Columns 2021
01 / Brexit
02 / Covid-19 Vaccination
03 / Will inflation make a comeback?
04 / Productivity
05 / The future of employment
06 / Will banks become redundant due to cryptocurrencies?
07 / Is inflations around the corner in the Western World?
08 / President Biden's China policy
10/ Post-covid developing countries
11/ This year’s Economics Nobel Prizes
12/ A new revolution in economics
Column January 2021
Brexit
At the very end of 2020 the United Kingdom (UK) and the European Union (EU) concluded a trade deal. Brexit became finally effective as of 1 January 2021, when the UK left EU’s single market and customs union. What are the consequences of this separation?
This column looks into some of the political and economic consequences.
What most people don’t know is that the United Kingdom (UK) is not the first country to turn its back on Europe. In 1985, Greenland – an autonomous territory of the Kingdom of Denmark - left the European Economic Community (EEC), the EU’s predecessor. Looking at the history of the relationship between the UK and the EU, one can draw only one conclusion: the relationship has never been a wholehearted one. Before the UK entered the EEC (as the European Union was originally called), the country had twice applied for membership. Both times the applications were vetoed by French President Charles de Gaulle. In 1973, UK’s third attempt was successful. By that time de Gaulle was no longer France’s President. But 1973 was not the beginning of a happy marriage between the two. Already two years later, the British government held a referendum asking the British population whether the UK should remain or leave the EEC. The outcome was: remain.
Future polls suggested that only a minority of the British population was in favour of British membership. The British did not consider themselves to be Europeans. Britain was an imperial power; the country used to ‘rule the waves’, and their hearts and souls still lived in that bygone era. The great British statesman Winston Churchill once remarked that Britain was connected to Europe but did not form part of it.
Under Prime Minister Margret Thatcher’s rule, the relationship was far from smooth. Time and again she demanded a reduction of the British contribution to EEC’s budget, arguing that the British people did not benefit enough from EEC’s membership. True, Thatcher did not always put the brakes on. For example, during the mid-1980s, she campaigned hard for greater integration in the single market area, and supported the European Commission, EEC’s executive body, to achieve this objective. She understood well that the single market would benefit British entrepreneurs.
Over time, the British sentiment did not change much - UK membership of the EU remained problematic. In 2016, then Prime Minister David Cameron was forced by Brexiteers in his own Conservative Party to call another referendum on the issue. We know the outcome; 51.9% of the population voted for leaving the EU. It took four years, thee prime ministers and two general elections before this was achieved.
In political terms, the EU loses a strong member. The UK is a permanent member of the United Nations’ Security Council and forms part of G-7. Britain leads the group of 54 Commonwealth sovereign states. The country spends a large sum on development assistance, which is channelled through their High Commissions on the ground. The country is a prominent member of NATO, the North Atlantic defence organisation. Britain is a nuclear power, and it avails of a sophisticated security system. However, Brexit triggered protests from Scotland and Northern Ireland.
The Scots are contemplating leaving the UK and applying for EU membership. The Irish may be inclined to unite the island into one republic. Finally, in the ongoing great-power competition between China, the USA and Europe, the UK now only plays second fiddle. Despite its political tradition to stay close to the US, President Biden will probably pay more attention to Germany than to the UK in his dealings with Europe.
Now, what are Brexit’s economic consequences? Brexit’s timing could not be worse, as it coincided with the height of the covid-19 pandemic in Britain, further deepened by the British variant of the virus. As a result of belated and bad handling, the British economy was badly affected by the pandemic. It is expected that Brexit will add another two percent of Gross Domestic Product (GDP) loss this year. The Bank of England projects that in ten years’ time the British economy will be three or four percentage points smaller than it would be had it stayed in the single market and customs union. In addition, just before Brexit, China and the EU entered into a trade agreement (be it a flawed one) from which the UK cannot benefit any longer. A missed opportunity as UK’s foreign policy will tilt to the Indo-Pacific, to pursue of the recreation of a ‘Global Britain’.
Brexiteers may have hoped that the UK could leave the EU while still benefitting from the single market without giving up its sovereignty at home. The EU stood firm and did not concede much. Indeed, when looking at the deal a bit closer, the first aspect that catches the eye is that it is only about the trade in goods. Services, which contribute on average 80% to UK ‘s GDP are not included in the deal. This includes financial services - such an important sector of the British economy. In anticipation of the deal, some banks had already moved their London offices to Frankfurt, Paris or Amsterdam; more may follow. No longer will Britain be able to treat the EU as its home market. So, there still is a lot to be negotiated between the two parties regarding services.
Yet the UK have a lot to offer. The country occupies slot five on the list of countries with the world’s highest GDP. London’s ‘City’ is one of the world’s most important financial centres. The same applies to quite a few commodity markets. The country can rightfully boast of having a few of the world’s best universities. The national broadcaster, the BBC, is world class, and so is The Economist, a weekly newspaper. In many ways, Britain is still very relevant. But the country has concluded a far from beneficial deal with the EU, its largest trading partner. Time will tell whether the UK will be able to limit the damage done by Brexit.
Peter de Haan January 2021
Column February 2021
Covid-19 Vaccination – first come first serve
The world witnesses a race between infections and injections. Rich countries invest large sums of money to buy up as many vaccines as they can. But not all countries can compete in this race. Poor countries cannot afford expensive covid-19 vaccines. Now that more vaccines get the green light, vaccine production is scaling up, and vaccination campaigns in rich countries defeat the pandemic, there is more room to help poor countries.
Pharmaceutical companies are no philanthropists. In order to develop new medicines and vaccines, pharmaceutical companies must earn money to finance their research and development. Hence, the price of a new medicine or vaccine is typically high. Patents prevent other companies from producing them at a cheaper price. Given high prices of newly developed drugs or vaccines, the simple conclusion is that those who can afford it will get them. It is a fact of life, unless governments, international institutions, and philanthropists with deep pockets step in to make new medicines and vaccines available to all, the poor included. It is their moral conviction that all human beings should have access to medical services. This conviction implies that covid-19 vaccines must be available for the rich and poor alike, and be distributed based upon clinical need.
This is very laudable, but the problem is that covid-19 vaccine production still falls short of worldwide demand for these vaccines. As a result, rich countries have bought up millions and millions of vaccines and compete between them to be served first. The recent row between the United kingdom (UK) and the European Commission (EC), the European Union’s executive body, in which the EC accused the UK of basically snatching Astra Zeneca vaccines from them, is a deplorable example of vaccination nationalism. Poor countries (even poorer now than before the outbreak of the pandemic) are left empty handed. This prompts the question what is being done to help them?
There are some initiatives to address this question. As covid-19 vaccines are not affordable for many poor countries, World Health Organisation (WHO) Director Tedros Adhanom Ghebreyesus said that people in the poorest countries will die, resulting in a ‘moral failure’. Sometime ago Tedros presented the following data: 39 million people have so far been vaccinated in 39 rich countries, whereas to date only 25 people from Guinee, a poor African country, received a jab. Another example: 90 percent of the population of 70 poor countries will not be vaccinated in 2021, perhaps next year - a sobering prospect.
WHO Director Tedros argued that if rich countries do not help poor countries in the fight against covid-19, more contagious variants of the virus will spring up, as already demonstrated by the South African and Brazilian variants; vaccination nationalism is thus self-defeating. And from an economic perspective, the sooner the pandemic is worldwide under control, the sooner the world economy can recuperate from the deepest recession in recent history, plunging 100 million people into dire poverty.
