Duncan’s Economic Blog

The Deficit, Currency Wars & Global Imbalances: The Social Democrat Solution

Posted in Uncategorized by duncanseconomicblog on October 26, 2010

The biggest issue facing the world economy over the next decade is the global imbalance between the “over consumption” in the West and “over saving” in the East. The large trade imbalances this causes, coupled with the potentially destabilising flows of hot money are at the root of the threatened “currency wars”.  Currency wars which make for a grim outlook for UK exports.

Meanwhile the biggest issue on the economic agenda for the UK is (in the popular imagination at least) the deficit and the question of reducing it.

There is one policy agenda which would tackle both issues – and it’s one that only the Social Democratic left can offer: state backed investment.

The largest driver of the recession was a collapse in investment as the confidence of businesspeople vanished. I’ve argued for a long time that only policies designed to increase investment will ensure strong growth and rising prosperity.

Solving the “investment problem” is the only way to reduce the budget deficit, as long as the private sector is accumulating but not investing a large surplus, as Chris Dillow has frequently argued, then the UK will be faced with a large budget deficit.

Policies that try to close that deficit through tax increases and spending cuts risk making the situation worse by increasing unemployment, lowering the tax take and damaging growth.

The coalition aims to increase investment by cutting corporation tax (whilst also, counter intuitively, cutting back on investment allowances). This hands off approach is unlikely to work.

David Cameron’s plans for growth speech yesterday, as Hopi Sen has noted, asks the right questions but then avoids answering them. The £200mn for regional innovation is welcome, but no where near enough.

A real growth plan, as Ed Miliband hinted at in his own CBI speech, will require a far more active State. Not necessarily a bigger state, but certainly one that is prepared to intervene more heavily in the economy in order to unlock, and “crowd in”, private sector investment.

Fiscal policy alone cannot, and will not, return the economy to growth. What is required is a far more fundamental rethink of policy and the use of tools that have stood all but idle for three decades or more

The exact mix of policies required to increase investment and reduce the private sector surplus will vary with the economic outlook, but one crucial component will be some form of state backed development bank (David Miliband certainly “got this”).   

A state backed investment bank to fund business investment, a state backed infrastructure bank to fund large scale projects, a state backed green investment bank to fund the technologies of the future could all be combined with state backed venture capital firms to incubate new firms.  All of these measures would have one real purpose – to take the private sector surplus and turn it into real assets that increase employment, create high skilled jobs and ultimately help reduce the deficit.

The laissez faire approach of the coalition (essentially, create the right conditions and hope for the best) represents the triumph of ideology over experience. Thirty years of this approach led to a seriously unbalanced economy, one that favoured investment in property over investment in real assets. Without state action to redirect investment, I see no reason that the future won’t resemble the past.

As UBS’s George Magnus has convincingly argued:

My basic position is that fostering the kind of structural economic transformation and innovation that has been laid bare as essential by the financial crisis is a – maybe the – central public purpose. The private sector cannot make the running here – certainly not yet. We have no choice. A national infrastructure bank that facilitates and channels the excess money in our economies towards, say, new and alternative energy technologies, and the type of infrastructure that might revolutionise manufacturing processes is a worthy pursuit.

But state backed investment, isn’t only crucial to reducing the deficit, it is crucial to controlling the global economic imbalances (as George Magnus notes).

By increasing domestic investment, especially in much needed infrastructure, the UK can play its part in increasing global demand without resort to “export led growth”.

There is a need for this investment and the means to finance it exist in the UK, all that is required is the political will to act.

82 Responses

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  1. Tim Worstall said, on October 26, 2010 at 12:34 pm

    “A state backed investment bank to fund business investment”

    Oh dear. You seem to think that such a bank will be anything other than the plaything of whichever politicians are in power at the time. Haven’t past such govt directed “investments” shown you anything about the political process?

    I don’t know whether Callaghan’s decision to split the one steel plant of economic scale into two, so Wales and Scotland could have half each, is actually a true story or not, but that’s the kind of thing I’m thinking of.

    To say nothing of what will happen if Harperson gets into any position of economic power. Seriously, you want people like this directing investment?

    • duncanseconomicblog said, on October 26, 2010 at 12:58 pm

      This doesn’t have to be about picking winners – more supporting sectors/regions.

      And, quite frankly, I’d rather risk some inefficient investment than have very little.

      (The link to George Magnus views above is worth a read).

  2. Tim Worstall said, on October 26, 2010 at 1:38 pm

    “This doesn’t have to be about picking winners – more supporting sectors/regions.”

    Supporting a sector isn’t picking a winner?

    And my point is a political one. Whatever we say about such a state investment bank it will make investments according to what the politicians (of any party or stripe) tell it to do. I am sufficiently a realist about the quality of politician we get/have in the UK to insist that whoever elected would be bound to screw it up.

    Please note that a lot of my objection to state or political action is not ideological. It’s an acknowledgement of my insistence that only blowhard egotistical fuckwits gain political power in the UK. This does mean Dave just as much as any of the Eds.

  3. Cian said, on October 26, 2010 at 1:58 pm

    Tim, given that your comment on any subject that doesn’t relate to rare metals is always 100% predictable, shouldn’t you have outsourced this activity by now?

  4. Cian said, on October 26, 2010 at 2:04 pm

    Duncan,
    There’s a couple of additional things, surely:
    1) Traditionally the UK government has chosen a winner, the city. And supported it, financed it when necessary, restructured fiscal policy for it and even bailed it out. So I think the argument could be better phrased not as “picking a winner”, but “picking a better one”.\

    2) I’m not sure its just directing funding, but providing more stable funding and a saner response to cash flow needs. One of the big problems has always been that banks can (and do) pull funding at very short notice. I know personally of quite a few small to medium companies (10-100 employees) which either went under, or came close, despite being profitable. And of another company that had to abandon a large overseas order because the bank wouldn’t provide extra funding so that they could manage the cash flow requirements.

  5. vimothy said, on October 26, 2010 at 2:29 pm

    “Traditionally the UK government has chosen a winner, the city. And supported it, financed it when necessary, restructured fiscal policy for it and even bailed it out. So I think the argument could be better phrased not as “picking a winner”, but “picking a better one”.”

