Working Papers

The US Current Account and Globalisation

Diana Farrell at the McKinsey Global Institute has been doing some excellent work highlighting the growing irrelevance of a residency-based view of trade, which ignores the increased importance of cross-border ownership of equity capital in driving current account balances.  Farrell estimates that one-third of the US current account deficit is attributable to trade with US-owned foreign subsidiaries.  Moreover, 

For at least the next decade, we would expect foreign investment by US multinationals to go on adding to the current-account deficit as it is currently measured. After all, globalization is in its infancy.

Record current account deficits should not be a surprise in this context, since globalisation should bring about a structural deterioration in the measured current account balance.  Insofar as this deterioration is symptomatic of globalisation, it should be welcomed rather than feared.  Farrell suggests moving to an ownership-based measure of trade balances, which might help defuse current account deficit angst.

posted on 25 March 2005 by skirchner in Economics

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It is now increasingly common to set up a blog to accompany the release of a new book.  Steve Levitt and Dubner have done this for their new book Freakonomics.  One of their first posts deals with why real estate agents are like the Ku Klux Klan.

I think the title of the book is unfortunate, because while Levitt’s interests are unconventional for an economist, he often explores issues that are of wider social interest and importance.  Too often economists are engaged in work that is of only limited interest, even to other economists.  I often get invited to economics conferences where I cannot find a single interesting paper on the conference program. 

Hopefully, this effort by the two Steves will help popularise econometric approaches to social and other issues that are often neglected by economists, leaving debate dominated by those from other disciplines that do not have a coherent theory of human behaviour and have limited interest in empirical testing.

posted on 23 March 2005 by skirchner in Economics

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Affiliate News - LFB 15% Off Everything Sale

Affiliate relationships are an important source of support for Institutional Economics, so we will occasionally highlight special offers from affiliate sites.

Laissez Faire Books is having a 15% off everything sale through to 30 April.  Laissez Faire Books claim to be 30% cheaper than Amazon on average and offer to match Amazon prices on any item.  Orders placed during March and April will also go in the draw to win free tickets to Freedom Fest in Las Vegas!

Note that LFB accept Paypal.

posted on 22 March 2005 by skirchner in Misc

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‘After the House Price Boom’

Peter Saunders (the CIS one, not the hairy lefty) has an article in the latest issue of Policy on ‘After the House Price Boom.’  Peter credits me with commenting on an earlier version of his paper, without implicating me in the argument.  Here I highlight some of my disagreements with the final version.

continue reading

posted on 21 March 2005 by skirchner in Economics

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Basil Fawlty Economic Commentary

One of Basil Fawlty’s favourite bits of hyperbole was “This is just how Nazi Germany got started!”  Over at the otherwise respectable On-Line Opinion, James Cumes, a former Australian diplomat, makes the same claim in relation to the RBA’s latest rate rise:

Hitler came to power in early 1933. So did Franklin Delano Roosevelt but even the “New Deal” was too little and too late to turn the economic tide around - or the drift into world war. Unfortunately, we are doing the same thing now. We are persisting with policies that can only be self-destructive. That applies not only to Australia but especially to the United States - and indeed to many other countries.

The rest of the piece is as economically illiterate as it is overwrought.

posted on 19 March 2005 by skirchner in Economics

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Voluntary vs Compulsory Student Unionism

Andrew Norton discusses the government’s voluntary student unionism (VSU) legislation over at Catallaxy, noting that as a market liberal, he opposes the legislation as just another form of centralised control over universities (leading to the ‘Minister for Sausage Rolls,’ as he puts it in another post).

Andrew raises what I think has always been a central problem for the advocates of VSU, which is that if universities were to bundle student services with tuition fees, then they become just another form of largely unobjectionable product bundling that we routinely see in the provision of private sector goods and services.  Andrew’s argument is that so long as market forces are allowed to operate in relation to the provision of higher education more generally, the problem of student unions will largely resolve itself.  Universities competing on price and quality will simply not permit the excesses and inefficiencies associated with today’s student unions. 

Andrew correctly argues that compulsory student union fees in Australia are a legacy of the funding model for higher education, which up until recently prevented universities charging tuition fees, giving rise to a separate ‘amenities’ fee for student services.  This is why student unionism has never been a major issue in the US, unlike Australia and the UK.  It is not coincidental that the Australian government is now addressing this issue in the context of wider changes to the funding model for higher education.

