Global Economics and Management

Inflation News

The have been a lot of news regarding inflation recently.

First, a Wall Street Journal article discussing the Fed's upcoming efforts to shrink its balance sheet. The article closely mirrors many of the themes we discussed in class last Monday. The figure on the left, taken from this article, shows the extent to which the Fed has purchased Treasuries in recent years - thereby facilitating the ability of the US government to incur debt.

The crucial paragraph in the article is the last one: "(...) there is little consensus within financial and central-banking circles over how changes in the Fed’s bondholdings influence economic conditions. Economists at Deutsche Bank estimate that if the Fed were to reduce its holdings by around $1.5 trillion between this summer and the end of next year, it could have the effect of around three quarter-percentage-point rate increases." Everyone understands that shrinking the balance sheet of the Fed will have the effect of raising interest rates. But no one really knows by how much. So the Fed will have to proceed in stages, carefully monitoring how closely it achieves the interest rate objectives that it will set. Asset sales and maturation will be the principal tools used to raise interest rates to fight inflation.

Second, wage data for 2021 from the Bureau of Labor Statistics came out today. For instance, here is the coverage in the Wall Street Journal. Labor costs rose at the fastest rate in 20 years. The steepness of the curve displayed nearby is very worrisome, because it signals the emergence of a wage-price spiral. As we discussed in class, once one of those begins, it is very difficult to stop - it requires determined and aggressive action by the Fed to do so. Note also that prices rose at a 7% rate in 2021 while wages rose at a 4% rate. In other words, workers on average took a 3% real wage cut. This sort of thing feeds a lot of voter discontent, which I am sure we will have a chance to discuss in class.

 

 

 

Third, I am pleased that there is a second installment of the Summers-Krugman debates over the state of the US macroeconomy. This one begins with a very gracious concession by Paul Krugman about the inflation predictions he made at the last debate. Krugman had disagreed with Summers on whether President Biden's $1.9 trillion recovery plan would accelerate inflation. It turns out Summers was right. The debate here is of very high quality, by two real luminaries in economics. If you are interested in finance and in the surge in inflation, I recommend it strongly.

The Recent Crypto Meltdown

(Bitcoin Price over the last year)

As we gear up to discuss innovations in the monetary realm in Module 4 of Global Trends, I want to note the recent decline of cryptocurrencies, with Bitcoin front and center. Indeed Bloomberg reports a 50% decline in the value of Bitcoin since its November peak. In a different article, the same source reports that the correlation between Bitcoin and the Nasdaq 100 is at an all-time high of 66%.

What to make of these facts? The first one is not new, as cryptocurrencies are notoriously volatile assets. The second is newer, and suggests market participants view the factors that move equity prices and crypto values as related. My guess is that the expectation of higher interest rates, driven by anticipated Fed policy, is an important common factor explaining the heightened correlation. One might conclude that the desirability of crypto as an asset to hold for portfolio diversification purposes has recently declined: the main argument for holding lots of crypto is that it provided such diversification services because, while volatile, it remained relatively uncorrelated with other asset values. If the trend toward greater correlation continues (and I am not sure at all that it will), this could result in people choosing to hold a smaller share of crypto in their portfolios.

It remains that people increasingly view cryptocurrencies as a store of value (i.e. assets to invest in) - albeit a particularly risky one. But I still see no indication of the use of crypto as a unit of account or as a medium of exchange - it would need to becomes far less volatile for that to happen.

A Contrarian Take on the Social Purpose of Business

Over at Bloomberg, Adrian Wooldridge, former Washington bureau chief of The Economist, takes a contrarian take on the social purpose of business. I post this here, not because I necessarily endorse the ideas in this column, but because it creates food for thought. Wooldridge argues that attempts to enshrine the social purpose of business in corporate law are risky because they will drag corporations into politics. Of course, if you like the current administration's policy stances, you will applaud that. But what if the government changes, and insists that corporations follow social and political goals that differ from yours? Making corporations follow political goals set by politicians goes both ways: it can imply seemingly virtuous goals, but it can also imply repugnant ones. What is virtuous and what is repugnant of course depends on where you stand along the political spectrum.