There are covid-19 vaccines available that I have not yet mentioned. Russia was first in announcing that it had approved a covid-19 vaccine: Sputnik V. And China followed suit with the development of Sinovac, Sinopharm, and Cansino. Critics argued that these vaccines had not been allowed full clinical trials. In response, the Chinese vaccines are undergoing fresh trails in different countries, to confirm their efficacy.
Russia offered the EC to buy its Sputnik V vaccine, not least inspired by diplomatic considerations. The EC hesitates in accepting the offer. EC’s President, Ursula von der Leyen, publicly wondered why Russia made this offer while many Russians had not even been vaccinated. This did not deter Hungary, EU’s maverick member-country, from buying Sputnik V. China supplies its covid-19 vaccines not just to poor countries but also to rich ones such as Bahrein and the United Arab Emirates. In return, these countries may be inclined to lend support to China in the international arena. However, now that the G-7 members, including the USA, will step up their support to Covax, China may face competition from rich countries-dominated Covax, in its ‘vaccine diplomacy’ drive.
Let me conclude with sketching a hopeful perspective. It is projected that by the end of this year covid-9 vaccine makers will be able to produce 2.1 shots for each of the world’s 5.8 billion adults. Meanwhile, vaccine production and vaccination programs in many countries are rapidly scaling up, and new vaccines will be coming on the market soon. In addition, world leaders have now expressed their commitment to lend a helping hand to poor countries devoid of covid-19 vaccines. All these developments combined suggest that the pandemic can be brought under control the world over in the foreseeable future.
Peter de Haan February 2021
A number of international organisations, among them the WHO, established Covax, a vaccines procurement mechanism, financially supported by rich countries. Covax’s purpose is to collectively procure large quantities of covid-19 vaccines. But, until very recently, rich countries largely ignored their pledge; instead they bought vaccines for themselves (Canada can jab its population 5 times over). Nor did they transfer the funds they pledged. Covax had ordered two billion doses, but none of them have been delivered, for lack of funds. But during the recently held G-7 summit, world leaders expressed their intention to donate vaccines to poor countries and to step up their funding of Covax. These leaders understand that keeping covid-19 vaccines strictly to themselves is morally difficult to defend. They also understand that the pandemic can only be defeated if and when immunity is reached the world over.
Column March 2021
Will inflation make a comeback?
Many pundits argued that inflation was dead and buried. But they are no longer so sure. Now that governments and central banks are dishing out trillions of dollars, euros, yuan, and yen, the worry is that so much money pumped into economies may spark inflation.
Is this worry justified?
Inflation occurs when, over time, the nominal value of your money becomes less than its real value. In essence, this happens when the quantity of money in an economy is larger than the smaller quantity of available goods and services; there is thus an oversupply of money. This is the most basic and simple description of inflation. Inflation has good and bad sides. Suppose you have a debt in nominal terms. Inflation results in your debt gradually losing its real value – your debt becomes cheaper. But inflation is bad news for people depending on a fixed nominal income, such as pensioners. Their real income will decline; they get poorer. The tragedy is that they can’t do much about it.
Until very recently, central bank presidents maintained that a bit of inflation, rather arbitrarily established at 2 percent, would promote economic growth. However, once inflation rises it is difficult to contain - it tends to run out of control. Think of Germany’s hyperinflation after the end of World War I. This is a long time ago; nonetheless more recent examples of countries suffering from hyperinflation are Zimbabwe and Venezuela. During the 1970s, economically advanced countries met with stagflation, a combination of high inflation, growing unemployment, and sluggish economic growth.
In his bestseller The Affluent Society, John Kenneth Galbraith argued that the principal cause of inflation was the toxic interaction of wages and prices. Management and unions, Galbraith explained, negotiated; wages were increased in part because of past price increases; prices were then raised further in compensation. The result: a price-wage spiral. Since Galbraith’s days, labour unions have lost power. Employment is moving from the industrial sector where the unions were strong, to the service sector, where they are not well represented. As a result, the price-wage spiral is something of the past. At present, economies enjoy less inflation even when employment is high. But inflation is a bit more complex than Galbraith thought. He overlooked the role played by governments, central banks and financial markets, as we shall see.
Covid-19 triggered the injection of huge sums of money into economies to prevent them from collapsing. For example, the European Central Bank (ECB) bought up a whopping Euros 2.5 trillion in government bonds. Add to this the recently enormous $1.9 trillion American stimulus package, which includes a cheque of $1,400 for most Americans (adding to the $600 they already received). In addition, the American Treasury and the Federal Reserve (Fed) will pour around $2.5 trillion into the banking system. These unprecedented financial doses inspired the debate among economists about a possible return of inflation.
Meanwhile, production and transportation costs have risen. Shortages of semiconductors is disrupting the production of cars, computers and smartphones. The price of a barrel of oil has risen to $65 a barrel. Once economies will be free from lockdowns, pent-up demand may well result in a spending spree. All these developments will contribute to the sense that rising inflation is on the horizon. The Economist, a British weekly, recently argued that America is running an unpredictable three-pronged economic experiment, featuring historic levels of fiscal stimulus, a more tolerant attitude of the Fed towards temporary overshoots in inflation, and large pent-up savings which no one knows if consumers will hoard or spend.
Given this American experiment, it makes sense to look into the perspectives and possible inflationary consequences for the US and for the global economy at large. The assumption is that the Fed will keep interest rates low for a sustained period of time. The idea behind it is that the government can spend as much as it likes (as it is cheap), including spending on President Biden’s stimulus bill. But will these dollar injections fuel inflation? America’s Treasury Secretary, Janet Yellen, tried to assure the markets by saying that the US has the tools to deal with inflation. And Fed Chairman Jerome Powell said that even if the American economy overheats it will be only temporary. But bond holders were not convinced. They feared that imminent inflation would lower the value of their bonds. Consequently, American and European bond markets registered an increase in bond yields. On 25 February last, the benchmark ten-year American Treasury yield surpassed 1.6%. True, this percentage was low by historical standards, but quite a bit higher than at the beginning of this year. Thanks to central banks buying-up government bonds the worst fears about inflation receded again. However, the question is: for how long?
Should the Fed not be able to withstand the pressure of rising prices and decide to increase the interest rate to keep inflation in check, this is not good news for markets. A lot of what is happening in financial markets depends upon the assumption that central banks would keep interest rates low for a long time. An increase in interest rates will probably shock the already inflated stock and housing markets, as well as emerging markets.
Many emerging markets applied rather unconventional monetary policies and allowed bigger budget deficits, mimicking rich countries’ practices. After all, borrowing is cheap. The interest rate on government debt is lower than the nominal growth rate of the large majority of emerging economies. For example, China’s projected growth-corrected interest rate for 2023 is minus 6.5%. A negative growth-corrected interest rate broadens monetary and fiscal limits. So, unconventional monetary policies were applied in the assumption that global financial conditions would stay what emerging economies had become accustomed to. Finance ministers of these economies were more relaxed in allowing budget deficits.
But now they need to worry about what may happen to interest rates in America, especially when they borrow in dollars. Higher interest rates in the US to counter inflation would mean a stronger dollar and capital outflows from emerging economies. This would badly affect the latter’s finances and make it more difficult for them to fight the economic effects of the covid-19 pandemic. So higher inflation in America would indeed impinge upon financial markets and emerging economies.
The fact that so much money is being pumped into economies justifies concerns about a comeback of inflation. However, readers who would have thought that I could give a clear indication of such a comeback will be disappointed because an indication can simply not be given. Nobody knows what will happen, but finance ministers and monetary authorities are aware of the possibility of inflation, and so are financial markets.
Peter de Haan March 2021
Column April 2021
Productivity
For economists productivity is a magic term. It is the elixir of economic growth, less poverty, higher incomes, better social services and more opportunity to counter climate change and global warming. However, the question is whether productivity is going up or down?
