The audacity Germany has shown in floating a demand to manage Greece’s finances is a window on the leaders of that country and how much perspective they’ve lost. Let’s be clear; not all in Germany agree with this narrow, insensitive stance and the uninformed and uneducated demands for austerity economics in debt-ridden and recessionary nations. For example, there are political parties in Germany that want their country to take the lead on a Marshall Plan for the periphery of the eurozone. But they are not the ones setting policy.

I am tempted to say that antediluvian economics is ruling in Germany, but it may not really be about economic theory, but rather superior pride, irrational fear of inflation, and perhaps vindictiveness. It’s as if a German version of our own Tea Party is now running economic policy in Europe. Germany reduced its unit labor costs beginning in the late 1990s, which were higher than much of the rest of the EU, but with the euro fixed, they benefited as their export prices remained low. Could they have done well without their eurozone trading partners buying more from them than they were selling? And they lent them the money to do so. Do they have no moral obligation here? Without the fixed euro, the DM would have soared.

Then there is David Cameron of Britain and his finance minister lecturing the rest of Europe about how to run their economies. Move over Monty Python. As everyone now knows, Britain’s GDP is still below its pre-recession high, its deficit is high and not falling as promised, it may have slid into recession, and often ignored, average wages are well down since a recovery supposedly began. The bombast with which Cameron proclaims the rightness of his austerity economics while his people suffer is right out of school-boy debating. This time his countrymen will lose the debate, not only him.

There are some hints that people of influence are talking sanely and recognize growth is necessary and that austerity in this environment is tragically anti-growth. Some believed there would be some actual policy initiatives in Monday’s summit, but there weren’t. Instead, the EU agreed to a nutty deficit limit for all its nations. The good news is that they won’t abide by in a crunch. Must we remind ourselves yet again that it was Germany that conspicuously violated the prevailing EU limits on deficits to 3 percent of GDP when it had problems? Some say the current limit is over a full economic cycle and therefore not that stifling, but 0.5 percent of GDP is stifling any way you size it up.

Other analysts are saying that now that Germany has won this round it will support further lending by the European Central Bank. What a group! Remember when Trichet, then the head of the ECB, actually raised interest rates in the spring of 2011? It is all a matter of confidence, he said. But trying to cut spending in the face of recession will not generate confidence; only renewed growth will.

It looks like Spain may have had enough of austerity economics. After all, it didn’t run crazy government deficits in the first place. I bet few non-expert citizens know how little government budget deficits had to do with the crisis, including in the U.S. For a long while, Spain’s leaders kept promising they would meet reduced deficits target, but slow growth and suddenly outright negative growth is reducing tax revenues far faster than expected. Spain is a dog chasing its tail, and it may finally realize it. Deficits as a percent of GDP come down a bit at the expense of a recession and high unemployment, but not nearly enough to satisfy Germany (or, apparently, bond markets) or to meet political promises. If Spain pursues further austerity, it may remain in recession for several years. What will that do to their democracy? Let’s hope they stop.

The Greeks would not stand for Germany running their country. Big surprise. Sarkozy then said no one should stand for it, and Merkel apparently backed off. Who knows if she was ever foolish or insensitive enough to believe in it? But she has some mighty thick-headed colleagues in her country to deal with. Meantime, Portugal is flailing, deep into recession, so it’s not only Greece we must worry about. Spain just reported negative growth. Ireland remains a mess, despite momentary cheers that austerity was working. Alas, GDP is still 10 or 15 percent below its pre-recession high there.

Germany wants to cure the problem by getting wages to fall — a solution it imposed on itself in the late 1990s — in Greece, Spain, Portugal and so on. It is commonly called an internal devaluation. Had everyone not been linked to the euro, some could have devalued explicitly. With an internal devaluation, these countries would allegedly reduce their European imbalances by importing less and exporting more as prices fell — and in the case of Greece in particular, attracting more tourists as prices fell. This is a long, painful process that will probably only marginally change imbalances.

