Global trade after the financial meltdown

A picture worth thousand words! The downfall of world merchandise trade during the crisis. Good news is that it is again picking up after hitting near-rock-bottom. Source: WTO

New measure of structural transformation: Index of Opportunities

Abdon, Felipe and Kumar have used Hidalgo et al. (2007) and Hausmann et al. (2007)’s concept of product space to come up with an “Index of Opportunities” (full paper here), which captures the potential for further upgrading production, economic growth, and development. It is based on a country’s accumulated capabilities (human and physical capital, legal system, institutions, etc.) to undergo structural transformation.

The idea is that “in the long run, a country's income is determined by the variety and sophistication of the products it makes and exports, and by the accumulation of new capabilities.” Hidalgo and Hausmann have shown that structural transformation occurs when countries grow sustainable by continually upgrading production structure, i.e. redeploying existing production structure to produce (upgraded) new products. It is related to “nearby goods”, “proximity”, and “open forests” concepts used in product space analysis. It is also used to see if coordination failures are binding constraints to growth while doing growth diagnostics of an economy. (An interesting idea that I have used to do growth diagnostics of the Nepalese economy).

Anyway, back to the new Index of Opportunities. It includes:

• Exports sophistication (EXPY--a weighted average of the income level of the products exported, where the latter is calculated as a weighted average of the GDP per capita of the countries that export a given product)
• Sophistication of the core commodities (machinery, chemicals and metals)
• Overall diversification (the number of products in which the country has acquired revealed comparative advantage)
• Diversification of core products (the number of core products in which the country has acquired revealed comparative advantage)
• Share of complex capabilities (the ratio of the number of core commodities with revealed comparative advantage to the total number of commodities with revealed comparative advantage)
• Standardness/uniqueness of the export basket (how many countries export the same product; this measure of uniqueness of the export basket has been called “standardness”)
• Open forest (measure of the potential for further structural change. This variable provides a measure of the (expected) value of the goods that a country could potentially export, i.e., the products that it currently does not export with revealed comparative advantage)

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“We estimate cross-country regressions of each of the seven indicators on the level of GDP per capita. Each indicator has two components that enter the construction of the Index. One is the actual value of the indicator, which captures the actual capabilities. The other one is the residual from the regression of the indicator on GDP per capita. This shows whether a country is a positive or a negative outlier given its income per capita. The residual obtained in each case is considered a “reward” or a “penalty”, respectively. A lower value of standardness is considered better. In this case, therefore, a negative residual corresponds to a reward and a positive residual to a penalty. We use highly disaggregated trade data covering 779 products for the years 2001-2007.

We rescale all seven indicators and the residuals such that they lie between 0 (minimum value) and 1 (maximum value). With all the seven indicators (and their residuals) scaled to lie between 0 and 1, and an increasing value corresponding to an improvement, we averaged the fourteen components to obtain the Index of Opportunities.”

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The result shows that China has the highest score, followed by India, Poland,Thailand, and Mexico. Nepal stands at number 33 with an index of 0.4729.

The authors use the index to predict average annual economic growth rate between 2010-2030. For instance, the average annual growth rate of Nepal between 1990-2007 was 4.33 percent. Based on the index, growth projection, average annual growth rate, for Nepal, between 2010-2030 is 5.49 to 6.61 percent. For the same timeframe, China’s is 10.34 and 4.15 to 5.12 percent and India’s is 6.47 and 5.78 to 7.07 percent. Their result is pretty close to the one done by Uri Dadush and Benn Stancil (2010) from Carnegie Endowment.

The conclusion is that countries (such as China, India, Poland, Thailand, Mexico, and Brazil) that have diversified and increased the level of sophistication of their export baskets have accumulated a significant number of capabilities, allowing them to perform well in the long run. For countries that have not done so yet, they will have hard time having structural transformation. The authors vouch for “soft” industrial policies advocated by Harrison and Rodriguez Clare (2010). [Soft industrial policies promote collaboration among government, industry, and cluster-level private organizations with an aim to directly increase productivity. It basically seeks to directly address coordination failures that keep productivity low in existing or promising sectors rather than engage in direct interventions that might distort prices. This is like facilitating the process that already looks promising but is not realizing its full potential, rather than instituting one all anew whose success is unclear.]

I am not sure how much impact this index will have but it does not add much new information than EXPY and PRODY analysis developed by Hausmann et al.. It just reaffirms the results that are already there (it reaffirmed the conclusion of the product space analysis and the projections done by Dadush and Stancil). Nevertheless, a series of interesting papers and one more index to look at export-led structural transformation. Also, read the papers I have linked to. The whole concept is amazing!

