Global Economics and Management

The Return of Industrial Policy?

Over at the Wall Street Journal, Greg Ip has written a fantastic article analyzing the return of industrial policy in many Western countries. Prompted by the economic success of China, governments are increasingly directing resources to favored industries. The WSJ article does a great job at outlining the costs and benefits of such an industrial policy.

My general view is that these efforts rarely deliver the promised results. The success of China is not primarily due to industrial policy but to the set of market-opening policies that China put in place starting in the 1980s. In fact, a good argument could be made that China's efforts to direct resources to certain industries or activities has resulted in huge amounts of waste. The reason is that, as Greg Ip outlines, industrial policy allocates resources on the basis of politicians' perceived "strategic priorities" rather than on the basis of market signals. And politicians are not very good at picking the next big thing. Instead, they subsidize certain industries largely out of political expediency - things like "how many jobs will I get in my district". This can be a recipe for short-run electoral success, but it is rarely a recipe for long-run economic growth.

With that on the table, and with a presumption that many of you will disagree with the preceding paragraph, I am sure we can have a healthy debate in the comments section!

The Coming Structural Disruption from Electric Cars

A very large number of people are employed in the automotive sector in the US. The Center for Automotive Research, an industry group with an apt acronym, says there are 1.7 million jobs in the sector, "engaged in designing, engineering, manufacturing, and supplying parts and components to assemble, sell and service new motor vehicles". Statista says there are about 900,000 people employed in auto manufacturing. The BLS, from which these numbers probably originate, is the most authoritative source, and its numbers are here.  Whatever the correct number, lots of jobs are at stake.

The coming transition from the internal combustion engine to the electric engine will disrupt employment in this industry. With government mandates to phase out traditional cars, these changes could be quite rapid. True, people are likely to still demand roughly the same number of cars, at least in the medium run. And these cars will need to be produced, sold and serviced. But the type of worker engaged in producing, selling and servicing electric cars are likely to be quite different from those that currently engage in these tasks for internal combustion cars. A wide range of parts, like carburetors and tailpipes, will no longer be needed. Instead, we will need more workers making batteries, and more software engineers. Moreover, gas stations, and the fleet of trucks that supply them with gasoline, will see demand decline. They will be replaced with electric charging stations, but will these involve the same number and mix of jobs? Servicing electric cars is also much simpler than servicing traditional cars - gone will be the days of the oil change and the smog check.

This is a bit like the debate over free trade. Of course it will be much better to transition to electric cars, for a wide range of reasons, starting with the effect on climate change. Free trade too yielded benefits to the average person, in the form of lower prices of imported goods and greater supply chain efficiencies. But, in the same way that we underestimated the effects of free trade on those who lost their jobs in declining sectors, we run the risk of forgetting those who will bear the costs of this transformation. We should not. Otherwise, the same causes will produce the same effects: discontent among the cost-bearers, manifested at the ballot box.

This is my somewhat long-winded introduction to a very important article in the Wall Street Journal today. The article describes, with many vivid examples, the changes that are coming to the auto industry. Recommended.

Trends in Fertility in the US

In module 9, we will study financial imbalances and aging as sources of risk for the world economy. The problem of aging populations is primarily an issue in rich industrial democracies, though it also affects China, due to reasons specific to that country's past policies (the one-child policy). This has caused policymakers to start thinking about ways to encourage families to have more children. France, for instance, has had a long-running policy of providing financial allocations to families with kids. The grants increase with the number of children that a family supports. France does have a birth rate that is higher than some other European countries like Italy or Spain, though the jury is still out as to whether the allocation system plays a major role in these differences. Personally, I think social norms are much more important than financial incentives. Nonetheless, the debate now rages in the US, and it seems like a bipartisan consensus is forming over the issue of child tax credits. This WSJ article has further details.

The Racial Gap in Socioeconomic Mobility

In Module 6 of the class we will deal with trends in local and global inequality. A recent research paper authored by scholars at both Brookings and the AEI highlights the racial gap in income mobility across generations in the United States. This Bloomberg article summarizes the results: the probability that a White person is in the bottom fifth of the income distribution and that their grandparents were as well is only 1%. For a Black person, it is 15%. In other words, poverty is much more persistent among African Americans than among Whites. I was particularly struck by this graph:

There is a lot of work to be done to address the current legacy of past injustice.

My Talk at the EGROW Foundation

On Friday morning, in the early hours of the day (due to the time difference), I was privileged to present my new paper on the global allocation of capital at the EGROW Foundation, located in Noida, near New Delhi. EGROW is one of India's up and coming policy think tanks, founded by my colleague and friend Charan Singh (a former Visiting Professor at UCLA Anderson). I had a great time talking about how developing countries can gain greatly by reducing barriers to flows of capital. Here is the talk, for those who are interested!

What Caught my Attention this Weekend?