Europe needs growth, but it is being handed recession by the Germans. Growth builds tax revenues. It’s just like the old days when even many economists believed a recession just cleaned out the dead wood so we could rebuild, which led to self-destructive policies in the early 1930s. Now we have learned that the ugly part of recessions is that they feed on themselves and sink economies deeper, clean out more new wood than old, have grave long-term consequences for standards of living, and can destabilize democracies.

Any good news? As recession hits, talk has increased that austerity is not working, as noted above. If Germany itself begins to suffer some pain because it can’t sell its exports, the nation may indeed wake up. The self-righteous there may at last be overwhelmed by the rational and sensitive.

Europe, and most importantly Germany, needs to encourage its central banks to lend more. It needs to build its rescue fund, and ultimately it needs to sell eurozone-backed bonds to generate more rescue money and enable it to transfer funds to needy countries as they scale back on spending so that citizens do not suffer so much. The U.S. does just this. There is no mystery, except one. That mystery is how nations repeat their follies so regularly in history.

For all I’ve said, I am not completely pessimistic. I see the glimmer of a horizon of hope. I think most of Europe believes in the euro and a united continent. I think they will save the day, but just by a hair’s breadth. And that’s too close for comfort. There is a chance the ship will sail too close to the horizon and fall off the earth.

This piece was originally published at New Deal 2.0.

Ecuador must be one of the most exciting places on Earth right now, in terms of working towards a new development paradigm. It shows how much can be achieved with political will, even in uncertain economic times.

Just 10 years ago, Ecuador was more or less a basket case, a quintessential “banana republic” (it happens to be the world’s largest exporter of bananas), characterised by political instability, inequality, a poorly-performing economy, and the ever-looming impact of the US on its domestic politics.

In 2000, in response to hyperinflation and balance of payments problems, the government dollarised the economy, replacing the sucre with the US currency as legal tender. This subdued inflation, but it did nothing to address the core economic problems, and further constrained the domestic policy space.

A major turning point came with the election of the economist Rafael Correa as president. After taking over in January 2007, his government ushered in a series of changes, based on a new constitution (the country’s 20th, approved in 2008) that was itself mandated by a popular referendum. A hallmark of the changes that have occurred since then is that major policies have first been put through the referendum process. This has given the government the political ability to take on major vested interests and powerful lobbies.

The government is now the most stable in recent times and will soon become the longest serving in Ecuador’s tumultuous history. The president’s approval ratings are well over 70%. All this is due to the reorientation of the government’s approach, made possible by a constitution remarkable for its recognition of human rights and the rights of nature, and its acceptance of plurality and cultural diversity.

Consider just some economic changes brought about in the past four years, beginning with the renegotiation of oil contracts with multinational companies. Ecuador is an oil exporter, but had benefited relatively little from this because of the high shares of oil sales that went to foreign oil companies. A new law in July 2010 dramatically changed the terms, increasing the government’s share from 13% to 87% of gross oil revenues.

Seven of the 16 foreign oil companies decided to pull out, and their fields were taken over by state-run companies. But the others stayed on and, as a result, state revenues increased by $870m (£563m) in 2011.

Second, and possibly even more impressively, the government managed a dramatic increase in direct tax receipts. In fact, this has been even more important in revenue terms than oil receipts. Direct taxes (mainly corporation taxes) increased from around 35% of total taxes in 2006 to more than 40% in 2011. This was largely because of better enforcement, since the nexus between big business and the public tax administration was broken.

Third, these increased government revenues were put to good use in infrastructure investment and social spending. Ecuador now has the highest proportion of public investment to GDP (10%) in Latin America and the Caribbean. In addition, social spending has doubled since 2006. This has enabled real progress towards the constitutional goals of free education at all levels, and access to free healthcare for all citizens. Significant increases in public housing have followed the constitution’s affirmation of the right of all citizens to dignified housing with proper amenities.

