Globalization and next best solutions

Harvard developement economist and blogger Dani Rodrik recently posted a brief review of a book by anti-globalization (or alter-globalization, the term that they now prefer) activists Robin Broad and John Cavanagh. Rodrik, as you'd expect from a top economist, is highly critical of the book, "Development Redefined":

As one might expect, the book takes swipes at the usual suspects: the Washington Consensus, the IFIs, the MNCs, Tom Friedman, and Jeff Sachs. Against the growth-focused and globalization-centered views of these institutions and commentators, Robin and John argue for a localized, community-based, self-sufficient model of development. What many others would celebrate as real development (for example the spread of commercial farming for export in the Philippines) they see as the destruction of local communities. They write: "We stand at a moment marking the end of what may well be the most destructive development era of modern history."

Can we be talking about the same era during which, according to World Bank calculations, the number of people in extreme poverty fell (in absolute terms!) by 400 million people? Broad and Cavanagh don't pay much attention to such figures because they seem to have a somewhat romantic view of the lives of rural poor, who apparently have a relatively decent quality of life until market forces in the form of international trade and MNCs encroach upon them.

Broad and Cavanagh responded to Rodrik's criticism in an essay that he posted on his blog. They conclude claiming, "...time and time again, the critics [of globalization] have been right. Witness the food crisis, the climate change crisis, the financial crisis, as well, of course, as the development crisis." I'd like to now respond to this:

"the food crisis" is nothing compared to the hunger before globalization. Compare hunger in China today to hunger in China before the era of globalization.

"the climate change crisis" – This is essentially due to reasons other than globalization, and certainly is possible to combat without getting rid of globalization. It's like saying that modern technology is the cause of climate change, so everyone should go back to living like cavemen. It would solve global warming, but it would cause mass starvation, and for the tiny percentage of the world that survived, it would make life harsh, miserable, and short, with an average lifespan of about 30 years. Economists would call discarding all technology a "next best solution" to the problem of global warming. It would solve global warming, but there are other ways to solve this problem at less cost, in this case at immensely less cost.

Global warming can easily be combatted effectively without getting rid of globalization, and in fact, because of the efficiencies and wealth creation of globalization, science and technology advance substantially faster, speeding up solutions, from safe nuclear, to solar, to exotic heat deflection and genetically engineered carbon eating algae. These solutions are also made cheaper by globalization, and therefore more widely adopted. The costs of solar, wind, and nuclear power, for example, are highly dependent on scale, and a global scale is far bigger than any local scale.

"the financial crisis" – again, not really due to globalization, and it's certainly possible to solve this and prevent future incidents without decreasing globalization. Transparency laws, good regulation, and smart central bank strategy would do it, and they're a far better solution than getting rid of, decreasing, or not increasing globalization. Diminishing globalization is again a next best solution.

"the development crisis" – My first thought when hearing this was that Broad's and Cavanagh meant the crisis from lack of development. My thoughts run this way because I care a lot more about people than rocks, trees, and butterfly eggs. I'm funny that way. The lack of development crisis has been tremendously decreased by globalization -- India and China are such large and amazing examples it would be hard to believe they could think otherwise. If, however, they meant environmental issues by "the development crisis", stopping globalization might help the environment – maybe – in the short run, but it's been overwhelmingly shown that the wealthier a country gets, after the point of basic industrialization, the cleaner it gets.

Environmental cleanliness is a luxury good. The wealthier people get, the more they're willing to spend on it, and globalization has been shown over the long run to be by far more effective than anything else in making poor countries wealthier – China, India, South Korea, Taiwan, etc., etc.

In general, free trade is extremely good for poorer countries over the long run, but it's very true that it depends greatly on the accompanying programs, laws, and governance, for example to make sure that the benefits are widespread and any negative effects are minimized. Nonetheless, as Nobel Prize winning economist Paul Krugman, a staunch liberal, wrote of Globalization in a 1997 Slate article:

These improvements have not taken place because well-meaning people in the West have done anything to help--foreign aid, never large, has lately shrunk to virtually nothing. Nor is it the result of the benign policies of national governments, which are as callous and corrupt as ever. It is the indirect and unintended result of the actions of soulless multinationals and rapacious local entrepreneurs, whose only concern was to take advantage of the profit opportunities offered by cheap labor. It is not an edifying spectacle; but no matter how base the motives of those involved, the result has been to move hundreds of millions of people from abject poverty...

