjoy the gains. Markets alone do not ensure universal access to health care, old age pensions or education. Greenspan must know this. He should write it, instead of describing free markets/central planning in black and white terms. Real economies – including the US economy – are mixtures of markets and government planning (interference).

Greenspan writes that income inequality reflects globalisation and innovation. There is some truth to this. But wouldn’t incomes be almost as unequal in a closed, free-market system without international trade, capital flows or innovation? Wouldn’t there still be greed, crony capitalism and abuse of wealth? I think so, unless the initial endowment of wealth was very equal, but economists (fortunately) cannot run an experiment to test my hypothesis.

In any event, it is clear that capitalism’s ‘creative destruction’ produces winners and losers. Government can distribute some of the increased income from winners, so that everyone gains at least something from economic growth. Greenspan does not mention this. He advocates market solutions, for example allowing skilled migrants to compete with high earners. Competition from immigrants would not, I suspect, have any effect on bonuses of fund managers, or on incomes of the super-rich in general. Nor would it improve earnings of those in the bottom half of the income distribution.

Photos: Ayn Rand, Alan Greenspan

President Ronald Reagan in 1987 appointed Alan Greenspan (born 1926) to succeed Paul Volcker as chairman of the US Federal Reserve. Greenspan served in this position until January 2006, when President G.W. Bush replaced him with Ben Bernanke.

Bruce Bartlett, an historian who became a senior economist at the White House, US Congress and Treasury, writes that Barack Obama missed an opportunity to call for reform of a tax code that “has become cluttered with far too many special tax breaks that cost a great deal of revenue and show little proof of effectiveness”.

Barack Obama effectively threw cold water on any tax reform effort in his State of the Union Address on Tuesday. ….

The president proposes a variety of … special tax breaks for activities in current political favour and penalties for individuals and businesses in disfavor. This is exactly the sort of thing that created America’s current tax mess. ….

Mr Obama’s decision to move away from reforming the tax code this year is both a substantive and political error that I believe he will come to regret.

Bruce Bartlett, “Obama is tinkering with a tax system that needs fundamental reform“, The A-List, Financial Times, 25 January 2012.

Bruce Bartlett (born 1951) was domestic policy adviser to President Ronald Reagan, a Treasury official under President George H.W. Bush, and worked also for Congressmen Ron Paul and Jack Kemp. He is author of numerous books, including Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy (Doubleday, 2006) and The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take (Simon & Schuster, 2012).

Bartlett left the Republican Party and now considers himself to be an independent:

I think the party got seriously on the wrong track during the George W. Bush years, as I explained in my “Impostor” book. In my opinion, it no longer bears any resemblance to the party of Ronald Reagan. I still consider myself to be a Reaganite. But I don’t see any others anywhere in the GOP these days, which is why I consider myself to be an independent. Mindless partisanship has replaced principled conservatism.

“Where is the GOP of yesteryear?“, Democracy in America, The Economist, 2 September 2009.

Columbia University economist Jeffrey Sachs has written an eloquent column for the FT series “Capitalism in Crisis”.

[S]uccessful capitalism has never rested on a moral base of self-interest, but rather on the practice of self-interest embedded in a larger set of values. Max Weber explained that Europe’s original modern capitalists, the Calvinists, pursued profits in the search for proof of salvation. They saved ascetically to accumulate wealth to prove God’s grace, not to sate their consumer appetites.

Keynes noted the same regarding the mechanisms underpinning Pax Britannica at the end of the 19th Century. As he put it, the economic machine held together because those who ostensibly owned the cake only pretended to consume it. American capitalism, more secular and less patriotic, created its own vintage of social restraint. The greatest capitalist of the second half of the 19th century, Andrew Carnegie developed his Gospel of Wealth, according to which the great wealth of the entrepreneur was not personal property but a trust for society.

Our 21st century predicament is that these moral strictures have mostly vanished.

Jeffrey Sachs, “Self-interest, without morals, leads to capitalism’s self-destruction“, Financial Times, 19 January 2012.

The problem is stated clearly, but what is the solution?. Greed has always been with us. How do we restore social restraint? Professor Sachs’ appeal to “regain our moral bearings” is not helpful unless interpreted as a call for political action. And this begs the question, What type of political action? More practical is John Kay’s emphasis yesterday on rules and institutions to direct greed “towards the creation of new wealth rather than the appropriation of wealth already created by other people”. I would add – and I think Mr Kay would agree – that rules and institutions are needed also to distribute some portion of growing incomes to those less fortunate.

Today the Financial Times launches a new series on “Capitalism in Crisis”. An editorial lays out the motivation for the series, which begins today with two articles.

It is now widely accepted that the big increases in pay seen over the past 30 years – the earnings of bosses at FTSE 100 companies have risen as a multiple of median pay from 14 times in 1980 to 75 times – cannot be justified by any measure of performance. As John Maynard Keynes observed, the businessman is “only tolerable as long as his gains can be held to bear some relation to what, roughly and in some sense, his activities have contributed to society”. Both in the eyes of the public and in fact, many companies have failed this test.

Today, as the Financial Times launches “Capitalism in crisis” – a series of articles about the problem of legitimacy that afflicts our economic system – there is a growing recognition that executive pay needs reining in.

“Undermining the case for capitalism“, Financial Times, 9 January 2012.

FT columnist John Plender has written a splendid lead essay, comparing the current crisis with earlier crises in the 19th and 20th centuries. Recommended reading. I would post the entire essay, were it not for copyright restrictions.

This article, the first in a series on rethinking capitalism after the financial crisis that began in 2007, argues that popular acceptance – which is a basic condition for business success – has waned in the Anglosphere for good reason. At the heart of the problem is widening inequality. ….

So what to do? It is not as if there are attractive alternative models. While the west is chastened by the rise of Asia, few would wish to adopt the communist Chinese mixture of state ownership, red-in-tooth-and-claw private markets, wholesale corruption and even greater inequality than the US. As for the cleaner authoritarian approach of Singapore, despite delivering high economic growth, it has started to lose its appeal with the island’s electorate. Nor would many in the west find free-market Hong Kong a comfortable environment.

The real question, as Keynes argued in the 1930s, is therefore how to improve the existing model of capitalism.

John Plender, “Capitalism in crisis: The code that forms a bar to harmony“, Financial Times, 9 January 2012.

Harvard economist Larry Summers supplies the second essay of the series.

It would have been almost unimaginable five years ago that the Financial Times would convene a series of articles on “Capitalism in Crisis”. That it has done so is a reflection both of sour public opinion and distressing results on the ground in much of the industrial world.  ….

But does this reflect an inherent flaw in capitalism or, as Keynes suggested, a “magneto” problem – like the failure of a car alternator – that can be addressed with proper fiscal and monetary policies and which will not benefit from large scale structural measures. I believe the evidence overwhelmingly supports the latter. Efforts to reform capitalism are more likely to divert from the steps needed to promote demand, than to contribute to putting people back to work. I suspect that if and when macro-economic policies are appropriately adjusted, much of the contemporary concern will fade away.

Lawrence Summers, “Current woes call for smart reinvention not destruction“, Financial Times, 9 January 2012.

Mr Summers then attempts to justify “why increasingly affluent societies need to roll back levels of social protection”. I was not convinced by his reasoning, but will refrain, for the moment, from posting anything critical. Read the entire column, form your own opinion, and post a comment on this blog if you have a strong reaction, positive or negative.