    Exactly.

  6. Luis Enrique said, on October 26, 2010 at 2:37 pm

    I’m on the fence on this one – I’m much more willing to contemplate the state doing a bit of winner picking – or sector nudging – identifying complementary inputs, especially infrastructure, education, and possibly financing / insuring experimentation, than Tim. At the same time, do you recognize that state-led investment has the potential to reduce growth, if it is invested poorly? How much faith do you have in the actually existing political machinery to deliver state-led investment that behaves like the mythical objective and unimpeachable Scandinavian rather than like a third-world system of political patronage? And what about sheer institutional incompetence?

    For instance, imagine a state bank for financing small businesses is created and commanded by Cian to be more sympathetic to cash flow needs. Can you see how that could go wrong?

    • duncanseconomicblog said, on October 26, 2010 at 2:41 pm

      I think the best, and most balanced, discussion of these issues is here:

      http://ftalphaville.ft.com/blog/2010/10/18/373051/magnus-vs-donovan-the-emails/

      • Luis Enrique said, on October 26, 2010 at 2:58 pm

        thanks Duncan,. will read that

    • vimothy said, on October 26, 2010 at 3:02 pm

      Hmm, in that case, China must be in a right pickle!

      On “picking winners”:

      The standard rap against industrial policy is that governments cannot pick winners. Of course they can’t, but that is largely irrelevant. What determines success in industrial policy is not the ability to pick winners, but the capacity to let the losers go – a much less demanding requirement. Uncertainty ensures that even optimal policies will lead to mistakes. The trick is for governments to recognize those mistakes and withdraw support before they become too costly.

      Thomas Watson, the founder of IBM, once said, “If you want to succeed, raise your error rate.” A government that makes no mistakes when promoting industry is one that makes the bigger mistake of not trying hard enough.

      http://www.project-syndicate.org/commentary/rodrik42/English

  7. Luis Enrique said, on October 26, 2010 at 2:40 pm

    in what sense has the state “picked a winner” with the City in a comparable sense to how that phrase is used in context of state-led industrial policy? I know the govt has been reliant on and cozy with bankers, but that’s not same thing as providing it was soft financing or protecting it from competition or favorable price controls etc.

    even the bailouts don’t really qualify – if you saw a bank lend to a business on the same terms that the govt lent to the banks, you’d accuse them of profiteering, not subsidizing them.

  8. CharlieMcMenamin said, on October 26, 2010 at 3:38 pm

    Luis,
    . I am very conscious of Not Being A Proper Economist (whereas you obviously are – or so I’d judge from your various interventions here and at Stumbling and Muimbling) but,surely,

    “..if you saw a bank lend to a business on the same terms that the govt lent to the banks you’d accuse them of profiteering, not subsidizing them” is rather missing the point. A bank would do this; it would let the company, so obviously insolvent, simply die. The Govt couldn’t do this with the banks. It had to think about the long term.

    If it is to invest again it is precisely the long term it should be investing in and thus be using different criteria from the banks..

  9. CharlieMcMenamin said, on October 26, 2010 at 5:14 pm

    P.S: so it is obviously to all that not merely am I Not a Proper Economist, I’m Not a Proper Proofreader either.

    I should of course have written:

    “..if you saw a bank lend to a business on the same terms that the govt lent to the banks you’d accuse them of profiteering, not subsidizing them” is rather missing the point. A bank wouldn’t do this; it would let the company, so obviously insolvent, simply die. The Govt couldn’t do this with the banks. It had to think about the long term.

    • Luis Enrique said, on October 27, 2010 at 8:26 am

      Charlie

      no, you’re quite right – the state would wear a loss if it thought it had to rescue a bank for the greater good, and I believe some elements of the bailout were directly loss making. Others involved lending and quite punitive rates, buying equity at bombed out prices etc. At the same time, when you write a “bank wouldn’t do this” actually I think it would – offering distressed companies “help” on terms that are favorable to the bank is a classic Wall Street move (isn’t that what they do in the first movie … can’t remember) – in some sense when the banks were on their backs, the state had the opportunity to act just like the banks do when they encounter an otherwise viable business in need of help: take them to the cleaners.

      NB I’m quite a way short of being a “Proper Economist” – still a student (PhD)

      • CharlieMcMenamin said, on October 27, 2010 at 8:53 am

        Luis,
        Forgive me but surely if a bank found a basically sound but badly run business it would seek to restructure/asst strip it and then sell it on at a profit?

        Surely what the govt has done with the banks is pump them full of money, put them back on their feet and say – ‘there you go, get back to doing what caused the problem in the first place.’ So the fact the face value terms of the loans/insurance /acquisition stakes the govt used to carry out this manoeuvre were relatively stringent is quite a small factor in any rounded view of all this.

        • Luis Enrique said, on October 27, 2010 at 11:11 am

          Charlie,

          a bank can’t asset strip/sell a struggling company at a profit without buying it first (and prob providing some financing during restructuring etc. ) – that’s more or less what the Treasury did – (partially) bought them out, provided other forms of financing (loans), and then (hopefully) sell it on at a profit. (the extent to which we’ll manage to do so is not yet known).

          of course a bank only cares about making a profit, whereas the govt had other objectives – nonetheless it may turn out that at least in the narrow sense the Treasury has fared rather like a bank who “rescues” a struggling business then asset strips / sells it on at profit. When a bank rescues a struggling business and sells it on at a profit, it also “pumps it full of money” (temporarily) and “puts them back on their feet” to carry on doing whatever it is they do. Of course you can pump a company full of money and leave it there – if you do that, you become a shareholder, become entitled to dividends etc. and can still sell your stake when you want to. Banks sometimes do that (private equity).

  10. George Irvin said, on October 26, 2010 at 5:31 pm

    No mention of the WB’s ‘East Asian Miracle’, or Alice Amsden on S Korea, of Ha-Joon Chang’s multiple contributions etc etc. Have any of these Worstall-reading finance people done any development economics?!

    • Tim Worstall said, on October 26, 2010 at 7:59 pm

      When and if we need or desire the contribution of the heterodox economists of the SOAS I’m sure we’ll give you a call George.