1) The WSJ featured an article on how the COVID crisis is accelerating the decline of cash as a method of payment. It is worth clicking on the links embedded in the story. It is closely related to what we discussed last Thursday, and also very much in line with a general theme we will repeatedly see in Global Trends: the COVID crisis is most likely to accelerate trends that were already in motion before its occurrence, rather than to represent a reversal. This is the case for income inequality, social strife, political polarization, the retreat from globalization, the mounting tension with China, the trend toward automation, the generalization of easy money policies, and the decline of cash...

2) Also in the WSJ, Greg Ip opines on the role of easy money in fueling, at once, record stock valuations and mounting government debt. Both worry me greatly - more than they seem to worry other economists. That is especially the case for mounting government deficits and debt, as we will discuss in Module 9. If the massive injections of liquidity that we have witnessed ever lead to inflationary pressures, the FED may have to start raising rates. A huge stock of public debt could make this very expensive for the government. The very demand for loanable funds that emanates from the public sector may in itself put upward pressure on rates, ultimately. Remember - interest rates have nowhere to go but up. I expressed these concerns last August. My concerns have not eased since, though the scenario I described could be quite removed from us in time. 

UPDATE: People from both sides of the political spectrum seem to be voicing the same concerns as I have on the possible inflationary effects of current US macroeconomic policies: Michael Bordo and Mickey Levy do so over on the Wall Street Journal opinion page, while Larry Summers expresses similar worries in the pages of the Washington Post.

A Pessimistic Take on India

Over at Bloomberg News, Andy Mukerjee offers a pessimistic take on the future of India's economic development. I link to this article because it voices what I would characterize as a relatively uncommon view. Most academic and policy elites that I talk to are quite upbeat about India. But the recent path of economic growth and the Modi government's focus on issues of nationalism and religion has created seeds of doubt about the commitment that Indian policymakers have regarding the countries march toward modernity. 

My personal view is somewhat more optimistic than Mukherjee's. I think that the structural factors that have led to strong growth in India over the last 30 years are likely to remain: a large market; a youthful, entrepreneurial population; a large diaspora facilitating technological exchange and the accumulation of human capital; democratic institutions with a free press and a decent emphasis on the rule of law; a decentralized mode of governance that allows some areas to thrive even if that does not happen everywhere.

That being said, the merits of the article are to highlight some of the limits to this optimistic view. It does so by adopting a very comprehensive historical view of India's development, which readers of this blog will find useful even if they don't espouse the article's overall pessimistic tone. Recommended.

World Inequality

Is inequality between individuals across the world rising? In Module 6 of Global Trends, we tackle this difficult question. According to most accounts, there is growing inequality of average incomes across countries (the global dispersion of per capita income is increasing). And within many countries, there is also growing inequality between citizens. For instance trends in inequality in the US, the UK, China and India seem to be pointing to growing gaps between the rich and poor. Together, these two facts seem to imply that global inequality has also been growing. Yet, this implication is wrong as a matter of mathematical logic. And it seems to be wrong also in terms of the actual data.

For the class, we read a 2006 paper by Xavier Sala-i-Martin showing quite convincingly that despite growing between-county inequality, and growing within-country inequality, inequality between individuals across the world has actually been falling. This is because the global decline of poverty and the growth of the middle class in India, China and other large emerging countries more than offsets growing within- and between-country inequality.

One problem with this evidence is that it is dated: Sala-i-Martin's data stop in 2000. In a recent article in Foreign Affairs, however, Branko Milanovic reminds us that the trend has continued since. This is not surprising, as the two major trends that explain Sala-i-Martin's fact, namely the reduction in global poverty and the growth of the middle class in large emerging markets, have continued unabated since 2000. Milanovic points out that while the growth of China was initially the main driver of the reduction in global inequality, China may now have become sufficiently rich that it may start to contribute to rising world inequality. It is the growth of India that is now in the driver's seat of the reduction in world inequality. In his own words:

"In 2008, the median Chinese income was just slightly higher than the world’s median income; five years later, China’s median income was 50 percent higher than the world’s—and it is probably even higher now. High growth in China, in global terms, is ceasing to be an equalizing force. Soon, it will contribute to rising global inequality. But India, with a population that may soon surpass China’s and is still relatively poor, now plays an important role in making the world more equal. In the last 20 years, China and India have driven the reduction in global inequality. From now on, only Indian growth will perform that same function."

Anyway, now I will know what reading to assign in Global Trends if I want to make the point that global inequality has been falling! 

Are Interest Rates About to Rise?

It is hard to read the tea leaves when it comes to interest rates. But I was struck by two recent news items, both in Bloomberg, that seem to show that interest rates may face upward pressures. 

The first was an article on how France and Germany have huge borrowing requirements, to finance the fiscal expenditures that were instituted to fight the COVID-related depression. These huge borrowing requirements are putting upward pressure on yields. You will note that even though yields there have risen in the last two months, they are still extremely low by historical standards. It is not the magnitude of the rise that causes me to report on this, rather it is the cause of the rise, which seems linked to unusually high borrowing requirements. This is likely to continue, and to put pressure on yields.

