Report from Lindau: Day 3

I am writing from St Gallen University in Switzerland, where the closing ceremony of the Lindau meetings is taking place. The ceremony includes a panel of economists who will discuss the origins of the financial crisis. Similarly ambitious topics were covered yesterday in the third day of the meetings.

Roger Myerson provided a model of moral hazard in the banking sector where bankers have career concerns and used it to explain financial bubbles. This way of integrating micro and macro considerations is much needed if better models of the economy are to be build. Daniel McFadden also tackled the important issue of government intervention in the health insurance markets when there exist frail consumers. Unfortunately, both talks were not well constructed, were technical and much of their message was lost.

Ed Phelps gave a more descriptive talk and denounced the rise of "corporatism", a way of conducting economic policy that goes back to Mussolini and that consists on a strong intervention of the state in favor of the interests of private enterprises. Phelps argued that corporatism was prevalent in Tunisia and Egypt, and led to corruption, nepotism and inefficiencies, but also in the US where corporatism has precluded the less well off from enjoying the benefits from the last episode of economic growth.

The lectures by Eric Maskin and George Akerloff were much better structured and clear. Maskin gave a talk on Condorcet and Borda voting rules that was almost identical to the one he gave in Edinburgh four years ago. Akerloff gave an introduction to the use of the concept of identity in Economics and its explanatory power. The talk, that was also a way of publicizing his recent book with Rachel Kranton, said nothing new to those have been reading his work with attention but it was of interest to those unfamiliar with his ideas. It is quite remarkable that when Akerloff first mentioned these concepts around fifteen years ago the profession received them with profound skepticism. Fortunately, thanks partially to the behavioral revolution, his work has received the appreciation it deserves.

But the big star of the day was, unsurprisingly, Joseph Stiglitz. It was amazing how Stiglitz managed to compress so many ideas in just 30 minutes. He started with his by saying that macroeconomics has failed as a science because it failed to predict the crisis and as an example mentioned the facts that the models used by central banks do not actually include a banking sector. But his two main ideas where that globalization has made the system less stable rather than in the other way: Financial integration helps contagion and exacerbate risks. The other idea was that the recent crisis, provoked by staggering inequality according to him, was a manifestation of a structural change . In the same way as the crash in 29 represented the transition from an economy based on agriculture to one based in manufacturing, the 08 crisis has marked the transition from a manufacturing based economy to a service based economy. Given this structural change, models and data from the previous "era" are of little use in the new one.

In the afternoon, I attended the parallel discussion session in which Stiglitz answered questions from a big crowd of young economists. He elaborated on some of these ideas and discussed how also with globalization the Pareto optimality of free trade gets severely undermined: With international prices of agricultural products, bad harvests mean that local farmers receive lower revenues for sure. He insisted in blaming, quite rightly, Alan Greenspan for the dire situation of the US economy who thanks to the Iraq war and the tax cuts transformed a superavit into a unmanageable debt.

Now is time to go on a boat trip at Lake Konstanz. So that's all from Lindau, folks!

Report from Lindau: Day 2

Disappointing. This is probably the word that best describes the second day of the Lindau Nobel Meetings, where panel and discussions revolved mostly around two issues, the reasons behind the financial crisis in 2008 and the foundations of economic behavior.

The morning did not start well. In a rather uninspiring lecture, William Sharpe did a very bad service to the profession when he showed a graph depicting the utility of financial traders in his model and said "I do not know whether traders have these utility functions, but does not this graph look really beautiful?". With this he gave more arguments to those who say that economists are completely detached from reality.

Sharpe was followed by John Nash who proved once again that he should not participate in scientific conferences. Sir John Mirrlees raised standards a bit with his talk on poverty and food markets. His most provokative idea was that rising food prices may actually help people in developing food-producing countries to leave poverty rather than actually impoverishing them even more.

After the break, Ed Prescott took the stage to shake the audience once more. He explicitly associated tax cuts and tax increases with booms and recessions respectively. He further argued that the financial crisis of 2008 did not lead to the subsequent economic crisis we are still in, the so-called Great Recession that, he said, after checking the newly revised economic data does not look like a big recession any more. Robert Mundell provided his own explanation to the crisis. For him it was big swing in exchange rates what precipitated the last crisis, as in many other cases in the past. He also argued in favor of a world currency, the eurodollar. This proposal was a big surprise, to say the least, coming from someone who received the Nobel prize for pointing out that single currency areas may not be a very good idea.

The set of lectures finished with Robert Aumann (in the photo), surely the most passionate and enthusiastic of all the laureates who spoke during the day. In his talk, Aumann discussed under which conditions strategic behavior can be analyzed as one-person decisions problems. Unfortunately, the lecture was not well pitched the audience got lost about half way.

Aumann played also an active role in the plenary session in the afternoon, a panel on "behavioral economics", in which he heatedly debated with Reinhard Selten. Aumann argued that the deviations from standard economic predictions uncovered in experiments are due to the unfamiliar nature of the decisions and that these deviations are much less frequent in decisions that are important or often repeated. He mentioned the concept of "rule-based rationality" by which people are not necessarily rational in their decisions but choose to use rules that usually lead them to take rational choices. Selten argued against the existence of such rules or, at least, against the idea that these rules are chosen or adjusted. He even suggested that utility functions not even exist and promised to elaborate more on his lecture in day 3. This comment acted as an ironic echo to Sharpe´s remark on utility functions in his morning lecture.

Unfortunately, apart from this debate, the panel on behavioral economics was rather confusing and basic. The discussions left out many aspects like reciprocity or social preferences. Let´s hope that tomorrow will be better.