(Failing to) Read Keynesian economics correctly…

Read today's piece by Niall Ferguson, who frets about  warlike spending during no-war time (but forgets about the depression economy), in FT:

When Franklin Roosevelt became president in 1933, the deficit was already running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. The federal debt burden [in the United States] rose only slightly – from 40 to 45 per cent of GDP – prior to the outbreak of the second world war. It was the war that saw the US (and all the other combatants) embark on fiscal expansions of the sort we have seen since 2007. So what we are witnessing today has less to do with the 1930s than with the 1940s: it is world war finance without the war.

Those economists, like New York Times columnist Paul Krugman, who liken confidence to an imaginary “fairy” have failed to learn from decades of economic research on expectations. They also seem not to have noticed that the big academic winners of this crisis have been the proponents of behavioural finance, in which the ups and downs of human psychology are the key.

The evidence is very clear from surveys on both sides of the Atlantic. People are nervous of world war-sized deficits when there isn’t a war to justify them. According to a recent poll published in the FT, 45 per cent of Americans “think it likely that their government will be unable to meet its financial commitments within 10 years”. Surveys of business and consumer confidence paint a similar picture of mounting anxiety.

The remedy for such fears must be the kind of policy regime-change Prof Sargent identified 30 years ago, and which the Thatcher and Reagan governments successfully implemented. Then, as today, the choice was not between stimulus and austerity. It was between policies that boost private-sector confidence and those that kill it.

Brad DeLong has a piece that tackles most of the concerns raised by Ferguson:

Here we have the crux: Greece, Ireland, Spain, Portugal and Italy need to be austere. But Germany, Britain, America and Japan do not. With their debts valued by the market at heights I had never thought to see in my lifetime, the best thing they can do to relieve the global depression is to engage in co-ordinated global expansion. Expansionary fiscal, monetary and banking policy, are all called for on a titanic scale. But, the members of the pain caucus say, how will we know when we have reached the limits of expansion? How will we know when we need to stop because the next hundred billion tranche of debt will permanently and irreversibly crack market confidence in dollar or sterling or Deutschmark or yen assets? Will this shrink rather than increase the supply of high-quality financial assets the world market today so wants, and send us spiralling down? Economists had asserted before 1829 that what we call “depressions” were impossible because excess supply of one commodity could be matched by excess demand for 

another: that if there were unemployed cobblers then there were desperate consumers looking for more seamstresses, and thus that the economy’s problems were never of a shortage of demand but of structural adjustment. But once Mill had pointed out that these economists had forgotten about the financial sector, the way forward was clear – if you could cure the excess demand in the financial sector. Monetarist dogma says the key excess demand in that sector is always for money – and so you can always cure depression by bringing the money supply up. The doctrine of the British economist Sir John Hicks says the key financial excess demand is for bonds, and you can cure the depression by either getting the government to borrow and spend or by raising business confidence so the private sector issues more bonds.

Followers of the US economist Hyman Minsky say the monetarists and the Hicksians (usually called Keynesians, much to the distress of many who actually knew Keynes) are sometimes right but definitely wrong when the chips are as down as they are now. Then the key financial excess demand is for high-quality assets: safe financial places in which you can park your wealth and still be confident it will be there when you return. After a panic, Minsky argued, boosting the money stock would fail.Cash is a high-quality asset, true, but even big proportional boosts to the economy’s cash supply are small potatoes in the total stock of assets and would not do much to satisfy the key financial excess demand. Trying to boost investment would not work either, for there was no excess demand for the risky claims to future wealth that are private bonds. The right cure, his followers argued, was the government as “lender of last resort”: increase the supply of safe assets that the private sector can hold by every means possible: printing cash, creating reserve deposits, printing up high-quality government bonds and then swapping them out into the private market in return for risky assets.

We don’t need one of expansionary monetary and fiscal and banking policy, we need all of them – until further government action begins to crack the status of the US Treasury bond as a safe asset, and further government bond issues reduce the supply of safe high-quality assets in the world economy. Has that day come? No. The US dollar is the world’s reserve currency, the US Treasury bond is the world’s reserve asset. The US has exorbitant privileges that give it freedom of action that others such as Argentina and Greece do not have. Will that day come soon? Probably not.

But trust me, we will know when the time comes to stop expansion. Financial markets will tell us. And not by whispering in a still, small voice.