      Until then we’ll carry on with this empirical shit shall we? Those places which you and yours have planned are poorer than those places which you haven’t.

      • Left Outside said, on October 27, 2010 at 11:37 am

        Come on Tim,

        “heterodox economists of the SOAS”

        You mean Ha Joon Chang of Cambridge? and Alice Amsden of MIT?

        “Until then we’ll carry on with this empirical shit shall we”

        You mean the research of Ha Joon Chang, Amsden and Robert Wade (of LSE, your former uni)?

        “Those places which you and yours have planned are poorer than those places which you haven’t.”

        You mean like the places described by Alexander Gerschenkron where the state and banks had to substitute for market mechanisms during late industrialisation, places like Germany and Russia?

        Or you mean South Korea and Taiwan where extensive state involvement helped produce and “Asian Miracle”.

        Or do you cherry pick to mean only the unsuccessful state directed development efforts of Latin America (which were still highly successful up to 1940s/50s)?

        • Tim Worstall said, on October 27, 2010 at 11:51 am

          No, I mean specifically George himself and the assorted fruit loops in the econ dept at SOAS.

          • George Irvin said, on October 27, 2010 at 12:33 pm

            Tim:

            What a delightfully cheeky chapie you are, ad hominem to the fault. Not that I expected an answer adressing a well-known body of literature on ‘picking winners’ and the developmental state. ‘Left outside’ (above) clearly knows the debate and its relevance to Britain’s situation today. Ha Joon Chang put the position quite nicely in a good piece a couple of months ago.

            http://www.guardian.co.uk/commentisfree/2010/may/03/uk-selective-industrial-policy

            We really must have lunch together sometime.

            George

            • Tim Worstall said, on October 27, 2010 at 12:48 pm

              From that piece:

              “That the necessary growth cannot come from the financial sector is plain. I am not sure whether the forthcoming financial reforms in Britain and elsewhere will go far enough, but it is certain that the financial industry will be reined in. This means that the British manufacturing sector needs to provide the bulk of growth in income and government revenues.

              The manufacturing sector will also have to generate far more exports in the coming years, given that financial service exports, which have financed much of the country’s large trade deficit in manufacturing (equivalent to 4% of GDP), are certain to decline.”

              So we’ll deliberately rein in our largest net export sector and this will mean that we have to develop other export sectors.

              Seriously? This is a good piece? If I shoot myself in the foot I’ll have to use a crutch? And this is *policy*? Policy about the desirability of crutches?

              Come on now, there have been two major periods of globalisation, late 19th and late 20th cent. In both the UK specialised in finance and Germany in heavy industry. Now, when you’ve got two episodes of increasing international division of labour and you find that the same places specialise in the same things each time, well, the thought that it’s not actually “policy” that drives such specialisation but, you know, this comparative advantage that Ricardo talked about? Mebbe? Just as a first approximation to thought perhaps?

              More Chang:

              “The country’s inability to generate a manufactured export boom despite a large devaluation of sterling over the last 18 months shows how feeble its manufacturing productive capabilities have become.”

              Eh? Strip out the recession bit and manufacturing output is at an all time high. What is “feeble” about that?

              “(the US was the most protectionist country in the world for virtually all of the 19th and early 20th century)”

              Nonsense, the US was the largest free trade area on the planet.

              “When winners are being picked all the time – sometimes by the government, sometimes by businessmen, and very often by the two of them working together – pretending that its government should not engage in selective industrial policy will only make Britain’s industrial policy incoherent and the necessary revival of its manufacturing sector unlikely.”

              GaAAH! Businessmen don’t pick winners….although they’d love to be able to.

              Consumers pick winners. Which means we need the market allocation of resources as only the market has the ability to porocess consumer desires about what is and isn’t a winner.

              • vimothy said, on October 27, 2010 at 2:16 pm

                Tim, I have to say that I’m impressed with how equitable you are when doling out patronising comments online–be they to liberal journalists or Oxbridge professors of economics, everyone gets the same refresher in sixth form micro. Your commitment to equally distributed condescension is borderline socialist!

                We should reign in our largest export sector because it’s socially malignant. A better analogy, I feel, would be to kicking heroin. Yes, in the short term it makes you very ill, but wouldn’t you feel better without the monkey on your back? It’s never to late to admit you have a problem, Tim.

              • Left Outside said, on October 27, 2010 at 4:02 pm

                “Nonsense, the US was the largest free trade area on the planet.”

                It had high tariffs, see “Alexander Hamilton and the American System”, and up to the end of the C19th/start of C20th transport costs would have insulated lots of domestic industries in a similar way.

                As Vimothy says in a rather nice snark, you can’t answer everything by ensuring “everyone gets the same refresher in sixth form micro.”

                • Tim Worstall said, on October 27, 2010 at 4:49 pm

                  Sure, it had high tarrifs on external to the US trade. But it had none at all upon internal trade. Thus making the US economy the largest no tarrif trade area in the world at the time.

                  Apply this argument to the modern world….gosh, isn’t it nice that we have no tarrif trade inside the EU ….well, yes, it is, adds to growth don’t you think?….yes, it does. a $15 trillion economy bubbling away without internal trade barriers.

                  Do we then note that external to EU trade barriers reduce the loveliness of this no internal barriers? Make those growth effects of no tarrif internal trade disappear?

                  No, in fact, we don’t. Certainly, I go on to argue that we’d have even more loveliness from trade if we had no external barriers as well as no internal barriers. But that doesn’t blind me to hte benefit from no internal barriers: just as the US’ high external (and falling precipitately, as shipping costs fell in the 19th by vastly more than tarrifs rose) tarrifs shouldn’t blind us to the benefits of having a large internal tarrif free area.

                  • Left Outside said, on October 27, 2010 at 4:54 pm

                    Oh indeed, I’m a free trader in general, goes with the cosmopolitanism, the UK’s at the technological/productivity/whatever you want to call it frontier, so we can’t really gain from trade protection. A developing country on the other hand, there is plenty of evidence that it can.

                    • Tim Worstall said, on October 27, 2010 at 5:00 pm

                      But Mssrs Chang et al do argue that we could gain from that trade protection, from that infant industry stuff.