I have a somewhat less principled position than Andrew.  Andrew has done more than anyone to highlight how far removed Australian higher education is from a market model.  In the context of a highly centralised and regulated system, I think we are permitted to play favourites with the interventions we like and don’t like.  Even bad legislation that forces universities to confront the consequences of their dependence on public funding and centralised control can serve as a catalyst for change.  As Andrew notes, the government’s legislation will move us in the right direction by forcing universities to take direct responsibility for student services.  The only unfortunate thing about the legislation is that it is symptomatic of the government’s broader agenda of centralisation across a wide range of portfolio areas that is undermining the foundations of Australia’s federal system of government.

posted on 17 March 2005 by skirchner in Politics

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Howard and Minchin as Revenue Hoarders

If recent comments by the Prime Minister are anything to go by, we can rule out a meaningful reduction in the overall tax burden in the May Budget and probably for the life of the current Parliament.  The government remains wedded to the view that tax cuts can only be funded out of the surplus, with the PM saying:

If we are able to give further tax relief after we have provided for essential spending, and that’s defence, health and roads and all of those things, and provided we have a strong budget surplus. (emphasis added)

In the government’s view, tax relief is a residual that can only be paid for out of the surplus.  The surplus is simply too small to accommodate a meaningful tax cut.  Tax cuts out of the surplus would only serve to hand back a portion of bracket creep, not reduce the overall tax burden.  The only way in which the government can fund a meaningful reduction in taxes is through reductions in government spending.  Unfortunately, the government’s record on expenditure restraint leaves much to be desired.

Equally disturbing is Finance Minister Nick Minchin’s proposal to take the proceeds from the privatisation of Telstra and invest them in a managed equity fund at arms length from the government.  The alternative of paying down debt would entail the effective elimination of the Commonwealth government bond market.  I have no objection to the elimination of the bond market, but since we are only a recession away from the government again having to raise funds in capital markets, we might as well keep it in place.  But selling equity in Telstra only to acquire an equity portfolio run by private fund managers shows that the government’s primary motivation is to hoard the income stream from this asset. 

If the government were genuinely interested in using the proceeds from the sale of Telstra to offset future demands on government spending, then it could simply deposit the proceeds from the sale of Telstra into the private superannuation accounts that every working Australian already owns.  A formula could be devised to ensure that low income earners benefited most from this process.  This would be very similar to privatisation by lottery and would constitute a transfer of wealth from the public sector to the private sector that would reduce the future demands on government from an aging population much more reliably than an income stream that simply accrues to consolidated revenue.

posted on 16 March 2005 by skirchner in Economics

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Throw the Book at China

The IIE’s Fred Bergsten says it is time the IMF and US Treasury started enforcing the rule book on China’s manipulation of its exchange rate:

key industrial countries and international institutions have done virtually nothing to counter these blatant market distortions. Despite their professed fealty to market principles, the US and European governments have limited themselves to ineffectual consultations with the perpetrators. Massive currency interventions by the Asian countries directly violate the charter of the International Monetary Fund, which calls on members to avoid manipulating exchange rates in order “to prevent effective balance of payments adjustment”. The chief culprit is China, whose continued dollar peg has helped weaken its currency by more than 10 per cent since 2002…

The US and the Europeans, the IMF’s leading shareholders, must insist the fund start implementing its rules. This calls for the managing director to send a consultation mission to each member country suspected of “manipulation” and, if resolution is not prompt, then to refer the problem to the fund’s executive board. The list of target countries should start with China. In addition, the Treasury Department must start fulfilling its legislative requirement to label these countries, most notably China, as “currency manipulators” in its next semi-annual report to Congress on the topic due later this month.

Fred Bergsten even goes so far as to call for IMF counter-intervention in foreign exchange markets and the erection of trade barriers under WTO auspices.  This is dangerous and unnecessary in my view.  But if the IMF will not enforce its own rule book, we have to ask, what is it good for?

posted on 15 March 2005 by skirchner in Economics

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Ross Gittins’ Martyrdom Operation

The Treasurer’s conspiracy to black-ban Ross Gittins has apparently widened to include two other Fairfax economics writers:

When I wrote last week that I was the only economic journalist not invited to attend the dinner for a closed Treasury conference, I didn’t know my colleague John Garnaut, and Tim Colebatch, Economics Editor of The Age, had also been given the treatment.