Brad DeLong has more to say about Ferguson's weak arguments bashing Keynesian economics:

Could we please have some acknowledgement of the fact that the reason the debt-to-GDP ratio did not rise across the 1930s was because GDP rose, not because debt didn't rise? Debt more than doubled from $22.5 billion to $49.0 billion between June 30, 1933 and June 30, 1941. But nominal GDP rose from $56 billion in 1933 to $127 billion in 1941.

And could we please have some acknowledgement that our 9.4% of GDP deficit in fiscal 2010 pales in comparison to the 30.8% of GDP deficit of 1943, or the 23.3% and 22.0% deficits of 1944 and 1945?

Niall Ferguson should not do this. The Financial Times should not enable Niall Ferguson to do this.

Krugman chips in:

If you were ignorant of basic facts about the Depression — or if you didn’t know that movements in a ratio can reflect changes in the denominator as well as the numerator — you might think that it’s possible to summarize fiscal policy by looking at the federal debt-GDP ratio, which looks like this from 1929-41:

Clearly, then, Herbert Hoover was a wild deficit spender, while FDR was much more cautious. Right?

OK, we know that’s wrong. Here’s what nominal debt, the numerator in the debt ratio, looks like:

So Hoover ran up very little debt — only about 6 percent of 1929 GDP. FDR, on the other hand, ran up a lot of debt, about 47 percent of 1933 GDP. But Hoover presided over a shrinking, deflationary economy, while FDR presided over a rapidly growing (from a low base) economy with rising prices.

Multidimensional Poverty Index (MPI) -- Nepal edition

The UNDP and OPHI have come up with a new measure of poverty— Multidimensional Poverty Index (MPI) — that will be used (rather update) the existing Human Poverty Index (HPI) calculated annually by the UNDP in its flagship report HDRs. Here is the full paper and methodology used in calculating MPI.

The MPI assesses a range of critical factors or “deprivations” at the household level: from education to health outcomes to assets and services.  The index ranges from zero to one, with low value meaning low MPI. It ranks countries based on MPI. The MPI value reflects both the incidence (percentage of people who are poor) and intensity (the average number of depravations each household faces) of poverty. Education, health and living standard are the three main indicators. Education is composed of two sub-indicators: years of schooling and child enrolment. Health is composed of two sub-indicators: mortality (any age) and nutrition. Living standard is composed of six sub-indicators: electricity, sanitation, drinking water, floor, cooking fuel, and asset ownership.

The MPI uses 10 indicators to measure three critical dimensions of poverty at the household level: education, health and living standard in 104 developing countries. These directly measured deprivations in health and educational outcomes as well as key services such as water, sanitation, and electricity reveal not only how many people are poor but also the composition of their poverty. The MPI also reflects the intensity of poverty – the sum of weighted deprivations that each household faces at the same time. A person who is deprived in 70% of the indicators is clearly worse off than someone who is deprived in 40% of the indicators.

The measure reveals the nature and extent of poverty at different levels: from household up to regional, national and international levels. The multidimensional approach to assessing poverty has been adapted for national use in Mexico, and is now being considered by Chile and Colombia.

OPHI researchers analyzed data from 104 countries with a combined population of 5.2 billion or 78 per cent of the world’s total. About 1.7 billion people in the countries covered – a third of their entire population – live in multidimensional poverty, according to the MPI. This exceeds the 1.3 billion people, in those same countries, estimated to live on $1.25 a day or less, the more commonly accepted measure of “extreme poverty”.

The MPI also captures distinct and broader aspects of poverty. For example, in Ethiopia 90 per cent of people are “MPI poor” compared to the 39 per cent who are classified as living in “extreme poverty” under income terms alone. Conversely, 89 per cent of Tanzanians are extreme income-poor, compared to 65 per cent who are MPI poor. The MPI captures deprivations directly – in health and educational outcomes and key services, such as water, sanitation and electricity. In some countries these resources are provided free or at low cost; in others they are out of reach even for many working people with an income.

Half of the world’s poor as measured by the MPI live in South Asia (51 per cent or 844 million people) and one quarter in Africa (28 per cent or 458 million).

 

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Case of Nepal: The percentage of people who are MPI poor (headcount) is 84.7 percent. The average intensity of MPI (average number of depravations each household faces) is 54 percent. Nepal is ranked 82 with a score of 0.350. The percentage of population at risk (deprived in at least one indicator) is 76.73 percent. There are 18.3 million MPI poor people in Nepal. Compare this with the World Bank’s estimate of poverty: 55.10 percent (15.59 million) of the population living below income poverty line of $1.25 a day. The national poverty line estimates 30.90 percent of population living below the poverty line. The incidence of poverty is 64.7 percent and average intensity across the poor is 54 percent.

