Embed Size (px)
DESCRIPTION
debt and economic growth
Citation preview
Does High Public Debt Consistently Stifle EconomicGrowth? A Critique of Reinhart and Rogoff
Thomas Herndon∗ Michael Ash Robert Pollin
April 15, 2013
JEL codes: E60, E62, E65
Abstract
We replicate Reinhart and Rogoff (2010a and 2010b) and find that coding errors,selective exclusion of available data, and unconventional weighting of summary statisticslead to serious errors that inaccurately represent the relationship between public debtand GDP growth among 20 advanced economies in the post-war period. Our finding isthat when properly calculated, the average real GDP growth rate for countries carryinga public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not −0.1 percentas published in Reinhart and Rogoff. That is, contrary to RR, average GDP growthat public debt/GDP ratios over 90 percent is not dramatically different than whendebt/GDP ratios are lower.
We also show how the relationship between public debt and GDP growth variessignificantly by time period and country. Overall, the evidence we review contradictsReinhart and Rogoff’s claim to have identified an important stylized fact, that publicdebt loads greater than 90 percent of GDP consistently reduce GDP growth.
1 Introduction
In “Growth in Time of Debt,” Reinhart and Rogoff (hereafter RR 2010a and 2010b) propose
a set of “stylized facts” concerning the relationship between public debt and GDP growth.
RR’s “main result is that whereas the link between growth and debt seems relatively weak
∗Ash is corresponding author, [email protected]. Affiliations at University of Massachusetts Amherst:Herndon, Department of Economics; Ash, Department of Economics and Center for Public Policy andAdministration; and Pollin, Department of Economics and Political Economy Research Institute. We thankArindrajit Dube and Stephen A. Marglin for valuable comments.
1
at ‘normal’ debt levels, median growth rates for countries with public debt over roughly 90
percent of GDP are about one percent lower than otherwise; (mean) growth rates are several
percent lower” (RR 2010a p. 573).
To build the case for a stylized fact, RR stresses the relevance of the relationship to
a range of times and places and the robustness of the finding to modest adjustments of
the econometric methods and categorizations. The RR methods are non-parametric and
appealingly straightforward. RR organizes country-years in four groups by public debt/GDP
ratios, 0–30 percent, 30–60 percent, 60–90 percent, and greater than 90 percent. They then
compare average real GDP growth rates across the debt/GDP groupings. The straightforward
non-parametric method highlights a nonlinear relationship, with effects appearing at levels
of public debt around 90 percent of GDP. We present RR’s key results on mean real GDP
growth from Figure 2 of RR 2010a and Appendix Table 1 of RR 2010b in Table 1.
Table 1: Real GDP Growth as the Level of Public Debt Varies20 advanced economies, 1946–2009
Ratio of Public Debt to GDPBelow 30 30 to 60 60 to 90 90 percent andpercent percent percent above
Average real GDP growth 4.1 2.8 2.8 −0.1
Sources: RR 2010b Appendix Table 1, line 1, and similar to average GDP growth bars in Figure 2of RR 2010a.
Figure 2 in RR 2010a and the first line of Appendix Table 1 in RR 2010b in fact do not
match perfectly, but they do deliver a consistent message about growth in time of debt: real
GDP growth is relatively stable around 3 to 4 percent until the ratio of public debt to GDP
reaches 90 percent. At that point and beyond, average GDP growth drops sharply to zero or
slightly negative.
A necessary condition for a stylized fact is accuracy. We replicate RR and find that
coding errors, selective exclusion of available data, and unconventional weighting of summary
2
statistics lead to serious errors that inaccurately represent the relationship between public
debt and growth among these 20 advanced economies in the post-war period. Our most basic
finding is that when properly calculated, the average real GDP growth rate for countries
carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not −0.1
percent as RR claims. That is, contrary to RR, average GDP growth at public debt/GDP
ratios over 90 percent is not dramatically different than when public debt/GDP ratios are
lower.
We additionally refute the RR evidence for an “historical boundary” around public
debt/GDP of 90 percent, above which growth is substantively and non-linearly reduced. In
fact, there is a major non-linearity in the relationship between public debt and GDP growth,
but that non-linearity is between the lowest two public debt/GDP categories, 0–30 percent
and 30–60 percent, a range that is not relevant to current policy debate.
For the purposes of this discussion, we follow RR in assuming that causation runs from
public debt to GDP growth. RR concludes, “At the very minimum, this would suggest that
traditional debt management issues should be at the forefront of public policy concerns” (RR
2010a p. 578). In other work (see, for example, Reinhart and Rogoff (2011)), Reinhart and
Rogoff acknowledge the potential for reverse causality, i.e., that weak economic growth may
increase debt by reducing tax revenue and increasing public expenditures. RR 2010a and
2010b, however, make clear that the implied direction of causation runs from public debt to
GDP growth.
Publication, Citations, Public Impact, and Policy Relevance
According to Reinhart’s and Rogoff’s website,1 the findings reported in the two 2010 papers
formed the basis for testimony before the Senate Budget Committee (Reinhart, February 9,
2010) and a Financial Times opinion piece “Why We Should Expect Low Growth amid Debt”
1http://www.reinhartandrogoff.com/related-research/growth-in-a-time-of-debt-featured-in
(visited 7 April 2013.
3
(Reinhart and Rogoff, January 28, 2010). The key tables and figures have been reprinted in
additional Reinhart and Rogoff publications and presentations of Centre for Economic Policy
Research and the Peter G. Peterson Institute for International Economics. A Google Scholar
search for the publication excluding pieces by the authors themselves finds more than 500
results.2
The key findings have also been widely cited in popular media. Reinhart’s and Rogoff’s
website lists 76 high-profile features, including The Economist, Wall Street Journal, New
York Times, Washington Post, Fox News, National Public Radio, and MSNBC, as well as
many international publications and broadcasts.
Furthermore, RR 2010a is the only evidence cited in the “Paul Ryan Budget” on the
consequences of high public debt for economic growth. Representative Ryan’s “Path to
Prosperity” reports
A well-known study completed by economists Ken Rogoff and Carmen Reinhartconfirms this common-sense conclusion. The study found conclusive empiricalevidence that gross debt (meaning all debt that a government owes, includingdebt held in government trust funds) exceeding 90 percent of the economy has asignificant negative eect on economic growth. (Ryan 2013 p. 78)
RR have clearly exerted a major influence in recent years on public policy debates over
the management of government debt and fiscal policy more broadly. Their findings have
provided significant support for the austerity agenda that has been ascendant in Europe and
the United States since 2010.
2 Replication
RR examines three data samples: 20 advanced economies over 1946–2009; the same 20
economies over roughly 200 years; and 20 emerging market economies 1970–2009. We
2A search on [Reinhart Rogoff "Growth in a Time of Debt" -author:rogoff -author:reinhart]
yielded 538 Google Scholar results on 7 April 2013).
4
replicate the results only from the first sample as these are the most relevant to current
U.S. and European policy debates, and they require the least splicing of data from multiple
sources. We focus exclusively on their results regarding means because these have generated
the most widespread attention. On their website, Reinhart and Rogoff provide public access
to country historical data for public debt and GDP growth in spreadsheets with complete
source documentation.3 However, the spreadsheets do not include guidance on the exact data
series, years, and methods used in RR.
We were unable to replicate the RR results from the publicly available country spreadsheet
data although our initial results from the publicly available data closely resemble the results
we ultimately present as correct. Reinhart and Rogoff kindly provided us with the working
spreadsheet from the RR analysis. With the working spreadsheet, we were able to approximate
closely the published RR results. While using RR’s working spreadsheet, we identified coding
errors, selective exclusion of available data, and unconventional weighting of summary
statistics.
Selective exclusion of available data and data gaps
RR designates 1946–2009 as the period of analysis of the post-war advanced economies
with table notes indicating gaps or other unavailability of the data. In general, RR used
data if they were available in the working spreadsheet. Most differences in period of coverage
concern the starting year of the data. For example, the US series extends back to 1946.
Outside the US, the series for some countries do not begin until the 1950’s and that for Greece
is unavailable before 1970. Nine countries are available from 1946, seventeen from 1951, and
all countries but Greece enter the dataset by 1957. There are some gaps and oddities in
the data. For example, public debt/GDP is unavailable for France for 1973–1978, real GDP
growth is unavailable for Spain for 1959–1980, Austria experienced 27.3 and 18.9 percent real
3See http://www.reinhartandrogoff.com/data/browse-by-topic/topics/9/ and http:
//www.reinhartandrogoff.com/data/browse-by-topic/topics/16/
5
GDP growth in 1948 and 1949 (with both years in lower public-debt groups), and Portugal’s
debt/GDP jumps by 25 percentage points from 1999 to 2000 when the country’s currency
and the denomination of the series changed from the escudo to the euro. We largely accept
the RR data on debt/GDP and real GDP growth as given and do not pursue the implications
of data gaps.
More significant are RR’s data exclusions with three other countries: Australia (1946–
1950), New Zealand (1946–1949), and Canada (1946–1950).4 The exclusions for New Zealand
are of particular significance. This is because all four of the excluded years were in the
highest, 90 percent and above, public debt/GDP category. Real GDP growth rates in those
years were 7.7, 11.9, −9.9, and 10.8 percent. After the exclusion of these years, New Zealand
contributes only one year to the highest public debt/GDP category, 1951, with a real GDP
growth rate of −7.6 percent. The exclusion of the missing years is alone responsible for a
reduction of −0.3 percentage points of estimated real GDP growth in the highest public
debt/GDP category. Further, RR’s unconventional weighting method that we describe below
amplifies the effect of the exclusion of years for New Zealand so that it has a very large effect
on the RR results.
RR reports 96 country-years in the highest public debt/GDP category. Our corrected
analysis finds 110 country-years in the highest, above-90-percent public debt/GDP, category.
The difference is accounted for by the years that RR excluded: 5 years for Australia; 5
years for Canada; and 4 years of New Zealand. With the spreadsheet error discussed below,
RR in fact estimated GDP growth in the highest public debt/GDP category with only 71
4All of these cases would contribute observations to the highest public debt/GDP category. In contrastto these exclusions, all of the data for the US, which contributes all of its four observations in the highestpublic debt/GDP category in these early years, are included. The US series includes the very large GDPdecline associated with post-World War II demobilization discussed in detail in Irons and Bivens (2010). In1946, the US public debt/GDP ratio was 121.3 percent, and the economy contracted by 10.9 percent. In the1946–2009 study period, the U.S. had exactly four years, 1946–1949, with a public debt/GDP ratio above90 percent. Growth in these years was −10.9, −0.9, 4.4, and −0.5. See Irons and Bivens (2010) for moredetailed discussion.
6
country-years of data: 25 years of Belgium were dropped in addition to the 14 already
accounted for by the years that RR excluded.
Spreadsheet coding error
A coding error in the RR working spreadsheet entirely excludes five countries, Australia,
Austria, Belgium, Canada, and Denmark, from the analysis.5 The omitted countries are
selected alphabetically and, hence, likely randomly with respect to economic relationships.
This spreadsheet error, compounded with other errors, is responsible for a −0.3 percentage-
point error in RR’s published average real GDP growth in the highest public debt/GDP
category. It also overstates growth in the lowest public debt/GDP category (0 to 30 percent)
by +0.1 percentage point and understates growth in the second public debt/GDP category
(30 to 60 percent) by −0.2 percentage point.
Unconventional weighting of summary statistics
RR adopts a non-standard weighting methodology for measuring average real GDP growth
within their four public debt/GDP categories. After assigning each country-year to one of
four public debt/GDP groups, RR calculates the average real GDP growth for each country
within the group, that is, a single average value for the country for all the years it appeared
in the category. For example, real GDP growth in the UK averaged 2.4 percent per year
during the 19 years that the UK appeared in the highest public debt/GDP category while
real GDP growth for the US averaged −2.0 percent per year during the 4 years that the
US appeared in the highest category. The country averages within each group were then
averaged, equally weighted by country, to calculate the average real GDP growth rate within
each public debt/GDP grouping.
RR does not indicate or discuss the decision to weight equally by country rather than by
country-year. In fact, possible within-country serially correlated relationships could support
5RR averaged cells in lines 30 to 44 instead of lines 30 to 49.
7
an argument that not every additional country-year contributes proportionally additional
information. Yet equal weighting of country averages entirely ignores the number of years
that a country experienced a high level of public debt relative to GDP. Thus, the existence
of serial correlation could mean that, with Greece and the UK, 19 years carrying a public
debt/GDP load over 90 percent and averaging 2.9 percent and 2.4 percent GDP growth
respectively do not each warrant 19 times the weight as New Zealand’s single year at −7.6
percent GDP growth or five times the weight as the US’s four years with an average of −2.0
percent GDP growth. But equal weighting by country gives a one-year episode as much
weight as nearly two decades in the above 90 percent public debt/GDP range. RR needs to
justify this methodology in detail. It otherwise appears arbitrary and unsupportable.
Table 2 presents average results by country for the above-90-percent public debt/GDP
category for the alternative methods. (Table A-1 presents the full results for all debt/GDP
categories.) The first three columns show the number of years that each country spent in
the highest debt/GDP category. The Correct column reports the most available data for
1946–2009. The RR Exclusion column excludes available early years of data for Australia
(1946–1950), Canada (1946–1950), and New Zealand (1946–1949). The RR Spreadsheet
Error column reflects the spreadsheet error that omits all years for Australia, Austria,
Belgium, Canada, and Denmark from the analysis. The Weights columns show the alternative
weightings to compute average real GDP growth. The Country-Years weights column shows
weights proportional to the number of country-years in the highest public debt/GDP category.
The RR weights column shows the equal weighting by country used in RR. The GDP Growth
columns show average real GDP growth for each country in the years in which it appeared in
the highest debt/GDP category. The Correct GDP Growth column shows the average real
GDP growth for all available country-years. The RR GDP Growth column shows the average
real GDP growth used in RR with excluded years, spreadsheet errors, and a transcription
error.
8
For example, Canada spent 5 years in the highest public debt/GDP category (4.5 percent
of the 110 country-years in this category) and Canada’s average real GDP growth during
these 5 years was 3.0 percent per year. However the RR spreadsheet error and the RR years
exclusion result in Canada not providing any data for the computation of the average for the
highest debt/GDP category.
In the case of New Zealand, instead of constituting 5 of 110 country-years at 2.6 percent
growth, the country contributes -7.9 percent growth for a full 14.3 percent (one-seventh) of
the RR’s GDP growth estimate for the above 90 percent public debt/GDP grouping.6
110 country-years appear in the highest public debt/GDP category with only 10 countries
ever appearing in the category. Three of these, Australia, Belgium, and Canada, were excluded
from the analysis by spreadsheet error, leaving seven countries in the highest category in RR.
The included countries are Greece (19 years in the highest category with average real GDP
growth of 2.9 percent per year); Ireland (7 years with average growth of 2.4 percent); Italy
(10 years with average growth of 1.0 percent); Japan (11 years with average growth of 0.7
percent); New Zealand (1 year with average growth of −7.6 percent), the UK (19 years with
average growth of 2.4 percent), and the US (4 years with average growth of −2.0 percent).
As we noted above, the exclusion of four years for New Zealand (only a 4.5 percent loss of
country-years in the highest public debt/GDP category) has a major effect on the computed
average in the highest public debt/GDP category. It reduces the average growth for New
Zealand in the highest public debt/GDP category from 2.6 to −7.6 percent per year. The
combined effect of excluding the years for New Zealand and equally weighting the countries
(rather than weighting by country-years) reduces the measured average real GDP growth in
the highest public debt category by a very substantial 1.9 percentage points.
6An apparent transcription error in transferring the country average from the country-specific sheets tothe summary sheet reduced New Zealand’s average growth in the highest public debt category from −7.6to −7.9 percent per year. With only seven countries appearing in the highest public debt/GDP group, thistranscription error reduces the estimate of average real GDP growth by another −0.1 percentage point.
9
Summary: years, spreadsheet, weighting, and transcription
Table 3 summarizes the errors in RR and their effect on the estimates of average real
GDP growth in each public debt/GDP category. Some of the errors have strong interactive
effects. Table 3 shows the effect of each possible interaction of the spreadsheet error, selective
year exclusion, and country weighting.
The errors have relatively small effects on measured average real GDP growth in the lower
three public debt/GDP categories. GDP growth in the lowest public debt/GDP category is
roughly 4 percent per year and in the next two categories is around 3 percent per year with
or without correcting the errors.
In the over-90-percent public debt/GDP category, however, the effects of the errors are
substantial. For example, the impact of the excluded years for New Zealand is greatly
amplified when equal country weighting assigns 14.3 percent (1/7) of the weight for the
average to the single year in which New Zealand is included in the above-90-percent public
debt/GDP group. This one year is when GDP growth in New Zealand was −7.6 percent. The
exclusion of years coupled with the country—as opposed to country-year—weighting alone
accounts for almost −2 percentage points of under-measured GDP growth. The spreadsheet
and transcription errors account for an additional −0.4 percentage point. In total, as we
show in Table 3, actual average real growth in the high public debt category is +2.2 percent
per year compared to the −0.1 percent per year published in RR. The actual gap between
the highest and next highest debt/GDP categories is 1.0 percentage point (i.e., 3.2 percent
less 2.2 percent). In other words, with their estimate that average GDP growth in the
above-90-percent public debt/GDP group is −0.1 percent, RR overstates the gap by 2.3
percentage points or a factor of nearly two and a half.
Figure 1 presents all of the country-year data, as continuous real GDP growth rates
plotted against public debt/GDP categories. RR mean growth estimates are indicated by
diamonds with the corrected growth estimates indicated by filled circles. The substantial
10
error in the RR estimates of mean real GDP growth in the 90 percent public debt/GDP
category is evident in the plot as is the relatively inconsequential errors in the lower three
categories. The plot also shows large variation in real GDP growth in each public debt/GDP
category. Finally, the plot includes an empty square as the data point for New Zealand in
1951, which alone accounts for one-seventh of RR’s result for the highest public debt/GDP
category.
3 Non-linearity at the “historical boundary”?
Our revised results also provide an opportunity to re-examine non-linearity in the relationship
between public debt and growth. RR asserts, “The nonlinear response of growth to debt as
debt grows towards historical boundaries is reminiscent of the ‘debt intolerance’ phenomenon
developed in Reinhart, Rogoff, and Savastano (2003)” (RR 2010a p. 577).
The corrected means within each public debt/GDP category cast doubt on the identi-
fication of a nonlinear response that was an important component of RR’s findings. We
explore the question in several ways. First, we add an additional public debt/GDP category,
extending by an additional 30 percentage points of public debt/GDP ratio—that is, we add
90–120 percent and greater-than-120 percent categories. Figure 2 shows the results of the
extension. Far from appearing to be a break, average real GDP growth in the category of
public debt/GDP between 90 and 120 percent is 2.4 percent, reasonably close to the 3.2
percent GDP growth in the 60–90 percent category. GDP growth in the new category between
120 and 150 percent is lower at 1.6 percent but does not fall off a nonlinear cliff. Equally
significant, as Figure 2 shows, variation in real GDP growth within each public debt/GDP
category is large.
In Figure 3, we present a scatterplot of all of the country-years with continuous real
GDP growth plotted against public debt/GDP ratio and include a locally fitted regression
11
function.7 No particular boundary or non-linearity is evident in either dimension around
public debt/GDP of 90 percent. The data thin out gradually between 70 and 120 percent as
is visible from the points in the scatterplot and the widening 95 percent confidence interval
for mean growth. More generally, the wide range of GDP growth at various public debt levels
is evident.
Finally, the scatterplot does suggest a non-linearity in the relationship, but that occurs
in the change in the public debt/GDP ratio from 0 to 30 percent. This contradicts RR’s
claim that “it is evident that there is no obvious link between debt and growth until public
debt reaches a threshold of 90 percent” (RR 2010a p. 575). Figure 4, which is a close-up of
Figure 3 shows more clearly that average growth declines sharply with public debt/GDP
between 0 and 30 percent; at 0 percent debt/GDP, average growth is almost 5 percent and by
30 percent it has declined to slightly more than 3 percent. The relationship between average
GDP growth and public debt/GDP is relatively flat over a wide domain of debt/GDP values.
Between public debt/GDP ratios of 38 percent and 117 percent, we cannot reject a null
hypothesis that average real GDP growth is 3 percent.
In Table 4, we present regression analysis of real GDP growth by public debt/GDP
category. The first row in both columns confirms significantly and substantively higher
growth rates in the lowest 0–30 percent public debt/GDP category relative to other public
debt/GDP categories.8 The results show modest differences among the other categories.
In the first column, average GDP growth in the category of public debt/GDP above 90
percent is lower by about 1 percentage point than GDP growth in the 30–60 percent and
7The locally smoothed regression function is estimated with the general additive model with integratedsmoothness estimation using the mgcv package in R. The smoothing parameter is selected with the defaultcross-validation method. Alternative methods, e.g., loess, and smoothing parameters produced substantivelysimilar results.
8Neither the US nor the UK ever appeared in the 0 to 30 percent debt/GDP range between 1946 and 2009.121 of the 426 country years in the lowest debt/GDP category consist of Germany (48), Japan (22), andNorway (51). These are special cases (two historically specific “growth miracles” and a petroleum producer),and the lessons for public debt management and growth for Europe and the U.S. today are limited.
12
60–90 percent public debt/GDP categories. In the second column, average GDP growth
in the category of public debt/GDP above 120 percent is substantially lower than GDP
growth in the 30–60 percent and 60–90 percent debt/GDP categories. However, in the second
column, which includes the new above-120-percent public debt/GDP category, differences
in average GDP growth in the categories 30–60 percent, 60–90 percent, and 90–120 percent
cannot be statistically distinguished. An F -test on the hypothesis that, relative to the 30–60
category, the 60–90 difference and the 90–120 differences are both zero cannot be rejected
(p-value = 0.11). To summarize, the regression results show that there is a non-linearity in
the relationship between GDP growth and public debt between public debt levels of 0 to
30 percent of GDP. The results also indicate that average GDP growth tails off somewhat
when the public debt/GDP ratio increases towards 120 percent, but there is no sharp turning
point.
Thus, the non-linearity in the relationship between public debt levels and GDP growth is
not around a public debt/GDP ratio of 90 percent where RR have identified it. That is, the
non-linearity is not in the domain of public debt/GDP values that is currently the focus of
policy debate in the US and Europe.
Different results by period
We further explore the historical specificity of the result by examining average real GDP
growth by public debt category for subsampled periods of the data. Table 5 presents results
for 1950–2009, 1960–2009, 1970–2009, 1980–2009, 1990–2009, and 2000–2009. We see that
the high GDP growth in the lowest public debt/GDP category erodes substantially in the
shorter more recent periods. Thus, in the lowest, 0–30-percent public debt/GDP, GDP
growth of 4.1 percent per year in the 1950–2009 sample declines to only 2.5 percent per
year in the 1980–2009 sample. Growth in the middle two public debt/GDP categories also
decelerates noticeably, with the average dropping by more than a percentage point in the
13
samples limited to later years. In contrast, average growth in the highest debt/GDP category
is quite stable across all samples of years, remaining within 0.3 percentage points of 2 percent
per year throughout. In recent years, real GDP growth in the highest, above-90-percent
public debt/GDP category has outperformed that in the next highest category.
These patterns suggest two important conclusions: (1) even the apparent non-linearity
between the lowest-debt country-years and higher-debt country-years is an historically specific
pattern, not a robust result across the full time period; and (2) the relationship between
public debt and GDP growth is weaker in more recent years relative to the earlier years of
the sample.
4 Conclusion
The influence of RR’s findings comes from its straightforward, intuitive use of data to construct
a stylized fact characterizing the relationship between public debt and GDP growth for a
range of national economies. However, this laudable effort at clarity notwithstanding, RR
has made significant errors in reaching the conclusion that countries facing public debt to
GDP ratios above 90 percent will experience a major decline in GDP growth.9 The key
identified errors in RR, including spreadsheet errors, omission of available data, weighting,
and transcription, reduced the measured average GDP growth of countries in the high public
debt category. The full extent of those errors transforms the reality of modestly diminished
average GDP growth rates for countries carrying high levels of public debt into a false image
that high public debt ratios inevitably entail sharp declines in GDP growth. Moreover, as we
show, there is a wide range of GDP growth performances at every level of public debt among
the 20 advanced economies that RR survey.
9For econometricians a lesson from the problems in RR is the advantages of reproducible code relative toworking spreadsheets. We are grateful to Reinhart and Rogoff for sharing the working spreadsheet, and wewill make our simplified version of the spreadsheet and R code that reproduces RR and corrected resultsavailable on our website.
14
RR’s incorrect stylized fact has contributed substantially to ensuring that “traditional
debt management issues should be at the forefront of public policy concerns” (RR 2010a
p. 578). Specifically, RR’s findings have served as an intellectual bulwark in support of
austerity politics. The fact that RR’s findings are wrong should therefore lead us to reassess
the austerity agenda itself in both Europe and the United States.
References
Irons, J. and Bivens, J. (2010). Government Debt and Economic Growth: OverreachingClaims of Debt “Threshold” Suffer from Theoretical and Empirical Flaws. Briefing Paper271, Economic Policy Institute, http://www.epi.org/page/-/pdf/BP271.pdf.
Reinhart, C. and Rogoff, K. (2011). A Decade of Debt. CEPR Discussion Papers 8310,C.E.P.R. Discussion Papers.
Reinhart, C. M. and Rogoff, K. S. (2010a). Growth in a Time of Debt. American EconomicReview: Papers & Proceedings, 100.
Reinhart, C. M. and Rogoff, K. S. (2010b). Growth in a Time of Debt. Working Paper 15639,National Bureau of Economic Research, http://www.nber.org/papers/w15639.
Reinhart, C. M., Rogoff, K. S., and Savastano, M. A. (2003). Debt Intolerance. BrookingsPapers on Economic Activity, 34(1):1–74.
Ryan, P. (2013). The Path to Prosperity: A Blueprint for American Renewal. FiscalYear 2013 Budget Resolution, House Budget Committee, http://budget.house.gov/
uploadedfiles/pathtoprosperity2013.pdf.
15
Figure 1: Real GDP growth by public debt/GDP categories, country-years, 1946–2009
4.1
2.93.4
−0.1
●● ●
●
4.23.1 3.2
2.2
−7.6NZ 1951
−10
0
10
20
0−30% 30−60% 60−90% Above 90%Public Debt/GDP Category
Rea
l GD
P G
row
th
0 1 2 3 4 5
010
2030
4050
6070
3
10
New Zealand 1951
● Correct average real GDP growth
RR average real GDP growth
Country−Year real GDP growth
Notes. The unit of observation in the scatter diagram is country-year with real GDP growth plottedagainst four debt/GDP categories. Our replication of RR published values for average real GDPgrowth within category are printed to the right. Corrected values for average real GDP growthwithin category are printed to the left.Source: Authors’ calculations from working spreadsheet provided by RR.
16
Figure 2: Real GDP Growth by Expanded Debt/GDP Categories, Country-Years, 1946–2009
●● ●
●●
4.23.1 3.2
2.41.6
−10
0
10
20
0−30% 30−60% 60−90% 90−120% Above 120%Public Debt/GDP Category
Rea
l GD
P G
row
th
Notes. As in Figure 1, the unit of observation in the scatter diagram is country-year with real GDPgrowth plotted, in this case, against five debt/GDP categories. Average real GDP growth withincategory are printed and indicated with a filled circle.Source: Authors’ calculations from working spreadsheet provided by RR.
17
Figure 3: Real GDP growth vs. public debt/GDP, country-years, 1946–2009
●
●
●●●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●●●
●
●
●
●●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●●
●●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
● ●●
●
●●
●
●
●
●●●●
●●●
●
●
●
●●
●●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
● ●
●
●● ●
● ● ●●
●
●●
●●
●
●
●
●
●
●
●●
●
●●
●●
●●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●●●
●
●●
●
●●
●
●
●
●
●
● ●
●●
●
●
●●
●
●
●
●
●
●●
●
●
●
●●
●●
●
●●
●
●
●●
●
●
●
●
●●
●
●
●●
●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●● ●
●
●
●
●●
●
●●
●
●●
●
●
●
●●●
●●
●
●●●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●●
●●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●●●●
●
●●
●
●
●
●
●● ●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●●
●
●
●
●
●
●●
●●
●
●●
●
●
●●
●
●
●●
●
●
●
●
●
●●
●
●
●
●●
●●
●
●●
●
●
●●
●
●
●
●●●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●
●
●
●●●
●
●●
●
●
●
●
●
●
●
●● ●
●
●
●●
●●
●●
●
●
●
●
●
●
●
●●
●
●
●
●
●● ●
●●
●
●
●●
●
●
●
●
●●●
●●●
●●
●
●
●
●
●●
●
●
●
●●
●
●●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●●●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●●
●
●
●●●
●●
●
●●
●
●
●●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
● ● ●
●● ●
●
●
●
●●
●
●
●
●
●
●●●
●
●
●●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●●
●
●
●●
●●
●
●
●
●
●
●●
●
●●
●
●
●
●
●
●
●
● ●
●
●
●●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●●●
●
●
●
●
●●●
●
●
●
●
●
●
●
●●●
●●
●
●
●
●●
●●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
● ●
●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●●
●
●
●
●
●
●
●
●
●
●●
●●
●
●
●
●
●
●
●●
●
●
●●
●
●
●
●
●
●●
●●
●●
●
●
●●
●
●
●
●●
●
●
●
●
●
●●
●
●
●
●●
●●
●
●●
●
●
●●
●
●
●
●
●
●
●●●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●●
●
●
●
●●
●●
●
●●●
●
●●
●
●
●
●
●
●●
●
●●
●
●
●
●
●
●
●
●● ●
●
●
●●
●
●
●
●
●
●
●
●
●●
●●
●
●●●
●●
●
●
●
●
●
●●
●
●
●
●
●
●
●●●
●
●●
●
●
●
●
●
●
●
●●
●
●●
●●
●
●
●
●
●
●
●●
●
●
●●
●●
●
● ●
●
●●
●
●
●
●●
●
●●
●
●
●
●
●
●
●
●
●●●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●●●
●
●
●
●
●●
●●
●
●
●
●
●
●●●
●
●
●
●
●
●
●
●●●
●●●
●●
●●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●●●
●
●
●
●
●
●●
●●
●
●
●
●
●
●
●
●
●
●
●●
●●
●
●
●●
●
●
●
●●●
●
●
●
●
●●●●
●
●
−10
0
10
20
0 30 60 90 120 150 180 210 240Public Debt/GDP Ratio
Rea
l GD
P G
row
th
Notes. Real GDP growth is plotted against debt/GDP for all country-years. The locally smoothedregression function is estimated with the general additive model with integrated smoothnessestimation using the mgcv package in R. The smoothing parameter is selected with the default cross-validation method. The shaded region indicating the 95 percent confidence interval for mean realGDP growth. Alternative methods, e.g., loess, and smoothing parameters produced substantivelysimilar results.Source: Authors’ calculations from working spreadsheet provided by RR.