                      As I said, fruit loops.

                  • vimothy said, on October 27, 2010 at 5:53 pm

                    “Sure, it had high tarrifs on external to the US trade. But it had none at all upon internal trade. Thus making the US economy the largest no tarrif trade area in the world at the time”

                    Wubble?

                    “As I said, fruit loops.”

                    You’ve done a lot of research in this area, I take it, widely published, etc?

              • Left Outside said, on October 27, 2010 at 4:05 pm

                Perhaps I should add,

                It would be lovely if all you needed to do was get a few simple (really fucking simple, we’d be talking about stuff done in England in the late C18th, where IQ was lower, education was poor for huge swathes of the population, science was embryonic etc.) market institutions right and development and riches would follow.

                This has not been the case historically, if only it were so simple.

                • Tim Worstall said, on October 27, 2010 at 4:50 pm

                  I know of no place that has got rich (ie, reached the technological production frontier of modern times) without them.

                  I’m willing to be persuaded that they are only necessary, not sufficient. But then I can see plenty of ways in which we don’t even have those necessary things at present…..

  11. Cian said, on October 26, 2010 at 6:33 pm

    in what sense has the state “picked a winner” with the City in a comparable sense to how that phrase is used in context of state-led industrial policy? I know the govt has been reliant on and cozy with bankers, but that’s not same thing as providing it was soft financing or protecting it from competition or favorable price controls etc.

    Fiscal/monetary policy has been for a very long time in the UK designed to favor the banks, at the cost of British industry. There is more than one way to pick a winner – that is one of them. Obviously governments can very successfully pick winners, given there are many examples of this. As there are many examples of successful state banks that finance industry. Apparently the argument here is that the UK, one of the least corrupt countries in the world, is somehow unable to do this. Well its possible, as arguably the most corrupt part of our country is made up of our financiers. So there’s that.

    • Luis Enrique said, on October 27, 2010 at 8:32 am

      I agree there’s more than one way of picking winners, and really I’m just asking for info, not asking in an argumentative rhetorical way – I’m quite ready to learn how the state has “picked” the City as a winner.

      I’m afraid I don’t know how “fiscal and monetary policy has for a very long time been designed to favor the banks” … what do you have in mind?

      Of course the state can pick winners, the question is whether it can on average and whether it’s better than the private sector (resources are scarce).

      I know the UK is relatively uncorrupt and I’d never say government’s can’t be sufficiently competent to be a net positive, but really look at the current crop of politicians, read Private Eye’s “rotten boroughs” and maybe worry a bit more than you appear to be!

      as it happens, I think the state does have a role in industrial policy, and think that in some ways the state can be better than the private sector – this strikes me as a very “mainstream economics” sort of view – in areas where there are externalities and/or coordination problems,there are opportunities for the state to do things the private sector would struggle to.

      • Cian said, on October 27, 2010 at 1:05 pm

        I agree there’s more than one way of picking winners, and really I’m just asking for info, not asking in an argumentative rhetorical way – I’m quite ready to learn how the state has “picked” the City as a winner.

        The state has always favoured interest rate policies, exchange rate policies and general monetary policies that favoured the city at the expense of industry (and which the city wanted). A lot of effort has also gone into providing a legal and regulatory framework that essentially gave the city what it wanted, which in recent years has made London a major “offshore” financial center. There are also all kinds of ways in which the city is (discretely) subsidised – if not usually as overtly as the recent bail out.

        I mean christ, we don’t even a proper education system to support industry in this country. Or anything like the Private/Public partnerships you get in Germany, Sweden, the Netherlands, etc in research. Or the ways in which networks of small to medium sized industries are helped to form in geographical clusters. And time and time again the UK has let areas where we are very successful dissipate for want of trivial sums of money. The latest of these is computer games, which we are slowly, but surely, losing.

        The two exceptions are Defense and Pharmaceuticals. One shows what can go wrong, and the other we’re world leaders at. Go figure.

        I’m afraid I don’t know how “fiscal and monetary policy has for a very long time been designed to favor the banks” … what do you have in mind?

        Well for example. If industry needed and requested lower interest rates, or a cheaper pound; and the city wanted the latter. The city won. For years we’ve had an exchange rate policy that has quite badly hurt industry, but which the city is very keen on. Since the 80s, we’ve also had a very tight monetary policy which has meant low inflation which is good for the city, but not terribly good for anybody else.

        Of course the state can pick winners, the question is whether it can on average and whether it’s better than the private sector (resources are scarce).

        Well it depends on whether you think the UK is worse that Japan, Korea, Singapore, Scandinavia, Germany, France, etc. After all the state doesn’t have to be perfect (private investment is very wasteful in the aggregate), just good enough. A start would be supporting areas where we’re strong in research, or have existing strengths (sheffield forge masters for example…).

        I know the UK is relatively uncorrupt and I’d never say government’s can’t be sufficiently competent to be a net positive, but really look at the current crop of politicians, read Private Eye’s “rotten boroughs” and maybe worry a bit more than you appear to be!

        No its relative. Compared to many countries that have had very successful industrial policies, the UK is very uncorrupt. Whether that is a problem in a larger sense is not hugely important here.

        • Luis Enrique said, on October 27, 2010 at 1:15 pm

          The state has always favoured interest rate policies, exchange rate policies and general monetary policies that favoured the city at the expense of industry

          this is what I am hoping to learn.

          we don’t even a proper education system to support industry in this country.

          I think you’re veering off topic there.

          Well for example. If industry needed and requested lower interest rates, or a cheaper pound; and the city wanted the latter. The city won.

          are you saying that there have been instances when a lower interest rates would have helped industry but a higher interest rate would have benefited “the City” and a higher interest rate was chosen? I am afraid I don’t understand how the level of the interest rate helps or hinders bankers (who work with relative rates – spreads) nor do I have reason to believe the BoE MPC chooses interest rates with the interest of bankers in mind. Why do bankers like low inflation more than the “real economy”?

          For years we’ve had an exchange rate policy that has quite badly hurt industry, but which the city is very keen on.

          what, a floating rate? What makes you so sure “industry” would benefit if we tried a pegged rate, what makes you think bankers could not also have fun with pegged rates?