In South Asia, Sri Lanka has the best MPI index with a value of 0.021 and ranks 32 in the world (first in South Asia). It followed by Pakistan, Bangladesh, India and Nepal with world ranking of 70, 73, 74, and 82 respectively. 

 
 

Hans Rosling on global population growth

He argues that living standard of the poorest has to be improved in order to check population growth. The population of the world is projected to reach 9 billion over the next 50 years.

Who reads Hayek correctly? Sachs or Easterly?

My econ professors Andrew Farrant and Edward McPhail, Dickinson College, argue that Jeff Sachs was right in interpreting Hayek's view on welfare state and the road to serfdom!(Btw, here is Easterly explaining the Hayekian insight on economic development) Read the full paper (can't find an online version) for more discussion on how people have failed to interpret what Hayek really meant when he discussed welfare state. They also claim that Glenn Beck and Rush Limbaugh have misread Hayek.

"A relatively recent example of the debate over whether Hayek’s arguments are intended to apply exclusively to full-blown command planning or to command planning and the welfare state alike is provided by the 2006 exchange between Jeffrey Sachs and William Easterly over the merits or otherwise of Hayek’s thesis and the relevance of Hayek’s arguments to debates over contemporary policy. Sachs contended that Hayek intended his argument to have ready applicability to the postwar welfare state. Sachs argued moreover that Hayek’s argument largely missed its mark, and the postwar performance of the Nordic social democracies—together with their clear failure to mutate into totalitarian polities—provided especially telling evidence against Hayek’s thesis.

In his rejoinder to Sachs, William Easterly (seemingly fully in agreement with Bruce Caldwell’s oft-repeated claim that Hayek’s thesis has no bearing on contemporary policy debates over the welfare state per se) suggests that Hayek’s thesis was intended to only have applicability to a system of wholesale state planning.4 In reply, Sachs rightly pointed to Hayek’s 1976 utterance that he deemed The Road to Serfdom to have much applicability to command planning and the redistributive Nordic-style welfare state alike.

Sachs notes that Hayek suggested “that high taxation would be a ‘road to serfdom,’ a threat to freedom itself” (Sachs 2006, 42). Similarly, Sachs maintains that “Hayek was wrong. In strong and vibrant democracies, a generous social welfare state is not a road to serfdom” (ibid.; emphasis added).

Unsurprisingly, Sachs’s reading of Hayek attracted much online commentary. For example, one leading authority on Hayek’s work insisted that Sachs had seriously misread “Hayek’s Road to Serfdom thesis” (Boettke 2006).

Our aim here, however, is not to evaluate whether Sachs and Easterly are correct per se in their claims and counterclaims about the growth performance (whether sterling or otherwise) of the Nordic social democracies. Instead, we argue that Sachs’s “welfare state” reading of Hayek’s thesis is accurate. Indeed, the Sachs-Easterly exchange is merely the latest spark on this particular issue to rise from the rather heated intellectual fire that Hayek’s book immediately lit upon its initial appearance in 1944 (see, e.g., Hansen [1945] 1947). Moreover, there is much clear evidence that Hayek himself had always intended his argument to apply with equal stringency against command planning and the welfare state alike (see, e.g., Hayek 1948, [1956] 1994, 1960, and [1976] 1994). Indeed, as we shall show, Hayek—during the 1940s and after—frequently argued that the logic supposedly set into play by any policy of persisting with the mixed economy, Keynesian demand management policy, and welfare state practices would lead to full-blown central planning. Importantly, Hayek frequently claimed that the “middle of the road” policies—pretty much the welfare state and demand management (Toye 2004)—adopted by the 1945–51 Labour Government in Britain aptly illustrated the veracity of his thesis in The Road to Serfdom."