18
Figure 4: Real GDP growth vs. public debt/GDP, country-years, 1946–2009 (close-up)
●●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●●
●
●
●●
●
● ●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●●
●
●
●
●
●
●
●
●
●●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
● ●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
● ●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
● ●●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
● ●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
● ●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
● ●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
● ●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●●
●
●
●
● ●
●
●●
●
●
●
●
●
●
●
●
●●
●
●
●●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●
●●
●
●
●
●
●
●
●
●
●
●
0
1
2
3
4
5
6
7
0 30 60 90 120 150Public Debt/GDP Ratio
Rea
l GD
P G
row
th
Notes. Figure 4 is a close-up on a region of Figure 3. Real GDP growth is plotted against debt/GDPfor all country-years. The locally smoothed regression function is estimated with the general additivemodel with integrated smoothness estimation using the mgcv package in R. The smoothing parameteris selected with the default cross-validation method. The shaded region indicating the 95 percentconfidence interval for mean real GDP growth. Alternative methods, e.g., loess, and smoothingparameters produced substantively similar results. As in Figure 3 , all available data were used inproducing Figure 4.Source: Authors’ calculations from working spreadsheet provided by RR.
19
Table 2: Years and real GDP growth with public debt/GDP above 90 percent, by country
Count of years with public debt/GDPabove 90 percent
RR Exclusion RR Spreadsheetof early years error excludingfor Australia, Australia, Austria Weights GDP GrowthCanada, and Belgium, Canada Country-
Correct New Zealand and, Denmark Years RR Correct RRAustralia 1946–50 5 0 0 4.5 0.0 3.8Belgium 1947,
1984–2005,2008–09 25 25 0 22.7 0.0 2.6
Canada 1946–50 5 0 0 4.5 0.0 3.0Greece 1991–2009 19 19 19 17.3 14.3 2.9 2.9Ireland 1983–89 7 7 7 6.4 14.3 2.4 2.4Italy 1993–01,2009 10 10 10 9.1 14.3 1.0 1.0Japan 1999–2009 11 11 11 10.0 14.3 0.7 0.7New Zealand
1946–49,1951 5 1 5 4.5 14.3 2.6 −7.9UK 1946–64 19 19 19 17.3 14.3 2.4 2.4US 1946–49 4 4 4 3.6 14.3 −2.0 −2.0
Average GDP GrowthCountry-year
Count of country-years and countries weights andwith public debt/GDP above 90 percent correct GDP
Country-Years 110 96 75 growth data 2.2
RR equal weights andCountries 10 8 7 RR GDP growth data −0.1
Notes. Years that each country spent in the highest debt/GDP category are listed. The Yearscolumns show the count of years that each country spent in the highest debt/GDP category. TheCorrect column uses all available data for 1946–2009. The Exclusion column excludes available earlyyears of data for Australia (1946–1950), Canada (1946–1950), and New Zealand (1946–1949). TheSpreadsheet column reflects the spreadsheet error that omits Australia, Austria, Belgium, Canada,and Denmark. The Weights columns show the alternative weightings to compute average real GDPgrowth. The Year column shows weights proportional to country-years. The RR weight columnshows equal weighting of country averages. GDP shows real average GDP growth for each country inthe years in which it appeared in the highest debt/GDP category for all available years. The valueof -7.9 for New Zealand in parentheses reflects both the exclusion of 1946–1949 and a transcriptionerror of −7.6 to −7.9.Source: Authors’ calculations from working spreadsheet provided by RR.
20
Table 3: Published and replicated average real GDP growth, by public debt/GDP category
Public debt/GDP categoryMethod/Source Below 30 30 to 60 60 to 90 90 percent
percent percent percent and above
Corrected resultsCountry-year weighting, all data 4.2 3.1 3.2 2.2
Replication elementsSeparate effects of RR calculationsSpreadsheet error only 4.2 3.0 3.2 1.9Selective years exclusion only 4.2 3.1 3.2 1.9Country weights only 4.0 3.0 3.0 1.9
Interactive effects of RR calculationsSpreadsheet error +Selective years exclusion 4.2 3.0 3.2 1.7Spreadsheet error +Country weights 4.1 2.9 3.4 1.4Selective years exclusion +Country weights 4.0 3.0 3.0 0.3Spreadsheet error +Selective years exclusion +Country weights 4.1 2.9 3.4 0.0Spreadsheet error +Selective years exclusion +Country weights +Transcription error 4.1 2.9 3.4 −0.1
RR Published ResultsRR 2010a Figure 2 (approximated) 4.1 2.9 3.4 −0.1RR 2010b Appendix Table 1 4.1 2.8 2.8 −0.1
Notes. Average real GDP growth by public debt/GDP category calculated using alternative methods.Spreadsheet error refers to the spreadsheet error that excluded Australia, Austria, Belgium, Canada,and Denmark from the analysis. Country weights refers to the RR averaging country averages ratherthan averaging country-years. Selective years exclusion refers to the exclusion of available data for1946–50 for Australia, Canada, and New Zealand. Transcription error refers to a transcription errorin the case of New Zealand’s average real GDP growth. All permutations of Spreadsheet, Exclusion,and Weights are shown.Sources: Authors’ calculations from working spreadsheet provided by RR, RR 2010a, and RR 2010b.Values from bar chart in RR 2010a Figure 2 are approximate.
21
Table 4: Regression of GDP growth on public debt/GDP categories
Debt/GDP Category Difference in average real GDP growthRelative to 0–30 percent public debt/GDPHighest category Highest two categories are
is above 90 percent 90–120 percent andand above 120 percent
30–60 percent −1.08 −1.08(0.20) (0.20)
60–90 percent −0.99 −0.99(0.25) (0.25)
Above 90 percent −2.01(0.31)
90–120 percent −1.77(0.36)
Above 120 percent −2.61(0.54)
R-squared 0.04 0.04
Notes. Table entries are average GDP growth differences for each category with standard errorin parentheses. Each column represents a regression of real GDP growth by country-year on aset of indicator variables for debt/GDP category by country-year. The first column shows thegrowth difference associated with the higher debt/GDP categories relative to the 0–30 percentdebt/GDP category. The second column shows the growth difference associated with the expanded,five debt/GDP categories relative to the 0–30 percent debt/GDP category. An F -test on the jointhypothesis that the coefficient on 60–90 percent and the coefficient on 90–120 percent are both thesame as the coefficient on 30–60 percent in column 2 fails to reject (p-val = 0.11).Source: Authors’ calculations from working spreadsheet provided by RR.
22
Table 5: Real GDP growth by public debt/GDP category, alternative periods
Public debt/GDP categoryPeriod Below 30 30 to 60 60 to 90 90 percent
percent percent percent and above1950–2009 4.1 3.0 3.1 2.11960–2009 3.9 2.9 2.8 2.11970–2009 3.1 2.7 2.6 2.01980–2009 2.5 2.5 2.4 2.01990–2009 2.7 2.4 2.5 1.82000–2009 2.7 1.9 1.3 1.7
Notes. Table entries by debt/GDP category indicate the average real GDP growth rate for country-years in that category computed for alternative periodizations.Source: Authors’ calculations from working spreadsheet provided by RR.
23
Table A-1: Average real GDP growth and years by country and debt/GDP category
Public debt/GDP categoryCountry Below 30 30 to 60 60 to 90 90 percent
percent percent percent and aboveAustralia Years 37 13 9 5
GDP growth 3.2 4.9 4.0 3.8Austria Years 34 27 1 0
GDP growth 5.2 3.4 −3.8Belgium Years 0 17 21 25
GDP growth 4.2 3.1 2.6Canada Years 3 42 14 5
GDP growth 2.5 3.5 4.5 3.0Denmark Years 23 16 17 0
GDP growth 3.5 1.7 2.4Finland Years 44 16 4 0
GDP growth 3.8 2.4 5.5France Years 24 20 10 0
GDP growth 5.1 2.6 3.0Germany Years 48 11 0 0
GDP growth 3.9 0.9Greece Years 13 5 3 19
GDP growth 4.0 0.3 2.7 3.1Ireland Years 10 14 32 7
GDP growth 4.2 4.5 4.0 2.4Italy Years 26 6 17 10
GDP growth 5.4 2.1 1.8 1.0Japan Years 22 17 4 11
GDP growth 7.3 4.0 1.0 0.7Netherlands Years 17 34 2 0
GDP growth 4.1 2.6 1.1New Zealand Years 9 33 17 5
GDP growth 2.5 2.9 3.9 2.6Norway Years 51 12 1 0
GDP growth 3.4 5.1 10.2Portugal Years 42 9 7 0
GDP growth 4.5 3.5 1.9Spain Years 5 36 1 0
GDP growth 1.5 3.4 4.2Sweden Years 18 35 11 0
GDP growth 3.6 2.9 2.7Continued
24
Table A-1: continued
Public debt/GDP categoryCountry Below 30 30 to 60 60 to 90 90 percent
percent percent percent and aboveUK Years 0 39 6 19
GDP growth 2.2 2.5 2.4US Years 0 37 23 4
GDP growth 3.4 3.3 −2.0
Country-years 426 439 200 110Countries 17 20 19 10
Source: Authors’ calculations from working spreadsheet provided by RR.
25
RESEARCH BRIEF Apri l 2013
Technical Appendix to The New York Times
Critique of Reinhart and Rogoff
Michael Ash and Robert Pollin
Political Economy Research Institute
University of Massachusetts, Amherst
April 29, 2013
Technical Appendix to The New York Times / page 1
April 29, 2012
Technical Appendix to The New York Times Critique of Reinhart and Rogoff
Michael Ash and Robert Pollin
This appendix provides the data and calculations underlying the material we present in our New
York Times opinion article, “Debate and Growth: A Response to Reinhart and Rogoff” which
was posted online at this link on April 29, 2013.
CALCULATION OF MEDIAN GDP GROWTH FIGURES FOR 1946 - 2009
1. Coding errors
In our original working paper with Thomas Herndon, “Does High Public Debt Consistently Stifle
Economic Growth,” (HAP hereafter) we discuss in detail the coding error Reinhart and Rogoff
(RR hereafter) made in their 2010 paper in the American Economic Review, “Growth in a Time of
Debt.” This coding error occurred in their calculations of mean values over their 1946 – 2009 da-
taset. In fact, RR made a similar spreadsheet coding error in calculating median GDP growth by
public debt/GDP category. Specifically, they calculated the median for cells in lines 30 to 44 in-
stead of lines 30 to 49. This coding error entirely excludes five countries—Australia, Austria, Bel-
gium, Canada, and Denmark—from their data analysis. By itself, this coding error alone reduces
median GDP growth by -0.3 percentage point in RR’s highest (90 percent and above) public
debt/GDP category. These same errors also lead to an overstatement in growth for lowest public
debt/GDP category (0 to 30 percent) by +0.3 percentage point. Overall, this coding error, by it-
self, exaggerates the negative association between high public debt and GDP growth by 0.6 per-
centage point in the analysis of medians.
As we discuss below, the impact of this one coding error becomes magnified in combination with
RR’s methodological flaws which we discuss in HAP and consider further below—that is, 1) se-
lective exclusion of available data; and 2) a flawed weighting methodology. In Table 1 (page 2),
we show the impact of this coding error on GDP growth estimates within each of the four public
debt/GDP categories. Table 1 also shows the effects on growth estimates due to the selective ex-
clusion of data and their flawed weighting methodology.
TABLE 1 . CALCULATION OF MEDIA N GDP GROW TH FIGURES W ITH REINHART/ROGOFF 1946 – 2009 DATAS ET
Public Debt/GDP Categories
under 30% 30 – 60% 60 – 90% above 90%
RR median figures in 2010 paper and NY Times 4/26/12 4.2% 3.0% 2.9% 1.6%
RR calculation method but with corrected spreadsheet 3.9% 3.1% 2.9% 1.9%
Recalculation with both corrected spreadsheet
calculations and inclusion of Australia, Canada and New
Zealand early years
3.9% 3.1% 2.9% 2.5%
Recalculation with full data and our preferred method
for calculating medians
4.1% 3.1% 2.9% 2.3%
Source: Underlying data all come from RR 2010 and 2010b.
Technical Appendix to The New York Times / page 2
April 29, 2012
2. Selective exclusion of data
RR excluded available data for Australia (1946–1950), New Zealand (1946–1949), and Canada
(1946–1950). In the Canadian case, all five omitted years were in the over 90 percent public
debt/GDP category. Those years were also the only ones in which Canada is in the highest public
debt/GDP category. Median GDP growth in Canada for the excluded years was 2.2 percent. For
Australia as well, all five excluded years were in the highest public debt/GDP category and were
the only years in which Australia was in this highest category.
The New Zealand exclusions are of particular significance. This is because all four of the excluded
years were in the over 90 percent public debt/GDP category. Real GDP growth rates in those
years were 7.7, 11.9, -9.9, and 10.8 percent respectively. After RR excluded these years, New Zea-
land contributes only one year to the highest public debt/GDP category, 1951. Real GDP growth
for New Zealand in 1951 was reported as -7.6 percent. Because it is the only value for New Zea-
land that RR included in the over 90 percent public debt/GDP category, this same one year’s ob-
servation at -7.6 percent is also the median value for New Zealand for the over 90 percent public
debt/GDP category. If we include in the data sample the years that RR excluded, New Zealand’s
median GDP growth in the highest public debt/GDP category becomes +7.7 percent, as opposed
to -7.6 percent. This raises serious concerns about aggregation methods that are highly sensitive
to individual country’s central tendencies.
As far as we know, the closest Reinhart and Rogoff have come to explicitly explaining their deci-
sion to exclude the early years of data for Australia, Canada and New Zealand is the following
remark in their January 2010 NBER Working Paper (full citation in HAP):
“Of course, there is considerable variation across the countries, with some coun-
tries such as Australia and New Zealand experiencing no growth deterioration at
very high debt levels. It is noteworthy, however, that those high-growth high-
debt observations are clustered in the years following World War II” (p. 11).
In other words, RR appear to justify these selective exclusions because they “are clustered in the
years following World War II” when economic growth was high. However, in contrast with this
apparent reasoning applied to the cases of Australia, Canada and New Zealand, RR chose to in-
clude all of the immediate post World War II observations in which the United States was in the
over 90 percent public debt/GDP category. In three of these years, the United States economy
was contracting at the same time as it was in the highest public debt/GDP category. RR still
have not provided a full explanation of their reasoning behind their decision to exclude Australia,
Canada and New Zealand in these years, while these economies were growing rapidly, while in-
cluding the United States while it was contracting in three of the four relevant years.
3. RR’s flawed data weighting methodology
We discuss in detail in HAP why we find RR’s weighting methodology to be flawed. Here we fo-
cus on the impact of applying this flawed methodology to the calculation of median GDP growth
Technical Appendix to The New York Times / page 3
April 29, 2012
figures for their 1946 – 2009 dataset. As we will see, RR’s flawed weighting method amplifies the
effect of the exclusion of years for New Zealand so that this exclusion has a very large effect on
RR’s median results.
Although RR do not document this in either of their 2010 research papers, in fact, the RR calcu-
lation of median GDP growth is a median of each country’s median GDP growth within each of
their four public debt/GDP categories. More specifically, after assigning each country-year to one
of the four public debt/GDP groups, RR calculates the median real GDP growth for each country
within each of the four public debt/GDP categories. This has the effect of creating a single medi-
an value for the country for the years it appeared in each of the public debt/GDP categories. RR
then takes the median of these country medians. This has the effect of massively amplifying the
impact of early years for New Zealand, Australia, and Canada. Including the early years for these
countries, median GDP growth in the over 90 percent public debt/GDP category is 2.5 percent.
When RR exclude those years, as we have seen, median GDP growth in the over 90 percent pub-
lic debt/GDP category is 1.9 percent. RR needs to justify their weighting methodology in detail.
It otherwise appears arbitrary and unsupportable.
Our preferred approach for the median analysis is to take the median GDP growth of all the coun-
try-years appearing in each of the four public debt/GDP categories. With this approach, excluding
the early years for Australia, Canada, and New Zealand finds median GDP growth in the highest
public debt/GDP category to be 2.2 percent. When we then include the early years for Australia,
Canada, and New Zealand, the resulting median GDP growth in the highest public debt/GDP cat-
egory becomes 2.3 percent. That is, the median under our preferred method is robust to small per-
turbations in the data. This is not true with RR’s median of medians methodology.
In conclusion, with RR’s median of medians approach, minor adjustments of the sample, result-
ing, for example, from a spreadsheet error, generate a wide range of GDP growth estimates for
the over 90 percent public debt/GDP category. As we summarize in Table 1, RR report 1.6 per-
cent median GDP growth; fixing the spreadsheet error adjusts the estimate to 1.9 percent, and
including available data for the early postwar increases the estimate to 2.5 percent. A more ro-
bust approach finds median growth in the over 90 percent public debt/GDP category to be be-
tween 2.2 and 2.3 percent. These results are robust regardless of whether we include the early
years for Australia, Canada and New Zealand. It is also notable that these median figures are
nearly identical to the average GDP growth figures for the over 90 percent public debt/GDP
category that we reported in HAP.
RR ANALYSIS OF 1790 – 2009 DATA
1. Coding errors
As with their calculations of both averages and medians with 1946 – 2009 data, RR 2010 made a
spreadsheet coding error in calculating mean GDP growth by public debt/GDP category for 20
advanced economies over the 220 year period 1790-2009. By calculating the mean for cells in lines
Technical Appendix to The New York Times / page 4
April 29, 2012
5 to 19 instead of lines 5 to 24, the coding error entirely excludes five countries—Australia,
Austria, Belgium, Canada, and Denmark—from the analysis. This spreadsheet error alone reduc-
es estimated mean GDP growth by 0.3 percentage point in the highest public debt/GDP catego-
ry. The spreadsheet error also overstates growth in the next highest public debt/GDP category
by 0.2 percentage point, erroneously expanding the reported gap between these categories by 0.5
percentage point.
2. Weighting methodology
RR’s flawed weighting method follows the following steps: 1) it sorts every country-year into
public debt/GDP categories, calculates the average for each country within each category, and
then averages the country averages within each category. This approach creates the possibility
that a single country-year can have a disproportionate effect on the results. For example, Nor-
way spent only one year (1946) in the 60-90 percent public debt/GDP category over the total 130
years (1880-2009) that Norway appears in the data. Norway’s economic growth in this one year
was 10.2 percent. This one extraordinary growth experience contributes fully 5.3 percent (1/19) of
the weight for the mean GDP growth in this category even though it constitutes only 0.2 percent
(1/445) of the country-years in this category. Indeed Norway’s one year in the 60-90 percent
GDP category receives equal weight to, for example, Canada’s 23 years in the category, Austria’s
35, Italy’s 39, and Spain’s 47.
Using their weighting method, RR find that GDP growth declines from 3.4 percent in the 60-90
percent public debt/GDP category to 1.7 percent in the over 90 percent category, a steep drop-off
of 1.7 percentage points. In contrast, country-year weighting of the means finds GDP growth of
2.5 percent in the 60-90 percent public debt/GDP category and 2.1 percent in the over 90 percent
public debt/GDP category. This is a modest difference of 0.4 percentage point. We summarize
these various GDP growth rate figures over the 1790 – 2009 dataset in Table 2.
TABLE 2 . CALCULATION OF AVERA GE GDP GROW TH FIGURE S WITH
REINHART/ROGOFF 1790 – 2009 DATAS ET
Public Debt/GDP Categories
under 30% 30 – 60% 60 – 90% above 90%
RR mean figures in 2010 paper and NY Times 4/26/12 3.7 3.0 3.4 1.7
Estimate with corrections for coding errors, selected
exclusions, and RR average method
3.7 3.2 2.5 2.1
Source: Underlying data all come from RR 2010,and 2010b.
The pattern with the corrected mean figures within each public debt/GDP category casts doubt
on the identification of a nonlinear response which was an important component of RR’s find-
ings. We explore this issue further by adding an additional public debt/GDP category. Specifical-
ly, we add 90–120 percent and greater-than-120 percent public debt/GDP categories. Average
GDP growth is computed as the mean over country-years in each category. We see the results
in Table 3. As we see there, far from appearing to be a break, average real GDP growth in the
Technical Appendix to The New York Times / page 5
April 29, 2012
category of public debt/GDP between 90 and 120 percent is 2.5 percent—identical to average
GDP growth in the 60–90 percent category. Even with the new highest grouping of over 120 per-
cent public debt/GDP, average GDP growth is lower at 1.6 percent but does not fall in a sharp
non-linear pattern. Thus, with RR’s roughly 220-year dataset, there appears to be no decline in
GDP growth at the 90 percent public debt/GDP ratio, despite the fact that RR had identified
this 90 percent threshold as an historic boundary.
TABLE 3 . RECALCULATION OF AVERAGE GDP GROW TH FIGURES W ITH REINHART /
ROGOFF 1790 – 2009 DATASET AND ADDITION AL PUBLIC DEBT /GDP C ATEGORY
Public Debt/GDP Categories
under 30% 30 – 60% 60 – 90% 90 – 120% above 120%
Estimate with corrections for coding errors,
selected exclusions, and RR average method
3.7% 3.2% 2.5% 2.5% 1.6%
Source: Underlying data all come from RR 2010 and 2010b.
In Figure 1, we present all of the country-year data for RR’s 220-year dataset. The figure also
shows the similarity of the means across public debt/GDP category and the large variation in real
GDP growth within each public debt/GDP category.
FIGURE 1 . REAL GDP GROW TH BY E XPANDED PUBLIC DEBT /GDP C ATEGORIES , COUNTRY -YEARS , 1790–2009
Notes. The unit of observation in the scatter diagram is country-year with real GDP growth plotted against five debt/GDP
categories. Average real GDP growth for all country-years within category are printed to the left. Source: Authors’ calculations from working spreadsheet provided by RR.
Technical Appendix to The New York Times / page 6
April 29, 2012
THE RELATIONSHIP BETWEEN HIGH PUBLIC DEBT AND ECONOMIC
GROWTH IN RECENT YEARS
In HAP, we explored the historical specificity of the association between public debt and GDP
growth by examining average real GDP growth by public debt category for subsampled periods
of the data. Here we focus on the relationship during the final decade of the analysis, 2000-2009,
a period that includes the Great Recession.
Only four countries appear in the highest public debt/GDP category in this period. They collec-
tively contribute 31 country-years: Belgium (8 years), Greece (10 years), Italy (3 years), and Ja-
pan (10 years). Mean GDP growth by public debt/GDP category is shown in Table 4. As we can
see, over this 2000 – 2009 period, real GDP growth in the over 90 percent public debt/GDP cate-
gory has actually outperformed GDP growth in the 60 – 90 percent public debt/GDP category.
TABLE 4 . CALCULATION OF AVERA GE GDP GROW TH FIGURE S WITH 2000 – 2009 DATA ONLY (S TANDARD ERRORS IN P ARENTHES ES )
Public Debt/GDP Categories
Under
30%
30 – 60% 60 – 90% above 90%
Estimate with corrections for coding errors,
selected exclusions, and RR average meth-
od
2.7%
(0.3)
1.9%
(0.3)
1.3%
(0.4)
1.7%
(0.5)
Source: Underlying data all come from RR 2010 and 2010b.
As we mention above, the number of observations is relatively small. Standard errors are conse-
quently high. We can see the detailed pattern more fully in Figure 2 (page 7), which presents all
of the country-year data for all countries in the 2000-2009 data. As we see, there is certainly no
sharp drop off in economic growth once the 90 percent threshold is dropped. Rather, the relation-
ship between public debt and GDP growth is even weaker in more recent years than in the earlier
years of the sample.
Technical Appendix to The New York Times / page 7
April 29, 2012
FIGURE 2 : REAL GDP GROW TH BY P UBLIC DEBT /GDP C ATEGORIES ,
COUNTRY -YEARS , 2000-2009 (IN PERC ENTAGES )
Notes. The unit of observation in the scatter diagram is country-year with real GDP growth plotted against four public debt/GDP
categories.
Source: Authors’ calculations from working spreadsheet provided by RR.
PO
LIT
ICA
L E
CO
NO
MY
R
ESEA
RC
H IN
ST
ITU
TE
How Big Is Too Big?
On the Social Efficiency of the Financial
Sector in the United States
Gerald Epstein & James Crotty
February 2013
This paper was presented as part of
a September 2011 Festschrift Conference in
honor of Thomas Weisskopf.
WORKINGPAPER SERIES
Number 313
Gordon Hall
418 North Pleasant Street
Amherst, MA 01002
Phone: 413.545.6355
Fax: 413.577.0261
www.peri.umass.edu
PREFACE
This working paper is one of a collection of papers, most of which were prepared for and presented at a fest-schrift conference to honor the life’s work of Professor Thomas Weisskopf of the University of Michigan, Ann Arbor. The conference took place on September 30 - October 1, 2011 at the Political Economy Re-search Institute, University of Massachusetts, Amherst. The full collection of papers will be published by El-gar Edward Publishing in February 2013 as a festschrift volume titled, Capitalism on Trial: Explorations in the Tradition of Thomas E. Weisskopf. The volume’s editors are Jeannette Wicks-Lim and Robert Pollin of PERI.
Since the early 1970s, Tom Weisskopf has been challenging the foundations of mainstream economics and, still more fundamentally, the nature and logic of capitalism. That is, Weisskopf began putting capitalism on trial over 40 years ago. He rapidly established himself as a major contributor within the newly emerging field of radical economics and has remained a giant in the field ever since. The hallmarks of his work are his powerful commitments to both egalitarianism as a moral imperative and rigorous research standards as a means.
We chose the themes and contributors for this working paper series, and the upcoming festschrift, to reflect the main areas of work on which Tom Weisskopf has focused, with the aim of extending research in these areas in productive new directions. The series is divided into eight sections, including closing reflections by our honoree himself, Professor Weisskopf. Each section except for the last includes comments by discussants as well as the papers themselves.
The eight sections are as follows:
1. Reflections on Thomas Weisskopf’s Contributions to Political Economy 2. Issues in Developing Economies 3. Power Dynamics in Capitalism 4. Trends in U.S. Labor Markets 5. Discrimination and the Role of Affirmative Action Policies 6. Macroeconomic Issues in the United States 7. Applications of Marxist Economic Theory 8. Reflections by Thomas Weisskopf
This working paper is 1 of 3 included in Section 6.
- Jeannette Wicks-Lim and Robert Pollin
How Big Is Too Big? ON THE SOCIAL EFFICIENCY OF THE FINANCIAL SECTOR IN THE UNITED STATES 1
Gerald Epstein and James Crotty
INTRODUCTION
By almost any measure, the size of the financial sector in the United States, and in many parts of the world, exploded over the past several decades, prior to the financial crash of 2008.2
Despite this general and, one might add, increasingly widespread view of the bloated state of the financial sector, until now, there has been relatively little research which has tried to analytically frame and carefully estimate the extent of “unproductive” finance and to estimate the dimensions of financial bloat and its im-pacts. More recently, though, some economists have been trying to study the topic.
In the aftermath of the crisis, many analysts, some in surprisingly high positions of authority in the world of financial governance, have ar-gued that the financial sector has grown too big, that many of its activities have little, or even negative social value, and that the productivity and efficiency of the world economy could be improved if the financial sector were to shrink. Lord Adair Turner, Chairman of the United Kingdom’s Financial Services Authority re-marked in an interview with Prospect Magazine and then in a speech in September, 2009, “…not all financial innovation is valuable, not all trading plays a useful role, and that a bigger financial system is not necessarily a better one.” (Turner, Mansion House Speech, 2009). Turner later defended his Prospect Magazine remarks say-ing, “…I do not apologise for being correctly quoted as saying that while the financial services industry per-forms many economically vital functions, and will continue to play a large and important role in London’s economy, some financial activities which proliferated over the last ten years were ‘socially useless’, and some parts of the system were swollen beyond their optimal size.” (ibid.) Paul Volcker was more blunt. He report-edly told a room full of bankers, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence,” said Mr. Volcker (Times of London, 2009).
3
How socially efficient is the financial sector? That is, does the financial sector provide socially useful services commensurate to the economic resources taken up by it? If not, how should we cut the financial sector down to size? In other words, how big is too big? These are all very important questions, not only theoretically and empirically, but also have important implications in terms of economic policy. For example, the financial transactions tax (FTT) is on the policy agenda in Europe, the U.S. and elsewhere. The financial industry has opposed the tax arguing that it would reduce the size of the financial sector below its optimal level and hinder useful financial innovation.
Most financial reform legislation, including the Dodd-Frank legislation recently passed in the United States call for increased capital and liquidity requirements for investment and commercial banks that may shrink the size of the sector relative to what it would be otherwise. Bankers and others have expressed concern that the-se need to be levied in such a way as to preserve “international competitiveness” of the financial sector, and to prevent activities from going “offshore.” But if, at the margin, the financial sector is not socially efficient, then a “lack of competitiveness” which causes the sector to shrink is not socially harmful. Others have called
for significant restrictions on the level or form of banker pay in order to generate more fairness and to reduce excessive risk incentives. (Crotty and Epstein, 2009a; Crotty, 2009). Critics have responded that these actions might lead to “banker brain drain”--the movement of the most highly paid bankers abroad. Here again, this is of particular social concern only if the activities of these highly paid bankers are making a significant social contribution. The answers to the questions posed above are obviously relevant to these key policy issues.
The question of the appropriate size, scope and operations of the financial sector from the point of view of social efficiency is obviously a massive one. In this chapter, we present some initial conceptual and empirical work, focusing on the United States in the post-World War II period. We humbly present our empirical work in the spirit of the creative, careful, and important conceptual and empirical work carried out by Tom Weisskopf (see the other chapters of this volume) and hope, eventually, to honor that work in future itera-tions of our own work.
In what follows we will first offer some initial definitions with regard to the social productivity of the financial sector. In section III we will present a broad overview of the growth of the financial sector in the last several decades and briefly review some literature that has raised questions about the social value of its role. Section IV presents some initial estimates of the social productivity of the financial sector in the U.S. and concludes that despite its declining social productivity, the rate of income extraction by the financial sector in the U.S. has been rising. We then identify other possible contributions of the financial sector that could account for this increase in the rate of income extraction. These include liquidity provision, financial innovation, and market making. We provisionally conclude that these are theoretically flawed or empirically inadequate to explain the apparent social inefficiency of the financial sector in the U.S. In the penultimate section we turn to a possible explanation for the increase in the rate of income extraction: the trading, gambling and speculative activities of investment banks. More specifically, we study the sources of income of large investment banks and show that at the height of the bubble, as much as 60 or 70 percent of some investment banks’ incomes derived from trading activities. In light of our discussion of liquidity provision and market making, we suggest that there is no strong theoretical reason to believe these activities are socially efficient. We conclude in section VII.
A SOCIALLY PRODUCTIVE FINANCIAL SECTOR? INITIAL DEFINITIONS
We begin with James Tobin’s important essay, “On the Efficiency of the Financial Sector” first published in Lloyd’s Bank Review in 1984 and reprinted in Essays in A Keynesian Mode (Jackson, 1987). One of Tobin’s concepts of efficiency is especially relevant here: the concept of functional efficiency.
“…the economic functions of the financial industries …. include: the pooling of risks and their al-location to those most able and willing to bear them...the facilitation of transactions by providing mechanisms and networks of payments; the mobilization of saving for investments in physical and human capital... and the allocation of saving to their more socially productive uses. I call efficiency in these respects functional efficiency…I confess to an uneasy Physiocratic suspicion, perhaps unbe-coming in an academic, that we are throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services, into activi-ties that generate high private rewards disproportionate to their social productivity.” (Tobin, 1987).