          Since the 80s, we’ve also had a very tight monetary policy which has meant low inflation which is good for the city, but not terribly good for anybody else.

          well again, you assert this but on what basis? Why does the city especially like low inflation and upon what do you base the idea that a low inflation environment is “not terribly good for anybody else”?

      • vimothy said, on October 27, 2010 at 2:18 pm

        What about Don Boudreaux?

        • vimothy said, on October 27, 2010 at 2:20 pm

          Sorry, the thread is reorganising my responses in a rather odd way. The “Boudreaux” comment is in response to Tim’s snide dig at “heterodox” economists.

      • vimothy said, on October 27, 2010 at 2:51 pm

        Luis,

        You seem like a very smart chap, so perhaps you’re being a bit obtuse here.

        The state has provided a great deal of support to the finance sector during the crisis, so it has “picked a winner” in exactly the sense described above by Tim–“Supporting a sector isn’t picking a winner?”

        The “neoliberal” macropolicy regime, if not designed explicitly to favour finance, has certainly had that effect. (Do you disagree? The increased “financialisation” of our economy is pure coincidence?)

        Steve Randy Waldman wrote a good piece on monetary policy during the Great Moderation here: http://www.interfluidity.com/posts/1256656346.shtml

        I don’t think it’s particularly controversial to look at the Keynesian demand management “Golden Age of Growth” regime in contrast to the “neoliberal” regime and conclude that the former was more favourable to labour and the latter to capital. Just look at the change in the share of income since the mid-seventies.

        There are numerous examples of countries using industrial policy to boost growth, both historical and contemporary. Rodrik’s short Project Syndicate article sums up the argument with admirable brevity. So it is clearly as gross a generalisation to say that state support is never good (because, duh, China, South Korea, the US, the UK, etc, etc, etc) as to say it’s always good (because, duh, communism).

        Since none of the states who successfully applied this were characterised by unimpeachable incorruptibility, such a characteristic cannot be necessary for success.

        • Luis Enrique said, on October 27, 2010 at 3:24 pm

          Vimothy

          bailing out the banks in order to minimize the fall-out on the real economy from a banking crisis, is not at all what I understand by the idea of “picking winners”

          I am asking how the macro policy regime has explicitly favored finance in a “picking winners” sort of way.

          I think there are lots of reasons behind the “financialisation” of the economy, including the nature of the regulatory regime and similar.

          If you want to say the government broadly “doing what the financial sector wants”, with to the regulatory environment and similar, amounts to “picking a winner” then fine, but that’s not what I had in mind by the phrase, which I thought meant rather more than merely being broadly favorable towards a certain industry … after all, how many economies are there with large X industries that do not also have a regime that is conducive to X and is to some extent in X’s pocket? If that’s all it means then it doesn’t mean very much at all, and you just end up saying that Chile has “picked a winner” in the mining industry, California the movie industry, and everywhere there are winners you also always find governments who treat them nice and hence have “picked” them. If that’s all you mean by “picking winners”, well I agree but I don’t think it’s very substantive.

          it’s quite possible I am being obtuse – looking back on discussion, I often think I am. A more charitable interpretation might be that I am struggling to understand something. (Or maybe I’m just right and y’all are wrong).

          • vimothy said, on October 27, 2010 at 3:50 pm

            Perhaps we’re having two different conversations here (probably my fault for not being more explicit about my assumptions). I am defining “picking winners” in the same sense as Tim above, as in broad support for particular sectors/industries. “Picking winners” in a literal sense I take to be irrelevant to the debate, per Rodrik’s argument. I don’t expect the government to be able to tell me whether Google is a better buy than Microsoft (or whatever), but I don’t see why their lack of facility in investment advice should preclude them from, say, protecting strategically important domestic industries, if that’s in the national interest.

          • vimothy said, on October 27, 2010 at 3:59 pm

            “after all, how many economies are there with large X industries that do not also have a regime that is conducive to X and is to some extent in X’s pocket?”

            Precisely so–it was ever thus.

        • Luis Enrique said, on October 27, 2010 at 3:28 pm

          please don’t get the impression that I’m defending the banking system and how it has been regulated / indulged by policymakers

          Duncan and others, I think you’ll like the speech by Mervyn “Banking: from Bagehot to Basel, and back again” can be found here:
          http://www.bankofengland.co.uk/publications/speeches/2010/

  12. Cian said, on October 26, 2010 at 6:37 pm

    For instance, imagine a state bank for financing small businesses is created and commanded by Cian to be more sympathetic to cash flow needs. Can you see how that could go wrong?

    It depends what more sympathetic means. I’m simply arguing that we need a financial sector that provides adequate financing on the model provided by some of our European neighbours. All it needs to be is predictable, and open. This has worked elsewhere, not sure why things would be different here. And even if there was a certain amount of corruption, so what? The Landesbanks are hardly models of probity (of course our commercial banks are worse, but I’ll let that slide), but they’ve very efficiently financed one of the most successful industrial area in the world.

  13. Adam Lent said, on October 26, 2010 at 9:26 pm

    Governments pick winners all the time: launch aid for Airbus, indirect subsidies to attract Japanese auto industry, artificially high prices for pharma, 3i, the BBC! But they also pick losers as well just like private investors. The question is not whether they can pick winners but whether we are willing to tolerate them picking losers as well.

    The key problem, as Duncan has argued consistently, is that private investors do not invest in enough long term, business innovation and this is a particular problem in the UK. Those who have a dogmatic opposition to a state bank need to explain why economies like Germany, which we are now trying to emulate as key exporters, have placed a state bank at the heart of their export led policy for decades.

    • Luis Enrique said, on October 27, 2010 at 8:40 am

      “private investors do not invest in enough long term”

      I don’t think you can get away with just asserting that. How many examples of private investors investing for the long term would you need to see before you’d concede you are wrong? If you are capable of being right, you must be capable of being wrong – this needs to be quantified some how. How much is “enough”. How many investments that are notionally “for the long term” will actually turn out to be bad ideas?

      I agree the German economy has very attractive qualities, I’m less sure it makes sense for every economy to try to copy Germany (although there are some things I think we could and should copy). It is possible to have a successful export sector because a state bank effectively subsidizes export at the expense of the other parts of the economy – that needn’t be a good thing (although it may have worked very well for Germany).