The column is useful I think because it draws a distinction between the corporate social responsibility (CSR) movement, which broadened the set of stakeholders toward whom corporations have a duty, and the current social purpose movement, which seeks to enshrine social goals into corporate law. The former was a voluntary movement. It is not recent, and dates back at least to the 1970s, with the first statements on corporate social responsibility from the Business Roundtable (the latest was in 2019). Why did CSR rise to the fore then? In my view, it did because technology (especially media technology, the rise of consumer advocacy groups, etc.) made it easier to shed light publicly on the environmental and social actions of corporations. So employees, customers and the broader public could more easily monitor corporate behavior, and punish or boycott those who deviated from ethical norms. As a result, it became more profitable to embrace CSR. The greater alignment between social objectives and corporate objectives is one of the most wonderful developments of the last half century (though this alignment is by no means complete or perfect). 

In contrast, enshrining social goals in corporate law begs the question of who gets to define these social goals. The answer, of course, is the government broadly construed - i.e. both legislators and regulators who write the rules by which corporations must abide. You will say that corporations are already subject to such rules and you would be right. But when it comes to limited liability companies, there is currently no requirement to enunciate any social goals in order to incorporate. Instead, laws and regulation guide and constrain what corporations can and cannot do according to public policy objectives formulated and pursued by democratically elected governments - without otherwise dictating that said corporations pursue specific social goals (beyond their fiduciary duty to shareholders).

I'll let you judge whether this is a distinction without a difference. It is, at any rate, a very interesting and central debate, to which we will return in Module 8 of Global Trends.

China's Falling Birth Rate

Some of the trends we study in class are very much at the forefront of public discourse: the rise of populism, the increase in inequality, the emergence of new technologies. Some trends, however, are more hidden. Nonetheless, they are often no less important than the visible ones. The example of China's falling birth rates is a case in point. Indeed, the situation with birth rates in China is a huge source of concern for the future of that country. As we will study in more detail in Module 9, the rapid ageing of the Chinese population and the eventual decline of its working-age population will put a lid on long-run growth there. A recent article over at Bloomberg contains details and numbers. This chart says it all:

The situation is so dire that population growth in China in 2021 was basically zero.

Why did this happen? Here is my quick take. Explosive birth rates in China following the Second World War led to the imposition of the One-Child Policy in 1980. The policy was enforced very stringently, and so, with a small lag, it led to a dramatic decline in births as seen in the chart above. In 2015 the policy was relaxed, but that did not lead to more births. On the contrary, the downward trend continued. It did so in part for cultural reasons: the one-child policy had lasting effects on family's fertility norms. The socially acceptable norm became to have fewer children. This was likely the result of social contagion and imitation. Growing levels of per capita income and education in China also contributed: birth rates tend to fall across the board when countries rise up in the income and education ladder. Then the COVID pandemic did not help: China is not the only example of plummeting birth rates as a result of the pandemic.

We will have a chance to discuss this issue in much more detail later in the class, of course. There are many interesting nuances that I am sure you will be eager to discuss. For instance, might these falling birth rates help the environment? To every coin there are two sides!

Automation, Robotization, and Labor

I came across two items of note on the topic of automation, which will occupy a good portion of Part II of Global Trends, devoted to the rise of new technologies.

