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Tuesday, September 28, 2010

A Comment on Germany's Health Care

Translation: Wife to fireman: "He is old and sick. He does not want to be a burden to the health care system." Fireman to man on ledge: "My respects. Your motives are noble." (Caption below: Be sure to select emergency personnel with care!)

Successions in Moscow, Pyongyang and Caracas

It has been a remarkable three days. In Moscow, Russia’s third most important political figure, Yury Luzhokv, the long-serving mayor of Moscow, was unceremoniously sacked. In Pyong-Yang, the son of Kim Jong-Il was named a major general. In Caracas, the opposition to Hugo Chavez won some fifty percent of the popular vote and almost 40 percent of the seats in parliament. All three events tell us something about the most important political successions that lie before us.

Although Luzhkov was fired by President Dmitry Medvedev (who has the official power to remove regional officials), he was really fired by Vladimir Putin to rid the country of the one politician who could contest him for the presidency in 2012. Luzhkov was fired for corruption and incompetence. The corruption charge is true. Luzhov’s control over Moscow was so complete that he was rarely challenged on his wife’s wealth, who became a billionaire through Moscow city contracts. His standard response to questions: “I have nothing to do with my wife’s business.” Luzhkov took kickbacks from companies doing lucrative business in Moscow, some of which he turned back to the city. Incompetent he was not. Compared to other Russian cities, Moscow is one of the best run. It is notable that Luzhkov had to be fired, rather than accepting a face-saving position elsewhere. He chose to stand and fight. As a price for this defiance, he may be dragged through the courts and suffer the same fate as Mikhail Khodorkovsky, who will spend most of his adult life in jail. Luzhkov’s is a cautionary tale to any other regional official, most of whom have enriched themselves through their offices: “Moscow (Putin) is your boss. You can only keep your office and your riches if you are unhesitatingly loyal.” It is important for Putin that they all know this lesson as the 2012 election campaign begins.

North Korea is run by a military council headed by the “beloved leader” Kim Jong-Il. Although the North Korean Communist Party is a key element in the power structure, it is trumped by the military. In this sense, North Korea is unlike the Soviet Union, where the party kept the military on a short leash. It was Kim Jong-Il’s father who invented the family succession in a communist state. In 1980, the last party congress named Kim Jong-Il the successor to his father. Prior to that, in other communist states, the sitting leader could not allow even the mention of a successor for fear it would become reality. Accordingly, the deaths of communist leaders were usually followed by disruptive power struggles. The family succession ensures that the leader-father can continue without the threat of overthrow, expulsion or scapegoating. In North Korean, party congresses are called only when important decisions need to be rubber stamped. The upcoming party congress, which will be the first in three decades, is clearly being called to approve the first steps of the eventual transition of power. Family succession has now become standard fare in dictatorships (Raol and Fidel Castro, Assad father and son, the Aliev father and son and so on). At least the North Koreans added something to the repretoire of dictators.

The parliamentary elections in Caracas are either the last gasp of democracyor a rebound. Despite long odds, Venezuelan voters cast as many or more votes for anti-Chavez candidates as for his supporters, despite the bullying, machinations, and corruption of the Chavez machine. The election left Chavez short of the supermajority required to allow him legally to rule by decree. The most likely outcome is that democracy’s days are numbered. Chavez can spin the election to his advantage (“I still have the most seats in parliament”). Despite an economy in shambles, sporadic electricity, and food lines, Chavez had avoided what would have been a disastrous defeat in the case of a fair election. If I were to guess, I would venture that yesterday’s election was democracy’s last gasp.

Saturday, September 18, 2010

The Mystery of Russian Grain Exports: It’s the Prices, Stupid!

A Soviet joke: A hick from the north is asked by his friend to bring back meat from Moscow. “I don’t know Moscow,” he responds. “How do I find meat?” Answer: “Just go stand in the longest line you can find.” The original punch line: The hick returns with no meat. He spent all his time standing in the line at Lenin’s mausoleum! My new punch line: The hick returns without meat and tells his friend: “I have brought you bread, instead.” Most readers will not understand what is going on. It is a joke because bread was the one food product you could buy anytime and anywhere. My joke sheds light on why Russia (and Ukraine) are again major grain exporters, despite the fact that grain production is no greater than in the 1970s and 1980s when Russia was a major grain importer. It also explains one of the reasons for the collapse of the USSR: the fact that low bread prices imposed huge costs on the Soviet state, exceeded only by its huge defense burden.