      [I’m more or less on your side here, just arguing that things aren’t as straightforward as I think you believe]

    • Luis Enrique said, on October 27, 2010 at 11:25 am

      You have to be careful making comparisons with Germany. There are other explanations for their success than “more and better investment”. Here’s one I just read:

      “The most efficient productive player in Europe is Germany; they benefited the most from the dropping of trade barriers and the replacement of the strong Deutsche Mark with the Euro. (Plus, they absorbed all the cheap labor they needed when they were reunified with East Germany). Selling into the rest of Europe without the drag of a strong currency or any trade barriers has been a boon for Germany.”

      • Cian said, on October 27, 2010 at 12:51 pm

        So you’re saying that Germany’s Post War success is down to the Euro and unification with E. Germany? So what’s the mechanism here? Time travel?

        Germany’s recent (and by its historical standards it’s struggling) success has indeed been helped by forcing down labour costs (more West than East) and by sharing the Deutschmark with weaker economies. But then the strength of the Deutschmark was caused by Germany’s success as an exporter. So I’m not sure that even that argument is really making the point that you want it to.

        And to be honest it would be nice if the UK had problems like these, rather than the ones we face. The argument that things aren’t perfect in a vastly more successful economy is…well its an argument I suppose.

        • Luis Enrique said, on October 27, 2010 at 1:19 pm

          what? are you even reading what I write?

          I thought we were all looking enviously at Germany – not Germany in 1960 but Germany now, Germany’s recent history – and thinking “we should be more like them”. I was merely pointing out that there are other potential explanations for their enviable success than the fact they’ve used state-led investment.

  14. Tim Worstall said, on October 27, 2010 at 3:34 am

    “have placed a state bank at the heart of their export led policy for decades.”

    Those State banks, half of which fell over buying up US mortgage bonds, the other half of which are about to be bankrupted by their holdings of Greek bonds?

    “The question is not whether they can pick winners but whether we are willing to tolerate them picking losers as well. ”

    No, it’s whether they pick a disproportionately large number of losers and thus on net waste capital.

    • Left Outside said, on October 27, 2010 at 11:40 am

      Oh, some Dani Rodrik for you which I think will be on your wave length.

      As you’re aware most of the social benefits of entrepreneurs accrue to society, not the entrepreneur. Consequently, they are under supplied. Therefore (its this therefore where I might lose you), the state should offer some sort of subsidy to encourage entrepreneurship.

      It just needs to offer support to and let failing ones go bankrupt. The net effect should be positive.

      Discuss.

      • Tim Worstall said, on October 27, 2010 at 11:49 am

        As Dani didn’t say, but should have done, rather than subsidise entrepreneurs the first step would be to stop taxing them. So no corporation tax nor CGT then!

        For of course, the intermediate stage between the current tax the hell out of them and the subsidising them is to take a neutral position.

        That’s a win.

        BTW, Dani’s drawing on research by William Nordhaus there, something I wrote up about 5 years ago. “Schumpeterian profits in the US economy” and the entrepreneur ends up with about 3% of the value created (that’s the entrepreneur AND his financiers BTW).

  15. Adam Lent said, on October 27, 2010 at 8:00 am

    Tim, you make an excellent point about the failings of those state banks. If they hadn’t been seduced by the idiocies of the commercial banking sector and had stuck instead to doing what they were set up to do – invest for the long term in business innovation – they would not now be in trouble. That’s precisely why we need state investment alongside private investment but some lost sight of that.

  16. Tim Worstall said, on October 27, 2010 at 8:12 am

    “had stuck instead to doing what they were set up to do”

    Indeed, but this is rather my point. Nothing ever does stick thus.

    See govt aid to Rover a few weeks before a number of West Midlands marginals were to be contested at the 2005 election.

    I simply do not believe that any form of state investment or intervention into the economy will not be bent by politicians to their immediate political ends and needs.

  17. Adam lent said, on October 27, 2010 at 10:21 am

    Tim, there is undoubtedly a risk of political interference although there is clearly a major distinction to be made between funds that come directly from a government department and a state bank with a clear remit to generate long-term returns and run at arms-length with no politician sitting on it’s board. However, the fundamental point is that we need to plug the business investment gap in the UK which has existed for decades in all sorts of different economic circumstances. The City never seems to be able to step up to the plate on this while economies that are ahead of us on business investment do have some form of state investment facility. It may not sit well with free market fundamentalists but there it is!

    • Luis Enrique said, on October 27, 2010 at 11:31 am

      sorry, an “investment gap” is not defined as “less investment in fixed capital than other countries” it’s defined as “less investment than we ought to be doing”. What evidence do you have of that?

      (this is a hard question to answer – you can’t just look at GDP growth because you have to control for countries experiencing technological catch-up, or starting from a low base of capital stock and investing like crazy as they catch up – aka “transition” in a growth model)

      • vimothy said, on October 27, 2010 at 3:08 pm

        “What evidence do you have of that?”

        The worldwide economic contraction driven by a fall in fixed investment? The large financial surplus the corporate sector has been running for the last decade?

        • Luis Enrique said, on October 27, 2010 at 4:07 pm

          both question begging imho … well certainly the former (and that’s without quibbling about “worldwide”) – the existence of that surplus does not tell us that “not investing very much” is not also “investing the optimal amount”, you need to justify the idea investment ought to be higher, not merely that it has been low

          • vimothy said, on October 27, 2010 at 4:25 pm

            Okay, okay, “worldwide” = major economies. I forget which particular blog the data are in. I have a specific post in mind. I can dig around if you haven’t seen it. It was widely discussed/link/etc at the time.

            As for question begging, how are you defining “optimal”? Shouldn’t more investment lead to faster growth? Not sure what you’re getting at here. (Now I’m being obtuse!)

            • vimothy said, on October 27, 2010 at 4:40 pm

              Found it: http://ablog.typepad.com/keytrendsinglobalisation/2010/06/the-great-recession-is-actually-the-great-investment-collapse-by-john-ross-li-hongke-and-xu-xi-chi.html

              Bad form to quote yourself, but:

              “Shouldn’t more investment lead to faster growth?”

