Recovery Doubts

(The Green-Shoot Worm And The Abracadabra Herd)

It is almost as interesting to follow the way the commentators of the global economy keep moving in odd herds, as it is to watch this wannabe recovery itself. A few days before the meltdown most of the people -- now famously -- thought things would be just fine. Then suddenly the lightning struck and the entire herd changed direction. But it turned out that in policy we believed. The herd changed direction again. Then a lull. Then lightning again. Etc etc etc. My favourite bit in this is the lull. You feel that another rampage is going to happen, you already can smell the change in the air.  But, usually you have no idea which way the herd is going to go.

From the end of spring, we have been wondering whether the recovery was really there. We, The Herd, convinced ourselves that this is going to be a short trough. Perhaps a deep, but definitely short one we were telling ourselves.

Occasionally the herd turned south again and again, mostly rather not on news, but on the observation that if the picture we saw was in the frames of our macroeconomic models, then we would have to worry a lot. Fortunately, we could always remind ourselves that the crisis proved that none of our models had anything to do with reality, and hence unconstrained optimism always won the day.

Now consider the comparison between the current “post a crisis” rally, and other similar one in 27 years ago. Although, it is only concerning the US markets, the table is a vivid illustration of how we are in a very different trouble. The past behaviour of any national economy during recovery from their respective crises is not going to tell us much.

It may be added, that this crisis was the first known truly global crisis. Although there were some economies less impacted than others (Poland, Brazil, Indonesia seem to have benefited nicely), all countries were affected in a significant way. As this blog has pointed it out before, we do not exactly have a model of the global economy anywhere near the quality of macroeconomic models. (And -- khm -- the public's trust in the latter is somewhat ... whatstheword, whatstheword, er, er... ah! disappeared without traces.)

And thus the only hope left is hope itself. (Oh, poetry!) If everybody gets excited about how amazing the future is going to be, by definition the future is going to be great. Square that, you rational expectations theory... (Imagine, along these lines, we could want an Anything!)

Which takes us to these wonderful green shoots that have been popping up Absolutely Everywhere. Consider the following graph (from the St Louis Fed's research page) :

That little wormy thing on the bottom right is the green shoot...

Or look at the retail spending dynamics in Europe (figure 2 in the Eurostat's Recession in the EU: its impact on retail trade). While the overall picture of the European economy is turning much less negative than the abyss looked, hunger for consumption is not exactly here.

It seems that the economic abracadabra herd is just about to go on a rampage on how long the to real recovery will take. This will get really boring after a while...

Copenhagen, Barack Obama, and Global Economics

"Obama damps hopes for final treaty on climate change at Copenhagen"

Grrrrrr.

The week starts with yet more global procrastination.

This blog has had a critical, but hopeful attitude towards Barack Obama's global policies. The global economics observation that the 2007-2009 crisis was an evidence of the failure of pre-existing institutions led to the expectation of a global economic policy framework emerging in earnest. (The view of this blog is that what we have seen so far as recovery is the result of a set of random policy measures, mere stabs in the dark. And in any case, the jury is still out on whether there really is a recovery out there.) Thus the obvious need for global economic policy institutions accompanied the even more obvious need for global environmental institutions.

It shouldn’t have been a far fetched assumption that the newly elected global-citizen-looking, not exactly ignorant US president would be a good candidate to lead the way. This weekend’s disappointing news about scaling down the Copenhagen ambition is the latest reminder of his failure to match these expectations.



The sad truth is that the carbon, or in general the global warming trouble is the easy problem. Or, at least, it should be. In the case of the carbon imbalance, we seem to understand what goes on. We know what should be done, and it would be our global leaders' job to sort the burden sharing out. Clearly, they are failing.

This is very bad news for the global problems that have much less straightforward solutions than the carbon trouble. The easier of these will be the future economic instability. For even if the price of the current inaction will be a trough way deeper than what we have seen now, the effect will be only temporary. Not so in the case of the global ecological crisis. By the time the human societies will be impacted enough to register the catastrophe, the long term damage will be done and irreversible. If the global society is unable to sort out such a -- relatively -- clear cut problem as carbon emissions, there is no hope for the more complicated and less understood dangers.

Barack Obama commented that

"we should not make the perfect the enemy of the good"

Which is a good soundbite. The trouble is that the truthful sentence should have been something like this: by scaling down the Copenhagen agreement we might manage not to make the barely-acceptable-already-far-too-late measure the enemy of the disastrous inaction.

The Honey Trap

(Notes from the Papuan Highlands, from about a year ago)

Imagine that globalisation had turned out differently. It had been not European cultures that somehow got spread and dominated the world, in fact created the ‘world’, but it would have come from the other end of the massive Eurasian continent. Imagine that Augustus, Kepler, Darwin, John von Neumann were actually Papuan highlanders, from New Guinea. Imagine that Papuan armies colonised much of the Globe, then turned them into subordinated states. Then left them, and coerced all into a global economic project.

Then imagine that some Papuan guys would have realised that there were tiny little parts of the world that are still left ‘untouched’. Say, a place called Oxford. Imagine then that they would set up a global institution that would aim to help the ‘poor’. A concept very much defined in their global, that is, Papuan culture and framework. Then imagine that this global help-the-poor organisation was to decide to elevate the people of Oxford from utter poverty. “You know, there 80% of the people are under the poverty line.” Thus a bunch of Papuan gals and guys would descend on the unsuspecting population of our land. What would we think?

In other words: who the hell are we even to attempt to provide a ‘strategic vision’ for the people of Papua?

The Western goodies, like metal axe, machetes, mobile phones, new crops, as well as the occasional electricity and satellite antenna connected television sets are as much a draw here as anywhere else. But, they are real honey traps. They come with the bible, with pressure to get ‘civilised’, dress up, as well as alcohol, drugs, and HIV.

And it is all internalised. “You know, our people here are very poor. They are still running around naked.” (Which in itself ignores the fact, that people here have never actually been naked, just had different, and often much smaller clothing items. But they can be beautiful and very sophisticated. These words are of course for our consumption only. What a dismal line of Westerners must have come before us!)

Five decades of being told off for their own heritage, as rich as any other in the world, and unique in every sense of the word, have led to a desperate attempt to assimilate. We have seen gold painted, enormous glass coffee tables with Roman motifs on them: huge pieces of inadequate furniture that had to be flown into the Highlands as there are no roads leading in. Wasting precious resources and flight space. We are fed melons, watermelons, rice, and chicken. Hardly indigenous food here. While not once have we been given sweet potatoes, the Highland staple. (On one occasion, our lunch, in the very middle of the Highlands was flown-in especially from the coast, in fast food like packets!) Most of the new buildings try to imitate western styles or other, wealthier parts of Indonesia. There is hardly any architectural reference among the housing of the well-to-do to the local heritage.

In other words, our cultural intrusion is screwing up a 45,000 year old society; or more precisely, a system of small societies. (There really are 253 languages for some 2.5 million people.) An now we will bring more roads, and ports, and airports, and a lot of hydro plants, and electrical grid, and water supply.

Which takes me back to a previous point. Who the hell are we to do this?

What is the justification for us to think about the “place of the Papuan society in the global economy”? Our intellectual toolbox is very much the product of the European cultures. Economics, is a western society-management engineering discipline, that is coming from, with its assumptions, questions-to-be-answered, and methodology, from West European socio-economic systems. Our values that we project onto the ‘objectives’ of economic development are themselves of European origin, even if in that case the net goes a little bit wider.

Opposed to that, the de facto European-in-origin global culture split from what is now Papuan Highlander, maybe around 40-50 millennia ago. There was no intermingling whatsoever until 1956.

I probably should have stayed at home, and let others do the destruction. In my value system, you don’t screw up others’ cultures. Unless you haven an excuse.