Tobin’s concept of functional efficiency is thus one way to frame a discussion of the roles the financial sector has been playing in recent decades.
Though it might be a useful starting point, Tobin’s taxonomy of different types of financial efficiency is itself problematic. Tobin suggests that the financial sector at worst can be unproductive. But a broader perspective, based in different ways on the works of Karl Marx and Hyman Minsky, would suggest that the financial sec-tor can have more sinister impacts: that it can engage in exploitation and also destroy value. We have certainly seen evidence for this in the sub-prime lending that stripped households of much of their wealth, and in the costs of the Great Recession which Haldane (2010a), for example, has estimated will cost the world some-where between $60 and $200 trillion.
In what follows, we first present some basic data that show how dramatically the finance sector has grown in recent decades to place the issue of “financial bloat” in an empirical context. Then we move on to a set of measures designed to shed light on the functional efficiency of the financial sector.
BRIEF OVERVIEW OF RECENT TRENDS IN THE SIZE OF THE FINANCIAL SECTOR
No matter how the size of the financial sector with respect to the rest of the economy is measured, the trend of massive growth is obvious. The financial sector’s total financial assets grew from about one-third of total assets in the U.S. economy during the post-World War II decades to 45 percent of total assets by 2010 The value of the financial sector assets was approximately equal to the U.S. Gross Domestic Product (GDP) in the early 1950s, whereas now it amounts to 4.5 times the U.S. GDP. Financial sector profit has grown from about 10 percent of total domestic profits in the 1950-60s to 40 percent in the early 2000s.
This massive rise in the financial sector as a whole is accompanied by a dramatic rise in some of its segments. Investment banking has drawn special attention during the 2007 - present crisis because these financial insti-tutions were at the heart of creating the new financial products that triggered the crisis. Financial assets of the securities industry, which includes investment banks, amounted to a constant 1 percent of total financial sec-tor financial assets from 1945 until the early 1980s. After that, they rose five-fold and reached the level of 5 percent of the total financial sector financial assets by 2008 Their rise as a share of GDP has been even more pronounced – from 1.5 percent in the post-World War II decades to 22 percent in 2007. Other measures of the size of the securities industry in the U.S. produce even larger figures, with the securities industry’s total assets reaching 45 percent of GDP in 2007.4
How much of this increase in the size and share of the U.S. financial sector is socially efficient? What does it contribute to the functioning of the U.S. economy? These are questions to which we turn next.
ESTIMATES OF THE CONTRIBUTION OF THE FINANCIAL SECTOR TO THE REAL SECTOR IN THE US 5
Broad contribution of the financial sector in the US
There are two broad approaches to answering the question of the social efficiency of the financial sector: one is to look at the role of finance from the point of view of the activities of the financial sector; the other is to look at the role of finance from the perspective of the real sector. Here, we present work from the perspec-tive of the real sector. Next, we combine the two by looking at the income extracted by the financial sector
for the services it provided to the real sector. As above, we focus on the United States. In future work we plan to expand this analysis to other OECD countries.
The financing gap
We begin by looking at the “financing gap” of broad sectors of the U.S. economy. The “financing gap” measures the extent to which different sectors of the economy depend on external finance as opposed to fi-nancing with internal savings. We assess how this dependence has evolved over the post-World War II peri-od. We then look at the degree to which the financial sector has been able to extract returns for supplying the credit needed to fill these financing gaps.
Lack of space prevents us from presenting data on the sectoral evolution of the financing gap, but we will briefly summarize the results here. Using flow of funds data, we observe three simultaneous trends. First, the non-financial corporate sector reduced its use of external finance over the period in relation to its capital ex-penditures. At the same time, households moved from being net lenders to the financial sector to being net borrowers, largely to finance the purchase of homes and durable consumer goods. Third, governments (fed-eral, state and local) increased their dependence on the financial sector for financing their capital expendi-tures. These trends illustrate a problematic shift of financial activity away from productive investment to lend-ing services that fuel asset-bubbles, such as in the housing market. We explore this shift from various angles in what follows.
Figure 1 below shows the evolution of the total non-financial sector financing gap from 1946 –2010, exclud-ing the federal government (we introduce the federal government’s financing gap below).
Figure 1. Total U.S. Non-Financial Sector Financing Gap, billions of U.S. Dollars, 1946 – 2010 (measure excludes the federal government)
A surge in mortgages and financing for consumer durables by households explain the great bulge in the fi-nancing gap in the later periods. This occurred despite the stagnating demand among non-financial corpora-tions, apart from a brief increase in the late 1990’s due largely to mergers, acquisitions and stock buy-backs.
0
200
400
600
800
1,000
1,200
1,400
1,600
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Source: calculations based on the Flow of Funds
billio
ns o
f US
dol
lars
Next we turn to an analysis of the income extracted by the financial sector and compare it with the roles the financial sector plays vis-a-vis the real economy.
Figure 2. Gross Value Added of Financial Corporate business relative to the Financing Gap
Figure 2 is the ratio of two variables. The first is the gross value added of the financial sector, i.e., the wages and profits received by the financial sector. This is the amount of income the financial sector extracts from the economy. This is divided by the financing gap which, as we saw above, is a measure of the services pro-vided by the financial sector. So the ratio, which is shown in the graph, is a measure of the income extracted by the financial sector, relative to the services it provides (see Philippon, 2011 for a related analysis).
Table 1 presents these data averaged roughly by decade from 1946 to 2010. They indicate that the financial sector has extracted more income relative to the financing it provides to the real sector over the post–war peri-od. In particular, for every dollar of financing gap the financial sector received on average 30 cents in 1946-1959 and $1.09 in 1990s and $1.74 in the 2000s. This analysis suggests that the financial sector may be as much as four times as large--relative to the booming 1960’s--as required for financing real economic activity.
Table 1. Gross Value Added of Financial Sector relative to Financing Gap (measure excludes the federal government)
simple decadal average
1946-1959 0.30
1960s 0.47
1970s 0.64
1980s 1.32
1990s 1.09
2000-2010 1.74
Source: See figure 2
0
1
2
3
4
5
6
7
8
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Source: calculations based on the Flow of Funds and NIPA, Table 1.14
mul
tiple
s of
the
finan
cing
gap
Simply inversing the data presented in Figure 2 and Table 1 provides a gauge of the financial sector’s “productivity,” i.e., the amount of financing gap per dollar of value added extracted by the financial sector. Productivity clearly declined over the post-war period, with a significant drop off occurring during the 2000’s.
Table 2 shows that for the same total revenue (value added), the financial sector services a declining share of financing gap. In particular, for each $1 of revenue, the financial sector financed on average $4-$6 financing gap after the World War II and financed only $1 of financing gap since 1990.
Thus far we have left the federal government out of the analysis. To be sure, the domestic financial sector has served a role of partially financing the federal budget deficit. However, the matter is complicated by the fact that the federal budget deficit is also financed by the Federal Reserve System and increasingly by foreigners. Moreover, much of the Federal debt is not intermediated by the financial sector but is bought directly by households. For all these reasons, our including the entire federal budget deficit is problematic for estimating the rate of income extraction (and productivity) by the financial sector. Still, to look at the outer range of the impact of including the Federal Budget, we present it below.
When we add the role of federal government borrowing, it changes the quantitative dimensions but not the qualitative dimensions of the analysis. Here we present the decadal averages.
Table 2. Income Extraction by the Financial Sector Relative to Financing Gap (including the federal government financing gap)
simple decadal average
1946-1959 0.31
1960s 0.44
1970s 0.46
1980s 0.60
1990s 0.73
2000-2010 0.66
Source: See Figure 2
According to these data – which we suggested above is probably an underestimate of the income extraction ratio – we still find that the rate of income extraction by the financial sector relative to the financing gap has doubled since the early post-war period. In this case, for every dollar of financing gap the financial sector re-ceived on average 30 cents in the 1950s and almost 70 cents in the 1990-2000s.
As before, we can look at the mirror image of the amount resources extracted per dollar of finance gap sup-plied, by looking at the productivity of the financial sector (not shown here for reasons of space). These data suggest a decline in the “productivity” of the financial sector: for a $1 of revenue, the financial sector fi-nanced on average $3-$5 financing gap after the World War II and only $1.5 financing gap since 1980.
DARK MATTER: LIQUIDITY PROVISION, FINANCIAL INNOVATION, MARKET MAKING AND THE RATIONALE FOR INCOME EXTRACTION BY THE FINANCIAL SECTOR
Of course, the financial sector provides services other than direct provision of credit. These include liquidity provision, risk sharing, provision of information and monitoring, market making and innovation in all these activities. Any analysis of the impact of finance – and explanations for income extraction by the financial sec-tor - must take these roles into account as well.
Estimating the social contributions of all these activities is not easy. This leaves this terrain ripe for self-serving assessment and interpretation. For example, economists of various stripes and defenders of the status quo in financial regulation and structure have identified a number of presumed contributions of the financial sector to the real economy that are not easily captured by statistics. . These are akin to debates over “dark matter”: contributions that are there but not easy to detect. These include “liquidity provision”, “market mak-ing” and benefits of “financial innovation”.
We briefly summarize some key points in what follows.
Liquidity provision
The mainstream economics literature has developed this concept of liquidity in vague and contradictory ways. Basically, providing liquidity means making the trade of financial assets relatively immediate and low cost. Mainstream economists argue that providing liquidity helps determine the value of an asset (i.e., “price dis-covery”) because each trade provides information about what buyers are willing to pay—and what sellers are willing to accept—for an asset. As these trades take place, the price of the asset should converge to a price that equates the buyers’ level of demand to the sellers’ supply level—an “equilibrium price” that represents the asset’s true value. If this were the case, liquidity provision would be a good thing.
But there is a key flaw in this literature that renders the liquidity-based justifications for financial sector activi-ties highly suspect: this justification depends on the assumption of the existence and “knowability” of the fundamental value of financial assets. This is an assumption that is incorrect (and of course, is inconsistent with a Keynesian or Minskian approach to understanding financial markets) in a world of fundamental uncer-tainty that characterizes all modern economies. In this world, liquidity provision is a more complex and dy-namic activity, and indeed, leads to “price creation” rather than price discovery. That is, the activities of fi-nancial institutions do not simply provide the liquidity that financial markets need to determine the true value of assets, their activities directly influence what the price will be. In this world, liquidity provision can con-tribute to a run-up in the price of an asset creating an asset price bubble. Then, inevitably, some event causes liquidity to dry up and the bubble to burst, triggering a massive freefall (or even non-existence) of asset prices. This is, in fact, what occurred for some assets of the global financial services firm, Lehman Brothers Hold-ings, Inc., during the 2008 financial crash.
Thus, the pathway to understanding the social efficiency of liquidity provision is to ask: liquidity provision for what? This is a question that is rarely asked in the mainstream literature because of the assumption that li-quidity provision assists in “price discovery.” The alternative perspective naturally leads to a distinction be-tween “good liquidity” and “bad liquidity” creation mechanisms. In this regard, an analysis of the social effi-
ciency of “liquidity provision” would look at the types of financial products created and traded and what their social impacts are. Price discovery cannot simply be assumed as the obviously “good” outcome.6
If one then considers the type of liquidity provision that grew in the last decade, how it contributed to the financial bubble and then dried-up after the Lehman collapse, it is difficult to argue that socially useful liquidi-ty provision by the financial sector can explain the large increase in the rate of income extraction by the fi-nancial sector (or conversely the decline in financial sector “productivity”) in the recent decade or so.
Market making
As we discuss in the next section, market making–the buying and selling financial instruments for the purpose of facilitating trade by others—is indeed a major activity of some of the biggest players in the financial sector. The mainstream literature once again assumes that market making is a socially efficient activity of “intermedi-aries” who bring together buyers and sellers and makes voluntary trades possible more cheaply. This view, however, assumes that investment banks and other financial institutions act as passive intermediaries, as in the case of price discovery. In fact, financial firms engage actively in creating and marketing financial products and then search for buyers and sellers.
A good example of what we have in mind is how Citibank and Goldman Sachs created and marketed collat-eralized debt obligations (CDOs) that were designed to fail and then took out bets against these products. Here, then, “market making” as actually practiced is not a neutral, intermediary action but is a market creation activity that must be judged on the merits of the types of markets created.7
The social efficiency of financial innovation
Here too, the recent history of financial products sold and markets made – the CDOs and credit default swaps (CDSs) that helped to crash the system – raise serious questions about whether the social productivity of such trading can account for the rise of the rate of income extraction received by the financial sector in recent decades.
Bankers often fight against financial regulation by arguing that regulations will stifle innovations. What is the functional efficiency of financial innovations? What is the impact of these financial innovations on the real economy? As a theoretical matter, there is no presumption that more financial innovation contributes to higher social welfare. Mathematical models created to demonstrate how financial innovation operates in an economy have shown that, in principle, they can either increase or decrease social welfare (Elul, 1995; Frame and White, 2004).
While mainstream authors discussed above have touted the social benefits of financial innovation, heterodox economists have taken a more critical stance toward them. Crotty shows in great detail the destructive nature of many of these “innovations” and how their existence deliberately made price discovery harder, and made financial products more difficult to understand. Doing so enabled those creating these new financial instru-ments to generate even more revenue than would be the case if buyers and sellers better understood the products they were trading. This flies in the face of the justifications for innovation based on efficient mar-kets theory (see Crotty 2008 and 2010).
Empirically, there has been very little evidence provided on these key questions. Lerner (2006) does find that financial innovation raises the profits of the innovating financial firm, at least in the short run. But what about
social impacts? Frame and White (2004) published a comprehensive survey of the determinants and effects of financial innovation. As their paper shows, there has been relatively little study of financial innovation. As a result, there is virtually no evidence that financial innovations contribute to a lower cost of capital, more investment, or higher rates of economic growth. Indeed, in light of the enormous costs associated with the current crisis, we have a great deal of emerging evidence on the high costs associated with some financial in-novations.
Micro-level data
Whereas the studies cited above refer mostly to macro-level (i.e., economy-wide) data, there is interesting mi-cro-level (i.e., firm-based) data that can be used to assess the nature of financial innovation.
In the most comprehensive studies to date, John D. Finnerty and his colleague Douglas Emery created a list of securities innovations organized by type of instrument and function/motivation of the issuers. The types of instruments studied include: debt, preferred stock, convertible securities, and common equities (Finnerty 1988, 1992, 2002). Finnerty's initial study (1988) dealt with both consumer and corporate financial innova-tions and listed eleven motivations/functions: (1) Tax advantages, (2) reduced transaction costs, (3) reduced agency costs (4) risk re-allocations, (5) increased liquidity, (6) regulating or legislative factors, (7) level and vol-atility of interest rates, (8) level and volatility of prices, (9) academic work, (10) accounting benefits and (11) technological developments. In his later work, Finnerty reduced the functions to six:(1) reallocating risk, (2) increasing liquidity, (3) reducing agency costs, (4) reducing transactions costs, (5) reducing taxes or (6) cir-cumventing regulatory constraints. One should add two other motives: first, firms have a motive to create a proprietary innovation that is complex and murky enough to give it proprietary advantages for at least an ini-tial period of time (Tufano, 2002; Das, 2006). We will call this (7) the "proprietary" or "redistributive" motive. An eighth motive, implicitly proposed by James Tobin, is to open new ways to gamble on trends or to limit losses when such gambling occurs. We will call this the (8) "gambling motive." Clearly, many of these have nothing to do with reducing transactions costs or increasing social efficiency.
Table 3, taken from Crotty and Epstein (2009b) uses the three Finnerty studies to calculate that number and percentage of innovations that are at least partly motivated by tax, accounting and/or regulatory "arbitrage" or "evasion." Our estimates reveal that roughly one-third of these "innovations" are motivated by these fac-tors, rather than simply efficiency improvements. This estimate, in fact, is almost certainly a gross under-estimate of innovations motivated by tax and regulatory arbitrage, since Finnerty and Emery presented a se-lected set of innovations which they suggested would have "staying power" due to their "addition to value." Their list is not anywhere near a complete list of new types of securities.
Table 3. Financial “Innovations” Motivated by Tax or Regulatory Evasion
Study Total number of
security innovations (1)
Number motivated at least partly be tax or regulatory reasons
(2)
Percentage of total innovations motivated by tax or regulatory reasons (2)/(1) x 100
(%)
Finnerty, 1988 103 45 44
Finnerty, 1992 65 21 34
Finnerty and Emery, 2002 80 25 31
Sources: Finnerty, 1988; Finnerty, 1992; Finnerty and Emery, 2002 and authors' calculations. (Crotty and Epstein, 2009b)
We believe that the data in Table 3 are likely to be an underestimate of the socially inefficient share of finan-cial innovations because these data do not look at the actual impact of these innovations. For example, these data do not capture the destructive effect of CDOs and CDSs since it is an accounting exercise with respect to what motivated the innovations, rather than a study of their actual effects. The latter will have to wait for future research.
WHAT DOES FINANCE’S INCOME DERIVE FROM? A CASE STUDY OF U.S. INVESTMENT BANKS 8
So how is finance managing to extract so much income relative to the apparent services it is providing to the real economy? This is, of course, a very difficult, highly complex question. But to begin to answer it, we “fol-low the money.” That is, we look at the income accounts of major investment banks in the U.S. and ask what activities have generated their incomes? This is of particular interest given that investment banks were at the heart of the recent crisis.
Specifically, we will look into the composition of the revenue-generating activities of investment banks and how this composition changed over time. The composition of investment banking revenues can proxy for the composition of activities investment banks perform. Growing components of revenue should reflect the types of activities accounting for the overall growth in investment banking business.
Investment banking is a highly concentrated industry with the top five investment banks receiving up to 65 percent of total revenues. Because of this, the revenue structure of the top five investment banks should give us important information about the activities of the investment banking industry, at least in the large-bank segment.
Functional efficiency of investment banking: trading vs. non-trading activities
Of course, it is very difficult to identify all the activities undertaken by investment banks that are socially use-ful versus those that are not. But as a first approximation, we will identify trading and trading-related activi-ties, versus non-trading activities which would typically include market making activities, hedging (i.e., trades made for the purpose of reducing risk) and other asset management services for customers. These are distinc-tions that very roughly parallel the notions of “proprietary trading” vs. hedging, market-making activities and asset management as defined in the Dodd-Frank Act. But as noted above, “market making” during some pe-riods primarily facilitated the creation and selling of highly speculative and ultimately destructive products.
We construct a data set for the five largest investment banks for 2006-2008. To show the evolution of the structure of investment bank activities, we need to compare these measures to an earlier time period. The tables below present the results of our calculations of trading as a share of net revenues for the five largest U.S. investment banks.
Take, for example, Goldman Sachs. In 2008, trading income as a share of net revenue was, according to our figures, about 56 percent. But if one goes back to the boom years of 2006, it was nearly three-quarters of net revenue, or 74 percent.
Table 4. Trading vs. Non-Trading Activities: Five Large US Investment Banks
a. Goldman Sachs (GS)
millions $ 1998 1999 2000 … 2006 2007 2008
Commissions 1,368 1,522 2,307
Trading and principal investments 2,379 5,773 6,627 25,562 31,226 9,063
Securities services 730 772 940 2,180 2,716 3,422
Net revenue 8,520 13,345 16,590 37,665 45,987 22,222
“Trading” as a share of net revenue, % 52.5 60.4 59.5 73.7 73.8 56.2
Note. Trading = commissions + trading and principal investment + securities services, for 1998-2000, and Trading = trading and principal investment + securi-ties services, for 2006-2008, due to a change in methodology.
b. Morgan Stanley (MS)
millions $ 1994 1995 1996 ……. 2006 2007 2008
Commissions 874.3 1,022.5 1,163.1 3,770 4,682 4,463
Principal transactions 421.9 478.9 449.3 13,612 6,468 1,260
Other 101.9 93.5 107.8 545 1,161 6,062
Net revenue 5,554.1 6,419.6 7,462.4 29,799 27,979 24,739
“Trading” as a share of net revenue, % 25.2 24.8 23.1 60.2 44.0 47.6
Note. Trading = commissions + principal transactions + other.
c. Bear Stearns (BSC)
millions $ 1993 1994 1995 …… 2005 2006 2007
Commissions 421 483 547 1,200 1,163 1,269
Principal transactions 1,157 1,134 860 3,836 4,995 1,323
Net revenue 2,143 2,417 2,075 7,411 9,227 5,945
“Gambling” as a share of net revenue, % 73.6 66.9 67.8 68.0 66.7 43.6
Note. Trading = commissions + principal transactions.
d. Lehman Brothers (LEHM)
millions $ 1989 1990 1991 1992 1993 …… 2005 2006 2007
Commissions 1,858 1,508 1,649 1,677 1,316 1,728 2,050 2,471
[Market making and] principal transactions 1,269 1,199 1,696 1,697 1,967 7,811 9,802 9,197
Net revenue 4,892 4,016 4,905 5,426 5,218 14,630 17,583 19,257
“Trading” as a share of net revenue, % 63.9 67.4 68.2 62.2 62.9 65.2 67.4 60.6
Note. Trading = commissions + [market making and] principal transactions.
e. Merrill Lynch (MER)
millions $ 1991 1992 1993 …….. 2006 2007* 2008*
Commissions 2,166 2,422 2,894 5,985 7,284 6,895
Principal transactions 1,906 2,166 2,920 7,248 -12,067 -27,225
Other 340 281 285 2,883 -2,190 -10,065
Net revenue 7,246 8,577 10,558 33,781 11,250 -12,593
“Trading” as a share of net revenue, % 60.9 56.8 57.8 47.7 -62.0 241.4
Note. Trading = commissions + principal transactions + other. * Losses (negative numbers) require cautious interpretation of these percentages.
EPSTEIN & CROTTY / HOW BIG IS TOO BIG? / PAGE 13
For these banks, the share of their income from trading activities was roughly 50 percent or more during the height of the bubble just before the crash of 2007.
Thus, these data suggest that the massive increase of income extraction by the financial sector relative to the provision of services to the real sector can conjecturally be explained by the explosion in revenue generated by trading activities as a share of investment banks’ income generating activities. This is reflected in the activi-ties of major commercial banks as well, such as Citibank and Bank of America. (see Crotty, Epstein and Levina (2010) for a discussion of Citibank).
Given the doubts raised earlier about the concepts of liquidity provision and market making and given what we know about the etiology of the financial crisis of 2007 - ?, it is reasonable to be skeptical about the social efficiency of such activities. Of course, future work must pin down the costs and benefits of these trading activities much more precisely.
CONCLUSION
Tom Weisskopf has shown us, among many other things, the power that comes from the careful develop-ment of well-designed descriptive statistics to help us understand the underlying structures and dynamics of our economy. In this paper we have made an initial attempt to do just that with respect to the question of the social efficiency of the U.S. financial sector.
A very preliminary range of estimates presented in Tables 1 and 2 above suggests that the financial sector in the United States is extracting 2- 4 times as much income relative to the services it provides to the real sector in the decade of the 2000’s as it did during the high growth period of the 1960’s. This suggests that the finan-cial sector may need to be only one-half to one-quarter as large as it is currently to serve the existing needs of the real sector.
Of course, these are very crude estimates. We must do much more work on the “dark matter” functions of the financial sector, as well as understand better the impacts of financial innovations, before we can present such estimates of financial bloat with a great deal of confidence. Still, these preliminary discussions are telling. They suggest that financial bloat is real and that, with further efforts, we can make our estimates of its size more precise.
We can also say that next time apologists for the financial sector criticize an attempt at reasonable financial regulation or restructuring by claiming it will harm at the margin the financial sector, reduce liquidity provi-sion or hinder market making -- it’s time to reach for our computers and fire back about the reality of “fi-nancial bloat.”
EPSTEIN & CROTTY / HOW BIG IS TOO BIG? / PAGE 14
REFERENCES
Arcand, Jean Louis, Enrico Berkes and Ugo Panizza, 2011. “Too Much Finance?”, Working Paper ://www.voxeu.org/index.php?q=node/
Crotty, James, 2009. “Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Fi-nancial Architecture’,” Cambridge Journal of Economics
Crotty, James, 2010. “The Rainmaker Financial Firm”, www.peri.umass.edu
, July. Vol. 33, No. 4, pp. 536-80.
Crotty, James, and Gerald Epstein, 2009a. “Avoiding Another Financial Meltdown”, Challenge Magazine, Janu-ary/February, pp. 5 – 26.
Crotty, James and Gerald Epstein. 2009b. “Controlling High Risk Financial Products Through A Financial Precautionary Principle”, Ekonomiaz N.º 72, third quarter.
Crotty, James, Gerald Epstein and Iren Levina, 2010. Proprietary Trading is a Bigger Deal than Many Bankers and Pundits Claim, SAFER Policy Note, Number 15. www.peri.umass.edu/safer
Elul, Ronel, 1995. "Welfare Effects of Financial Innovation in Incomplete Markets Economies with Several Consumption Goods", Journal of Economic Theory, 65. pp. 43 -78.
Finnerty, John D. 1988. "Financial Engineering in Corporate Finance: An Overview", Financial Management 17, No. 4. Winter, pp. 23 – 39.
Finnerty, John D. 1992. "An Overview of Corporate Securities Innovation", Journal of Applied Corporate Fi-nance, Vol. 4, No. 4, pp. 23 – 39.
Finnerty, John D. and Douglas R. Emery. 2002. "Corporate Securities Innovation: An Update"
Journal of Applied Finance, Spring/Summer, pp. 21 – 48.
Frame, Scott and Lawrence White. 2004. “Empirical Studies of Financial Innovation: Lots of Talk, Little Ac-tion?” Journal of Economic Literature, Vol. 42, No. 1 (March, 2004), pp. 116 – 144.
Haldane, Andrew. 2010a. “The Contribution of the Financial Sector; Miracle or Mirage”. Bank of England.
Haldane, Andrew. 2010b. “The 100 Billion Dollar Question”. Bank of England.
Lerner, Josh, and Peter Trufano. 2011. “The Consequences of Financial Innovation: A Counterfactual Re-search Agenda.” NBER Working Paper 16780.
Lerner, Josh. 2006. "The New Financial Thing: The Origins of Financial Innovations" Journal of Financial Economics. 79. pp. 223 -255.
MacEwan, Arthur and John Miller. 2011. Economic Collapse, Economic Change; Getting to the Roots of the Crisis. Armonk, NY: M.E. Sharpe.
Mehrling, P. 2011, The New Lombard Street: How the Fed Became the Dealer of Last Resort, Princeton University Press, Princeton, Oxford.
EPSTEIN & CROTTY / HOW BIG IS TOO BIG? / PAGE 15
Morgenson, Gretchen and Louise Story. 2009. “Banks Bundled Bad Debt, Bet Against It, and Won.” New York Times, 12/24/09
Panizza, Ugo. 2011. “Finance and Economic Development”, Working Paper UNCTAD.
Partnoy, Frank. 2009. Infectious Greed: How Deceit and Risk Corrupted Financial Markets. updated edition. New York: Public Affairs.
Philippon, T. 2011. Has the US Financial Industry Become Less Efficient. NYU Working Paper. http://pages.stern.nyu.edu/~tphilipp/papers/FinEff.pdf
Stiglitz, Joseph (2010b). Freefall: America, Free Markets, and the Sinking of the World Economy. New York: W.W Norton and Company.
Taub, Jennifer. 2009. “Enablers of Exuberance: Legal Acts and Omissions that Facilitated the Global Finan-cial Crisis.” Discussion Draft.
Tobin, James. 1985. “Financial Innovation and Deregulation in Perspective.” Cowles Foundation Paper 635, May 1985, pp. 19 – 29.
Times of London, 2009. “Wake up, gentlemen’, world’s top bankers warned by former Fed chairman Volcker” December 9. http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6949387.ece
Tobin, James. 1987. “On the Efficiency of the Financial Sector”, Policies for Prosperity; Essays in a Keynesian Mode, ed. Peter M. Jackson. Cambridge: MIT Press.
Tufano, Peter. 2003. "Financial Innovation," in Handbook of the Economics of Finance (Volume 1a: Corporate Fi-nance), George Constantinides
Turner, Adair. 2009. “Mansion House Speech”, September, 22. http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/0922_at.shtml
, Milton Harris and Rene Stulz, eds. Amsterdam: Elsevier. pp. 307-336.
Turner, Adair. 2010. What do Banks do? Why Do Credit Booms and Busts Occur and What Can Public Poli-cy Do About It?, in The Future of Finance; and The Theory that Underpins It. futureoffinance.org.uk .
Wolfson, Martin and Gerald Epstein, eds. 2012. Handbook on the Political Economy of Financial Crises. Oxford: Oxford University Press.
Zhu, Andong, Michael Ash and Robert Pollin, 2002. Stock Market Liquidity and Economic Growth: A Critital Appraisal of the Levine/Zervos Model. PERI Working Paper, No. 4
EPSTEIN & CROTTY / HOW BIG IS TOO BIG? / PAGE 16
1 We thank Leila Davis, Nina Eichacker and Iren Levina for excellent research assistance, John Miller for very helpful comments, the Editors for helpful editorial suggestions, and INET for financial support. We are responsible for all errors. 2 See some summary data in section II below; see MacEwan and Miller, 2011, and the papers in Wolfson and Epstein, 2012, on the role of finance in the crisis. 3 See, for example, Arcand, Berkes and Panizza, 2011, and Panizza, 2011, for recent work. The work by Turner, Haldane and col-leagues, 2010, is also of significant interest here as is that of Philippon, 2011; for earlier important work, see Zhu, Ash and Pollin, 2002. 4 These data are based on the Board of Governors Flow of Funds Accounts, Bureau of Economic Analysis (BEA) National Income and Product Accounts (NIPA), and Securities Information Financial Analysis (SIFMA). Iren Levina gathered these data and per-formed these calculations. 5 Iren Levina and Leila Davis who served as research assistants on this project, developed the data presented in this section. 6 See Mehrling (2011) for an important discussion of the nature of liquidity which informs our analysis as well. 7 We discuss this further in the section on income estimates of investment banks below. 8 Iren Levina carried out the data collection and analysis for this section. For more discussion see Crotty, Epstein and Levina, 2010.
PO
LIT
ICA
L E
CO
NO
MY
R
ESEA
RC
H IN
ST
ITU
TE
Austerity Economics and the
Struggle for the Soul of U.S. Capitalism
Robert Pollin
April 2013
WORKINGPAPER SERIES
Number 321
Gordon Hall
418 North Pleasant Street
Amherst, MA 01002
Phone: 413.545.6355
Fax: 413.577.0261
www.peri.umass.edu
AUSTERITY ECONOMICS AND THE STRUGGLE FOR THE SOUL OF
U.S. CAPITALISM
By Robert Pollin Department of Economics and
Political Economy Research Institute (PERI) University of Massachusetts-Amherst
Draft 1: April, 2013
Written for Social Research special issue on Austerity
JEL Codes: H6, E6, H7
Abstract of Paper
Amid the wreckage of the 2008-09 Wall Street collapse and Great Recession, orthodox
economists and political elites in both the United States and Western Europe have been strongly pushing the idea that austerity is the only viable policy option. The basis for the austerity hawks claim is that both the U.S. and European economies are being consumed by out-of-control levels of public indebtedness. Public spending must therefore be slashed before economic collapse becomes a real possibility.