Let me start with some facts: Russia became Europe’s breadbasket in the 1870s. It was only around the turn of the century that the United States matched Russia in grain exports. Under Stalin’s rule, agriculture was collectivized and the best peasants deported, imprisoned or killed. By 1972, the Soviet Union started importing huge quantities of grain from the United States and other countries, driving up world food price throughout the rest of the 1970s.

Agriculture has been slow to reform after the breakup of the Soviet Union. The rural population is old; it is still not legal to buy and sell agricultural land; and there have been no substantial new investments in agriculture. Russia, in the last three years, has averaged around one hundred million metric tons of grain; The Russian Republic’s contribution to USSR grain production was also about one hundred million metric tons in 1985, a year in which one fifth of grain consumption had to be covered by imports.

Contemporary Russia has transformed itself from a grain importer to exporter not because it is producing more. It is consuming less grain domestically, leaving a “surplus” for export. Skeptics may say that this is a sign of poverty, that the Russian diet is deteriorating. It is the opposite: Russians no longer have to make do with just bread. They can buy what they want with the money they have. For the older generation, this is a novelty. In the Soviet period, the state set food prices low. After all, this was a worker-peasant state and food should be affordable to all. Low food prices were not simply an act of benevolence on the part of the leadership. Attempts to raise food prices were met with bloody riots, such as in Novocherkassk in June of 1962. After 1962, there were no more attempts to raise food prices, except by stealth. Party leaders could not forget that the Bolshevik Revolution began with bread riots in March of 1917. Communist functionaries thereafter lived with fear of a bread riot in their district. Near the end of Gorbachev’s chaotic rule, rumors of shortage could still empty bakeries of bread.

At low food prices, consumers had to stand in line for just about everything. They often returned home without the goods they wanted, but at least there was always bread, which cost only a few kopeks. Bread was like a safety valve into which unspent food money flowed. In effect, the Soviet state had an implicit contract with the people that they could always get cheap bread, no matter what. Cheap bread, however, also met waste. Throughout the Soviet period, there were accounts of peasants feeding bread to hogs.

This implicit contract sounds noble, but it had unintended consequences that hastened the end of the Soviet Union: It caused the USSR, with some of the richest agricultural land in the world, to become a grain importer. State agricultural subsidies became the second largest item (behind defense) in the state budget. Food problems revealed to Soviet citizens the weaknesses of the system.

The commitment to make bread available to all at a dirt-cheap price meant that there had to be enough of it. In terms of real economic costs, Soviet bread became among the most expensive in the world. Because its retail price was below the cost of production; state subsidies to state and collective farms equaled around four percent of GDP (more than the cost of running the entire government). Even that was not enough. There was no way Soviet agriculture was going to produce enough grain to satisfy the artificially-inflated domestic demand. Starting in 1972, the Soviet Union began to import large quantities of grain, which it paid for with foreign credits and energy exports. These policies made the contradictions of the Soviet system apparent to all: The country that should have been the bread basket of Europe was forced to import grain, paying for it with its earnings from the one product that it could sell at a profit in world markets – energy. When world energy prices were low, the Soviet Union had to borrow from the West, accumulating foreign debt that reached alarming proportions by the standards of the time. All of this to make sure that any and every family could buy bread for kopeks.

We economists (not all) tend to preach the “allocative efficiency” of market prices. We warn that rent controls, subsidized interest rates, and other interventions into the price system have unintended consequences that overwhelm the original “good” intention. In the case of Russia, the almost incalculable unintended consequences are evident from a “natural experiment.” We see a Soviet Russia with low prices of food products but bread prices are particularly low. We then see a Russian Federation with market prices for food. In both cases, the domestic production of grain is about the same. In the Soviet case, food subsidies consume a large portion of the state budget, scarce foreign exchange is used for grain imports, foreign debt is piling up, and people cannot buy the food products they want. In the Russian Federation case, food subsidies have disappeared, the country is earning foreign exchange not only from energy but also from grain, foreign debt is being repaid. In the Soviet Russia case, the country is hostage to grain suppliers. In the Russian Federation case, Europe is hostage to Russian natural gas supplies and world grain prices are affected by Russia’s export policies.

There will be a sequel to this piece. It shows that Russian agriculture is still in the early phases of reform. It is producing about the same amount as it did during the disastrous Soviet period of collective and state farming. When Russian and Ukrainian agriculture reach their potential, world grain markets will be changed forever. We do not know how long we will have to wait to see this happen.

Putin 2012? Should There Be Any Doubt?

The media is abuzz with Vladimir Putin’s new “Putin2012” web address. This, along with other hints that he has been dropping, reveal that he intends to return to the presidency in 2012. Another hint is that the state-controlled media has begun a campaign of innuendo against Moscow Mayor Luzhkov, one of Putin’s few possible rivals in an election campaign.

