Mapping Development

David Ricardo was an early proponent of the idea of comparative advantage. Roughly stated, comparative advantage suggests that when a particular economy has an advantage at producing a certain type of good, relative to other goods, it should focus on that good and then trade the surplus to other economies for whatever else it needs.

It helps to think of this at the individual level: a farmer is better off producing one item really well (say, coffee) and selling that item in the market to buy other goods (like clothing), than trying to do everything independently. This also advantages clothing-makers who aren't good at growing coffee by allowing them to focus on doing what they do best. Everyone will be better off if the coffee farmer specializes in coffee. And so it is with countries, says Ricardo.

The trouble is, the concept of comparative advantage isn't very dynamic. There are many reasons why an economy would not want to produce just one good and have to buy everything else (price volatility, poverty, etc). But one cannot simply turn coffee farmers into commercial jet engineers very easily. For resource-rich countries looking to diversify their workforce, the question of how to move up the value-added chain is vital.

Insert the authors of the Product Space. Over at their website, these clever folks have tried to math out the links between different types of goods. The research is based on the notion of proximity, or "that the ability of a country to produce a product depends on its ability to produce other ones. For example, a country with the ability to export apples will probably have most of the conditions suitable to export pears. They would certainly have the soil and the climate, together with the appropriate packing technologies, frigorific trucks and containers. They would also have the human capital, particularly the agronomists that could easily learn the pear business. However, when we consider a different business such as mining, textiles or appliance manufacture, all or most of the capabilities developed for the apple business render useless."

That seems pretty straight-forward, but here's where it gets cool: they try to map out these linkages, and break it down by country. Go ahead, have a look. You'll notice that some goods are linked closely to others, while others are off on their own.

It's too bad they haven't mapped out the United Arab Emirates yet, because they could really use a glance at one of these things. They might then realize that oil production is not in any way linked to "indoor ski hill in the desert." But I doubt it.

Thought of the Day

John Reed - the former head of Citibank - had some interesting things to say before the US Senate Committee on Banking and such things. See this transcript, which provides a brief, but excellent, list of observations. These lists aren't helpful in providing answers, but I think all of his points are worth keeping in mind when you set out looking for those answers.

For example: "Fourth, while much has been made of the low interest rate environment that accompanied the build up to the crisis, one would not design a financial system that could not function in such an environment."

This is the first time I've heard anyone frame the argument in this way. Alan Greenspan and Ben Bernanke have been taking a lot of flack for keeping interest rates low for an extended period of time, providing an easy-lending environment that led to excessive risk taking. There is good reason for this flack-taking.

But given the economic benefits to regular folks of having low interest rates for a steady period of time, is the problem the low interest rates or the abuse of those low interest rates by those financiers who get all antsy-in-their-pantsy when cheap money is lying around? I suspect it's the latter, so that should the focus of our regulators' attention.

That said, it is much easier for a central bank to raise the interest rate than to turn our investment bankers into socially responsible citizens (kidding!, sort of).

Quick hits and pink picks: From Euro to Zero

-George Soros on Greece and the Eurozone's inherent flaws.

-Kenneth Rogoff sees a wave of sovereign defaults in the years ahead (they tend to follow banking crises).

-There is an interesting debate at Free Exchange on the need for a European Monetary Fund.

-We cite Paul Krugman a lot of these pages; The New Yorker profiles the man and his politics.

-In the wake of another coup in Africa (Niger, this time), FP Passport asks, 'Why are coups always led by colonels?'

-In Olympics news other than US Hockey's epic beatdown of Team Canada (sorry, Dave), the NYT has an interesting analysis of the controversial (for Russians, at least) men's figure skating competition, explaining why American Evan Lysacek didn't need a quad to win gold.

Friday Readables

Dept. of Checks and Balances
After refusing to bow to the government's policy whims, the previous head of Argentina's central banker was dropped like a sack of rice. One is not suprised to learn that his replacement is decidedly more cooperative. There has been some debate recently as to whether inflation targeting should be the only goal of central banks (see here). With inflation running about about 32%/year, Argentina does not figure in this debate.