              E.g., in a simple long-run growth model.

              Also, if investment were higher, the corporate sector’s balance would be closer to zero, and so the government’s deficit would reflect that, and we wouldn’t have to have this discussion.

              • Luis Enrique said, on October 27, 2010 at 4:49 pm

                will have a read – although causation story could just be

                1. banks blow up, expectations of future demand and risk appetite plummet
                2. leads to collapse in investment

                investment is well known to be much more volatile the consumption and is what falls big time in recessions – not same thing as saying “actually, the current recession was caused by too little investment”

                in a growth model you invest and grow rapidly if you are in transition – perhaps after a positive shock – but if you are already in “steady-state” you don’t. It would be wrong to look at economies investing heavily and growing because they are starting from a position of “too little capital” and conclude that economies already with the right level of capital ought to force more investment in order to grow. I’m not saying that’s how things are, but it’s one reason why it’s hard to interpret this stuff.

                • vimothy said, on October 27, 2010 at 5:41 pm

                  I agree with the first half of your story. You have the causation running in exactly the right direction, IMO. That said, I would add a point 3: leads to a global contraction. That is, the decline in fixed investment expenditure explains the lion’s share of the fall in GDP (across the OECD countries; fig. 1 in Ross’ post).

                  I also agree that in a long-run growth model, if you are at the steady-state, raising the capital stock will not increase the long-run growth rate. But you have to be in the steady-state. And the steady-state itself is defined by constant per capita income and capital. Moreover, if we increase the capital-output ratio, although the *growth* rate is exogenous, we do increase the steady-state *level* of income.

                  But that said, I take your point about developing economies growing faster because they’re starting from lower levels. It would be wrong to conclude that we should aim for Chinese levels of investment because it will generate Chinese levels of growth. That’s cargo cult reasoning in its purest form–right out there, clearing runways in the forest, wearing home made headsets and waving wooden landing signals.

                  • Luis Enrique said, on October 27, 2010 at 8:15 pm

                    (one very small and pernickety point, which I’m sure you know already – per capita income and capital are not constant in SS in models with technological progress, they are growing)

                    • vimothy said, on October 28, 2010 at 10:27 am

                      But then we don’t get to the steady state, do we? I can’t remember. Oh dear. I shouldn’t have brought this up really, should I? And now we’re discussing models instead of the policy.

                      Let me try a different tack: One justification of the coalition’s programme of cuts is that it will crowd in private investment and lead to strong growth that will offset the loss to income caused by the cuts. Another story is that the BoE can set the expected future path of monetary policy such that the real rate of interest is brought down, which will stimulate private investment and lead to a boom sufficient to offset the programme of cuts. In both cases we’re hoping for a rebound in private investment. But this of course is based on the assumption that a rebound in private investment is desirable given our current situation. What do you think of this assumption? Maybe we’re already at the optimal level, in which case, both these policies are either unnecessary or possibly even harmful.

                    • Luis Enrique said, on October 28, 2010 at 2:43 pm

                      vimothy

                      yes you’ve just mis-remembered a little – with tech progress, steady-state is defined in those “efficiency units”, and in steady state income and capital grow at rate of tech progress.

                      oh yes for sure I’d have thought any theoretical picture of what’s just happened would involve a shock that’s knocked us away from SS. I suppose if you believe there is lots of excess capacity about and the problem has been a collapse in demand, you might not think we need much more capital than we already have, but I imagine if your policy manages to raise expected future GDP that’s going to entail more investment. And from what I can see argument about government stepping in and spending when every body else wants to save look sensible, and if you’re going to spend, fixed capital is the thing to spend on I’d have thought.

                      here’s what I take to be the mainstream story that might justify cuts, if you thought the circumstances match the story:

                      “expansionary fiscal adjustments can indeed occur and he also showed why. He argued that a fiscal adjustment by removing fear of future harsher ones, and future taxes, can stabilize expectations, increase consumers’ expected disposable income, and increase confidence of investors and therefore can stimulate private demand.”

                      from here
                      http://blogs.ft.com/economistsforum/2010/10/why-martin-wolf-is-wrong-on-expansionary-fiscal-adjustments/
                      a article which I take mainly as a reminder that the future is uncertain

                    • vimothy said, on October 30, 2010 at 11:21 am

                      Thanks for the link. I agree with the sentiment–humility is the proper response (if not always the easiest!).

                      Good discussion all round.

  18. Tim Worstall said, on October 27, 2010 at 10:41 am

    “However, the fundamental point is that we need to plug the business investment gap in the UK which has existed for decades in all sorts of different economic circumstances.”

    Well, that’s something that has to be shown, not assumed or asserted. Is, for example, private sector investment a smaller share of GDP in the UK than it is in other countries?

    Got any figures?

  19. Tim Worstall said, on October 27, 2010 at 11:02 am

    That’s a fascinating chart. For Japan has the higest numbers for fixed capital and yet, well, we don’t really normally regard Japan as having done all that well in recent years.

    So while we don’t, as you say, have a particulalry high rate, it’s not entirely evident that a high rate is in itself a solution.

    And, we might note, large amounts of that Japanese fixed investment have been politically driven investments in infastrucure, haven’t they?

    Which rather brings me back to my orginal point…..

    • duncanseconomicblog said, on October 27, 2010 at 11:09 am

      Tim,

      Here’s a longer term chart of the same thing:

      (Japan has its own problems – broken politics, broken banks and a shrinking population – that said 20 yrs of near zero growth and unemployment consistently below 5%. Also Japanese fixed investment was much higher in the 1960s/70s/80s when it was a very high growth economy).

    • vimothy said, on October 27, 2010 at 3:01 pm

      Here are a couple of interesting facts about Japan:

      During the ’90s, PC GDP growth was only 0.5 percentage points lower than the US.

      During the ’00s (?), PC GDP growth was higher than the US.