There are numerous other measures: expanding direct public employment; increasing minimum wages and legally enforcing social security provision for all workers; diversifying the economy to reduce dependence on oil exports, and diversifying trading partners to reduce dependence on the US; enlarging public banking operations to reach more small and medium entrepreneurs; auditing external debt to reduce debt service payments; and abandoning unfair bilateral investment agreements. Other efforts include reform of the justice system.

One exciting recent initiative is the Yasuní-ITT biosphere reserve, perhaps the world’s first attempt to avoid greenhouse emissions by leaving oil underground. This not only protects the extraordinary biodiversity of the area but also the habitats of its indigenous peoples. The scheme proposes to use ecotourism to make human activity compatible with nature.

All this may sound too good to be true, and certainly the process of transformation has only just begun. There are bound to be conflicts with those whose profits and power are threatened, as well as other hurdles along the way. But for those who believe that we are not condemned to the gloomy status quo, and that societies can do things differently, what is happening in Ecuador provides inspiration and even guidance. The rest of the world has much to learn from this ongoing radical experiment.

This piece was originally published by The Guardian.

The World Economics Association’s forum for the open review of proposed articles for the World Economics Journal and for Economic Thought is now open. 19 submissions have been posted so far. It is located at http://discussion.worldeconomicsassociation.org/.

The World Economics Association has been founded in spring 2011 and has so far attracted more than 7000 members from around 120 countries. The Journals of the association are committed to a policy of inclusiveness, openness and transparency. You are encouraged to read and comment on submitted papers that interest you. Editors will also make public comments to make their final decision making process transparent and to allow readers and authors to react and interact.

Papers submitted to the World Economics Journal include:

Microfinance and the Illusion of Development: from Hubris to Nemesis in Thirty Years, by Milford Bateman and Ha-Joon Chang

Incorporating the Rentier Sectors Into a Financial Model, by Michael Hudson

External Fragility or Deindustrialization: What is the Main Threat to Latin American Countries in the 2010s? by Roberto Frenkel and Martín Rapetti

Pension Liabilities: Fear Tactics and Serious Policy, by David Rosnick and Dean Baker

Grass Roots War On Poverty, by Alice H. Amsden

Papers submitted to Economic Thought include:

Mathematical Modelling and Ideology in the Economics Academy: competing explanations of the failings of the modern discipline?, by Tony Lawson

On the Limits of Rational Choice Theory, by Geoffrey M. Hodgson

An Evolutionary Efficiency Alternative To The Notion Of Pareto Efficiency, by Irene van Staveren

Norbert Häring is editor of the World Economics Journal.

Emerging markets have fallen victim to unstable capital flows in the wake of the financial crisis. In an attempt to mitigate the accompanying asset bubbles and exchange rate pressures that come with such volatility, a number of emerging markets resorted to capital controls. Although these actions have largely been supported by the International Monetary Fund, some policy-makers and economists have decried capital controls as protectionist measures that can cause spillovers that unduly harm other nations.

Recently-published research shows that these claims are unfounded. According to the new welfare economics of capital controls, unstable capital flows to emerging markets can be viewed as negative externalities on recipient countries. Therefore regulations on cross-border capital flows are tools to correct for market failures that can make markets work better and enhance growth, not worsen it.

This work has been developed by economists Anton Korinek, Olivier Jeanne, and others, and is summarised by Korinek in the August issue of the IMF Economic Review. According to this research, externalities are generated by capital flows because individual investors and borrowers do not know (or ignore) what the effects of their financial decisions will be on the level of financial stability in a particular nation. A better analogy than protectionism would be the case of an individual firm not incorporating its contribution to urban air pollution. Whereas in the case of pollution the polluting firm can accentuate the environmental harm done by its activity, in the case of capital flows a foreign investor might tip a nation into financial difficulties and even a financial crisis.

