Saturday
Jun252016

Hayek and Friedman in Chile

I gave a talk last night on the role of economist as public policy advisor. In particular, I was interested in challenging the prevelent conspiracy theory that economic crises lead to neoliberal policies, which lead to bad outcomes.

I think this theory rests on two important pieces of ignorance about economics. The first is the conflation of neoclassicism (a method) and neoliberalism (an ideology). I explain more in this IEA blog post. The main point:

To the extent that ‘neoliberalism’ has come to dominate western policy making, it isn’t liberal. To the extent that ‘neoliberalism’ is extreme free market dogma, it’s of negligible impact.

The second area of ignorance is Public Choice theory. I argued that treating neoliberalism as being synonymous with corporatism simply ignores what "neoliberals" actually believe - we don't think that unemployment is due to individual weakness, but to instutitional barriers such as labour markets rigidities and occupational licensing. In other words "we" have a very clear theory of regulatory capture and crony capitalism. 

Notice that I am claiming the term "neoliberal". Indeed this brings us to Friedman and Hayek in Chile, because if this is an example of neoliberal intervention it is worth pondering what happened and challenge whether it's the smoking gun that critics to often claim. After documenting the role of Friedman and Hayek, I mentioned a great paper by Bob Lawson and J.R. Clark. They make the following definitions:

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    • Economic freedom – 0.5 standard deviations higher than average on the Economic Freedom Index
    • Political freedom – 1 standard deviation higher than average on the Freedom House Index (and average of “political rights” and “civil liberties”)
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This produces a 2x2 matrix where we can not only assign countries to various quadrants, but also map how they move between quadrants over time. I used this as a basis for "The Economic Freedom Parlour game" and it seemed to go down well.

According to Hayek and Friedman, you can’t have political freedom without economic freedom, which implies that quadrant B is unstable. According to Lawson & Clark's data, less than 10% of the data set is contained in quadrant B. In 1980, for example, there were 12 cases, and typically these were "high income Western nations who were in the final stages of their most socialist periods”. The fact that 11 of them (with the exception of Venezuela) subsequently becamer more economically free (B->A) seems to support their thesis.

We can also bring in the Road to Serfdom, where Hayek claims that when democratic socialism fails planners will move toward totalitarianism (i.e. B ->D). If we consider this to be a prediction (i.e. that it will necessarily happen) it looks to have been refuted. 11 of the 12 avoided that path. But if we consider it to be a warning, the sole example of Venezuela is validation. In other words, those European countries didn’t let the planners continue their planning, and neoliberalism saved the day.

According to Lawson and Clark the key findings are as follows:

  1. Chile's drastic increase in economic freedom was soon followed by increases in political freedom
  2. Israel's lack of political freedom in the 1970s/1980s didn't last, and relatively free-market policies have coincided with a steady increase in political freedom
  3. Venezuela really began to lose economic freedom from 1990-1995 and since then political freedom has fallen (and is falling).

This latter case - Venezuela - is the Road to Serfdom before our eyes. And I think the framework is a very interesting one to think about the dynamics of transition. Should we focus on moving from D -> B and hope that political freedom begets economics freedom (and run the risk of lapsing into the Road to Serfdom?); or should we aim for D -> C and risk getting "stuck" in an authoritarian but prosperous country like Hong Kong or Singapore. To help with this, I presented some of the key findings from my 2009 book on neoliberalism in Eastern Europe, and also shared Anders Aslund's point that it may be a false choice. The tradeoff may not be D -> C or D -> B but between D -> Cor nothing. After all,

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    “Market economic reforms have been highly successful, whereas democratisation has only been partially auspicious, and the introduction of the rule of law even less so” (2007, p.305)

    “At present, we seem to understand how to build a market economy, whereas the ignorance of democracy building and the construction of a legal system are all the more striking” (2007, p.311)

     

For me, Eastern Europe is an example of the success of neoliberalism. However the success could have been greater still.