The fact that governments play favourites with journalists is not exactly news and hardly a scandal.  I don’t recall Ross complaining about being invited to closed RBA conferences at the H C Coombs Centre, from which other journalists were excluded.

posted on 14 March 2005 by skirchner in Economics

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Ben Bernanke Right on the Money

I have long been a fan of FRB Governor Ben Bernanke.  In his Sandridge Lecture, he advances what he calls an ‘unconventional’ interpretation of the deterioration in the current account balances of the Anglo-American economies (as Bernanke reminds his American audience, this is not a phenomenon unique to the US).  Bernanke is probably being ironic, because there is nothing at all unconventional about his interpretation, except in the sense that it goes against a conventional wisdom that is thoroughly mistaken. 

Despite underselling his case, he makes many good points, but most importantly, he firmly points the finger at the role of forced saving in East Asia as a contributing factor in global imbalances:

current account surpluses have been an important source of reserve accumulation in East Asia.  Countries in the region that had escaped the worst effects of the crisis but remained concerned about future crises, notably China, also built up reserves. These “war chests” of foreign reserves have been used as a buffer against potential capital outflows. Additionally, reserves were accumulated in the context of foreign exchange interventions intended to promote export-led growth by preventing exchange-rate appreciation…

In practice, these countries increased reserves through the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then using the proceeds to buy U.S. Treasury securities and other assets. Effectively, governments have acted as financial intermediaries, channeling domestic saving away from local uses and into international capital markets.

Highly recommended reading.

Deepak Lal suggests China could do something more useful with its foreign exchange reserves.

posted on 13 March 2005 by skirchner in Economics

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Current Account Deficit Angst and Behavioural Finance

Terry McCrann on current account deficit angst:

Did any of you spend even a single day in the actual December quarter worrying whether the deficit would be funded by foreigners? Whether “today’s” $230 million had come in on any single business day, so you could retire to the plasma TV that evening “knowing” that Australia was safe from bankruptcy for another day; and another $230 million?

Of course not. That $15 billion was not only funded, but over-funded. More money wanted to come than we needed - so the RBA had to take some of the foreign coin and the Aussie dollar was pushed higher by the excess demand.

The reason most of us don’t lie awake at night worrying about the current account is that we rightly figure that we have taken prudent decisions in relation to our personal finances.  Yet we are also prone to the belief that collectively we are behaving irresponsibly.  Most of those who express public concern about the current account deficit would have personal balance sheets that differ only in degree rather than kind from the current account deficit.

Much of the air of moral panic that surrounds the current account deficit probably stems from the commentariat’s belief that there must be something wrong when the lower middle-class start moving into large, debt-financed homes and enjoying cheap imported goods that were once considered minor luxuries.  When the masses start tapping into what were previously perceived as positional goods that helped set the commentariat apart, there is a natural tendency to assume that economic corners have been cut.

Who said insights from behavioural finance couldn’t be used to support free markets?!

posted on 12 March 2005 by skirchner in Economics

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The RBA as Central Planner

Alan Kohler accuses the RBA of central planning:

the basic problem is that the Reserve Bank does not trust the market. And why should it? It is a regulator whose sole purpose is to offset market forces.

Right now Australia needs market forces to work. There are, it is generally agreed, shortages of skilled labour and infrastructure capacity. There is also general agreement that the only answer to this is to slow “the economy” by lifting interest rates so the demand for these things falls to meet the supply.

This is a strategy straight out of central planning. Forcing the economy to slow so that demand meets an inadequate supply is a policy of despair by those who don’t trust the market.

At least we can be reasonably sure Alan hasn’t been nobbled by any insider relationship with the RBA!  I have a little more sympathy for the RBA’s position.  The current debate about monetary policy is actually a good example of how the RBA’s conflicted, catch-all statutory mandate gets it into trouble.  An independent, inflation targeting central bank is perfectly entitled to wash its hands of structural issues.  A central bank reliant on a letter from the Treasurer for its independence and responsible for ‘the welfare of the people of Australia’ cannot expect to get off the hook quite so easily.  This is why the RBA Governor gets asked about everything but the kitchen sink when he fronts the House Economics Committee.

posted on 12 March 2005 by skirchner in Economics

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Did the Japanese Ministry of Finance Save the World?

Richard Duncan, one of the many ‘US Dollar Crisis’ hysterics, argues that Japan’s intervention to weaken the yen in 2003 saved the world and even goes so far as to suggest this might have been a policy coordinated with the US:

Intentionally or otherwise, however, by creating and lending the equivalent of $320 billion to the United States, the Bank of Japan and the Japanese Ministry of Finance counteracted a private sector run on the dollar and, at the same time, financed the US tax cuts that reflated the global economy, all this while holding US long bond yields down near historically low levels.

