Socialists for free trade!!!

From the folks over at the World Socialist Web Site (published, if you were wondering, by International Committee of the Fourth International):

While those promoting “free trade” speak for the bankers, financiers and more globally competitive sections of capital, there is a definite constituency for protectionism among less competitive industries. The whipping up of economic nationalism also serves a vital ideological function in diverting the anger of working people over job losses and the precipitous decline in living standards outwards rather than at the real source of the crisis—the profit system itself.

Not exactly the kind of defense for free trade I'd mount, but nowadays we need all the allies we can get.

Johnny Biofuelseed's free lunch

It's certainly understandable that in a time of $100 a barrel oil many laud the promise of biofuels. Yet, Ricardo Hausmann, an economist at Harvard's Kennedy School of Government is guilty of overstating the case for them. For instance, he boldly claims the following:

Peering into the future seldom produces a clear picture. But this is not the case with bio-energy. Its long-term impacts on the global economy appear to be pretty clear, making many long-term predictions quite compelling, including the demise of the price-setting power of the Organisation of the Petroleum Exporting Countries and the end of agricultural protectionism.

While no one can deny that biofuels will be part of tomorrow's energy mix, that's a stretch. Let's begin with the following claim:

Second, the world is full of under-utilised land that can grow the biomass that the new technology will require. According to the Food and Agriculture Organisation, the world has a bit less than 1.4bn hectares under cultivation. But using the Geographic Information System database, Rodrigo Wagner and I have estimated that there are some 95 countries that have more than 700m hectares of good quality land that is not being cultivated. Depending on assumptions about productivity per hectare, today’s oil production represents the equivalent of some 500m to 1bn hectares of biofuels. So the production potential of biofuels is in the same ball park as oil production today

It is very unseemly for an economist to claim that there's a free lunch to be had. After all, why is all that land being underutilized? Maybe there are good reasons for that! It's not as if there's a shortage of land hunger in those countries. Also, let's not forget the inconvenient truth that some of that land is bound to be forested and turning into cropland is, shall we say, not an attractive proposition given our climate change worries.

Let's check out another of his claims:

Fifth, the increase in the price of agricultural land and of food will relieve governments from the current political pressure to protect the agricultural sector. Governments that, as a consequence of the land glut, have been protecting and subsidising farmers will see them grow rich either because they “plant” biofuels themselves or because other producers switch into them, lowering the supply and increasing the price of other crops.

The man clearly underestimates the power of the agricultural lobby. Even at today's high prices, farmers and big agro firms are set to push through a massive farm bill that leaves subsidies intact.

And last but not least, Hausmann dismisses the impact of higher food prices by saying that will create pressures to liberalize agricultural trade. Maybe. But it's not at all clear that liberalization would lead to lower prices, specially if, as he argues, subsidies are reduced. Let's not forget that even if a biofuel boom leads to higher rural incomes overall, some groups will be net losers due to high food prices, like landless agricultural workers.

Why come down so hard on Hausemann? I'm not against biofuels. But overselling their promise will lead to unnecessary policy mistakes, with long-term negative consequences. Yes, it's certainly worthwhile to promote R&D in this area, but subsidies, mandates and tariffs should not be used to promote their use.

Home prices are irrelevant!

So argues Willem Buiter, a well-known monetary economist, in his FT blog. Why? The answer is that people usually live in their own house, hence:

As long as your endowment is positive, your wealth obviously increases when the house price increases. However, an increase in house prices means that the present discounted value of future rents has increased. As a consumer of housing services, now and in the future, you are therefore worse off. On average, in a country like the UK, people consume the housing services they own. Hence an increase in house prices does not make them better off. For financial assets like equity there is no corresponding “present discounted value of future equity services consumption” whose cost increases whenever the value of equity goes up. An increase in stock market values therefore unambiguously makes you better off.

But as regards house prices, regardless of whether a change in price is due to a change in risk-free discount rates, in risk premia or in expected future rents, you are neither better off nor worse off as a result of that price change, if you consume, now and in the future, the same contingent sequence of housing services whose present discounted value is part of the wealth you own. In that case, despite the increase in your housing wealth, once you have paid for the consumption of your initial contingent sequence of housing services, there will be nothing left to spend on anything else.

Great! So today's news of deepening falls in house prices in the U.S. can be happily dismissed. Move along, nothing to see here.

Back to reality, this is one of the most striking examples of ivory tower airy-fairy thinking I've come across in a while.

Now, Mr. Buiter's argument hinges on house prices being equal to the present value of future owner-equivalent rents. This simply does not hold up in real life. Judge for yourself:



There are many reasons for this. But in essence it comes down to the fact that people believe housing is real wealth. How else can one explain the decline ins the personal savings rate to almost zero in recent years?

So, yes, house prices do matter. How much? We'll find out soon enough.

Oil reaches $92 after Iran says "Boo!"

Attributing every single rise in the price of oil to some minor Middle East-related event has become one of the most tiresome parlor games in financial journalism. What's driving the jump in oil prices is supply and demand. Jim Hamilton of Econbrowser explains this eloquently.