Are the austerity hawks correct that there is simply no alternative to their agenda? In
fact, the austerity hawks’ arguments are wrong across the board. Focusing on the U.S. case, this paper shows that the austerity hawks claims about large deficits causing high inflation and interest rates have been consistently wrong for four years. Moreover, U.S. is nowhere near experiencing a fiscal crisis in the commonsense definition of the term, which is to say, the government is facing difficulties in meeting its commitments to creditors. The paper then reviews the recent experiences of U.S. state and local governments, which show how the austerity agenda is attacking the foundations of is already a modest U.S. welfare state. It is becoming increasingly clear that many, if not most, austerity hawks view this period as an opportunity to eviscerate the public sector, labor unions, social insurance and other basic social protections. The paper closes by sketching some ideas capable of countering the austerity agenda, by both moving the U.S. economy toward full employment in the short-term and sustaining full employment in the long term.
Pollin, “Austerity Economics” Draft: 4/13 p. 2
2
Amid the wreckage of the 2008-09 Wall Street collapse and Great Recession, orthodox economists and political elites in both the United States and Western Europe have been strongly pushing the idea that the only way out of the mess is to deliberately make life worse for almost everybody. Details aside, this is the basic idea behind the austerity agenda that has become the conventional wisdom in both the U.S. and Europe, regardless of which political parties happen to hold office. It has been the underlying premise for both the Democratic and Republican sides of all recent debates—on debt limits, the “fiscal cliff,” sequestration, and all skirmishes in between—concerning the U.S. federal budget.
Thus, despite Barack Obama’s reelection last November, the inside-the-beltway Democrats, including Obama, appear committed to reaching common ground with Republicans over a bipartisan austerity agenda that would entail significant cuts in Medicare, Social Security and public spending on education, infrastructure, family support and the environment. No such cuts have been agreed to as of this writing (March 2013). But Obama continues to offer them to Republicans as part of a fiscal “grand bargain” that would also include some tax increases for the wealthy beyond the modest increases enacted in January 2013. To be sure, the Obama austerity agenda is softer than the hard-right approach favored by Republicans. But it is the long-term Republicans agenda to gut Medicare, Social Security and public education that continue to frame the debate.
The situation is still worse throughout Europe, where the dominant elite view is that the
European welfare state is no longer affordable. Public employment, health care budgets, and pensions are being slashed, while poverty is rising dramatically. For example, The New York Times reported in September 2012 that 22 percent of Spanish households are living in poverty and that 600,000 have no income whatsoever. As the Times noted (Daly 2012), “For a growing number, the food in garbage bins helps make ends meet.”
But such human suffering aside, could the austerity hawks be correct that there is simply
no alternative to forcing this bitter medicine down people’s throats? The basis for the austerity hawks claim is that, both the U.S. and European economies are being consumed by out-of-control levels of public indebtedness. Public spending must therefore be slashed before total economic collapse becomes a real possibility.
In fact, austerity hawks claims are wrong across the board: the public debt burden in the
U.S. is actually at a near-historical low level, not a high; in Europe, where government debt burdens are severe, there are still clear alternatives for managing the problem that do not entail a
Pollin, “Austerity Economics” Draft: 4/13 p. 3
3
crushing austerity agenda; and finally, the austerity agenda actually solves nothing. Making life worse now for most people also makes it more difficult to pull the economy out of the ditch in which Wall Street has shoved it.
What then is behind the austerity agenda? Can we envision viable alternatives to austerity? The short answer is “yes,” both in the short- and long-runs, as I try to show. I will focus here on the U.S. case, with which I am most familiar. But there certainly are broad parallels with the situation throughout Europe, which many others have explored insightfully (Arestis and Pelagidis 2010, Sawyer 2012, Zezza 2012). U.S. REALITY: THERE IS NO FISCAL CRISIS
U.S. government deficits—i.e. how much the government is borrowing each year—did rise sharply between 2008 – 2012. This was entirely due to the Wall Street collapse and ensuing Great Recession. To begin with, the onset of the recession itself generated a sharp decline in tax revenues, as a consequence of falling household incomes and business profits. Total federal tax revenues (in real 2012 dollars) fell from $2.9 trillion in 2007 to 2.3 trillion in 2009, a 21 percent decline in two years. As of 2012, federal revenues are still, at $2.5 trillion, nearly 14 percent billion below the pre-recession level.
In addition, U.S. policymakers did enact extraordinary measures to counteract the crisis
created by Wall Street. These measures included financial bailouts and the Federal Reserve pushing its policy interest rate—the federal funds rate—close to zero by late 2008 and keeping it there for at least four years subsequently (as of this writing, the Fed has stated its intention to keep the federal funds rate at near-zero until the unemployment rate falls to 6.5 percent). In addition to these, the federal government passed a large-scale fiscal stimulus program that was financed by a major expansion in the federal government deficit. This federal stimulus program was the American Recovery and Reinvestment Act (ARRA), which President Obama signed into law in February 2009. This measure included $787 billion in new government spending and tax cuts for households and businesses.
Figure 1 presents data on the federal deficit as a share of GDP from just prior to the recession in 2007 through 2012, with the projected figure for 2013. It also shows the average figure for the 63-year period 1950 – 2012. As we see, in 2007, the deficit was at only 1.2 percent of GDP, which is below the average historic figure of 2.2 percent. This is while all tax cuts enacted under President George W. Bush were fully in force and with the U.S. military heavily engaged in both the Iraq and Afghanistan wars. The deficit rose to 3.2 percent of GDP in 2008, due to the initial decline in tax revenues that resulted from the onset of the recession. In 2009,
Pollin, “Austerity Economics” Draft: 4/13 p. 4
4
the deficit spiked to 10.1 percent of GDP, as tax revenues fell further and ARRA spending began. The deficit then fell modestly from 2010 – 2012, with the 2012 figure at 8.5 percent of GDP. As we see, the U.S. Office of Management and Budget projects the deficit at 5.5 percent of GDP in 2013. This decline in the deficit for 2013 would result from a projected $400 billion increase in revenues along with modest spending cuts in real dollars. As we see, the 2013 projected deficit would represent a sharp decline over the 2009 – 2012 period, though it would still keep the deficit well above the historic average of 2.2 percent of GDP. FIGURE 1 BELONGS HERE Overall, what is evident from this full 2007- 2013 period is that, regardless of the merits of the Bush tax cuts and the military spending increases devoted to Iraq and Afghanistan, these factors were not responsible for generating the historically outsized federal deficits. The large deficits were solely the result of the 2007-09 financial crisis and subsequent Great Recession.
The question we need to ask here is whether this pattern of deficit spending created a
government debt crisis that can only be brought under control through austerity. This has been the claim of austerity hawks since 2009. Some of the main figures making these claims have been leading U.S. macroeconomists such as John Taylor, Alan Meltzer, Martin Feldstein, and Robert Barro.1 Beginning soon after the deficit began expanding significantly in 2009, these and other austerity hawks focused, with only small variations, on three major hazards. These are:
1. Inflation. The large government deficits would produce significant inflationary
pressures, because large-scale government borrowing is pushing liquidity into the economy much faster than the economy is producing new goods and services.
2. Rising interest rates. The deficits generate an aggregate increase in demand for credit
much faster than the supply of credit is increasing from the overall pool of available savings. 3. Unsustainable debt burden. The growing deficits will produce a correspondingly
sharp increase in the ratio of government debt/GDP. The government will not be able to able to meet its debt servicing requirements without either imposing some combination of sharp tax increases or spending cuts, or allowing inflation to rise to dangerous levels.
Why Inflation and Interest Rates are Low
1 The initial formulations of these austerity hawk positions are reviewed in Pollin (2010). See also Meltzer (2012) and Taylor (2012) .
Pollin, “Austerity Economics” Draft: 4/13 p. 5
5
I present basic summary data in Figure 2 on inflation and interest rate patterns since the fiscal deficit first rose sharply in 2009. As we see there, both inflation and the interest rate on U.S. Treasuries were at historic lows in the four years, 2009 – 12, during which government deficits were at their peak. Thus, the average inflation rate over the between 1953 – 2008 was 3.8 percent, while between 2009 – 12, inflation averaged only 1.6 percent. Similarly, the interest rate on 5-year Treasuries averaged 6.2 percent between 1953 – 2008, while, over 2009-12, the average rate on 5-year Treasuries was 1.6 percent.2 FIGURE 2 BELONGS HERE
Why did inflation and interest rates on government bonds reach such low average levels
despite the historically large fiscal deficits? First, the lack of inflationary pressure is the direct result of the high rates of unemployment and low rates of capacity utilization. These translate into no upward pressure on wages and prices from the demand side of the economy. Indeed, the predominant effect of high unemployment and low capacity utilization is deflationary pressures, not inflation. As Martin Feldstein himself acknowledged in 2010, “sustained budget deficits…do not cause inflation unless they lead to excess demand for goods and labor.” The other factor that could have caused inflationary pressures is an oil price shock similar in magnitude to the experience of the 1970s. In fact, oil prices did indeed spike in this period. The average retail price of a gallon of gasoline rose by 115 percent, from $1.84 to $3.96 between January 2009 and May 2011 and remained at this higher level into 2013. The fact that this did not create broader inflationary pressures throughout the U.S. economy only underscores the strength of the economy’s deflationary counter-pressures coming from the demand side.3 What about the sharp decline in interest rates on U.S. Treasuries? Two factors have been at play. The first is that financial market investors globally became increasingly focused on reducing their risks after the financial collapse, in a dramatic reversal of their mindset during the hyper-speculative years. Since the onset of the crisis, these investors have voted strongly in support of U.S. government bonds as the single safest store of their wealth.
The second factor has been the Federal Reserve’s aggressive policies to hold down
interest rates. This includes the Fed’s near-zero interest rate policy for its short-term policy target rate, the federal funds rate. In addition, under its “quantitative easing” program, the Fed has also
2 These time series data begin in 1953, since that is the first year in which figures are available for Treasury bond interest rates. 3 It is notable that food prices also spiked over this same period, both in the U.S. and globally. The sharp global increases in both oil and food prices are tied to the corresponding rise in speculative trading on the commodities futures markets. For further discussion, see Pollin and Heintz (2011) on oil prices and Ghosh, Heintz, and Pollin (2012) on food prices.
Pollin, “Austerity Economics” Draft: 4/13 p. 6
6
successfully lowered the longer-term rates on U.S. Treasuries by buying long-term Treasuries directly in the open market. Disastrous Government Debt Burden?
Even with low inflation and interest rates, it is still the case that large fiscal deficits have
led to an increasing level of accumulated government debt. Figure 3 shows the pattern of federal debt owed to the public as a share of GDP rising sharply from 2008, at 36.4 percent of GDP, to 62.9 percent in 2011, and a projected 73.5 percent of GDP for 2013. At the same time, as is also clear from the figure, the U.S. operated with a debt/GDP ratio above 50 percent from the World War II spike in borrowing in 1942 until 1956. The federal debt/GDP ratio hit a peak of over 100 percent in 1945-46. The federal debt/GDP ratio also rose sharply in the early 1980s under President Ronald Reagan, after having fallen steadily since the World War II peak. The figure for 1982 was 25.8 percent, which rose to a high of 49.1 percent in 1996.
Despite these broader historical perspectives on the current U.S. debt situation, the
austerity hawks have been pounding on the idea that the rising debt/GDP ratio since 2009 is creating a massive and unsustainable burden on U.S. government finances. The leading conservative macroeconomist John Taylor of Stanford has perhaps been most vociferous on this point. Taylor has written regularly about the increase in the U.S.debt in a tone that is openly alarmist. For example, Chapter 3 in his 2012 book First Principles is titled “Defusing the Debt Explosion.” He writes there as follows: “Nothing better signifies America’s recent failure to follow the principles of economic freedom than the exploding debt of the federal government. I do not exaggerate when I use the word “exploding,” (p. 101).
Taylor then presents a graph taken from the U.S Congressional Budget Office, showing total federal government debt as a share of U.S. GDP from 1850 – 2050 and beyond. Taylor observes about this graph that:
Its soaring upward climb resembles the fireworks on America’s Independence Day. But rather than remind us of America’s founding, it portends America’s ending. I carry a version of the chart in my wallet and show it to my students, and to my children and grandchildren, because it’s their future on the line,” (p. 101).
What Taylor does not clarify in his discussion of this figure is that the segment of the
graph that is exploding “like fireworks,” is occurring well into the future, starting around 2040. This explosion represents only a long-term projection of future U.S. debt growth by the Congressional Budget Office, working from a set of highly unrealistic assumptions about U.S.
Pollin, “Austerity Economics” Draft: 4/13 p. 7
7
fiscal deficit spending and taxation over the next 35 years. But the fact that someone of Taylor’s professional stature would write in such alarmist tones reflects the broader tenor of debate that has dominated U.S. fiscal policy debates since 2009.
What is still more remarkable about the perspective advanced by Taylor and allied
austerity hawks is that they make no mention of the fact that since 2009, the U.S. government’s debt servicing burden has been at historically low levels, not historic highs, despite the government’s rising level of indebtedness. We can see this in Figure 4, showing U.S. government interest payments as a percentage of total federal expenditures. As we see there, government interest payments from 2009 through 2013 averaged 6.4 percent. This contrasts with an average figure of 12.9 percent between 1981 – 92, under Presidents Ronald Reagan and George Bush-1. That is, the government’s debt-servicing burden since 2009 is less than one-half the average under Reagan and Bush. Moreover, the figure for 2009 – 2013 is nearly three percentage points below the 9.1 percent average figure for the full period 1940 – 2013. The explanation for this is straightforward: the low interest rates at which the U.S. has been able to borrow since 2009—the rate on 5-year U.S. Treasuries again averaging 1.6 percent from 2009 – 2013—has enabled the government to accumulate increasing debt without experiencing an accompanying heavy debt-servicing burden. By contrast, under Reagan and Bush-1, the average interest rate on 5-year U.S. Treasuries was 9.5 percent—i.e. nearly eight full percentage points higher than since 2009. This in turn meant that heavy government borrowing during the Reagan-Bush-1 era also produced severe debt-servicing burdens.
What is therefore evident from these figures on government interest payments is that,
claims of austerity hawks notwithstanding, in fact, the U.S. has not been facing a fiscal crisis at all in the commonsense meaning of the term. That is, the federal government is nowhere near approaching a point where it could become unable to cover its upcoming debt obligations. THE AUSTERITY AGENDA IN PRACTICE How Sequestration Cuts Favor the Military On March 1, 2013, the federal budgetary “sequestration” agenda was put into effect, fully in keeping with the perspectives advanced by the austerity hawks. The sequestration agenda includes $55 billion per year in annual cuts to both social and military spending relative to previously allocated levels. When Congress and President Obama originally agreed to the sequestration plan in November 2011, it was widely understood in mainstream political circles that these measures would never actually be enacted. Rather, the broadly shared mainstream
Pollin, “Austerity Economics” Draft: 4/13 p. 8
8
view was that Congress and the President would reach some alternative agreement for a deficit reduction program prior to hitting the deadline for imposing the automatic sequestration cuts. As of this writing in late March 2013, it is still possible that the President and Congress will reach some alternative agreement that will enable them to nullify the scheduled sequestration cuts. But based on how discussions have evolved since the sequestration bill was initially enacted in November 2011, and where the reports say any further discussions may be heading in the coming months, it is almost certain that any new agreement is not going to be more than marginally less committed to austerity than what would transpire through continuing with sequestration as is. For example, the Obama Administration has already made clear its willingness to accept cuts in Social Security, even though the spike in the fiscal deficits that began in 2009 had nothing whatsoever to do with funding Social Security.4
More generally, mainstream Democrats and Republicans appear to agree on reducing spending cuts for the military, and, therefore loading cuts disproportionately onto social spending. This is despite the fact that there is a basic asymmetry in the budgetary situations for military versus social spending. That is, the recent budgets for the military—which brought the military budget from 3.0 percent of GDP in 2000 to 4.7 percent in 2012—included funding to fight the Iraq and Afghanistan wars. With spending on these wars now nearly ended, there is no legitimate reason as to why the military budget should be maintained at its wartime levels. In fact, if the sequestration-based cuts in military spending are enacted in full, the net impact of these cuts would be to bring the military budget only to a level equal to that prior to Iraq and Afghanistan. That is, under full sequestration, the military budget would return to being about 3 percent of GDP as of 2017. Moreover, such calculations on the military budget also assume—hopefully but perhaps implausibly—tht the U.S. does not engage in additional wars between now and 2017. If we do end up fighting more wars, the budgets to pay for them would be exempt from any spending caps. The sky would be the limit. In short, aside from winding down Iraq and Afghanistan, the defense cuts that will result through sequestration are actually modest and easily reversible.5 In contrast with this situation for the military budget, spending on education, healthcare, family support, infrastructure and the environment have already fallen sharply as a result of the Great Recession. Further cuts will deeply compromise the already modest level of welfare state
4 The Obama administration is supporting cuts in Social Security through endorsing a change in the way in which Social Security cost-of-living adjustments are calculated. Specifically, they are supporting a change to a “chain-weighted” Consumer Price Index as opposed to maintaining the current Consumer Price Index for Urban Workers (CPI-W) as the basis for cost-of-living adjustments. In practice, the shift to the chain-weighted index will mean a reduction in the annual benefits to Social Security recipients. 5 See Pollin and Garrett-Peltier (2012) for further discussion on the U.S. military budget and sequestration.
Pollin, “Austerity Economics” Draft: 4/13 p. 9
9
provisions in the United States. We can see this clearly through considering conditions for state and local governments throughout the country. State and Local Governments’ Fiscal Crises Due to the sharp falls in incomes, spending, and property values tied to the recession, tax revenues from the two main sources for state governments—income and sales taxes—declined precipitously, and even local property taxes, after expanding continuously for decades, were flat in 2010. By 2010, state tax revenues (adjusted for inflation and population growth) had fallen by fully 13 percent relative to where they were in 2007. By comparison, revenues fell only 7 percent following the 2001 recession. Even during the 1981-82 recession, the most severe post World War II downturn prior to 2007 – 09, the decline in state tax revenues was less than 2 percent.6 Table 1 below shows the change in inflation-adjusted state tax revenues from the most recent revenue peaks in each state—those mostly being 2007—through 2011. We show figures aggregating revenue levels for all states, as well as those for six large, representative states, from different regions of the country—i.e. California, Illinois, New Jersey, New York, Texas and Virginia. As we see, overall, by the end of 2011, state tax revenues were down by 7 percent relative to the most recent peak levels. There were significant differences among the six representative states. But in the best case, New York, revenues were still down by 0.2 percent, while in the worst case, New Jersey, the revenue decline was 15 percent. TABLE 1 BELONGS HERE The recession also meant that people’s needs for state services rose sharply. This is clear through considering the situation with Medicaid, the U.S. health insurance program for low-income families that is jointly funded by the federal and state-level governments. Four million more people received health insurance through Medicaid in 2012 relative to 2008, as a result of rising unemployment and employers cancelling health care coverage. In addition, the number of people seeking assistance from the Low Income Home Energy Assistance Program, another joint federal/state government program, rose by 53 percent between 2008 and 2011, from 5.8 to 8.9 million households. That is, as of 2011, about 8 percent of all households were receiving this assistance. The net result of the collapse of tax revenues and rising demand for state services was budgetary shortfalls of $191 billion in 2010, $130 billion in 2011 and $112 billion in 2012. The 2011 shortfall was equal to 19 percent of all state spending commitments (Pollin and Thompson 2011). 6 Data are from Pollin and Thompson (2011). See also Heintz (2009) for related data and perspectives.
Pollin, “Austerity Economics” Draft: 4/13 p. 10
10
All states in the U.S. other than Vermont are required to maintain a balanced budget on their operating budgets every year. Without having the option of deficit spending on their current account, the states adjusted to these budgetary shortfalls through a combination of measures. The 2009 ARRA federal stimulus program, along with supplemental funds for Medicaid, did provide substantial support to help cover state and local government budget gaps. This amounted to about one-third of total budget gap generated by the recession. But that still meant that about two-thirds needed to be filled by other means. The ARRA funds also ran out by 2011.
The other two–thirds of the states’ budget gaps were filled primarily through expenditure cuts. The extent of the expenditure cuts is reflected in the changes in employment for state and local governments. Table 2 presents basic figures for the United States as a whole, along with six of the large, regionally representative states, California, Illinois, New Jersey, New York, Texas and Virginia. As the table shows, between December 2007 – June 2009, state and local government employment rose slightly, by 0.7 percent, before falling by 3.1 percent from June 2009 – May 2012. The patterns of the six major states in the table are broadly reflective of this same nationwide pattern.
TABLE 2 BELONGS HERE
State and local governments spend most of their money on education, health care, public
safety and various forms of non-health related social support, such as the home heating oil programs. The gaps in state and local governments have led to significant cuts in all these areas of public sector funding. The severity of the cuts have been exacerbated by the fact that, the population being supported by these programs has grown by approximately 12 million people, nearly 4 percent, between 2007 and 2012. From Fiscal Crisis to Attacks on the Public Sector7 Despite the reality that the state-level fiscal crisis was caused by the Great Recession, a widespread movement emerged among powerful groupings on the political right to claim that the fiscal crisis was the result of long-term excesses in public sector programs and on compensation for public sector workers. Thus, Arthur Laffer and Stephen Moore wrote in their introduction to the 2009 Annual Report of the American Legislative Exchange Council (ALEC), “The real
7 This section is mainly based on Pollin and Thompson (2011).
Pollin, “Austerity Economics” Draft: 4/13 p. 11
11
problem facing states is the fundamental issue of overspending taxpayers dollars.”8 Yet in fact, state and local spending has remained remarkably stable for decades, without having ever produced anything close to the severe budget crisis tied to the 2008-09 recession. Thus, in 2006, just prior to the recession, spending by state and local governments was 22.2 percent of total personal income, only slightly higher than the average figure over the mid-1990s of 21.5 percent. State and local government spending levels do fluctuate on a short-term basis as the overall economy alternates between phases of growth and recession. Over the longer term, state and local governments do also face rising cost pressures to cover health care expenses. But this is an economy-wide problem, with the federal government and private businesses experiencing similar pressures resulting from the excessive administrative burdens of the U.S. health-care system relative to those of other advanced economies.
It is also untrue that state and local government workers are overpaid, despite widespread claims to the contrary. One widely cited 2009 Forbes Magazine cover article reported that “State and local government workers get paid an average of $25.30 an hour, which is 33 percent higher than the private sector’s $19….Throw in pensions and other benefits and the gap widens to 42 percent.”
What such figures fail to reflect is that state and local government workers are older and substantially better educated than private-sector workers. Forbes is therefore comparing workers with different attributes. As John Schmitt of the Center for Economic Policy Research has shown (2010), when state and local government employees are matched up to private-sector workers of the same age and educational levels, the state and local government workers throughout the U.S. actually earn, on average, about four percent less than their private-sector counterparts. Moreover, the results of Schmitt’s properly constructed comparison are fully consistent with numerous studies examining this same question over the past 20 years. Broader Attacks on U.S. Workers Rights Such attacks on public sector workers emerging out of the recession broadened to becoming state-level attacks on workers collective bargaining rights generally. Thus, amid the struggle over its fiscal crisis, the state of Wisconsin passed a law in 2011 curbing the collective bargaining rights of many public employees. In that same period, Indiana enacted a right-to-work law, which enables workers to receive the benefits of union contracts without having to join the union. The state of Michigan, which, since the 1930s, had been the most significant stronghold of unionism in the United States, also became a right-to-work state in December 2012. The Michigan legislation enacting the right-to-work legislation was rushed through the
8 ALEC is primarily funded by the notorious right-wing billionaire Koch brothers. See, for example, Nichols (2011).
Pollin, “Austerity Economics” Draft: 4/13 p. 12
12
Michigan legislature, without hearings during an end-of-year lame duck session. As a result of these and related actions, the proportion of U.S. workers who were union members fell to a 97-year low in 2012, of 11.3 percent of the U.S. workforce (Greenhouse 2013). Austerity as a Tool of Class Struggle It is clear from the experiences of U.S. state and local governments that austerity policies have not brought the U.S. economy onto a healthy growth trajectory. This is not surprising since there is nothing in the austerity agenda that can serve as an engine of economic recovery. Indeed, since, collectively, state and local governments are the largest single source of employment in the U.S. economy, any agenda to cut state and local government employment will act as a drag on any movement toward expanding overall job opportunities. Moreover, this pattern for the U.S. is fully consistent with the experiences with fiscal austerity in Europe since 2010. In an important January 2013 paper examining the austerity experience in Europe, IMF Chief Economist Olivier Blanchard, along with IMF colleague Daniel Leigh acknowledge that the negative effects of austerity cuts have been more severe than the IMF had originally estimated. Specifically, they found that austerity cuts in the Eurozone have led to reductions in overall output in excess of the total level of spending cuts. The IMF had previously held that austerity cuts in public spending would rather encourage more private sector spending that would offset to a significant degree the public sector cuts. This previous IMF position was derived from the “crowding out” theory of fiscal deficits. According to the crowding out theory, increases in government deficit spending reduces the amount of affordable credit available for private investors, and thereby discourages private investment. Correspondingly, according to this approach, reducing government deficit spending will provide a larger pool of affordable credit for private sector investors. The increasing availability and affordability of funds for private investors was supposed to create a channel through which government austerity policies could promote recovery. But the overall body of evidence had never supported this crowding out position.9 The most recent experiences in both the U.S. and Europe have only confirmed the conclusions of this longstanding literature. This does raise the question: if the evidence is overwhelming that austerity policies do not promote recovery out of recessions, then why do elites in the U.S., along with those in Europe, continue to push this agenda? No doubt, there are sincere austerity hawks such as John Taylor who think—however erroneously—that there are no alternatives in the face of historically
9 Some earlier references on this debate, offering alternative perspectives, includes Eisner (1986), Friedman (1988), Heilbroner and Bernstein (1989), and Rock (1991).
Pollin, “Austerity Economics” Draft: 4/13 p. 13
13
high debt levels. Focusing on the U.S. again, there are also no doubt scheming Republicans who support austerity now because they calculate that it could well drag the economy down, which in turn will damage Obama and the Democrats just in time for the 2014 election. But there is also a deeper, longer-term factor at play: that elites in both the U.S. and Europe are eager to dramatically push down wages and eviscerate the welfare states in their respective countries. Their purpose is to permanently lower their labor costs and taxes, which in turn mean fatter profits and still higher incomes for the rich. The evidence from the U.S. since the recession officially ended in June 2009 is certainly consistent with this perspective. Thus, Emmanuel Saez of UC Berkeley reports (2013) that the richest one percent of U.S. households captured an astounding 121 percent of the economy’s total income growth from 2009 – 2011, i.e. the two first years of official recovery. The bottom 99 percent of U.S. households experienced -0.4 percent income growth over 2009 – 11. This was after the bottom 99 percent experienced an average income decline of 11.6 percent during the official recession years 2007 – 09. It is precisely due to such patterns that the U.S. stock market could begin booming in early 2013, even while GDP growth for the last three months of 2012 was at a paltry 0.4 percent, and official unemployment had only edged down to 7.7 percent as of February 2013—i.e. nearly four full years since the recession had officially ended. SHORT- AND LONG-TERM ALTERNATIVES TO AUSTERITY Coming up with alternatives to the austerity agenda in the U.S. begins with asking a different set of questions than those posed by the austerity hawks. Instead of asking how to bring down the U.S. fiscal deficit to control the economy’s supposed fiscal crisis, the question we should rather ask is: how do we eliminate mass unemployment and move the U.S. economy onto a path of sustainable full employment? There is a wide range of issues to address if we want to seriously advance full employment as a serious alternative to today’s dominant austerity agenda. These include issues around globalization, financialization and financial regulation, the inflation-unemployment trade-off, industrial policy, new progressive sources of tax revenues, and controlling health care costs.10 For the current discussion, I focus on only two issues that I consider central to the broader discussion. These are: 1) Creating an effective overall stimulus program in the short-run; 2) Permanently expanding decent employment opportunities in the long run through investments in the green economy and education. Credit Policies for Short-Run Stimulus
10 I cover this broader set of questions in Pollin (2012A).
Pollin, “Austerity Economics” Draft: 4/13 p. 14
14
As we have seen, the federal government is not in a fiscal crisis. Interest payments on the federal debt are at a near-historic low of 5.9 percent of total government spending as of 2013, a figure that is less than half the average under Ronald Reagan and George H.W. Bush. Especially with interest rates for the U.S. government remaining at historically low levels, the federal government can and should expand spending on education, health care, public safety, family support, traditional infrastructure and the green economy, as well as unemployment insurance. Much of this funding can be used simply to stop and reverse the cuts we have seen in state and local government budgets. Overall, the amounts devoted to spending in these areas should be at least as large as the roughly $400 billion per year that was budgeted through the original ARRA. Fiscal policies such as I describe above have been widely discussed in progressive circles, including the Congressional Progressive Caucus.11 I want to therefore focus on what I consider to the equally important area of money and credit policies, where there has been much less attention paid to the possibilities for building a viable alternative to austerity.
Commercial Banks’ Cash Hoards All such discussions should begin with the fact that increasingly since 2010, U.S.
commercial banks are sitting on massive, historically unprecedented cash hoards. As of the most recent data from the last quarter of 2012, the commercial banks were carrying an unprecedented $1.5 trillion in cash reserves. This is equal to nearly 10 percent of U.S. GDP. The banks obtained most of this money through the Federal Reserve having maintained the interest rate at which banks can borrow at nearly zero percent—that is, the banks have access to nearly unlimited liquid funds at no borrowing costs. The other big source of the banks’ funds was the Fed’s quantitative easing program, whereby the Fed purchased longer-term Treasury holdings from the banks.
Figure 5 shows how the commercial banks cash reserves have ballooned relative to pre-
recession levels. As we see, as of 2007, the total cash holdings of the banks were under $20 billion. By the end of 2011, it was $1.6 trillion. The total since edged down slightly to $1.5 trillion in 2102. Of course, banks need to maintain a reasonable supply of cash reserves as a safety cushion against future economic downturns. One of the main causes of the 2008-09 crisis and other recent financial crises was that banks’ cash reserves were far too low. But increasing reserves to $1.5 trillion is certainly a new form of financial market excess.
It is true that a significant fraction of these funds need to be held by the banks to carry an
adequate margin of safety in the currently highly risky environment. However, as I have 11 See, for example, the Congressional Progressive Caucus’s (2013).
Pollin, “Austerity Economics” Draft: 4/13 p. 15
15
analyzed elsewhere (Pollin 2012B), after making highly conservative assumptions about the safety requirements of the banks in the current environment, I concluded that a reserve fund of $600 billion for the commercial banks would provide a safety margin far beyond any previous historical experience as well as beyond current needs. This means that about $1 trillion should be available to move into the economy as productive loans.
Escaping the Liquidity Trap Of course, saying the money is available in abundance doesn’t mean it is going to get
channeled into job generating job-generating investments. Private businesses operate to earn a profit. As such, the fact that banks are sitting on approximately $1 trillion in excess cash rather than lending these funds for productive purposes must mean that, at some level, they do not see adequate profit opportunities in the U.S. economy today through investments and job creation. These conditions in credit markets over the Great Recession and subsequently are hardly unique relative to previous recessions, in the U.S. and elsewhere, and the 1930s Depression itself. Indeed, this contemporary experience represents just the most recent variation on the classic problems in recessions in reaching a “liquidity trap” and trying to “push on a string.” This is when banks would rather sit on cash hoards than risk making bad loans, and businesses are not willing to accept the risk of new investments, no matter how cheaply they can obtain credit. The liquidity trap that has prevailed since the 2008-09 recession has served as a major headwind, counteracting the effects of what, on paper, had been a strongly expansionary macro policy stance through the ARRA.