This is what I commented last time when professors Farrant and McPhail published an interesting paper on Samuelson, Hayek and the inevitability thesis:

"Consider this by Hayek (Foreword to the 1956 American paperback edition of The Road to Serfdom, pp44 in the definitive edition of The Road to Serfdom):

The hodgepodge of ill-assembled and often inconsistent ideals which under the name of the Welfare State has largely replaced socialism as the goal of the reformers needs very careful sorting out of its results are not to be very similar to those of full-fledged socialism. This is not to say that some of its aims are not both practicable and laudable. But there are many ways in which we can work toward the same goal, and in the present state of opinion there is some danger that our impatience for quick results may lead us to choose instruments which, though perhaps more efficient for achieving the particular ends, are not compatible with the preservation of a free society. The increasing tendency to rely on administrative coercion and discrimination where a modification of the general rules of law might, perhaps more slowly, achieve the same object, and to resort to direct state controls or to the creation of monopolistic institutions where judicious use of financial inducements might evoke spontaneous efforts, is still a powerful legacy of the socialist period which is likely to influence policy for a long time to come.

Apparently, Hayek overstretched his warnings and considered that economic planning and reforms would lead to (ultimately result in) a totalitarian state. For the sake of justifying freedom, he blinded himself to the  possibility of having a managed mixed-economy. See the success of the Nordic countries. Also, it is hard to believe that  the US (and other Western countries) would end up being  totalitarian states, especially after the financial crisis (with all those bail-out interventions and activist government policies)."

Nepal's fiscal budget 2010/11 & Economic Survey 2009/10

There is hardly anything to say about the “special budget” worth Rs 110.21 billion rolled out by the caretaker government. It is meant to finance regular bureaucratic activities and is devoid of development and growth agendas. The inability of the political leaders to forge consensus on major economic issues is extremely frustrating because this budget is not going to do anything in addressing the major macroeconomic and development challenges faced by the nation. Unfortunately, misplaced political ambitions of the main political vision less leaders is holding hostage the aspiration of Nepalese people.

 

I usually assess and comment on the fiscal budget but this one is not even worth commenting because it lacks details about key economic expenditure and revenue issues. There is Rs 78.81 billion allocated for appropriate heads (parliament approval needed) and Rs 31.40 for chargeable items (parliament approval not needed). With such a half-hearted and incomplete budget, we should not be expecting much from the government in terms of spurring growth, development, and employment in the upcoming fiscal year. The messy macroeconomic situation will persist (or even worsen).

Meanwhile, the Ministry of Finance (MoF) released Economic Survey 2009/10 this week. It is one of the most anticipated reports coming out of the MoF. Here is an excellent summary and interpretation, based on the Economic Survey, of the state of the Nepalese economy. Here is my take based on the main message of the report: The economy is in a mess, growth is sluggish, and macroeconomic troubles are imminent. The government urgently needs to address the non-economic constraints such as bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages, among others, to kick-start the jammed growth engine of the Nepalese economy.

 

The economic growth rate (real GDP) in the current fiscal year 2009/10 is estimated to be 3.5 percent – lower than 4 percent achieved last year. Government argues that the decline in production of crops (blaming monsoon and adverse weather for growth stagnation!) and sluggish non-agricultural sectors contributed to the slowdown of Nepal’s growth engine. The non-agricultural sectors were (and are) plagued by frequent but fickle bandas, deteriorating industrial relations and labor strikers, power shortages, and supply-side constraints such as deficient supply of infrastructure. Meanwhile, real per capita GDP is nevertheless expected to increase by 2.3 percent, reaching US$562 per year – about 20 percent higher than last year’s figure.

As a percentage of GDP, gross investment is expected to increase to 38.2 percent as compared to 31.9 percent in the last fiscal year. Meanwhile, gross national savings is expected to decline to 9.4 percent from 9.7 percent of GDP in the same timeframe. The gap between gross domestic savings and gross investment, as a percentage of GDP, is expected to be negative 28.8 percent. It is widening by about six percentage points from last year’s figure. This essentially means that we are consuming more and have little money to fund projects and trigger capital accumulation.

The net export of goods and services is estimated to expand by almost 10 percentage points to a negative 28.4 percent of GDP. Exports are estimated to decrease to 9.2 percent of GDP from 12.4 percent last year. Meanwhile, imports are estimated to increase to 38.1 percent of GDP from 34.6 percent last year. Hence, trade deficit is expected to widen by 41 percent. The growth of remittances income is expected to slow down to 7 percent from 47 percent last fiscal year. The contribution of remittances to GDP is expected to stand at 19 percent, compared to 21.2 percent last fiscal year. This is leading to current account deficit of Rs 27.60 billion, which is an estimated negative 2.3 percent of GDP. Note that the current account balance was Rs 41.44 billion surplus last year. Overall, the Balance of Payments (BoP) deficit is projected to be Rs 19.57 billion.

State of the Nepalese economy (2001/02 to 2009/10):