It should also be noted that a lot of the non-free trade things added to free trade agreements are bad, like increased enforcement of drug patents for very poor countries, but the free trade part itself has been a crucial factor in lifting hundreds of millions out of the most extreme poverty. We just need to improve the side agreements, and make these agreements freer in the things that can really help the poor, like by dropping first world agriculture tariffs and subsidies.

There are benefits to allowing secrecy (at least from other investors) in stock trading, as well as costs.

Steve Waldman has another interesting article, "Share buybacks and uninformed investors". There are several points I'd like to comment on, but I don't have time (deadlines for the University of Arizona Free Personal Finance Site, with five hour personal finance course, set for release December 15th). I will, however, comment on one important one.

Steve summarizes the main focus of the post when he writes:

An easy way to think about all this is just in terms of information: Share buybacks of an overvalued firm create artificial, potentially price-insensitive demand that allows informed investors to exit without suffering adverse price movements from revealing their information. Dividend payouts serve as a shock to investor portfolios that forces informed investors to periodically reveal their information, diminishing their advantage over less informed investors. So uninformed, buy-and-hold investors are less likely to be taken advantage of if they invest in firms that issue frequent, substantial dividends and don't repurchase stock than if they invest in firms that don't pay substantial dividends but use stock buybacks to "return cash".

He makes a good point that a corporate share repurchase may provide some camouflage to informed investors, so that they can buy/sell more when the company's shares are underpriced/overpriced ,without tipping off others, who would jump in and bid up/down the price before they could milk it for very many shares (or as many).

There is, though, definitely a question of how big an effect this would be. The effect seems logical, and it may exist, but if it's tiny, then it's not a big deal. I don't know of any research on this, but it certainly may be out there. Also, the camouflaging from a share buyback is going to make no difference to the vast majority of uninformed /liquidity investors anyway. They have no idea what's going on either way, and won't spend the time to closely watch the market for a single stock. The money sits in the 401K, probably in a fund, or funds, of hundreds, or thousands, of stocks, and they periodically check the balance, that kind of thing. What the camouflage may help is to protect one expert and active investor's information from being used by other active expert investors, or specialists at the exchange.

But the issue that I'd like to bring up is whether we'd even want to eliminate all camouflaging – or hiding – of informed investor's trades, so that they benefit very little, if at all, from their information and understanding. I don't think that should be the goal, because then the informed and expert investors get little or no compensation for obtaining that expertise and then using it, spending the time and money to research the company and the real worth of its stock.

And this effort is very important. The more accurate the prices of firms are, the more accurately capital will be funneled to its highest and best use (for the most part – even with perfect accuracy of stock prices, there are still other market imperfections), so we want to make sure that this effort is adequately rewarded.

The situation is analogous to patents. Most patents lasts about 17 years. If we make patent lengths shorter it gives less reward, and thus incentive, for people to become expert, and then put in the work and/or money to innovate. But if we make patent lengths longer, then the ideas are less utilized. If the idea is free, then everyone who gets any marginal benefit from using it, will use it. But If you charge, say, $100,000 to use it, plus transaction, negotiation, and/or legal costs (and these can be really big), then anyone who has a marginal benefit of less than $100,000 will not utilize it, even if that marginal benefit was still big, like 80 to 90 thousand dollars.

Suppose there were 3,000 people or organizations like this, which had an average marginal benefit of $50,000 each. With the patent in force, they would not use the idea – a big waste, because the idea, the understanding, has zero marginal cost, but the marginal benefit is 3,000 x $50,000 = $150 million.

If the patent had instead expired, then the idea/understanding/invention could be placed on the internet and made easily available for free to anyone, anywhere in the world, so it would not be underutilized (or perhaps ridiculously underutilized). So, you can see a big problem that can often occur when relaying on the pure free market, instead of balancing the benefits of the market with the benefits of the government to find the most efficient mix or hybrid.

Could you imagine how much less medicine would advance if instead of the government sponsoring the mapping of the human genome, and then placing it for free on the internet to be used easily be any scientist orstudent in the world, it was owned be a company and kept secret, and could only be utilized by a small number of companies paying a high fee after long negotiations. It would be monopolized, and with the great difficulty of price discrimination, monopoly's maximize profits when they restrict supply, and usually when they restrict it greatly.