In 2004, the global economy grew at the fastest rate in 30 years. Money creation by the Bank of Japan on an unprecedented scale was perhaps the most important factor responsible for that growth. In fact, ¥35 trillion could have made the difference between global reflation and global deflation. How odd that it went unnoticed.

Unfortunately, this subject is getting too much notice.  Duncan is not alone in exaggerating the importance of the recycling of East Asian current account surpluses through USD asset markets.  There is now a veritable cottage industry of blogs dealing almost exclusively with this subject.  But while the amounts sound impressive in flow terms, they are trivial in relation to the total turnover in USD asset markets.  Even daily turnover in foreign exchange markets is in the trillions.  East Asian financing of the US current account deficit has at best a marginal influence on the USD and bond yields, because they trade in such deep and liquid markets.  The idea that the US is some how completely dependent on this very small subsidy from East Asian central banks is ludicrous.

Peter Hartcher’s excellent book on the Japanese Ministry of Finance was subtitled ‘How Japan’s Most Powerful Institution Endangers World Markets,’ which comes much closer to the truth.

posted on 10 March 2005 by skirchner in Economics

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The Reserve Bank-Ross Gittins Nexus

‘Ernie Economist’ attributes the Treasurer’s ban on Gittins to his role as unofficial front man for the Reserve Bank:

What you have to understand about SMH Economics Editor Ross Gittins is his own undeclared role as a virtual media liason officer for the Reserve Bank. Because of the lack of transparency from our central bank (it does not release minutes of its meetings, does not hold media conferences and its governors do not grant interviews), it manages its public image through a couple of well chosen media pundits - Gittins being one of them.

But in return for this privileged access to our most important economic policy-making institution, Gittins tends to represent the bank’s views to the wider public. This role is critical at a times, such as now, when the bank is at odds with the government and the economic commentariat. And that is exactly what Gittins is up to now - doing the bank’s bidding by justifying an increase in interest rates that the government and a lot of independent commentators have good reason to believe is a high risk gamble.

The point here is that if Mr Gittins is going to use his columns to depict himself as some of kind of cleanskin (and there’s no denying a lot of points he makes are on the money), he should really front up about his ‘insider’ arrangement with the RBA. And the bank itself should clean up its own act and face its critics directly, rather than hide behind newspaper columnists.

I highlight some of the problems with RBA governance and transparency here.

posted on 08 March 2005 by skirchner in Economics

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American Job Creation Act Repatriation Flows

Action Economics chief economist Mike Englund on the impact of repatriation flows under the American Job Creation Act, something which is getting little attention outside of financial markets:

US repatriation of funds in 2005 related to legislation passed last October should reach $350 bln. This will relieve FX intervention pressure on foreign central banks that are defending the dollar, boost U.S. debt and equity markets at the expense of foreign counterparts, directly contribute to U.S. economic growth.  Repatriation will have an enormous impact on the “direct investment abroad” and “foreign official asset” components of the U.S. capital account data in some of the quarters of 2005, with details depending on how the BEA specifically chooses to treat the payments…

It appears that the BEA is unlikely to boost the “direct investment receipt” component of the U.S. current account export measure but, rather, will reveal two offsetting component adjustments on “distributions” and “reinvested income” that will leave U.S. receipts, or “factor income,” unaffected by the payments. This means that the payments will not directly impact the headline current account or GNP figures for each of the quarters of 2005. But, the payments will depress the “U.S. direct investment abroad” figures in the U.S. capital account by the size of the quarterly dividend payments.

The magnitude of these potential flows highlights a broader issue: growing cross-border ownership and control of equity capital requires greater sophistication in interpreting current account data. 

In Australia’s case, the net income deficit is the main contributor to the current account deficit over time.  Like the more cyclical balance on goods and services, it can also be interpreted as a measure of the relative performance of the Australian economy.

When the Australian economy outperforms, the foreign owners of the stock of Australian equity capital will be repatriating profits, while Australian-owned companies abroad will be performing less well.  This effect is becoming more pronounced, because while foreigners control a large part of Australia’s stock of equity capital, in flow terms, Australia has become a net exporter of direct investment capital in recent years.  At least part of Australia’s current account balance is funding the globalisation of Australian business. 

Extensive cross-border control of equity capital associated with globalisation requires that we re-think our views on current account balances and leave behind the ‘balance of payments constraint’ mindset that is a hang-over from Bretton Woods-era institutional arrangements.

posted on 08 March 2005 by skirchner in Economics

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