How China beat the Global Financial Crisis

If you were hoping for something on yesterday’s interest rate rise, I can only direct you to the leader in the FT today which says: “There is no compelling reason to increase the cost of borrowing in the UK, but there is definitely good cause to wait.” On why nine intelligent people could all make the same mistake, you have to question their mandate, and move to something that focuses on having the right environment for growth, as I do here.

I recently finished reading the latest book by Adam Tooze (of which much more in a subsequent post), and it reminded me of a story that was not told enough in the early days of austerity. Everyone knows about how quickly the Chinese economy has grown over the last few decades, and how strong exports have been an important part of that. In dollar terms the value of Chinese exports more than quadrupled between 2000 and 2007. By 2007 Chinese exports represented 35% of GDP.

An important characteristic of the Global Financial Crisis (GFC) was how quickly world trade collapsed. If we compare the beginnings of Great Recession after the GFC with the start of the Great Depression, while world industrial production moved in a similar fashion, world trade collapsed by much more in the Great Recession than the Great Depression. Here is a chart from Barry Eichengreen and Kevin O'Rourke’s ‘A Tale of Two Depressions Redux’ VoxEU article.

Trade collapsed in the winter of 2008 around the globe, without exception. This was very bad news for China. Whereas exports had been around 35% of GDP in 2007, they fell to around 25% of GDP in 2009. That is a big hole to fill, and if it wasn’t filled, there was a chance that Chinese growth would collapse completely with damaging knock on (multiplier) effects to the rest of the economy. Above all else, China feared the political consequences of the unrest widespread unemployment would bring.

As Tooze recounts, China’s reaction was swift and bold. In November 2008 it announced a stimulus package of public spending worth 12.5% of GDP. (The Obama stimulus package, by comparison, was around 5% of GDP.) “Over the days that followed [the announcement], across China, provincial party meetings were hurriedly convened …” Within a year 50% of the stimulus projects were underway. Some of this stimulus paid for what Tooze describes as “perhaps the most spectacular infrastructure project of the last generation anywhere in the world”, the Chinese high speed rail network. Monetary policy was also relaxed.

In 2008 as a whole, before the stimulus and hardly touched by the collapse in world trade, Chinese GDP grew by 9.6%. In 2009, when GDP in the advanced countries fell by 3.4%, Chinese growth was 9.1%. The stimulus package had filled the whole left by collapsing Chinese exports. (Source)

Basic macroeconomic theory says that a negative shock to GDP, caused for example by falling exports, can be completely offset by a monetary and fiscal stimulus. China is a good example of that idea in action. What about all the naysayers who predicted financial disaster if this was done? Well there was a mini-crisis in China half a dozen years later, but it is hard to connect it back to stimulus spending and it had little impact on Chinese growth. What about the huge burden on future generations that such stimulus spending would create? Thanks to that programme, China now has a high speed rail network and is a global leader in railway construction.

Now of course people will say that China is not like an advanced democracy, and it was not part of the global banking network that caused the GFC. But the US and UK stimulus programmes could and should have been larger. Those close to the action tell me that the UK was running out of things to spend more money on in 2008/9, but I cannot help think this amounts to a failure of imagination: it is not as if UK infrastructure is great, there are no flood defence projects left to do etc. Above all else China’s example tells you what a huge mistake 2010 austerity was.

Brexit: a battle lost but who will fight the war?

The Brexit vote was, in economic terms, an act of self harm. You do not need to just ‘trust the experts’ on this: it is pretty close to common sense. As Rebecca Driver clearly explains, leaving the single market will make it much more difficult for (particularly small) firms to trade in Europe. As Europe is on our doorstep and geography matters, that cannot and will not be compensated for by trading more elsewhere. [1] Finally greater trade is associated, for clear reasons, with higher growth. Lower growth will impact unfavourably on every area in the UK, whether they voted Leave or Remain.

The harm done is not just economic. As Ben Chu writes, “The crude majoritarian politics of this referendum has seen half of the population (a generally poorer, less well-educated and elderly half) effectively strip major freedoms and even a cherished identity from the other half (a more prosperous and predominantly younger half)”. Before the referendum, I had conversations with people arguing that a Brexit vote would be more harmful than a Trump presidency, and this deep sense of anger, loss and despondency will not go away. We therefore need to understand why it happened.