Report from Lindau: Day 1

The opening ceremony of the Lindau Meetings started with an address by the German Federal President Mr Christian Wulff. His address covered many of the issues raised after the financial crisis in Europe and tried to be quite consensual. He mentioned the unfairness of taxpayers funding rescue packages whilst CEOs still enjoy milliionaire bonuses. He acknowledged that financial markets are very important drivers of economic policy these days and that politicians are often too eager and not toughtful enough when respondind to them. But he also insisted in the German official rethoric where irresponsible spending by the Southern European countries is deemed as the main culprit of the situation. The response, Mr Wulff said, is that spending cuts and austerity must be enforced if the crisis is to be overcome.

The panel on "sustainability" that followed started with Roger Myerson thanking macroeconomic theories for improving standards of living since 1929. It continued with the rather inane interventions of two young economists. Then McFadden put his farming cap on and used agricultural methapors to describe the world economy. The last turn was for Joseph Stiglitz's. His words were probably the highlight of the day. He started by contradicting both Mr Wulff and Myerson by saying that spending cuts are leading countries to disaster as Medieval doctors' use of leeches were drove weak patients to death. Then he continued arguing that precisely macroeconomic theories led us to the crisis in the first place. Finally, he talked about the euro, doomed for disaster from the outset according to him, but still worth saving.

After the break Peter Diamond reminded central bankers that there is no clear reason why an inflation target of 2% is better than 3% and that price control, although important, should not become an obsession. On the other hand, Chris Pissarides addressed the gap in work hours between the US and Europe and highlighted two reasons: First, that activities such us health care, cooking or cleaning that in the US are "marketized" in Europe are performed by families, mostly because taxes are higher. And second, and more worrisome for Europeans, because public employment in education and health have increased considerably in the US compared to Europe.

Finally, the panel discussion on democgraphic change generetaed a very interesting debate between Prescott and Peter Diamond, especially regarding taxation of savings. Predictably, Prescott (in the phote) argued for no taxation on savings and actually went further and advocated the abolition of income taxation, that should be replaced by consumption taxation. Diamond on the contrary argued that no taxation of capital was not a good idea, as suggested by the negligible effect on savings after they were partially declared tax-free by Mrs Thatcher.

What has become evident after this first day of sessions is that there is a heated and healthy debate within the discipline. Huge names in Economics hugely disagree on huge issues. So let's keep on discussing.

Report from Lindau: Day 0

I am right now at Lindau, Germany, where the 4^th Lindau Meeting on Economic Sciences will take place during this week. Since 2004, Nobel Laureates and selected young researchers from all over the world meet in this beautiful island in the middle of Lake Konstanz to discuss their ideas and interact. In this edition, the Lindau Foundation has gathered 18 laureates and more than 370 young economists from more than 60 countries (although from my first impressions I would say that more than Germans dominate over all other nationalities).

Given the scientific potential of the meeting and the interesting discussions and plenary sessions in the programme I thought it would be a good idea to act as an improvised reporter for the Edinburgh Economics Blog and write a daily report on what will be going on here in Lindau.

Today we will have Nobel Laureates McFadden, Myerson and Stiglitz talking about sustainability and growth whereas Peter Diamond, Chris Pissarides and Dale Mortensen will talk about the future of employment in Europe (grim, I guess) and demographic change. I will report on the highlights of these discussions tomorrow.

For the time being let me tell you about the first thing related to meetings that I encountered at my arrival to Lindau: the banners you can see in the photo above. They were hung in front of the Conference Centre by ATTAC, Real Democracy Now and other organizations whose German names I cannot translate. As you can see, they ask economists to drop “neoliberal” ideas and to introduce ethics in Economics. The “Heterodox” economic views endorsed by these banners deserve more than one post, so let me just mention that they made me think about two ideas related to the Lindau meetings. First, how wrong these views are. They portrait Economics as a monolithic discipline, populated by Machiavellian and perverse scientists who are leading the world to chaos. To the very least, that vision is wrong because participants in the Lindau meetings include Nobel Laureates with such disparate thoughts as Akerlof and Stiglitz on the one side, and Scholes and Prescott on the other. If there is something absent in Economics at this moment is consensus (and that is a good thing).

Second, these protests highlight how badly we as economists have managed public perceptions of Economics (or how little we have cared about them), and also the extent to which this is due to the fact that for too long the discipline has been rowing in the direction of interested parties (as Nick Stern pointed out already two years ago). I will never get tired of repeating that the rational model of behaviour that we economists handle is descriptive rather than prescriptive and that it does not rule out other motivations. But I am not naïf enough to ignore that Economics has often treated selfishness (which is not equal to self-interest) as an all-encompassing view of human beings. Still, if anything, one of the causes of the present crisis is that the relentless force of selfishness has been underestimated.

Nobel Laureates and young economists will see these banners every day at the start and end of the sessions. I hope they will not ignore them. These banners represent both a reminder of our failures and a challenge for the future.

World without the risk-free bench mark…

Last week’s S&P’s downgrade of US debt undoubtedly marked a new chapter in the history of the recent crisis. Double-dip recession is no longer a mere possibility, but a sad reality. Extensive use of fiscal and monetary policies, otherwise known as Quantitative Easing, was implemented by the Fed and ECB to battle against the meltdown of the financial system in 2008. But, by driving the interest rates to near to zero levels, the developed world locked itself in the liquidity trap, while soaring debt levels stripped the governments of the ability to use fiscal policy if the recession returned. The Debt crisis became a new malaise in the developed world, which caused a fall of investors’ confidence in the strength of political institutions and their ability to deliver quick and much needed anti-recession solutions. S&P used weakening of political leadership as their main reason for the US downgrade, an event which caused massive market sell offs last week.

So what effect might the US downgrade have on the economy, other than from the need to rewrite hundreds of thousands of economic text books to correct for the absence of the risk-free bench mark? Market uncertainty and increased volatility had already been reflected in recent panics which caused share sell offs all around the world. As for the average consumer, a cut in debt rating usually results in higher interest rates paid on mortgages, car loans etc, as they are linked in the short term. However, some suggest that a mistake in S&P calculations by almost $2 trillion(!), and their worries about the US political strength and not the country’s creditworthiness will make investors even more unsure who to believe. Thus the most immediate effect is the increase in the uncertainty premium needed to compensate investors for holding US Treasuries. We should really start getting worried if the other two major rating agencies (Moody’s and Fitch) follow the steps of S&P, which will only make the panic worse. But for now, what S&P did goes against vital economic assumption- they deprived investors of beloved ‘risk-free’ assets, leaving them hanging without a safety net.