The second was a similar item, related to the Reserve Bank of India. It seems that in India too, yields have been rising, for slightly different reasons. Here it seems policymakers are worried about inflation, and may be letting yields rise rather than printing more money to keep them down.

When I was learning economics in the 1990s, a very popular story for why public deficits were bad for growth had to do with crowding out. Crowding out was a story based on supply and demand. The story was that when the borrowing requirements of the public sector were high, interest rates would tend to rise as a result of the demand for loanable funds emanating from the government. In turn, these rising rates would raise the cost of capital to the private sector, depressing private investment. In this manner, public spending would "crowd out" private investment, reducing growth.

The crowding out story kind of disappeared from the economics lexicon in the 2000s. During the Great Recession, central banks injected massive amounts of liquidity to shore up the banking sector and avert a depression. New terms like quantitative easing, whereby central banks would purchase all sorts of assets besides government debt, in exchange for newly-created money balances, meant that interest rates could fall all the way to the lower bound (zero) even in the presence of large public deficits. Inflationary pressures were tame, so central banks could do this without fear of igniting generalized increases in the price level. But with the COVID pandemic, we are testing the limits of this process. The borrowing requirements are so huge, and the amounts of injected liquidity so enormous, that we may get either inflation or rising interest rates.

Of course, we are not there yet, and it could take months, maybe years, for this to become a serious concern. But I am flagging it now because we are possibly seeing some early signs of the reemergence of crowding out. This is not yet the case in the US, and in most countries. But it is showing up a bit in Europe, in India... and the economic mechanisms that make these concerns valid there make them potentially valid elsewhere, because governments everywhere are running unprecedented deficits. I doubt that we will continue to be able to monetize massive amounts of public debt without paying - at some point - the consequences in terms of growth and inflation.

UPDATE: A few days after I posted this, the Fed made an announcement that they would likely keep rates near zero for the next 5 years, and that they would relax their stance toward inflation. This seems to go counter to the two articles I linked to above. I have some observations: if growth resumes and inflationary pressures appear again during the recovery, the Fed may not be able to maintain their new stance: if inflation rises, the Fed will have to do something about it, and that something may involve a departure from zero rates. In that case, the policy will have proven to be time-inconsistent, leading to a loss of credibility for the Fed. But if the Fed fails to convince firms and consumers that they are committed to low rates for a while, people may not act to restart the economic engine by consuming and investing: the Fed is between a rock and a hard place (as it usually is!). There is also the possibility that if rates elsewhere rise, the Fed may face the prospect of a dollar depreciation, and consequently may be forced to soften its stance on low rates. The Fed typically does not target the exchange rate, so this may be a weak channel for rising rates, but if combined with domestic inflation, it may contribute to a departure from the announced policy stance. I'm not saying this will necessarily happen or that rates will rise for sure, I'm only thinking through one possible scenario. And by making this announcement, the Fed sure is indicating that they believe we will be in this slump for a long time - if anything I take this as an indication of the seriousness of our current economic predicament.

Research Update

The month of July has been a productive one for my research agenda:

1) My long-in-the-making paper on the modernization of a French village in the 18th and 19th centuries, written with my PhD student Guillaume Blanc, is finally forthcoming in published form, at the excellent Explorations in Economic History. This is a very unusual paper for me, as it studies the modernization of a single village over a long period of time (I usually adopt a more macro - and more contemporary - approach to studying economic issues). We gathered very detailed data on individuals living in this village between 1730 and 1895, to trace out in great detail the sequencing of demographic, educational and economic change. A little known secret, not revealed in the paper, is that the village in question is the ancestral village of my mother. The oldest ancestor I can trace there was born around 1661. It was a lot of fun to work on this project over the last few years, as I was able to learn a lot not just on my own lineage but also on the context in which my ancestors lived, and the changes that they experienced over the generations.

2) My paper on the link between preferences for Trump and social capital is finally presentable, and has been submitted to a journal. WIth my colleague and coauthor Paola Giuliano, we argue that locations that have lower social capital tended to support Trump to a greater degree in the 2016 election. It is a straightforward paper, but if you believe our result, it suggests that one way out of the populist wave is to work to rebuild civil society. Easier said than done, especially in times of social isolation and impersonal social media.

3) My new paper with Klaus Desmet on spatial variation in COVID-19 severity across counties of the United States has been revised, and submitted to a journal. In this paper, we show that there are vast and persistent differences in disease severity across the US, identify the factors that explain this variation, and suggest that public policies should be tailored to local circumstances. We also show that counties favorable to Trump in 2016 experience lower disease severity, but that this association disappears when controlling for factors like population density and racial composition that are associated with both Trump support and disease severity. Once accounting for these factors, Trump-leaning counties actually have worse disease severity - perhaps because the policies they put in place or the behaviors their inhabitants adopted to fight COVID were less aggressive than in other areas.