The first is a Forbes article by my fellow economist Effi Benmelech, from Kellogg. In this article Professor Benmelech takes a contrarian view on the rise of robots, arguing that expenditures on robots make up a tiny fraction of overall investment, and that these expenditures tend to be confined to the manufacturing sector (itself a modest share of GDP and overall employment). This leads him to conclude that the disruptive effects of automation might not be as severe as is often anticipated (displacement of labor, rising income inequality). However, as he recognizes at the end of the article, robotization is not the only manifestation of automation. And the other manifestations of automation (AI, cloud computing, etc.) may indeed have disruptive effects, replacing workers and leading to more inequality. Broadly speaking, I agree that robotization is unlikely to be the major issue. Automation more broadly, however, has the potential to really affect productivity (positively) and employment (negatively, at least for low-skilled labor). (For a full-blown academic study of this issue, I direct you to this link, where the ideas in the Forbes article are much more fleshed-out).

The second is an intriguing article from the Wall Street Journal on the growing use of automation and AI for job applicant screening and recruitment activities. Such technologies, in my view, have the potential to greatly improve the allocation of workers to jobs, resulting in efficiency gains. What gets programmed in the algorithms, however, raises very deep and interesting ethical questions, and it it not obvious that the resulting matching process will result in more equity and inclusion (a WSJ article from September 2021 goes into these issues in more detail). To be pondered...

Returns to Large Firms in India

In class today I mentioned that the rate of return to capital is higher in poor countries than in rich ones (based on my recent paper on this subject). I also said that India had experienced very healthy equity returns over the last couple of years. I mentioned that this is especially true of large cap companies. This was a subject of a GEM blog post from a few years ago. Here is the article from The Economist to which this blog post refers. The facts stated at these links remain by and large true today.

One of you also mentioned in class that India has 81 unicorns. Here is a source for this fact. Indeed the startup scene is vibrant in India, and I make a point of visiting startups and incubators when we visit India on the occasion of the immersion course that I teach.

Does Globalization Reduce Conflict?

One of the better established propositions in the field of international relations is known as "liberal peace theory". This theory holds that democracies tend not to go to war with each other, and that economic interdependence reduces the likelihood of conflict between states. Hence, in an open, liberal world, characterized by globalization and democracy, we should see fewer wars. The idea that globalization reduces conflict is pretty well documented in the literature (see the link above and also this very convincing study - there is a huge literature on this issue).

Why? In part because when countries are tightly linked by trade, going to war is more costly: these beneficial trade links have to be foregone. As a result, those who stand to lose from war will tend to resist. We see this all the time. Germany is reluctant to rattle things too much with Russia because it gets a lot of natural gas from Russia (and just got even more). One of the things keeping the US from an even more adversarial relationship with China is that many mutual trade links would be severed in a broader conflict. Of course, as the second link above points out, things can be more complicated when everyone is interconnected: if Germany were connected to an alternative source of natural gas imports (e.g. the US), then the existence of that trade link would reduce the cost of conflict with Russia. Similarly, as the US diversifies its supply chain away from a heavy reliance on China, conflict with China may become less costly.

Still, everything else equal, if you and I trade more, we are less likely to fight, because fighting would be more costly to both of us.

I mention this because the Wall Street Journal's Gerald Seib has a very thought-provoking piece in this morning's WSJ. The article argues that globalization has an asymmetric effect on autocracies and democracies. Seib's reasoning is along the lines above. Yet, I don't think his observation disprove liberal peace theory. On the contrary, the presence of trade links with Russia, in his reasoning, implies that Western powers will be reluctant to enter into a conflict with Russia. Instead, to the extent that Vladimir Putin seeks to attack Ukraine, he can do so largely unimpeded. Similarly, Seib's reasoning implies that China would face little resistance to reuniting with Taiwan because of the extensive trade links that exist with the US. To me, this is perfectly in line with the idea that globalization reduces conflict. We would get small scale regional conflicts (where the big players - Russia and China - would likely win easily) rather than a broader conflagration.

However, I am not so sure that the existing interdependencies are sufficient to prevent Western countries from getting involved in these conflicts. This uncertainty is probably what keeps Putin and Xi hesitant to precipitate things.

This subject is a nice point of connection between Module 2 of the class, which we will discuss today, and Module 7, where we will discuss new geopolitical risks.