In my last post I argued that Brexit was a protest vote against both the impact of globalisation and social liberalism. The two come together over immigration, and of course the one certainty of the Brexit debate was that free movement prevented controls on EU migration. Globalisation has benefited the majority in the UK, so those who had not benefited could not alone have won a Brexit vote. Equally social conservatives have lost battle after battle in the UK on specific social issues. Brexit was the perfect storm where these two groups came together, and combined they just managed to win.

Explanations do not imply inevitability, but instead tell us why the result could easily have been different. We need a sensible discussion about immigration, rather than assume it is always and everywhere a problem. However to follow the social conservative route and say concern over immigration is just xenophobia is not helpful. [2] We need to challenge the view the right wing press has patiently built up that immigration is responsible for declining public services and making it difficult to get housing. Too many people continue to discount the power and influence of the media: that is a mistake, as this research on Fox news shows. It is not difficult to get across the benefits of immigration, given how much the NHS and our construction sector depend on immigrants, but it is not something many of our leading politicians have done for some time.

More generally it is becoming increasingly clear how destructive the doctrine of neoliberalisation has been. Neoliberalism combines the encouragement of globalisation with demands for a much reduced role for the state. In the advanced economies the deindustrialisation implied by globalisation and the growth of China and elsewhere has been beneficial overall, but there are sections of society that have lost out, which invites a backlash. As Kevin O’Rourke shows, globalisation has often led to fierce resistance in the past. Dani Rodrik has demonstrated how state spending can protect, and has often in the past protected, the losers from trade. [3] (As an economist mights say, globalisation is a Kaldor/Hicks improvement, but in recent times the compensation part has been missing.) Brexit, like the financial crisis and perhaps also Donald Trump, are in this sense problems created not by globalisation alone but by neoliberalism.

For the UK it is worse than that. It is not just that austerity is the real cause of declining public services, and a failure to build houses is the cause of rising prices and rents. (See Chris Dillow or Mariana Mazzucato) It is that this government in particular has connived with the right wing press to transfer blame for an NHS in crisis and unaffordable housing from their own policies on to immigration. The Remain campaign was Cameron and Osborne, and neither were prepared to change their tune and start talking about how limiting immigration would mean there was even less money for public services. As I noted in the previous post, the NHS was an important concern for Leave voters, and they thought Brexit would make things better. Can you imagine a worse background for the EU referendum vote than a government that continually stressed the importance of limiting immigration, but failed to achieve those limits so spectacularly. [4]

This was not the only problem with the Remain campaign. In terms of getting the message across, Leave seemed to understand their target audience much better. (It is not my field, but this from Mark Hind makes sense.) To get the message across the Remain campaign relied on the institutions of the establishment: the Treasury, Bank of England, IMF etc. Fine for those for whom the establishment is respected, less so for those who regard it as remote and detached from their lives. Remain made very little use of academics, despite the fact that this group is trusted by the public. [5] Leave did seem to understand this, which is why they went to ridiculous extremes to discredit these experts. The broadcast media hardly ever noted the consensus among economists that Brexit would reduce everyone's standard of living, and instead did their ‘he says, she says’ thing. This media also failed to point out the lies Leave told, preferring ‘balance’ over truth.

All this implies that while the potential for a Brexit vote was always there, reflecting the perfect storm of anger against globalisation and social liberalism, it might not have been realised if the Remain campaign had been better, the Leave campaign had been honest and the broadcast media had not departed from its mission to educate and explain. The lies of the Leave camp are already apparent. The depreciation in sterling that immediately followed the vote is a cut in living standards for everyone in the UK with no lasting compensation. It is permanent unless the markets have got things spectacularly wrong. The economic downturn that is underway is as predicted. In both cases voters were told this was fear mongering by the Remain side: now those that promoted Leave are in the ludicrous situation of arguing that markets and firms have somehow been deceived by Project Fear.

In normal circumstances this would all be a cause for optimism. We do not need many voters to realise that they were conned by the Leave campaign before Leavers become a minority, or at least for the majority to favour a deal that can keep the UK in the single market with essentially free movement of labour. (There may have even been such a majority on the day of the vote.) To call this the denial stage in some ‘grieving process’ by Remain voters misunderstands the nature of the decision. Leaving is compatible with a whole range of alternative arrangements: some quite close to EU membership, some not. In that sense the vote only gave the green light to an ongoing struggle over what these arrangements will be. (For a discussion of the politics involved, see here but also here.) Thus those who say we should accept the verdict of the people are wrong, because a great deal is still to play for.