Written by Daria Rusanova - 4th year MA (Hons) Economics and Economic History

The long run starts now!

What should the government do about the disappointing growth in the UK economy? To traditional Keynesians, the answer is obvious: spend, and spend hard. The big problem is not the deficit or the national debt; these will come good if the economy grows and tax revenues rise, and a little bit of inflation wouldn’t do much harm either. That’s how we dealt with the debt we had built up after World War II.

The Coalition Government has taken the opposite view: we need to cut, and cut hard. Unless we can get our debt under control, then markets will lose confidence and we will go the way of Greece, Portugal and Ireland. And by reducing the size of government, we allow room for the private sector to grow.

Both sides of this argument are wrong. Markets are more understanding if there is a good reason for building up debt. But under Labour the government was borrowing even when the economy was booming; when the crash came we had nothing to show for it except a structural deficit. We hadn’t won a war, or radically improved our infrastructure, or ensured that every child could read by the age of six. But we did have some good memories of foreign holidays. So why on earth should markets now believe that borrowing is going to be put to good use?

But the Government is trying. The problem is that the private sector is not doing its bit. Much of this is outside the Government’s control, whether it be Greece induced Euro jitters, or a dysfunctional constitution taking the US to the brink of default. But whatever the reason, for many firms this is not a good time to recruit or invest.

In my view, we need to think about where we want to be in 10 or 20 years time. What sort of Scotland do we want and what policies do we need to take us there? That means it’s not so much the level of government spending as its quality and composition that’s important. We need fewer wars and better trains, less bed blocking and more fibre optic cables; we need a regulatory environment that makes it easy to set up a business, employ young people, and keep the fruits of risk-taking. Crucially for Scotland, we need to address public sector reform. Are we really sure that we are getting good value in the way we organise our schools, hospitals and local services?

The longer view is often politically difficult; but it is economically essential, and much more likely to convince the markets that the UK is a good place to invest in.

The Dracula Effect

Why do we vote for politicians who propose protectionist trade policies when it is not in our interest to do so? In a seminar held by Giacomo Ponzetto at the Universitat Pompeu Fabra this summer a simple answer was proposed to me: we don’t know we’re doing it.

The argument goes like this:
An individual consumer (like you or I) has no incentive to inform themselves of a candidate’s trade policy since their chance of affecting the electoral outcome is effectively zero. Producers on the other hand, regardless of their ability to influence the election result, value information on trade policies because it allows them to forecast prices and make appropriate investments. Producers are in the know and consumers are oblivious.

Politicians will therefore propose protectionist policies since this will boost their popularity amongst producers whilst the uninformed consumer is none the wiser. This is a very interesting theory because it says that producers will be offered protection even without forming a lobby - the mere existence of information in their minds is enough to secure a political favour!

This set up is good for everyone. Except consumers. And unfortunately, consumers make up the majority of ‘everyone’. Producers get a nice little pay-off, politicians get extra votes without sacrificing uninformed consumer support and the consumer unwittingly picks up the bill through higher prices.

So what on earth does this have to do with Dracula?

Exposing a vampire to the harsh light of day is sufficient to reduce him/her to dust. The Dracula Effect says the same will occur to consumer-hostile policies when they are exposed to the harsh light of public attention. If consumers are just as informed as producers, the politician can no longer get away with his furtive bribe and those terrible tariffs turn to dust.

If you’re interested, see Ponzetto’s paper here for empirical evidence on the Dracula Effect

Post written by Stephen Devlin - 3rd year MA (Hons) Economics

Spending cuts, elections and the Great Recession

In a recent lecture at the Barcelona GSE, Prof. Alberto Alesina from Harvard University talked on the effect of fiscal policies on recovery from economic crisis and their effect on the electoral prospects of incumbent politicians. You can find the video of this very interesting lecture above these lines, but if you are to busy to watch it (and you trust me enough), I will summarize for you the two main points made by Prof. Alesina based on empirical data on previous economic crisis:

1. Spending cuts are less contractionary and lead to more stable adjustments of debt and deficits than tax increases.
2. Voters reward rather than punish governments who undertake fiscal reforms.

These findings have interesting implications on economic policy and political outcomes: Spending cuts probably are the right way to go and politicians have no reasons to be shortsighted; they should be brave and undertake deep economic adjustments and reforms. Good news for David Cameron, I guess. But Prof Alesina's results also open new questions and leave other unanswered. Spending cuts on what? Education? Health? Social Security? Are all of them equally virtuous? And secondly, what about tax evasion? In countries like the UK that may not be a big issue but in other like Spain or Italy it is. So, as we often say at the end of our academic papers, "further research is needed."

Spain’s Persistent Problem

The fifth largest economy in the EU is currently suffering the highest level of unemployment in the developed world. A staggering 20.6% of the Spanish working population is jobless, or nearly 5 million people (compare that with 3 million jobless in Germany which has a population twice the size). However, the absolute level of Spanish unemployment is not the only problem; its persistence is equally worrying.

Historically, we observe that the US jobless rate (blue line) seems to continually return to a base level of 4-5% whereas the EU rate (black line) and especially the Spanish rate (red line) do not exhibit this tendency. In other words, Spaniards must face the likelihood that high unemployment is going to stick around for a while.

