New Economist

Globalisation: good for jobs?

Chris Giles summarises a new report on globalisation by the Ifo-affiliated European Economic Advisory Group in today's Financial Times: Globalisation ‘a blessing’ for west Europe

Increased trade, outsourcing and offshoring do not create unemployment but boost the number of jobs in advanced economies, a study of European labour markets says on Tuesday. The European Economic Advisory Group...argues that although globalisation can lead to a fall in demand for certain types of skill, it also tends to sweep away job-destroying rigidities in labour markets.

The evidence from the group’s work suggests the positive effects of globalisation outweigh the negative effects. Although the group concedes that its statistical work remains “crude”, the report concludes that globalisation is likely, if anything, to lead to long-term rises in employment. “If so, globalisation will not be a curse for employment in western Europe, it could instead turn out to be a blessing,” the report says.

The report in question is Chapter 3 of the EEAG's seventh report on the European Economy, Europe in a Globalised World, launched today in Brussels. It warns of "dark clouds" in the US, but no recession in Europe. The chapter, The effect of globalisation on Western European jobs: curse or blessing? (PDF 2.9Mb), comes to more qualified and tentative conclusions than the FT article suggests:

Our basic message is that we probably should not expect globalisation to have adverse effects on overall employment in Western Europe in the long run if one takes all effects into account. It is true that trade integration and factor mobility vis-à-vis low-wage economies are likely to cause unemployment if European labour markets remain rigid. But there is a good chance that globalisation will help reduce these rigidities. Politicians in some countries may try to swim against the tide and uphold or even strengthen regulations in the labour market, such as Germany is currently doing. But in the end, globalisation is likely to strengthen the incentives to deregulate. Therefore, the net result could be that employment is promoted.

If globalisation does not hurt employment, it will produce aggregate gains. There is a possibility that globalisation could eventually benefit almost everyone, although some will gain more than others. However, there is also a fair amount of evidence that economic integration with low-wage economies reduces the relative demand for less-skilled workers and their relative compensation. So, it is also possible that there could be a large group of losers.

But maybe that's the wrong way of looking at it? The authors suggest we should examine how effectively our institutions handle a more global world:

It makes more sense to recast the issue in the following way: are our labour market institutions and our welfare states designed well enough so that the gains from trade reform will be broadly shared? Or are they likely to breed opposition to these reforms?

The 34 page chapter ends with a useful discussion of the possible components of schemes to compensate the potential losers from the globalisation process. A thoughtful piece, deserving a wide readership.

Growth diagnostics: the dangers of agnosticism

Why does income grow faster in some countries than others? A common empirical approach in recent growth analysis has been to adopt an 'agnostic' approach and let the data do the talking (i.e. weak priors). But a new paper by Antonio Ciccone from Barcelona's ICREA-Universitat Pompeu Fabra, and ECB economist Marek Jarocinski, question this approach. In their new ECB working paper no. 852, Determinants of economic growth: will data tell? (PDF), they show that small differences in the comparative income data can have a substantial effect on the outcomes:

As many potential explanatory variables have been suggested, these agnostic empirical approaches inevitably need to start out with a long list of variables. We show that, as a result, the growth determinants emerging from these approaches turn out to be sensitive to seemingly minor variations in international income estimates across datasets. This is because strong conclusions are drawn from small differences in the R2 of different growth regressions. Small changes in the relative fit of different models—due to Penn World Table income data revisions or methodological differences between the PWT and the World Bank income data for example—can therefore lead to substantial changes regarding growth determinants.

Their analysis clearly shows that agnostic growth regressions can be sensitive even to small data revisions. They suggest that "the available income data may be too imperfect for agnostic empirical analysis". So what to do? Stronger (and fewer) priors:

At the same time, we find that the sensitivity of growth determinants to income differences across data revisions and datasets falls considerably when priors regarding potential growth determinants become stronger. That is, the data appears good enough to differentiate among a limited number of hypotheses. Empirical models of the typical size in the literature, for example, tend to point to the same growth determinants using different versions of the PWT or the World Bank income data.

Researchers who want to continue giving equal a priori weight to all potential growth determinants in the literature, should consider shrinkage priors, explicitly incorporating priors about measurement error in the income data, or implementing Zellner’s (2002) adjustment for data quality.