The left falsely identify Friedman (rather than Hayek) as leader of the neoliberal revolution because they can pin more on him. But it’s Friedman’s neoclassicism (i.e. method) that dominated the economic and public policy debate, not his neoliberalism (ideology). We need more of it. 

 

Tuesday
Jun072016

The Upper Turning Point

In 1979 Jeff Hummel published an important critique of Austrian business cycle theory. I'm biased, but I felt it's received insufficient attention amongst Austrians. Especially in terms of the unsustainability of the boom - how inevitable is the upper turning point?

I think that many Austrians take it as a given that at some point an increase in the money supply will begin to accelerate, couched under the claim that "X is necessary for the boom to continue". But what about if you don't want a boom to continue? What if, after a boom, you just want a soft landing? Can you avoid a recession? At this point my inner Austrian resorts to hand waiving and saying things like "structure of production" and "relative price effects". But I also find it interesting how many explanations revert to political economy claims.

I thought a good way to approach this issue would be to present the ABC textbook style, side-by-side with alternative explanations. David Romer uses illustrative path dynamics, and Mishkin's textbook analysis presents the following scenarios for monetary expansion:

In 2013 I wrote up a working paper and have decided to release it now as a special report.

Must an increase in the money supply lead to an increase in the growth rate of the money supply? According to Hayek (1934) this would be necessary to sustain the boom, and this is true. But what if you don’t want to sustain the boom? What if you want the structure of production to be maintained at its existing level?

I point to "capital heterogeneity" effects and the Ricardo effect as distinctly Austrian explanations. However the literature review is incomplete and there are some serious flaws and problems.

The main reason for not taking it any further is that back in 2013 I became aware of a working paper by Larry White and George Selgin, on the same topic. Their stylised paths of money paths of the money stock, nominal interest rate, and real interest, approximated what I felt had been missing in the Austrian literature. And, interestingly, they suggest that a slowdown in the growth of money supply is not a necessary turning point. In fact, they criticise Hayek (and others) for the same reasons Hummel does, as far as I can tell. Their article is called "The Austrian Theory of the Business Cycle in a Fiat Money Regime" and I look forward to reading it in print.

Tuesday
Jun072016

UK economic update - June 2016

I spent this morning populating the monetary dashboard, and thought I'd write up why my current view of the UK economy is "meh".

Monetary growth is reasonably strong and consistent. M3 has fallen from 2.7% to 2.3% and M4ex has fallen from 4.8% to 4.2% but narrower measures have grown - MAex is 7.8% (from 7.3%) and household Divisia 8.9% (up from 7.4%). Inflation measures remain subdued - CPI has fallen from 0.5% to 0.3%, RPI is down from 1.6% to 1.3%, input prices are -0.7% and output prices -6.5%. From a monetarist perspective there's no sign of impending return to the inflation target - indeed inflation expectations over the coming year have fallen from 2% to 1.8% and the Fed 5 yr be rate is 1.45%. We are still a long way from "normal" inflation.

It's important to take a broader look at inflationary pressure, but the picture doesn't change. Although the House Price Index jumped from 7.6% to 9% last month the Nationwide measure fell to 4.7% and Halifax remains elevated at 9.2%. IMF's measure of commodity prices is 4.7%. Stock market indicators are up over the last 3 months but the FTSE 100 is down 7.6% since last year. NGDP grows at a modest 2.5% and altough the PMI index has risen (slightly) above 50, Industrial Production is down 0.3% and business investment fell by 0.5%

The unemployment rate is 5.1% and the ratio between vacancies and unemployment for Jan-Mar at 0.45. Average Weekly Earnings have risen slightly, but are under 2%. The HM Treasury survey of forecasts shows that growth of 2.1% is expected next year, and inflation of 1.9%. Interest rates have fallen slightly, sterling is down, yields are down. With so much uncertainty due to the possibility of Brexit it would be wise to be cautious. And with inflation so low, policymakers hands are pretty tied.