The Dario Fo of economics

By now you've probably heard that Leonid Hurwicz, Eric Maskin, and Roger Myerson won this year's Nobel economics prize. With all due respect to all concerned, they're to economics as Dario Fo, Elfriede Jelinek and Wislawa Szymborska are to literature.

If you even want to attempt to know why they got the prize, scoot over to Marginal Revolution.

Not that I'm complaining. Part of the charm of the Nobel prizes is that every two or three years the prize committees throw a wild curveball at us, coming up with the most unexpected winners. Of course, everyone is outraged that more deserving candidates were ignored, once again. Nonetheless, it keeps the world tuned in.

My favorite Nobel peeve is that those pesky Swedes evidently have a something against Spanish-language literature. Octavio Paz was the last winner, in 1990. Since then, there have been 8 English-language winners. Does anyone seriously believe that someone like Harld Pinter is more deserving than a Carlos Fuentes or Mario Vargas Llosa? Please. Not that this problem is recent. They let giants like Jorge Luis Borges, Julio Cortázar and Alejo Carpentier die without recognition.

GM: The free lunch that isn't

Last week, the deal between GM and the UAW to end the strike was hailed in the press almost as a miraculous solution that will save health benefits for current and retired workers and resotre the automaker's competitiveness.

The UAW will manage the health benefits plan as a trust separate from the firm, which won't have to pay those crippling health care contributions from now on. This article by The Economist illustrates the tone followed in much of the coverage.

Sounds like a free lunch? We should know better and so should the press.

To get rid of its health care obligations, GM will have to deposit a lot of money into the VEBA trust. Where will it come from? From its shareholders' pockets, as its contribution will be paid in GM stock (thorough convertible notes).

Would it be any different if the firm made a secondary share offering and kept managing the health plan? Nope, unless I'm missing some sort of fiscal angle. Nor are workers much better off risk-wise, since they will still be tied financially to GM's stock performance.

Actually, the fact that this deal wasn't struck long ago (it's not as if this problem is a recent one) is telling. It's another sad reminder of the low quality of most financial journalism that even The Economist falls for this smoke-and-mirrors trick so easily.

The euro kicks sand in the dollar's face

There's hope for the greenback yet! Sure, by reaching 1.42 against the euro, the dollar sure looks like a 90 pound weakling at Muscle Beach. But take a look at this 30 year graph (before 1999, the ECU --the euro's shadow predecessor--is used):



It looks like 1.4 dollars per euro (approximately) is a pretty hard ceiling!

Just kidding. It's most likely coincidence, unless some strange technical analyst voodoo is taking place.

But there's a real pattern here: dollar lows coincide with U.S. recessions AND oil price surges (in 2001 the first condition is met, but not the second). Correlation is not causation, but this certainly seems to support the dollar-oil price link many have been talking about lately.

Robert Lucas doesn't get it

Via Mark Thoma, we learn that Robert Lucas, Nobel laureate, wrote a rather incoherent opinion piece on the WSJ. This paragraph left me dumbstruck:

It ... is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. ... [But] I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.

Where to begin? Sure, housing construction won't drop to zero, but housing starts have fallen from 2 million in 2005 to just 1.3 million (annual rate) this August, dragging down the economy. And then there's the slight detail of falling house prices and negative payroll growth.

It's amazing how many people are still in denial about the severity of the housing-led threat.

When the U.S. gets a cold, the rest of the world.....

Stephen Jen tries to complete that sentence in an interesting note that reviews the academic evidence on contagion. Historically, U.S.-based shocks have had very different impacts on the rest of the world. For instance, the 1990-1991 recession hardly affected Europe or emerging markets, while the 2000-2001 shock certainly did.

While trade is the most obvious channel for contagion, evidence suggest that confidence and financial markets have a greater, and certainly speedier, impact.

In the end, Jen believes that any U.S. slowdown will only have a limited impact on the rest of the world. I hope he's right.

Mapping economic development

Tim Hartford describes some very interesting work being done by physicists and economists to map out the relationship between products at global and national scale (hat tip: Marginal Revolution). The idea seems to be that poor countries have different product clusters (say, tropical agriculture and mining) from rich nations and it's not easy moving from one to another.

"The physicists' map shows each economy in this network of products, by highlighting the products each country exported. Over time, economies move across the product map as their export mix changes. Rich countries have larger, more diversified economies, and so produce lots of products—especially products close to the densely connected heart of the network. East Asian economies look very different, with a big cluster around textiles and another around electronics manufacturing, and—contrary to the hype—not much activity in the products produced by rich countries. African countries tend to produce a
few products with no great similarity to any others."

That could be a big problem. The network maps show that economies tend to develop through closely related products. A country such as Colombia makes products that are well connected on the network, and so there are plenty of opportunities for private firms to move in to, provided other parts of the business climate allow it. But many of South Africa's current exports—diamonds, for example—are not very similar to anything.

If the country is to develop new products, it will mean making a big leap. The data show that such leaps are unusual.

This is a pretty compelling argument for industrial policy (paging Dani Rodrik!). The question, of course, is what type of industrial policy is best and how it can be implemented. Needless to say, this debate has been going on for nearly 50 years and, curiously, but it's striking how little we know.