How to escape this liquidity trap? Clearly, if businesses don’t see investment opportunities, that means that one overarching problem in the economy is insufficient demand from consumers, businesses, and the government itself as a purchaser. In the face of inadequate market demand, a federal government austerity agenda—cutting back on government spending—would then just make the economy’s demand problem worse, not better. So step one for ending the liquidity trap has to be reversing the fiscal austerity agenda, and instead getting refocused, as discussed briefly above, on a viable federal stimulus.
However, the economy has also been operating with severe credit constraints, with small
businesses, in particular, having been locked out of credit markets. We therefore need to explore a range of policy approaches that can reduce the level of risk for borrowers and lenders, and/or raise the costs for banks to continue holding cash hoards. I focus here on two ideas: extending federal loan guarantees for small businesses and taxing the excess reserves of banks.
Pollin, “Austerity Economics” Draft: 4/13 p. 16
16
Combining One Carrot and One Stick This approach is simple, combining the use of one big carrot and one big stick to
creating millions of new jobs quickly. The carrot would be measures to substantially reduce the level of risk being faced by both borrowers and lenders. This can be done through the federal government’s existing loan guarantee program. In terms of practical implementation of such a program, the federal government does already operate various loan guarantee programs on a major scale. Thus, for 2012, the total level of loans guaranteed by the federal government was about $780 billion. This equals about 2.8 percent of all outstanding debt held by U.S. households and domestic non-financial businesses. By far, the largest category of loan guarantees was housing subsidies, with about $130 billion going to businesses. The federal government should pursue an agenda to roughly triple as rapidly as possible its overall loan guarantee program to non-housing related businesses to about $450 billion in total, with the focus of the expansion on small businesses. That would entail an increase of guaranteed loans for small business of about $300 billion. This would represent a major expansion of the existing federal guarantee programs, while still remaining within the scale of existing overall programs. It would also be a huge benefit to small businesses, which—as the Republicans never stop touting—do indeed create significantly more jobs per dollar of spending than big businesses.
The stick would be for the federal government to tax the excess reserves now held by
banks. This should create a strong disincentive for banks to continue holding massive cash hoards. It is difficult to know in advance what the appropriate tax rate should be for this purpose—probably in the range of 1-2 percent. But any such initiative should also allow Congress to operate with flexibility, to adjust the rate as needed for channeling excess reserves into job-generating investments. For starters, the Fed needs to stop paying interest on bank reserves. It currently pays 0.25 percent on these accounts. Indeed, this whole initiative could be conducted through the Fed, as opposed to having Congress pass an excess reserve tax. The way they could do this is to establish a maximum level of reserves that they would allow banks to hold without facing a penalty for holding excess cash hoards.
One crucial feature of this combination of policies is that its impact on the federal budget
will be negligible. Loan guarantees are contingent liabilities for the federal government. This means that, beyond some relatively modest increase in administrative costs, the government would incur costs from the loan guarantee program only as a result of defaults on the guaranteed loans. Even if we assumed, implausibly, that the default rate on the new loans was triple the proportion that prevailed in 2007, prior to the recession, this would still increase the federal
Pollin, “Austerity Economics” Draft: 4/13 p. 17
17
budget by less than one percent. Moreover, a significant share of this budgetary expense could be covered by the revenues generated by the excess reserve tax.
Austerity hawks should therefore take note: the carrot of a new loan guarantee program
for small businesses and the stick of taxing the massive cash hoard now being held by commercial banks—with money they obtained nearly for free from the Fed’s zero interest rate policy—would be a nearly cost-free approach to providing serious support for small businesses especially. This would enable small businesses to expand operations and begin to making the job-generating investments we need. Clean Energy and Education Investments for Long-Run Prosperity12
We can envision the path to creating a sustainable full-employment economy through considering some basic data on the job-creating effects of investing in clean energy and education relative to spending on fossil fuel energy and the military. Figure 6 shows the level of job creation in each of four sectors—clean energy, education, fossil fuels and the military—for every $1 million in spending in these sectors. By a significant margin, education is the most effective source of job creation among these alternatives--about 27 jobs per $1 million in spending. Clean energy investments are second, with about 17 jobs per $1 million of spending. The U.S. military creates about 11 jobs, while spending within the fossil fuel sector, by far the weakest source of job creation per dollars, creates about 5 jobs per $1 million. FIGURE 6 BELONGS HERE
These figures combine three categories of job creation—what are termed direct, indirect
and induced job creation—that result through spending on any activity. Direct jobs are those created by an activity itself, such as building a wind turbine, hiring school teachers, opening a military base in Afghanistan, or transporting oil from the Persian Gulf to Houston. Indirect jobs are those generated by businesses providing supplies to support the direct activities, such as steel manufacturers supplying a wind turbine manufacturer, or a paper company providing office supplies to a school, military base, or an oil company’s corporate headquarters. The term “induced jobs” refers to the expansion of employment that results when people who are newly hired—either through direct or indirect job creation—spend the money they have begun to earn. This is also frequently termed the “multiplier effect” of direct and indirect job creation. These multiplier effects that generate induced jobs are especially beneficial in offering expanding market opportunities for small businesses, such as food service firms selling lunches at a wind-energy work site.
Two main factors account for the differences in total job creation across sectors, including all direct, indirect, and induced jobs. The first is relative labor intensity, the amount of
12 This section is based mainly on Pollin, Heintz, and Garrett-Peltier (2009) and Pollin and Garrett-Peltier (2011).
Pollin, “Austerity Economics” Draft: 4/13 p. 18
18
people, as opposed to everything else, a business utilizes in its operations. For example, a clean energy investment program utilizes far more of its budget to hire people than to acquire machines, supplies, land (either on- or offshore), or energy itself.
The second factor is relative domestic content per overall spending amount—how much
of the work is done within the U.S. rather than other countries. The clean energy sector relies much more than the fossil fuel sector on economic activities taking place within the United States—such as retrofitting homes or upgrading the electrical grid system—and less on imports.
Consider an agenda in which we transfer about 25 percent of total spending in both the
military ($700 billion) and fossil fuel ($625 billion) sectors—that is, about $330 billion per year—in equal shares into education and clean energy? Before assessing the effect of this transfer of spending priorities on employment, we should of course also recognize their crucial and complimentary political and environmental benefits. Reducing the Pentagon’s budget by 25 percent would simply return the military to its spending level prior to the wars in Iraq and Afghanistan, i.e., as discussed above, to about 3 percent of U.S. GDP. Such cuts would result if the sequestration program were carried out through 2017 under its current stipulations.
Cutting spending from fossil fuels and transferring it into clean energy of course reflects the imperative of controlling CO2 emissions to fight global climate change. Indeed, if we are going to meet widely recognized minimum level of reductions to stabilize average global temperatures at acceptable levels—80 percent below our 2000 level as of 2050--we will need to reduce fossil fuel spending by far more over the coming generation. Finally, transferring approximately $165 billion per year into spending on education would represent a roughly 16 percent increase over the current total public spending level of about $1 trillion. An increase in educational funding of this magnitude could mean, for example, reducing average classroom sizes nationwide from 23 to 19 students per class, plus an increase in the average amount of financial aid of $1,500 for college students, plus substantial improvements in school buildings throughout the country—or some appropriate combination of these and other priorities. In terms of employment effects, the impact of a $330 billion annual spending shift out of the military and fossil fuel sectors and into education and clean energy would be dramatic. It would create about 4.8 million more jobs for a given level of total spending. The job expansion would be across all sectors and activities—i.e. new opportunities for highly paid engineers, researchers, lawyers and business consultants as well as for elementary school teachers, carpenters, bus drivers, cleaning staff at hotels, and lunch-counter workers at wind energy construction sites. Note also, that I am not proposing net increases in aggregate spending at all, but rather shifts in relative levels of spending between sectors that will generate a rise in overall labor intensity and domestic content for a given amount of spending. In the context of today’s economy, the injection of 4.8 million new jobs would reduce the unemployment rate by about one-third, from about 8 to 5 percent. Realistically however, this kind of large-scale shift in spending economy-wide will not occur rapidly enough to affect today’s unemployment rate, in contrast with the short-term fiscal and credit policy measures
Pollin, “Austerity Economics” Draft: 4/13 p. 19
19
discussed above. But this large-scale shift in the country’s investment priorities is capable of transforming the employment picture over the long-term. For example, assume that the unemployment rate were to fall over the next two years, if only to, say, 6.5 percent, through some combination of government interventions from the Obama administration and Federal Reserve along with something akin to a normal pattern of recovery. Within such a scenario, 4.8 million additional jobs through a spending shift that raises the labor intensity and domestic content of overall spending would drop the 6.5 unemployment rate to 3.4 percent. At this point, we would be at an unemployment rate where, in both the 1960s and 1990s, significantly in both periods when unemployment fell below 4 percent. In short, this kind of shift in investment priorities—toward clean energy and education and away from fossil fuels and the military—can be the foundation for building a sustainable full employment economy. THE BATTLES BEFORE US
The ascendency of austerity economics, both in the U.S. and Europe, is the most harmful intellectual and political development of our time. First and foremost, the austerity hawks are alarmed over the sharp rise in fiscal deficits. But the deficits themselves obviously emerged to counteract the deflationary effects of the global financial crisis caused by Wall Street hyperspeculation. In fact, the financial crisis led to the global Great Recession. Yet yet the effects of the crisis would have been more severe still in the absence of the large fiscal deficits that supported countercyclical spending measures. Thus, while the crisis was clearly caused by Wall Street, and the fiscal deficits emerged to counteract the crisis, the austerity hawks have managed to turn the policy debate on its head, through their insistence that the overarching problem of our current period is actually the fiscal deficits themselves. The austerity hawks have prevailed in advancing this position even though—focusing on the U.S case—the large-scale fiscal deficits from 2009 - 12 did not produce either dangerously high inflation or interest rates, as the hawks had repeatedly predicted. Of course, heavy borrowing by the federal government did produce rising government debt levels. But as we have seen, the U.S. has been able to service this debt with historically low levels of interest payments, precisely because the interest rates on U.S. Treasury bonds have themselves remained low since the onset of the crisis. As such, the U.S. is nowhere near experiencing a fiscal crisis in the commonsense definition of the term, which is to say, the government is facing difficulties in meeting its commitments to creditors. This is a simple fact which, to my knowledge, the austerity hawks have never recognized. The recent experiences of state and local governments reviewed above show us clearly how the austerity agenda is attacking the foundations of what had already been a modest U.S. welfare state. But it is becoming increasingly clear that many, if not most, austerity hawks see
Pollin, “Austerity Economics” Draft: 4/13 p. 20
20
this development not as a problem, but rather as part of their agenda. That is, many austerity hawks in the U.S. view this historical moment as an opportunity to eviscerate the public sector, labor unions, social insurance and other basic social protections. To date, as we have seen, the austerity agenda has succeeded over the 2010-11 “recovery” years in delivering sharply rising incomes for the richest one percent of households while incomes for everyone else have stagnated or declined. It is not difficult to develop viable alternatives to this austerity agenda. I have sketched some ideas capable of both moving the U.S. economy toward full employment in the short-term and sustaining full employment in the long term. Investing in the green economy and education, while allowing both the fossil fuel and military sectors to contract, are central to this long-term full employment agenda. The most difficult question with these and similar proposals is not whether they are analytically sound, which they are, most certainly in comparison with the unsupportable analytic claims of the austerity hawks. The real challenge with all such alternatives is whether progressives can develop the political strength to force these ideas onto the mainstream policy agenda, as effective tools for reversing the ongoing descent into austerity.
References
Arestis, Phillip and Theodore Pelagidis (2010) “Absurd Austerity Policies in Europe,” Challenge, 53:6, pp. 54 – 61. Blanchard, Olivier and Daniel Leigh (2013) “Growth Forecast Errors and Fiscal Multipliers,” International Monetary Fund, IMF Working Paper WP/13/1, http://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf Congressional Progressive Caucus (2013) Back to Work Budget, Washington, DC: http://cpc.grijalva.house.gov/back-to-work-budget/ Daly, Suzanne (2012) “Spain Recoils as Its Hungry Forage Trash Bins for a Next Meal, The New York Times, September 24, http://www.nytimes.com/2012/09/25/world/europe/hunger-on-the-rise-in-spain.html?pagewanted=all&_r=1& Fitch, Stephen (2009) “Gilt-Edged Pensions,” Forbes, February 16, http://www.forbes.com/forbes/2009/0216/078.html. Eisner, Robert (1986) How Real is the Federal Deficit? New York: The Free Press. Friedman, Benjamin (1988) Day of Reckoning: The Consequences of American Economic Policy under Reagan and After, New York: Random House.
Pollin, “Austerity Economics” Draft: 4/13 p. 21
21
Greenhouse, Steven (2013) “Share of the Work Force in a Union Falls to a 97-Year Low, 11.3%” New York Times, January 23, http://www.nytimes.com/2013/01/24/business/union-membership-drops-despite-job-growth.html Heilbroner, Robert L. and Peter Bernstein (1989) The Debt and the Deficit: False Alarms/Real Possibilities, New York: WW Norton and Company. Heintz, James (2009) “The Grim State of the States: The Fiscal Crisis Facing State and Local Governments,” New Labor Forum 18:2, pp. 7 – 15. Ghosh, Jayati , James Heintz, and Robert Pollin (2012) “Speculation on Commodities Futures Markets and Destabilization of Global Food Prices: Exploring the Connections,” International Journal of Health Services, 42:3, 465-483. Laffer, Arthur and Stephen Moore (2009), “Introduction,” to 2009 Annual Report of the American Legislative Exchange Council, http://www.americanlegislator.org/. Meltzer, Alan (2012) Why Capitalism? New York: Oxford University Press. Nichols, John (2011) “The Koch Brothers, ALEC and the Savage Assault on Democracy,” The Nation, 12/9, http://www.thenation.com/blog/165077/koch-brothers-alec-and-savage-assault-democracy Pollin, Robert (2010) “Austerity is Not a Solution: Why the Deficit Hawks are Wrong,” Challenge, 53:6, November/December, 6-36. Pollin, Robert (2012A) Back to Full Employment, Cambridge, MA: MIT Press. Pollin, Robert (2012B) “The Great U.S. Liquidity Trap of 2009 – 11: Are We Stuck Pushing on Strings? Review of Keynesian Economics, 1:1, pp. 55-76. Pollin, Robert, James Heintz, and Heidi Garrett-Peltier. 2009. The Economic Benefits of Investing in Clean Energy, Washington, DC: Center for American Progress. Pollin, Robert and James Heintz (2011) “How Wall Street Speculation is Driving Up Gasoline Prices Today,” Amherst, MA: Political Economy Research Institute Research Brief, June, http://www.peri.umass.edu/fileadmin/pdf/research_brief/PERI_AFR_Research_Brief_June20.pdf Pollin, Robert and Heidi Garett-Peltier (2011) The U.S. Employment Effects of Military and Domestic Spending Priorities: 2011 Update, Amherst, MA: Political Economy Research Institute, http://www.peri.umass.edu/fileadmin/pdf/published_study/PERI_military_spending_2011.pdf Pollin, Robert and Jeff Thompson (2011) “State and Municipal Alternatives to Austerity,” New Labor Forum, 20:3, pp. 22-30. Pollin, Robert and Heidi Garrett-Peltier (2012) “Benefits of a Slimmer Pentagon,” The Nation, May 28, 2012, pp. 15-18.
Pollin, “Austerity Economics” Draft: 4/13 p. 22
22
Rock, James L ed., (1991) The Debt and the Twin Deficits Debate, Palo Alto, CA: Mayfield Publishing. Saez, Emmanuel (2013) “Striking it Richer: The Evolution of Top Incomes in the United States,” Department of Economics, University of California Berkeley, http://elsa.berkeley.edu/~saez/saez-UStopincomes-2011.pdf Sawyer, Malcolm (2012) “The Tragedy of UK Fiscal Policy in the Aftermath of the Financial Crisis,” Cambridge Journal of Economics, 36:1, pp. 205 – 222. Schmitt, John (2010), “The Wage Penalty for State and Local Government Employees,” Center for Economic and Policy Research, May, http://www.cepr.net/index.php/publications/reports/wage-penalty-state-local-gov-employees/. State Budget Crisis Task Force (2012) Report of the State Budget Crisis Task Force, http://www.statebudgetcrisis.org/wpcms/wp-content/images/Report-of-the-State-Budget-Crisis-Task-Force-Full.pdf Taylor, John (2012) First Principles: Five Keys to Restoring America's Prosperity, New York: W. W. Norton & Company. Zezza, Gennaro (2012) “The Impact of Fiscal Austerity in the Eurozone,” Review of Keynesian Economics, 1:1, pp. 37 – 54
Pollin, “Austerity Economics” Draft: 4/13 p. 23
23
0
2
4
6
8
10
12
1950 -2012
av erage
2007 2008 2009 2010 2011 2012 2013estimate
1.2%
3.2%
10.1%
9.0%8.7% 8.5%
5.5%
2.2%
Deficits after Great Recession
Figure 1. U.S. Federal Deficts as Share of GDP
Def
icit
s as
pct
of
GD
P
Source: U.S. Office of Management and Budget
Pollin, “Austerity Economics” Draft: 4/13 p. 24
24
1
2
3
4
5
6
7
8
Inflation
1953 - 2008
3.8%
5-Year Treasuries
1953 - 2008
1.6%
6.2%
2009 - 2012
1.6%2009 2012
Infl
atio
n a
nd
in
tere
st r
ates
, in
per
cen
tag
es
Figure 2.U.S. Inflation and Government Bond Interest Rates:
Source: Economagic
Long-term Patterns (1953 - 2008) and post-Great Recession Fiscal Deficit Spike (2009 - 2012)
Pollin, “Austerity Economics” Draft: 4/13 p. 25
25
20
30
40
50
60
70
80
90
100
110
1940 1950 1960 1970 1980 1990 2000 2010
Figure 3. U.S. Federal Government Debt Owed to the Public
as a Share of U.S. GDP, 1940 - 2013
Fed
eral
deb
t as
a p
erce
nta
ge
of
GD
P
Source: Economic Report of the President 2013
Debt increasesunder Reagan
and Bush-1
World War IIdebt increases
Debt increasessince Great Recession
Note: 2012 and 2013 figures are estimates
Pollin, “Austerity Economics” Draft: 4/13 p. 26
26
0
2
4
6
8
10
12
14
16
1940 1950 1960 1970 1980 1990 2000 2010
Figure 4.U.S. Federal Government Interest Payments as Share
of Total Government Expenditures, 1940 - 2013
Source: U.S. Office of Management and BudgetNote: 2012 and 2013 figures are estimates
Fed
eral
in
tere
st p
aym
ents
as
pct
. o
f to
tal
fed
eral
exp
end
itu
res
1945 - 50interest burden:10.1%
Interest burdenunder Reagan andBush-1:12.9%
Interest burdensince 2009:6.4%
Average interest burden 1940 - 2013: 9.1%
Pollin, “Austerity Economics” Draft: 4/13 p. 27
27
0
400
800
1,200
1,600
2,000
01 02 03 04 05 06 07 08 09 10 11 12
Figure 5.Cash Reserve Holdings by U.S. Commercial Banks, 2001 - 2012
Bil
lio
ns
of
$
$17.5billion
$20.8billion
$860billion
$1.6trillion $1.5
trillion
Source: Flow of Funds Accounts of U.S. Federal Reserve System
Pollin, “Austerity Economics” Draft: 4/13 p. 28
28
0
5
10
15
20
25
30
Figure 6. Job Creation in the U.S. through$1 Million in Spending
nu
mb
er
of
job
s c
rea
ted
FossilFuels
(oil, coal,natural gas)
5.2 jobs
MilitarySpending
11.2 jobs
Clean energy(efficiency/renewables)
16.8 jobs
Education
26.7 jobs
Sources: Pollin, Heintz, and Garrett-Peltier (2009); Pollin and Garrett-Peltier (2011)
Pollin, “Austerity Economics” Draft: 4/13 p. 29
29
TABLE 1. Decline in State Tax Revenues:
From Pre- Great Recession Revenue Peak to 2011
All U.S. States
-12.0% -7.0%
California
-14.9% -4.8
Illinois
-18.7% -8.2%
New Jersey
-17.2% -15.0%
New York -4.3% 0.2%
Texas
-15.4% -9.2%
Virginia
-15.9% -12.6%
Source: State Budget Crisis Task Force (2012) Note: Figures are adjusted for inflation, but not for legislative changes.
Pollin, “Austerity Economics” Draft: 4/13 p. 30
30
TABLE 2. Employment Changes for State and Local Governments over the Great Recession:
December 2007 to May 2012
Percentage Change in Employment December 2007 –
June 2009 June 2009 – May 2012
All States
0.7% 2.9%
California
-0.4% -5.6
Illinois
1.2% -3.0%
New Jersey
0.8% -3.6%
New York
0.8% -1.7%
Texas
3.5% -2.6%
Virginia
1.6% 2.4%
Source: State Budget Crisis Task Force (2012)
PO
LIT
ICA
L E
CO
NO
MY
R
ESEA
RC
H IN
ST
ITU
TE
The Rebranding of Capital Controls
in an Era of Productive Incoherence
Ilene Grabel
April 2013
WORKINGPAPER SERIES
Number 318
Gordon Hall
418 North Pleasant Street
Amherst, MA 01002
Phone: 413.545.6355
Fax: 413.577.0261
www.peri.umass.edu
DRAFT; April 1, 2013 version
THE REBRANDING OF CAPITAL CONTROLS IN AN ERA OF PRODUCTIVE INCOHERENCE Ilene Grabel* Josef Korbel School of International Studies University of Denver Denver, CO 80208, USA Email: [email protected] Paper prepared for the annual conference of the International Studies Association San Francisco, 3‐6 April 2013; panel on “Capital Controls and the Global Financial Crisis” Abstract The re‐branding of capital controls has occurred against a broader backdrop of change and uncertainty. This state of affairs—which I have elsewhere termed “productive incoherence”‐‐constitutes the broader environment in which thinking and practice on capital controls is now evolving. The present incoherence is, in my view, productive because it has widened the space around capital controls to a greater and more consistent degree than in the years that followed the East Asian crisis of 1997‐98. How are we to account for this extraordinary ideational and policy evolution on capital controls during the current crisis? I examine five factors that, in my view, must appear in any comprehensive account of the evolving re‐branding of capital controls during the current crisis. These include: (1) the rise of increasingly autonomous developing states, largely as a consequence of their successful responses to the Asian financial crisis; (2) the increasing self confidence and assertiveness of their policymakers in part as a consequence of their relative success in responding to the current crisis at a time when many advanced economies faltered badly; (3) a pragmatic adjustment by the IMF to an altered global economy in which its influence has been severely restricted; (4) the intensification of the need for capital controls by countries at the extremes—i.e., not just those that faced implosion and thereby threatened cross‐national contagion, but also and far more importantly by those that fared “too well” during the current crisis; and (5) changes in the ideas of academic economists and among IMF staff. I conclude by exploring in passing important tensions that have emerged in conjunction with the re‐branding of capital controls. Paramount in this regard are the efforts by IMF staff and some academic economists to “domesticate” the discussion and use of capital controls, in part by the implementation of (something akin to) a “code of conduct” to regulate and constrain capital account interventions. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ *I thank George DeMartino for comments on this draft and Alison Lowe for excellent research assistance.
1
1. INTRODUCTION There’s a political cartoon that I’ve had in mind these days when I think about the recent changes in the international political economy of capital controls. Picture a sailboat in stiff winds on rough seas.. The wind in the sails is labeled something like “Brazil, China, or the Global South.” The boat is labeled “S.S. Capital Controls.” The International Monetary Fund’s (IMF) Managing Director Christine Lagarde is at the tiller, and she barks at her worry‐stricken shipmate—“No, don’t trim the sails!” But we also see that the ship is trailing its anchor, which is labeled “Neoliberalism.” I begin with this image because I think it captures well the conflicted practical and ideational processes surrounding capital controls during the current global financial crisis. Many extraordinary things have happened during the crisis, one of which is that capital controls have been successfully “re‐branded” as a tool of prudential financial management, even within the corridors of the IMF. In this paper I examine the myriad factors that have enabled this re‐branding. As with most rebranding exercises there is uncertainty about whether the framing will prove sufficiently sticky, especially in the context of tensions and countervailing impulses at the IMF and elsewhere around this effort. The re‐branding of capital controls has occurred against a broader backdrop of change and uncertainty. This involves unfolding transformations within the IMF; changes in its relationships to increasingly assertive governments in the global South; the appetite for innovations in financial architectures in the developing world; a reduction in the degree of hubris and monotheism in the economics profession; and the uncertain and lagging recovery in the US and Europe. This state of affairs—which I have elsewhere termed “productive incoherence”‐‐constitutes the broader environment in which thinking and practice on capital controls is now evolving [see Grabel, 2011]. By productive incoherence I refer to the proliferation of responses to the crisis by national governments, groups of countries, multilateral institutions (particularly within many quarters of the IMF) and the economics profession that to date have not congealed into a consistent, singular approach to capital controls. The term productive incoherence is intended to signal the absence of a unified, consistent, universally applicable (new) view on capital controls. The present incoherence is, in my view, productive because it has widened the space around capital controls to a greater and more consistent degree than in the years that followed the East Asian crisis of 1997‐98.1 How are we to account for this extraordinary ideational and policy evolution on capital controls during the current crisis? In what follows I will examine five factors that, in my view, must appear in any comprehensive account of the evolving re‐branding of capital controls during the current crisis. These include: (1) the rise of increasingly autonomous developing states, largely as a consequence of their successful responses to the Asian financial crisis; (2) the increasing self confidence and assertiveness of their policymakers in
1 See Best [2005] for discussion of the related issue of ambiguity in international monetary governance. She argues that the international political and economic stability of the postwar WWII era depended on a carefully maintained balance between coherence and ambiguity.
2
part as a consequence of their relative success in responding to the current crisis at a time when many advanced economies faltered badly; (3) a pragmatic adjustment by the IMF to an altered global economy in which its influence has been severely restricted; (4) the intensification of the need for capital controls by countries at the extremes—i.e., not just those that faced implosion and thereby threatened cross‐national contagion, but also and far more importantly by those that fared “too well” during the current crisis; and (5) changes in the ideas of academic economists and among IMF staff. I will conclude by exploring in passing important tensions that have emerged in conjunction with the re‐branding of capital controls. Paramount in this regard are the efforts by IMF staff and some academic economists to “domesticate” the discussion and use of capital controls, in part by the implementation of (something akin to) a “code of conduct” to regulate and constrain capital account interventions. My discussion of the re‐branding of capital controls highlights the complex interaction of economic realignments, tension, aperture and uncertainty in facilitating a powerful evolution in ideas about and the use of capital controls during the current crisis. My account of this evolution resonates with accounts of ideational and policy change within constructivist international political economy, including those that focus on the way that exogenous shocks create opportunities for new ideas to become sticky within a narrow window of time or incrementally [e.g. Best, 2003; Blyth, 2002; Moschella, 2010, 2012; Widmaier et al., 2007]; those that focus on the interaction of ideas and external interests in driving ideational change [e.g., Blyth, 2003; Kirshner, 2003; Moschella, 2010]; and those that focus on interests [e.g., Wade and Veneroso, 1998]. My account also resonates with constructivist work that traces the micro‐processes by which norms and rules around capital controls have (or have not) changed. Here I refer to research that focuses on the role of and processes by which leaders of international organizations have sought to rewrite formal rules around capital account liberalization (as in Abdelal, 2007); research that focuses on informal processes of internal norm entrepreneurship by mid‐range IMF staff (as in Chwieroth, 2010); research that focuses on the interaction between ideas and the larger political environment (as in Moschella, 2009); and work that highlights the pragmatism of actors in the IMF, who may abandon ideas around capital liberalization when they become less useful as during the current crisis, a process that is eased by the weakness of the theoretical and empirical case for liberalization (as in Nelson, 2012; see also Kirshner, 2003). 2. CAPITAL CONTROLS AND THE ASIAN CRISIS The current crisis has achieved in a hurry something that Keynesian and other heterodox economists were unable to do for a quarter‐century. As we will see below, it has provoked policymakers in many developing countries to deploy capital controls as a means to protect domestic economies from the financial instability, currency pressures, and trade dislocation associated with uncontrolled international capital flows. What is perhaps more surprising is that today’s IMF has responded to these controls in a way that makes clear that they are necessary (though under particular circumstances), prudent and reasonable. The credit rating agencies no longer flinch when new controls are announced, and private
3
investors continue to find the markets of many of the countries that utilize capital controls quite attractive. This reception contrasts sharply with the IMF and investor condemnation that was provoked when Malaysia imposed stringent capital controls during the Asian crisis. At the time the IMF called these controls on capital outflows a “step back” [Bloomberg.com, May 6, 2010], and a representative article in the international business press stated that “foreign investors in Malaysia have been expropriated, and the Malaysians will bear the cost of their distrust for years” [cited in Kaplan and Rodrik 2001:11]. Flagging the country’s capital controls, rating agencies Moody’s, Standard and Poor’s, and Fitch downgraded Malaysia’s sovereign debt rating [Abdelal and Alfaro, 2003]. More recently, capital controls in Thailand were reversed by the Central Bank within a few days after their implementation in December 2006 (following a coup) after they triggered massive capital flight [Bloomberg.com, May 6, 2010]. During the neo‐liberal era of the last several decades views on capital controls by IMF staff and in the economics profession shifted dramatically away from tolerance.2 The reception that greeted Malaysia’s capital controls during the Asian crisis was unremarkable inasmuch as it was consistent with the view of neo‐liberal economists and policymakers at the time. Indeed, up until the Asian crisis the IMF was poised to modify Article 6 of its Articles of Agreement to make the liberalization of all international private capital flows a central purpose of the Fund and to extend its jurisdiction to capital movements. But despite the neo‐liberal tenor of the times, some developing countries nevertheless maintained capital controls—most notably, perhaps Chile and Malaysia, but also China, India, Colombia, and Thailand. And even during the neo‐liberal era, staff in different areas of the IMF held divergent views on capital controls, though the general thrust of thinking and policy cohered in the direction of liberalization. Then a subtle‐‐though uneven and inconsistent‐‐process of ideational change on capital controls began to occur in the years that followed the Asian crisis. In the wake of the crisis, IMF research staff started to change their views of capital controls—modestly and cautiously to be sure. In the post‐Asian crisis context, the center of gravity at the Fund and in the academic wing of the economics profession shifted away from an unequivocal, fundamentalist opposition to any interference with the free flow of capital to a tentative, conditional acceptance of the macroeconomic utility of some types of capital controls. Permissible controls were those that were temporary, “market‐friendly,” focused on capital inflows, and were introduced only when the economy’s fundamentals were mostly sound and the rest of the economy was liberalized [Prasad et al. 2003]. Academic literature on capital controls in the period that followed the Asian crisis reflected this gradually evolving view: as Gallagher [2010a] points out, cross‐country empirical studies following the Asian crisis offered strong support for the macroeconomic
2 The turn away from capital controls began at the IMF during the 1970s [see Chwieroth, 2010]. This was part of a broader intellectual transformation toward liberalism in the economics profession in the same period [see Blyth, 2002].
