April 26, 2013

April 26, 2013 (GDP Byte)

Carmen Reinhart and Ken Rogoff, used their second NYT column in a week, to complain about how they are being treated. Their complaint deserves tears from crocodiles everywhere. They try to present themselves as ivory tower economists who cannot possibly be blamed for the ways in which their work has been used to justify public policy, specifically as a rationale to cut government programs and raise taxes, measures that lead to unemployment in a downturn.

This portrayal is disingenuous in the extreme. Reinhart and Rogoff surely are aware of how their work has been used. They have also encouraged this use in public writings and talks. While it is unfortunate that they have "received hate-filled, even threatening, e-mail messages," as one who works in the lower-paid corners of policy debates, let me say, welcome to the club.

This column is careful to halfway walk back the main claim of their famous paper, telling us:

"Our view has always been that causality [between high debt levels and slow growth] runs in both directions, and that there is no rule that applies across all times and places."

It is good to hear the reference to causation from slow growth to high debt and that "no rule applies across all times and places." However it is worth noting that Reinhart and Rogoff never felt the need to use their access to the NYT's opinion pages to correct all the politicians who used their paper to argue the exact opposite: that their paper implied that countries with high debt levels could anticipate long periods of slow growth.

A federal district court has ruled that the Obama administration must declassify records with the names of individuals trained at the Western Hemisphere Institute for Security Cooperation (WHINSEC), formerly known as the U.S. Army School of the Americas or SOA. 

Famously known as the “School of Assassins,” the school trained members of foreign armed forces who later went on to participate in some of the bloodiest and most repressive regimes in contemporary Latin America.   During El Salvador’s civil war, the most heinous violations of human rights were committed by SOA graduates, who organized death squads and planned the assassination of Archbishop Oscar Romero (1980) and participated in the El Mozote Massacre (1980), where more than 800 civilians were murdered.  SOA graduates made up the majority of the Chilean officers who overthrew Allende in favor of Pinochet in Chile.  And in Argentina, General Roberto Viola was among the many SOA graduates that participated in the dirty war—he was convicted of murder, kidnapping and torture in 1985.

Though SOA changed its name and instituted reforms in 2001, its graduates have continued to be involved in anti-democratic activity and egregious human rights abuses.  Case in point: Honduras.  Four of the six generals linked to the coup against democratically elected President Manuel Zelaya were trained at the WHINSEC in recent years, including top General Romeo Vásquez.  SOA graduates have been  the subject of CEPR’s ongoing coverage of violence and impunity in Honduras; we wrote about soldiers that shot and killed a 15-year-old boy in Tegucigalpa, Honduras, which included among their number at least one soldier trained at the WHINSEC. 

Thanks in large parts to the grassroots campaign against the school organized by SOA Watch, a number of Latin American countries have stopped sending troops to WHINSEC.  The first country to pull out was Venezuela in 2004, followed by Argentina and Uruguay in 2006.  Other countries that stopped sending troops include Bolivia, Ecuador and most recently Nicaragua.  However, Honduras and other Central American countries – including Costa Rica – continue to send police and military personnel to the school.  The Bayonet reports that for the “Cadet Leadership Development Course” that began October of 2012, there were 64 Honduran Army cadets in attendance, representing the largest share from a single country.  One cadet was quoted saying that the course was “useful in the future during joint operations.” As readers of the Americas Blog are aware, a joint U.S./Honduras counternarcotics operation last May resulted in the killing of four indigenous villagers with no apparent ties to drug trafficking. 

I have a policy of not discussing items that directly refer to me in this blog, but I will make an exception today because the issues raised by Robert Samuelson are important. In his column Samuelson makes two key arguments. First, that the Reinhart-Rogoff conclusions about high debt leading to slow growth still stand even after the errors in the original paper were corrected, and second, that this work was never really the basis for austerity anyhow.

Taking these in order, Samuelson constructs a chart showing the originally reported and corrected relationships between debt levels and GDP growth.