In fact, a private company, Celera, launched by mathematician Craig Venter, tried to do this, and it really showed the pros and cons of the market. Venter did come up with a faster and better method than the government project -- with the market you often have the benefit of many people and parties working on an idea in competition from many angles -- but then he tried to patent the genes, which would have caused them to be grossly underutilized by scientists. In 2000 however, President Clinton ruled that the genes could not be patented, and were to be made freely available to any scientist or student in the world over the internet. As a result, Celera's stock plummeted.

What's best here is for the government and the market to both be involved. The government pays private companies for their work (that is, it does some sub-contracting, like in a well run private business when -- and only when -- the control and coordination costs don't outweigh the benefits. This is an important lesson taught in MBA schools that the Republican party never learned.), for example paying Celera for it's improved gene finding process, but the government owns the gene information, and makes it available for free over the internet so that it is100% fully utilized, with virtually zero transactions costs.

In any case, you can see the trade-off in extending or shortening the length of patents, and there's a similar trade-off with the secrecy/camouflaging of trades by expert and informed investors; the more secrecy you allow, the less you let others use someone's ideas/understanding/information (about a stock) for free, and so the more reward and incentive there is to perform the important function of pricing stocks accurately. But, there is also more of a problem with things like market manipulation and corporate corruption, plus, like with patents, your ideas/understanding/information get less widely used.

Suppose you understand that IBM is worth $110, but it's only currently priced at $100, and suppose you have complete secrecy for your trades, but you only have enough wealth that you buy enough shares to push IBM to 105. The stock is still mispriced by $5. But if everyone could use your ideas/understanding/information, there would be far more people buying IBM, and it's price would be pushed all the way to its correct level of $110. In other words, your ideas/understanding/information would be fully utilized, rather than substantially underutilized.

There is a trade-off, so you want to allow the amount of secrecy/camouflaging that optimizes the trade-off, an amount where any more would provide more additional costs of lower utilization of ideas/understanding/information, and of market manipulation, corporate corruption, etc., than benefit from increased incentive to learn about the true values of stocks. And with any less, you'd lose more in incentive than you'd gain in increased utilization and decreased market manipulation, corporate corruption, etc. In the jargon of economists, you want to find the optimal point where the marginal benefits just equal the marginal costs.

Just because some government action or regulation would be bad, doesn't mean that any would

With regard to Arnold Kling's post, "Mark Thoma's Question", there's a few things I'd like to note:

"Moreover, to the extent that there are problems with executives looting corporations, I doubt that government is the solution. If you want to see real looting, watch what happens when Progressive Corporatism kicks into gear."

Yes, there is a lot of government action that would be bad, but that doesn't mean that all government action would be bad, or that all government institutions or regulations are bad. There is much that has been shown to be enormously good. So just don't do the bad government actions, but don't not do any, even the enormously efficient and good. Any well trained economist knows that there are market problems which can cause enormous inefficiency without a government role, such as externalities (especially the gargantuan positional/context/prestige externalities, the pink elephant of economics), asymmetric information, inability to patent, inability to perfectly price discriminate or come anywhere close, gigantic economies of scale and at the same time the gross inefficiencies that come with monopoly, and many more well established and accepted in economics, and in any college economics texts.

Note also that government has improved greatly over time with experience, academic study, and other learning. Look at how much more professional and objective the civil service had become over the last 100 years, unfortunately until the conservative Republicans predominantly took power 28 years ago.

"My idea of what to do with insolvent banks isn't to inject capital. My idea is to close the doors and tell the executives, "Don't let the door hit you on the way out."

If there are banks that are borderline because their securities are not trading, then put them on a watch list, quarantined from other banks, until their situation clarifies. My hunch is that the healthy portion of the banking system is sufficient for the economy, but we have to get rid of the zombie banks first."

Why would the zombie banks be such a problem in preventing the healthy portion of the banking system from providing adequate liquidity, if that healthy portion is, as you have a hunch, sufficient? Clearly from the various financial measures reported, there is, and especially was before the recent government actions, a very serious liquidity problem.

In any case, a hunch is not strong enough to risk a severe recession or depression for, not given the relatively small expected cost of acting in the way Krugman and Eichengreen recommend. If you have a hunch that you will not have a fire, that's not a strong enough reason to risk not buying fire insurance. If there's even a 1% chance of having your house burn down, that makes it worth buying insurance, even though 99% of the time you'd be able to say, "Ha Ha, see my hunch was right."

