Back in early 2009, Sam asked what the contemporary lessons were of Japan's fiscal stimulus efforts during the 1990s. I suggested that one lesson from both Japan and the 1930s US experience was that fiscal stimulus works when it's tried, but that inconsistent, or insufficient, stimulus was unlikely to deliver the desired results. Sam's response at the time suggested he didn't necessarily buy this.

I was reminded of this by the ongoing debate about the effectiveness of the US fiscal stimulus. Earlier this week, Martin Wolf had a very good column in the FT, arguing that the Obama Administration had been far too cautious with its stimulus package. One result: 'This has allowed opponents to claim that policy has been ineffective when it has merely been inadequate.'

Note that this is not a case of being wise after the fact. Wolf also pointed to an earlier column where he had warned of the inadequacy of the measures being planned: 'Unfortunately, what is coming out of the US is desperately discouraging. Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused.' Paul Krugman, who also argued at the time that the Obama package was going to be too small, has been making the same kind of point.

But, and for pretty much the same reason that Sam doubted my response to his question, I suspect that, for many, these arguments will fall on deaf ears. Maybe the success of emerging Asia's stimulus efforts will make for a more compelling example of how stimulus can work?

Finally, that Martin Wolf column begins with a thought-experiment about what might have gone wrong with FDR's policy response in the 1930s, had political circumstances been different. For one very grim take on a possible alternate America, keying off from a prolonged Great Depression, see this short story by Jo Walton.

Photo by Flickr user cbcastro, used under a Creative Commons license.

A recurring theme on The Interpreter is the problems associated with making predictions. The recent financial crisis is just the latest piece of evidence of a failure to forecast, and one of the big lessons we are now being encouraged to take away from it is that we no longer live in a normal world: instead of those nice bell-shaped curves with their thin tails, we are faced with much flatter probability distributions and fat tails. Or, to be a bit more poetic about it, we live in a world of black swans.

All of which makes it all the more striking that we continue to hold a very clear view of what the future for the world economy will hold.

This 'consensus future' is the world of what I have described as the Great Convergence: it is the product of rapid catch-up growth in some of the world's most populous emerging markets, which is taking us to a future where many of the biggest economies are middle income economies, and where these economies are increasingly the home of a new and expanded global middle class.  And it's a future where all of the transition problems that this process entails are (more or less successfully) overcome.

This is a view of the future that is shared by international financial institutions, by investment banks, by consultancy firms, and by think tanks. It's also the view that underpins much Treasury and RBA thinking about Australia's future. Fair enough; this is pretty much my base case for the world economy, too.

And yet. Shouldn't all of our past lessons about predictive failure serve as a warning here? 

So, if you took a range of scenarios for the future of the world economy and assigned a probability to each, then I think that the one with the highest probability score would indeed be some version of what I have described as 'our consensus future'. But note that's not the same thing as saying that the probability assigned to that scenario is especially high. In fact, my hunch is that, right now, many of us are placing too high a probability, either implicitly or explicitly, on this particular forecast of the future. An example of the overconfidence effect at work?

For more on our consensus future, see my recent Lowy Institute Perspectives paper on the subject, available here.

Photo by Flickr user mrbendy, used under a Creative Commons license.

• Graeme Dobell's post, noting that the election is being fought by leaders who both won their spurs in education, employment and health, reminded me of this Anatole Kaletsky essay, which argues that the GFC has ushered in a 'new era' in which the state will intervene less in the 'new commanding heights of the economy' – pensions, health and education. (Mind you, China and other emerging markets are now being encouraged to deliver sizeable increases in public spending in such areas.)
• Sticking with pensions, this piece from Megan McArdle has received a fair amount of attention, including a response from the late Benjamin Strong, as channeled by Brad Delong.
• Here's Jeremy Siegel and Jeremy Schwarz on 'The Great American Bond Bubble' and here (again) is Delong.
• Chronicles of the new austerity: tough times in Greece.
• I liked this short piece by Paul Seabright on how we need to be careful about the lessons we learn from financial history. (Paul was one of my supervisors when I was at Cambridge; I'd also recommend his excellent book.)