He then tells readers:

"After recalculating the Reinhart/Rogoff data, the UMass economists confirm that high debt implies lower economic growth."

No, that is not right. The recalculated numbers show that high debt levels in the countries examined by Reinhart and Rogoff were associated with lower growth. However as the paper by Thomas Herndon, Michael Ash and Robert Pollin that exposed the error clearly explained, the growth falloff for countries with debt-to-GDP ratios above 90 percent was not statistically significant. In fact, they found a much stronger negative relationship between debt and GDP growth at very low ratios of debt-to-GDP. This means that if someone was basing policy on the corrected Reinhart-Rogoff numbers they would be arguing for debt-to-GDP levels in the range of 15-20 percent. That is not what Reinhart and Rogoff or anyone what else in this debate is saying. 

There are often shades of grey in interpreting people's views, but the NYT seems to be giving us assessments of Federal Reserve Board Vice Chairman Janet Yellen's views that are 180 degrees apart. An article today on Dr. Yellen's prospects of being chosen to replace Ben Bernanke as chair tells readers:

"In July 1996, the Federal Reserve broke the metronomic routine of its closed-door policy-making meetings to hold an unusual debate. The Fed’s powerful chairman, Alan Greenspan, saw a chance for the first time in decades to drive annual inflation all the way down to zero, achieving the price stability he had long regarded as the central bank’s primary mission.

"But Janet L. Yellen, then a relatively new and little-known Fed governor, talked Mr. Greenspan to a standstill that day, arguing that a little inflation was a good thing."

Okay, this is pretty clear, Yellen is on the side of promoting growth at the risk of somewhat higher inflation.

This seems hard to reconcile with a piece the NYT wrote three years ago:

The worldwide debate over fiscal policy and austerity was turned upside down last week by a paper co-authored by a University of Massachusetts grad student Thomas Herndon and two professors, Michael Ash and Robert Pollin (HAP). The paper uncovered serious calculation in errors in an important paper by Harvard professors Carmen Reinhart and Ken Rogoff (R&R).

The Reinhart and Rogoff paper, “Growth in a Time of Debt,” has been widely cited in policy debates in the United States and around the world as providing the basis for cutting deficits even at a time when the economy is suffering from large amounts of unemployment and interest rates are extraordinarily low. Ordinarily economists would argue that these are exactly the circumstances in which governments should undertake aggressive stimulus measures. Government spending can both boost growth and increase employment in the short-run, and also lead to long-run benefits insofar as the stimulus takes the form of investment in infrastructure, research and development, and education.

The Reinhart and Rogoff paper was used to argue against increased spending because it purports to show that high ratios of debt-to-GDP lead to large falloffs in growth. The implication of the paper is that the United States and other wealthy countries are at debt levels near a tipping point where further increments of debt can lead to decades of slow growth.

The moral of the Reinhart and Rogoff analysis is that we have no choice but to live with the pain of high unemployment and slow growth now, since the eventual cost in terms of a prolonged period of slow growth and high unemployment would be so awful. This is the sort of reasoning behind the austerity plans that are leading to double-digit unemployment across Europe and slow growth and high unemployment in the United States.

The paper by HAP was a body blow to the intellectual foundations for these policies. When corrected, the R&R analysis provides no basis for the concerns about a high debt cliff that they had been pushing for the last three and half years.

Dean Baker
Caixin Online, April 23, 2013

In February, the United Nations confirmed that a Canadian serving with the United Nations Police contingent of MINUSTAH had been accused of sexually and physically assaulting a Haitian woman. Yesterday, Marie Rosy Kesner Auguste Ducena, a lawyer with the Haitian National Human Rights Defense Network, told CBC news that, though the victim reported the assault to police, “nothing will happen... Women who will go to complain, you will see that maybe somebody will take the complaint and will say to her you will be called after. But in fact, the case will just be closed.” CBC notes that the “day after the incident, the man boarded a flight back to Canada, where he remains.”