So I made up one: global impact community.

Nature's Planetary Boundaries

A fantastic Nature page on Global Boundaries. The only missing item is the human society and global economics...

This Nature publication is a great overview of the boundaries that humanity should not cross, if it wants to ensure its survival. However, you can really not do this well, unless you deal with the nature of human society itself. You cannot treat the global society as being separate from the earth-systems. Albeit there certainly are plenty of special human phenomena that are so distant from the environmental issues that no linkage makes any sense (the financial crisis that we just have experienced is one of these), the relationship between the two is not unidirectional.

Economic inequality can create migration, for instance. Migration tends to create environmental pressures. These often manifest in chopping down forests, burning the wood, releasing the carbon from the peatsoil into the atmosphere, the collapse of local ecosystems. These in turn tend to worsen the economic conditions, especially in a development setting, generating more migration. -- In this example, where is the boundary? There is none, for the social and environmental dynamics are interconnected.

The need for a common approach is trivial. It seems, though, it is not happening fast enough.

Global Economics On Ecological Diversity

(Two notes on diversity.)

Note one. The we are making a mistake by focusing on carbon. Carbon is easy.

The claim that the carbon problem, or in general the problem of global warming, is easily solved might strike you as an odd statement if you are involved in the effort to curb the release of greenhouse gases into the atmosphere. Clearly, getting the global society to recognise the problem and act accordingly is very difficult. However it is difficult only because at the same time that we are trying to limit the total amount of greenhouse gases that are sent up into the air, the global society is also in the process of learning to think about global processes, and setting up institutions that could generate, implement, and enforce common, global action. Still, the problem of carbon, the phenomenon itself, is quite simple. At least in the short run, and that is where the focus is now.

Compared to that, there is another global problem, also of environmental nature, which is pressing, and harbours big dangers for us, humans. This one we could also do something about, but it is devilishly difficult to figure out what. In other words, not only getting our act together is problematic but also knowing what to do.

This problem is the threat to biodiversity.

What makes biodiversity so difficult a question has to do with two quite different reasons: the meaning of diversity is localised in specific ecosystems, and we know very little about it.

First, biodiversity, it seems from the outside at least, is really just a cover word, referring to there being a high level of variation in an ecological system. When you get down to the problem of actual ecological diversity in the Amazonas or in New Guinea or in the Congo, very different geographical conditions and evolutionary history would yield very different systems that have nothing to do with each other.

This is of course trivial, but my suspicion is that not only the species and the ecosystems in different parts of the world have nothing to do with each other, but also the problem of diversity is very different in its different particular manifestations. Models work in abstraction, but in practice you need to take the local reality into account. (This is not so different from the problem of economics, where we have some more or less well functioning models of an abstract economy, but anyone who tries to apply them to a new economy, plugging the data in, would not gain the first idea what that place was about. You really need to go there and dig yourself into the economy anthropologist-style to have any kind of meaningful insight.)

However, all these local ecosystems with their local manifestation of diversity make up the global ecological system, the Biosphere. A local collapse of ecosystems can devastate local human societies. So we suspect that a similar process on a global level may turn the Earth into an uninhabitable place, at least for humans. But we do not know. In other words, the local ecosystems may form a global ecosystem, but we know very little about how that global system works. Diversity probably has something to do with the stability of the Biosphere, but perhaps diversity is just a characteristic of a system, a measure, with a lot of different mechanisms behind it.

Second, we are so incredibly ignorant about the real diversity out there. This in itself would not necessarily pose an urgent problem, had our actions not resulted in a rapid destruction of this diversity. It seems that there is no other way to get ourselves together and stop those actions, than learning first about the variety of life, and also what it means. Yet while we are in the process of slowly convincing ourselves that preservation of wildlife, the halting of deforestation, or the protection of coral reefs are good ideas in general, we keep on doing the stuff that leads to the depletion of ecological systems in practice. It seems that the past 20 or so years of environmentalist activism has led to the more or less general acceptance that extinction is bad, yet we still focus on individual species and not on systemic effects, which we just do not know enough about.

One of the preparatory materials that I sought to acquire before going to West Papua was a list of endangered species. I could not get one. After having talked to a relatively large number of naturalists who work on western New Guinea, I realised that such a list did not exist (if you have it, please let me know). Even more of a shock was to learn how rudimentary our understanding is about the ecosystems of that part of the world. Not only do we have enormous gaps in our list of species, and can only suspect that there are many more than we know about, but our current description of all but a few species is extremely basic: a name, and some brief description about how it looks. (This was truly a shock. I was nurtured on the ethological approach, in which you think you know the behaviour of a species if you have annotated notes for 2000 hours of observation. An expectation that was combined with my experience with the developing countries I covered, where there was always a history to read first, all those fantastic museums to go to, and if you ran out of other options, you could always just ask them. Well, this luxury is not there if you’re into biodiversity.)

We know that the current rate of extinction, directly linked to human action at a very high probability, is comparable to the previous five big extinction events in the history of life on Earth in magnitude. Alarmingly, it seems that this one is also much faster. The ecological models suggest that a global level extinction event will have catastrophic consequences for the environment in which human societies exist.

So there is my first rant. We, as a global society are targeting the easy problem, by putting almost all our energy into carbon and global warming. In two months, we might even have a major step towards sorting it out -- which is / would be great. However, we have taken our eyes off the ball. The rapid loss of biodiversity is a much harder problem to crack. Not cutting down forests is probably a first step. But almost certainly learning about it, that is going out there and mapping what is out there, would be the most important and urgent move on our side.

Note two. On the narrow-mindedness of naturalists when it comes to the human society and cultural diversity.

There was a very particular phenomenon that I observed as I chatted about West Papua and its development problem with biologists. While the quest for a sustainable development pattern was the focus of every social scientist, all the biologists without exception had a suspicious side look at me as I told them that I was a World Bank hired development economist on a West Papua infrastructure mission. One question always followed: why don’t you just let them be as they are? Why do you have to go there and change their lives? Wouldn’t they obviously be better off without the kind of development you bring, and without their resources being exploited by foreign companies?

The first part of the answer is that these tribes have already been opened up. They have already started a path to globalisation and global integration, a path that is almost certainly irreversible.

But this is not the point I am trying to make here. Instead, it was striking how homogeneous the biologists’ approach to the economic development problem was. I realised that these researchers were so entrenched in studying and protecting ecological diversity that they did not understand cultural diversity. It seems, that ecologists see all human action, at least since the arrival of agricultural technologies, and definitely since industrialisation, as devastating for the environment. The best way to protect the forests from being felled, the fish stocks from being over-harvested, the coral reefs from being disturbed, is to let the people who have been coexisting with these ecosystems in relative balance for millennia just go on in the way they have always lived.

This is fine as long as you’re not talking about human beings. Unfortunately, unlike other animals, people invent technology. If it works, they adopt it. Then they learn it from one another and the technology spreads. The ecologists’ view of how the global society should treat indigenous people is not very different to that of building a reservation. I sometimes point this out suggesting that their approach is nothing short of a human zoo. The indignant naturalist at this point usually refers to the fact that these ancient cultures managed to survive for a very long time and thus have proven to be well-equipped with adequate technology without Western intervention; and claims that at any rate these tribes do not want to open up.