4
achievements of controls on inflows [see overviews in Magud and Reinhart, 2006; Epstein, Grabel and Jomo 2004; Chwieroth, 2010:ch.8]. 3 While evidence supporting the achievements of outflow controls remains more scant, research on Malaysia by Kaplan and Rodrik [2001] finds strongly in favor of the achievements of Malysia’s controls on outflows. They find that compared to other countries in the region that had IMF programs during this period, Malaysian policies produced faster economic recovery, smaller declines in employment and real wages, and a more rapid turnaround in the stock market [on Malaysia, see also Magud and Reinhart, 2006; Magud, Reinhart and Rogoff, 2011]. It bears acknowledging that even during the neo‐liberal era there were exceptions and unevenness in the IMF’s treatment of both inflow and outflow controls by countries in crisis, as the IMF’s internal watchdog, the Independent Evaluation Office (IEO), found in a 2005 study of the matter that covered the period of the Asian financial crisis to 2004 (and as Chwieroth [2010] explores). The 2005 IEO report [p. 48], finds that during the 1990s the IMF “displayed sympathy with some countries in the use of capital controls and...even suggested that market‐based measures could be introduced as a prudential measure.” The report finds that the IMF’s support for capital controls increased after the Asian crisis, and that the IMF supported the use of capital controls in 7 of the 12 countries it assisted in the 1990s, and that in two of these countries (namely, Peru and Estonia) it advised policymakers to deploy capital controls as part of their overall reform recommendations. That said, the report acknowledges (correctly) that there was a lack of consistency in the IMF’s advice on this matter during the post‐Asian crisis period. Thus began the tepid, gradual and uneven practical and ideational process by which some types of capital controls came to be normalized conditionally by the IMF and by academic economists after the Asian crisis. Although the seeds of an intellectual evolution had been planted in the post‐Asian crisis context, there was push back in this period from stalwarts in the academic wing of the profession [e.g., Forbes 2005; Edwards 1999]. In addition, there was a curious disconnect between the research of IMF staff, on the one hand, and the creeping tolerance for capital controls by the institution’s economists when they worked with particular countries, on the other (as the 2005 report by the IEO acknowledges) [IMF, 2005:48]. This disconnect might be explained by the relative autonomy of different departments at the IMF, a lack of leadership from the top on capital controls, and the internal entrepreneurship of mid‐range IMF staff when working in different contexts [Chwieroth, 2010]. 4 It is important to keep in mind in this connection that like any complex organization, the IMF comprises diverse actors that may very well disagree among themselves about some fundamental matters pertaining to the institution’s strategies. 3 There is also a voluminous empirical literature that questions the effects of capital account liberalization on various aspects of economic performance [BIS, 2009:section A; Kose et al., 2009]. 4 Chwieroth [2010] suggests that we should expect the process of change in a complex organization like the IMF to be messy and uneven. See also Abelal [2007] on the messy process of changing formal rules pursued by the leaders of multilateral organizations. As I argue throughout this paper, an uneven, messy process is an apt description of the ideational and policy transformation at the IMF and in the economics profession during the current crisis.
5
Hence, despite the modest intellectual progress on capital controls that began after the Asian crisis, capital controls remained an exceptional and generally contested measure that could achieve desirable outcomes only where state capacity was high and/or where investors were undeterred by controls because opportunities in the country were so attractive. These qualifications begin to change, however, during the current financial crisis, when circumstances coalesce so as to legitimate capital controls to a far greater and more consistent degree. Today, scarcely 15 years down the road, controls on both capital outflows and especially on inflows are not just tolerated but are in many cases understood as a central tool of prudent financial management. Both in academic and policy‐making circles, capital controls have achieved a renewed legitimacy—begrudging legitimacy in some camps, to be sure, but legitimacy nonetheless. The changes in thinking and practice on capital controls at the IMF at the present time represent an important reversal back in the direction of the post‐war institution and toward aspects of Keynesian and Structuralist economic thought. As is well known, capital controls were the norm in developing and wealthy countries in the decades that followed WWII [Helleiner 1996]. In the first several decades of its existence, the IMF supported capital controls, a position that was consistent with and reflected the views of the economics profession (and notably, the views of John Maynard Keynes) and public figures (such as the US Treasury’s Harry Dexter White) [Crotty, 1983; Helleiner 1996]. Keynes famously observed that “control of capital movements, both inward and outward, should be a permanent feature of the post‐war system” [cited in Crotty, 1983:62]. And Keynes and White agreed that in order for capital controls to work properly that coordination between source and recipient countries was needed [Helleiner, 1998:38]. Support for capital controls came from other intellectual traditions as well. Raul Prebisch, the intellectual father of Structuralism (a central tradition in development economics), argued prior to Keynes that capital controls were an essential tool of counter‐cyclical and exchange rate management [Perez and Vernengo, 2012; Gallagher, 2012b]. 3. ENABLING CAPITAL CONTROLS DURING THE GLOBAL FINANCIAL CRISIS A range of factors has facilitated the reemergence and legitimization of capital controls during the current crisis. For ease of exposition I will discuss them separately, though as will become clear I do not think of them as “independent variables” that can be summed up to give a full account. Instead, I see the factors as thoroughly interdependent and cumulative. Emerging State Autonomy in the Developing World Precisely because of the constraints on policy space that followed the East Asian crisis, the crisis created momentum around the idea that developing countries had to put in place strategies and institutions to protect against future encroachments on their autonomy and sovereignty. The explicit goal was to escape the IMF’s orbit. To the extent possible, developing country policymakers sought to accomplish this aim by relying on a diverse array of strategies: the attraction of international private capital inflows; the establishment of swap arrangements among central banks; and most importantly, self‐insuring against
6
future crises through the over‐accumulation of reserves.5 The experience of the Asian crisis and IMF intervention in the region, in fact, had powerful behavioral effects on the reserve accumulation strategies of central banks and governments that extend well beyond the region. These behavioral changes in turn have given some policymakers the means to increase their relative policy autonomy. Policymakers in rapidly growing developing countries (such as Brazil, China, Turkey, South Korea, Argentina, South Africa, Russia) have amassed massive pools of foreign exchange reserves in order to enhance the prospects of financial stability and to self‐insure against the possibility of future IMF conditionality.6 How extensive are the increases in foreign exchange reserves in the post‐Asian crisis period? From 2000 to 2012 (third quarter), global foreign exchange reserves increased by 456%, from $1.9 trillion to $10.7 trillion.7 Emerging and developing countries (with reserves of $7.1 trillion in the third quarter of 2012) accounted for 72.5% of the increase. Foreign exchange reserve holdings relative to GDP have also increased dramatically over the last three decades. In the 1980s, foreign exchange reserve holdings by developing countries were equal to about 5% of their GDP. This figure has doubled every decade since then, reaching around 25% of GDP by 2010 [Ghosh, Ostry, and Tsangarides, 2012:3]. These figures are in stark contrast to reserve holdings in OECD countries: in 2000 OECD countries held reserves of $1.3 trillion (5.1% of GDP). By the start of 2011 OECD reserves had grown to $3.4 trillion (8.1% of GDP) [Dadush and Stancil, 2011]. Reserve holdings are highly concentrated among regions in the developing world, and are also concentrated within particular developing countries. Over 90% of developing country reserves are held in the 20 largest holders (which now have enough reserves to cover over a year of imports or their short‐term debt nearly five times over) [Dadush and Stancil, 2011]. Among developing countries the largest reserves as of 2010 were held by countries in what the IMF terms Developing Asia (with $3,658.4 billion in reserves, of which China held $2889.6 billion in reserves), the Middle East and North Africa (with reserves of $1,107.5 billion), Latin America and the Caribbean (with $651.4 billion in reserves, of which Brazil held $287.5 billion and Mexico $120.3 billion), and the Commonwealth of Independent States (with $566.8 billion in reserves, of which Russia held $456.2 billion). The over‐accumulation of reserves has been facilitated by a variety of circumstances: the boom in commodity prices; the ability of some countries to maintain current account surpluses by sustaining low production costs in consumer goods; the persistent appetite for imported energy, low‐cost consumer goods, and capital goods in wealthy countries (itself a consequence of many factors, such as deindustrialization, energy policy, income inequality and wage compression in these countries); and the need to find an outlet for the vast pools of liquidity that were created during the recent long boom. Though this hoarding 5 We might think of these strategies collectively as promoting resilience and even what Nassim Taleb [2012] refers to as “anti‐fragility,” or the ability to thrive in periods of instability. 6 This is the precautionary or self‐insurance motive for excess reserve accumulation. Moreover, over‐accumulation of reserves facilitates export‐led growth since states with sufficient reserves can sterilize capital inflows so as to maintain an undervalued exchange rate. This is often referred to as modern mercantilism [Ghosh, Ostry, Tsangarides, 2012]. 7 Reserve data from IMF, COFER (IMF, 2012a; unless otherwise noted).
7
of reserves enhances financial resilience and policy autonomy it nevertheless entails important opportunity costs for reserve holding countries (as Rodrik [2006] and Gallagher and Shrestha [2012] have argued).8 Data on official reserves do not provide a complete picture of the resources that enable some developing countries to enjoy an increase in policy autonomy. Developing countries with large reserves generally transfer a portion of their holdings to sovereign wealth funds to be managed separately (from official reserves) so as to maximize the returns on these assets. At the end of 2010 developing and emerging economy funds held the majority of sovereign wealth fund assets ($3.5 trillion of the $4.3 trillion held globally in such funds).9 Oil‐producing countries hold three quarters of all sovereign wealth fund assets, and $800 billion is held by funds in East Asia. As of March 2011, there were forty‐one sovereign wealth funds maintained by developing and emerging economies.10 Ten developing and emerging economy sovereign wealth funds held assets between $100 and $627 billion. Generally sovereign wealth fund managers invest in longer‐term, less liquid assets [Griffith‐Jones and Ocampo, 2008].11 Though the explicit function of sovereign wealth funds is not to promote financial stability, a speculative attack against a country’s currency is less likely to occur when governments have signaled that reserves are so large as to justify cleaving off some of them to capitalize a sovereign wealth fund. In this way, the presence of large sovereign wealth fund assets may enhance policy autonomy by making it less likely that a country will experience an attack on its currency. In sum, considerable resources are available in both official reserves and sovereign wealth funds held by developing countries. Though these two pools of finance serve different roles, they both contribute to an environment wherein developing‐country policymakers now have the material means to enjoy increasing policy autonomy relative to the IMF during the current crisis. Robust economic growth and commodity price inflation have contributed to policy autonomy by amplifying reserves.12 In short, policymakers in a number of developing countries now have the ability to deploy capital controls without much worry about negative reactions by investors or the IMF. Indeed, capital controls have become necessary in some national contexts precisely because of the strong performance of some developing countries during the crisis (a matter to which we return below). Reserve accumulation and the related growth in sovereign wealth fund assets also enable developing country policymakers to finance counter‐cyclical macroeconomic policies that (like capital controls) were unavailable to them during previous crises. There is, in fact,
8 Many have claimed that excess reserve accumulation poses other problems as well—namely, it can contribute to global financial instability insofar as global imbalances contribute to fragility. 9 Data in this paragraph from Griffith‐Jones [2011:8‐9]. 10 In 2011 the governments of India, Peru, Colombia, Panama, and Bolivia began to discuss launching sovereign wealth funds [Singh, October 31, 2011; ft.com, September 23, 2011]. 11 Though Norway’s sovereign wealth fund is exceptional since it reportedly holds 40% of its assets in equities, which are quite liquid. 12 This is likely to be sustained even as economic conditions deteriorate since the reserves now on hand appear to be more than ample.
8
evidence that sovereign wealth funds in some developing countries supported domestic banking systems by depositing assets in them and recapitalizing banks, while some also increased domestic stock purchases [Park and van der Hoorn, 2012].13 The enabling effect of reserve and sovereign wealth accumulation is part of a broader, supportive set of economic conditions that collectively enhance policy space in many developing countries during the current crisis. These broader, supportive conditions include the reduction in external public sector debts; the development of domestic bond markets after the Asian crisis; healthy financial sector performance in some countries; and the counter‐cyclical support offered by multilateral, and especially regional and sub‐regional financial institutions and some national development banks [Ocampo et al., 2010]. Increasing Assertiveness of Developing Country Policymakers A number of developing country policy makers have demonstrated an eagerness to take advantage of the increased autonomy they now enjoy. I explore here three “indicators” of increasing assertiveness: the use of counter‐cyclical macroeconomic policies; innovation in financial architecture; and a new activism at the IMF. (A fourth indicator of a new assertiveness is the frequency and context in which capital controls have been deployed during the current crisis. We will treat this matter separately in the next section of the paper.) Countercyclical macroeconomic policies Those developing countries that have been able to maintain and even expand their autonomy during the crisis have used the resulting policy space to pursue a variety of counter‐cyclical macroeconomic policies.14 This marks a sea change in the behavior of developing country policymakers from the past, when macroeconomic policy during crises was strongly pro‐cyclical. When we look across the developing world we find diverse and uneven counter‐cyclical macroeconomic policy responses to the crisis. Ocampo et al. [2010] is the most comprehensive survey of counter‐cyclical policy responses to the crisis in the developing
13 Some developing country sovereign wealth funds also played a counter‐cyclical role outside their borders. For example, some increased their exposure to euro area assets and participated in the European Financial Stability Fund’s inaugural bond issue in 2011 [Park and van der Hoorn, 2012]. It is estimated that the sovereign wealth funds of China, Singapore, and several Middle Eastern countries provided around $80 billion in recapitalization to financial institutions in Europe and the US in late 2007 and early 2008 [BIS, 2009: 153; Campanella, 2012:20]. However, some decisions by sovereign wealth funds have been pro‐cyclical and destabilizing [Drezner, 2008:118]. Some developing country sovereign wealth funds also lost a great deal of value because of overseas equity investments during the crisis [Campanella, 2012]. More broadly, there is debate in the literature on whether these funds should be seen as developmental and financially stabilizing. See Helleiner [2009] for discussion of how sovereign wealth funds may contribute to a growing financialization of the state. 14 Some observers have rightly advocated for a more aggressive and consistent shift toward countercyclical policy [e.g. Ffrench‐Davis, 2010].
9
world, and so we draw from this study in what follows.15 They find that counter‐cyclical policies tended to be more powerful in larger, less financially liberal economies (such as China, Brazil and India), and that monetary policy in most developing countries was expansionary. Monetary policy instruments were diverse, and involved the reduction of reserve requirements, the provision of credit to exporters and private firms, and an active role for public sector banks (especially in Brazil, China and India). The same study finds that fiscal policy responses were also counter‐cyclical, though their magnitudes varied substantially. The most expansionary fiscal policies were in East Asia (indeed 7 out of 13 developing countries in the region had fiscal packages that were equal to more than 5% of GDP). South Asian countries also had strongly expansionary fiscal policies (despite the presence of high debts and deficits at the start of the crisis). Sub‐Saharan African countries ran very active counter‐cyclical fiscal policies (e.g., Kenya, Mauritius, South Africa, Tanzania, though Botswana is an exception). In Latin America, the picture was more mixed. Chile ran the clearest counter‐cyclical fiscal policy; other countries in the region had more modest increases in public sector spending amounting to over 2% of GDP (e.g., Argentina, Costa Rica, Paraguay); while some countries reduced public spending (e.g., Bolivia, Dominican Republic). China deployed the most ambitious program of counter‐cyclical support—in 2009 and 2010 it was equivalent to around 14% of the country’s GDP. As discussed previously, supportive economic conditions enabled many developing countries to pursue counter‐cyclical policies (and, as we will see, capital controls) without fearing the reaction of investors and the IMF. In addition, the ideational climate, especially in the first few years of the crisis, was supportive of national policy responses that sought to protect developing countries from the crisis. Here I am referring to the outbreak of Keynesianism at the G‐20 during 2008‐2009. And even after the G‐20 switched to an austerity message in 2010, expansionary monetary policies in the US and Japan through 2012 and early 2013 helped normalize counter‐cyclical policies and capital controls in developing countries.16 Innovation in financial architectures Another indicator of the increased appetite for autonomous action by developing country policymakers is given by the expansion of existing and the creation of new regional, sub‐regional, bilateral and multilateral financial institutions and arrangements during the crisis. The Asian crisis had earlier turned attention in the region to the creation of an institution that could serve as a counterweight or an alternative to the IMF. In that context, Japan’s Ministry of Finance proposed in the summer of 1997 the creation of an Asian Monetary Fund, an institution that would provide emergency financial support—sans the IMF’s conditions‐‐to countries in the region that were caught up in the crisis [see Kirshner, 2006; Grimes, 2009]. The proposal was eventually tabled in the wake of tensions between Japan and China. As with the Asian crisis, the current crisis has promoted interest in the creation of institutions that deliver liquidity support and which complement or (perhaps)
15 See Kasekende, Brixova, and Ndikumana [2010] for extensive discussion of counter‐cyclical monetary and fiscal policies in Africa; Barbosa [2010] on Brazil; and Reddy [2010] on India. 16 The IMF’s rhetorical attention to pro‐poor spending during the crisis also enabled counter‐cyclical policies [Grabel, 2012].
10
substitute for the IMF. The current crisis has also stimulated interest in the creation of alternative means for delivering trade and long‐term (project) finance. These initiatives have been given life by the new economic environment in which many developing country policy makers find themselves. There are far too many of these initiatives to discuss comprehensively here (but see Grabel [2012] and Chin [2012]). In what follows I provide a few illustrative examples of these institutional innovations as suggestive evidence of the increasing assertiveness of developing country policymakers during the crisis. Central banks of the Association of Southeast Asian Nations, plus China, Japan and South Korea, have expanded the scope of the Chiang Mai Initiative. This arrangement, now known as the Chiang Mai Initiative Multilateralisation (CMIM), is a regional reserve pooling arrangement. CMIM members have also been prompted by the crisis to make some progress on long‐standing governance issues involving the CMIM’s relationship to the IMF. Indeed, decisions taken in May 2012 (to double the size of the CMIM reserve pool to US$ 240 billion and to loosen its link to the IMF) underscore the way in which the global crisis is stimulating a broadening and deepening of regional financial liquidity support arrangements despite political and historical obstacles to doing so.17 The re‐emergence of more populist governments in Latin America and the success of large commodity exporters in the region have stimulated growth of regional, sub‐regional, bilateral, and unilateral initiatives. One such initiative is the Latin American Reserve Fund (FLAR). Like CMIM, FLAR is a regional reserve pooling arrangement; its capitalization and the modalities by which it provides financial support to distressed countries has broadened considerably during the current crisis. Another Latin American institution, the Latin American Development Bank, has taken on an increasingly active and important role in the region during the crisis. Latin America is also home to two new (and related) initiatives that bear mention‐‐the Bank of the South and the Bolivarian Alliance for the Peoples of Our Americas. In 2012 the BRICS countries (namely, Brazil, Russia, India, China and South Africa) began discussions about the creation of a new development bank, a credit rating agency and a reserve pooling arrangement. Preliminary proposals for operationalizing these institutions and arrangements are to be discussed at the BRICS Summit in South Africa in March 2013. There are also a variety of bilateral initiatives among developing countries, especially involving currency swaps and mechanisms aimed at settling trade transactions without using the US dollar as the vehicle currency (e.g., between Brazil and Argentina, and more broadly among a group of twelve Latin American nations). During the current crisis national development banks (such as Brazil’s National Bank for Economic and Social Development and China’s Development Bank) have also become active lenders outside their borders and regions. Collectively, the innovations that I have briefly surveyed here suggest that a significant group of developing country governments has been stimulated by the current crisis to push forward on architectural initiatives that express an increasing self‐confidence and an appetite for increasing autonomy from the IMF and World Bank. Some of these institutions
17 See Grabel [2012]; see Grimes [2011] for a skeptical view, and Wade [2013] for a strongly dissenting view on the prospects of breaking the CMIM‐IMF link.
11
will no doubt fail to achieve their promise. But taken together they represent a central part of the messy, uneven landscape of change that has emerged during the crisis. Moreover, it is conceivable that innovations in IMF views and practice on capital controls stem partly from attempts to protect the institution’s franchise from perceived or actual competition from these institutional innovations.18 New roles, new pressures at the IMF Finally, the increasing assertiveness of developing countries is given expression in the new role that they have taken on at the IMF during the current crisis. The IMF now finds itself dependent on raising new resources from vibrant developing countries. Developing countries have now twice been called upon to and have committed funds to the IMF. Most important about these new commitments is that they reflect the economic power of rapidly growing economies and the IMF’s evolving relationships with some of its former clients. Indeed, at the same time that developing countries have begun to contribute substantial funds to the IMF they have become more outspoken in demands for overdue reform of the institution’s formal governance. The first of these new commitments by developing countries came about at the April 2009 G‐20 meeting. For the first time in the institution’s history, several developing countries committed to purchase the IMF’s first issuance of its own bonds: China committed to purchase $50 billion while Brazil, Russia, South Korea and India each committed to purchase $10 billion. Thus, $90 billion of the $500 billion in new resources for IMF lending came from countries that have traditionally not played an important role in Fund governance, and which never committed funds to recapitalize the institution. As the Eurozone crisis continued to unfold, IMF Managing Director Lagarde began in late 2011 to call again on developing countries to step forward with a second tranche of commitments to the institution (while also seeking new resources from wealthy countries). Among developing countries Brazil’s government was initially most receptive. However, Brazil’s President Rousseff refused to announce the dollar amount of the country’s new contribution until she was apprised of plans for IMF governance reform and until a later BRICS‐wide conversation on the matter could take place. Never one to miss a chance to note historical ironies, Brazil’s Finance Minister Mantega quipped during Lagarde’s 2011 visit: “[i]t’s a great satisfaction to us that this time the IMF did not come to Brazil to bring money like in the past but to ask us to lend money to developed nations” [ft.com, December 2, 2011]. New funding commitments from developing countries were announced in June 2012 when BRICS leaders met informally on the eve of the G‐20 Leaders’ Summit in Mexico. China committed $43 billion; Brazil, Russia and India each committed $10 billion, while
18 There is some anecdotal evidence that the Fund is beginning to face competition from other institutions, even its sister institution the World Bank. For instance, Wade [2010:fn10] points out that the IMF is losing new business to the World Bank outside of the European rescues. And he notes that even in Europe, Turkey broke off negotiations with the Fund in early March 2010 because of the severity of its conditions. A few weeks later the country negotiated a $1.3 billion loan with the Bank.
12
South Africa pledged $2 billion. This meant that the BRICS countries pledged $75 billion of the $456 billion in new funding for the IMF to come from G‐20 countries.19 The contributions by the BRICS countries were pointedly conditioned on IMF governance reform. Brazil’s Mantega stated the BRICS position quite clearly when he said that the promise of additional funding was tied to “an understanding that the reforms of the Fund’s quotas, which will result in a greater voting power for emerging countries, will be implemented according to the timetable agreed by the G20 in 2010” [ft.com, June 19, 2012]. As of this writing, the US has not yet ratified the very modest 2010 agreement on IMF governance reform, and the matter remains stalled at the IMF (and at the World Bank) [see Wade, 2013, on the Bank]. This perhaps makes it more likely that the BRICS countries will continue to explore the development of their own financial arrangements and institutions, which in turn increases the possibility that the IMF may face some competition in the coming years. A Chastened IMF The IMF emerged from the Asian crisis a greatly weakened institution. Indeed, prior to the current global financial crisis, demand for the institution’s resources was at an historic low. From 2003 to 2007, the Fund’s loan portfolio shrunk dramatically: from $105 billion to less than $10 billion, while just two countries, Turkey and Pakistan, owed most of the $10 billion [Weisbrot et al., 2009a]. After the loans associated with the Asian crisis were repaid, the scope of the Fund’s loan portfolio contracted dramatically since those countries that could afford to do so deliberately turned away from the institution. This trend radically curtailed the geography of the IMF’s influence. The dramatic decline in the IMF’s loan portfolio after the Asian crisis indicates the degree to which these escapist strategies proved to be successful. Even in the context of the current crisis, countries did their best to stay clear of IMF oversight. Indeed, South Korea would have been a good candidate for a new type of (precautionary) Flexible Credit Line with the Fund. But it did not apply for the credit line, presumably because of its prior experience and to avoid the stigma of being one of the IMF’s clients again [Wade, 2010:fn10]. Instead, it negotiated a reserve swap with the US Federal Reserve. The current crisis has rescued the IMF from its growing irrelevance by re‐establishing its central place as first responder to financial distress. This re‐empowerment has come about for a number of reasons. Even with reduced staffing the Fund still holds a monopoly position when it comes to experience in responding to financial distress in poorer countries. Moreover, the IMF’s rescue was facilitated by G‐20 and Eurozone leaders’ decisions during the crisis [Lütz and Kranke, 2013]. Representatives at the April 2009 meeting of the G‐20 gave the IMF pride of place in crisis response efforts. The message was not lost on the Fund’s former Managing Director, Strauss‐Kahn who, at the meeting’s end
19 The BRICS countries committed the new funds (via bilateral loan agreements) with the understanding that they are only to be drawn upon after the IMF’s existing resources are substantially utilized. This condition makes the use of these new resources highly unlikely in practice [Chowla, 2012].
13
said: “Today is the proof that the IMF is back!” [Landler and Sanger, 2009]. The meeting not only restored the IMF’s mandate but also yielded massive new funding commitments to the institution. Representatives committed $1.1 trillion in funds to combat the financial crisis, with $750 billion of that amount to be delivered through the IMF. The crisis has reinvigorated not only the IMF, but also other multilateral financial institutions (such as the World Bank and the Inter‐American Development Bank). As previously discussed, during the crisis developing countries emerged as lenders to the IMF on two occasions. And even after a group of developing countries agreed to recapitalize the IMF in the spring of 2012, the IMF’s Lagarde was still highlighting the fact that other developing countries were economically strong enough to offer support. Indeed, during a visit to Colombia in December 2012 Lagarde noted “that [the country] is in a situation where it can offer support to the [IMF], which has not happened in the past” [Colombia Reports, December 10, 2012]. In sum, then, the IMF has experienced conflicting developments. It has discovered new vitality as a first‐responder to economic distress while at the same time facing a substantially diminished territory over which it can dictate economic policy. The newly resurrected institution faces a dramatically altered landscape. It no longer enjoys wall‐to‐wall influence across the developing world. The geography of its influence is now significantly curtailed as a consequence of the rise of relatively autonomous and increasingly assertive states in the developing world. The Fund may also be facing potential competition from evolving and nascent financial arrangements in the developing world. The institution’s staff today faces the challenges of restoring and protecting its franchise in an environment where many former client states are able to walk on their own. Hence, the IMF appears to be forced to negotiate to retain the influence that it was able to take for granted not so long ago. We see this negotiation not least in the domain of capital controls, where the IMF now often finds itself responding after the fact to policy decisions implemented unilaterally by assertive developing country governments and central banks. Relatedly, even where it retains substantial authority its economists are responding to the current crisis in some ways that diverge from their recent past practice. We turn to these matters in what follows. The Crisis, Winners and Losers The current crisis is marked by many firsts, such as developing country support to the IMF. Another departure from the old script is that some developing countries have emerged as winners during the crisis. Many of the countries that have put capital controls in place faced not the usual developing country problems of capital flight and attendant currency collapse. Rather, they faced “too much of a good thing”—namely, asset bubbles, inflationary pressures and currency appreciations induced by large international private capital inflows. The use of capital controls by winning economies (some of which are also lending to the IMF), may well figure into their acceptance by the IMF and international investment community. As each country deploys capital controls with no ill effects on investor sentiment and no finger wagging by the IMF, it becomes easier for policymakers elsewhere
14
to deploy the controls they deem appropriate. And they are doing so with the consequent effect of destigmatizing this instrument. Capital controls in losing economies Some countries have used capital controls during the current crisis for the more usual reasons of protecting against currency collapse and/or severe financial turbulence. In these cases, the IMF tolerated controls on outflows, and in the case of Iceland encouraged expanding their coverage. Iceland’s policymakers put outflow controls in place to slow the implosion of the economy before signing a stand‐by arrangement (SBA) with the IMF in October 2008. The country faced the prospects of disorderly deleveraging and the damaging effects of unwinding the carry trade because of large non‐resident krona holdings [IMF, 2012b]. The SBA with the Fund made a very strong case for the maintenance and extension of outflow controls as means to restore financial stability and to protect the krona from collapse. Not surprisingly, given the IMF’s long‐held allergy to capital controls, the institution’s staff was questioned repeatedly in news conferences on Iceland on what seemed to be an abrupt about face. Fund staff repeatedly said that the outflow controls were crucial to prevent a free fall of the currency, that they were explicitly temporary, and that it was a priority of the Fund to end all restrictions as soon as possible. These temporary outflow controls have turned out to have quite a long life span—indeed the central bank is not planning to phase out the 2008 controls until 2015 in view of the severe risks that the economy still confronts. Iceland’s use of outflow controls continues to receive praise from many quarters—e.g. the IMF’s Mission Chief in the country stated that “capital controls as part of an overall strategy worked very, very well” [WSJ, 5/21/12]; the Deputy Director of the IMF’s European Department said they provided “breathing room” for the country to figure out “how to deal with the enormous challenges…ahead” [Thomsen, 2011]; the Deputy Managing Director of the Fund stated that “unconventional measures [as in Iceland] must not be shied away from when needed” [IMF.org, October 2011]; and the rating agency, Fitch, praised the country’s “unorthodox crisis policies” when it announced that it was raising its credit rating to investment grade in February 2012 [Bloomberg.com, August 27, 2012].20 The IMF’s stance with respect to Iceland’s outflow controls initially appeared anomalous. But it soon became clear that it marked a dramatic precedent and revealed a change in thinking about capital controls that was far more consistent than that observed in the 1990s. For example, the SBA with Latvia in December 2008 allowed for the maintenance of pre‐existing restrictions arising from a partial deposit freeze at Parex, the largest domestic bank in the country [IMF, 2009c]. Soon thereafter, a Fund report acknowledged that Iceland, Indonesia, the Russian Federation, Argentina and Ukraine all put capital controls
20 See Krugman [October 2011] and Wade and Sigurgeirsdottir [2012] on the broader lessons of Iceland’s crisis‐recovery strategy. They argue that Iceland broke the rules not just by using outflow controls, but also by failing to bail out the banks (and foreign depositors) and by expanding public spending. None of this is to imply that neo‐liberals in Iceland are sanguine about the country’s unorthodox response or the IMF’s advice to the country (especially on capital controls) [e.g., Arnason and Danielsson, 2011].