Why should there be such a dramatic discrepancy between two highly developed countries such as Spain and the USA? There are many proposed explanations, ranging from labour market malfunctions to cultural differences. However, there is one theoretical explanation which I find particularly appealing and intuitive. It has to do with Employment Protection Legislation (EPL). The role of EPL is to prevent unfair practices in the hiring and firing of employees and consequently represents a barrier (or cost) to firms in changing their level of labour employment. The theory is that these costs are sufficient to discourage firms from terminating contracts but also from taking on new ones (since they expect it is a decision which will not be easily reversible). So as a result of strict EPL, employment levels do not adjust easily, temporary shocks have long term effects and unemployment becomes a very persistent problem. Where does Spain rank on the spectrum of EPL strictness?

Although this model makes no predictions regarding the absolute level of unemployment I find it to be a compelling example of the way in which over-regulation can clog up markets and well-meaning legislators can exacerbate the problems they are looking to solve.

There's an interesting animation that shows how the unemployment figures are rising in the USA at: http://www.latoyaegwuekwe.com/geographyofarecession.html

Post written by Stephen Devlin - 3rd year MA (Hons) Economics

Suspicious Economics

Do you have trust issues? Well, as an economist you certainly should! The validity of every theory and statement should be checked and verified before you can use it as your source or let it influence your personal opinion. And the recent article that I read in the Financial Times highlights this issue.

The article defends Gordon Brown’s decision of “selling off national silver (gold)” between 1999 and 2002, underplaying potential gains which could have been realized if UK gold was sold at a later date. However, it is not the actual content of the argument but the following discussion by the readers that drew my attention. Almost every single comment disagreed with the article and pointed out to other important issues that needed to be looked at. Overall the comments provide you with much more diversified information than the article itself, thus representing a less biased view of the issue. This allows us, students, to look at an issue from different perspectives, which is crucial for the study of economics.

Despite the fact that the columnist represented a highly biased view in well-respected newspaper-Financial Times, it is important to note that it is purely his opinion. FT columnists are free to express their opinions on economic issues, even if some may not necessarily agree with it. Economics allows almost every question could be answered with “It depends...” However, us as students (due to the lack of expertise) rely heavily on opinions of established economists, and if those opinions are not questioned properly they might be misleading. So even in such quantitative subject as economics different subjective opinions must be considered before you can make your own judgement.

However, the extent to which economics can be “subjective” is debatable. Expressed opinions of some people might have the power to move markets and manipulate animal spirits of the investor. For example, in the midst of the recent financial crisis leading rating agencies attempted to shed their responsibility for ignoring potential threats from overrated CDOs by emphasizing that their ratings merely represents their opinion and should not be solely used for making important financial decision.

If you are interested in reading the article and the following heated debate, follow the link: http://on.ft.com/kAhovE

Written by Daria Rusanova - 3rd year MA (Hons) Economics and Economic History

Shanghai Securities News

I am proud to share the news that some of us at the School of Economics are becoming regular contributors to China's leading financial newspaper: Shanghai Securities News.

In March, Stuart Sayer and Kohei Kawamura gave valuable viewpoints in an article about the effect of the earthquake on the Japanese economy (see http://finance.qq.com/a/20110321/001615.htm).

Today Angela Nolte and Stuart joined three other experts in discussing the European debt crisis in an article entitled "The European Sovereign Debt Crisis in EU: How about the future of monetary union" (see: http://money.cnstock.com/waihui/mrzxbd/201105/1283749.htm).

You might want to try using Google Translate, unless your Chinese is very good, and interestingly, Stuart's name translates as Stuart Tesar Jersey for some reason.

Official? Or False?

The Portuguese request for financial assistance from the EU last week begs an important question: could Spain really be next?

To answer this we may look to any number of sources; however one place we should not expect to find a reliable prediction is the mouth of a public official.

You might remember some of these quotes from the past year:

“We need no bilateral loans. We haven’t asked for any and don’t need any” George Papandreou, Greek Prime Minister, January 2010.

"The state is well funded into June of next year, we have substantial reserves, so this country is not in a situation or position where it is required in any way to apply for the [European Financial Stability Facility]" Brian Lenihan, Irish Minister for Finance, November 2010.

"There are no links between Portugal and Ireland... I've heard a lot of talk of the IMF. The country does not have any need for aid." José Sócrates, Portuguese Prime Minister, November 2010.

‘risk of contagion is absolutely ruled out’ Elena Salgado, Spanish Minister of Economy and Finance, April 2011.

Why do public figures, who undoubtedly recognize the desperate financial situation their countries are facing, feel the need to make these exaggeratedly optimistic statements? Their assertions are essentially a desperate attempt to calm the onslaught of speculation against their nation’s financial credibility. They hope that their steady manner and unreserved, if false, resolution will calm the fears of investors and constrain the spread of their bond yields, thereby reducing their cost of borrowing.

Is it worth a shot? Sure. Does it work? Apparently not.

However, so far the threat of contagion for Spain really does appear to be limited. The government has been decisively tackling the deficit and taking measures to strengthen the banking industry and last Thursday €4.1bn of debt was successfully auctioned. The spread between Spanish and German borrowing costs has remained steady.

Perhaps this time we might believe the official stance...?

Post written by Stephen Devlin - 3rd year MA (Hons) Economics

Austerity cuts

Here is an interesting post concerning the government’s austerity cuts. It answers the question of how, in the face of reduced government spending, the Office for Budget Responsibility can still predict output growth. It expects the private sector to take up the slack. But this is not a story of dynamic private sector entrepreneurs. It is a story of household spending. It expects private sector debt to grow enormously over the next two years. That is, despite squeezed incomes, the recovery relies on household keeping their spending going, and hence borrowing more. The irony, pointed out by the article, is that it was supposed to be excessive private sector debt that caused the problem in the first place.

Crises of Capitalism

For a while I have been interested in hearing the responses of economists to the seemingly widespread anger that society helds against the profession. Economists, many say, have failed society because they failed to predict and prevent the financial crisis that we are now suffering. I do not have yet a fully articulated response to that anger but let me say that two things are clear to me now: 1) Society has a distorted view of what Economics is about and what economists do 2) and that that is not society´s fault but mostly ours as economists because we have been often too shy and sometimes too arrogant to reply back.