Growth theory: Solow or Lucas?

I've just come across a new OECD economic working paper on growth theory: Solow or Lucas? Testing growth models using panel data from OECD countries. Authors Jens Arnold, Andrea Bassanini and Stefano Scarpetta test whether the growth experience of a sample of OECD countries over the past three decades is more consistent with the human-capital augmented Solow model of exogenous growth, or with an endogenous growth model à la Uzawa-Lucas with constant returns to scale to “broad” (human and physical) capital. Here's their methodology:

We exploit the different non-linear restrictions implied by these two models to discriminate between them. Using pooled cross-country time-series data, we specify our growth regression by imposing cross-country homogeneity restrictions only on  long-run  coefficients, while  letting  the  speed  of  convergence  and  short  term  dynamics  to  vary  across  countries.

Their conclusions?

The results suggest a strong effect of human capital accumulation: the estimated long-run effect on output of one additional year of education (about 6-9%) is also within the range of the estimates obtained in microeconomic analyses of the private returns  to  schooling. Our estimated speed of convergence is too fast to be compatible with the augmented Solow model, while is consistent with the Uzawa-Lucas model with constant returns to scale. This main finding is robust to several robustness tests. 

US recession risk revisited

My previous posts, Is the US heading into a recession? seems to have a caused a flurry of comments. I remain of the view that the US economy will just scrape through 2008 without one. Admittedly, the run of data since that post has hardly been encouraging, with a plunge in the ISM (signalling a likely manufacturing recession) and some very weak non-farm payroll numbers.

Richard Berner & David Greenlaw from Morgan Stanley put the case for the prosecution in their recent piece: Is Recession Now in the Price?

Incoming data suggest that tighter credit has pushed the US economy to the brink, and we reiterate our call for a mild US recession in the first half of 2008. Weak employment data and slowing in export orders reported by purchasing managers undermine the case that a healthy consumer and strong global growth would forestall a downturn. Moreover, the ongoing housing recession is deepening, declines in capital goods bookings hint that business equipment spending will contract, and inventory liquidation seems likely. ...Most of the weakness is concentrated in the first half of the year; we project the economy will contract by about ¾% annualized in the first half of 2008, compared with 0.3% last month.

I agree the weakness will be in the first half, as I argued in my post 2008: No US recession. We might even see one negative quarter; but I'd be surprised if we see two consecutive declines. And that is the standard definition of a recession. My views are closer to those of Stefan Schneider at Deutsche Bank. In today's talking point he puts forward the DB baseline:

The US economy staggers for a few quarters, but does not actually collapse. The USD recovers in line with the US economy and the pricing process on the oil market returns to “more reasonable” ranges. In this environment the emerging markets grow somewhat less than last year but still quite strongly, at roughly 6½%.

Like Deutsche, I agree most of the risk are to the downside, and I could well be proved wrong. But don't underestimate the Fed. Today's dovish comments by Ben Bernanke show a preparedness to take whatever steps are deemed necessary:

...we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks.

Meanwhile, the Economist today published its's latest R-word index. While it is certainly spiking upwards, we are not in 2001-territory just yet.

The Economist's informal R-word index is also sounding alarms. Our gauge counts how many stories in the Washington Post and the New York Times use the word “recession” in a quarter. This simple formula pinpointed the start of recession in 1981 and 1990 and 2001. In the past few years the R-word index has been extremely low. It began to rise in the second half of 2007 and, measured at a quarterly rate, has soared in early 2008 (see chart). Although the number of stories is still lower than before previous recessions, the recent jump—if sustained for a quarter—is similar to that which preceded the 2001 downturn

Other pointers include the Economic Cycle Research Institute weekly index. According to an Investor's Business Daily report, we're not there yet:

"A lot of things are teetering on the edge of tipping toward a recession," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.

...The ECRI's leading U.S. index ticked higher in the latest week. But the annualized growth rate fell to -6.2%, the weakest since Nov. 16, 2001, at the end of the last recession. The index's components include housing activity, job growth, interest rates, investor confidence, money supply growth, corporate profits and productivity.

"If these downward trends in the leading indicators continue for much longer, we will end up with a recession," Achuthan said. F

Finally, what about the prediction markets? Intrade have a US recession 08 contract, where you can bet on the likelihood that there are "two successive quarters of negative real GDP growth" this year. The contracts were hovering around the 50% mark until last week. Since then they have shot up to the 60-65% mark (click on chart). Given my assessment, I should probably short the contract.