I was very much part of this paradigm before I had went to Papua. My poor wife, friends and relations can attest that I was harassing anybody who was willing to listen about the moral problem of us going there in the first place. Exactly the same set of questions were bugging me: why are we there and who are we to interfere with the Papuans’ future anyway. My preliminary answer to this question was also the same: let the Papuans decide. (I felt that that there was a caveat to this answer, for you cannot expect indigenous New Guinea Highlanders to be able to judge without the kind of global experience that you might want to shelter them from. But, I had decided that the mission was too interesting for me to miss for some lousy moral concerns…)

It didn’t take long to realise that this entire argument is false. The New Guinea Highlanders did not choose to live in closed cultures, in closed societies, but rather were forced to do so by their environment. As any anthropologist will attest, indigenous life in the rainforest is extremely tough. Add to this a 600 km long mountain range, much of it rising above 4000 meters. You do not have shoes, you do not have metal, you do not have pottery, you do not have much control over your environment, and -- worst of all -- your little family and group is surrounded by others who will kill you or harm you if they can. You may be living in a long-term balance with the forests, but it definitely is not the way you would prefer to do it. Unless you are a weirdo. (For my first lesson in in this, see a previous note on the pilot of the Nduga)

The trouble is that in abstraction, the ecological and cultural diversity problems are not that different. In practice, however, they often go against each other. Thus, we have another diversity problem on our hands, and this, the cultural one, is probably even more difficult than that of ecological diversity.

It seems to me, that we, social scientists, are increasingly aware that there is an ecological lesson to be learned. At the same time, naturalists still seem to have 19th century ideas about human society.

Global Economics And Global Government

(Funny how an idea that looked so strange and impossible even a few years ago, is self evident now.)

A very odd thing is going on in the world. The rise of the global market led to unprecedented global flows of products and services, technology and capital, people and resources. International economics is giving way to global economics. It has become clear that there can be no national stability without taking into account global systemic risk. And there can be no - or at least little - national economic development without being integrated into the global economy. We are living, in other words, in a global socio-economic system with global stability risks, global environmental problems, and global resource constraints.

But we do not have a global government.

If we look back to the way we thought about the world even ten years ago, it is striking how much more global our problems have become. The economic crisis (arguably one of the two largest in the Western world ever, and probably the first truly global crisis) has highlighted the cost of not having a global financial regulatory framework. The panic and despair of policy-makers as they have tried to react to the meltdown has made us painfully aware of the necessity of a global economic policy framework.

At the same time - and independent of the crisis - economic inequality and the lack of a global cultural framework bring serious instability issues.

And if that was not enough, the world, or to be more precise the global society, is learning how to live with an ecological system that has run out of buffers. The climate is warming as a direct effect of human action, the Earth is going through its sixth major extinction period (and all signs show that this is also the fastest), fish stocks are almost certain to collapse in the foreseeable future as a consequence of overfishing, and our short-termist exploitation of resources is set to make a large part of the global population destitute in the coming decades.

To top it all, the threat of nuclear proliferation has returned, a situation which is certain to worsen thanks to easier access to technology and a renewed interest in nuclear power, both of which we otherwise see as positive developments.

Imagine that the above list of functions and problems was not about the global society and the global economy or the biosphere or the global climate, but were characteristics of just one country. It would be obvious that this country needed country-level rules to prevent financial meltdown. It would need institutions able to manage the economy and solutions that would ensure internal systemic stability, whilst preventing self-destructive, unnecessary weapons from spreading. We have known for quite some time now that there is no other solution to the tragedy of commons problem than a communally accepted and enforced set of rules. These are all government functions. Obviously.

The funny thing is, that the above reasoning is a technocratic argument and not a political one. There is no need for any other values than the value of human survival and common sense (in economics terms, a not very high discount rate of the future, and a minimum efficiency requirement when managing socio-economic systems). There are no other norms at play here. It should not matter whether you are socialist, conservative, or liberal, or any other flavour, as long as you agree on the value of human survival and common sense. And, apart from some fringe movements, these values are rarely questioned. The rest should be straightforward.

But it is not.

The global society is now learning to think hard about itself. Our record in creating knowledge about our global self is not bad at all. Global climate models were extremely rudimentary 20 years ago, and did not exist 40 years ago. Global economics was still international economics five years ago, and there were no global economic models whatsoever 30 years before that. Even a few decades back we did not understand the first thing about ecological systems or the role of human societies in them.

The trouble is that we are not learning fast enough. We understand short-term climate change well, but our understanding of the long-term climatic cycles is very limited. Thus we know that it is getting warmer but not compared to what. We have unprecedented quality and quantity of economic data collected in publicly available data sets, combined with computing capacity that we only dreamt about a few years back. Still our economic models can predict the behaviour of the global economy only a few months or perhaps a year ahead, at the best of times. Worst of all, although we increasingly understand the fragility of the ecological systems that we are part of, our understanding of the details and thus our ability to intervene is extremely limited.

We need some serious thinking about the global socio-economic and ecological system, and we need to get down to building those global institutions earlier than later.

Global Policy Options Open Up Again

(Two boats, a lot of waves, and one Mount Fuji)

There’s a new law of global economics: the deeper you are in a crisis, the emptier the policy tool box becomes. And the emptier the policy toolbox is, the more similar the measures become in practice. (Global economics starts its life in a very odd way…)

Before the credit crunch, we all thought that monetary policy was rapidly converging towards flexible exchange rate based inflation targeting, while fiscal policy keeps being all around the place. The size of the state relative to the economy, the structure of the tax system, the principles governing the government’s actions, as well as the source of legitimacy and relationship with the population, all varied tremendously. It was not only that the mature economies were following very different paths, the US and Sweden being the two different poles, but also emerging markets started to display a very varied set of behaviour. The logic of high resource revenue - weak manufacturing wealthy emerging markets is drastically different from the logic of manufacturing export-based rapid structural change countries, or even from the logic of commodity exporting but poor economies. The world of the mid-2000‘s was dominated by monetary policy convergence and fiscal policy divergence.

This picture changed dramatically a year ago. As the monetary transmission mechanism disappeared, suddenly central banks were at a loss, and governments found themselves in shock, imagining the picture of total collapse. And there came the surprise: there was more homogeneity among the panic policies than any time during the past two decades. As the world economy was nosediving towards the abyss, the fiscal solutions employed around the world were all being read from the same book. In the course of the past two years, for example, the average budget deficit of the advanced economies shrunk from -0.5% to the the staggering -4.5%. As a consequence, the average OECD gross debt per GDP measure, for instance, is jumping 26 percentage points to 100% between 2007 and 2010.

Which is funny, for probably, the way governments started to spend as well as the magnitude of the fiscal stimuli was far from optimal. However, wanting to appear as proactive during the crisis, most governments ended up doing the same as others, and against their best protectionist wishes they ended up providing the world economy with a decent fiscal push. As an example, the total increase in budget deficit of the advanced economies (using the IMF’s categorisation), amounts to 5.2 percent of the global GDP. Add to these the gigantic government boost in a host of emerging markets, China, India, Brazil being the prime examples.

Curiously enough, now that the recovery seems to be under way, the policy space seems to be opening up again. Some of the badly hit countries, like Japan (expected to reach 197% in 2010 from 172% in 2008), Italy (to 127% from 112%) or Hungary (to 82% from 73%) were already in a tight spot, while Iceland (to 62% from 34%) or the UK (to 91% from 54%) or Ukraine (to 35% from 20%) had started off from relatively good debt positions (although the premia varies tremendously of course). Clearly, some will find it easier to restart their economies than others.


The variation in the upcoming fiscal constraints does not stop with countries in trouble. While Germany and France already see the signs of recovery, they are way out of the Maastricht bounds, and thus they will have to combine the management of slow recovery (and possibly a jobless one, see previous posts on jobless recovery and the role of technology dynamics in jobless recovery) with getting back into the limits they never supposed to have left. Compare that to Sweden’s 46.6% that was virtually unchanged from 44% in 2008, which -- combined with the fact that they reduced it from 80%, where it was a decade earlier -- shows real discipline. (Or take the Czechs, Denmark, Finland, all expected to be under 40% in 2010.) -- Check out the OECD's "Beyond the crisis" report.