Yet circumstances are far from normal, and there seems little ground for optimism. Our new Prime Minister - who was as complicit in the sham targets for immigration as Cameron and Osborne - has appointed those who supported Leave to handle negotiations. She knows that the only way she can unite her party is to end free movement and therefore leave the single market.

Worse still, the government will do whatever it wants to do when it comes to the type of Brexit we have. Our official opposition will, if the polls are right, be the same opposition that was both ineffective and conflicted in the Brexit campaign, preoccupied as it will almost certainly be with cleansing the PLP rather than the details of trade arrangements. There is no alternative opposition with any strength. The SNP cannot speak for the rest of the UK, and anyway will be focused on trying (and probably failing) to drum up enough support for independence. As a result the 48% or more who did not want an end to the single market will not be able to do much about it. I fear that if you want a vision of what Britain after Brexit will become, you just need to look in the pages of the newspapers that were a vital part in bringing Brexit about.

[1] My impression was that discussion on broadcast news programmes, which is the main source many people have to unbiased news coverage, or even the debates never got to this point. We had someone from Remain saying trade with Europe would suffer, and someone from Leave saying we would be ‘free’ to trade with other countries. You do not need the Treasury’s gravity equations to make this simple point about geography and trade, but you need to go a little beyond soundbites.

[2] A similar point can be made about nationalism, which is hard to combat and may be a symptom rather than a cause.

[3] Rodrik, D. (1998), "Why do More Open Economies Have Bigger Governments?" Journal of Political Economy 106(5): 997-1032

[4] None of this was hard to see before the last general election. Those who in 2015 voted Conservative but also wanted to Remain need to ask why they took no notice of the warnings that some of us made. Those ‘business leaders’ who seemed to unanimously endorse Cameron need to ask, or be asked, why they were gambling with their company’s future in doing so.

[5] Part of the problem is that Leave voters tended not to trust anyone. This, by Jean Pisani-Ferry, is good on experts and trust.

A divided nation

After the Brexit vote, economists and others who voted Remain are quite right to say I told you so as the economic hit they expected comes to pass. The Brexit Bust needs to be labelled clearly, given the power the Leave side has over the means of communication. (Those behind that campaign are already talking utter nonsense in order to pretend it had nothing to do with them.) But those who voted Remain also need to understand why they lost.

The studies I’m going to focus on here use regressions and the breakdown of the Brexit vote district by district. [1] It is important to do regression analysis, which can look at more than one factor at a time, because influences are correlated with each other. We might note, for example, that districts are less likely to vote Leave if they contain relatively high earners, or relatively well educated people. So is it lack of education or lack of money that caused people to vote Leave? That is what any kind of multiple regression can try and sort out.

Before looking at individual studies, let me mention some things that appear to be uncontroversial. Education and age are key determinates: if you are less educated or older you tend to vote Leave. Both matter independently: although young people with few qualifications tend to vote Leave, they are less likely to do so than less qualified older people.Once you take these into account, income is not a significant factor. Geography matters in key ways. One of those is that people in Scotland and Northern Ireland were much less likely to want to leave (controlling for other factors). The other I will come to.

A key issue is whether the local level of migration has had an influence. Stephen Clarke and Matthew Whittaker at the Resolution Foundation find that the level of immigration is not important, but its recent rate of change is, in making people vote Leave. Zsolt Darvas at Bruegel also finds the level unimportant. However Monica Langella and Alan Manning from the LSE find that areas with high immigration are more likely to vote Leave, and confirm the finding that the rate of change matters too. So while two studies agree that areas with a recent large increase in immigration are more likely to vote leave, more work needs to be done on whether its actual level matters. However, even if it matters, it does not matter that much, as the large majority for Remain in London tells us.

One other area where the studies differ is employment or unemployment. Clarke and Whittaker suggest areas with a low employment rate are more likely to vote Leave, but Langella and Manning seem to find the opposite, and Darvas says any impact from levels of unemployment (which is not the same as the inverse of the employment rate) is explained by other factors which I will now come to.

