Wednesday, October 13, 2021

My take on this year's Nobel.

Vivek Dehejia

2021 Nobel in Economics

The anticipation in advance of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel — to give the prize its full title — is always palpable for academic economists, especially for those of us who’ve had the privilege of working with a future Laureate as doctoral students. To add to the sense of occasion, the Economics prize, by coincidence, happens to fall on Thanksgiving Day in Canada, a major national holiday. This year’s prize was awarded to David Card (one-half share) and to Joshua Angrist and Guido Imbens (one quarter-share each), for their pathbreaking work in allowing us make credible causal claims when analyzing data.

In a sense, this year’s prize is the flip side of the 2019 prize, awarded to Michael Kremer, Indian-born Abhijit Banerjee, and Esther Duflo. That trio won, in good measure, for their work in popularizing “randomized controlled trials” (RCTs), long a staple in the natural sciences, in the realm of economics research. RCTs allow us to make causal claims by randomly assigning subjects to a “control” and a “treatment” group — the randomness ensuring that any difference between the two groups can plausibly be attributed to the treatment, rather than any unobserved differences; the theory being that such differences should average out when subjects are randomized.

But, RCTs have some major limitations, which your columnist has argued in detail in these pages (“The experimental turn in economics”, 30 January 2016). A key problem is “external validity” — can a finding in one context be replicated in another, very different, one? Equally importantly, because creating an RCT is not always feasible, nor even ethical, in many situations, such an approach simply cannot address some of the “big” questions in economics, which perforce require that we analyze raw, non-randomized data, but find some way to tease out causality, if it is present.

Recall at the outset that observing a statistical correlation between two variables in the data is not, in itself, evidence of a causal relationship. Take an example close to home. During the pandemic, my classes switched on-line, with a pre-recorded two-hour lecture followed by a “live” one-hour Q&A session. Attendance at the latter was highly recommended, but not mandatory. Uniformly, I observed that students who attended, and participated activity, in the discussion session performed better on the course. But is this because my discussion session allowed them to perform better? Flattering as that would be for any professor, it is equally plausible that those who were anyway going to do well chose to participate — what we call “reverse causality”. Or, perhaps there were unobserved differences between those who participated and those who did not — say, access to high quality internet and the time to read, study, and discuss rather than struggling with poor internet, work, and school — which could plausibly explain the correlation instead? In other words, does non-random selection, rather than causality, matter in this case?

Economics is filled with such situations, where a correlation in the data entices us to draw a causal inference — which may be treacherous to do, in the absence of randomization, which, as noted, is impossible to achieve in most real world situations. The genius of David Card, working with the late Alan Krueger, was to find a clever solution, which was to look at a real world situation presenting as close to a natural experiment as the real world gives us — in this case, two contiguous US states which were otherwise similar, and which shared a common labour market and general macroeconomic conditions, but one of which increased the minimum wage whilst the other did not. (Interested readers may find a detailed exposition in fine write-ups on this year’s prize by economist Alex Tabarok in the Marginal Revolution blog and Tim Harford in the Financial Times .) By computing the “differences in differences” before and after the change and across the two jurisdictions allowed them to infer that any differential impact on unemployment was very likely driven by the policy change, not any unobserved differences.

In a similar vein, research by Angrist and Imbens, again with Krueger, in a series of papers, studied important questions such as whether increased schooling increases earnings, an obvious situation where any assumption of a unidirectional causal link may be problematic. (For instance, brighter students may study more and also earn higher incomes, both because of higher intrinsic ability.) In one seminal paper, Angrist and Krueger asked whether compulsory schooling could increase wages, and found a brilliant technique for randomization: given the oddities of the US school system, students born in late December would be one class behind those born in early January, and laws in some states allowed students to drop out at 16. The upshot is that there would be at least some students otherwise almost identical who got a year more of schooling for a purely random reason, and, these students, did indeed earn higher wages, making a causal claim tenable. (Again, check Tabarok and Harford for more details.)

The beauty of these contributions is that they were not founded on a complex and technical mathematical or statistical result that would be undecipherable to the layman, but on a simple and profound intuition of how randomization may be found even in our messy and non-random world, thus making causal inference tenable. Three cheers!

Vivek Dehejia is associate professor of economics and philosophy, Carleton University, Ottawa, Canada.

Monday, October 4, 2021

My latest column asks whether Evergrande's woes mean this is a Schandenfreude moment for China critics.

Is this the Schadenfreude moment for China sceptics?