The consequence of this might shape the global economy’s dynamics the post-crisis years. We might find that the combination of the new primacy of fiscal policy and the variation of fiscal capacities might have a long-lasting effect. If the 2000’s can be taken as an indication, the next decade we’ll see new global structures emerging, and activist governments might just give a crucial competitive edge.

Reinventing the BRICs Amidst The Global Recovery

The silly talk is returning about emerging markets as the global economy is turning into a full-blown recovery mode. In particular, there is a renewed hype about the non-existent group formed by Brazil, Russia, India and China: the BRICs.

The reality is that the term BRICs has never made sense in either the International macroeconomics, or the global economics framework. For much of the 1980’s and 1990’s, emerging markets formed a marginalised asset class. Although global finance was itself materialising, most of the action took place in the mature economies, while the developing nations with their backward economies and underdeveloped financial markets entered the headlines only in times of crisis. When in 2001 Goldman Sachs started to use the term BRIC, it was a mere shorthand for the four largest emerging markets that could not be ignored any more. (See how the future of the BRICs was imagined in 2003. Or read the Goldman Sachs 2007 book 'BRICs and Beyond', which is a good book, apart from using the obsolete national economies framework -- it is also a brill reminder how rosy the pre-crisis outlook was. We are rapidly returning to the same dreams and myth now...)

However, apart from size, there never was much commonality among the BRICs. Russia and Brazil are commodity exporters. India, and especially China are commodity importers. China and Brazil are becoming important manufacturing bases of the world economy, and India a specialty exporter. In opposition to these, Russia has no manufacturing exports of importance whatsoever, almost all of its domestic dynamics is based on the raw material revenues the country is collecting. Brazil and India are full-blown democracies, Russia and China less so. India and Brazil have sheltered capital markets, unlike the wild waters of China and Russia. Furthermore, the term BRIC has never really taken off as an analytical notion, and stayed merely as an investment banking sales concept only. And, all attempts by the four governments to harmonise any of their international stances yielded empty rhetoric, no real action (see for instance the official BRIC summit website).



The height of the BRICs hype came in the middle of the credit crunch, when people had started to argue -- notably people who were not emerging market experts -- that the crisis will decouple the largest developing economies from the mature economies. This is based on the observation that while in 1992 only 5% of the global GDP was produced by these four countries, their combined share grew to 15% by 2008. In this process, they achieved breakneck growth speeds, and one could easily imagine how a small dip in their growth would still leave enough momentum to provide an effective demand a bridge during the crisis of the developed economies. A dream, as it turned out.

(The funny thing is that for most emerging market analyst crowd this argument never really made sense. The origin of the difference in the emerging market decoupling expectations might be in the difference of experience emerging economies had compared to the mature one. While the history of the developed economies, at least post-war, is mostly about the rise of their domestic demand followed by their opening up, the history of the emerging economies is more about external dynamics. In the case of the former, structural change tended to originate in processes generated by entities at home. In the case of the latter, almost without exception, the source of the change has always been outside the country. For the Asian tigers, it was Japan, then the US, then the world economy. For the resource rich developing countries, e.g., South Africa, or the Gulf, or Central Asia, it was the global demand for raw materials. For Central European transition economies, it was the West European economic dynamics. The point is that although the rise in exports tended to generate “rapid structural change”, which in turn creates domestic demand, it is a long time down the line of the development before their domestic dynamics takes over the export engine. Supporting this, the experience has always been that at the time of crisis not only exports fall, but so does the previously genuine domestic demand looking stuff as well.)

Thus there is no reason to group these four countries together now any more than before the crisis. However …

The mid 2000‘s, the category of emerging markets had been falling apart, giving space to a completely new grouping of developing economies. However, as the global economy was melting down, emerging markets started to behave like coherent group again. While, their rise was differentiated, they are plunged was synchronised. We were back to the old world.

Yet, now they are coming out of the ditch, and some are rising more unscathed than others. Early calculations even suggests that unlike the BRIC’s, there are some emerging markets that did even contribute to the global recovery. Indonesia and Turkey might be two candidates for this role. (But it is far too early, as the data for the summer is not out yet.) The pecking order, to say the least, has changed. If there is going to be a table at which the new global regulatory framework, or even a currency framework, will be set, some emerging markets will want to have a seat there. And it will be the large ones and the healthy ones only to have a chance to get it. (Ukraine, Hungary, Argentina need not apply.) And thus, even if neither the old term BRIC, nor its new versions would make any more analytical sense than any time before, a global politics shorthand to the new guys at the table might be handy.

If so, we surely have some better name for them than the one that sounds like the “rectangular-shaped, heavy clay object”.

Global Economics’ Disappointment In Barack Obama

Once upon a time there lived a very very large dragon. This beast was the scariest of all creatures ever lived. It was taller than a house, and its mouth was big enough to gobble down six little children at once. Its teeth? Oh those giant, yellow teeth were the largest, sharpest, spikiest in the whole wide world. There were all kinds of princes, kinglets, knights, and quite a few of the smallest and cleverest sons of men with agricultural occupations trying to fight off the fearsome dragon. But to no avail. The world was getting darker by the day. Even some very brave princesses had a go at the beast, but they failed too. Everyone who had gone up to the firebreathing basilisk, either got a bit burned and went home, or died the most horrifying of deaths, deep in the dark lair of the monster.

There was only one who could stop it.

But he didn’t.

And that’s the end of the story. Goodnight.


Obama is disappointing the global economics crowd again. As the crisis went into full swing around a year ago, the global nature of the meltdown became undeniable. "Sweeping global actions needed", went the empty words at every summit. But, there was a problem. The global policy that could have dealt with the root causes of the crisis and stopped the spiral would have required more than just a few one-off actions. Rather, a lasting institutional framework on the global level with powers to set, implement, and enforce policy would have been needed. However, there were no political leaders that could’ve led the transformational action. The US was amidst its presidential election, and unlike Clinton eight years earlier, the Bush administration lacked the global clout, as well as the will to rise to the challenge. The new Obama administration was, obviously, nowhere in sight. After its lost decade, Japan was not in shape, either. And the Chinese government was still well before its change of tack with regard to global institutions. The most likely candidate alternative to the US, the EU, failed yet again to come up with a common idea about what to do with the global economy, or even to put forward one person to represent it on the world scene.

Granted, the leadership should have been intellectual as much as political. Despite the pretence of the macro economics profession, neither analysts, nor policymakers had the first idea about what was going on.

This blog has argued the need for theoretical innovation: a new global economics. The main argument against it was that you should not use untested theories for policy-making. (Which is rather funny in retrospect having seen the random policy “innovation” to which politicians turned in their utter panic.) In any case, the global economics policy argument in its current form is not necessarily pushing for a new theory, rather the recognition that the subject matter of our research, as well as, our policy problem has moved from the national level to the global level. Thus, we end up with the same conclusion: irrespective of whether the world economy will end up being modelled in an international macroeconomics framework, or a new global economics framework, the rise of global economic policy institutions is inevitable.

Barack Obama, as the new president of the US, came to power with unprecedented global political capital. Not only was he seen as a possible, legitimate leader for the entire world, but the Bush administration’s policies, as well as the failure of the governments of the developed economies to stop the crisis, had left a political vacuum. Obama was seen as the only one who could become the leader the global economy needed. He combined credibility and trust, the hope of a fresh start, and the power to act.

It is unfortunate, at least from a global economics point of view, that he did not use this opportunity. His domestic economic policy hardly contains any new vision, most of it is a mix of traditional economics and policy solutions already tested in other countries, mostly Europe. And his global economic policy … Well, there is none.