A couple of years ago, I wrote a review of The Rise and Fall of American Growth (2016), written by Robert Gordon, professor in the social sciences at Northwestern University, USA. The book’s central message is that after the American Civil War, spectacular economic growth improved the standard of living. Americans enjoyed a doubling of real output every 32 years. Total factor productivity jumped sharply, in particular between the 1920s and 1950s. What caused this revolutionary improvement? Electric lighting, indoor plumbing (i.e. water taps, toilets, showers), motor cars, air travel, air conditioning and television dramatically transformed households and workplaces. Between 1870 and
1970, medical inventions improved Americans’ life expectancy from forty-seven to seventy-two years.
Gordon wondered whether this era of unprecedented growth had come to an end? He concluded that, indeed, it had because all these life-changing inventions could not be repeated. American productivity slowed down from 1970 onwards. And it was further held back by growing inequality in the American economy, the ageing population, rising debts of the federal government as well as debt incurred by college students. Gordon concluded that the younger generation would be the first in American history failing to exceed their parents’ standard of living. A bleak prospect indeed. But was Gordon right in his gloomy projection?
It seems that he may be wrong, as there are signs that productivity might be growing again. True, the covid-19 pandemic may temporarily have affected labour productivity; yet, it may well be that once the covid-19 pandemic is brought under control, we may see a return of economic dynamism, propelled by a resurgence of productivity growth.
But what is productivity growth exactly - what does it consist of? As mentioned, economists distinguish labour productivity and total factor productivity. Labour productivity increases after improvements in education, rising investment, and adoption of new innovations. In simple terms: a worker produces more than before. Indeed, productivity grows when more output is wrung out of available productive resources. Now, total factor productivity (TFP) is a measure of productivity calculated by dividing economy-wide total production by the inputs of labour and capital. It shows growth in real output which is in excess of the growth in inputs. As for a rise in TFP, or the efficiency with which an economy uses its productive inputs, this requires the discovery of new production technologies, or – alternatively – the reallocation of scarce resources from low-productivity firms (or entire sectors) to high-productivity ones. In sum, productivity is the ultimate source of long-run increases in incomes and wealth.
Beyond 1970, productivity slumped until the mid-1990s, after which it suddenly increased in advanced economies. However, it levelled off in the early 2000s. Surely, emerging economies also enjoyed rapid productivity growth prior to the outbreak of the global financial crisis in 2008. This increase was triggered by high levels of investment in these economies combined with an expansion of trade which, in turn, brought more sophisticated technologies. Developing countries also saw the productivity of their economies rising, benefitting from their participation in global supply chains.
But since the global financial crisis, a persistent slowdown in productivity growth ensued. The World Bank calculated that 70% of the world’s economies saw their respective productivities go down. As regards emerging economies, slowing trade growth and fewer opportunities to adopt and adapt new technology from advanced economies put a brake on productivity growth. Across economies worldwide, sluggish investment resulting from the 2008 financial crisis explains the general productivity slump, aggravated by ageing and shrinking workforces in some countries.
How come? After all, cloud computing had meanwhile been introduced and robots began replacing workers in increasing numbers. Some analysts say that these inventions are simply not as productivity-enhancing as optimists claimed. Others maintain, however, that in the medium-term Artificial Intelligence (AI) may well result in productivity growth. As a positive side-effect of covid-19, cloud computing and video conferencing proved their economic value, enabling large amounts of productive capacity to continue without interruption despite the shuttering of many offices. So, new technologies are certainly able to give productivity a boost.
Another productivity-enhancing inspiration could well be resumed growth of aggregate demand. A small example: before the outbreak of covid-19, demand in the US increased, resulting in unemployment falling. Wages started to increase, but labour productivity picked up as well, from 0.3% in 2016 to 1.7% in 2019, resulting from demand pressure.
There is a third explanation for a possible resurgence of productivity, which concerns the use of the new technologies I mentioned above. AI is a so-called general-purpose technology, like electricity, having the potential to boost productivity not just in one industry, but industry-wide. But it takes time and experimentation to use AI and other new technologies in an effective manner. The build-up of know-how in this vein is an investment in intangible capital, which can work out like a so-called J-curve. This means that once these intangible investments bear fruit, productivity will surge, because output rises sharply without inputs having changed much.
This J-curve phenomenon is not really new. Way back in the 1980s and 1990s, computers did not seem to contribute to productivity. However, during the 1990s there was a sudden productivity increase: an early example of the J-curve. Even covid-19 may have a J-curve effect. During the pandemic quite a few firms started to adjust their production processes (robotics, among others) and organisational overhaul (working from home, fewer overseas business trips) which in the medium-term may result in productivity improvements.
There is more. The pandemic boosted distance education and telemedicine delivered by the cloud. These new phenomena help promote growth in services trade, triggering economies of scale in the service sector which has long struggled to register productivity gains.
Governments will have a role to play in boosting productivity. After Covid-19, they must help recover aggregate demand. This was already done in a formidable way by the Biden Administration, sending out $1600 checks to every American citizen and by many other governments. Another activity for the government is tackling the educational shortfalls suffered by many students as a consequence of school and university closures.
In sum, private - and government investments combined will probably unleash the productivity-boosting potential offered by a variety of new technologies coming to fruition.
Peter de Haan April 2021
Column May 2021
A possible future of employment
John Maynard Keynes predicted that the working week could be brought down to 15 hours, thanks to the rapid growth of productivity. He proved to be wrong. David Graeber explains why and what has gone wrong with the jobs people in advanced economies have.
Way back in 1930, celebrated British economist John Maynard Keynes predicted that a working week of, say, 15 hours was sufficient to produce all the goods we needed. This was possible, said Keynes, because labour productivity was increasing. This meant that one worker could produce much more than in the old days, as he or she had more machines to their disposal, benefiting from advances in technology.
Was Keynes right in predicting a shorter working week? Although he was spot-on regarding increased labour productivity, Keynes was wrong about his 15-hour working week. It is still 40 hours and in some countries, it is more than that. Why is this? American anthropologist David Graeber concluded that in the course of the last few decades an astonishing number of ‘bullshit jobs’ had been created in America and other advanced economies. In 2018, he published Bullshit Jobs; A Theory, which became an entertaining bestseller. Now, how did Graeber define these useless jobs, to use a more elegant term? A bullshit job is a form of employment that is so completely pointless, unnecessary, or pernicious that the employee cannot justify its existence even though, as part of the conditions of employment, the employee feels obliged to pretend that this is not the case.
Graeber observes that given the choice between fewer hours of work and more goods, we opted for the latter: consumerism is calling the shots. Since the 1930s, endless new jobs and industries were created. Graeber argues that very few of these jobs have anything to do with the production and distribution of consumer goods and services. Productive jobs have been automated away. Simultaneously we have seen a ballooning not so much of the service sector but of new fairly useless industries like financial services, telemarketing, and the unprecedented expansion of sectors like corporate law, academic and health administration, human resources, and public relations. It is as if someone out there, observed Graeber, was creating pointless jobs just for the sake of keeping us all working 40 hours per week.
Needless to say, Graeber’s book is polemic. On the other hand, real-life examples support his message. A paradoxical situation has emerged in which corporations are downsizing (productive) personnel, while the number of staff not directly involved in the production process is increasing, often working more than 40 hours per week. But Graeber argues that they effectively only work 15 hours (as Keynes predicted) and spend the rest of their time attending useless motivational seminars, team building sessions, updating their Facebook profiles, etc. One extreme example Graeber provides is at first sight amusing, but tragic as well. After many years of satisfactory performance, a Spanish water engineer was placed under a new director, who assigned him a useless job, as he despised the engineer’s political preference. The engineer decided not to show up for ‘work’ any longer. Instead, he studied Spinoza’s philosophy for six years in which he became an expert. When he was up for retirement, only then he was found out and was fined $30,000.-.