• Charles Goodhart remembers the great Euro-area break up of 2013.
• Reinhart and Rogoff return to their analysis of the linkages between growth and debt. Paul Krugman is not impressed.
• Dani Rodrik on the myth of authoritarian growth.
• The Economist takes tea with Dr Doom.
• Blanchard and Cottarelli on the false choice between austerity and stimulus.
• Dick Smith's Population Puzzle, broadcast last night, included the often-heard allegation that, by accepting skilled migrants, the rich world is stripping the developing world of much-needed talent. Here's some research which suggests it's rather more complicated than that.
• And related: for some reason, discussions on the need to curb population growth always remind me of this.

During his recent Wednesday Lowy Lunch speech, Joel Negin reminded us of the other GFC – the global food crisis. For much of 2007 and 2008 it was this crisis, rather than its financial counterpart, that was on my mind. I wrote about the food crisis here and here, and I have a longer effort due out some time in the future.

The lessons you draw from the 2007-2008 food crisis depend in large part upon how you interpret that event. One view is that the surge in food prices that peaked in 2008 was just the latest in a long line of commodity price booms and busts. It might tell us quite a lot about the cyclical drivers of prices over that period of time, but nothing very much about the long term. At the other end of the spectrum, a neo-Malthusian viewpoint would see the crisis as a warning of deep structural imbalances in global supply and demand for food. 

While my own view is closer to the first of these competing perspectives – much of the food price spike was the product of a particular set of circumstances prevailing at that time – I still think that the food crisis told us some important things about the future longer-term trajectory of the world economy.

More specifically, in my view the food crisis made for a powerful case study of the dynamics of a resource-constrained world economy: that is, a world economy where the rapid growth, industrialisation and urbanisation of some of the world's most populous economies periodically bumps up against supply constraints. In the long term, these constraints can be eased through appropriate policy responses (getting prices right, ensuring the appropriate amount of investment). But there will still be adjustment problems. 

This lunchtime I was lucky enough to be invited to a small round-table with distinguished economist Max Corden. This was fun for a bunch of reasons, not least because I'm a long-standing fan of two of his books on international macro.

Over lunch, Max referred to some of the other topics he has covered, and with my recent lament on the migration debate in mind, I thought it worth recommending the inaugural Richard Snape Lecture (pdf), which Max delivered in 2003. The lecture gives Max’s take on the immigration debate and asks whether Australia's population will reach 40 million by 2050. While some of the numbers are now in need of an update, it's still worth a read.

Photo by Flickr user aris-ressy, used under a Creative Commons license.

I've been out of the office for a while, so here's a collection of some of the things that caught my eye while traveling over the last week or two:

• Can we use early warning systems to predict the next major financial crisis? Jeffrey Frankel and George Saravelos say 'yes'. Andrew Rose and Mark Spiegel are sceptical.
• China's much anticipated IMF Article IV report is now available. And here is the Fund's latest report on the US economy.
• Barry Eichengreen and Peter Temin compare (pdf) the euro to the gold standard.
• Niall Ferguson debates himself.
• In the FT, Martin Wolf muses on the political genius of supply-side economics, Edward Luce writes on the crisis of middle-class America and Alan Beattie has lunch with Alan Greenspan.
• A report from the BIS on long-term issues in international banking.
• John Cassidy on Paul Volcker in the New Yorker.
• The Harvard Kennedy School's Indonesia Program has released its strategic assessment of Indonesia's development challenges.

As a member of a group the ABS calls 'overseas-born Australians', I'm always interested in the latest data on migration. According to last week's report, the overseas-born accounted for 27% — a bit more than 1 in 4 – of the total resident population as of end June 2009. According to the ABS, that's the highest share for more than a century:

As well as being part of that 1-in-4 group, I'm also part of another group – this time a 1-in-5. Of overseas-born residents, persons born in the UK (like me) make up the largest sub-group, accounting for about 1-in-5 of total overseas born residents, or 5.4% of Australia's total population. Persons born in New Zealand account for 2.4% of the population, followed by China (1.6%), and India (1.4%).

It's interesting to note that, as the chart shows, while UK-born residents still account for the biggest group of overseas-born Australians, 'our' share has been sliding since 1999. This is in contrast to the steady increase in people born in New Zealand, China and India.

As a member of the 1-in-4 and 1-in-5, it's probably not going to be any surprise that I'm finding the pre-election debate on migration pretty depressing. 