Vivek Dehejia

The woes of Chinese property development firm, Evergrande, heavily indebted to both domestic and foreign lenders and on the verge of collapse, has engendered a Schadenfreude moment amongst China sceptics: but is it premature? After the crisis broke out, some proclaimed that the imminent failure of Evergrande might just be China’s “Lehman moment”, referring to the 2008 bankruptcy of the New York investment bank, Lehman Brothers, which was the opening salvo in the global financial crisis. Yet, global financial markets settled after a day or two of turmoil, as investors bet that that the Chinese state, which still heavily regulates the economy, will restructure the debt-laden firm in a manner that forestalls any potential international contagion. The critics might just have to wait before popping the Schadenfreude champagne corks.

Yet, even absent contagion, the Evergrande saga is but the tip of the iceberg of an overheated and indebted property sector which potentially threatens the edifice of the larger Chinese economy and, therefore, indirectly the global economy, too. In a fascinating long read, British-born historian, Niall Ferguson, makes just such a case (“Evergrande's Fall Shows How Xi Has Created a China Crisis”, Bloomberg Opinion, 26 September ).

As Ferguson observes, Evergrande is emblematic of a China which has developed in the past decade with an economic development paradigm premised on “urbanization on steroids”. For all of the skyscrapers, both commercial and residential, that dot the landscape of Chinese cities, large and even small, many of these remain empty and their property developers unable to sell enough units to pay off the debt incurred in putting up the buildings to begin with.

In other words, the property sector in China, larger even than in the US on the eve of the collapse of Lehman, is a ticking time bomb that could have significant macroeconomic consequences beyond the property and financial sectors through the impact on Chinese households, who are heavily invested in a property market that has been in bubble territory for some time. Citing research by Harvard economics professor, Kenneth Rogoff, and his co-author, Yuanchen Yang of Beijing’s Tsinghua University, Ferguson notes that housing wealth accounts for a whopping 78 percent of total assets in China, much higher than the 35 percent share in the United States, for instance. The upshot is that consumer spending in China is, per Rogoff-Yang, “significantly more sensitive to a decline in housing prices” than in the US. The impacts of a more generalized collapse in the property market in China could be large and consequential for the global economy.

For those with a long enough memory, none of these recent developments should come as a surprise. As long ago as 2004, economist James Dean and I argued, and as I summarized for Mint readers much later (“Will the elephant overshadow the dragon?”, Economics Express, 5 March 2015 ), that the Chinese model is characterized by the glaring contradiction between ever-increasing economic freedoms and an authoritarian political dispensation. What is more, the economic development paradigm of the Chinese Communist authorities was focussed on an infrastructure-driven, “build and they will come” model, in sharp contrast to, say, the Indian model, in which the supply of new infrastructure is driven by the demand for it, rather than the reverse.

The consequence, as Dean and I argued in 2004, was a Chinese development success story that was something of a house of cards, and built upon excessive investment, including in housing — what the Austrian school of economics would call “malinvestment”. Chinese growth statistics would, therefore, in an important sense be inflated: after all, if the economy grows rapidly because of a stock of property and infrastructure that ultimately will never be put to use, and which leads to the accumulation of large debts, such rapid growth may be unsustainable and, in a certain sense, illusory.

Up until now, China sceptics, including your columnist, have been confounded by the reality that successive generations of the Chinese leadership have shown a remarkable ability to continue to refresh and reinvent their model — both economic and political — thus ensuring that growth rates remain high and that the spectre of social chaos and unrest remains at bay. Every Chinese leader since Deng Xiaoping and his pioneering reforms of the late 1970s have managed to maintain the unwritten but all-important bargain with the populace: “we will give the you the opportunity to get rich, and the price is that you must stay out of politics”. But perhaps, just perhaps, the chickens may finally have come home to roost on the watch of authoritarian strongman, Xi Jinping — what, writing in 2015, I had reckoned might be an “implosion” in the Chinese economy or  a “belated and disorderly democratization” of the society.

What might make this time different is that, in the past few years, Xi has begun to rewrite the unwritten social compact, and increase government and party control over the economy, and reign in what he clearly believes is an excessively free and insufficiently regulated market economy, undoing the premise of Deng’s reforms. He has also been, first quietly, now overtly, building a cult of personality to match that around Mao. If the economy, and the public mood, sour, Xi may end up ruing these choices.

Vivek Dehejia is associate professor of economics and philosophy at Carleton University in Ottawa, Canada.

Friday, September 17, 2021

My latest column analyses the Canadian election campaign.