There are some variables that have not been considered by all three of these studies. Darvas has one particularly interesting result: the Leave vote increases in areas where there is a lot of poverty and local inequality. Langella and Manning find that areas with long term declines in agricultural, manufacturing or public employment are more likely to vote Leave. This is also the conclusion of a team led by Bristol geographer Ron Johnston, which is worth quoting in full.

“There are substantial parts of the country where large numbers of people have lost out from the deindustrialisation and globalisation of the last few decades of neo-liberal economic policies, and where the educational system has not helped large proportions of the young to equip themselves for the new labour market. Increasing numbers in these disadvantaged groups were won over during the last few decades by the campaigns in parts of the print media, taken up by UKIP since the 1990s, linking their situations to the impact of immigration – uncontrollable because of the EU freedom of movement of labour principle. The wider Leave campaign built on that foundation in 2016, producing the geography displayed here.”

That conclusion of course goes beyond the finding that areas hard hit by globalisation tended to vote Leave, and adds an explanation that sees the press and politicians actively trying to link the experience of disadvantage to the issue of immigration. It is an argument I have also made. Unfortunately it is an argument that is very difficult to prove using regression analysis, because - as newspapers often argue - they may print just what sells newspapers, so any correlation does not imply causation.

It is also important to remember that the link between voting Leave and areas of deindustrialisation is in additional to the strong links with education and age. Education may fit in with a story where the anti-EU stance (to say bias does not do it justice) of most of the tabloid press is important, for obvious reasons. The same is true with age, as younger people are likely to get their information by other means than the tabloid press.   

There is another, very different, line of argument that tries to explain the Leave vote not in terms of class but psychology/culture. Eric Kaufmann finds simple correlations between voting Leave and authoritarianism. A story you can tell is that, for some at least, Brexit was a vote against not neoliberalism but social liberalism. The link between social liberalism and the EU is once again migration, which represents one more unwelcome change for social conservatives. Social conservatism and authoritarianism may also map more easily into nationalism and wanting to 'take control', and it was part of the tabloid 'grooming' to do exactly that. Social conservatism may also explain the importance of age and perhaps also education.

There is no reason why we need to choose between the economic and the social types of explanation. Kaufmann and Johnston et al can both be right. As Max Wind-Cowie says (quoted by Rick here):

“Bringing together the dissatisfied of Tunbridge Wells and the downtrodden of Merseyside is a remarkable feat, and it stems from UKIP’s empathy for those who have been left behind by the relentless march of globalisation and glib liberalism.”

Both these explanations see antagonism to the idea (rather than the actuality) of migration as the way an underlying grievance got translated into a dislike of the EU. But was immigration really so crucial? A widely quoted poll by Lord Ashcroft says a wish for sovereignty was more important. The problem here, of course, is that sovereignty - and a phrase like taking back control - is an all embracing term which might well be seen as more encompassing than just a concern about immigration. It really needs a follow-up asking what aspects of sovereignty are important. If we look at what Leavers thought was important, the “ability to control our own laws” seemed to have little to do with the final vote compared to more standard concerns, including immigration.

However there are other aspects of the Ashcroft poll that I think are revealing. First, economic arguments were important for Remain voters. The economic message did get through to many voters. Second, the NHS was important to Leave voters, so the point economists also made that ending free movement would harm the NHS was either not believed or did not get through to this group. Indeed “more than two thirds (69%) of leavers, by contrast, thought the decision “might make us a bit better or worse off as a country, but there probably isn’t much in it either way””. Whether they did not know about the overwhelming consensus among economists who thought otherwise, or chose to ignore it, we cannot tell.

Third, Leave voters are far more pessimistic about the future, and also tend to believe that life today is much worse than life 30 years ago. Finally, those who thought the following were a source of ill rather than good - multiculturalism, social liberalism, feminism, globalisation, the internet, the green movement and immigration - tended by large majorities to vote Leave. Only in the case of capitalism did as many Remain and Leave voters cite it as a source of ill. These results suggest that Leave voters were those left behind in modern society in either an economic or social way (or perhaps both).

Taking all this evidence into account it seems that the Brexit vote was a protest vote against both the impact of globalisation and social liberalism. The two are connected by immigration, and of course the one certainty of the Brexit debate was that free movement prevented controls on EU migration. But that does not mean defeat was inevitable, as Chris makes clear. Kevin O’Rourke points out that the state can play an active role in compensating the losers from globalisation, and of course in recent years there has been an attempt to roll back the state. Furthermore, as Johnston et al suggest, the connection between economic decline and immigration is more manufactured than real. Tomorrow I’ll discuss both the campaign and what implications this all might have.