Just as we did not understand what was really happening as the global economy was spiralling into recession, we do not understand how it is coming out now. If it is coming out, at all. But assuming that recovery is on the way, it is nothing but the lucky, unplanned, undesigned outcome of a set of spur of the moment, short-termist policy actions. Bar another stroke of luck, the next crisis will bring much scarier pictures than those we have seen this time. History, I fear, will be harsh on Barack Obama.

G20 In Yet Another Fake Action

Is that very funny how the G20 is doing it again? As the crisis unfolded, some 'out of line' people suggested that banks should perhaps be treated as utilities. They were wiped off the table. Now, that it is becoming clear that the largest economies of the world will again fail to harmonise real policy action, they are pledging to clamp down on the banks together instead. The previously marginalised view of regarding banking services as utilities is returning via plans to increase capital requirements. Banks will be asked to put down more money to back their actions.

The trouble with all of this, is that there is no distinction being made between banking services that aims at the domestic market and banking services that are essentially international in nature: global financial hubs. While there is merit to the idea that domestic economy focused banking provides general services not dissimilar to some characteristics of utilities, it would not be too difficult proposition to defend that the regulations around that part of the industry were in most countries in not too bad shape. Arguably, the US and the UK perhaps were exceptions, but their troubles would not have necessarily translated into a global recession. It was the second form of banking, namely that with global coverage and global reach, that caused the negative spiral. There is no reason for us to believe that this bit of finance has anything to do with being a utility. (Perhaps far in the future, this may change, but it is definitely not the case now.)

It seems, another opportunity is being missed.

Discriminating Against Women in the Job Market

(off global economics)

At the apropos of an FT article about the small rise of the gender pay gap in Britain, I thought I would share an anecdote.

After my years in Cambridge I took a gap year from academia, which turned out to be a gap decade. I was running a smallish research consultancy, seated in Hungary, but covering the macroeconomics and fixed income markets of many emerging markets. Our main client and almost all our smaller clients were in Western Europe. The size of the unit, at its peak, was 25 people. All our admin personnel were local Hungarians, but the analysts were not, we always tried to hire people from countries that we were covering. That gave me an insight into both how the labour market works in a host of emerging markets, but also the kind of decisions an entrepreneur has to face.

One of these was about discrimination.

We tried to be an equal opportunities employer. It so happened that as the research team grew it was entirely made up of white men. The two admin personnel were women, and the IT guys were, well, guys. Very traditional indeed. So, at one point, I thought that we should do something about this. We tried to hunt down a Roma analyst, but the market was illiquid, to say the least. We also decided to hire a female analyst. At the time, we were looking for someone from Turkey, and thus we advertised an analyst position in the Turkish media. We had a lot of applications, but all of them were men. Damn it! After some internal debates, we re-ran the ads, but with the line added that women are especially encouraged to apply. Now we got fewer applications, but all of them were women… (This probably is telling about Turkey as well…) We hired a well qualified woman, a really nice person.

But the story does not end there. In our business, our human resources model was that we were aiming at young macroeconomists or finance professionals who had a couple of years of work experience. Then we’d train them in-house, which was mostly on the job training. We had a rule of thumb that a new analyst would take one and a half years on average to become a fully functional, ‘useful’ part of the team. That took a lot of investment, and obviously only made sense if then our colleague would stay on after that period (which most of them did). Except that the nice Turkish lady started to try to get pregnant right after having moved to Budapest with her, also rather nice, husband. We discussed this, she was forthright about it, and Liz and I gave her advice (we just had our first baby a bit before) with regards to doctors and hospitals. It was all fair and fine.

Except for the fact that at the same time, our small company was pouring resources into her. Her, as an analyst. There was no way that we would ‘punish’ her for having a baby by not teaching her. But she ended up having a complicated pregnancy, and was away a lot from her job. And, after the baby was born, she decided to be with the baby a lot, and not to follow up on the previous plans of becoming a professional investment banking analyst. In other words, she made a set of personal choices: getting pregnant, long absence after the birth, and eventual departure from the career path, coupled by some uncertainty linked to her medical difficulties linked to the pregnancy. All of these were her decisions, and all of these bore costs for our research company. Part of the cost was personal: we had to fill in for the unexpected time she was not there, and thus some of us had to cut down on our holidays. One analyst, and good friend, in particular did not have a summer holiday that year, at all, as a direct consequence. Furthermore, her costs both in terms of her wage, taxes, the relevant overhead, and the time we had spent on teaching her were all lost, as well as the search cost that we had spent on a replacement. In a small company this is a lot. There was considerable amount of tension. We did hire an other female analyst from Turkey afterwards, but only because we could not live with the idea of not doing so. We knew however, that if she was to become pregnant too, our company would be in serious trouble.

I have recounted this story here to highlight an issue that is a taboo when talking about the pay gap. We like the fact that women can chose if and when they have babies. We also like the idea of equal pay. The two are in contradiction, and the cost of this contradiction is being forced onto the companies by our societies. In our story above everybody was a nice person, and all of them I count as my friends still now, six years later. But I cannot deny the fact that it would have made business sense to either hire a man for the same cost, or hire a women at a lower cost instead.

Most of my friends would throw hard objects at me at this point…

There are two observations on top of this. One. Obviously, there will be substantial variation among sectors. Some of this will come from economic rationality along the lines we faced, that is, long on-the-job training period of employees, and some along plain misogyny. One would expect that there would be sectors typically female or male due to economic reasons, and others due to ‘tradition’. When the society forces every employer, in every sector to offer exactly the same conditions for young men and young women, it may effectively counter some prejudices, but may, at the same time, force some good guys and gals into an awfully tricky situation.

Two. Perhaps part of the problem is that the feminist movement that highlighted the gender gap issues tends to have an ideological, political agenda. It seems that it is all too tempting for some proponents of the women’s issues to pour an anti-capitalist, anti-market sauce on labour market discrimination. However, unfortunately, this might weaken rather than strengthen the attack.

A solution suggested. I would think that there are two real questions here. First: who should pay for the kids, and second, how to reduce the cost of the inevitable uncertainty, by insuring the risk.

The current solution seems to be partial cost sharing, and coverage of a part of the risk. In the developed world, it does not make economic sense for the individual to give birth to babies, a marked departure from the past. Therefore, some of the cost is being born by the ‘pleasure parents’ who enjoy having kids. Some cost is being covered by the society, by providing education, playgrounds, healthcare, etc., when it does. There is a host of arguments why it may make sense for the society to invest into the future generation. But some costs fall on the employers. They do not get anything in return. Thus they discriminate. Once there are laws against discrimination, I suspect that there will be silent discrimination. The kind of pay-gap that we see, perhaps. (By the way, it is interesting that the gender pay-gap rises during a recession, perhaps a signal that the policy, at least in its current form, is a societal luxury.)

I would think that an insurance scheme to which everybody contributes up until the end of fertility (mid 40’s), or pension age (if you want to take into account that men have a longer period of fertility), which then compensates the companies once their employees go on a maternity or paternity leave, and then which gives a return of funds to those who did not have kids, would be a much fairer system. Companies would not feel an economic need to discriminate, thus real prejudice-based discrimination could be outed, and people who opted (or were unfortunate enough) not to have kids would not have to pay for them. If the society wanted to ensure future generations, then the investment into public education, health care, and child care in general should be increased (by the way, that is the model that seems to have worked for the Scandinavian countries).

You might think that this solution would essentially punish people for having children. You are right, in a way. It is a personal choice with cost consequences, and as long as I should have a control over it, I should pay for it. If you think that this is silly for then people will not have any kids, then your worry is probably about the future generations, and thus a societal function. You can solve this by increasing the state investment into kids.