  20. Richard Stevens said, on October 27, 2010 at 11:19 am

    Duncan, your post on the need for state-backed investment was very interesting, as are the comments from the contributors above. The calls during the leadership campaign by both David Miliband and Ed Miliband for better-directed, more sustainable investment in the UK was welcome, and certainly got me thinking. By coincidence I posted an article, “Why we need a British Investment Bank”, on the Progress website yesterday:
    http://www.progressives.org.uk/columns/column.asp?c=528

    I think the German and Nordic experience of state investment banks is worth looking at. The scope of the mandates of KfW and NIB is quite striking to Anglo-Saxon eyes. But a cultural counter-argument to establishing a similar institution here is, I suppose, that we aren’t the Swedes or the Germans…

    There is also an interesting report on the proposal to turn RBS into the Green Investment Bank:
    http://www.platformlondon.org/carbonweb/documents/bankfuture.pdf

    • duncanseconomicblog said, on October 27, 2010 at 11:34 am

      Richard,

      I saw that yesterday – a good article indeed.

  21. duncanseconomicblog said, on October 27, 2010 at 11:33 am

    Tim/Luis,

    From a far more free market perspective than my own, here is an argument for state led investment in the US:

    https://www.clsa.com/about-clsa/media-centre/2009-Media-releases/clsa-launches-the-corruption-of-capitalism-by-richard-duncan.php

    • Tim Worstall said, on October 27, 2010 at 11:45 am

      As Mr. Duncan says (in another piece online)

      “nd the third and most important lesson we need to learn from Japan’s experience is not to waste all this money … building bridges to nowhere the way they did, but to spend the money wisely.”

      Quite….and we’ll not spend money wisely if politicians direct the spending.

      • Luis Enrique said, on October 27, 2010 at 12:01 pm

        There are some “wise things for the state to spend money on” – so what we’re talking about is whether the UK state is capable for identifying enough of them, on average, to justify doing a bit of it. I’d say yes …. although if I had to chose between no state involvement at all and the level of state involvement I think Adam Lent (for example) would choose, I think I might choose none at all.

  22. Left Outside said, on October 27, 2010 at 4:12 pm

    One finds evidence of the government’s cold-bloodedness towards poorly managed firms in distress in a variety of otherwise prosperous industries. For example, a company named Shinjin had a larger market share in the Korean automobile industry in the 1960s than Hyundai Motors. Shinjin’s owner, however, could not survive competition from Hyundai’s “Pony” and the oil shock in the 1970s. The company went bankrupt and the government, as banker, transferred Shinjin’s holdings to Daewoo Motors. Another early automobile manufacturer, Asia Motors, was also abandoned (Amsden and Kim, 1985). In the cement industry, the largest producer in the 1970s went bankrupt because it tried to optimize an old technology rather than switch to a new one. Its production facilities were transferred by the government to a chaebol, the Ssangyong group, owned by one of the ruling party’s elders. The Taihan group, a pioneer in the electronics industry, had an ailing consumer electronics division which failed. Eventually the government oversaw its transfer to Daewoo Electronics. Construction firms such as Kyungnam (merged into the Daewoo group) and Samho (acquired by Daelim Engineering) are typical cases of firms that although they once enjoyed government support, were abandoned after going bankrupt—when other firms in their industry were prospering—for reasons which observers generally agree were related to incompetence. A badly managed chaebol of considerable size that the government recently punished with dismemberment was the Korea Shipbuilding and Engineering Company. The Kukje-ICC group has also been pilloried.

    Although it is important to point out that developing economies and developed economies are different, S Korea dropped losers where necessary, so it is possible.

    http://www.oxfordscholarship.com.gate2.library.lse.ac.uk/oso/private/content/economicsfinance/9780195076035/p021.html

    You will probably need an academic login to get access to this, full text of Amsden’s “Asia’s Next Giant.”

    • Tim Worstall said, on October 27, 2010 at 4:57 pm

      Very deeply suspicious of using the economic methods of a dictatorship (which S Korea was up until, arguably, the early 90s) in a democratic system like ours.

      You know, smacks a little too much of that Pinochet bloke, smacked a few heads together but sorted out the economy, didn’t he?

      Indeed, I lean rather towards the view that representative democracy doesn’t allow such economic management methods to be used anyway.

      Compare and contrast Shinjin and Asia Motors’ fate with, as I’ve already mentioned, the propping up of Rover just before the 2005 elections. The claim that that was an electoral bribe purely to secure a few West Midlands marginals is, well, let’s put it somewhere between fair enough and completely correct, shall we?

      • Left Outside said, on October 27, 2010 at 5:23 pm

        More Rodrik, Democracy is best for growth, http://ideas.repec.org/p/nbr/nberwo/7540.html warms the cockles of my heart and always gets brought out when someone says “rah rah, Singapore’s economic model is great.” (Not that I’m accusing you of saying that). “Advantages of dictatorship” are fewer than those of democracy (hence me bigging up India).

        You’re all about the Public Choice Economics aren’t you Tim? Democracies and Dictatorships are going to be subject to different forces, I’m not sure that democracy is more likely to suffer from more patronage than dictatorships. That is certainly a shaky assumption to base your opposition on.

        PS You mean the Pinochet whose government only avoided bankruptcy from the revenues of the copper mines they’d failed to privatised?

        • Tim Worstall said, on October 27, 2010 at 5:28 pm

          “Democracies and Dictatorships are going to be subject to different forces, I’m not sure that democracy is more likely to suffer from more patronage than dictatorships. ”

          Sure, Russia being the current poster child for the problem.

          But I want a system with no patronage: that’s not possible in a dictatorship but is in a minimalist democracy. Why do I want no patronage? Because the politicians will inevitably fuck up the application of any they can get away with.

  23. […] bank, taking sides with Gerry Holtham‘s ideas – spelt out in an FT article – and with Duncan who made a social democrat case for the state’s role in financing much-nedeed investment, […]

  24. […] ideally alongside a new State Investment Bank to fund infrastructure, would be an important step both in rebalancing the UK economy and in helping to combat global imbalances. It’s a shame we are being fobbed off with a gimmick. […]

  25. […] enough the State Investment Bank idea (long backed by me and supported by Robert Skidelsky and Gerry Holtham amongst others) may help to address both these […]

  26. […] them, with democratic control. – “Productive” firms are starved of finance? Create a state investment bank.In this sense, there’s nothing that positive money cures that couldn’t be cured […]


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