Above all, we as economists should not be dismissive of society's arguments nor of arguments coming from "heterodox" or "critical" thinkers such as David Harvey, a Professor of Anthropology at CUNY, with a distinguished career as a social theorist. I wanted to show you this video in which one of Harvey's lectures on the crises of capitalism is illustrated as he speaks. The video is interesting for several reasons. One, because it is very nicely done. Second, because the first half makes a very nice summary of the arguments put forward as explanations of the financial crisis. And finally, because he proposes several arguments, probably wrong, but that can help to ignite some debate. As I said, I do not think that we should dismiss his ideas just because he is a marxist. We should reply with sensibility, arguments and evidence. And I would like to hear your views on it.

The Importance of Tradition for British Universities

Great Britain has always been good at preserving its traditions. Taking tourists to see Big Ben in London in red buses, teaching English to international students in prison-like boarding schools, making roast dinner each Sunday and uniting people of all races and nationalities in pubs all across the country to watch Manchester United play Arsenal over a pint of beer-these constitute only a small part of centuries-old traditions which makes Britain truly Great.

Whether you are coming to the UK to live, work or study, the country offers you a ‘complete package’ in the form of the fusion of many cultures which promises to make your stay in Britain very unique. As for UK universities, they are world famous for the quality of their programs as well as their diverse student body which sets top institutions apart from their Ivy League competitors.

Did you know that Edinburgh University welcomes around 25,000 students, 20% of which are international? Such openness to foreign students does not only benefit international and British students who get to explore different cultures as a preparation to their global careers, but also serves as a huge benefit to the UK, which attracts many talented individuals who increasingly contribute to the development of a new, large export industry - higher education.

Recently, FT calculated that the tuition fees paid by the overseas students were the 2nd highest revenues collected in 2010 following financial services, a shocking figure! However, recent proposals by the UK Government to limit the number of working visas issued to non-EU citizens to 21,700 Tier 1 in 2011 (20% reduction) caused a new wave of discontent.

The argument behind such radical measures is based on a theory that a decrease in immigration of skilled workers (including graduates from UK universities) will help UK citizens to find jobs in depressed economy. However, many academic studies proved such theories wrong using empirical evidence to claim that immigration does not affect employment for local citizens (if interested, see papers by Christian Dustmann, Francesca Fabbri and Ian Preston). On the contrary to that, others consider visa plans as ‘hostage against British Universities’.

Reduction of student visas being issued is most likely to devastate pre-university pathway courses as well as have a serious impact on a reduction of number of students admitted to undergraduate programs costing the country billions of pounds in tuition fees and other income. Overseas students contribute to the local economy enormously in fees, rents and living expenses, so it is not surprising that Government’s actions are most likely to spike further public outburst.

Countries already began showing their discontent with the measures. Last week, India took up issue with the new UK student visa curbs. Major stake-holders in Britain have opposed the measures that are likely to result in thousands job losses and a cut in the annual contribution of 5 billion(!) pounds to the British economy from the international student market.

Recently, LSE surveyed all its overseas students (from outside the UK and the EU) to gather views on the recent UK Border Agency's consultation on changes to the student immigration system and found out that abandonment of post-study visa (PSV) will most likely result in less overseas applicants, as many students choose UK over US/Canada/Australia precisely because of the attractiveness of PSV. Moreover, research shows that due to the specifics of particular positions, there are actually very few jobs taken by post-study visa holders would have otherwise gone to unemployed Britons. This poses an important question - how will the UK universities survive recent changes brought forwards by the Government?

Due to newly imposed immigration rules, universities will not be able to attract more international students to compensate for their lost revenues as a result of dramatic increase in tuition fees for English students. So if English students will not be able to afford higher education while foreign students will not be allowed into the country or deported back home due to abolishment of post-study visa, how does Britain plan to increase its recovery and sustain the number of high skilled workers?

Those are vital factors contributing to Britain’s other long-standing traditions which are as well-known as fish and chips, namely - innovation, highly qualified labour force and global cultural reach.

Written by Daria Rusanova - 3rd year MA (Hons) Economics and Economic History

Inside Job

Last Sunday I’ve decided to take a break from working on my essays and catch a movie at a nearby cinema. To feel somewhat less guilty about it I picked Inside Job, a documentary about the causes and effects of the recent financial turmoil – that still counts as revising economics, right?

Here’s a little review I came up with.

The film starts with a short prologue describing the crisis in a nutshell on the example of Iceland. Next, we move to US where we’re greeted by a hypnotizing voice of Matt Demon who narrates throughout the rest of it.

The core of the movie comprises of a number of interviews with top players from the world of finance and extracts from politician’s TV appearances. It’s all divided into five chapters, focusing on different stage of economic downturn. Those go from the regulatory changes of 1980s and a resulting increase in the financial sector’s power, through the very tense weeks of autumn 2008, all the way to its immediate aftermath.

The director (Charles Ferguson) seems to be particularly concerned with close ties between Wall Street and not only the US government but also, quite interestingly, the entire discipline of economics. The latter is represented by lectures by Deans of top American universities like Harvard, Columbia Business School, Berkley or Brown University.

Inside Job isn’t exactly the most objective documentary I’ve seen. It seems quite determined to depict the employees of the financial sector as a bunch of greedy and self-egoistic hustlers whose sole goal is to make as much money as possible so they can spend it on more jets, mansions, drugs and prostitutes (there’s actually a bit on all four of those “expenses” in the film).
Nevertheless, I really liked that it wasn’t over-dramatic or shocking where it didn’t need to be – which unfortunately isn’t very common for films of that genre these days.

All in all, the film provides a good summary of the recent events and explains some terms from the glossary of crisis (like CDOs, credit default swaps, subprime mortgages etc.) in a fairly clear way. It’s also simply a good entertainment and gives you a chance to get to know a bit more about people like Alan Greenspan, Ben Bernake or Nouriel Roubinin.