Tuesday
Jun072016

MAex growth at 7.81%

A recent update to MAex has revealed that narrow money growth is a robust 7.81%, up slightly from 7.33% in March. It's been in the 6%-9% range for over a year.

Here's the data.

Tuesday
May242016

Beware of misleading headlines

Firstly, I wanted to provide some warranted coverage of a letter cosigned by 280 economists (at the time of writing) on the economic impact of Brexit. Here is the text of the letter:

Focusing entirely on the economics, we consider that it would be a major mistake for the UK to leave the European Union.Leaving would entail significant long-term costs.
The size of these costs would depend on the amount of control the UK chooses to exercise over such matters as free movement of labour, and the associated penalty it would pay in terms of access to the single market. The numbers calculated by the LSE’s Centre for Economic Performance, the OECD and the Treasury describe a plausible range for the scale of these costs.

The uncertainty over precisely what kind of relationship the UK would find itself in with the EU and the rest of the world would also weigh heavily for many years. In addition, there is a sizeable risk of a short-term shock to confidence if we were to see a Leave vote on June 23rd. The Bank of England has signalled this concern clearly, and we share it.

Although I don't feel sufficiently familiar with the studies mentioned to add my own name, I respect and admire those who have done so. This is a serious and authoritative statement that is helpful to voters who want to understand the economic arguments (although I'm not sure we can ever focus "only" on the economics without having a very narrow, technical and unhelpful definition of what constitutes economics).

Recently The Telegraph published an article by Tony Yates, one of the organisers of the letter. Unfortunately, I think the article gives a misleading account of the scale of consensus amongst the economics profession.

When I raised this on Twitter Tony said that I'd misunderstood the article, which was split into two parts. The first part was about whether economists should be listened to generally; the second on the specific issue raised by the letter. But I was confused. If the main point was "there isn't a lot that economists agree upon so when they do, it's worth paying attention" I'd be in full agreement. But if this were the case, he'd have identified the range of issues where the cosigners disagree. Instead, Tony says they differ on a somewhat vague "Was the Coalition austerity policy right?", but previously in the article he says that:

Compare the Great Depression to the financial crisis. In the US, output fell by 30pc to its trough. Following 2008, it fell by 4pc. A lot of factors are at work here. But part of it was about lessons we have learnt in macroeconomics. 

For example, we understand better why a fiscal stimulus works and when it’s beneficial. The support for this in the economics community helped bring about the US fiscal stimulus package of 2009.

It isn't clear to me whether Tony is saying that (i) there are some topics where economists have a consensus, and can therefore give good policy advice (and fiscal stimulus and the economics of Brexit are two of those areas); or (ii) disagreements between the cosigners on fiscal stimulus is all the more reason to take seriously their agreement on Brexit. Who were the cosigners who believed that the US fiscal stimulus backfired? Which ones thought UK austerity was a myth and cuts should have been deeper? Also, if he wanted to pick a topic on which there was genuinely a consensus among the profession then why didn't he choose free trade? Indeed that would be much more relevent in the context of a vote to leave a free trade area.

Furthermore, whether he's using "we" to refer to economists, or the cosigners, isn't helped by The Telegraph's editing team. Consider the final paragraph:

It is very clear that the "disorderly, fractious and argumentative" group that Tony is referring to is the cosigners of the letter. Indeed this is also clear from the URL of the article:

 However the headline conveniently drops the word "these":

The headline reads as if Tony is referring to all economists. In fact, he's claiming that he's only referring to a group of 280. I've written plenty of op eds and am used to editors using a slightly misleading headline in order to generate a response. But usually I'd say "I didn't write the headline!" I don't think Tony wrote the headline, but I'm surprised that he's not willing to distance himself from it. If 280 economists agree on something policy relevent then it is worth reporting. But if it's reported in a way that implies consensus within the entire profession, this actually reduces the quality of public debate.