[1] Please let me know if I missed any studies. One I found out about as this post was about to be published was this by Richard Mann.

Rolling Postscript: Studies I've seen since. This by Jo Michell (particularly on migration impact). Geoff Tily argues that London may be special.  

Economic History and Krugman’s Crib Sheet

One of the positive things about reading blogs is that sometimes you see connections in apparently diverse offerings. So here are two seemingly unconnected posts: Paul Krugman’s discussion of how he came to do his path breaking research in international trade and economic geography, and Kevin O’Rourke’s post on why economics needs economic history.

I remember many years ago being in a large interdisciplinary forum, where Krugman’s research on economic geography came up. The economists in the room were of course very positive, but the geographer there could not hide his disdain. There is nothing in this work that geographers have not actively discussed for the past 50 years, he said. I have no reason to doubt that he was right, but it kind of missed the point. What Krugman and others did was manage to formalise these earlier thoughts in a particularly tractable and useful way.

What is so great about formalism, you might ask. The trouble with just talking and writing about the way the world works is that it is quite easy to become confused or to make mistakes. Macro, because it deals with a highly interconnected system, is full of these pitfalls. The example I use with undergrads when they first come to IS/LM is as follows. Cutting taxes may appear to boost the economy, but if it is financed by more government borrowing, to persuade people to lend more will probably push up interest rates. These higher interest rates reduce output, so as a result tax cuts could end up reducing output. Sounds reasonable, but the reasoning is incorrect. The worst that can happen with a tax cut is that people save it all, in which case output does not change, and neither do interest rates. IS/LM shows us that if interest rates rise it is because output has increased.

So it is good to be able to express ideas about how the world works in terms of simple models. But creating a new type of model for the first time is not an easy thing to do, which is why you get prizes for this kind of thing. Crucially, it may take a long time (decades or more) before someone comes up with that nice simple formalisation that captures those ideas. Yet those ideas are as important before the formalisation as they are afterwards - it is just the reasoning about them that has improved.

How is economics generally taught? In both macro and micro, most of the time we teach the formalisation. This is understandable (it is what has advanced the discipline and made it science like) and to a degree appropriate (understanding models is difficult). However there is a real danger that teaching this stuff crowds out all else. I used not to be concerned about this for macro, because I saw the discipline as inherently progressive, where the data would naturally push advances in the right direction. (My excuse for believing this in part comes from my background in building structural econometric models, where the data really did do that.)

If that is your view, you are likely to be a little dismissive about things like economic history, economic methodology or the history of economic thought. After all, most scientists do not worry too much about these things in their own discipline, and economics tries to be like a science. Even if we take a more realistic view, and think that economists are more like doctors (who fail to understand quite a lot), doctors do not spend too much time thinking about things like the methodology of medicine.

I changed my view in the last few years as a result of both the financial crisis and the subsequent domination of austerity policies. Teaching just what can be currently formalised in what now passes as a rigorous manner excludes too much of what is important. Of course we (hopefully) tell students that there are gaps in what economists can do this way, but perhaps these gaps need to be given a little more space than footnotes. There is a great deal of knowledge and insight in less formal economic reasoning, insight that can too easily be dismissed. Unfortunately it is natural for future academics or policy makers to believe that what is taught in undergraduate or graduate macro is what is important, rather than what has so far been formalised, or what the demands of this particular time and context require formalising, or worse still what political or ideological forces wish to formalise.

The analogy with doctors breaks down because, unlike doctors, an economist does not constantly have the full range of empirical problems thrown in their face. They are also unlikely to have politicians picking and choosing which treatments they like to promote based on the interests of those they serve. In particular, developments in macro over the last few decades have shielded economists from having to explain much of the data. (In my view the dismissal of single equation time series work as a vital component in model building because of identification problems was a crucial mistake.)

As Kevin O’Rourke eloquently argues, teaching economic history provides a useful counterweight to these tendencies. We also need to make room for teaching some elements of methodology and the history of thought, for similar reasons. This is why I have actively supported Diane Coyle’s initiative in the UK (see here, here and here). I think having the occasional option in these subjects misses the point. It is much more about integrating these elements into core courses, although how best to do this remains an open question.