However, for this, or any other solution to the opposing values of equal opportunity, personal liberty, and social fairness, to work, one needs to accept that the problem is much more complicated than just traditional prejudice lingering on. And talking about it should be a taboo no longer.

Taking Count

In academia - unlike in my previous profession - one might occasionally be asked to check out his own previous forecasts. So here it is: a qualitative revisiting my global economics forecasts of the past two years.

One. About the nature of the current crisis. The argument originally put forward was that the current crisis is that of models and not that of over-hype or under-regulation, as suggested by most commentators. In particular, the observation went, the underlying problem was not that risk was ‘excessive’ or that ‘shameless finance professionals sent the world to the brink’ and not even that ‘corrupt politicians deregulated the banking sector to the extent that the world turned into a gold rush town’.

The argument was that instead of risk being badly structured and managed, the root cause of the crisis had been the improper valuation of risk. Which, in turn, was due to the lack of adequate economic models. The global economy had bloomed into something entirely new, while the economic modelling and forecasting profession still treated the national economies as the unit of analysis.

The evidence came in (a) observing that such an uncertainty about global processes increased in several other areas as well (global c/a imbalances, emerging markets), before the crisis took the particular manifestation it did; and (b) demonstrating how the IMF, albeit keeps pretending otherwise, has no clue as to what will happen next (which is bad news as they do have the best global economic forecasting system to date).

The forecast was then that there surely will be a new breed of models, or at least a call for them, that would explicitly make the global economy its primary subject matter. Furthermore, the suggestion had gone that this new, global economics, will be as different from macroeconomics, as Keynes’s innovation seemed compared to the microeconomic mainstream of his day.

This forecast failed totally. The consensus of the economics profession - after some early hesitation - has become that all what we had seen is originating in the US banking sector, and is primarily a regulatory failure, although with systemic consequences. Furthermore, there seems no global Keynes in sight. At least I have not seen any breakthroughs that would offer a whole new theory passing as global economics. And those who have called on the economics profession to generate new ideas, stayed - disturbingly - in the language and theoretical framework of macroeconomics, or even worse, the engineering science of economy repair and management...

(And certainly, my hopes that my global models based on networks would bring one of the new insights, I am sad to report, were also unfounded. The network dynamics - I think now - does seem to reveal some structural properties, but will - at best - offer only a refinement to a macroeconomics based global view, rather than a completely new one.)

Two. About the global policy institutions emerging. The argument on this one was really a consequence of the above. If there is a global economy out there which contains all the national economies, but which at the same time, is really an entity in itself, then no policy could work unless it was on that, global level.

The rest is fairly straightforward. National level economies will have only a limited reaction to the national level policy mix. National level regulation will not work, as they have not in the years before the crisis broke (and on this point I agree with those advocating that there was something wrong with the regulation of finance); national level monetary policy will be very limited in its extent; and national level fiscal policy will have long term negative consequences - although might work in the short run. My forecast was that all of this will result in the emergence of a whole new set of global economic policy institutions. An effective global regulatory framework, with enforcement ability, not just information, a cooperation among central banks so strong that in itself could be regarded as a global monetary authority, and global fiscal policy of some sorts - perhaps Maastricht like limits and some global emergency intervention authority (an extended IMF like role).

And thus another failed forecast had been revealed. The worry that instead of going global, super-costly protectionist measures will be implemented on national level is becoming the reality. Early, and way too weak attempts towards a global regulatory framework seem to be falling through. Fiscal policy never really was meant to be harmonised (although there were lots of talk about it, mostly after summits, followed by a renewed set of rather local fiscal action). And early harmonisation of monetary policy is turning into a currency feud, especially between the Fed and the ECB.

One should learn from his mistakes. But a habit is habit. I still agree with my original analysis, as well as the forecast that came out of it. Despite the occasional talk about green shoots (the latest is the ADB’s forecast for Asian growth returning to 6% next year, published yesterday), I can’t see any apart from wishful thinking, and I cannot see how the current policy mess will be sorted out following the current trajectory.

The trouble is that if the above argument happens to be right, then the times coming will be much worse than what we have seen so far. High global inflation, low growth, jerky policy moves (probably around taxation and desperate ‘policy innovation’), and plenty of protectionism. Apart from being a tough time, the Earth might not even be such a safe place to be in.

Technology In Jobless Recovery

The technology-update dynamics (see previous post) is central to the argument that the current crisis will finish with a jobless recovery, similar to the years after the 2001 dot.com bubble burst.

The raw form of the hypothesis suggests that the firms that had shed labour during the recession subsequently invest into technology, new technology in particular, rather than expand their labour force, when demand for their products is renewed. Here are some interesting graphs (source: Fed):

Or, in a different version (using the same data as that behind the second graph above):

(The above graph: US manufacturing growth rate MoM, minus the same without the high-tech sectors. The red line is the 12 month moving average. The second half of the 1990's is clearly over the average of the rest of the period, and the return to normal is rapid after the 2001 drop. Although this is no proof, it seems at least consistent with the hypothesis.)

Both of the above graphs suggest that there was a substantial amount of over-investment into technology before the 2001 crisis, and thus the 2002-04 years saw a productivity rise as a result in part of using the previously acquired technology, and only in part because of purchasing new technologies.

Interestingly, this is not necessarily the case for the current crisis: the level of investments into technology seems to have been on par with the rest: there was no over-investment into technology that would jump out of the data, at least not the data I am looking at now. However, the hypothesis does not necessarily require a previous over-investment, only the potential to increase production without new labour. Thus a lengthy halt to the technology-intensive fixed capital could do the same. If this was to happen so, there would be a fairly straightforward equity price consequence...

I have been trying to find data for comparable variables for the rest of the world. (The usual trouble: lack of comprehensive global statistics). The best I could come up with is the share of computer and communication services in services imports by the WBDI. Each regression had a linear time variable, and a dummy for the 1996-2004 years. Here is the result:

Eastern Europe, Latin America, Middle East, South Asia: either not significant, or low R-squared. East Asia, and the Euro area behaved - at least by this measure - in line with the US and the hypothesis. And so did Sub-Saharan Africa (but why, if the rest of the emerging and developing world did not?)

In sum, these back-of-envelope results do not contradict the hypothesis that jobless recovery stems from an underlying technology dynamics. In the case of the 2001 dot.com bubble, it seems that the productivity rise came, at least partially, from the over-investment into technology during the preceding years. This seems to be true for the mature economies, not only the US, but less so for the emerging world.

It also seems to be the case, that the mid-2000's did not accumulate excess technology intensive capital. Thus the current crisis would be different.

At the same time, the length of this recession means that investment is halted for a long time. Perhaps that means a strong demand for the new technologies after the crisis, as well as another jobless recovery.

The Jobless Recovery Scenario

The jobless recovery scenario goes like this. (1) During a recovery (as at all other times) the basic labour market identity holds: the number of people employed depends on overall demand and productivity. (2) Productivity growth depends on innovation. (3) While the relationship between employment and demand is short term, the relationship between productivity and innovation is long term. Therefore, when there is a short-term drop in economic activity, you can expect to see a fall in employment, but innovation goes on. (4) Thus when demand rebounds, there are a lot of new technologies around, and it pays to be the first to invest into them.

There was an important ‘if’ at the core of the worse case scenario: the recession will not end if the global confidence level goes where it should - to the bottom of a deep mine. Unlike with real gravity, economics is an odd place, where one might actually lift oneself up by pulling one's own hair, Baron Münchhausen-style. We saw a similar global bubble before the crisis, where most of the justification for one’s enthusiasm kept being others' enthusiasm. Bubbles can work for a surprisingly long time.