There are a range of reasons for feeling this way, but perhaps the most depressing is the way migration policy is now being used as a response to policy failures elsewhere. It seems that failing to deliver good infrastructure to urban-dwellers, failing to get the housing market right, and failing to deliver appropriate policies on sustainability are all to be dealt with by migration policy. In each of these cases, this is not just about an apparent inability to deliver what should be the first best policy solution. It's also about an inability to deliver a second, or even third best policy as well. 

Actually, that's not just depressing. It's worrying.

Via Free Exchange, this charting tool at the Minneapolis Fed is rather neat. It allows you to compare the current US downturn with past recessions across a range of metrics, including output...

...and employment:

Conclusion: the current recession is the worst for the US economy since the Second World War.

I noticed that one of the links in Sam's roundup yesterday was to The Economist's question about the future of China’s labour supply (incidentally, a topic I posted on a while back). Seeing this reminded me that there's now almost a surfeit of entertaining economic debate available on the internet. 

So, for example, the China labour question is only the latest in a series of topics covered by The Economist's 'by invitation' feature, which brings together a range of top economists to offer their views on a range of subjects, including the future of China's currency policy, inflation vs. deflation, and the case for a bank tax.

Alternatively, you could head over to the Financial Times and track the austerity-or-stimulus debate underway between a number of prominent commentators. Then there's the FT's Economists' Forum, not to mention the somewhat more democratic Exchange.

I've just finished reading The Dervish House by Ian McDonald. Set in a future Istanbul, in a Turkey that has recently joined the European Union, the story takes in nanotechnology, prediction markets, international gas deals, as well as mysticism and a quest for the fabled Mellified Man. It's wonderful stuff. 

The Dervish House comes in the wake of a couple of other excellent novels in which McDonald has explored a future India (River of Gods) and a series of alternate Brazils (Brasyl).

One of the many reasons these books are interesting is that they are a sign of how Western SF writers are now imagining that many of the interesting bits of our international future will be found in non-Western societies (another good example is Paolo Bacigalupi's The Windup Girl). In this way, these stories are a nice indicator of shifts in attitudes in our contemporary world. They are also an enjoyably different way to think about some of the potential futures that might be underpin all of those economic forecasts about the BRICs and the N-11.

If you haven't read any McDonald, it's worth giving him a try.

As a follow up to my previous post on FDI, I thought it might be interesting to take another look at Chinese investment into Australia. 

This is only a partial look: the next ABS set of data on FDI by country is not due until the end of the month, and as far as I can tell, the latest official Chinese data on Chinese outward FDI (OFDI) by country is only available up to 2008. But there’s enough information out there to make three useful observations.

The first view comes from the Foreign Investment Review Board (FIRB), which earlier this year released its latest (2008-2009) annual report. This is recent enough to have captured some of the ongoing jump in Chinese investment into Australia:

Source: FIRB annual reports, various years. Note no values for Chinese investment are reported for 2000-01 and 2002-03. 

read more

More evidence of what happens when other countries have the money: Gillian Tett has a piece in the FT arguing that European governments have been paying increased attention to Asian investors. 

Tett notes that, for much of the past year, governments in Berlin, Paris and Madrid resisted the idea of conducting US-style stress tests on their banks, despite encouragement from the likes of the IMF, the BIS and the Obama Administration. What finally got them to change their minds? According to Tett, it was events around the G20 finance ministers' meeting at Busan. More specifically:

In the days before and after that G20 gathering, eurozone officials met powerful Asian investment groups and government officials who expressed alarm about Europe’s financial woes. And while those officials did not plan to sell their existing stock of bonds, they specifically said they would reduce or halt future purchases of eurozone bonds unless something was done to allay the fears about Europe’s banks.That, in turn, sparked a sudden change of heart among officials in places such as Germany and Spain.

Since then, China's SAFE and other Asian investors are reported to have returned to the Spanish bond market. Related:

• A week or so back, SAFE was reported as pledging that it has no plans to dump its massive holdings of US T-bills, following earlier reports of a shift into JGBs.
• Michael Pettis argued that, far from dumping its US dollar assets, China is much more likely to be growing them.

Photo by Flickr user Talke Photography, used under a Creative Commons license.

During the recent debate  over Australia's response to Chinese foreign investment, many references were made to the OECD's index of foreign direct investment (FDI) regulatory restrictiveness. 