This is a classic market failure argument and calls for what is referred to as a Pigouvian tax (named after the 20th century Cambridge economist Arthur Pigou) that will correct for the market failure and make markets work more efficiently.

Of course, economists such as Keynes argued long ago that capital controls are important to prevent crises and to maintain an independent monetary policy that can strive for full employment and financial stability. This new work however elegantly models capital flows and capital controls in a broader contemporary economics context and thus could be seen by some to be a more rigorous justification for policy action on capital flows.

This work is not just for the blackboard. With quantitative easing, and as interest rates were lowered for expansionary purposes in the industrialised world between 2008 and 2011, capital flows returned to emerging markets at an alarming rate, where interest rates and growth were relatively higher. With eurozone jitters in the final quarter of 2011, capital flight occurred to the “safety” of the US and beyond. This has caused significant asset and exchange rate volatility that has made for an uncertain environment for policy-making and investment alike.

In response, many nations deployed capital controls to regulate the negative effects of cross-border capital volatility. Like earlier studies confirming that capital controls can change the composition of inflows, make for more independent monetary policy, and ease exchange rate tensions, new studies are emerging that show how nations such as Brazil, Taiwan, and South Korea have been at least moderately successful as well.

In addition to the cries of protectionism by Gordon Brown and others, some have also argued that controls create negative spillovers to neighbouring nations. MIT economist Kristin Forbes and colleagues examined Brazil’s numerous taxes on capital inflows from 2008 to 2011 to test whether such measures were harming Brazil’s neighbours.

On the one hand, Forbes and colleagues found that Brazil’s controls were meeting their stated objectives. However, in some attempts the authors did find that Brazil’s actions impacted other emerging market nations. Some of these spillovers were positive — some fund managers steered away from not only Brazil but from other nations that have regulated cross-border capital in the past. In other cases global investors did indeed increase their allocations to neighbouring nations.

These mixed findings miss some of the broader context, especially when seen in the light of the new welfare economics of capital controls. First, Brazil’s taxes can be seen as Pigouvian measures to correct against the negative spillovers generated from quantitative easing and the dollar/real carry trade. Second, the ‘costs’ that Forbes et al find to a small number of nations are not juxtaposed with the benefit of preventing a crisis in Brazil — one only has to look at Brazil’s 1999 crisis to see its contagious effect on the region then.

Over a dozen  years ago, prominent trade theorist Jagdish Bhagwati reminded us that capital account liberalisation is not analogous to trade liberalisation and that measures to regulate capital flows are not inherently evil.  The new welfare economics of capital controls further show that such measures can be seen as the new “correctionism” rather than the new protectionism — at exactly a time when nations need as many tools in their crisis preventing arsenal as possible.

This piece was originally published at the Financial Times. It is based on Gallagher’s new working paper, ‘The Myth of Financial Protectionism:The New (and old) Economics of Capital Controls’.

Growth in China, it is said, is slowing. GDP growth has reportedly fallen from 9.7 per cent in the first quarter of 2011, to 9.5 per cent in the second quarter, 9.1 per cent in the third and 8.9 per cent in the fourth. Much is being made of these numbers, though the 9.2 per cent average over 2011 is still high and the government has itself attempted to slow the system to rein in inflation.

One can sense an element of schadenfreude here. For too long now China has been showing up the rest of the world with its high rates of growth. This is especially true of the United States, which imports much from China, depends on inflows of capital from that country to finance its deficits, and is always looking for the next country to challenge its global supremacy.

However, if China’s growth is indeed slowing, this is no cause for even the US government to celebrate. A poorly performing China can drag the US down as well. Not just because China, with its large geographical size and population, is the growth pole that prevents the multi-speed global economy from sinking into another crisis. But because China is too important a market for the large multinational corporations that symbolise US economic power.