We really do not need such hints and maneuvers to know that Putin will seek to return to the presidency in 2012. The simple reason is that he cannot afford not to. There has been one succession since Russian independence: the handover of power from Boris Yeltsin to Vladimir Putin as the last century ended. It now appears that the second succession was no succession at all. Dmitry Medvedev was put in as a place holder until Putin can constitutionally return to the presidency. Notable about Medvedev is that he does not have KGB ties in a state run by former KGB officers. As such, he lacks the power to go against Putin in the 2012 presidential election.

Putin must remain in power because this is the only way he can protect himself from future unpleasantness. The deal that the Yeltsin family and Yeltsin-favored oligarchs struck with Putin and the KGB was that they would not prosecute Yeltsin or his family and that the oligarchs could keep their business empires. Putin kept the first part of the deal, but he removed all uncooperative oligarchs – either to jail or to posh exile in London.

Putin must now ask himself whether he can strike a credible deal with an incoming regime for himself that will insure him the same two things – freedom from prosecution and keeping the enormous wealth he has secretly accumulated in the course of his presidency. The answer is no. Putin could not be sure that a new regime might find it in its interest to go after him at some point. Perhaps, the new leaders will need a scapegoat to explain why things are not going well. He understands it will not matter whether the new leaders are his “best friends” or not. As Stalin used to say: “Friendship is friendship but business is business.”

Putin is chained to the office by the same lack of rule of law that makes other types of contract enforcement impossible. In an authoritarian/totalitarian state, whoever is in power is the law, and is free to change the law at any time. There would therefore be no mechanism for Putin to enforce a contract with a new regime.

Tuesday, September 7, 2010

Do We Need a New Economics 101?

As we began to write our Principles of Economics text (Roy Ruffin and Paul Gregory, Principles of Economics) exactly thirty years ago, economics was in disarray, shaken by the stagflation that was not supposed to be. Ours was among the first to introduce the new ideas of the 1980s -- rational expectations, Barro-Ricardo equivalence, the natural rate of unemployment, moral hazard, and new Keynesian economics. At that time, Economics 101 was taught, with few exceptions, the unabashed Keynesianism of Samuelson and McConnell. Principles textbooks are intended to give a sense of the state of economics. Selected by committees, they must at least try to give a balanced viewpoint. Although labeled “conservative,” our text garnered strong sales for a decade. We must have done something right.

Will the deep recession, which likely ended in late 2009, require a rethinking of economics, as did stagflation? Compared to other economic downturns of the past forty years, the current recession definitely stands out. Its probable 20-month duration is greater than the previous peak of 16 months (and the 40-year average of 11 months); its peak unemployment of 10.2 percent was exceeded only by the 10.8 percent of 1981-82 (The 40-year average was 7.8 percent); and the 4.1 percent loss of output well exceeds that of previous recessions. Moreover, it follows a long period of economic growth, interrupted by extremely mild recessions, dubbed “the Great Moderation.” The current recession, despite its severity, pales in comparison to the Great Depression with its 25 percent unemployment rates and loss of a quarter of GDP. The threat of a repeat of this catastrophe was remote, although politicians could not resist invoking its image.

In 1980, policy makers despaired that “the rules of economics were no longer working.” The Phillips Curve had taught that we had a policy choice of inflation or unemployment and had no instructions for when both rose at the same time. Rational expectations provided the new paradigm: As inflation crept up due to the energy shocks of the 1970s and central banks created more money to combat the resulting unemployment, people began anticipating higher and higher inflation, which led to the incredibly high interest rates of the late 1970s and early 1980s. The new policy prescription was that inflationary expectations had to be beaten by a draconic and steady policy of monetary restraint, despite its negative effects on GDP and unemployment. A more positive message was that inflationary expectations could change quickly and in a positive direction if people became convinced that economic policy would be enlightened and consistent.

Complaints are again being voiced that “the laws of economics are not working.” Despite easy money, zero interest rates, and massive increases in government spending, unemployment rates remain high, and consumer and investment spending remain anemic. We may still face a double-dip recession. Are we, in 2010, facing a “new” phenomenon similar to stagflation of the late 1970s? Do we need entirely new ways of thinking? Can “contemporary” economics can explain these recent policy disappointments. Let us examine each of these failures to determine if they were expected or unexpected.