That index measures the restrictiveness of a given country's policy towards FDI on a scale of 0 (no restrictions) to 1 (prohibition of FDI). The index in use at the time covered nine sectors and provided results for 29 OECD member economies (excluding Luxembourg and before Chile joined this year) as well as 14 other non-member economies.

On this measure, Australia appeared to operate one of the most restrictive FDI regimes among advanced economies. According to the 2007 index, Australia operated the sixth most restrictive FDI regime out of the 43 economies covered. The only two OECD economies judged to have tougher regimes were Iceland and Mexico, along with the non-OECD economies of China, India and Russia. 

Australia was identified as running a much more restrictive regime that its close neighbour, New Zealand, and a tougher regime than Canada, which is sometimes depicted as a competitor for foreign investment. Australia's index of restrictiveness was above the OECD average, the non-OECD average, and the overall country average. 

Moreover, the index also highlighted the fact that the main reason Australia stood out from the other OECD economies in its restrictiveness was as a result of the Foreign Investment Review Board (FIRB) screening process: as the OECD chart shows, the level of equity and operational restrictions did not significantly distinguish Australia from the rest of the world.

• The NY Times profiles economists Carmen Reinhart and Ken Rogoff, authors of the magisterial This Time is Different. (Via Greg Mankiw.)
• George Soros – who famously helped bring down an earlier European exchange rate experiment – delivers his thoughts on the euro crisis. See also Edward Chancellor in the FT.
• Gideon Rachman reckons US business is falling out of love with China, a development that will have adverse consequences for trade policy.
• John Makin offers a warning on the rising threat of deflation.
• As always, lots of interesting stuff at VoxEU. Recent items worth a look include Corsetti on fiscal consolidation, Suominen on the future of the US dollar, and Edwards on life expectancy around the world.
• The ECB provides a detailed summary of the recent extraordinary measures taken to support the financial sector in the EU and the US. (Via Free Exchange.)

I've posted before about the ongoing policy debate over the swing back to fiscal consolidation — a debate that also dominated the recent G20 meeting.

For now, the argument appears to have moved in favour of those advocating austerity. Policymakers across the developed world have announced spending cuts in a gamble that an incipient private sector recovery will prevent a re-run of the 1930s. Proponents of a more Keynesian approach are left wondering how they have seen such a quick reversal in the battle of ideas, and forecasting more economic pain ahead.

Might their pessimism be overdone? I have noted before that some advocates of fiscal consolidation have pointed to empirical work arguing that fiscal contractions can sometimes have expansionary effects: or to put it another way, maybe sometimes Keynes is wrong and Alesina is right. 

I suppose it's possible, but the trouble is, two of the most likely mechanisms to deliver the kind of anti-Keynesian outcomes that have occurred in the past do not look promising under current conditions:

Daniel Davies explains his superior approach to modelling monetary economics:

I think we can all agree that things will go better if all currently working monetary economists stop teaching their models to undergraduates and instead adopt my modelling approach:

1. A bank is a box, with "BANK" written on it
2. A central bank is a box with a pitched roof and lines on the front representing the fascia of the Bank of England
3. The household sector is a stick man
4. The industrial sector is a box with a sawtooth roof
5. Long term savings are a stick figure with a top hat

With these basic concepts, plus sufficient scribbled arrows, more or less any problem in monetary economics can be solved, up to the level of accuracy of any other model.

Brad Delong develops the concept, and Eric Rauchway contributes as well. 

I enjoyed it, anyway.

• Simon Evenett delivered a terrific talk on trade policy here at the Institute yesterday. Simon also coordinates the work of global trade alert, and a summary of their latest assessment of the state of international protectionism is available here.
• This NY Times piece on the Irish economy has been receiving lots of linkage. Ireland's determined push for fiscal austerity has received a fair bit of praise, with Dublin's tough action being contrasted to developments in Southern Europe. According to the NYT story, however, the reality is pretty grim. (Via Free Exchange.)
• Sticking with fiscal policy, the IMF's chief economist has laid down his ten commandments for fiscal adjustment in rich countries.
• Some great news via Brad DeLong: The Journal of Economic Perspectives is now freely available online.
• Also at DeLong's website, this very interesting essay on the history of macroeconomic thought. It's in part a response to this recent attack on economic blogging. Some other responses are here and here.