The tragedy is that many workers realize that their job is not useful. Polls held in different countries asked the question of whether one’s job was making a meaningful contribution to the world. The response in Britain was that more than 37% said it did not. The response in my home country, Holland, was that even 40% said that their jobs had no good reason to exist at all. So, almost half of all work being done could be eliminated without making any real difference at all, concluded Graeber. The only result is that people’s health and self-esteem are affected. After all, work is what for most people gives meaning to their lives.
Advanced economies have become societies based on work – not even productive work - but work as an end in itself. So the creation of more jobs, whatever their societal relevance, is always welcomed. To solve this existential problem Graeber proposes to introduce a universal basic income. This would serve two objectives: to lower the working week to 15-hours and, second, to do away with useless jobs. The introduction of a universal basic income would massively reduce the amount of bureaucracy dealing withal all kinds of income subsidies, which would no longer be necessary. It would also give workers the freedom to quit a job in which they feel unhappy. Graeber ends his book as follows: ‘If we let everyone decide for themselves how they were best fit to benefit humanity, with no restrictions at all, how could they possibly end up with a distribution of labor more inefficient than the one we already have?’
Indeed, Bullshit Jobs is a polemic book. Not all jobs will be taken over by robots, and one can wonder whether such a large percentage of workers in advanced economies find their job useless or not contributing to benefit humanity. I discussed Graber’s book with my grown-up children and asked them whether they would have had experience with useless jobs. Some of them felt that, indeed, now and again they had had a useless job. But they assured me that now they were happy with their present job. Graeber based his analysis on workers’ opinions, which are necessarily subjective, about the usefulness of their job. So the weakness of his analysis is that it lacked an objective set of criteria based on which scientifically sound conclusions could be drawn. Nonetheless, Graeber unearthed anomalies in the evolution of some types of jobs in advanced economies that plunged workers into unhappiness or depression.
Peter de Haan May 2021
So, why had these jobs been created in the first place? It could not have been because of efficiency considerations or other free-market principles. The answer, says Graeber, has to be found in the mindset of the political class, because it is in their interest. In this sense, British author George Orwell once noted that a population busy working even at completely useless occupations does not have time to do much else. In addition, the prospect of unemployment is a horror prospect for any government. But this is not the only explanation. The vanity of senior managers also plays a part. The more underlings they have, the more prestige they derive from them. Graeber calls this managerial feudalism. And there is more. A lot of jobs were created in the realm of telemarketing and ‘beauty work’. These jobs create demand either by making people feel ugly or luring them into debt. Both involve selling, sometimes aggressively, products to clients they don’t really need.
Column June 2021
Will banks become redundant due to cryptocurrencies?
My first column for Fortune World was about bitcoin. That was in early 2018. Since then, cryptocurrencies have not just become accepted phenomena, they are proliferating and are moving into unchartered territory for monetary regulators. What is more, they may threaten the existence of the traditional banking system.
Bitcoin, in its thirteenth year, is the most popular but no longer the only cryptocurrency. It is the best-known, occupying 40% 0f the cryptocurrency market. There are now also scores of others, such as Ethereum, Dogecoins, and Stellar. Facebook introduced its own coin: the Libra. The proliferation of these cryptocurrencies and digital payment systems such as Ali Pay and PayPal, over which central banks have no control, was simply unthinkable if they did not have the appeal of especially young users. There are 3 billion users by now and Bitcoin alone represents a value of $1 trillion. Last May, the market capitalisation of cryptocurrencies put together was more than $2.5 trillion. In sum, cryptocurrencies are no longer a side-show in financial markets.
We have become accustomed to them, to the extent that even central banks are toying with the idea to issue digital currencies. In fact, there is already one country issuing its currency in digital form: the Bahamas, a small island group, located in the Caribbean. China is undertaking an e-yuan pilot involving over half a million people. The European Union wants a virtual euro by 2025. Britain is also toying with the idea and the US is already developing a hypothetical e-dollar. Meanwhile El Salvador made bitcoin legal tender - the trend seems unstoppable.
There are advantages but also disadvantages (or dangers, as Andrew Bailey, the Bank of England’s boss said) in all this. Let’s first look at the advantages. The creation of ‘govcoins’ allows people to open an account at the central bank through an interface that looks like apps such as Ali Pay or WeChat Pay, thereby bypassing their more expensive retail bank (just think of their expensive cross-border transfers). Clients do not have to write checks any longer or pay on line, they just use their central bank account to do transactions. It is cheap and - another advantage - one’s money is guaranteed by the state. This sounds great, but there are also disadvantages.
Governments and central banks do not want to lose control of the proliferation of digital money. After all, if money deposits and loans move from banks into privately-run digital firms, central banks will have difficulties in managing the economic cycle, as unsupervised private pay networks function beyond their control. In sum, governments and central banks will lose sight of what is going on in the monetary realm, including money-laundering activities through cryptocurrencies. . A lawless situation may then ensue, inviting fraud and privacy abuses. For example, the hackers who last May shut down the Colonial pipeline in the US, were paid a ransom of $2.3 million in bitcoin.
Last April Turkey banned cryptocurrencies as means of payment. The United States and China are preparing legislation to protect citizens from the risks involved in cryptocurrencies. There are also measures underway to prevent money laundering. But there is another aspect to worry about which requires explanation. Money provides a reliable store of value, a stable unit of account and an efficient means of payment. In an ideal situation, this is the case. However, today’s money does not meet all three criteria. For example, uninsured depositors can suffer when banks fail, as happened during the 2008 financial crisis. As for bitcoin: true, some retailers accept bitcoin but it is not yet widely accepted as a means of payment. Moreover, bitcoin, and other cryptocurrencies for that matter, are no currencies with a stable unit of account. One day the bitcoin rate was sky-high, but the next day it took a 35% nose dive, as happened when Tesla’s boss Elon Musk declared that bitcoin could no longer be used to pay for a Tesla vehicle. In general terms, cryptocurrencies are highly volatile speculative assets. Transactions in cryptocurrencies, in particular bitcoin, consume a lot of electricity. In April last, for example, trading in bitcoin consumed more electricity than the Netherlands did in the same month.
Now, govcoins score well on these criteria, since they are state-guaranteed and use a cheap payment hub: the central bank. So, govcoins could very well cut operating expenses of the global financial system and, at the same time, allow poor people to have bank accounts – an attractive perspective. In addition, should govcoins be brought in circulation, this would facilitate governments to make direct payments, such as subsidies, to their citizens. Again, looking at the three criteria above, for ordinary money users the appeal of a free, safe, and instant universal means of payment is attractive.
However, this appeal is fraught with dangers. One of them refers to the title of this column: will banks become redundant? Imagine a situation in which people decide to withdraw their money from their retail bank and transfer the funds into an account at the central bank. In quite a few high-income countries this would result in the central bank further inflating its already bloated balance sheet. The central bank would then no longer only play its role as lender of last resort for banks; it would also become a competitor for them. This would bleed banks from a very important fund on which they extend loans. Should their clients’ deposits crumble, then retail banks may lose one of their principal functions: providing loans to people and firms wanting credit. As celebrated economist Joseph Schumpeter once summarised: banks liberate innovation and investment - the engines of creative destruction! This function would then be transferred to tech firms, such as Pay Pal and other digital payment networks. However, the banking sector in many countries is till very powerful; hence bankers will use their strong lobby position to limit possible damage to be done.