1. The failure of the fiscal stimulus to raise output and employment.

The Obama administration’s assurances that increased federal spending would have a potent effect through the multiplier have not proven to be true. This is not a surprising outcome at all. Contemporary economics long cast doubt on the multiplier – the notion that $1 of extra government spending would raise GDP by more than a dollar. The Keynesian multipliers of Samuelson and McConnell apply to an economy in which wages are stuck, and there is an almost infinite supply of workers prepared to work at going wages. Unemployment could therefore not be reduced by lower wages. In such a circumstance (that Keynes thought to apply to deep depression), increases in government spending have magnified effects on output and employment. (Much of “modern” Keynesianism is therefore about finding reasons for sticky wages in today’s economies). In contemporary texts, aggregate supply and demand replaced the Keynesian multiplier. The steeper the positive slope of the aggregate supply curve, the smaller the effect of a stimulus program. Moreover, the more the effects of stimulus are anticipated, the smaller its effect. We decided in 1980 (with surprisingly little resistance) to drop the multiplier from our text. It is therefore surprising that the Keynesian multiplier has played such an important role in the current policy debate. Is this again an example of Keynes’ warning that we are hostages to the outdated ideas of dead economists? The demise of the multiplier is not the only reason for questioning fiscal stimulus. The Keynesian model assumes that public debt does not affect consumer behavior. The Barro-Ricardo equivalence theorem teaches, to the contrary, that deficit spending can be offset as people cut private spending to prepare for tax increases that are sure to come. The current increases in private saving that have accompanied today’s soaring deficits are striking confirmation of this proposition. There is yet another effect: government spending “crowds out” private spending (More government spending for education or medical care mean less private spending for both). This “crowding out” may be particularly strong today as the government expands into more activities that were traditionally the responsibility of private individuals.

2. The failure of Obama’s 2009 tax rebate to stimulate private spending.

The textbooks of the 1980s introduced the Friedman-Modigliani permanent income hypothesis, which taught that temporary changes in current income (such as from a one-shot tax reduction) have no effect on consumer spending. Indeed, this proposition has been substantiated in the many failures of temporary tax cuts from the administrations of Johnson (1968) to George W. Bush (2001, 2008). Short term tax rebates remain politically appealing despite the evidence of their impotence because they show a government “doing something” about the economy. We have sufficient evidence to conclude that only tax changes that are perceived to be durable affect real outcomes. Hence, Friedman-Modigliani predicts that a one-year (or even two year) extension of the Bush tax cuts will have little or no impact on consumer spending. If anything, economists should have been surprised if the tax rebates of 2009 had had any effect whatsoever. Any positive impacts of the 2009 tax rebates would have been swamped by the persistent chatter about higher taxes – on energy, the expiration of the Bush tax cuts, “hidden” taxes associated with health care, value added taxes, and eliminating the cap on social security taxes.

3. The persistence of high unemployment.

The administration’s economic advisors were clearly unduly optimistic about unemployment. The textbooks of the 1980s substituted the natural rate of unemployment (of Friedman and Edmund Phelps) for the crude Keynesian concept. The natural rate hypothesis placed unemployment in the context of cost-benefit analysis. If the costs of remaining unemployed are high, the unemployment rate will fall. Hence, if unemployment compensation is generous and long lasting, the unemployment rate will remain higher than it would have otherwise. In fact, empirical studies found that unemployed persons remarkably found jobs just as their unemployment benefits were expiring. Other studies showed that the higher unemployment in the European welfare states was partially due to unemployment insurance becoming an entitlement. Admittedly, it is politically difficult to place time limits on unemployment insurance, but the administration’s extensions are on the verge of making unemployment insurance a permanent entitlement.

4. The lack of private investment and job creation.
Keynes wrote “in the long we are all dead.” His multiplier is dead, but his writings about uncertainty and investment remain as relevant as the day they were written. Keynes emphasized in his writings about “animal spirits” that business expectations can shift quickly. As businesses become pessimistic, they cut back. The future is always uncertain, and the greater the uncertainty, the fewer investments and the fewer workers hired. We live now in a world of great uncertainty. We do not know our future tax liabilities; businesses do not know what their employee health care costs will be. Boards of directors are less free to make compensation decisions; government bureaucrats now increasingly do either directly or through political pressure. Businesses cannot calculate their bottom lines and until they can, their best strategy is to sit tight. Lenders with first claims to assets have been told to go to the back of the line in some cases; others have been told to renegotiate mortgages. The result: little investment and little lending. In a word, businesses fear that the rules of the game are being changed by an administration that is unfriendly to them. These points are not to be found in Economics 101 textbooks. They are evident and have been with us since Adam Smith and before. Our main economic message to countries with poor institutions is to settle on reliable rules of the game; we have not followed our own advice. In my view, this is the main reason for the “failed” recovery.

