Knowing and Making

This quite clever proposal from Cavallo and Cottani sounds plausible at first but my immediate reaction is: how can it work? The idea is to eliminate payroll taxes in Greece and instead raise VAT to 25%. This is meant to increase competitiveness while reducing distortions in the economy. It feels like a magic solution - which naturally makes me suspicious. If the economy really needs a devaluation, then how can they miraculously solve the problems without one? But then I realise that magic really can happen . A devaluation is only a nominal change - it simply breaks people's money illusion and affects relative prices. In fact, a devaluation requires no real actions at all, although it does change the pattern of of future real demand. All the benefits of a devaluation can, in principle, be achieved through the coordinated individual choices of all the agents in the economy. Of course such coordinated choices are highly implausible, which is why devaluation is a good short...

This article at VoxEU implies that companies in Italy which are 'connected' with politicians make 5% more profit. Could be true. But an equally plausible story is that companies become less profitable around election time because they are spending 5% of their profits on subsidising politicians. On this interpretation, contributing to political campaigns is seen as a cost of doing business, and depresses profits immediately before an election. Note that in the graphs shown in the article, the firms' profits take a dip in the year before the politician's term ends. Far be it from me to impugn the Italians' proud record of rent-seeking and corruption - my Italian friends would claim they have a unique comparative advantage in this field, and lead the world in their craftsmanship (though there are some volume producers in Africa and Asia who compete for sheer scale of bribery). But I want to allow them the elegance of a convincing escape clause - which is, after all, ...

I have a commentary up at VoxEU, outlining how financial regulators should use results from behavioural economics to stabilise the economy. The article is here - highlights include: ...behavioural tests can give insight into accurate asset pricing. A sharp rise in house prices, for example, might originate partly in irrational buying decisions, and partly in by a genuine increase in the expected long-term return on property. While the long-term return cannot be tested today, the irrationality of consumers can, through specific experiments. Thus the change in expected returns can be deduced by subtracting the irrationality effect from the actual price rise. There are many other tools which have been experimentally tested at the micro level but not yet applied to macroeconomics. Price anchoring, framing, endowment effects, confirmation bias and various social and peer effects all demonstrably allow us to influence behaviour in the lab; they should have applications to what we might call...

Robert Peston is revisiting the argument for the Bank of England buying shares in private companies - proposed by me in December and (the slightly more eminent) Roger Farmer in January. He points out that the Hong Kong government did this in the late 1990s, during the Asian financial crisis, and succeeded in both supporting the market and making a big profit when they resold the stakes a couple of years later. Stephanie Flanders has a good piece about Tim Geithner's position and particularly about the IMF and other possibilities for fiscal burden-sharing between G20 countries. Meanwhile Paul Mason has an excellent summary of the issues to be dealt with by the G20 conference in a few weeks: Far from the emergence of a harmonised and increasingly unified world economy [globalisation] has produced a lopsided and malformed structure that is now falling apart. The low paid worker in Detroit cannot buy his new pair of trainers unless the low paid worker in Shenzhen a) makes them, b) d...

I've had an article published today in VoxEU: Models of bounded rationality and the credit environment : Responses to the recession should not be based on unrealistic expectations of rational behaviour. We now know enough about real, flawed human psychology to be able to take some account of it in policy setting. Mark Thoma has linked to it and there are some interesting responses in the comments to his posting.

An amazing piece of research is published today in VoxEU. Louis Putterman and David N. Weil have discovered that the proportion of a country's ancestry which lived in Europe in 1500 explains 44% of the variation in per-capita GDP in 2000. This is a huge influence and should have a big impact in understanding how countries - and people - achieve economic success. The VoxEU article speaks for itself really, so have a look. Possible areas to follow up: How is the migration distributed through time - for example if most emigration to the US happened in the 1800s, the dominant effect may not be 500 years old but only 150. Today's ethnic classifications express only roughly the ancestry of individuals. How many ancestors do you have who were alive in 1500? The answer is: around a million (assuming 25-year generations and minimal inbreeding!). I don't think the survey purports to account for the fact that these people must have almost certainly come from more than one country. As...