For if people want to believe that the non-existent global policy framework works, if people want to believe that the recent return to growth by asset prices has anything to do with fundamentals, and if people are willing to believe that everybody else is willing to believe, then such a global pyramid scheme might even work. In a Startlingly Pink World, there might not even be a reason for this new would-be bubble to burst; reality might grow up to it.

If that happens, an old phenomenon might return: a jobless recovery. Except, this time, potentially on a global level.

When the troubles started, there was an inevitable comparison to the last Bad Times: the 2001 burst of the dot.com bubble. Though fun, a consensus quickly emerged that there was no similarity whatsoever… Maybe, on the way out, there will be.

The most conspicuous feature of the last time the mature economies returned to growth was the delay in job creation. When the economy was already booming, employment kept lagging.

Here is the original version:



In the above graph: the red line is US industrial production, and the blue line is unemployment (both are re-based to 1997 M7 = 100%). While production returned to previous levels, unemployment stayed at a high and surprisingly stable level for years.

There has a been a lot of discussion about it; here is my version:



The above graph takes the change of the monthly rate of US unemployment data, and regresses it on the change in the monthly rate of US industrial production, and time. All are moving averages of 20 months (that’s where the R-squared peaked). A one-month lag is employed. The time series is the longest I found: 1961 to 2009, and the relationship is very close: 82% R-squared. The graph shows the fit residuals. The interesting part comes when there is a lengthy period away from the mean: the end of the 1960’s and early 1970’s see a long period of ‘too many’ jobs being in the economy, while most of the 1980’s is ‘jobless’, and then comes the ‘jobless recovery’ after the 2001 dot.com bubble.

The whole point is that there is an underlying story about productivity. If you think that in the long run, productivity dynamics rule, then the recovery is catch-up time for firms. During recession, investment into new technologies halts, and thus when there is a return to growth, the surviving companies have the option to buy into the latest technology. As the innovation cycle is much longer than most troughs (if you want evidence, look at the OECD patent stats here), this means that for a while you can increase production by investing into new technologies, and thus delay re-hiring people.

The first time this hit me was during the 2001 crisis, when I was heading an investment banking research unit and a physicist friend of mine told me about the latest developments in the physics of computer technology. We realised that if half of what he saw was really getting into production, the economy coming out of recession would be all about this and not about giving jobs back.

Investment into technology has almost entirely stopped all around the world in the past 18 months. Yet, it is very clear that the advancement of technology has been as fast as ever. And thus, we are wondering if there will be a repeat show.

(Although, I am not at all convinced that this really is the end of the recession, see the previous post. But, if it is…) You could well argue that many of the forces that created the jobless recovery seven years ago, are here now, too. In particular, the productivity mechanism might be very similar.

So, are there any signs of this?

Well, look at an interesting confidence measure from the US:



The above graph is the differential between the demand confidence and employment tendencies, survey based, from the US. (That is above zero means that the demand confidence is above the employment confidence level. The red dots are the 2002-04 years, as well as the last month's data.) Not only it confirms the jobless nature of the post 2001 recovery, but it also provides us with one point, which is very much in the same direction.

Furthermore, if you look at the other countries from which comparable data is reported, support for this argument emerges. Here is the picture of the industrial confidence and employment sentiment data from 19 OECD countries (the red line stands for the annual averages, similar confidence differential as above, positive signalling that industrial production confidence is stronger than the propensity to employ people):



And here is the same, dissected: the red countries are the four that saw the most negative differentials during the post-dot.com burst recovery, and the blue is the rest. (The lines are averages for the respective groups):



Just like the US case, it is clear that at least for the countries that saw a jobless recovery last time around, there are signs that this time might not be that different.

All this depends on the optimistic assumption that the crisis is nearing its end. Which is either still (a) in the confidence measures only; or (b) directly related to fiscal spending. (Sorry, no time to illustrate the second one in this post). This makes this scenario just as likely or unlikely as the worst-case one.

If you wanted to pick, probably it will be the size and length of the boost in self belief that will decide. If there is a moral here, then it must be about there being no point in having small Münchhausen lies.

Now What? The W-Shaped scenario

Is this really the end of the recession?

Perhaps, there is reason to be sceptical about last month’s fashion of optimism.

The new, global economics framework for modelling the world economy in a post transition-phase state is still missing. The models we use still have major systemic errors in them, we obviously still have the same valuation problems and mis-specification of the policy mix. Despite some calling for the New Thinking, there is little new that has been put forward in reality.

Much of the problem in valuations is still here. Others argue that while the visible part of the sub-prime mess is mostly cleaned up, a lot of the less visible, but rather sizeable side-effects of it are still on the books, without ‘proper’ valuation. I would add my own observation, that the way the markets approached emerging markets has not really changed much, differentiation is still not really the name of the game. If the capital markets asked for the a realistic risk premium, some emerging market treasuries would have gone into default, whatever the urgent ambulance package was. In any case, we would see a much wider performance range from emerging markets than was the case the past months.

Plus, the policy response has been mostly inadequate. The global economy has gone through a transition phase the past ten years, making national level policy responses unlikely to do the job. The problem is that to tackle the kind of global crisis that is at hand, one would need to have enforceable monetary and fiscal policy in place, on a global level, and that is clearly not there. What has been there instead, after an initial bout of panic, is a set of protectionist measures, and a happen-to-be-at-more-or-less-the-same-time fiscal stimuli around the world that kind of works as harmonised global stimulus.

Yet, the current stimuli take most governments way-way beyond known territories: deficits are up to levels unimaginable before, and debt as well as debt projections are through the roof. For the majority of the governments the current stimulus it is a one-off action. This one really needs to work.

Which takes us to the really bad news: most of the ‘green shoots’ seem to be directly dependent on the fiscal stimuli. There is hardly anything else. Scratch any bit of ‘end of recession’ data around, independent whether the US, China, Germany, or Australia. Although there is some actual money in the pockets, it is not that much. The biggest across the board factor is the change of confidence. In other words, the governments are inducing a new bubble, and we lay all our hopes on it.

This might work. Yet, there is a significant momentum towards further slowing in the global economy. The multiplying effect of the initial hit is just taking shape. The main survival strategy in sectors hit only indirectly by the crisis has been to cut back spending as much as possible, and try to bridge over the shortage of revenues from reserves and bank loans. Banks are still hesitant to lend (even if they are ordered to by their respective governments, as we have seen many examples around the world), which means that the bridging exercise is mostly from own reserves. And there signs that reserves are running out.

If the global confidence boom will not be sustained, and there is plenty of reason why it should not be, then the coming fall might turn out to be even bigger than the one allegedly bottoming. The W-shape scenario might see a deeper, and longer, second trough.

China Hugs The IMF

(Some good news about China's strategic choices in the global arena)

China's role on the global scene has gone through a spectacular metamorphosis in the past ten years. In the early 1990's China was still very much in the developing economy category. Although it was very large, its international behaviour resembled that of poor countries. Then, around a decade ago, its global action-set started to look more like a powerful emerging market. These were the BRIC years (an term that never reflected any real group of any cohesion, apart from encapsulating a somewhat similarish policy problem). By the mid 2000's China grew out of this category; running short on raw materials it needed to step up the power of its actions. China's search for reliable, long - and short - term sources of ores, hydrocarbon, and food led to a strategic change in the way the country approached its international relations, in particular vis-à-vis developing countries. Hence the new-found Chinese interest in African, South American, South East Asian countries.

As the current crisis intensified, China saw a strategic opportunity to forge closer, long term relationships with a host of weakened emerging markets that found themselves in desperate need of short-term funds. By doing so, China emerged as an alternative to the path offered by the international organisations, the IMF in particular. This reinforced a pre-existing battle between Chinese companies and international aid and development agencies. (I happened to see one of these local battles from close proximity, and can report that (a) it is a very real competition, and (b) all that is said about difference in post-material values is true. The international community's regard for environmental and cultural diversity, and procedural transparency - even if I sometimes feel that its by far not enough -, seems almost entirely lacking on the side of resource extraction focused Chinese approach.)