So, if you want to see the film for yourself, it’s screened at Cameo at least twice a day, and now that it has won itself an Academy award for the best documentary, probably in all the other cinemas in the weeks to come.

Post written by Witold Gawlikowicz - 3rd year MA (Hons) Economics and Mathematics

Staff v Students Football 2011

Toppling dictators: The role of natural resources

2011 is not being a good year for Arab dictators. After 24 years of rule, Mr Zine El Abidine Ben Ali, Prime Minister and President of Tunisia was ousted from power. In Egypt, Mr Hosni Mubarak was forced to step down after having ruled the country for three decades. And now in Lybia, Mr Muammar Al-Qaddafi is using extreme violence to avoid being overthrown by masses of discontented citizens and factions of the army after holding an iron grip on the country for more than 40 years.

This has been a series of remarkable revolutions. Driven by the desire of people in these countries to end corruption, tyranny and to improve their economic conditions. These three rulers used their position to accumulate enormous amounts of wealth and to benefit their inner circle of relatives and friends by "privatising" national companies. For instance, Mubarak's family wealth was estimated to be between US $40 and $70 billion. Of course, one big question from an economist perspective is why these kleptocratic rulers, with their bad economic policies and corruption could stayed in power for so long. And, especially in the case of Qaddafi, why are they so difficult to overthrow.

The paper by Daron Acemoglu, Jim Robinson and Thierry Verdier entitled "Kleptocracy and Divide-and-Rule: A Model of Personal Rule" (Journal of the European Economic Association, 2004) addressed this problem. These authors developed a model aimed at answering this question and focused mostly on the cases of Mobutu Sese Seko in Congo (1965-1997) and Rafael Trujillo in the Dominican Republic (1930-1961), but it is possible to apply their ideas to these Arab autocrats. The main point of the paper is that a kleptocrat (from Greek, a ruler who steals) can stay in power if he is able to buy the support from the different groups that conform their country. These groups could oust the ruler if they were united but they fail to do so because the kleptocrat "bribes" pivotal groups and make them content, mostly by taxing and mistreating other social groups. That is the Divide and Rule strategy.

Critical to this strategy is the budget constraint of the ruler. The amount of income that it is at his disposal and that allows him to buy these groups. That is why Arab revolutions were sparked by the severely deteriorated economic conditions in these countries, poverty and unemployment. That is why these rulers and the rulers in other Arab countries such as Saudi Arabia or Morocco have used subsidies on food or massive housing programs to avoid revolts. Critical to this strategy is also foreign aid and natural resources. They can provide kleptocrats with more wealth they can then distribute across social groups to buy their support. This can help to explain the position of Qaddafi, who has been able to stay in power because of the revenues from the massive oil and natural gas reserves that Lybia enjoys, as well as the revenues derived from contracts with other nations on the supply of these resources

That is what is missing in Acemoglu, Robinson and Verdier's analysis. That in order to stay in power, autocratic rulers not only need to buy the support of pivotal groups within their countries but also of pivotal governments abroad.

The Peseta Returns

If you thought you were witnessing tough times in the UK, just take a look at Spain for a little perspective. I’m spending my third year abroad studying in Barcelona and never have I been more intensely aware of the economic woes of the people around me. Wages falling, retirement age rising, government bond yields still over 5%, stagnant GDP growth, and over 20% unemployment – it all adds up to some pretty pissed-off locals. So when I read in a local newspaper this week about a town which had given up on futile strikes and was taking its own proactive measures against the systemic Spanish hardships I was thoroughly impressed.
In the Atlantic province of Galicia the local businesses of a tiny pueblo named Mugardos have begun accepting the old Spanish currency of pesetas. The idea is that local businesses which are struggling because of feeble consumer demand will get a boost by giving everyone a chance to get rid of the pesetas they forgot to change into euros 9 years ago. The businesses can then make a communal trip to the Banco de España in Madrid where they can still exchange the pesetas for euros.
This is an incredibly brilliant idea for a number of reasons. It taps into a huge dormant source of wealth – the Banco de España estimates that Spaniards are still sitting on 1.7 billion euros worth of pesetas! What’s more, the market is effectively the entire nation and, indeed, businesses in Mugardos are reporting visitors from all over Spain.
It is particularly interesting for an economist because this situation showcases the peculiar properties of money – something physical which has had no real worth to the owner since the switchover to the euro has suddenly been re-imbued with purchasing power and once again has value. Nothing about the material notes or coins has changed in all this time, only their interpretation.
But my favourite aspect of this new idea is the symbolic move against the euro. With many Spaniards begrudging their new currency and blaming it for their recent troubles this is the perfect way to give it a kick in the proverbial balls.

Post written by Stephen Devlin - 3rd year MA (Hons) Economics

School of Economics Mug - the new edition

The latest edition of our mug is now available from the office.

Edinburgh Climate Conference, February 26-27 2011

On the weekend of 26th and 27th February, Edinburgh University Economics Society will be hosting the Edinburgh Climate Conference in Appleton Tower.

This unprecedented major event will take a multi-disciplinary academic approach to climate change, looking at how Scotland can contribute to the global effort to tackle the problem.

Across the course of the two days, some of the most notable academics in the field, and a variety of local groups and businesses will come together with students and staff here at the University of Edinburgh, including our very own Stuart Sayer.

They will be looking at climate change from a variety of angles; the costs of inaction, Global solutions, the environmental policies of Scotland and the UK, technologies to change the world, adaptive business solutions, and the things we can all do in our everyday lives to tackle climate change.

In addition to Stuart, speakers will include Dr Andy Kerr, Director of the Edinburgh Climate Change Centre and Nobel Prize winner Professor Gabi Hegerl. The full list of speakers and further details are available on the Conference website.

http://edinburghclimateconference.com/index.html

www.oured.ed.ac.uk

The event is entirely student organised and is designed for students from all disciplines and backgrounds. Student delegates will take away a holistic understanding of climate change, so that they can return to their speciality better informed so as to make effective decisions affecting all our futures.

