FT - Economist Forum

By Paul De Grauwe

The financial crisis continues to create victims. Not only people but also some of our most cherished ideas risk falling by the wayside. Take the hugely influential idea that financial markets are efficient. Its proponents told us that when financial markets were left free, they would work miracles. Savings would be channelled to the most promising investment projects, thereby boosting economic growth and welfare. In addition, these financial markets would spread risk around over a large number of participants, thereby lowering the risk of doing business, again boosting growth and welfare. In order to achieve these wonders, financial markets had to be freed from the shackles of government control.

The country that embodied these principles most was the US. Helped by the missionary zeal of successive American administrations and pushed by international financial institutions, country after country freed their financial markets from pernicious government controls, hoping to share in these economic wonders.

The remainder of this column can be read here. Debate from our panel of economists appears below.

by Edmund Phelps

Many people see every downturn of employment from a long-sustained plateau as a fall of aggregate demand - “effective demand” in Keynes’s terms. They would have the central bank cut interest rates to restore that demand.

If employment is down because of aggregate demand, the problem can be addressed at zero cost through rate cuts and the ensuing rise in the money supply. Many central banks like to do that: to “lean against the wind”.

This time, though, there are forebodings of “stagflation” - lower employment without the solace of lower inflation. Some economists instinctively feel that the present downturn is the effect of structural shifts in the economy, not a shift in aggregate demand. They doubt that a central bank should retard effects it cannot prevent.

If employment is down because of shifting structures, gearing the money supply to attempt to prop up employment would generate ever-rising inflation. Inflation expectations would break loose from their moorings and the attempt would fail. Some central banks are refraining from rate cuts.

We have a difference of opinion and of policy. But the structuralist case needs to be argued. What are the primary forces of a structural nature? And, crucially, what are the nonmonetary channels through which these forces have structural impacts on the economy - on the size of the labour force and the natural rate of unemployment?

 The remainder of this post can be read here. Debate from our panel of economists appears below.

By Christian Broda

The US presidential campaign has sometimes sounded like a contest to prove who despises trade the most. Media reports of job losses to China and the destructive effect of Wal-Mart on local businesses are ubiquitous. In recent weeks, Lawrence Summers and Martin Wolf have in the Financial Times both highlighted the dangers of having high-income countries turn against globalisation. This public debate has taken for granted that inequality in these countries has risen as a result of globalisation.

But has it really? In a recent paper*, co-authored with John Romalis from the University of Chicago, I argue that it has not. The reason is simple. How rich you are depends on two things: how much money you have, and how much the goods you buy cost. If your income doubles but the prices of the goods you consume also doubles, you are no better off. Unfortunately the conventional wisdom on US inequality is based on official measures that look only at the first half, the income differential. National statistics ignore the fact that inflation affects people in different income groups unevenly because the rich and poor consume different baskets of goods.

Inflation differentials between the rich and poor dramatically change our view of the evolution of inequality in the US. Inflation of the richest 10 per cent of US households has been 6 percentage points higher than that of the poorest 10 per cent in the period 1994-2005. This means that real inequality in the US, if measured correctly, has been roughly unchanged.

The reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart.

Poor families in America spend a larger share of their income on goods whose prices are directly affected by trade - such as clothing and food - than wealthier families. By contrast, the higher a person’s income, the more they spend on services, which are less subject to competition from abroad. Since 1994 the price of goods in the US has risen much less than the price of services - and, yes, this includes the recent surge in food prices. Focusing on the past few quarters of high relative food prices misses the fact that the main trend we have observed for decades is exactly the opposite.

This trend can partly be explained by China. Prices of consumer goods in US stores have fallen most heavily in sectors where the Chinese presence has increased most. In canned seafood or cotton shirts, for example, where China’s exports to the rest of the world have increased dramatically this decade, inflation has been negative. In sectorswhere there is no Chinese presence, inflation has been more than 20 per cent. Moreover, as China produces goods of relatively low quality, sectors that have a strong Chinese presence are disproportionately consumed by the poor.

The expansion of superstores - such as Wal-Mart and Target - has also played an important role in accounting for the inflation differentials between rich and poor. Superstores sell the same products as traditional shops but at much lower prices. Today the poor buy roughly twice as much of their non-durable goods in these stores as the rich do. Poor consumers have therefore been the biggest beneficiaries of Wal-Mart’s coming to a town.

What is really worrying is that, in spite of these facts, we have had a backlash against China and Wal-Mart in the US. Trade sceptics who suggest that there is no point in buying cheaper goods if you have lost your job should check America’s unemployment rate again. It is about 5 per cent, close to its record low.

We need to remind politicians and the public that the gains from trade are broadly shared. Every time the discussion of trade is diverted towards problems facing specific producers - from farmers in France to textile workers in the US - the central point is missed. Trading allows everyone, and especially the poor, to buy things that they could not otherwise afford.

Without better public understanding of these facts governments will not only keep supporting policies that are aimed against China and Wal-Mart but may receive the uninformed support of many consumers who are benefiting from trade.

* Inequality and Prices: Does China benefit the Poor in America? (mimeograph) University of Chicago, Christian Broda and John Romalis

The writer is associate professor of economics at the University of Chicago, Graduate School of Business

By Martin Wolf

“We told you so.” The Bank for International Settlements has long warned of the dangers of unrestrained credit growth and asset price inflation. In this year’s annual report, the last to be prepared under the direction of William White, its long-serving Canadian economic adviser, it felt free to point out how right it had been. But it did so with restraint: “Rather than seeking to apportion blame,” it says, “thoughtful reactions must be the first priority.”

The report provides just such reactions. But it also describes the mess created by those who ignored its earlier warnings. “The current market turmoil in the world’s main financial centres is,” it claims, “without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point. These fears are not groundless.”

The remainder of this column can be read here. Debate from our expert panel appears below.