Trudeau has taken a gamble in calling an early election

On 20th September, Canadians go to the polls, in an election that no one much wanted, except for incumbent Prime Minister Justin Trudeau of the Liberal Party. At the helm of a minority government since 2019, Trudeau called an election two years early, in the hopes of capitalizing on Canada’s successful vaccination campaign to entice the voters into returning his government with a majority.

The snap election, in the midst of a burgeoning fourth wave of the still ongoing COVID19 pandemic, has been much criticized, but, according to Canadian law, the head of state, Governor General Mary Simon, did not have any choice but to grant Trudeau’s dissolution request and drop the election writ. This was even despite Trudeau’s minority government not having been defeated in a confidence vote, and therefore still enjoying the confidence of the House of Commons.

As your columnist has noted on previous occasions, Canada’s brand of the Westminster model gives almost unlimited power to an incumbent prime minister, much more than the power enjoyed by his or her counterpart in the United Kingdom or in India. The prime minister not only appoints the head of state but members of the Supreme Court, as well as filling any vacancies in the Senate, the unelected upper house of Parliament. This would be akin to a Prime Minister of India appointing the President, appointing members of the Rajya Sabha, as well as the Supreme Court. Likewise, in the U.K. and India, an incumbent prime minister has only limited ability to change the normal electoral calendar — which in India is decided by the Election Commission and in the U.K. is governed by the Fixed-Term Parliament Act. Canada, in theory, also has a fixed term law, but it is essentially toothless, and, in effect, only puts an upper limit on the lifespan of a government, rather than preventing a prime minister from opportunistically calling an early election midway through the government’s mandate.

If the polls are to be believed, Trudeau’s gamble is not likely to pay off, as the Liberals are running neck-and-neck with the main opposition, the Conservative Party, led by Erin O’Toole, its new leader. At the time of filing, it appears to be a coin toss whether the Liberals or Conservatives will win the election, which will almost certainly be a minority. A minority government would be vindication for O’Toole, who became party leader after a fractious leadership battle and that too in the midst of the pandemic. For Trudeau, it would be a major defeat, given that he had called an election for the self-evident purpose of winning a majority. His leadership would most certainly be in doubt and the knives within his party would certainly be out for calling the gamble of calling a premature election and then losing the bet.

The election is also a test for Jagmeet Singh, leader of the New Democratic Party (NDP), a social democratic party that stands to the left of the Liberals. The NDP perennially run third, or sometimes even fourth, behind the Quebec separatist Bloc Quebecois, and have never sniffed victory, although Singh did play a pivotal role in keeping Trudeau’s minority government afloat the past two years. More interesting, perhaps, is the rise of the People’s Party of Canada (PPC), a conservative party that stands to the right of the Conservatives. The party was founded by Maxime Bernier, a former Conservative, who lost a bitter leadership contest with O’Toole, and then left the party to start his own. Canada has not, until now, had a viable right wing party, and, while under Canada’s first-past-the-post electoral system, the PPC, like the left wing Greens, are unlikely to win more than a handful of seats, at best, they could become increasingly important going forward, especially if they are able to pull the Conservatives back to the right and away from the crowded centre that they share with the governing Liberals. Likewise, if the Greens eat into the NDP’s votes, that might induce Singh to pivot further to the left.

For an election that Trudeau had described as “pivotal”, in an attempt to sell it to voters, the campaign has been singularly devoid of substance, with little daylight between the solidly centrist positions of the two main parties. Trudeau had attempted to create a wedge issue with his support for mandatory vaccination for federal employees and in other areas under federal jurisdiction, in the hopes of baiting O’Toole, whose party has its share of “anti-vaxxers”; likewise, Trudeau has raised the bogeyman of a putative privatization of Canada’s socialized healthcare system were the Conservatives to win. It is unclear how many, if any, of the undecided voters may be swayed by either of these issues. (Note: The Alberta crisis, with Conservative Premier Jason Kenney declaring a state of emergency, admitting he had mishandled the COVID19 pandemic, which may also hurt the federal Tories, occurred after this piece was filed.)

Looked at from India’s vantage point, given the frictions with Trudeau over his public comments on the farmer protests in India, and the memory of his disastrously failed India visit in 2018, which your columnist had elsewhere described as a “slow-moving train wreck”, New Delhi mandarins are unlikely to be terribly disappointed if Trudeau is shown the door. Having said that, O’Toole does not enjoy the close personal relationship and obvious chemistry that Prime Minister Narendra Modi enjoys with the previous prime minister, the Conservative Stephen Harper, and is himself new in the job. Don’t expect any major shift in the moribund Canada-India bilateral relationship, no matter the outcome of the election no one wanted.