Central banks may avoid getting involved in providing loans but it is likely, given their expanded role, that they will interfere in capital markets. If so, a situation might emerge in which bureaucrats decide on the allocation of credit - not an advisable possibility for market economies. Another prospect could be that, in case govcoins would become by far the dominant money, this would create an instrument for government to control its citizens. Govcoins could also change geopolitics, by providing the means for international transfers as an alternative to the American dollar, still the world’s reserve currency; in other words, digital money could threaten the dollar’s hegemony.
Given the possible destabilising effects which I just described, it is understandable that the Chinese government opted for a very limited pilot, allowing participants to spend small government handouts of digital e-yuans. At the same time regulators are reigning in private networks such as Ant.
Digital currencies will be the next great challenge in finance. What, at any event, policy makers should be doing is to prepare or adjust privacy laws for the implications of the rise of digital currencies, prepare reform of central banks, and contemplate the future (smaller) role of retail banks.
Peter de Haan June 2021
Column July 2021
Is inflation around the corner in the Western World?
Roughly a year ago, there was a fear of deflation; now it is the other way around: fear of inflation. Central banks in Brazil, Hungary, Mexico, and Russia have already raised interest rates. There are various indications that targeted inflation levels of 2% may be overshot, and not just temporarily. So what is the situation, in particular in America, and what would the causes of inflation be?
At the end of June last, Jerome Powell, the Chairman of the Federal Reserve, the American system of central banks, admitted that prices were increasing faster than central bankers had thought. Nonetheless, Mr Powell reiterated his view that pressures will eventually ease, avoiding any return to the 1970s levels of inflation, the era of The Great Inflation. Fed officials now think consumer prices in America will be 3.4% higher in the fourth quarter than a year before, up from 2.4% in an earlier projection. Mr Powell also pointed out that price rises are the sharpest in sectors linked to the reopening of the economy after Covid was brought under control, and will recede – this inflation will be ‘transitory’. The Fed continues buying up bonds not just to stimulate the economy but also to help keep short-term and long-term interest rates low. Inflation in other rich countries has been more modest. As regards emerging economies, the aggregate inflation there rose from 3.9% in April to 4.5% in May.
The question is whether prices will indeed recede or, worse, continue to rise. And sustained rising prices is what central bankers and politicians wish to prevent. After all, inflation is the rate at which prices change, not a measure of how high they are. Meanwhile, the Fed announced that initially projected interest rate increases for 2023 may be brought forward to 2022.
The fact that: (i) so much money is being pumped into economies to counter the negative economic effects of covid-19, (ii) there are bottlenecks in production and delivery of essential items such as semiconductors, building materials, and available containers, disrupting the production of cars, computers, and smartphones (triggering 9% factory-gate price hikes of in China), (iii) labour costs rise and (iv) consumers want to spend their savings resulting from covid lockdowns, justify concerns about a comeback of inflation. Nobody knows what will happen; nevertheless, finance ministers and monetary authorities are concerned about the possibility of more inflation. As one newspaper put it: inflation is the bogeyman of financial markets.
Let us first analyse what caused the Great Inflation of the 1970s, as inflation is not just caused by a mismatch between a larger quantity of money and a smaller quantity of goods and services. It was Milton Friedman who at the time explained why inflation was running out of hand. He argued that governments had pumped too much money into the economy to push unemployment down. However, pushing unemployment below the natural rate of employment, as Friedman called it, caused inflation.
Fresh insights tell us that not one but three possible factors explain inflation: (i) the effects of supply shocks, (ii) the extent to which an economy is operating above or below capacity, and (iii) people’s expectations of inflation. Which of these factors are now at play? Well, factor number one, supply shocks, is clearly playing a part, as I mentioned above. The fact that OPEC limited oil production, triggering a near-doubling of the price of a barrel of oil, added to inflationary pressures. These supply shocks also happened in the 1970s. The good news is that once these shocks abated, inflation dropped. This might happen again if the present supply bottlenecks are overcome. Then, the capacity issue - the second factor explaining inflation. Now, if pent-up demand is overshooting the economy’s capacity to deliver the goods, inflation would be the result. Looking at the American economy, the unemployment rate there is still high, suggesting that there is spare capacity. However, it may be that the unemployed may fairly quickly find jobs. At any event, the Fed reckons that unemployment in the US may fall below its long-run rate by the end of 2022. But one should keep in mind that shifts in unemployment appear to have had smaller effects on inflation over the last few decades. This brings me to the third factor: expectations. This factor is the most slippery of the three. How come? Surely, measuring expectations is not clear-cut. One group of respondents may have a gloomier expectation about inflation than other groups, depending on whose information the respondents trust. Generally speaking, expectations about inflation have not risen as much as inflation itself. Researchers concluded that in the early 1980s inflation expectations dropped substantially because the public perceived a regime shift at the Fed. In this vein, a repeat of the Great Inflation might require another dramatic change in central banks’ policies. Last year the Fed adopted a 2% average inflation target over the whole economic cycle. This average implies that inflation may temporarily be above the 2% norm, as long as it returns to this 2% in due time. Last month the European Central Bank (ECB) slightly increased its inflation target; ECB central bankers are buying more time to keep long-term interest rates low.
Should the Fed, the ECB, and other central banks for that matter, not be able to withstand the pressure of sustained rising prices and decide to increase the interest rate to keep inflation in check, this is not good news for markets. A lot of what is happening in financial markets depends upon the assumption that central banks keep interest rates low for a long time, which they did. An increase in interest rates will probably shock not just already inflated stock and housing markets, but also emerging markets, and heavily indebted developing countries.
So, finance ministers of emerging economies need to worry about what may happen to rising interest rates in America to keep inflation in check, especially when they borrowed in dollars. By the way, these rising interest rates would also be bad news for America’s indebted government. Higher interest rates in the US would mean stronger dollar and capital outflows from emerging economies. This would badly affect the latter’s finances. So, higher inflation in America would indeed impinge upon financial markets and emerging economies.
Is inflation as inevitable as it was way back in the 1970s? We know much more about the factors causing inflation than 50 years ago. Policymakers have more instruments at their disposal to quell sustained price rises, not just raising interest rates, but also limiting the money supply and tapering bond purchases. Central banks are charged with the task to ensure price stability. By keeping unacceptably high inflation expectations anchored, central banks must limit inflation by taking appropriate measures. Clearly, central bankers are buying time to see whether inflation will prove to be a temporary phenomenon or whether it has turned permanent. If so, decisions to raise interest rates, and possibly other measures, will be taken, realising that it would not be a popular measure but a necessary one to prevent inflation to run out of hand.
Peter de Haan July 2021
Column August 2021
President Biden’s China policy
Is the Biden administration’s policy towards China different from former President’s Trump chaotic and belligerent approach?
One might have thought that, indeed, it would be different. However, it appears that there is not much difference between the two.
In the past, America’s attitude towards China was one of friendly engagement. This policy was briskly brushed aside by Mr Trump. After Trump’s defeat during last year’s presidential elections, the question was what the Biden administration’s attitude towards China would be. President Biden,
rather than returning to engagement, is building a strategic framework with a view to check and counter China’s rise in the international arena.
The US is worried that China may overtake America in the international political and economic domain. In short, America is striving to curb China’s further rise. In the first six months of Mr Biden’s presidency doing business with Huawei, and many other technology companies and military- affiliated enterprises was prohibited. America is trying to get other like-minded countries behind this policy.