And thus the news that China committed a large sum (even if only 2.5% of its total reserves) to purchase IMF bonds is so good. Perhaps it has something to do with the country finding itself being less isolated from the global crisis, and thus weaker than it expected. Certainly, the strategic aspirations to take a global role reflecting its perceived self image are also at play here. It almost does not matter. The fact China wants to take stronger role in the global governing institutions as opposed to building its own is the best possible news.

Now the only task is to find out what these global governing institutions will do.

Self-Delusion, Here We Go Again

Many economist spent the years before the current crisis in utter frustration. They saw their bit of the world being upside down, valuations being all over the place, and their arguments being not heard by the markets. "Hey! You gloomy guy! Shut up! If you were right, the markets would have reacted! Have you heard of efficient markets?" And thus the markets pointed at themselves as the justification for their own valuation. "This asset's value is here because we think so. Don't come to us with this shadows -in-the-cave story. That's so last millennium." (OK, millennia.)

This is why it is such an entertainment to watch the global financial markets talk themselves into exactly the same trap. "The end of the fall is here because the prices go up. The evidence is that the prices go up." And we see the analysts modelling the fundamentals scratching the wall in frustration, again, as they try to point out how meaningless the markets' very recent moves are.

Here is an example from the FT:

Traders pointed to China, which yesterday revealed a large increase in raw materials imports, reflecting in part the economic recovery but also Beijing's attempt to take advantage of lower prices to stockpile commodities. Iron ore and copper imports reached a record high last month, while crude oil imports hit their second best month at the same time.

Other analysts said supply and demand fundamentals were still weak, even taking into account China's swelling imports, and said that speculative money was the main reason behind the rally.

"Recent price strength is not based on fundamentals, but on financial flows," said Mike Wittner, oil analyst at Société Générale in London. He said investors' appetite for riskier assets such as commodities was "better entrenched, and more sustainable" than earlier this year.

That't it. "Recent price strength is not based on fundamentals, but on financial flows." Oh, how well I know this song!

U’s And V’s

(Fooling around with the credibility of global forecasts. Or the lack of it therein.)

The collapse of ability to forecast during this current global economic crisis, resulted in the abandonment of the previously employed semi-sophisticated merge of national level macro models, and the return of the U’s and the V’s. The debate is reduced to discussions whether the recession will take a u-shape or a v-shape. Not being able to do anything with the data, one can always ignore it, and assume that whatever is happening is merely a blip in the trend. All you have to do then is to figure out how fast your subject, the global economy, will return to its well established long term behaviour.

And thus the two new ‘theories’ of this crisis were born: u-shaped versus v-shaped. In both cases, the previously ‘detected’ trend will return, the only question is how long we will have to wait for it. ‘Phase transition’ is not exactly in the vocabulary of economics…

On the history of U’s and V’s.

Incidentally, I witnessed a previous occasion for these two letters to rule the explanations-and-forecasts-find-it-here business. The history of economic thought during the post-communist transition will surely spend many words on how the lack of any adequate model of what transition was, of how an economy behaves during those times, and what comes after, had resulted in the rise of discussing curve shapes. Even in some textbooks taught today, well after the rise of the New Theory of Transition, intellectual laziness keeps winning, and the discussion of the u-shaped dynamics persists.

Yet, in reality, the reduction to observing the shape of the curve, an arbitrary pattern projected onto a time series, very much in line with the statistically irrelevant, but much watched ‘technical analysis’ of capital market price data, was merely the result of no models working at all. In the early years of post-communist transition, there were three sets of theories that were offered as ‘the truth’. A bunch of economic-liberal economists, mostly of Anglo-Saxon origin, pushed ahead with the microeconomic theory of privatisation. They should have given up after a quick check, for it is obvious that the privatisation of an entire economy has nothing to do with the lessons learned from the nationalisation-privatisation saga of the British Rail. Nor, did the Theory of Poor People (a.k.a. development economics), for although the poverty stats showed a fairly bad picture, the reality had more to do with very high human capital levels all across the transition world, which rendered much of the prescriptions entirely irrelevant. Nor did the balance-obsessed monetarist approach, for - at the beginning at least - there were no institutions around that could deliver the ‘adequate policy mix’, while the underlying structure was going through a rapid and radical change.

Thrilling it is, how similar the the global economy theory-pretence is to the transition theory-pretence. The intellectual abyss is paired with a yes-of-course-I-know-EXACTLY-what’s-happening shamelessness.

On the consequences on ‘What the hell is happening to me?!?”

The previous post discussed how the IMF’s Word Of Final Truth, as usually taken without the warning about the side effects, has nothing to do with reality. Even if they happen to be right in retrospect, that will be a random event (and an unlikely one, in my view). However, there is one more phenomenon, which is mostly disregarded: the Other Views about where the current troubles come from.

One of the favourite economist bashing topics of our days is how unforeseen the current crisis was. And then a few puts their hands up and say, well, actually, they themselves had foreseen these events, and then follow on with digging up some old forecast of theirs as an evidence. That exercise is semi-interesting at best, though. For forecasting is a multi-dimensional effort in a random world, and thus if a high enough number of people are involved, there will always be some in the tail, to point at their amazing-foresight once the low probability event they forecast takes place.

A lightning will hit this bush! A lightning will hit this bush!! A lightning will hit this bush!!! Watch out!!!! Bang. Thump. Fire. OMG, OMG, I am a prophet! ... Okay, people, here is what you need to do from now on.

(Btw., my mother thinks she has healing power in her hand, so I have been well versed in the beauties of self-delusional explanations well before my first macro class… What the funniest is that she is also exceptionally gullible to the same tricks coming from other charlatans. See also the economics equivalent: the consensus long-term forecast...)

There is perhaps another interesting feature here. That is the other tail-forecasters who foresaw the end of the world, but via a different mechanism than the sub-prime and co. story. I was one of these lunatic visionaries, arguing that the sky is about to fall from some six years ago onwards. But my own eschatological visions were more to do with emerging market macro than with US mortgages. There were also the people who were worried about too high complexity of new instruments, those who worried about excessive risk taking in general (a.k.a., bonus structure induced gambling), and those who kept fretting on about global imbalances, particularly the current account deficit of the US. What is interesting maybe is the common element in the thoughts of all of all of us crazies.

The intersection it seems is complaints about the markets misjudging a particular risk element, and thus ending up with ‘wrong’ valuations. In my universe, it was the lack of separation of different emerging markets. For it seemed very clear that the risk associated with different developing countries by the financial markets had little to do with the real underlying fundamentals. All our forecasts were based on national level behaviour being projected onto a global economic trend, the latter being entirely exogenous variable, in just an aggregate in essence. If the global forecast is solid growth, then portfolio flow dynamics will rule the day. That’s it.

My suspicion is that it was the same lack of real global modelling that lay at the base of all of our fringe end-of-the-world-is-here predictions. In some cases directly (emerging markets, global imbalances), or indirectly (mostly due to lack of adequate policy response to misalignments, valuation or structural, or the misjudgement of the impact of deregulation).

In the post-communist transition case, the u-shape focused intellectual abyss was followed by a set essentially random policy action (a true lab-experiment, given the high number of countries involved in it at the same time) coupled with an independent theory-event (the rise of the endogenous growth models) that gave rise to an understanding about what was really going on. If we insist on being optimists, we might say that the current U’s versus V’s nonsense may give rise to real thinking. For that, of course, you need one of these random policies work first...