Sacrilege
Adair Turner, the head of Britain's Financial Services Agency (a position not known for siding with the pitchfork-waving anti-capitalist crowd) calls into question the prevailing dogma about the value of financial liberalization. Ditto over at the IMF blog, where the notion of capital controls is beginning to take hold as part of a 'reasonable' policy approach.

Mine is 1 louder
Last weekend, the Sunday Times published a letter from 20 economists supporting the British Conservatives' plan for fiscal, er, conservatism. This week, 60+ economists responded that the risks of cutting spending are far too high, and could tip the UK back into a recession. So the question is this: are we 1981 or 1997?

Communication Gap
Mobile/cell phone usage, worldwide. I'm guessing that using public transit in Puerto Rico is super-annoying for this reason alone.

Light Posting

Posting has been a bit thin of late - mostly due to work concerns. Don't expect that to change for the next two weeks, however, because the winter Olympics are completely dominating my life right now. I apologize for nothing.

For the skeptics among you, I point to FP passports photo essay of unlikely olympians, including athletes representing Ghana, Ethiopia, Iran, Jamaica and Cyprus.

Go World. More importantly: Go Canada.

Out of the History Books

I'm about a third of the way through Charles Kindleberger's Manias, Panics, and Crashes - a historical examination of financial crises over the past few centuries. It's an interesting read, and Kindleberger regularly sprinkles in some real gems. For instance, in discussing some of the causes of over-zealous investment during a financial bubble, he opines that "There is nothing so disturbing to one's well-being and judgment as to see a friend get rich." The same can be said of our financial institutions.

Here's another: "For historians, each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways. History is particular; economics is general."

Kindleberger tries to weave his way through the particulars to arrive at some general conclusions about crises, and it's sobering stuff. We're used to hearing about the Great Depression, but things pretty much drop off for anything prior. But let me tell you, there were crises galore in the 18th and 19th centuries. The worst part? Although the particulars differ, they tend to bear remarkable similarities to our latest meltdown.

In fact, many of the debates back then echo to the debates being waged today. Writing in the post-WWII period, Chicago economist Henry Simon was arguing that it was not the money supply, not government policy, but rather the instability of credit markets that created a fragile financial system: "He was concerned about the speculative temper of the community and the ease with which short-term nonbank borrowing and lending made society vulnerable to changes in business confidence." Again, the details have changed, but the collapse in confidence in uninsured non-bank lending was a major component of the credit crunch that fed our latest meltdown.

It's something to ponder as practitioners, regulators and policymakers pick up their socks and attempt to try again. How long before the lessons from mortgage-backed securities fade away and the unintended consequences of the latest policy decisions set the stage for the next crisis?

Eurozone Crisis- Simon Johnson has you covered

I have been mulling a thorough post on the developing Eurozone sovereign debt crisis for the past two days, thinking of ways I could adequately present the necessary context, theoretical arguments and implications to the global economy. But in reading through Simon Johnson's coverage of the developments in Europe, I realized something: I can't possibly deliver a better analysis than he has. So instead of trying in vain to duplicate his efforts, I point you towards The Baseline Scenario:

-Johnson's first look at the situation asked whether US policymakers, specifically Tim Geithner, understood the risks posed by a European sovereign debt crisis to America and the global economy

-Over the weekend, Johnson looked at the likelihood of IMF involvement in Greece, the irrelevance of the G7 and the implications of European policymakers' dithering

-Today, Johnson, Peter Boone and James Kwak released their Revised Baseline Scenario for 2010, which includes a great treatment of the Eurozone's sovereign debt woes and its broader implications. This is a long post, but I recommend reading it in full for their 2010 outlook.

Markets rallied yesterday on signs the European big boys would step in and back Greece. ECB President Trichet rushed back from a trip abroad and there were rumors circulating that Germany, the only Eurozone country that really has the balance sheet and power to step in at this point, was constructing a 'firewall' of sorts that would stem any contagion from the Greek crisis. But Germany later denied any plans were in the works, which rattled investors again.