How useful is Okun's Law?

Edward S. Knotek asks an interesting question in the latest Kansas City Fed's Economic Review: How Useful is Okun's Law? (PDF)

From the beginning of 2003 through the first quarter of 2006, real gross domestic product in the United States grew at an average annual rate of 3.4 percent. As expected, unemployment during the period fell. Over the course of the next year, average growth slowed to less than half its earlier rate--but unemployment continued to drift downward. This situation presented a puzzle for policymakers and economists, who expected the unemployment rate to increase as the economy slowed.

Typically, growth slowdowns coincide with rising unemployment. This negative correlation between GDP growth and unemployment has been named “Okun’s law.” Part of the enduring appeal of Okun’s law is its simplicity, since it involves two important macroeconomic variables. Additionally, the relationship appears to enjoy empirical support. In reality, though, Okun’s law is a statistical relationship rather than a structural feature of the economy. As with any statistical relationship, it may be subject to revisions in an ever-changing macro economy.

Knotek considers the usefulness of Okun’s law for policymakers and economists. The evidence suggests that Okun’s relationship between changes in the unemployment rate and output growth has varied considerably over time and over the business cycle. Nevertheless, Okun’s relationship can still be useful as a forecasting tool--provided that one takes its instability into account.

Productivity vs employment growth: a zero-sum game?

All economists know productivity matters. But they also know it isn't easy to measure, nor to explain the often large and persistent productivity gaps between nations. A new paper by Harvard's Ian Dew-Becker and Northwestern University's Robert J. Gordon makes a provocative contribution to the productivity debate. Presented at a meeting of the NBER Program on Technological Progress and Productivity Measurement in Boston last week, the authors argue there is a "strong negative tradeoff between productivity and employment growth". The abstract from their paper, The Role of Labour‐Market Changes In the Slowdown of European Productivity Growth (PDF), continues:

We document this tradeoff in the raw data, in regressions that control for the two‐way causation between productivity and employment growth, and we show that there is a robust negative correlation between productivity and employment growth across countries and time. We simplify the task of explaining intra‐EU differences in the performance by reducing the dimensionality of the issue from the 15 EU countries to four EU country groups, chosen by geography.

We provide a comprehensive analysis of the role of policy and institutional variables in causing changes in productivity and employment per capita growth across these country groups. Using both a calibrated theoretical model and several reduced‐form regressions, we document the strong effects of European policies that raised labour costs, such as the tax wedge, employment and product market regulation, unemployment compensation, and union density, in causing employment to fall and productivity to rise before 1995, and for this process to be reversed after 1995.

The policy implications of their research are stark:

The strong evidence that we find for a productivity‐employment growth tradeoff changes the questions that European policymakers should be asking. They should no longer ask how they should boost productivity growth or raise employment growth. Most policies will push productivity and employment in opposite directions, and we have shown that these offsetting effects make the effects of policies on growth in output per capita ambiguous. Our new policy framework suggests that policy changes be assessed as much on their effects on government budgets as on productivity or employment, since the productivityemployment tradeoff causes some policy changes to have a negligible effect on growth in output per capita.

I'm not sure I'd necessarily agree with the authors 'zero sum' conclusions. There are for example some economies which perform better on both productivity and employment growth than others; so it's not always such a direct trade-off. One implication - that higher employment rates or higher productivity in large part reflect different national preferences - has certainly been argued before. But if their general 'zero-sum' argument proves to be more the rule than the exception, it has profound implications for policy makers throughout the OECD - especially in Europe.

OECD Economic Outlook: "not that bad in view of the recent shocks"

The OECD released its latest Economic Outlook today. Though some fear that falling house prices and the global credit crunch might drive the US into a recession, that view is not shared in Paris. Their US forecast expects weakness in the US housing sector to drag down growth in the near term but it "is unlikely to trigger a recession". GDP growth is forecast to 2.0% in 2008. Private consumption will be weak - but public and non-residential investment should remain quite perky, and the cheap US dollar will see net exports add to growth next year just as it they have this year. Here's their summmary of the US outlook:

Healthy gains in private consumption have helped to keep GDP growth above trend thus far this year. However, the correction in residential construction is likely to accelerate over the near term, and housing wealth could decline which, together with weaker labour market conditions, could lead to lower consumption growth over time. GDP should therefore slow to a pace below potential in 2008 and then recover in 2009, although there are considerable downside risks.