Monday, September 6, 2021

My latest Mint column, on how dollar hegemony threatens emerging markets, revising the old Triffin Paradox.

As the last instalment of this column observed (“The dangers of continuing with unconventional policies”, 20 August), there is a rising drumbeat of debate about the unwinding of US “unconventional monetary policies” — in particular, large scale asset purchases, more commonly called “quantitative easing” — as well as the eventual normalization of the policy interest rate to above the near-zero level at which it has been stuck since the global financial crisis.

The topic came up for discussion during the recent (virtual) Jackson Hole meeting of the US Federal Reserve, where Fed chief, Jerome Powell, sent the markets his strongest signals yet that the US central banks is preparing to wind down its asset purchases, at present a staggering $120 billion per month. In a much-watched speech, Powell asserted that “substantial further progress” has been made on the Fed’s twin goals of keeping inflation on a low and stable path and the economy moving closer to full employment.

The minutes of  a recent Federal Open Mark Committee (FOMC) meeting, which sets Fed policy, and which met before the Jackson Hole event, suggests a broad-based consensus amongst committee members that QE should start winding down later this year, although it is expected that the Fed will continue to hold an elevated stock of bonds even as the inflow of additional purchases tapers and eventually comes to a stop.

It is noteworthy that, in Powell’s remarks, he sharply distinguished the tapering of QE from interest rate normalization, noting that a much more “stringent test ” would apply to the latter operation. The significance of this important distinction should not be passed over lightly.

Readers will recall well the 2013 “taper tantrum” crisis, on which your columnist has dilated on, and which created a panic in global financial markets — especially, emerging economy stock, bond, and currency markets — after then Fed chief, Ben Bernanke, rather loosely remarked that the Fed was planning to begin dialling down its asset purchases, without being terribly clear on his likely forward guidance on a glide path for interest rate normalization.

Speaking on the possibility of Fed tapering in an interview to the Financial Times (“Emerging economies cannot afford ‘taper tantrum’ repeat, says IMF’s Gopinath”, 29 August), International Monetary Fund chief economist, Indian-born, American economist Gita Gopinath, warned that emerging economies could not “afford” a repetition of the 2013 taper crisis. She told the FT: “[Emerging markets] are facing much harder headwinds….They are getting hit in many different ways, which is why they just cannot afford a situation where you have some sort of a tantrum of financial markets originating from the major central banks.”

The danger that Gopinath and others have pointed out is that higher or stickier than expected inflation in the US will  likely prompt the Fed to more aggressively ramp up interest rates as part of an accelerated normalization of monetary policy.

The danger scenario for emerging economies, especially heavily indebted ones, would be the twin blows of rising debt service costs on their dollar-denominated debts as well as the likely outflow of a large quantum of capital funds enticed by the now higher returns to be earned in dollars, to say nothing of the safe haven value of the dollar in times of economic volatility. Indeed, this is exactly what spooked the markets, and hobbled many key emerging economies, including India, back in 2013.

If such a “double whammy” scenario, as Gopinath terms it, returns today on the back of Fed tightening, the IMF estimates that $4.5 trillion of global gross domestic product could be wiped out by 2025. What is worse, the hit will likely falling disproportionately on low income developing and middle income emerging economies, according to former IMF chief economist, Maurice Obstfeld, also speaking to the FT. The fact that these economic shock waves would emanate in the context of a pandemic crisis that is worsening in many parts of the still largely un-vaccinated developing world might just make this the perfect storm.

In an unusually candid (as well as rather canny) comment, Gopinath observed that one of the difficulties at the time of Bernanke’s 2013 remarks that touched off the taper crisis was his announcement on QE tapering got “mixed up” with market expectation of more rapid interest rate normalization. This confusion may, indeed, have abetted the seriousness of the 2013 crisis, as it created greater uncertainty, with many more “carry trade” and other speculative investors in the emerging markets bolting for the door at the same time. She noted that, this time around, “super clear communication” is the need of the hour, and suggested that Powell is doing a good job. The implied criticism of Bernanke’s poor communication in 2013 is the understated inference.

Some perspective may be useful. As I noted in one of my earliest columns in this newspaper (“Illusions bred by a reserve currency”, 17 July 2014), reliance on a single global reserve currency, the US dollar — whether de jure, under Bretton Woods, or de facto, as at present — creates a peculiar dilemma, noted in the 1960s by economist Robert Triffin: the short term, domestically driven goals of the reserve currency economy may diverge from long term needs of the global economy. Inevitably, the hegemonic large country, which provides the reserve currency as a global public good, will privilege itself, at the expense of the rest of the world. The “Triffin paradox” is still with us.