I suspect we'll get some official statements out of the ECB and Commission by the end of the day, hopefully laying out some concrete steps to resolve the situation. But if you believe Simon Johnson, it may all be too late.

Krugman on Spain

Paul Krugman deconstructs the Spanish case and shows why: a) it's different from Greece, and b) how it reflects the Eurozone's broader problems.

Tuesday Readables

- Facts and Myths about Greek's sovereign debt woes: this is one of the better pieces I've seen so far.

- Michael Arghyrou and John Tsoukalas argue for the creation of a "strong" and weak" euro, both managed by the European Central Bank, as a solution to the looming sovereign debt crisis in southern Europe. (possibly gated link, sorry)

- Spillover effects: as investors are betting against the Euro and possibly forcing EU governments to make some tough decisions (see below), they are simultaneously fleeing towards the safety of the US dollar. So long as the US can continue to borrow cheaply, they are less likely to be forced to make some tough decisions about their own problems.

- What if Google was a state-owned company in the Ukraine?

- Indulge yourself and set aside 12 minutes to watch this stunning video. On as big a screen as you can find. It's almost entirely computer generated (except the person, clouds and pigeons), and makes Avatar look like an etch-a-sketch drawing.

Eurozone Crisis: Sell, Sell, Sell

I apologize for the light posting of late. I've been preoccupied with some pretty heavy work-related stuff. But I want to devote much of this week to the developing eurozone crisis. A backgrounder will follow shortly, but to give you an idea of how serious the situation in Europe is, traders have taken over $8bn in short positions against the euro, the largest bet ever against the common currency.

That's massive, almost equal to the $10bn bet against sterling made by George Soros that 'broke' the bank of England in 1992 and ejected sterling from the European Exchange-Rate Mechanism.

The euro was supposed to be one of the big winners of the financial crisis; for the 'safety' it provided countries like Slovakia, for the credible external commitment its accession criteria provided countries like Hungary and Poland, and for its rise as a viable reserve alternative to the dollar. But all of the sudden the euro is confronted with its biggest crisis and I sense that policymakers will soon encounter a stark choice: explicitly back countries like Greece and Portugal or eject them from the common currency.

Stay tuned.

Keynes vs. Hayek: Rap Duel

For a little while back in grad school, I was toying with the idea of writing my thesis as a sort of "Keynes vs. Hayek" debate, early 21st century edition. I eventually abondoned the idea as impractical, and thank goodness: I would never have been able to top this:



Thanks to Tony H for this awesomeness.

In the News: Canadian Banking Regulation

The Links
- For the second year running, the World Economic Forum has ranked the Canadian financial system as the soundest in the world. (It's a decidedly lower bar these days, no?)

- Paul Krugman tries to explain why this is the case in his weekend editorial, but in his effort to create a narrative he misses some important points.

- For a more comprehensive look at the issue, Chrystia Freeland does the job well.

Missing from all of these summaries, however, is one minor niggling point: had the US not bailed out some of its major financial institutions, the story in Canada could very well have been very different.

A few thoughts
The lesson of Canada is not one easily grafted on to major banking sectors like those in the US and UK. Underlying all of this prudent banking is a fundamental lack of competition, both domestic and foreign - something that simply would not fly in any city aspiring to be a global financial hub. To a certain extent, the ease with which Canadian financial institutions have access to American markets has given them space to take a more conservative approach. And while the lack of competition may be stable, it's not something the customers of Canadian banks are always the beneficiaries of, either.

I recently read a US Congressional research report attempting to draw lessons from the Canadians for American banking reform efforts. One of the most noticeable contrasts is between Figure 1 and Figure 2 in the report. Compared to the relatively simple and centralized regulatory structure in Canada, the flow chart of the US system is reminiscent of that ridiculous COIN graph. Nevertheless, the report concludes that, essentially, the Canadian system works pretty well in Canada but is heavily context-specific. There are good lessons to be learned, but they are not easily transferable elsewhere. Sorry.