The final communiqué from the Toronto meeting of G-20 leaders contains no big surprises. As foretold by the earlier meeting of finance meetings in Busan, the group placed a greater emphasis on the need for fiscal consolidation than it has in the past, while no global deal on a bank tax was forthcoming. 

In fact, leaders have either agreed to disagree (on fiscal policy) or have postponed possible agreement until later (on bank capital and other financial rules). This means a key theme of the Toronto Summit has been divergence rather than convergence on policy initiatives.

To some extent, this inability to achieve consensus is disappointing, although it's not particularly surprising.  It's also a sign that policymakers and politicians think that the world economy is returning to (relative) stability.

At the height of the GFC, there was both a remarkable degree of consensus on what action was needed – basically, to throw fiscal policy, monetary policy, and the kitchen sink at the world economy in order to fend off a major collapse – and a collective sense that if the world's major economies didn't hang together, they would all hang separately. 

Now we are in the post-crisis phase, neither of these two conditions hold. As a result, differences in national positions and priorities are accorded their traditional prominence.

Photo by Flickr user future15pic, used under a Creative Commons license. 

I noted some time back that an important part of the sovereign risk element of the Resource Super Profits Tax, at least as far as the miners were concerned, was the potential demonstration effect of a higher resource tax take on other countries which might follow Australia. Well, to the extent that there has been any demonstration effect to date, it's been rather different to the one that I had in mind in my original post.

Granted, we still have to see what a new PM (and an upcoming election) will ultimately deliver. But in the meantime, the signal that's gone out so far from Australia regarding the politics of resource taxation has turned out be more miner-friendly than taxation-friendly.

Incidentally, did anyone else find the image conjured up by this headline a little bit unsettling?

Photo by Flickr user Tony Spencer, used under a Creative Commons license. 

When G-20 leaders meet this weekend there will be plenty of scope for debate. China’s decision to move on the RMB has defused one potentially contentious issue, at least for now. But several more remain on the agenda. 

Disagreement over the appropriate pace and timing of the withdrawal of fiscal stimulus is probably the most prominent of these, but there is also ample scope for further argument over financial regulation. With other sources of discord such as climate change and the future of the Doha round still waiting in the wings, the world economy’s new steering committee faces some tough challenges if it is to continue to build on what has been a promising start.

Still, the presence of an element of discord at G-20 summits really shouldn’t come as a huge surprise. Indeed, it’s pretty much an unavoidable design feature of the new international economic architecture. 

By bringing together a broader and significantly more diverse group of countries than the G7/G8, the G-20 inevitably increases the scope for disagreement, since the range of policy interests and priorities is now much greater. While that makes it much tougher to reach any kind of consensus, it’s the inescapable consequence of a more multi-polar world. 

In fact, many of the current disagreements pit the G-20’s rich countries — the established powers — against each other. But there is also plenty of scope for North-South divisions to complicate matters, too.

This raises a broader point. Until now, much of the debate around the G-20, and around the international economic architecture more broadly, has concentrated on the issue of representation: of updating membership lists and re-jigging voting weights in light of the shifting balance of global economic power. All of which is, of course, necessary and important. But it’s only part of the story. 

Once the architecture is in place and the membership issues settled — and the G-20 is actually a pretty good start — then the new arrangements actually have to deliver agreements. And getting them to do this is not going to be straightforward.

Beijing has now made its latest move in the on-going game being played with Washington over the future of Chinese exchange rate policy.  It appears that the currency peg to the US dollar has been abandoned, although all indications are that any subsequent appreciation is likely to be both cautious and modest — much like what happened in 2005 when China last decided to opt for greater currency flexibility and in line with reasonable forecasts of what China was likely to deliver.

Unfortunately, this cautious approach also means that the bilateral friction over exchange rate policy is still going to be with us.

The timing of the decision to quit the peg is interesting, and seems to have caught many observers by surprise.

The run-up to next week’s G-20 meeting had brought growing US pressure for an adjustment to China's exchange rate regime, with President Obama sending a letter to G-20 leaders calling for market-determined exchange rates and US senators reviving legislation targeting the currency peg.  But conventional wisdom has always held that confronting China over the yuan is a counterproductive strategy, since, like most leaders, China’s do not want to be seen to be bowing to foreign pressure.  What's more, there appeared to be two further complications as far as Beijing was concerned – the crisis in the Euro area which had already seen the yuan appreciate significantly against the euro, and an upsurge in domestic labour unrest.  Yet this time, conventional wisdom looks to have been wrong, and the pressure seems to have paid off.