This is one approach. Another one is based upon the idea that America should increase its influence in the world. Strategists around Mr Biden repeatedly say that America needs to restore its greatness after decades of decline. The US must again invest in itself so that it can deal with China from a regained position of strength. The United States Innovation and Competition Act, which passed the Senate last June, intends to boost America’s competitiveness in areas such as semi-conductor research and manufacturing. The Act also includes an applied-sciences fund that supports projects in advance materials, robotics, and artificial intelligence. This is not all. Mr Biden’s huge pandemic recovery package, and his multi-trillion dollar bill to fund ‘hard’ and ‘soft’ infrastructure, and his call to buy American products; all this must be understood in the context of making America more resilient, while having China’s rise in mind.
Put together, this sounds impressive. However, these investments dwarf compared with China’s huge investments in comparable areas. In this context it is simply impossible for America to outwit China. If economic developments continue as projected, China will indeed become the world’s largest economy in 10 to15 years’ time. China’s gigantic internal market will be a great help in this endeavour. In addition, China’s investments in research and development will promote the country’s technological prowess even more. What may help the US in this realm, as introduced by the Trump administration, is enforcing export controls to stop or at least frustrate China’s rapid development of critical technologies. Huawei was already victimised by it, and so was Semiconductor Manufacturing International corporation, China’s largest chipmaker. There is no hurry within the Biden administration to lift these controls, nor lift the Trump-inspired ‘phase-one’ trade deal, let alone
returning to some form of (semi) free trade. In fact, it has maintained almost all existing trade sanctions, export controls and customs orders; it even instituted a few more, ignoring the fact that economists outside and inside the government argue that tariffs hurt America more than they hurt China.
Trying to rally old allies behind America’s policy behind America’s policy, such as European countries, is being done. But not all of them support the US wholeheartedly. When they weigh their allegiance to the US on the one hand and potential economic gain from doing business with China, the latter may get the upper hand. For example, British Prime Minister Boris Johnson recently said that he did not want to scare away investment just because of an ‘anti-China’ spirit an ‘anti-China’ spirit. He may well have thought that if Britain would turn away from China, others would gladly step in. Other, smaller countries express similar sentiments. This is not surprising when one takes into consideration that the number of countries which China shares more trade than America is far greater than the other way around. There is also opposition within the US against the government’s China policy. After all, businesses and financial institutions want to keep access to China’s markets, preferably unrestricted by export controls. It would be better, they argue, to give up America’s tough stance and, instead, cooperate with China on climate change or nuclear non-proliferation.
There are other aspects of Mr Biden’s China policy. One of them concerns America’s dependence on raw materials of which China is the dominant producer, such as rare-earth, lithium, cobalt, and refined silicon. The same applies to some drugs and drug ingredients.
The US undertook a supply chain review and concluded that America should look for other suppliers to lessen its dependence on
Chinese producers. This may make sense but it is costly.
The other day I came across a proposal that, to me, is worth debating America’s position vis-à-vis China and the world at large. The proposal comes from the Centre for Strategic and International Studies; a think tank. It boils down to America broadening its view beyond China. The US now appears to react to everything Chinese leaders do: China adopts an industrial policy, America adopts an industrial policy; China has its Belt and Road Initiative, so must America, etc. Instead, America should ask itself what role the country wants to play in, say, 20 or even 50 years from now.
This is exactly what the US did during the Cold War years, when it successfully contained the Soviet Union within a broader vision of the world. If the US could articulate such a broad vision again, it might become clearer how China would fit in America’s continuing global role, rather than America only reacting to China’s rise.
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Peter de Haan August 2021
Column September 2021
Public Debt Galore?
Governments pumped enormous amounts of money into their economies to counter the economic effects of Covid-19.
What are the consequences? This column presents a few potentially disturbing ones.
Covid-19 affected economies badly. But not as badly as anticipated, thanks to governments’ pouring money into their economies to prevent them from sinking too deep. Employers, workers and households have been assisted with temporary financial support. After an initial steep increase, unemployment figures went down again. The number of bankruptcies was also kept in check. As I write, economies of high-income countries and quite a few middle-income countries, such as China, are doing well again; some are even booming.
Given these positive developments, one government after the other is contemplating to end covidinspired financial infusions. This is meeting protests from sectors such as hotels and restaurants, travel and entertainment; they need more time and thus financial help to recover from income losses. Hence governments will continue supporting them. One consequence is that governments are making a comeback as a prominent actor in their economies, after a long period in which the notion of small government was in vogue. Another consequence is that past, present and future support is resulting in dramatic rises in public debt.
Looking at the Euro-zone, before the outbreak of the covid pandemic, governments spent on average 48% of Gross Domestic Product (GDP). Some spent more: France, for example, spent on average 55%. The US was spending much less: some 40% of GDP. In 2020 and 2021, the covid-inspired financial infusions resulted in budget deficits of 7% on average. These deficits were financed by central banks by way of loans and bond buy-ups. As a result, Euro-zone’s total public debt has risen to 125% of GDP. By the way, the percentage for the United Kingdom is 144% and the one for America is 141%. The question is, of course, can this rise go on and, secondly, what does it imply for the fiscal space and for monetary policy.
Meanwhile, financial markets seem undeterred; interest rates on government bonds are still very low, suggesting that investors are not concerned. But this only seems to be the case, especially when one asks who is prepared to buy government bonds of highly-indebted countries such as Spain, Italy and Greece. The short answer is: nobody; that is, with the exception of central banks, who still buy-up longterm government bonds with newly created money in large monthly quantities, also known as Quantitative Easing (QE). To put a figure to this statement: rich-world central banks have bought assets worth over $10 trillion since the covid pandemic began.
After the outbreak of the 2008/9 financial crisis, central banks, the Fed (the system of American central banks) and, later, the European Central Bank (ECB), introduced this new QE instrument with a view to stabilise financial markets after the crisis and to get affected economies out of the deep recession. However, QE was continued after the worst crisis was over. The Fed and the ECB tried to gradually limit their monthly bond buy-up programs (tapering in bank-language), but financial markets reacted like stung by a wasp, as they feared that this tapering would not just trigger a slowdown in economic growth but would also be a harbinger for a rise in interest rates. So, QE was continued to prevent a taper tantrum, and thus putting financial markets at rest.
After the outbreak of the pandemic, which could have affected economies badly, central banks reacted swiftly by opening their money taps to finance governments’ extra spending. These considerable financial infusions might have put an upward pressure on interest rates. In order to prevent this from happening, central banks increased their QE investments which kept the long-term interest rate low.
However, the consequence is that the Fed and ECB are saddled with bloated balance sheets - they own huge quantities of government bonds. What may be more worrying is that, as noted, Spain, Italy, and Greece, now totally depend on the ECB to buy up their bonds at very low interest rates. The combination of low interest rates and easy access to ECB loans, is not helpful in forcing these countries to economise and take tough measures to make their economies more productive and resilient.
A situation has arisen in which central banks have been taken hostage by governments, especially by heavily-indebted ones. But now that economies are climbing out of the covid-dip, the challenge for central banks is to gradually end buying up bonds without upsetting financial markets. And given the increasing inflationary pressures, another question is whether (and wen) central banks will increase their short-term interest rates, which will frustrate fresh investment and probably trigger a dramatic drop in share prices. In addition, heavily-indebted governments will see their borrowing costs rise.
China, whose economy grew in 2020, has meanwhile tightened its credit policy, which is slowing down economic growth while lessening inflationary pressures. And some central banks, such as Australia’s, have already begun to scale back their bond purchases.