When does it take a socialdemocrat to call for the army?

On December 4th, Spanish Prime Minister Mr Jose Luis Rodriguez Zapatero called for a national state of emergency in order to dismantle the strike mounted thet weekend by the air controllers. The air controllers were protesting against their working conditions and the proposal to cut their wages. They had held a low-intensity protest for a long time and finally decided to escalate to a strike in order to make their demands heard. The center-left wing government of Mr Zapatero, afraid of a collapse in all Spanish airports, and following a quite "Thatcherite" approach to labor negotiations, decided to call for the army. The Ministry of Defense took control of the Spanish aerial space and all air controllers (civilians) were threatened with a court martial if they failed to report to their posts. Leaving aside issues such as whether the air controllers' demands were fair or whether the strike was legal, many commentators were surprised to see a socialdemocrat government to make use of the army in a country were the military has been an instrument of the political right from the early XIX century to the (failed) military coup of 1981.

The truth is that this event can be seen as part of a long list of situations in which some policies were implemented by very "unlikely" political parties. For instance, France privatized its public sector under socialist Mitterand, Israelies conceded the Sinai peninsula to Egypt under hawkish Prime Minister Begin, and it was the blatant anti-communist Richard Nixon who first opened the US to trade with the Republic of China.

More than ten years ago, professors Alex Cukierman and Mariano Tommasi wrote a very nice paper entitled When does it take a Nixon to go to China? (American Economic Review, 1998) in which they gave an explanation to this phenomenon of "policy reversals": When voters do not know exactly what is the best policy to be followed and they do not know either whether a party takes a stand because it is in the citizens' interest or just because ideology, "unlikely" parties have an advantage in signalling credibly. If a hawkish israely government negotiates with Egypt or if a republican visits China, voters can be reasonably sure that it is because these are the best policies for the majority of the populations and not just because they are what politicians would prefer to do themselves. A socialdemocrat government thus signal more credibly than a rightist government that being hard on strikers and (perhaps) calling the army is the best strategy. Voters have less reasons to suspect that such a policy is proposed solely because of the ideological tendency of the party in office. This also explains why previous center-right governments in Spain failed to take a hard stand in previous conflicts with the air controllers.

And this also explains why, if the UK ever adopts the euro, it will be probably under a tory government.

Quantitative Easing Explained by Teddy Bears

Two cartoons on quantitative easing. The second one is funnier but more wrong.

Sumner Re-Spins Quantitative Easing

Quantitative Easing Explained by Cartoon Characters

Balmoral Asset Management Prizes

Balmoral Asset Management came to the School of Economics recently to award prizes to last year's students.


Pictured from the left: Caroline Rae, General Manager, Balmoral Asset Management, First Prize winner: Silviya Foteva (Economics), Second prize: Tom Harwood (Economics), Third prize: Lesley Clark (Economics and Accounting), Chris Hendry, Financial Advisor, Balmoral Asset Management (Graduate of University of Edinburgh, School of Economics)

Well done everyone!

Tram fiasco: an incomplete tale

http://thescotsman.scotsman.com/12445/What-went-wrong-39It39s-hell.6610706.jp

It's a spectacular failure of contracting (the picture is an Edinburgh tram that did run on on Princes Street). But what's wrong? Is that because the Germans are 'delinquent'? Well, maybe, maybe not, but in any case a good contract should take into account the incentive to go delinquent, but this contract hasn't, apparently.

We economists are fully aware that most contracts are incomplete: we cannot possibly specify every future contingency on a contract, so there must be circumstances where the contract does not say what to be done and contracting parties disagree on it. But in standard models of incomplete contracts (such as the famous Grossman-Hart-Moore model, yes Moore is our Prof Moore) we don't see such a prolonged dispute or lawsuit as we see now, because if the players are rational and there is no asymmetric information, they renegotiate efficiently (and any delay or lawsuit is inefficient so they shouldn't occur!).

This means there must be an assumption(s) that does not hold in reality. Asymmetric information about the the other party's outside option, i.e. what happens to the opponent if they never reach an agreement, could explain an aspect of the dispute (my colleague Santi has a very nice paper about a related theme, though in the context of war http://www.voxeu.eu/index.php?q=node%2F5551), but I am inclined to think more about rationality and the very basic assumption in game theory (and contract theory) that all players fully understand and agree on the rule of the game (i.e. what exactly the contract means), not least because it may also give an insight into how we could have avoided such inefficiency by designing the initial contract in a cleverer (and perhaps less incomplete) way.

But then there are so many ways in which people can be irrational and disagree on the rule (contract) they should abide by. So we would need to think carefully and precisely about how they have been irrational and/or what's each party's understanding of the contract like.

Anyway, I think there's a good undergraduate dissertation to be written on this subject... I'm really curious what exactly the actual contract says, and how that can be interpreted and analysed both from legal and economic viewpoint.

Cuts and Economics

Maybe because I'm from a country that has a debt GDP ratio of 200%, George Osborne insisting Britain (the ratio is a little above 70%) is at "the brink of bankruptcy" has always sounded a bit funny. Anyway, as everyone knows, he announced big budget cuts today. (by the way the chap is the Scottish Danny, Treasury secretary, not George)

I don't have a strong opinion about the likely consequences of the cuts (sorry!). But I find it amusing that what those Tory/LibDem politicians say sounds exactly like what a good third year economics undergrad would say about fiscal policy in his/her homework essay. It strikes me that those politicians do believe strongly in textbook economics and actually use it as THE justification for the cuts. I think, the politicians are, or must have been, good economics students (e.g. Danny and David were indeed PPEists: I don't know whether they did economics in their second and third years though).