15
on outflows in place to “stop the bleeding” related to the crisis [IMF, 2009a]. This report neither offers details on the nature of these controls nor commentary on their ultimate efficacy, something that further suggests that capital controls—even and most notably on outflows—are increasingly taken for granted by the Fund.21 Capital controls in winning economies Policymakers in a far larger set of developing countries have deployed and adjusted capital controls to curb the fallout from their strong performance during the current crisis. Brazil is a particularly interesting case since the country’s government (particularly Finance Minister Mantega) has been such a strong voice during the crisis on policy space for capital controls. The IMF’s changing stance regarding Brazil’s capital controls also provides a window on the evolution and continued equivocation in the views of Fund staff on capital controls. In late October 2009, Brazil began to utilize capital controls (after a long period of liberalizing capital flows). It imposed capital controls via a tax on portfolio investment. The controls were self‐described as modest, temporary and market‐friendly; they were intended to slow the appreciation of the currency in the face of significant international capital inflows. Initially they involved a 2% tax on money entering the country to invest in equities and fixed‐income investments, while leaving foreign direct investment (FDI) untaxed. Once it became clear that foreign investors were using purchases of American Depository Receipts issued by Brazilian corporations to avoid the tax, the country’s Finance Ministry imposed a 1.5% tax on certain trades involving them. The IMF’s initial reaction to Brazil’s controls on capital inflows was ever so mildly disapproving. A senior official said: “These kinds of taxes provide some room for maneuver, but it is not very much, so governments should not be tempted to postpone other more fundamental adjustments. Second it is very complex to implement those kinds of taxes, because they have to be applied to every possible financial instrument,” adding that such taxes have proven to be “porous” over time in a number of countries. In response, John Williamson and Arvind Subramanian indicted the IMF for its doctrinaire and wrong‐headed position on the Brazilian capital controls, taking the institution to task for squandering the opportunity to think reasonably about the types of measures that governments can use to manage surges in international private capital inflows [Subramanian and Williamson, 2009]. A week later the IMF’s Strauss‐Kahn reframed the message on Brazil’s capital controls. The new message was, in a word, stunning: “I have no ideology on this”; capital controls are “not something that come from hell” [cited in Guha, 2009]. The Brazilian government continued to strengthen and indeed layer new types of controls over existing ones as it dealt with a high volume of inflows and as officials sought to close
21 Ukraine’s 2008 outflow controls introduced a five‐day waiting period on non‐resident conversion of local currency proceeds from investment transactions to foreign currency. A recent Fund report mentions in passing that the controls were not effective [IMF, 2012c:fn68], though the modest nature of the measure hardly tests the efficacy of outflow controls.
16
new channels of evasion. In 2010 the tax charged on foreign purchases of fixed‐income bonds was tripled (from 2 to 6%). The controls taxed foreign equity purchases at a lower rate (i.e., the 2% rate in place since 2009), and FDI was not taxed at all. This is a particularly good example of fine tuning controls so that they affect the composition, rather than the level of foreign investment. (Indeed, numerous IMF reports, as well as those by scholars such as Gallagher 2011a, note the effect of Brazil’s capital controls on the composition of capital inflows.22) In March 2011 Brazil imposed new capital controls, this time on foreign purchases of domestic farmland, and also increased to 6 percent a tax on repatriated funds raised abroad through international bond sales and new, renewed, renegotiated or transferred loans with a maturity of up to two years (the previous limit was up to 360 days). In August 2011, policymakers placed a 1% tax on bets against the US dollar in the futures market. Notably, in an August 2011 review of Brazil, IMF economists called the use of capital controls “appropriate” [Bloomberg.com, August 31, 2011].23 In a similar vein, an IMF Article IV report on Bangladesh credits the effective closure of the country’s capital account with its ability to avoid the global “flight to safety” in the early moments of the current crisis [IMF, 2010a]. Like Brazil, many other well performing developing countries have implemented and dynamically adjusted controls on outflows and especially on inflows during the crisis. Some have strengthened existing controls, while others continue to introduce new measures. For some countries (such as Argentina, Ecuador, Venezuela, China, and Taiwan) these measures are part of broader dirigiste or heterodox approaches to economic policy. For most other countries (e.g., Brazil, South Korea, Indonesia, Costa Rica, Uruguay, the Philippines, Peru, and Thailand), capital controls are part of a multi‐pronged effort to respond to the challenges of the currency appreciations (and in some cases, inflationary pressures) associated with attracting too much foreign investment and global carry trade activity. In December 2008 Ecuador implemented a number of measures governing inflows and outflows. In terms of outflows, it doubled the tax on currency outflows, established a monthly tax on the funds and investments that firms kept overseas, and also sought to discourage firms from transferring US dollar holdings abroad by granting tax reductions to firms that re‐invest their profits domestically. In terms of inflow controls, the government established a reserve requirement tax (in the form of an unremunerated reserve requirement) [Tussie, 2010].24 In October 2010, Argentina and Venezuela implemented controls on outflows: in Argentina they involve stricter limits on US dollar purchases; in
22 Gallagher [2011a] also finds that taxes on foreign investment in Brazil during 2009 and 2010 were associated with a lower level of currency appreciation, an eventual slowing of the currency’s appreciation, and increased monetary policy space. These effects were particularly strong when the tax was increased to 6%. 23 Curiously in the same month Canadian Prime Minister Harper used some of his time in the country inexplicably to lecture the government about the need to dismantle capital controls [Bloomberg.com, August 8, 2011]. His advice was ignored. 24 As Tussie [2010] notes, what is particularly interesting about Ecuador’s measures is that they demonstrate that even a dollarized country has more policy space than is usually understood.
17
Venezuela they involve new restrictions on access to foreign currency.25 Argentina’s capital controls were strengthened considerably on several occasions during 2011. In October 2011, all dollar purchases in Argentina had to be authorized by tax authorities, and the country’s oil and gas companies were required to repatriate all export proceeds and convert them to pesos [ft.com, October 30, 2011]. Unlike the other capital controls implemented during the current crisis, the 2011 measures in Argentina did lead to a ratings downgrade (on oil and gas companies by Moody’s). However, this may have as much to do with the capital controls as with the nationalization of a Spanish oil company and the government’s on‐going conflict with foreign investors and the IMF [Bloomberg.com, October 31, 2011]. Peru has been deploying a variety of inflow controls since early 2008. The country’s reserve requirement tax was raised three times between June and August 2010 and again in May 2012 as the central bank sought to address currency appreciation (and inflation) pressures. The May 2012 measures included a 60% reserve ratio on overseas financing of all loans with a maturity of up to three years (compared to two years previously) and curbs on the use of a type of derivative [ft.com, May 1, 2012].26 What is particularly interesting about Peru’s measures is the way in which they are being branded by the central bank. The Central Bank President maintains that the country does not need capital controls despite the fact that the reserve requirement tax in place since 2008 is a capital control [Bloomberg.com, January 25, 2013]! It may be that the Central Bank is branding its inflow controls as something other than they are because the country’s 2006 free trade agreement with the US makes it vulnerable to lawsuits by investors who believe themselves harmed by controls. In August 2012, Uruguay began to utilize a reserve requirement tax of 40% on foreign investment in one type of short‐term debt issued by the country’s central bank [Reuters.com, August 16, 2012]. Currency pressures also caused Costa Rica to use capital controls for the first time in twenty years. The country began to use capital controls in September 2011 when it imposed a 15% reserve requirement tax on short‐term foreign loans received by banks and other financial institutions [LatinDADD‐BWP, 2011]. In January 2013, the country’s President began to seek Congressional approval to raise the reserve requirement tax to 25%, while also seeking authorization to increase to 38% (from 8%) a levy on foreign investors who transfer profits from capital inflows out of the country. Taking a page perhaps from the rhetorical strategy of Brazil’s President and Finance Minister, Costa Rica’s President Chinchilla called capital inflows “weapons of mass destruction” [Bloomberg.com, January 24, 2013]. Numerous countries in Asia deployed new or strengthened existing capital controls during the crisis. Indeed, the Asian Development Bank gave its blessing to capital controls aimed at battling the risks of inflow surges in 2010 [Bloomberg.com, May 18, 2010]. In November 2009, Taiwan imposed new restrictions on inflows to reduce speculative pressures from
25 Argentina has not had a completely open capital account since its 2001 economic crisis (after which it began to pursue more heterodox economic policies). 26 The Central Bank also intensified currency market interventions to address appreciation pressures.
18
overseas investors. The controls preclude foreign investors from placing funds in time deposits in Taiwan; at the end of 2010, controls on currency holdings were strengthened twice [Gallagher, 2011a]. In 2010, China added to its existing and largely quantitative controls on inflows and outflows (such as those that involve preventing foreign investors from investing in the country’s money or derivatives markets, and an intricate approval process that is required before foreigners can trade stocks or bonds) [Gallagher, 2011a]. In June 2010, Indonesia announced what its officials termed a “quasi capital control” that governs short‐term investment. This awkward term might suggest that some governments are still afraid of the stigma of capital controls, and so are either denying their existence (as in Peru) or doing all they can to label them so as to reduce the potential stigma. Indonesia’s inflow controls seek to dampen speculation in the country via a one‐month holding period for central bank money market securities, the introduction of longer maturity instruments, and new limits on the sales of central bank paper by investors and on the interest rate on funds deposited at the central bank. Thailand began to deploy capital controls in October 2010: authorities introduced a 15% withholding tax on capital gains and interest payments on foreign holdings of government and state‐owned company bonds. In December 2012, officials in the Philippines announced limits on foreign currency forward positions by banks and restrictions on foreign deposits [Bloomberg.com, December 26, 2012]. South Korean officials also began to introduce controls on inflows in June 2010. Controls limit the amount of currency forward and derivatives trading in which financial institutions can engage, and limit the foreign currency loans extended by banks to local companies. Since October of 2010, regulators have audited lenders working with foreign currency derivatives. Since 2011 they have levied a tax of up to .2% on holdings of short‐term foreign debt by domestic banks (with a lower tax levied against longer term debts), banned “naked” short selling, and reintroduced a tax on foreign investment in government bonds sold abroad [Reuters.com, July 25, 2011]. In another sign of changing sentiments by the rating agencies, Moody’s recently recommended that South East Asian countries could use capital controls to temper the appreciation of their currencies [Maqtulis, February 22, 2013]. It must be noted that policymakers in Brazil, Korea and China have loosened or abandoned particular capital controls during 2011 and 2012 as their economies began to slowdown and investors turned back to US markets. For example, Brazil lowered a tax on foreign equity flows to 0% in December 2011 and loosened a requirement on the average maturity of overseas borrowing by domestic companies [Forbes.com, June 14, 2012]. In January 2011 China loosened some of its outflow controls (such as the requirement that the country’s exporters turn over their US dollar profits to the government in exchange for yuan) [Gallagher, 2011a]; in June 2012 it reduced some barriers to foreign ownership of domestic stocks and bonds [ft.com, June 21, 2012]. Similar pressures, divergent responses Not all policymakers responded to the pressures of large capital inflows with capital controls, of course. Indeed, Turkish, Chilean, Mexican and Colombian policymakers have publicly rejected capital controls. Instead they have increased their purchases of dollars and, in some instances, have used expansionary monetary policy to stem currency
19
appreciation. These divergent responses to similar pressures reflect many factors, not least of which are differing internal political economies, the continued sway of neo‐liberal ideas, the long shadow cast by the belief that central banks must signal their commitment to neo‐liberal strategies, and perhaps also pride associated with the problem of an excessively strong currency in countries that have so long faced the opposite problem. There may also be skepticism about the efficacy of capital controls, especially since Brazil’s currency (and that of other countries’ as well) appeared almost unstoppable for several years despite the many measures taken. One other factor that explains the decision not to deploy capital controls in some national contexts is the fact that some countries simply cannot do so because of the strictures of bi‐ or multilateral trade and investment treaties with the US [Gallagher, 2010a, 2011b, 2012a; Shadlen, 2005; Wade, 2003]. Writing about NAFTA in the 1990s, Mead [1992] was prescient on this matter. He argued that the agreement was more about importing external constraints into domestic policy and tying the hands of any future (populist) policymakers than about promoting free trade. This constraining agenda has been quite successful since then. Indeed, the majority of the US’ 52 existing bi‐ and multilateral trade and investment treaties make capital controls an actionable offense or prohibit them entirely [Anderson, 2011]. The basic template for these treaties requires that all parties allow capital and all transfers related to an investment to move “freely and without delay.” The template also subjects governments that violate this to special dispute settlement mechanisms that allow investors to sue a government that imposes controls on inflows or outflows after a “cooling off period” (of six months to one year) [Anderson, 2011]. Governments face other strictures on capital controls from the obligations to liberalize financial services under the General Agreement on Trade in Services of the WTO [Gallagher, 2012a]. There are also particular constraints on the ability to use capital controls in the European context. Article 63 of the Lisbon Treaty of the European Union (EU) enforces open capital accounts across the EU and requires that members not restrict capital transactions with other countries.27 Turning back to the developing world, Chile’s refusal to use capital controls during the current crisis may then have more to do with its free trade agreement with the US than with its own internal political economy. After all, the country’s central bank pioneered in the 1990s inflow controls of the sort that are being used today in many developing countries [Grabel, 2003b]. But the free trade agreement (that went into effect in 2004) exposes the country to lawsuits by investors who demonstrate that they are harmed by capital controls. Costa Rica may soon test the limits of its own policy space. The country’s policymakers have recently introduced some capital controls. But it cannot go any further with them because of its bilateral trade and investment treaties [LatinDADD‐BWP, 2011]. By contrast, Brazil is free to utilize an array of controls because it has not signed a trade or 27 This has important implications for countries on the European periphery that have not been able to use capital controls during the current crisis. Such countries enjoy less policy space to use capital controls than do many developing countries. I thank Rawi Abdelal for this point. Other strictures on the ability to use controls may be found in the OECD’s Code of Liberalisation of Capital Movements, which also requires capital account liberalization as a condition for accession to the organization (though there are some exceptions that allow for temporary suspensions of liberalization) [see Abdelal, 2007 on the EU and OECD; see Gallagher, 2012a on OECD exceptions].
20
an investment treaty with the US. Future research will take up the matter of why some countries’ policymakers push up against the limits of their trade and investment agreements (as in Costa Rica), while others do not (e.g. Chile). Policymakers in some countries may resort to rebranding capital controls if they do not have the appetite to push the limits of their trade or investment agreements (as with Peru), or if they otherwise fear being branded anti‐free market (and hence, Indonesia’s “quasi capital controls”). Notwithstanding some important national exceptions, the current crisis is marked by a radical departure from the recent past. Since 2008 many developing countries have implemented capital controls without seeking permission from the IMF. For most of these countries, controls are a response to the costs of economic success (their safe haven status and carry trade activity). It is hard to imagine that capital controls could have been rebranded as legitimate policy tools (rather than desperate and regrettable measures) as quickly and deeply as has been the case had it not been for the divergent effects of the crisis across the globe, and the initiatives of many of the winners from the economic crisis to assert control over financial flows. Just as history is written by the victors, so may it be the case that the resuscitation, rebranding and re‐legitimizing of a forbidden policy tool depends primarily on the practices and strategies of those countries whose economic success grants them the latitude and confidence, and the influence over other countries, to not just “cheat” in this policy domain but to tear up the rule book altogether. In addition, the rebranding of capital controls may have been facilitated by the fact that the pressures of the carry trade caused central bankers in wealthy countries to reconsider their long‐held opposition to currency interventions and even capital controls. For example, the Swiss National Bank (SNB) intervened quite aggressively to curb the appreciation of the Swiss franc on several occasions during the current crisis (e.g., when speculation on Greece’s exit from the euro was particularly intense). At that time, the head of the SNB, Thomas Jordan, announced that the Bank was considering capital controls on foreign deposits [ft.com, May 27, 2012]. More surprisingly, a top Bundesbank official signaled a softening in its traditional opposition to capital controls by stating that “limited use of controls could sometimes be appropriate” in the context of growing currency tensions [Reuters.com, January 24, 2013]. Finally, it may also be the case that controls on capital outflows have been legitimized by widespread acknowledgement of their success in Iceland (as well as by their use elsewhere). Outflow controls may still be seen in a different light than inflow controls, but the current crisis seems to have catalyzed a degree of rethinking on this instrument as well. We find suggestive evidence of this in the evaluation of Iceland’s program by the IMF and the credit rating agencies, and (as we will see below) in recent IMF research and Executive Board statements regarding the circumstances under which (temporary) outflow controls are warranted. A New Pragmatism in the Economics Profession and at the IMF I have suggested that changing world circumstances have placed the IMF in a position of having to adjust to policy innovations by countries that no longer are under its control.
21
Certainly a new pragmatism at the institution is apparent. But there is also a deeper transformation underway—one operating at the ideational level. Today IMF staff economists and leading academic (neoclassical) economists have pulled back from full‐bore advocacy of the neo‐liberal development model, and have even taken steps toward elaborating a theoretical and empirical case for capital controls. The rapid succession of financial crises over the past two decades may be having the effect of encouraging those economists at the IMF who have long had reservations about the neo‐liberal model to give voice to their concerns and to assert themselves more effectively and consistently, particularly now that views on capital controls by academic economists are evolving rather significantly. After all, economists at the Fund are not immune to the loss of confidence of many economists in the models, theories and policy tools that have long dominated professional practice. A recent statement by the IMF’s Chief Economist, Olivier Blanchard, is instructive in this regard: “We have entered a brave new world. The economic crisis has put into question many of our beliefs. We have to accept the intellectual challenge” [Blanchard et al., 2012:225]. My arguments about ideational change complement those advanced by constructivists (as discussed briefly in the introduction to this paper). However, I do not intend in what follows to engage in process tracing. Instead, I intend to explore diverse forms of evidence of ideational change regarding capital controls in the economics profession and within many quarters of the IMF. Neoclassical economics and capital controls Two views on capital controls predominated among neoclassical academic economists during the neoliberal era. The first was a minority view, associated with libertarian thought, which derided controls as violations of investor rights. This was a principled rather than a consequentialist opposition, and as such did not allow for renegotiation based on new evidence. In contrast, the majority (consequentialist) view within neoclassical economics claimed that controls were imprudent and costly interventions in the market. In this view, controls raise the cost of capital (especially for small and medium‐sized firms) and generate costly evasion strategies. On balance, then, controls were seen to induce economic inefficiency and distributional disparities in countries that could hardly afford them. In the context of the current crisis the first view lost some of its appeal, even though its most ardent defenders have not given up the ghost. For instance, Nobel Laureate Michael Spence bemoaned the recent use of capital controls in many countries [Dobbs and Spence, 2011].28 More importantly, within neoclassical thought a new pragmatism has set in. Today there is great emphasis on the negative externalities associated with highly liberalized international financial flows. Liberalized short‐term capital flows are now recognized to induce ambient risk that can destabilize the economy and, in the developing world context, imperil development. Capital controls are now increasingly theorized as a second‐best strategy (in an imperfect world) that can reduce risk and dampen economic instability. 28 And some neo‐liberals have rebuked the IMF for its support of capital controls in Brazil and Iceland.
22
Hence, what were formerly recognized as unwarranted economic interventions into otherwise efficient capital markets have now been rebranded in a Pigouvian sense as prudential financial regulation. There are two dimensions to the raft of new academic research being done on capital controls by prominent neoclassical economists. This work is not explicitly linked together by its authors, but it is nevertheless complementary. The first of these strands involves what are usually highly technical formal models using the tools of welfare economics [for a survey, see Korinek, 2011]. In this work, termed the “new welfare economics of capital controls,” it is assumed that in an environment of uncertainty, imperfect information and volatility, unstable capital flows have negative externalities on recipient economies. Externalities are generated by capital flows because individual investors and borrowers do not know or find it advantageous to ignore the effects of their financial decisions on the aggregate level of financial stability or instability in a particular nation (for example, by ignoring systemic risk or the likelihood of firesales). Controls on capital inflows are therefore conceptualized as a type of Pigouvian tax that corrects for a market failure, rather than a cause of market distortions. Inflow controls induce borrowers to internalize the externalities of risky capital flows, and thereby promote macroeconomic stability and enhance welfare. In a related vein, Jeanne [2012] finds that it is optimal to impose a Pigouvian tax on debt inflows in a boom to reduce the risk and severity of the bust. He finds that Brazil’s controls on inflows are consistent with the main features of the optimal prudential tax implied by this new welfarist theory. Furthermore, the optimal (prudential) tax should be what he terms “light touch,” i.e., should fall on inflows, be counter‐cyclical, and be differentiated by type of inflow (so that it is highest on those flows that are most dangerous, such as short‐term or foreign currency debt). Brazil’s controls fall into this category. Finally, he finds that there is theoretical support for the international coordination of capital account policies. Variants on the Pigouvian argument bring reserve accumulation into the welfare analysis. For instance, Korinek [2012] argues that capital controls or reserve accumulation in one country leads to significant international spillover effects via lower world interest rates and greater flows to other countries. In this case, unilateral capital controls act as second best devices to correct an economic distortion. But if policymakers face an imperfect set of instruments (e.g., targeting problems or costly enforcement), then there is a role for multilateral coordination to mitigate the inefficiencies arising from such imperfections. Aizenman [2009] finds that a type of capital control can provide a subsidy to offset the costs of reserve accumulation in developing countries. He terms this a “Pigouvian tax‐cum‐reserve hoarding subsidy.” In this model, a tax on external borrowing reduces the amount of reserves needed in developing countries at the same time as it finances reserve accumulation (via the very capital flows that expose the economy to the need to self insure in the first place). A second strand of new research is empirical in nature and it now substantiates many of the theoretical claims of the welfarist approach. For example, Qureshi et al. [2011] study what they call prudential foreign currency‐related measures, domestic prudential
23
measures, and financial sector capital controls in 51 developing countries from 1995 to 2008. They find that both capital controls and foreign currency‐related prudential measures are associated with a lower proportion of foreign currency lending in total domestic bank credit and a lower proportion of portfolio debt in total external liabilities. The study concludes that prudential and capital control policies in place during the boom have enhanced resilience during the bust of 2008. Even Forbes, a longstanding critic of capital controls, finds in new work [Forbes et al., 2011] that Brazilian taxes on foreign purchases of fixed‐income assets between 2006‐11 achieved one of its key goals of reducing the purchase of Brazilian bonds.29 They find that controls had a blunt impact insofar as investors also cut their exposure to Brazilian equities even though the tax was assessed only on debt. Moreover, they also conclude that capital controls have what they view as negative spillover effects on investment in other countries as investors reduced their exposure to other economies that they deemed likely to follow the Brazilian example. Another type of empirical work involves “meta analysis” of a large volume of existing empirical work. In their examination of policies that existed prior to the current crisis, Magud and Reinhart [2006] find that controls on inflows enhanced monetary policy independence, altered the composition of inflows, and reduced real exchange rate pressures (though evidence for the latter is less solid than for the first two findings). Their work also finds that inflow controls did not reduce the aggregate volume of net inflows. They find, finally, that outside of the Malaysian case (during the Asian crisis) there is little evidence for the success of outflow controls. It bears noting that in a larger meta analysis in 2011, Magud and Reinhart find the same results over a larger number of studies including some that focus on policies during the current crisis. Jeanne, Subramanian, and Williamson’s [2012] meta analysis shows that free capital mobility seems to have little benefit in terms of long‐run growth. In view of this finding, they conclude that the international community should not promote unrestricted free trade in financial assets, even in the long run. They tie this finding to research on the welfare economics of capital controls, and in doing so commend Brazil for the types of inflow controls it is using to curb the boom‐bust cycle in capital flows. They argue further that the effective tax rate for market‐based capital controls should not exceed 15%. They conclude by calling for the development of an international code of good practices under the auspices of the IMF, in coordination with the WTO, that would legitimize the use of capital controls while discouraging inappropriate uses so as to enable their optimal use and to prevent negative international spillovers. The coordination of controls, as we will see, has been a matter of great interest to the IMF in 2011 and 2012. The IMF and capital controls The changes in thinking on capital controls by academic economists are reflected in and reinforced by developments at three over‐lapping levels of practice at the IMF: research,
29 Gallagher [2011a] also finds that the capital controls in place from 2009‐11 were relatively successful in Brazil (and Taiwan), and moderately successful in South Korea.
24
official statements by key officials, and policy recommendations by its staff.30 Indeed, the ideas of economists at the Fund on capital controls have continued to evolve quite significantly and coherently during the crisis, a development that has contributed to the normalization of this instrument. By now, many reports by IMF research staff and statements by the institution’s highest officials have documented that under certain (albeit restrictive conditions) capital controls are a legitimate part of the policy toolkit, and that they have had positive macroeconomic accomplishments in many countries. Examples of the new research abound. An IMF report drafted early in the crisis states that the impact of the crisis on banking systems in low‐income countries has been modest insofar as “(t)he existence of capital controls in several countries and structural factors have helped moderate the direct and indirect effects of the financial crisis” [IMF 2009b:9, fn9]. A joint report by the World Bank and Fund discusses capital controls in the same vein, and the brief discussion concludes cautiously that “nonetheless, capital controls might need to be imposed as a last resort to help mitigate a financial crisis or stabilize macroeconomic developments” [WB‐IMF, 2009:65]. In February 2010 a team of IMF economists writing in a Staff Position Note [Ostry et al., 2010] reached far beyond the Fund’s public statements or practice to date in regards to controls on inflows. In a thorough survey of econometric evidence, Ostry et al. [2010] commend controls on capital inflows for preventing crises and ultimately making crisis‐induced recessions less likely and less severe, and for reducing financial fragility by lengthening the maturity structure of countries’ external liabilities and improving the composition of capital inflows. These findings pertain to capital controls that were in place prior to and after the Asian crisis, as well as during the current crisis. The report also indicates that ”such controls, moreover, can retain their potency even if investors devise strategies to bypass them….the cost of circumvention strategies acts as ‘sand in the wheels’” (p. 5) The paper argues that “policymakers are again reconsidering the view that unfettered capital flows are a fundamentally benign phenomenon…even when flows are fundamentally sound…they may contribute to collateral damage….” This latter statement is illustrative of a Keynesian‐inflected view that is now recurring within recent Fund research. Other parts of Ostry et al. [2010] qualify this new acceptance of inflow controls, however. The report hedges in the expected ways—identifying the restrictive conditions under which capital controls can work (or be justified). But in comparison with earlier reports by the IMF the qualifications are just that‐‐‐they are not offered as insuperable obstacles to the use of controls. And that, in itself, represents a major advance, as many observers have acknowledged. After Ostry et al. [2010] was released, prominent IMF watchers praised the Fund for finally embracing a sensible view of capital controls. For example, Ronald McKinnon stated “I am delighted that the IMF has recanted” [cited in Rappeport, 2010]; former IMF official, Eswar Prasad states that the paper represented a “marked change” in
30 We should of course not presume that developments at these three levels necessarily unfold in a lock-step manner. What is remarkable about the current conjuncture, however, is the degree to which there have been parallel developments on all three levels as concerns capital controls.
25
the IMF’s advice [cited in Wroughton, 2010], and Dani Rodrik stated that the “the stigma on capital controls [is] gone,” and [Ostry et al. 2010] “is a stunning reversal – as close as an institution can come to recanting without saying, ‘Sorry, we messed up’” [Rodrik, 2010]. Rodrik also noted that “[j]ust as John Maynard Keynes said in 1945—capital controls are now orthodox” [Thomas, 2010]. No less telling is the sharp rebuke to the empirical work in Ostry et al. [2010] by William Cline, which is illustrative of the discomfort that “true believers” in capital account liberalization have with what they see as the Fund’s new troubling and wrong‐headed embrace of capital controls [Cline, 2010].
Research from various quarters of the IMF continued to spill out of the institution through 2011 and 2012. These reports continue to cement the legitimacy of capital controls, making clear that they should be considered alongside taxes and other prudential measures, and that they have had positive macroeconomic accomplishments in many countries [IMF, 2011a, 2011c, IMF 2010b; Ostry et al., 2011, 2012; IMF, 2012c, 2012d].31 This work culminated in a December 2012 report of the IMF Executive Board, which the IMF terms the “institutional view” [IMF, 2012c]. There is much in the IMF’s 2012 institutional view report that is illustrative of the evolution of thinking and practice on capital controls at the IMF during the current crisis. For instance, the report makes clear that inflow surges and sudden exits of capital can induce financial instability; that countries should not consider the liberalization of international capital flows prematurely; that temporary inflow and even outflow controls may be warranted under certain circumstances (principally during moments of turbulence); that countries retain the right under Article VI to put controls in place; and there is a tepid acknowledgement that the IMF’s new and more permissive stance on capital controls may conflict with and be subsumed under the standing strictures on such measures in trade and other agreements. Lost in this report is the “capital controls as last resort” language that appeared in many of the 2010 and 2011 reports, something that is suggestive of further evolution of the thinking by Fund staff.32 Despite the advances in the institutional view statement, there is also evidence of the IMF’s continued effort to “domesticate” the use of controls. Toward this end, the report states that capital controls should be targeted, transparent and temporary, and should not discriminate against foreign investors. Moreover, the arguments in the report continue to be guided by the outdated view that capital flow liberalization is ultimately desirable, 31 Even though they do not represent the official position of the Fund, Staff Position Notes (such as Ostry et al., 2011) are nevertheless authorized for distribution by the institution. Thus, they are important documents in tracking the evolution of thinking by the IMF. Indeed, the Ostry et al. [2011, 2012] studies were authorized by no less than Olivier Blanchard. 32 As the IMF was developing its institutional view, the G‐20 was developing a statement on capital controls. That position is articulated in a November 2011 statement, “G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences,” approved by the group’s central bankers, finance ministers and national leaders. The G‐20 statement goes further than does the IMF’s institutional view‐‐it takes an unambiguous, firm stand against “one size fits all” approaches to capital controls, rejects the idea of developing a set of conditions for the use of controls, and calls upon nations to develop their own approaches to their use. The IMF’s institutional view report includes the G‐20 document as an appendix and notes the importance of building on it (though at the same acknowledging that the G‐20 document is the product of a “hard‐won consensus” and is non‐binding).
26
though the claims to this effect are more nuanced than in previous Fund statements on the subject (insofar as they reject the presumption that this is the right policy for all countries at all times). Tensions over these (and other) matters among members of the IMF’s Executive Board were given an oblique airing in a Public Information Notice released by the Fund, and more directly in press accounts, many of which focused on criticisms of the report by Paulo Nogueira Batista, IMF Executive Director for Brazil and ten other countries [IMF, 2012e; Beattie, 2012]. That said, the fact that the IMF has shifted the discussion of capital controls away from straight economics and toward the legal and institutional conditions that are required for their success is further evidence that stubborn resistance to controls on economic grounds is now behind us (at least, for now). The practical implications of these developments in Fund research is immense. In recent IMF reports, including those discussed above, capital controls are referred to matter‐of‐factly as “capital flow management” techniques [e.g., Ostry et al., 2011; IMF, 2011a, 2012c]. This rebranding of capital controls is highly significant. The new, entirely innocuous term is suggestive of a neutral, technocratic approach to a policy instrument that had long been discredited as a vestigial organ of wrong‐headed, dirigistic economic meddling in otherwise efficient markets.33 Stepping away from research, public statements by current and former officials at the Bretton Woods institutions beginning in 2009 provide evidence of the rhetorical and policy normalization of capital controls. For example, the IMF’s former First Deputy Managing Director, John Lipsky, in an address to the Japan Society in December 2009 stated that “[c]apital controls also represent an option for dealing with sudden surges in capital flows.” In this address he makes clear that controls should be used when the surge in capital inflows is temporary (though we have to wonder when sudden surges would not be temporary?), and he emphasizes that the controls themselves should be temporary. Despite these caveats, he argues that “[a]bove all, we should be open‐minded.” After the Governor of the Bank of Thailand made a speech in the summer of 2010 embracing the rise of capital controls in Asia, the IMF’s Strauss‐Kahn stated that he was “sympathetic” to emerging countries embracing controls as a last resort to counter the role of foreign investors in inducing asset bubbles, but he also warned that “[y]ou have to be very pragmatic…long‐term capital controls are certainly not a good thing…But short‐term capital controls may be necessary in some cases: it is matter of balancing the costs of different options” [cited in Johnston, 2010]. He argued in July 2010 that “it is just fair that these [developing] countries would try to manage the inflows” as a last resort against a flood of investors pumping up inflation and asset values [cited in Oliver, 2010]. Strauss‐Kahn reiterated the new mantra that capital controls are a legitimate part of the toolkit in a speech in Shanghai in October 2010 [Strauss‐Kahn, 2010], while in the same month the director of the Fund’s Western Hemispheric department made a case (unsuccessfully) for the utility of controls in Colombia owing to the rapid appreciation of its currency [Crowe, 2010]. The World Bank’s
33 Others have also sought to rebrand capital controls. In a paper before the current crisis, Epstein, Grabel and Jomo KS et al. 2004 refer to capital controls as one among many capital management techniques. Ocampo [2003, 2010] has long used the term capital account regulations to refer to a family of policies of which capital controls are one type.