This last fact has been driven home by the recently released estimates yielded by the 2009 edition of the five-yearly benchmark surveys of the operations of US multinational corporations conducted by the Bureau of Economic Analysis of the US Department of Commerce. According to those figures, growth in the value added by US multinational firms slowed by almost half from 4 per cent to 2.2 per cent between 1999-2004 and 2004-09. However, that deceleration was accompanied by a shift in the relative importance of parents and majority owned foreign affiliates (MOFAs) in the aggregate performance of US MNCs. In 1999 and 2004, parent firms accounted for a little more than three-quarters of valued added by US MNCs. But since then the share of parent firms in valued added by US MNCs has fallen by close to 10 percentage points to 68.3 per cent in 2009. In sum, while operations of parent companies still dominate the activities of US MNCs, there appears to have been a significant shift in US multinational operations away from parent firms at home to affiliates abroad.

Of relevance here is the fact that, of the countries that were locations contributing to the increment in the operations of US multinationals over 1999-2009, China was one. The Asia-Pacific region, which accounted for 18 per cent of the value added by majority-owned affiliates of US multinationals in 1999, contributed 26 per cent of the increment in their value added during the decade ending 2009. And within the Asia-Pacific, China, which accounted for less than 4 per cent of the value added by MOFAs in 1999, contributed close to 19 per cent of the increment in MOFA-value added in that region during the relevant decade. Manufacturing accounted for a dominant 61 per cent of MOFA value added in the China, as compared with a much lower 42 per cent in all global locations.

These facts are particularly significant because of the nature of US multinational operations in China. There is a perception that China, with its large reservoir of relatively cheap labour, is a target for relocative investments by international firms. These firms, including multinationals from the US, are seen as using China as a low-cost production base for global markets, including markets in their parent countries. And the Chinese government is seen as exploiting this opportunity by maintaining an undervalued exchange rate so as to enhance the country’s export competitiveness.

But what the BEA’s benchmark survey has revealed is that the large increases in the value added of US multinational affiliates in manufacturing in China “reflected expanded production to serve the large and growing local market.” About two-thirds of the total output of US MNC affiliates was sold to local customers in both 1999 and 2009. On the other hand, the share of their output sold to U.S. customers declined from 16.3 per cent in 1999 to 10.2 per cent in 2009.

So China’s growth matters, since it is an important market for US firms located there. And what is important is not to look to their return, but to ensure that profits from China are used to invest in jobs at home.

The Obama administration has launched a “21^st Century” trade negotiation with a number of pacific-rim nations referred to as the Trans-Pacific Partnership (TPP).  While the full details of the proposed treaty are yet to be made public, early estimates show that the economic benefits of the agreement will be relatively small and the regulatory costs could be significantly high—especially for the emerging market and developing countries engaged in the negotiations.

The gains of the agreement may be a mere $20 billion, or just over one percent of GDP on average for the nations involved.  To get those small gains nations will have to trade away the ability to use measures to prevent and mitigate financial crises, to develop a growth-based innovation system, to protect public health and the environment, and more.

That’s right, according to a study by the East-West Center, at best the agreement will bring a one-time boost in GDP to participating countries of just over one percent. The accompanying table to this note shows how these gains would be distributed.



Vietnam and Malaysia seem to stand to gain more than half the benefits of the treaty, but those two countries would likely have to bear the most in terms of regulatory cost.  Both of these nations are significant low-wage assembly manufacturers that would export more goods to the US and Australia, and also import more intermediate goods for final assembly from those and other TPP nations.

These gains should also be seen as gross over-estimates as well.  The models deployed by the authors have estimates not only for goods trade, but also for services trade, and for the amount of foreign direct investment flows to the region.  The methods for the latter two estimates have little traction in the economics profession and are often not reported in official reports by the World Bank and others. Indeed, work by myself and others show that such models should be viewed in a very critical manner.

These over-estimated but still small benefits need to be juxtaposed with the costs.  The provisions for investment and intellectual property will bring significantly high costs to these nations.  What is more, the treaty will divert trade that probably should occur among others worse off.