On the other hand, I guess their teachers (we academic economists) have been less enthusiastic, perhaps because we tend to believe that the actual fiscal policy doesn't actually work like that. At least I used to think that, in any country, even when a big spending cut is deemed appropriate in theory, politicians favour tax increase or do nothing in practice. For instance, a large decrease in "G" seemed to me like a mere intellectual exercise, rather than anything practical.

So, to me, what the UK government is trying to do is a big policy experiment to test whether undergrad macroeconomics actually works in reality. The point is that, rather surprisingly, it doesn't seem to have been tested before. If it works, then I'll definitely have more faith in what I teach.

Are apes the real Homo Economicus?

A new academic year has started and it's about time for the Edinburgh Economics Blog to become active again. But first of all, we in the School of Economic would like to thank you readers for all your feedback and suggestions during last year.

And now, a brand new entry.

A good friend recently sent me a reference to a scientific article saying "Santi, I am sure you will like this". The featured article was a work by a team of three US anthropologists who have studied during 10 years the aggressive behaviour of chimpanzees at Kibale National Park in Uganda. In the paper they published this year in Current Biology John Mithani and co-authors describe how these chimpanzees formed coalitions in order to attack others chimpanzees, killing around 20 rivals in the process, and then seized and occupied the territory of the vanquished. Chimpanzees have been long suspected to display this very human type of behaviour and this study seems to provide definitive evidence of it. The authors attribute these aggressions to the desire of extending territories and obtain resources that winners later distribute rather cooperatively among them.

A second study, this one published in 2007 in Science, shows another instance of selfish and materialistic behaviour in chimpanzees. In a paper authored by Keith Jensen, Josep Call and Michael Tomasello, the authors show that, contrary to humans, these apes behave rationally in the Ultimatum Game. Rather than rejecting them, chimpanzees accept low offers, somehow demonstrating that fairness concerns and other-regarding preferences are what distinguish us humans from our primate cousins.

In recent times, the behavioural revolution within Economics has enriched our models of human preferences by incorporating inequality aversion, reciprocity and efficiency concerns. In the end, it seems, apes and not homo sapiens were the true homo economicus.

Economic thinking and political radio shows

Our main objective when teaching Economics is that students become capable of using economic thinking to analyze problems. Unfortunately many still believe that Economics is about regurgitating ideas (imperfectly) learned by heart or just knowing where to invest. Economics changes your way of thinking and will help tremendously in your understanding of the world. Moreover, this "economic mindset" is not that difficult to grasp and once you start using it you will be able to apply it to many aspects of your everyday life. Take for instance this fragment from Consider the lobster (2005), a book by late David Foster Wallace (in the photo), one of the greatest modern american writers and, also, an economic thinker. He uses the basic ideas of public good provision to analyze the rather conservative leaning of political radio shows in the US.

It is a fallacy that political talk radio is motivated by ideology

"The persistence of this fallacy among left-wing opponents of talk radio is extraordinary (...) the usual claim here is that right-wing radio is "owned by large, profit-hungry corporations of wealthy, profit-driven individuals, who use their companies to push a conservative, pro-capitalist agenda." This analysis also identifies the gross economic illogic of this claim. Suppose that I am the conservative and rabidly capitalist owner of a radio company. I believe that the free-market conservatism is Truth and that the US would be better off in every way if everybody were conservative. This, for me, makes conservatism a "public good" in the Intro Econ sense of the term - i.e., a conservative electorate is a public good in the same way that a clean environment or a healthy populace is a public good. And the same basic economics that explains corporate contributions to air pollution and obesity explains why my radio company has zero incentive to promote the public good of conservatism. Because the time and money my one company would spend trying to spread the Truth would yield (at best) only a tiny increase in the conservatism of the whole country - and yet the advantages of that increased conservatism would be shared by everyone, including my radio competitors, even though they wouldn't have put themselves out one bit to help shift public opinion. In other words, I alone would have paid for a benefit that my competition could also enjoy, free. All of which plainly would not be good business... which is why it is actually in my company's best interests to "under-invest" in promulgating ideology."

Impressive, don´t you think?

General Election Hustings

Monday 26 April, 6.30 p.m. - 8 p.m.
George Square Lecture Theatre, George Square, Edinburgh, EH8 9LK

Do you have a burning question to ask Edinburgh's parliamentary candidates for the Westminster General Election? Come along to this event and hear first-hand from Edinburgh South candidates why they believe their parties have the best policies. Find out what their priorities are for higher education and for students, and ask them questions about key issues that are important to you.

Panel members are:
Neil Hudson (Conservatives)
Ian Murray (Labour)
Fred MacKintosh (Liberal Democrats)
Sandy Howat (SNP)
Robin Harper (Green candidate for Edinburgh East)
Chair: Dr Mark Aspinwall, Senior Lecturer in Politics and International Relations, School of Social and Political Science, Edinburgh University

There will be questions from the audience on the night but if you would like to submit a question to the panel in advance please email it to anna.maciulewicz@eusa.ed.ac.uk

Prof. Jeffrey Sachs: Live Video-Seminar Mon 26th April

(Photo courtesy of psdblog.worldbank.org)

Organised by the University of Edinburgh Economics Society

Professor Jeffrey Sachs is one of the worlds most prominent development economists. Author of The End of Poverty, his books have twice been New York Times bestsellers. He is Special Advisor to the UN Secretary-General Ban Ki-Moon and was also the director of the Millennium Development Goals. He is an important figure in the world of development economics.
Event Details:
Date: Mon 26th April
Time: 18.20 19.20
Location: TBC
(Registration required)
This event is free, but registration is necessary. To register please send your name, email and student number (where applicable) to ed.econsoc@gmail.com subject: Jeffrey Sachs. Registration will close on the 18th April.

This seminar may be of particular interest to studying Economics of Developing Countries, as Jeffrey Sachs is the author of one of the key texts.

If you have any questions or for further information please email ed.econsoc@gmail.com.
Hope to see you there,
Robbie Marwick
Co-President
The University of Edinburgh Economics Society