27
former President Robert Zoellick had this to say of the reemergence of capital controls in Asia: “it’s not a silver bullet but it doesn’t surprise me that people are trying them and they may help at the margin” [cited in Gallagher, 2010b]. Another key Bank official, Hans Timmer, Director of its Development Prospects Group, also spoke of the legitimacy of controls on inflows in January 2011 remarks [Beattie, 2011]. Given the inertia at the IMF (and the unevenness of its position on capital controls in the years following the Asian crisis), its recent research, policy advice and statements coming from key officials mark by its standards a minor revolution.34 Change at the Fund has been sometimes uneven, to be sure, with one step back for every two steps forward. Capital controls were often discussed as a last resort up until the Fund’s definitive institutional view was released in late 2012. None of this should be surprising. We should expect that long‐held ideas—especially those that have hardened to the level of ideologies and been codified in institutional practices—have very long half lives [Grabel 2003a]. The process of changing these ideas and practices is necessarily uneven and slow; moreover, progress will inevitably generate push back from within the institution and the economics profession itself. Hence we should expect to find continuing evidence of tension and equivocation in research by academic economists and in future IMF reports and practice that preclude a clear and decisive verdict on capital controls. To this point, however, recent welfarist arguments for capital controls have not been challenged. 4. Conclusion: Domesticating Capital Controls? From late 2010 to the present the IMF has provided us with an interesting vantage point from which to observe the continuing tension within the institution on capital controls. In several reports, Fund staff note that the institution is seeking to develop standards for the appropriateness of different types of controls [IMF, 2010b, 2011c, 2011d, 2011e; Ostry et al., 2011, 2012]. This effort is reminiscent of the project to revise the IMF’s Article 6 that was stalled by the Asian crisis. The discussion of developing standards for controls was also given life by the French government, which seemed eager to use its leadership of the G‐20 and G‐8 in early 2011 to give the Fund a role in coordinating capital controls via a code or mandate on the subject [Hollinger and Giles, 2011].35 The issue has since fallen off the European agenda—perhaps because the G20 torch has passed from France, and perhaps because the continued Eurozone crisis necessarily dwarfed other initiatives. But the fact that the IMF continues via its 2012 institutional view report to test the waters on the matter of organizing its views on capital controls is instructive—it at once suggests the further normalization of capital controls, and the IMFs desire to influence their use. Equally instructive is the fact that Brazil and numerous developing countries in the G‐24 (a group of key developing countries that work through the Bank and the Fund) have unequivocally and quite publicly rejected any such role for the Fund [Wagsty, 2011; Reddy,
34 But see Gabor [2012], who argues that the IMF's view on capital controls has changed far less than I suggest. 35 This French interest is consistent with what Abdelal [2007] argues is a commitment to managing globalization through rules mediated by multilateral institutions.
28
2011; G‐24, 2011]. Newly enjoying policy autonomy in this domain, these countries are not anxious to succumb to new IMF rules or sanctions that could tie their hands in the face of potentially destabilizing flows of hot money. The ultimate outcome of this rethinking of capital controls by the IMF and the economics profession more broadly is uncertain, of course. It is possible that the neo‐liberal worldview may re‐establish itself, not least because its advocates have proven remarkably adept at “paradigm maintenance” over the last three decades as Wade [1996) has noted and as Polanyi [1944:143] suggested long ago. Mirowski [2010] and Hodgson [2009] are also strongly pessimistic about the economic profession’s ability to learn from its mistakes. Others, such as Farrell and Quiggin [2012], see the state of confusion in the economics profession as reflective of an open‐ended “dissensus” that is reflected in swings between Keynesian and austerity‐directed responses to the crisis. However, it seems unlikely to me that the pendulum will swing back in the direction of reifying capital liberalization. And in the end, whether the IMF’s new openness on capital controls fades with the crisis may not matter in the end insofar as the institution has been rendered less relevant as it faces increasingly autonomous and assertive developing country members—some of which are now among its lenders.36 In this environment of disruption, economic and institutional change, intellectual aperture and uncertainty we find a productive expansion of policy space for capital controls, something that may ultimately be seen as an important legacy of the current crisis. This change, messiness, and uncertainty exemplify the productive incoherence of the present environment [Grabel, 2012]. In a similar vein, Mittleman [2013] uses the term “global bricolage” to describe the current environment of shifting relations (especially among groupings of developing countries), institutional adaptation, and changing ideas, while also acknowledging the tension and uncertainty of the current environment. Helleiner [2010] relatedly speaks of the current moment as an interregnum.37 Just as liberalized capital accounts are associated with negative spillovers in the form of economic instability, capital controls in one country can certainly induce positive and negative spillovers abroad. For instance, one country’s inflow restrictions can overvalue other countries’ currency values, harming their export performance. And so it is not inappropriate that the IMF and economists drawing on the welfarist approach are raising the need for some type of regulatory regime or framework for coordinating capital controls. But we must be certain not to go back toward a simple‐minded regime (such as the neoliberal regime) that dictates the same policies for all countries and which also places the responsibilities for policy spillovers on developing countries while giving wealthy countries a pass. These forms of policy coherence ought to be rejected along with the neoliberal form that it took for the better part of a quarter century. 36 Another possibility is that the center of the battle over policy space has shifted from the IMF to legal arenas (in regards to existing treaties, codes, etc). This may be why the IMF’s 2012 institutional view report on capital controls focuses not on economics but on legal matters. 37 This contrasts with Wade [2013] who, while acknowledging some changes (such as some degree of cooperation among the BRICS countries on some issues), argues that there are far more important signs of continuity at the present time in terms of US and Western power.
29
It is, in my view, critical that efforts be made to maintain and expand the opportunity that has emerged in the crisis environment for national policymakers to experiment with capital controls and other measures. Hence, the pressing policy challenge today is to construct a regime that provides for substantial national policy autonomy while managing cross‐border spillover effects [Rodrik, 2001]. This certainly suggests abandoning the strictures on policy space in bilateral, regional and multilateral agreements since many of these preclude capital controls. At the same time it is also critically important that if such a regime does involve some type of coordination, it must involve capital source and recipient countries (as Keynes and White acknowledged long ago), and a genuinely even‐handed acknowledgement that monetary policies and capital controls have global spillover effects that are can be positive and negative. In this regard, the same factors that have contributed to the rebranding of capital controls as prudent capital flow management techniques—the diminished influence and pragmatic adjustment of the IMF in the context of rising autonomy and confidence of leading development states, coupled with increased open‐mindedness and new research within economics—might also contribute to the construction of a viable, flexible and permissive capital controls regime that is consistent with the goals of managing economic instability, promoting economic development and maximizing policy space
References Abdelal, R. (2007) Capital rules: The construction of global finance, Cambridge: Harvard University Press. Abdelal, R. and Alfaro, L. (2003) ‘Capital and control’, Challenge, 46(4) July-August: 36-53. Aizenman, J. (2009) ‘Hoarding international reserves versus a Pigouvian tax-cum-subsidy scheme: Reflections on the deleveraging crisis of 2008-09, and a cost benefit analysis’, National Bureau of Economics Research Working Paper, No. 15484. Anderson, S. (2011) ‘Capital controls and the Trans-Pacific Partnership. Institute for Policy Studies’, Presentation to the Stakeholder Forum, Chicago, IL, 10 September, 2011. Arnason, R. and Danielsson, J. (2011) ‘Capital controls are exactly wrong for Iceland’, Vox, 14 November, 2011. Aquino, N. and Batino, Cl. (2012) ‘Philippines imposes currency-forward caps to restrain peso surge’ Bloomberg.com, 26 December 2012. Barbosa, N. (2010) ‘Latin America: Counter-cyclical policy in Brazil: 2008-2009’, Journal of Globalization and Development, 1(1), Article 13.
30
Beattie, A. (2012) ‘IMF drops opposition to capital controls,’ Financial Times, 3 December 2012. Beattie, A. (2011) ‘World Bank backs efforts to counter rapid inflows,’ Financial Times, 13 January 2011. Best, J. (2005) The limits of transparency, Ithaca: Cornell University Press Best, J. (2003) ‘From the top-down: The new finanicial architecture and the reembedding of global finance,’ New political economy, 8: 363-384. Bank for International Settlements (BIS). (2009) ‘Capital flows and emerging market economies’, CGFS Papers, No. 33. Blanchard, Olivier, David Romer, Michael Spence, and Joseph Stiglitz (eds.). (2012) In the wake of the crisis, Cambridge: MIT Press. Blyth, M. (2003) ‘The political power of financial ideas’ in Kirshner, J. (ed.) Monetary orders: Ambiguous economics, ubiquitous politics, Ithaca: Cornell University Press, 239-259. Blyth, M. (2002) ‘Great transformations: Economic ideas and institutional change,’ Cambridge: Cambridge University Press. Campanella, M. (2012) ‘Where is the big money going? SWFs: A balancing act or a game-changer of the globalization story’, Unpublished paper. Chin, G. (2010) ‘Remaking the Architecture: The Emerging Powers, Self-Insuring and Regional Insulation,’ International Affairs, 86(3): 693-715. Chowla, P. (2012) ‘Does BRICS money for the IMF mean they are bailing out Europe?’ Triple Crisis, June 21 2012. Chwieroth, J. (2010) Capital ideas: The IMF and the rise of financial liberalization, Princeton: Princeton University Press Cline, W. (2010) ‘The IMF staff’s misleading new evidence on capital controls,’ Peterson Institute for International Economics, Realtime Economic Issues Watch. 24 February 2010. Cookson, R. (2012) ‘China lowers barrier to foreign investors’ Financial Times, 21 June 2012. Crotty, J. (1983) ‘On Keynes and capital flight,’ Journal of Economic Literature., XXI, March: 59-65.
31
Crowe, D. (2010) ‘Colombia central bank rules out capital controls,’ Colombia Reports, 19 October 2010. Dadush, U. and S, Bennett. (2011) ‘Why Are Reserves So Big?’, Vox, 9 May 2011. Dobbs, R. and Spence, M. (2011) ‘The era of cheap capital draws to a close,’ Financial Times, 31 January 2011. Drezner, D. (2008) ‘Sovereign wealth funds and (in)security of global finance’ Journal of International Affairs, 62(1): 115-130. Edwards, S. (1999) ‘How effective are capital controls?’, Journal of Economic Perspectives, 13(4): 65-84 Epstein, G, Grabel, I and Jomo, K.S. (2004) ‘Capital management techniques in developing countries: An assessment of experiences from the 1990's and lessons for the future,’ G24 Discussion Paper No. 27, United Nations, NY and Geneva Farrell, H. and Quiggin, J. (2012) ‘Consensus, dissensus and economic ideas: The rise and fall of Keynesianism during the economic crisis,’ Unpublished paper. 9 March 2012. Ffrench-Davis, R. (2010) ‘Latin America: The Structural Fiscal Balance Policy in Chile: A Move Toward Counter-cyclical Macroeconomics,’ Journal of Globalization and Development, 1(1): Article 14. Forbes, K. (2005) ‘Capital controls: Mud in the wheels of market efficiency,’ Cato Journal, 25(1): 153-66 Forbes, K., Fratzscher, M., Kostka, T. and Straub, R. (2011) ‘Bubble thy neighbor: Direct and spillover effects of capital controls,’ Paper presented at the 12th Jacques Polak Annual Research Conference, IMF, 10-11 November 2011. Forelle, C. (2012) ‘In European crisis Iceland emerges as an island of recovery,’ Wall Street Journal, May 21 2012.
Gabor, D. (2012) ‘Managing capital accounts in emerging markets: Lessons from the Global Financial Crisis,’ Journal of Development Studies, 48(6): 714-31. Gallagher, K. (2012a) ‘The global governance of capital flows: New opportunities, enduring challenges,’ Political Economy Research Institute Working Paper, No. 283, November 2012. Gallagher, K. (2012b) ‘The myth of financial protectionism: The new (and old) economics of capital controls,’ Political Economy Research Institute Working Paper, No.278.
32
Gallagher, K. (2011a) ‘Regaining control: Capital controls and the global financial crisis,’ Political Economy Research Institute Working Paper No. 250, University of Massachusetts-Amherst. Gallagher, K. (2011b) ‘Losing Control: Policy Space for Capital Controls in Trade and Investment Agreements,’ Development Policy Review 29(4) July: 387–413.
Gallagher, K. (2010a) ‘Policy space to prevent and mitigate financial crises in trade and investment agreements,’ G-24 Discussion Paper. No. 58, United Nations, NY and Geneva. Gallagher, K. (2010b) ‘Obama must ditch Bush-era trade deals,’ The Guardian, 1 July 2010. Gallagher, K. and Shrestha, E. (2012) ‘The social cost of self-insurance: Financial crisis, reserve accumulation, and developing countries,’ Global Policy, 3(4) November: 501-509. Ghosh, A., Ostry, J. and Tsangarides, C. (2012) ‘Shifting Motives: Explaining the Buildup in Official Reserves in Emerging Markets cine the 1980s,’ IMF Working Paper, No. 34. Washington, DC. Giles, C. (2012) ‘Brics to create financial safety net,’ Financial Times,19 June 2012. Gill, N. (2011) ‘Moody’s cuts Argentine oil companies on capital control law,’ Bloomberg.com, 31 October 2011. Gill, N. (2011a) ‘Brazil’s capital controls are ‘appropriate’ tool, IMF says,’ Bloomberg.com, 31 August 2011. Grabel, I. (2012) ‘Financial Architectures and Development: Resilience, Policy Space, and Human Development in the Global South,’ Background paper prepared for the United Nations Development Program, Human Development Report 2012, March. Appears as Political Economy Research Institute Working Paper No. 281, University of Massachusetts-Amherst, June 2012.) Grabel, I. (2011) ‘Not Your Grandfather’s IMF: Global Crisis, ‘Productive Incoherence,’ and Developmental Policy Space,’ Cambridge Journal of Economics, 35: 805-30. Grabel, I. (2003a) ‘Ideology, power and the rise of independent monetary institutions in emerging economies,’ in Jonathan Kirshner (ed.), Monetary orders: Ambiguous economics, ubiquitous politics, Ithaca: Cornell University Press, 25-52 Grabel, I. (2003b) ‘Averting crisis: Assessing measures to manage financial integration in emerging economies,’ Cambridge Journal of Economics, 27(3), 317-336
33
Griffith-Jones, S. (2011) ‘The Potential Role of South-South Cooperation for Inclusive and Sustainable Development,’ Background Paper No. 2, prepared for the UNCTAD Least Developed Countries 2011: The Potential Role of South-South Cooperation for Inclusive and Sustainable Development. Griffith-Jones, S. and Ocampo, J. (2008) ‘Sovereign Wealth Funds: A Developing Country Perspective,’ Paper presented at the workshop on Sovereign Wealth Funds organized by the Andean Development Corporation, London, 18 February 2008. Grimes, W. (2011) ‘The Asian Monetary Fund Reborn? Implications of Chiang Mai Initiative Multilateralization,’ Asia Policy, Number 11, January 2011. Grimes, W. (2009) ‘Currency and Contest in East Asia: The Great Power Politics of Financial Regionalism,’ Ithaca, NY: Cornell University Press. G-24. (2011) ‘Intergovernmental Group of Twenty-Four on International Monetary Affairs and Development Communiqué’. International Monetary Fund, Washington DC, 14 April 2011. Guha, K. (2009) ‘IMF refuses to rule out use of capital controls,’ Financial Times, 3 November 2009. Helleiner, E. (2010) ‘A Bretton Woods moment? The 2007-2008 crisis and the future of global finance,’ International Affairs, 86(3): 619-36. Helleiner, E. (2009) ‘The geopolitics of sovereign wealth funds: An introduction,’ Geopolitics, 14: 300-304. Helleiner, E. (1996) States and the Reemergence of Global Finance, Ithaca: Cornell University Press Hodgson, G. (2009) ‘The great crash of 2008 and the reform of economics,’ Cambridge Journal of Economics, 33: 1205-1221 Hollinger, P. and Giles, P. (2011) ‘Sarkozy seeks capital flow code,’ Financial Times, 24 January 2011. International Monetary Fund, Independent Evaluation Office (IEO). (2005) ‘Evaluation report: The IMF’s approach to capital account liberalization,’ Washington DC, IMF IMF. (2009a) ‘Annual report on exchange rate arrangements and exchange restrictions,’ International Monetary Fund. IMF. (2009b) ‘The implications of the global financial crisis for low-income countries,’ International Monetary Fund. March 2009. https://www.imf.org/external/pubs/ft/books/2009/globalfin/globalfin.pdf
34
IMF. (2009c) ‘Review of recent crisis programs,’ Report prepared by the Strategy, policy and review department, IMF. http://www.imf.org/external/np/pp/eng/2009/091409.pdf IMF. (2010a) ‘Bangladesh: 2009 Article IV consultation—Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion,’ IMF, February 2010. IMF. (2010b) ‘The Fund’s role regarding cross-border capital flows,’ Report prepared by the Policy, strategy and review and Legal departments, IMF. http://www.imf.org/external/np/pp/eng/2010/111510.pdf IMF. (2011a) ‘Recent experiences in managing capital inflows-Cross-cutting themes and possible policy framework,’ Report prepared by the Strategy, Policy, and Review Department, IMF, 14 February 2011. IMF. (2011b) ‘Policy responses to capital flows in emerging markets,’ IMF, Report prepared by the Asia and Pacific Department, 21 April 2011. IMF. (2011c) ‘The effectiveness of capital controls and prudential policies in managing large inflows,’ IMF Staff Discussion Note, No. 14, 5 August 2011. IMF. (2011d) ‘The multilateral aspects of policies affecting capital flows-Background paper,’ Prepared by the Monetary and Capital Markets Department and the Strategy, Policy, and Review Department, IMF, 13 October 2011. IMF. (2011e) ‘The multilateral aspects of policies affecting capital flows-Background paper,’ Prepared by the Monetary and Capital Markets Department and the Strategy, Policy, and Review Department, IMF, 21 October 2012. IMF (2012a) ‘Currency Composition of Official Foreign Exchange Reserves’, IMF. (COFER). IMF. (2012b) ‘Iceland: Ex post evaluation of exceptional access under the 2008 Stand-by arrangement,’ IMF Country Report No. 12/91, April 2012. IMF. (2012c) 14 November 14 2012. ‘The liberalization and management of capital flows: An institutional view,’ IMF. IMF. (2012d) ‘IMF adopts institutional view on capital flows,’ IMF Survey, 3 December 2012. IMF. (2012e) ‘IMF Executive Board Discusses the liberalization and management of capital flows-An institutional view,’ IMF, Public Information Notice, no. 12/137, 3 December 2012.
35
Jakarta Globe (2010). ‘Asia Should Consider Using Capital Controls to Limit Inflows, ADB Advises,’ The Jakarta Globe, May 18 2010. Jeanne, O. (2012) ‘Capital flow management,’ American Economic Review, 102(3): 203-206. Jeanne, O., Subramanian, A. and Williamson, J. (2012) ‘Who needs to open the capital account?’ Institute of International Economics, Washington DC. Johnston, T. (2010) ‘Thailand joins Asian central bankers taking on Greenspan,’ Financial Times, 21 July 2010. Kaplan, E and Rodrik, D. (2001) ‘Did the Malaysian capital controls work?’ National Bureau of Economic Research (NBER) Working Paper No.8142, Cambridge, MA. Kasekende, L., Brixova, Z. and Ndikumana, L. (2010) ‘Africa: Africa’s counter-cyclical policy responses to the crisis,’ Journal of Globalization and Development, 1(1): Article 16.
Kirshner, J. (2003) “The inescapable politics of money.” in Kirshner, J. (ed.), Monetary orders: Ambiguous economics, ubiquitous politics, Ithaca: Cornell University Press: 3-24 Korinek, A. (2012) ‘Capital controls and currency wars,’ Unpublished paper, presented at the American Economics Association Conference, San Diego, CA, 4-6 January 2013. Korinek, A. (2011) ‘The new economics of prudential capital controls: A research agenda,’ IMF Economic Review, 59(3): 523-559. Kose , M., Prasad, E., Rogoff, K. and Wei, S. (2009) ‘Financial globalization: A reappraisal,’ IMF Staff Papers, 56(1). Krugman, P. (2011) ‘The path not taken,’ New York Times, 28 October 2011.
Kwan Yuk, P. (2012) ‘Peru: LatAm’s latest currency warrior,’ Financial Times, 1 May 2012. Landler, M. and Sanger, D. (2009) ‘World leaders pledge $1.1t to tackle crisis,’ New York Times, 2 April 2009. LatinDADD-Bretton Woods Project (BWP). (2011) ‘Breaking the mould: How Latin America is coping with volatile capital flows,’ LatinDADD-Bretton Woods Project (BWP), December 2011. Lee, C. (2011) ‘S. Korea to undertake stress test on banks’ FX funding-source,’ 25 July 2011.
36
Leahy, J. (2011) ‘Brazil’s Mantega gloats as Europe burns,’ Financial Times, 2 December 2012. Lipsky, J. (2009) ‘Building a post-crisis global economy,’ Address to the Japan Society, New York, 10 December 2009. Lipsky, J. (2010) ‘The road ahead for central banks: Meeting new challenges to financial stability,’ International Monetary Fund, 18 June 2010. Lütz, S. and Kranke, M. (2013) ‘The European rescue of the Washington Consensus? EU and IMF lending to Central and Eastern European countries, Review of International Political Economy,’ 20(2):1-29. Magud, N., Reinhart, C. and Rogoff, K. (2011) ‘Capital controls: Myth and reality-A portfolio balance approach,’ National Bureau of Economic Research (NBER) Working Paper No. 16805. Magud, N. and Reinhart, C. (2006) ‘Capital controls: An evaluation,’ National Bureau of Economic Research (NBER) Working Paper No.11973 Maqtulis, P. (2013) ‘Moody’s backs limited use of capital controls in SEA,’ The Philippine Star, 22 February 2013. Martinez, A. and Barden, A. (2013) ‘Costa Rica central bank may impose more currency controls’, Bloomberg.com, 24 January 2013. Mayeda, A. (2011) ‘Harper clashing with Rousseff on capital controls may herald G-20 discord,’ Bloomberg.com, 8 August 2011. Mead, W. (1992) ‘Bushism Found,’ Harpers, September 1992: 37-45. Mirowski, P. (2010) ‘The great mortification: Economists’ responses to the crisis of 2007- and counting,’ Hedgehog Review, 12(3). Mittleman, J. (2013) ‘Global bricolage: emerging market powers and polycentric governance,’ Third World Quarterly, 34(1): 23-37. Moschella, M. (2012) ‘Institutional roots of incremental change: The IMF, the global financial crisis, and capital controls,’ Unpublished paper. Presented at the ECPR Joint Sessions, Workshop on Economic Ideas and the Political Construction and Meaning of Financial Crisis, Antwerp, 11-14 April 2012. Moschella, M. (2010) Governing risk: The IMF and global financial crises, Basingstoke: Palgrave Macmillan.
37
Moschella, M. (2009) ‘When ideas fail to influence policy outcomes: Orderly liberalization and the IMF,’ Review of International Political Economy, 16(5): 854-882. Nelson, S. (2012) ‘The IMF’s evolving role in global economic governance,’ Draft paper prepared for Manuela Moschella and Catherine Weaver, Crisis and change in global economic governance. Ocampo, J., Griffith-Jones, S., Noman, A., Ortiz, A., Vallejo, J. and Tyson, J. (2010) ‘The Great Recession and the Developing World,’ Paper presented at the conference on ‘Development Cooperation in Times of Crisis and on Achieving the MDGs,’ Madrid, June 9-10, 2010. Ocampo, J. (2010) ‘Time for global capital account regulations,’ Economic and Political Weekly, XLV(46): 32-33. Ocampo, J. (2003) ‘Capital account and counter-cyclical prudential regulation in developing countries,’ In Ricardo Ffrench-Davis and Stephany Griffith-Jones(eds.), From capital surges to drought: Seeking stability for emerging markets London: Palgrave Macmillan. Oliver, C. (2010) ‘IMF warns on emerging market currency controls,’ Financial Times, 11 July 2010. Ostry, J., Ghosh, A., Korinek, A. (2012) ‘Multilateral aspects of managing the capital account,’ IMF Staff Discussion Note No. 12, 7 September 2012. Ostry, J., Ghosh, A., Habermeier, K., Laeven, L., Chamon, M., Qureshi, M., and Kokenyne, A. (2011) ‘Managing capital inflows: What tools to use?’ IMF Staff Position Note No. 11, 2011. Ostry, Jonathan, Ghosh, Atish, Habermeier, Karl, Laeven, Chamon, Marcos, Qureshi, Mahvash, Reinhardt, Dennis. (2010) ‘Capital inflows: The role of controls,’ IMF Staff Position Note No. 4 2010. Park, J., and Van der Hoorn, H. (2012) ‘Financial crisis, SWF investing, and implications for financial stability,’ Global Policy Journal, 3(2): 211-221. Perez, E. and Vernengo, M. (2012) ‘Portrait of the Economist as a Young Man: Raúl Prebisch’s evolving views on the business cycle and money, 1919-1949,’ CEPAL Review, No. 106, April 2012: 7-21. Polanyi, K. (1944) The Great Transformation: The Political and Economic Origins of Our Time, Boston: Beacon Press. Quigley, J. (2013) ‘Velarde says he doesn’t see need for Peru capital controls,’ Bloomberg.com, 25 January 2013.
38
Qureshi, M., Jonathan, O., Ghosh, A., and Chamon, M. (2011) ‘Managing capital inflows: The role of capital controls and prudential polices,’ National Bureau of Economic Research (NBER) Working Paper No. 17363. http://www.nber.org/papers/w17363 Rapoza, K. (2012) ‘Brazil relaxes capital controls; currency to strengthen,’ Forbes, 14 June 2012. Rappeport, A. (2010) ‘IMF reconsiders capital controls opposition,’ Financial Times, 22 February 2010. Reddy, YV. (2010) ‘Asia: Counter-cyclical policies: Indian experience and some general observations,’ Journal of Globalization and Development, 1(1): Article 11, 2010.
Reddy, S. (2011) ‘IMF under fire over plans for capital controls,’ Wall Street Journal, 18 April 2011. Reuters. (2012) ‘Uruguay cenbank moves to stem peso’s appreciation,’ Reuters, 16 August 2012. Reuters. (2013) ‘Bundesbank warms to capital controls in currency war debate,’ Reuters, 24 January 2013. Rodrik, D. (2010) ‘The end of an era in finance,’ Project syndicate, 3 November 2010. Rodrik, D. (2001) ‘The Global Governance of Trade as if Development Really Mattered,’ UNDP Background Paper. Rodrik, D. (2006) ‘The Social Cost of Foreign Exchange Reserves,’ International Economic Journal 20(3): 253-66. Santiso, J. (2011) ‘SWFs-the Chilean Model’, Financial Times, 23 September 2011. Shadlen, K. (2005) ‘Exchanging development for market access? Deep integration and industrial policy under multilateral and regional-bilateral trade agreements,’ Review of International Political Economy 12(5):750–75. Shafik, N. (2011) ‘Global economic challenges and fostering future prosperity,’ Address at the University of Iceland, 28 October 2011. Shamim, A. and Ten Kate, D. (2010) ‘Asia should consider capital controls to stem asset-bubble risks, UN says,’ Bloomberg.com, 6 May 2010. Singh, K. (2011) ‘Should India join the sovereign-wealth-fund herd?’ Vox, October 31, 2011.
Strauss-Kahn, D. (2010) ‘Macro-prudential policies-An Asian perspective,’ Speech, Shanghai, China, 18 October 2010.
39
Stringer, J. (2012) ‘IMF director praises Colombia’s economy,’ Colombia Reports, 10 December 2012. Subramanian, A. and Williamson, J. (2009) ‘The Fund should help Brazil to tackle inflows,’ Financial Times, 25 October 2009. Taleb, N. (2012) Antifragile: Things that gain from disorder. New York: Random House. Thomas Jr, L., (2010) ‘Countries see hazards in free flow of capital,’ New York Times, 11 November 2010. Thomsen, P. (2011) ‘How Iceland recovered from its near death experience,’ IMF Direct, 26 October 2011. Tussie, D. (2010) ‘Ecuador after the financial crisis: Room for external or internal policy space?’ TripleCrisis, 18 October 2010. Valdimarsson, O. (2012) ‘Iceland to apply new rules before capital controls are removed’, Bloomberg.com, 27 August 27 2012.
Wade, Robert. (2013) ‘The art of power maintenance: How Western states keep the lead in global organizations,’ Challenge, 56(1): 1-35. Wade, R. (2010) ‘The state of the World Bank,’ Challenge, July-August, 1-25. Wade, R. (2003) ‘What Strategies are Viable for Developing Countries Today? The WTO and the Shrinking of ‘Development Space’, Review of International Political Economy, 10: 627–44 Wade, R. (1996) ‘Japan, the World Bank, and the art of paradigm maintenance: The East Asian miracle in political perspective’, New Left Review, 217: 3–36 Wade, R. and Veneroso, Frank. (1998) ‘The Asian crisis: The high debt model versus the Wall Street-IMF-Treasury Complex,’ New Left Review, March-April : 3-23. Wade, R. and Sigurgeirsdottir, S. (2012) ‘Iceland’s rise, fall, stabilization and beyond,’ Cambridge Journal of Economics, 36(1): 127-44. Wagsty, S. (2011) ‘IMF and capital controls: Sauce for the goose should be sauce for the gander,’ Financial Times, 6 April 2011. Webber, J. (2011) ‘Argentine’s face tighter forex controls,’ Financial Times, 30 October 2011.
40
Weisbrot, M., Ray, R., Johnston, J., Cordero, J. and Montecino, J. (2009) ‘IMF-Supported Macroeconomic Policies and the World Recession: A Look at Forty-One Borrowing Countries,’ Center for Economic and Policy Research. Widermeir, W., Blyth, M. and Seabrooke, L. (2007) ‘Exogenous Shocks or Endogenous Constructions? The Meanings of Wars and Crises,’ International Studies Quarterly, 51(4), December: 747 – 759. World Bank. (2009) ‘Global monitoring report 2009: A development emergency,’ World Bank (WB)-IMF. Wroughton, L. (2010) ‘Update 1-IMF endorses capital controls as temporary measure,’ Reuters, 19 February 2010.