This assessment is broadly in line with recent Federal Reserve and private sector forecasts. An outside risk of recession, to be sure - but not considered that likely. (For another recent official US economic overview, see yesterday's Congressional testimony by CBO Director Peter R. Orszag).

But what about the overall economic outlook? You can watch a webcast of the news conference by OECD's acting Chief Economist Jorgen Elmeskov here. Or just read his 18 page handout (PDF), which contained this precis:

Several shocks have hit OECD economies recently: financial turmoil, cooling housing markets, and higher prices of energy and other commodities. Fortunately, they have occurred at a time when growth was being supported by high employment that boosts income and consumption; by high profits and strong balance sheets that underpin investment and resilience in the face of financial losses and tighter credit; and by still buoyant world trade driven by robust growth in emerging economies. Hence, although near-term growth has been revised down virtually everywhere in the OECD area, the baseline scenario depicted in this Economic Outlook is actually not that bad in view of the recent shocks.

Of course, as the accompanying chartset makes very clear, there are still plenty of reasons to be concerned. Energy and commodity prices have surged, headline inflation has picked up, credit conditions are tight, house prices are decelerating, consumer confidence is softening, and job creation is slowing. Against that, fiscal positions have improved and world trade is buoyant.

It's not the end of the world, but it's not exactly time to crack open the champers either. Or as Elmeskov put it at the news conference: “It’s not a recession but obviously it’s not going to feel all that great either.”

Who's on top?

Lists and rankings fascinate many, from Letterman's top ten to People magazine's best and worst dressed. Even economies have their own such lists. This week the Economist Intelligence Unit published its business environment rankings, with the United States the 9th most attractive place for business out of 82 countries, "the lowest the country has placed since the launch of the business environment rankings in 1997". Angola came last, while Denmark was ranked first, followed by Finland and Singapore. Canada came fourth, followed by Switzerland and Hong Kong.

The World Economic Forum's Global Competitiveness Report 2007-08 was also published this week. They rank the United States first for their Global Competitiveness Index, followed by Switzerland and Denmark.

The IMD's World Competitiveness Yearbook 2007 also ranked the US first, closely followed by Singapore and Hong Kong. Luxembourg was fourth, followed by Denmark and Switzerland.

Finally, the World Bank's Doing Business 2008 (sic) report ranks Singapore first in its Ease of Doing Business Index - followed by New Zealand and the United States. Hong Kong was fourth, followed by Denmark and the United Kingdom.

One can of course argue with the components and weighting of the various indices, which are by their nature somewhat arbitrary. Nonetheless, despite very different methodologies, the same handful of countries crop up time and time again. The general conclusion, as a previous post on this topic argued, is that three groups typically do well:

* the Nordic economies, particularly the smaller economies of Denmark and Finland;

* the Anglo-saxon economies - the US, UK, Canada, Australia and New Zealand;

* the Asian city-states of Singapore and Hong Kong.

So too does Switzerland.

These are clearly very different economic models, showing that in the path to economic prosperity 'one size fits all' just isn't true. Second, most of these countries have relatively 'free' markets and light regulatory regimes. Third, the relative success of the Nordic economies show that low tax rates are not a necessary pre-requisite. Fourth, in Europe smaller countries seem to do better than the larger ones.

Growth: the central questions

Daron Acemoglu's new textbook on economic growth concludes at Chapter 24 with a discussion of 'what we have learned', some answers to what he dubs 'the central questions', and a quick overview of 'some of the many remaining questions' faced by researchers. On page 1068 (sic) he writes:

The central questions are these:
(1) Why did the world economy not experience sustained growth before 1800?
(2) Why did economic takeoff start in 1800 and inWestern Europe?
(3) Why did some societies manage to benefit from the new technologies and organizational forms that emerged starting in 1800, while others steadfastly refused or failed to do so?

I will now offer a narrative that provides some tentative answers to these three questions.