During the recently held annual Fed seminar at Jackson Hole, Wyoming, Fed Chairman Jerome Powell said that, indeed, the Fed will be tapering their bond buy-ups. But he did not say when exactly that would happen, so as not to disturb financial markets, including stock exchanges. For the ECB the challenge is even more complex. Over the short-term, the ECB simply cannot end buying bonds of governments, such as those of Spain, Italy and Greece. With one stroke, these countries would lose their fiscal space, which they still need to stimulate their post-covid economies.
The conclusion is a rather sombre one: central banks are confronted with two pending decisions: one concerns QE and the other the short-term interest rate. Should they be forced to start tapering, this will probably plunge highly-indebted countries in a financial crisis. And an increase in short-term interest rates will give investors and shareholders shivers down their spines - stock prices may take a nosedive and fresh investments may dry up.
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Peter de Haan September 2021
Column October 2021
Post-covid prospects for the developing world
Before the outbreak of the covid-19 pandemic, the economies of emerging economies and developing countries were doing quite well. How did covid-19 affect them? This column deals with the question.
In 2019 I published a book entitled Whatever Happened to the Third World? 1 The answer was that most developing countries had been doing quite well. I compared their situation in 1978 with that of 2018. It showed (see bar chart below) that the percentage of low-income countries had gone down from 27% to 16% of all countries, while the percentages for high-income countries had increased considerably from 16% in 1978 to 37% in 2018. As for the middle-income group, the percentages are not as impressive as for the high-income countries. In 1978, some 57% were middle-income countries while in 2018, this percentage had slightly fallen to 48%.
In short, the developing world has done quite well over the past four decades. Incomes had risen, absolute poverty declined considerably, and access to health and education had improved. Hence the title of my book suggested that there was no longer one solid Third World. Quite a few former poor developing countries were catching up. Some reached a high-income country status; others graduated to middle-income level. A few very large ones became known as BRICS countries - short for Brazil, Russia, India, China, and South Africa. The BRICS are playing an ever more prominent role in the world; not just economically but also in the global geopolitical realm. Spectacular economic growth figures were registered by China and India, explaining part of the past upward trend. Other favorable factors were the downward movement of interest rates, globalized finance, sky-high commodity prices, and a steep increase in international trade.
Would this upward trend continue? During the first decade of this century, these favorable factors positively influenced the economic growth of emerging economies and most developing countries. However, during the second-decade economic growth figures started to decline, triggered by the 2007-2009 financial crisis, declining commodity prices and international trade. For example, the BRICS countries’ growth rate dropped from an average growth rate of 18% in the first decade to only 5% in the second. Low and middle-income countries did not do any better.
There is more to say about China’s role. The Chinese economy is no longer growing as fast as it used to. Secondly, China continued investing in manufacturing, leaving few opportunities for developing countries to take over some of China’s manufacturing. This led to premature
de-industrialisation in developing countries that had hoped to take over labour-intensive production processes from China. This could have helped to diversify their economies and boost their export earnings. Another explanation for slower growth is that greater productivity in manufacturing resulted in lower prices, so low that even low-income countries now import manufactured goods, rather than produce them.
Then interest rates. They have been extremely low for a long time. However, there are signs that some high-income economies may be overheating, funnelling the flames of inflation. This may prompt central banks to increase interest rates. This would be bad news for emerging economies and developing countries alike. Capital may leave them searching for higher yields elsewhere, while indebted emerging economies and developing countries will have to pay higher interest payments on their foreign currency loans.
Now, how much did covid-19 affect the developing world? To date, 5 million people died of covid-19. The developing world accounts for 86% of global mortality. Very few people in developing countries have been vaccinated: more than half of the developing world’s population will not have received jabs by the end of 2021. The pandemic will linger on there, opening the doors to new, possibly more aggressive, covid-variants and more covid-related deaths.
The economic impact of covid-19 has been severe. All countries experienced massive job losses, economic contraction, falling investments and exports, and declining income from tourism. Apart from China, whose economy expanded again in 2020, other emerging economies shrank on average by 2.1% last year. Most BRICS did worse, such as India: its economy shrank by 7.3%, Brazil’s by 4.1%, and South Africa’s by 7%. True, the International Monetary Fund (IMF) projects BRICS economies to grow quite robustly this year. For example, India’s economy may bounce back by 9.5%. For the emerging world, the IMF expects a 6.3% growth this year. This sounds heartening, but what about covid’s consequences for poor developing countries?
The extremely poor have been hardest hit by covid. Progress made over the past few decades in eradicating extreme poverty is partly wiped out. The absolute number of people living in extreme poverty rose for the first time since 1997. The World Bank estimates that since the outbreak of covid, the number of extremely poor have risen by around 150 million. The Brookings Institution, a think tank, estimates that by 2030, 588 million people could still live in extreme poverty, an additional 50 million people compared with pre-covid estimates.
One of the many conditions for catching up is an investment in education - so, in human capital. Due to covid, schools across the world had been closed for some time. Pupils in the poorest countries suffered most; they lost most schooldays compared with children of less developed countries, a loss which will probably not be overcome.
The long-term covid impacts will be concentrated in specific countries. According to the latest IMF growth projections, in 2026, 33 developing countries will still have per capita income levels below their 2019 levels. Fifteen of these countries are in sub-Saharan Africa and nine are small island developing states.
The pandemic affected governance and political stability, even in the emerging world. There is increasing evidence that slower economic growth contributes to political instability, which may negatively affect foreign investment. The economic consequences of climate change are visible in
many developing countries. How covid-affected developing countries may bear them is an open question.
The conclusion is a rather grim one. The factors that helped sustain high economic growth in the early 2000’s gradually petered out during the second decade. The result was slower growth. The negative economic effects of the covid-19 pandemic, and the costs of climate change, put a brake on economic growth. Hence, the prospect for developing countries catching up seems dim for the time being. However, the prospect may not be as bleak for the BRICS. Researchers of Goldman Sachs, an investment bank, project that by 2040, the BRICS could still match the output of America, Britain, France, Germany, Italy, and Japan.
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1 De Haan, P. (2020) Whatever Happened to the Third World? A History of the Economics of Development.London: Palgrave Macmillan.
Peter de Haan October 2021
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Column November 2021
This year’s Economics Nobel Prizes
Three economists share this year’s Nobel prize for economics. In 2019, also three economists shared the price.
Is the comparison justified, and what does it say about the economic science?
My fellow countryman Jan Tinbergen (1903-1994) was the first economist ever to be awarded the Nobel Prize for economics. That was way back in 1969. He shared this prestigious prize with Norwegian economist Ragnar Frisch. Why was this? Both had developed an entirely new field in economics: econometrics. This branch of economics portrays an economy in a number of mathematical equations (and an equal number of variables) to clarify how various economic forces influence each other and how all these influences together mimic the economy’s dynamics, depending on the assumptions applied.
I felt a sense of pride when I learned that one of this year’s three Nobel laureates is a Dutchman, although working in America. His name is Guido Imbens, a professor at Stanford University, California, USA. In an interview he gave, Imbens confessed that he was destined to study mathematics after leaving high school. However, after reading about Tinbergen, and his influence not just on the economic science but also on global challenges, such as world poverty, Imbens decided to study econometrics. I am sure Tinbergen would have been very pleased to learn about Imbens’ switch, had he been alive. The other two laureates are David Card of the University of California, and this year’s President of the American Economic Association, by the way. The third one is Joshua Angrist, of the Massachusetts Institute of Technology.
Now, why were these three economists awarded the Nobel Prize? The short answer is: for their empirical work. They contributed to empirics by developing tools and methodologies that made results from empirical work credible. Their work reflects the trend from theoretical to empirical research that can be discerned in economics: economic theory is being eclipsed by empirics.