As far as letting the bad companies go bankrupt, I basically agree, but in a fast track way – i.e., the government takes them over, gives the shareholders nothing, if the firm is really worth nothing, gives the bondholders only what their bonds are really worth, no more, and tells the executives, "Don't let the door hit you on the way out.". But then the government keeps at least most of these companies running, so as not to risk a "house fire" over your hunch. It injects capital, cleans up the balance sheets, and then re-sells the newly healthy companies back to the private sector.

If instead you let these companies go bankrupt the conventional way, it could take years for them to complete the standard legal bankruptcy process, and for other companies to take over their earlier liquidity provision. Waiting for the long run means potentially allowing a severe credit crunch to start a demand-decrease chain reaction that leads to an acute recession or depression.

We can fight the recession, make large high return government investments, and balance the budget, all three – over four years.

It's common now to hear implied, or stated explicitly, that we have to choose between balancing the budget and fighting the recession, or between balancing the budget and investing in high social return projects. This is wrong on the latter as we can and should greatly increase government spending on high return projects, and we can just pay for them with increased taxes on the wealthy, or better yet, once the recession is over, more than pay for them to turn the deficit into a surplus. The former is also wrong at least over a period of four years.

In the first four years of what will hopefully be an Obama administration, we can do all of these things; fight the recession, make large high return government investments, and balance the budget. And four years is really not that long to wait for all of that.

It is important to keep in mind that with intelligent government, i.e. not Republican, we can deal effectively with both the short-term demand crunch (recession) and the long-term deficit. We just pass the measures now (shortly after the new, hopefully Obama, administration begins) that will stimulate short run demand and not lower the deficit, but then after two years these measures schedule steady increases in taxes on the wealthy to the point where the budget is balanced by 2013, and in surplus thereafter, until the entire national debt is paid off by 2020 (or at least there is no debt net of government savings).

By passing the tax increases now which will lead to the budget surpluses, but having them phase in later, after the recession is over, we fight the recession, but we still give confidence to the public and purchasers of our bonds that we are committed to a path of fiscal soundness. A large amount of the tax increases on the wealthy could still take effect immediately, without hurting the fight against the demand crunch, as long as they are countered by tax cuts for the middle class and increased high social return government spending.

The first part of the plan is to greatly increase spending -- as soon as possible -- on government investments of the kind that have extremely high social returns, yet will be grossly underprovided by the free market due to well proven in economics market problems like externalities (especially the grossly underappreciated gargantuan positional/context/prestige externalities, the pink elephant of economics), inability to patent, and many more. A great example is alternative energy. For more on the compelling case for these government investments please see here and here.

These projects help both the short-run demand crunch (increasing short-run spending on, and demand for, goods and services) and the long-run national debt (increasing national productivity -- and income -- over the long run, because of the high returns of these projects). Again, a great example is investment in alternative energy. How about spending an extra $200 billion on that, rather than increasing demand the Republican way, by giving $200 billion predominantly to the wealthy in a tax cut, and then saying go on a shopping spree, so we stimulate demand employing people to produce lots of new yachts, $3,000 suits, and $200 meals, instead of a solar grid, wind farms, and lots of R&D to make these things much better, much faster.

This is all very do-able; it's just like the vast majority of intelligent highly beneficial plans it takes voting out enough Republicans that it can pass.The less Republicans we vote out, the less likely it is that something like this will happen -- and history has really shown this; under Republican administrations the economy has been far worse; the stock market has been far worse, and the deficit has been far worse (see here, here, here, and here).

Paul Krugman a great economist, but more importantly a great person

What can you say about Paul Krugman. He's one of the great economists in history, and one of the worlds most brilliant people. This isn't a man who won the Nobel just by being a superworkaholic with the ability to do mechanical and not particularly hard to understand things and memorization fast, with great endurance and energy, so that he's the first with an Ivy pedigree to get to the frontier and write up something new formally, that's very valuable, but wasn't that hard to figure out. This is a man with immensely powerful high level intelligence, immensely powerful intuition.

More importantly, however, Paul is a great person. About two decades ago, in the prime of his career, he diverted a huge amount of his time and energy towards teaching economics to the general public and promoting the public good with his popular books, articles, and columns. It is likely this greatly decreased his academic output and odds of winning the Nobel and being recognized as one of the greatest economists in history. He made a great personal sacrifice to do good.