This is but the latest in a series of sexual abuse allegations leveled against MINUSTAH personnel in Haiti. According to U.N. data, since 2007 there have been 70 allegations of sexual abuse and exploitation against MINUSTAH members, but as CBC news points out, “not one has ended up in a Haitian court.”

The lack of accountability of U.N. military and police personnel in Haiti has “undermined” the organizations reputation and its ability to carry out its mandate, according to Mark Schneider of the International Crisis Group (ICG). "The UN should ensure that in the agreement with the troop-contributing countries, that there is an understanding of what will happen if an abuse occurs — that there will be a full investigation, and that there will be appropriate action taken," Schneider added.

According to the CBC, the current case is complicated by the fact that the Canadian was serving as a UN Police agent. The CBC reports:

Soldiers can be tried in a military court, but under UN rules, civilian staff — including police officers — are immune from criminal prosecution in the country where the alleged offence occurred. Once back in Canada, they cannot be charged for a crime committed abroad.

The Bureau of Economic Analysis (BEA) will adopt a new methodology for measuring GDP this summer. The methodology will treat research and development and the creation of artistic works as forms of capital that depreciate through time rather than one-time expenditures. This will lead to an increase in measured GDP of close to 3.0 percent according to BEA's analysis.

There are three points worth making on this change. First, for you conspiracy buffs, this one has been in the works for close to two decades. The government didn't just come up with it to make President Obama look better. Go back to digging up the Real Story about the plunge in gold prices.

The second point is that the methodology for this will inevitably be very troubling. If Pfizer has a patent for a great new cancer drug we will now pick this up as an increase in the investment component of GDP. Suppose Merck develops a drug that does the exact same thing, except that it gets around Pfizer's patent. According to the new methodology this would further increase GDP.

Of course, this is a battle over rents, not actually an increase in total output. That is a problem. Expenditures for rent-seeking don't make us richer in aggregate. In fact, this is already a problem now, it's just likely to be more of a problem in the future. Consider the situation where a software developer makes their great new software available for free. Our friends over at BEA won't show any gain to GDP even though our living standards will certainly be improved by much more than if they had patented the software and charged for it.

The renewed interest in breaking up too-big-to-fail (TBTF) banks may remind people about the extraordinary influence that banks and financial institutions hold over our economy. The financial industry has experienced substantial growth over the last few decades. The financial sector’s share of corporate output (gross value added less Fed profits[1]) has grown rather steadily from 5.7 percent in 1960 to 14.1 percent in 2006 (see Graph 1).  Yet, the financial sector’s share of total corporate profits (net operating surplus less Fed profits) soared from slight losses to 22 percent (corresponds to an increase of $142 billion in 2006) in the same timeframe. This increase in finance’s share of profits far exceeded its gain in the share of corporate production. In the years leading up to the financial collapse (2001-2006), the financial industry enjoyed profits that were hugely disproportionate to their share of output. The disparity between the share of profits and production peaked in 2003 at a difference of 8.3 percentage points. The financial sector’s share of total corporate business profits has been very erratic over the last few decades with a general upward trend, contrasting to a more gradual increase for its share of output. It is important to remember that the high pay and bonuses of top executives and traders, which can run into the millions or tens of millions a year, do not count as profits.

Graph 1
(Click for a larger version)

The growth in the size of the financial industry provides an interesting juxtaposition to the growing inequality over the last few decades. Between 1970 and 2006, the bottom 40 percent of households’ share of aggregate income fell by almost 3 percentage points while the shares of the top 20 percent and 5 percent rose 7 and 6 percentage points, respectively. Many of the highest incomes were earned in the financial sector. (The pay of top executives and traders are counted as wages rather than profits in the National Income Accounts.)

When toxic assets threatened the operations of those prominent banks and financial institutions, bailout funds provided them liquidity. The total amount lent at below market interest rates was well over $10 trillion; although most of the loans were relatively short-term. These subsidized loans enabled the financial sector to return to its pre-recession profit levels by 2009. In contrast, American households are still recovering from income shocks, unemployment stints and wealth shocks.