That said, the most likely reason that Beijing has decided to move on the exchange rate is that this is the best decision for the Chinese economy.  According to the latest upbeat assessment from the World Bank, for example, China’s economy is in good shape, and economic prospects now 'warrant a normalization of the overall macroeconomic stance.'  In other words, this is a good time to exit from the set of policies that were put together in response to the GFC, including the decision taken in mid-2008 to effectively re-peg to the US dollar. 

Moreover, by moving now, China has both managed to avoid a confrontation over its exchange rate policy at the G-20 and simultaneously shift the onus onto other countries to do their bit for the meeting's declared aim of delivering on global rebalancing.  Not a bad start.

Photo by Flickr user Patrick Yan, used under a Creative Commons licence.

Michael Wesley’s post on alliances and international trade reminded me that I never got around to posting a link to this fascinating paper by Daniel Berger, William Easterly, Nathan Nunn and Shanker Satyanath. It seeks to 'exploit the recent declassification of CIA documents and examine whether there is evidence of US power being used to influence countries' decisions regarding international trade.'

The conclusion:

Our analysis has provided evidence that increased political influence, arising from CIA interventions during the Cold War, was used by the US to create a larger market for its products. We show that following CIA interventions, foreign-country imports from the US increased dramatically. Further the increase was greatest in industries in which the US was the least competitive in producing, and there was no similar increase in US purchases of intervened-country exports.

Slate's Ray Fisman noted that this paper meant there was now some evidence to support one of the claims of John 'Economic Hitman' Perkins, who believed there was a massive US government conspiracy to serve American corporate interests abroad. William Easterly's slightly amused reaction to Fisman is here.

A couple of weeks back I posted on the dark side of globalisation. The UN Office on Drugs and Crime (UNODC) has just released a threat assessment of what it describes as transnational organised crime (TOC). According to this new report, 'organized crime has globalized and turned into one of the world's foremost economic and armed powers.'

While the report admits the tentative nature of some of its numbers, it puts the estimated total value of the illicit flows that are discussed in the report at about US$125 billion a year, of which around 85% is generated by drugs markets:

UNODC emphasises the way in which the world's biggest trading powers are also the biggest markets for illicit goods and services, and argues that this 'reflects the extent to which the underworld has become inextricably linked to the global economy, and vice versa, through the illicit trade of legal products (like natural resources), or the use of established banking, trade and communications networks (financial centres, shipping containers, the Internet) that are moving growing amounts of illicit goods'. The globalisation of crime is well illustrated in this accompanying slideshow.

I've posted before about the quest for a possible alternative to the US dollar as the world's reserve currency. The leading candidate was supposed to be the euro, but that prediction isn't looking so hot at the moment and may even be headed the way of earlier forecasts for the yen. This has opened up the field to new competition. Setting aside manufactured solutions like the SDR, the yuan is most people's long-term bet.

In the meantime, since the big players don't look as attractive as they used to, the search is for alternative safe havens. The Swiss Franc has long been a contender here, although the Swiss National Bank is doing its best to fend off appreciation in a way increasingly reminiscent of the efforts of the People's Bank of China. 

Last year, currency analysts were touting the Norwegian Krone as a safe haven currency. And the idea of resource-backed currencies as safe havens may be catching on: reserve managers in Russia are now reportedly considering adding the C$ and A$ to their reserves for the first time.

Photo by Flickr user TW Collins, used under a Creative Commons license.

The international press is full of stories about labour unrest in China. 

There have been several (usually complementary) interpretations on offer: this is push-back against China's high level of inequality; its a product of demographic change and the changing nature of the workforce (fewer and younger workers more aware of their rights); it signals the drying up of what had until now seemed like an endless supply of migrant workers from rural China. 

Put these explanations together, and you get the proposition that these events could mark a significant new phase in China's development story. A slightly different way of phrasing that proposition is to ask whether current events signal the arrival of the much-anticipated Lewisian turning point.