And so he does. It's the best summary of the economic growth literature I have read - but alas, too long to include in this blog. To tempt readers, here is a small sample, from pages 1077f:

Why did some societies manage to benefit from the new technologies while others failed?

The economic takeoff started in Western Europe, but quickly spread to certain other parts of the world. The chief importer of economic institutions and economic growth was the United States. The United States already had participatory political institutions, founded by settler colonists, who had just defeated the British crown to gain their independence and set up a smallholder society. This was a society built by the people who would live in it, and they were particularly keen on creating checks and balances to prevent a strong political or economic elite. This environment turned out to be a perfect conduit for modern economic growth.

The lack of a strong political and economic elite meant that a broad cross-section of society could take part in economic activity, import technologies from Western Europe and then build their own technologies to quickly become the major industrial power in the world (Galenson, 1996, Engerman and Sokoloff, 1997, Keyssar, 2000, Acemoglu, Johnson and Robinson, 2002). In the context of this example, the importance of technology adoption from the world technology frontier is in line with the emphasis in Chapter 18, while the growth-promoting effects of a lack of elite creating entry barriers is consistent with the approach in Section 23.3 in Chapter 23.

Similar processes took place in other West European offshoots, for example, in Canada. Yet in other parts of the world, adoption of new technologies and the process of economic growth came as part of a movement towards defensive modernization. Japan started its economic and political modernization with the Meiji restoration (or perhaps even before) and a central element of this modernization effort was the importation of new technologies.

New book online: Daron Acemoglu's 'Introduction to Modern Economic Growth'

When Dani Rodrik recently asked his many readers which economist they most wanted to see start a blog, MIT's Daron Acemoglu came second only to Joseph Stiglitz. Rodrik asked him if he would start a blog:

Daron Acemoglu responds by saying blogging "seems like a lot of work." He adds "I am already overcommitted, so it's a bit scary to take something else on."

Busy? And how! Acemoglu has somehow found the time to write a new magnum opus. His Introduction to Modern Economic Growth is a whopping 1,169 pages. It covers the whol gamut, from the Solow growth model to the role of political regimes and institutions. Acemoglu explains the background to this textbook in his introduction:

This book grew out of the first graduate-level introduction to macroeconomics course I have taught at MIT. Parts of the book have also been taught as part of a second-year graduate macroeconomics.

In the preface, Acemoglu writes that the book is intended to serve two purposes:

First and foremost, this is a book about economic growth and long-run economic development. The process of economic growth and the sources of differences in economic performance across nations are some of the most interesting, important and challenging areas in modern social science. The primary purpose of this book is to introduce graduate students to these major questions and to the theoretical tools necessary for studying them. The book therefore strives to provide students with a strong background in dynamic economic analysis, since only such a background will enable a serious study of economic growth and economic development. It also tries to provide a clear discussion of the broad empirical patterns and historical processes underlying the current state of the world economy. This is motivated by my belief that to understand why some countries grow and some fail to do so, economists have to move beyond the mechanics of models and pose questions about the fundamental causes of economic growth.

In a somewhat different capacity, this book is also a graduate-level introduction to modern macroeconomics and dynamic economic analysis. It is sometimes commented that, unlike basic microeconomic theory, there is no core of current macroeconomic theory that is shared by all economists. This is not entirely true. While there is disagreement among macroeconomists about how to approach short-run macroeconomic phenomena and what the boundaries of macroeconomics should be, there is broad agreement about the workhorse models of dynamic macroeconomic analysis. These include the Solow growth model, the neoclassical growth model, the overlapping-generations model and models of technological change and technology adoption. Since these are all models of economic growth, a thorough treatment of modern economic growth can also provide (and perhaps should provide) an introduction to this core material of modern macroeconomics. Although there are several good graduate-level macroeconomic textbooks, they typically spend relatively little time on the basic core material and do not develop the links between modern macroeconomic analysis and economic dynamics on the one hand and general equilibrium theory on the other. In contrast, the current book does not cover any of the shortrun topics in macroeconomics, but provides a thorough and rigorous introduction to what I view to be the core of macroeconomics. Therefore, the second purpose of the book is to provide a first graduate-level course in modern macroeconomics.

A considerable achivement. Acemoglu asks readers to note that "this is a preliminary draft of the book manuscript. The draft certainly contains mistakes. Comments and suggestions for corrections are welcome."