In terms of investment, the treaty would rob the ability of parties to deploy regulations on the flow of cross-border capital flows to prevent and mitigate financial crises.  Such regulations are a cornerstone of Vietnam’s exchange rate and export policy.   Malaysia’s regulation of capital outflows in the wake of the Asian financial crisis is credited with making Malaysia among the least worse off due to that crisis.  If these tools were used, the treaty’s “investor-state” dispute system that allows private firms to directly sue host country governments would kick in.

The agreement will also make it harder for nations to establish the appropriate innovation policies that are necessary to diversify the economy toward higher value added goods.  While nations like Brazil and China—with only commitments under the WTO and not a deal with the US—are free to learn from foreign firms and spur domestic industries, this will be much more difficult for nations under its deal with the US.

Finally, the agreement will make other area nations worse off.  The treaty will distort markets in the Asian region such that Indonesia, the Philippines, Thailand, Japan, China, and South Korea would all be worse off.

Prominent trade theorist Jagdish Bhagwati has said that if TPP nations accept this deal they will truly be “bamboozled.”  When looking at the potential gains and the real costs it is hard to come up with a rival conclusion.

One year ago, Gerald Epstein and Jessica Carrick-Hagenbarth, two economists at  the University of Massachusetts Amherst, organised an open letter to the American Economic Association urging the organisation to

“adopt a code of ethics that requires disclosure of potential conflicts of interest that can arise between economists’ roles as economic experts and as paid consultants, principals or agents for private firms”.

More than 300 economists signed the letter, among them Nobel laureate George Akerlof and Christina Romer, a former advisor to US president Barack Obama.

Almost exactly one year later, the American Economic Association in fact agreed on a new disclosure codex. (Luigi Zingales also presented an interesting paper on the “Capture of Economists”.)

What do the authors of the open letter make of the new guidelines? I did an interview with Gerald Epstein, who wasn’t involved in the discussions about the new rules.

Olaf Storbeck: Gerald, what do you think about the new AEA disclosure guidelines? Are you satisfied?

Gerald Epstein: I think the AEA guidelines are a very big step forward. They make very clear the importance of disclosure of potential conflicts of interest by economists and set out in detail the types of conflicts that should be disclosed. In some ways these guidelines are stronger than i had expected.

For example?

They require disclosure with respect to publication in AEA journals, rather than just recommend it. And they require such disclosure with respect to a broad range of possible conflicts including those connected to groups that might have an ideological interest in the outcome of the article and not just material or financial. While this cuts a broad area, I think it is healthy.

The guidelines also suggest that these same criteria for disclosure apply to all other publications, including non academic publications, media appearances and testimonies. By suggesting their application to these areas, as well as by requiring such disclosures for AEA publications, these guidelines will help to set norms of behavior that colleagues, the press, students and citizens can help hold economists accountable to.

Is there anything missing?

One could quibble about the $10,000 limit. For an economist who makes a low salary, smaller amounts would have a significant impact. Still, I think that as a bench mark, the $10,000 figure is fine since it will catch most of the economists for whom such kinds of activities are an important part of their work.

What should happen next?

These guidelines should be widely promoted and reported on in the press and it would be important for journalists, students and others to try to see if such guidelines can be broadly implemented for other publications, TV and radio appearances, etc. The point would be to make such guidelines a broad norm that are widely implemented .

Will these guidelines have any impact?

I do think they will have an impact in terms of providing information to the public. it is very difficult to predict whether it will have an impact on the professional activities of economists. It will take five  years or so to see that.

Would you recommend economic associations abroad to adapt similar guidelines?

Yes. Absolutely. I think this would be a good starting point for other associations. If they do not have publications, then they could still recommend the broad guidelines as indicated in point 7 of the guidelines. In fact it would be good to start with point 7 and then if they have publications, then require that they apply to the organizations’ publications.

This interview was originally published at Economics Intelligence.