The idea of a 'Lewisian turning point' derives from a classic 1954 paper by Arthur Lewis called 'Economic Development with Unlimited Supplies of Labour'. That paper is 'widely regarded as the single most influential contribution to the establishment of development economics as an academic discipline'. It also won Lewis the Nobel Prize in economics. 

I've been posting recently about debt crises, fiscal rules and the Golden Straitjacket. Here, I want to think a little bit more about the political sustainability of the Golden Straitjacket approach.

One historical example of the Golden Straitjacket – and one which is explicitly cited in Dani Rodrik's idea of the trilemma – is the Gold Standard. As described, for example, in this essay by Barry Eichengreen and Peter Temin, by requiring governments to buy and sell gold at a fixed price, the Gold Standard imposed limits and disciplines on government policy that came to be seen as a sort of 'good housekeeping seal of approval'. 

As a result, although the world's major developed economies were knocked off the Gold Standard by the First World War, many policymakers were keen to return to these Golden Fetters as soon as possible after the conflict was over, hoping to signal their renewed commitment to 'sound' financial policies.

In the post-World War One world, however, the Gold Standard was no a longer viable policy option. Several factors were at work, but a substantial part of the explanation relates to the changing nature of labour markets and the shifting balance of power between labour and capital. 

In my previous post I looked at fiscal rules, independent fiscal agencies, and Thomas Friedman's Golden Straitjacket.

The latter is cited in a nice paper by Dani Rodrik for the Journal of Economic Perspectives (JEP). In it, Rodrik is thinking about the future of globalisation, and as a way of plotting out possible scenarios, he identifies a stylised international trilemma for the world economy.* Rodrik argues that countries can choose a maximum of two out of the following three options: democratic politics, national sovereignty and international economic integration: 

Rodrik's proposition is that the kind of deep economic integration implied by globalisation requires the removal of the transaction costs that arise when transactions cross international borders. Nation states are the big driver of these costs – they produce sovereign risk and regulatory discontinuities at the border, and they also make it difficult to agree on global standards and regulations.

One solution to this problem is to do away with nation states – Rodrik’s 'Global federalism' in the above diagram – and align global markets with global politics and global rules and regulations. 

One potential solution to the budgetary credibility problem I posted  on last week is the use of fiscal rules. They've certainly become more popular over time: according to the IMF, in 1990 only seven countries had fiscal rules. By early 2009 that number had risen to 80:  

Fiscal rules are intended to impose permanent, numerical constraints on fiscal policy by placing strict limits on budgetary aggregates. The latter could include the budget balance itself (headline, structural or cyclically adjusted) as well as various measures of government debt, expenditure or revenue. The most popular choices appear to be rules covering debt and the fiscal balance:

Having discussed the effects of conflict on trade in my previous post, what can we say about the implications of international trade for conflict?

The optimistic case for commerce reducing the likelihood of war can be traced back to Montesquieu ('peace is a natural effect of trade'), Kant ('The spirit of commerce, which is incompatible with war, sooner or later gains the upper hand in every state') and JS Mill ('It is commerce which is rapidly rendering war obsolete'). A bit more recently, as Michael mentioned in his initial post, there is Norman Angell, who gave a great diagnosis of the material futility of war in the modern age, but was famously unlucky when he moved from analysis to prediction. 

Subsequently, this thesis has been updated and refined by John Mueller and more recently still by 'Norman Angell with nukes', Thomas Barnett. One of the famous modern statements of the commercial peace comes from Solomon Polachek, who argued that mutual economic interdependence would make conflict more costly, and hence increase the chances of peace. 

Away from theory, and the establishment and growth of the EU is arguably a concrete manifestation of these kinds of ideas. But is there much other empirical support for the idea of the commercial peace? 

The chart below plots globalisation (measured as the ratio of world trade to GDP) and the occurrence of conflict (measured as the number of country pairs which in a given year are in a military conflict, divided by the number of existing country pairs) over the period 1870 to 2001. It suggests that there is no simple relationship between the two. For example, the first era of globalisation (1870-1914) is marked by both growing openness and rising military conflict. And the sharp rise in trade integration since 1970 has been associated with a relatively stable pattern of conflict.  

This shouldn't be a complete surprise. Any sophisticated version of the theory would have to assert that trade discourages conflict, all else equal. But that last qualification is important since in reality, all else is never equal. This means that it's helpful to use statistical techniques to try to isolate the influence of trade on conflict.