Causality between economic phenomena seems easy to be established at first sight. However, in the real world there are often more factors at play that influence a particular development. In chemistry, for example, laboratory tests can be done to prove causality. And in pharmaceutical studies, the effectiveness of a new drug is tested through different groups of people: some receiving the drug and other groups receive a placebo. In such a set-up, causality between the drug and its effectiveness can be established.
This methodology is also applied in development economics. The 2109 Economics Nobel laureates applied randomised controlled trials to establish the effectiveness of poverty alleviation policies. However, many economic questions cannot be tested in this manner as ethical, political or logistical considerations prevent testing. Hence, economists don’t often have the opportunity to do experiments – the real world is their laboratory, so to speak.
Now, back to causality. How does a rise in the minimum wage impinge upon employment; is there a causality between them? Not necessarily; other factors may be at play as well, such as a weak labour market. Hence, causality is undermined by these other factors. The three awarded economists developed instruments to overcome this drawback.
Let us take the minimum wage again. In 1994, David Card and a colleague investigated, through a natural experiment, the impact of a rise in the minimum wage on employment in the American state of New Jersey. A natural experiment is one in which a comparable situation exists, based on which reliable conclusions can be drawn. Card and colleague compared the effect the rise in the minimum wage had on employment in New Jersey with what happened at the other side of the border with Pennsylvania, where the minimum wage had not been increased. Theory (and common sense, I add) had it that the minimum wage rise would have a negative effect on employment. Card’s research showed that this was not the case; the negative effect was by far not as large as anticipated. He undertook more of this kind of natural experiments, such as the effects of migration on the labour market. Other economists quickly took over his approach was, contributing to the growth of empirical studies and the credibility of their outcome.
Joshua Angrist applied a comparable technique in his research on the causality between more education and better pay. He analysed a sample of students born in the same year and who had started school on the same date, regardless of their birthday. It appeared that those born in December, therefore, received more schooling on average than those born in January of that year. It turned out that the ones born in December tended to earn more. Since the student’s birth month was a random phenomenon, Angrist concluded that the added education received caused the higher earnings. The schooling study found that an extra year of education raised subsequent wages by 9%.
However, some economists wondered whether this was a justified conclusion. Now, Guido Imbens comes into the picture, so to speak. He had met Joshua Angrist during his student days in a laundry shop where both did do their weekly laundry. While waiting for the laundry to wash and dry, they exchanged philosophical thoughts. This was the beginning of their cooperation in economics.
Imbens and Angrist developed methodologies to make conclusions from natural experiments more useful - to give them more legitimacy. In the example of Angrist’s education research, the birth month of a student is an ‘instrument’. Now, Angrist and Imbens explained the assumptions that need to hold for an instrument’s use to be valid: it must, for example, influence only the outcome being studied (i.e. earnings) through its effect on the years of schooling. So, in a case like this, causality is established.
The importance of Card’s, Angrit’s and Imbens’ contributions to the economic science is that the outcome of empirical research is now more credible. After all, the reader of an empirical paper can judge whether an instrument satisfies the needed assumptions. If not, the result can be discarded. This valuable contribution to economics will help theorists to capture the real world better.
Peter de Haan November 2021
Column December 2021
A real-time revolution in economics
There are not many revolutions in economics. The last one took place in the 1930s in the aftermath of the Great Depression, when
John Maynard Keynes offered an entirely new thinking about economics. The world is now undergoing another crisis: the ongoing Covid pandemic which triggered lower growth and raised inflation. This, like the Great Depression, brought about a real-time revolution in economics.
During the Great Depression, Keynes observed that the market was not, as assumed, self-correcting, in that equilibrium was not restored.
To compensate for the fall in aggregate demand, he argued that the government had to help restore full employment and economic growth through public investment. Keynes looked at the economy as a whole: macroeconomics was born. In 1936, he presented these new insights in The General Theory of Employment, Interest, and Money, the most influential economics book of the past century.
Interest rates are at an all-time low for a very long period, huge amounts of money have been injected into many of the world’s economies through central banks’ bond buy-ups. Despite these very large cash infusions, inflation refused to pick up, until very recently. In addition, the American
and European governments, among others, borrowed enormous sums of money to counter the negative economic effects of the covid-pandemic, increasing their respective public debt tao, here and there, dangerous heights. However, financial markets did not get nervous.
Would all these unprecedented developments not require a comprehensive explanation by way of a new economic theory, comparable to Keynes’s eighty years ago? This is what I expected. Something new is indeed appearing. Triggered by the covid-pandemic, it is a new real-time revolution, resulting from a steeply increased use of instant economic data.
When the covid pandemic broke out, bureaucrats began studying ‘dashboards’ of high-frequency economic data, ranging from credit card spending to day-to-day movements of ships. In the past, it sometimes took months, if not years, to produce relevant data. It all started in America in 1934, with Simon Kuznets’ collection of data to put together the country’s first-ever Gross Domestic Product (GDP). The result was presented 13 months after the exercise had started. Now, most data are instantly and abundantly available. Economists can use these data to advise and influence policymakers in a timely manner.
This real-time economics requires little theory (or even none), as the data speak for themselves. Some economists are very good at making use of these instant data. They have laboratories (called industrial labs) at their disposal where teams of economists are crunching enormous quantities of
high-quality data. A pioneer among them is Harvard’s Raj Chetty. He and other superstars, such as Stanford’s Susan Athey, developed an emerging discipline, which may be called third-wave economics. Adam Smith created the first wave; the second, as mentioned, was created by Keynes (later rather dramatically adjusted by Milton Friedman, who believed in the market). The three of them had a big impact on economic policies.
In the course of time, purely theoretical work was emulated by empirics, supported by ever more sophisticated and instant statistical data, processed by powerful computers. It was no surprise that last year’s Economics Nobel Prize went to three economists who contributed to making empirical research broader and more credible, as presented in my previous column.
During times in which economies rapidly change, instant data help to design timely economic policies. In the past, some policy decisions had been made on the basis of outdated data or, worse, on guesswork. An example: in October 2008, the International Monetary Fund (IMF) observed that the American economy was not necessarily heading for a deep recession. Statistical data, which became later available, showed that the recession had, in fact, already started in December 2007.
The availability of timely data does help policymakers to take decisions at the right moment, preventing worse developments from happening.
This was well understood in China. In January 2020, when the lockdown started in Hubei province, statistics on beer consumption in combination
with movie visits indicated that China’s economy was entering into a slump. Countering measures were swiftly taken – the slump was prevented.
Instant data on economic activities are not just produced by governments’ statistical offices, private firms also collect them. Think of Visa, Apple, Google, and large Chinese companies such as Alibaba. On a daily basis, they record what their clients buy or where their interests are directed to. Way back in 2015, J.P Morgan Chase, an American bank, started to examine data from the bank’s network to analyse consumer finances, helping reveal whether people were spending cash or hoarding it.
Instant data are obviously also very useful for businesses. For example, hedge funds use data collected by economists who analyse daily newspaper data to study market behavior. The same applies to data on the transiting to remote work once the pandemic forced workers to work from home.
Now, what about the theoretical dimension? The emphasis on data gathering (and interpretation) is correcting a historical imbalance
as macroeconomics has become too theoretical, too distant from real life. And, indeed, a better balance with data improves theory!
In sum, the covid-pandemic has given economics a real-time shot in the arm, to use an appropriate metaphor. The real-time revolution provides policymakers with up-to-date information to take timely decisions and prevents wrong decision-making. And, fed by an abundance of relevant data, we may hopefully also welcome a new economic theory that explains the new phenomena I mentioned at the beginning of this column.
Peter de Haan December 2021