So I give my heartfelt congratulations to Paul Krugman, great economist, but more importantly great person.

Humans also evolved to have high level intelligence and mental discipline

With regard to the Scientific American article in Mark Thoma's "Links for 2008-10-12":

I haven't read this article, but I've seen many that look like it, about tendencies towards flaws in human reasoning that have evolved, or instincts to tend to think in certain ways which can cause errors, but the thing you have to keep in mind when reading any of these is that you shouldn't exaggerate, or make absolute, their effects, because the human mind also evolved to have high level, flexible, ultra high dimensional thinking, and mental discipline. If these things are strong enough in a human they can over-ride these tendencies, and they are very strong in many humans, just unfortunately not our President.

Tax cuts and one more reason why a small minority of successful economists might support Republicans

With regard to Mark Thoma's post today, Tax Cut Follies:

First, now or in the near future would be a fine time to raise taxes (on the wealthy) if you first enact and get started more than offsetting stimuli to demand in spending on extremely high return government projects of the type that the pure free market will grossly underprovide due to well proven in economics market problems like externalities, asymmetric information, inability to patent, and many more in any university intermediate economics textbook.

Such projects include alternative energy -- how about stimulating demand by spending an additional $100 billion on that over the next year instead of giving $100 billion to people in tax cuts and asking that it's spent on fashions, cars, and big screen TVs, not to mention Rolex watches and yachts. Wouldn't greatly diminishing the monumental risks of global warming and the resources going to terrorists be a better way of increasing spending to stimulate demand?

I've listed reasons before why a small minority of successful economists would support Republicans:

1) There are relatively few successful university economists who support the Republicans, so there is much less competition for plum and high paying jobs in Republican administrations and propaganda tanks. Becoming a Republican crony can mean a lot of money and/or very high level government jobs, like Mankiw's job as Chairman of the Council of Economic Advisers in George W. Bush's administration. He's also currently a fellow at the American Enterprise Institute. Mankiw has a strong incentive to please the Republicans by misleading for them.

2) He may be an extreme libertarian (more economic than social obviously), and very willing to mislead for that cause, even if he knows it hurts total economic, scientific, and medical growth greatly, and embarrasses him professionally.

3) He may be plutocratic, and willing to mislead for that cause, even if he knows it hurts total economic, scientific, and medical growth greatly, and embarrasses him professionally.

4) He may have Slipperyslopeaphobia -- for details see my blog post.

5) A well intentioned reason -- He may think he can affect change to the historically disgraceful and brain dead Republican party better from the inside than from the outside, and in order to stay inside he can't displease those in control too much.

6) If every intelligent, well trained economist leaves the Republican party, imagine how incompetent their appointees will be. Obviously a party this cronyistic will be extremely reluctant to appoint Democrats. The perfect example is Ben Bernanke. He's a Republican from way back, before the party was taken over by extremists. If he had left, he wouldn't have been appointed to be the head of the Fed by Bush. If all competent economists had left, Bush would just have appointed an incompetent Republican ideologue. So Bernanke's staying in the Republican party left a qualified economist that they could appoint, but obviously his views and understanding of the economy are not simple-minded Republican. His actions have been very Keynesian and intelligent.

I'll add another one which may be applicable to Nobel winner Robert Mundell:

7) Mental instability or illness -- Anyone who has seen the movie "A Beautiful Mind" knows that a Nobel Prize winning economist can suffer from severe mental illness. What evidence is there that Mundell may suffer from mental illness? Princeton economist Paul Krugman writes in his book, "Peddling Prosperity" (pages 87-88):

His academic reputation rests largely on a series of papers he wrote in the early 1960s, as his native Canada wrestled with the question of whether to peg its currency to the U.S. dollar...The fact is that around 1970 Mundell veered off from conventionality in a number of ways. Some of these were superficial: He began to wear his hair long and speak in a slow mumble. Some were more significant: Mundell dropped out of the usual academic round of conferences and seminars, and began holding his own conferences in a crumbling half habitable villa he owned near Sienna. Most importantly, Mundell completely abandoned his former intellectual style; since 1970 he has written little, and what he has tends to be marked by extravagant rhetoric, accusing his fellow economists of "Sheer quackery" in espousing ideas that he himself held when younger.