The last three years will be dissected and analyzed by generations of economists. Their main question should be why the “Great Moderation” ended with such severe consequences? Was this a failure of private markets or public policy? We already know the immediate cause: the abrupt end of the housing price bubble and the associated collapse of mortgage and security markets worldwide. Some one half of private wealth in the United States was in home equity. The collapse of this wealth would inevitably bring the entire economy down with it. But were these events the result of market excesses or policy blunders? The argument for market excesses rests on the failure of asset markets to properly value risks. The argument for policy failure rests on the deliberate use of public institutions to underwrite high risk mortgages with the aim of making Americans home owners whether they could afford it or not. For a long time, we were warned that public lenders (Fannie and Freddie) were technically insolvent, but few law makers were willing to pay attention, on either side of the aisle. The textbooks of the 1980s introduced moral hazard. Applied to financial markets, moral hazard rears its head when lenders assume that a lender-of-last resort will bail them out. They therefore take risks they otherwise would not have. With moral hazard, it becomes extremely difficult for private markets to value risk because of moral hazard and the fact that the outcome depends on unpredictable government actions and reactions.

There is no need for a new Economics 101. What we have experienced over the past two years is nothing new. There is nothing unexpected that has happened. Events however should serve as “teachable moments. What is surprising is that Keynesian economists do not seem to have learned its lessons.

Paul Gregory is the co-author with Roy Ruffin of Principle of Economics, the first edition of which appeared in 1982 with Scott, Foresman.

Preserving History: The Strange Case of the Lakoba Papers

The N. A. Lakoba papers, one of the most fascinating collections at the Hoover Institution Archives, contain the personal papers of one of Stalin’s closest friends, Nestor Lakoba, the party boss of Abkhazia (now part of Russian-occupied Georgia) and Stalin’s host on his frequent visits to the Black Sea resort of Sukhumi. The crown jewel of the collection is Lakoba’s personal photo album, filled with candid pictures of Stalin and his retinue hunting and fishing; it also contains Lakoba’s personal papers, including his official health certificate, which indicates that he was almost completely deaf. Most documents are in Lakoba’s own hand, including his personal notebook containing his candid musings. Secret correspondence with and reports from his informers reveal his concern about encroachments on his authority by political rivals, including Georgian boss Lavrenty Beria.

Shortly before Christmas 1936, Beria poisoned Lakoba during a dinner in Beria’s home. Lakoba’s body was returned from Tbilisi to Sukhumi by special train; he was buried with full honors in the Sukhumi botanical garden. Beria was among the mourners, somberly carrying a funeral banner in honor of his old friend. In the aftermath of the murder, Lakoba’s extended family was either executed or imprisoned, and those associated with him were accused of being part of his plots to kill Stalin and other Soviet leaders. Before their arrest, the family, having learned of Beria’s plan to burn the body to destroy evidence of the poisoning, secretly reburied his body in an undisclosed location, presumably near his home village. Despite torture, Lakoba’s wife took the secret to her grave.

In reading the autobiography of Lakoba’s sister-in-law (more than a quarter-century his junior), I came across the following account of how the Lakoba family saved his archives from Beria’s grasp and certain destruction:

“In this difficult time, Saria [Lakoba’s wife] and Musto [her younger brother] succeeded in saving Nestor’s archive. In the presence of witnesses, they burned in the courtyard letters from Trotsky and other dangerous letters. Other documents they placed in a box, which they packed in thick paper and then hid in a hiding place under the floor of their house. When Musto [one of the few to survive] returned from prison and exile in 1955, he found that their house had been turned into a dormitory of a technical institute. The package was not in the secret hiding place. Workers, who remodeled the floors, had found the box. Musto began a personal investigation of its whereabouts. He learned that it was in the possession of local authorities (who did not understand what it was), and to his astonishment the box was returned to him. To his surprise, the archives was remarkably well preserved. After Musto’s death, the archives went to his son.”

Lakoba’s sister-in-law thus provides us with one link in the chain of events that eventually brought the Lakoba archive to Hoover and tells us that the family burned documents that it felt would be incriminating, such as the correspondence with Trotsky. The candid photos of the vacationing Stalin have been widely reproduced in many books on Stalin. The collection is also a valuable source on the history of Abkhazia, which, even in Lakoba’s time, had separatist tendencies. Abkhazia and its capital city, Sukhumi, today have a government appointed by Putin and are occupied by Russian troops.

When I read through the Lakoba archive in July, it was in the hands of the capable Hoover Archives preservation staff, who were applying preventive care to the eighty-year-old photographs. It is fortunate that the Lakoba archive ended up at Hoover. In a poorly funded Russian state archive, there is no telling what its condition would be today (or if it would even be accessible).