A Manifesto for economic sense (by A.J. Marques-Mendes et al.)

More than four years after the financial crisis began, the world’s major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.
These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.

• The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions - other than Greece - this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
• The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but - just like the similar response of debtors in the 1930s - it has proved collectively self-defeating, because one person’s spending is another person’s income. The result of the spending collapse has been an economic depression that has worsened the public debt.
• The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that’s exactly what many governments are now doing.
• The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn - focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy - while it should do all it can - cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

Read the full text here.

The sports industry and positional externalities (by Francesc Trillas)

Since I’m following the Eurocup (with all these astonishing stadiums), writing on the economics of big sports events and also reading “The Darwin Economy” by Robert H. Frank, which I have to review for a journal, I have been associating the three things in my mind. In the years devoted to pursue the dream of organizing a big sport event, public intervention is radically biased to costly actions related to the event, which are subject to escalation of commitments and behavior similar to an arms’ race. This is to the detriment of other public investments, such as in human capital (health and education) or social expenditure, which are less visible but far more important. Only large net economic benefits from hosting these events would justify the bias, and these benefits just do not show up in the empirical evidence. Financial Times journalist Simon Kuper has repeatedly pointed out that big sports events should honestly be sold as big parties and not as investments. But this would not solve the problem, because as Frank shows in his book, parties are subject to consumption cascades. Nobody wants to be left behind and this goes also to the detriment of other more important expenditures where there are not positional externalities or these are less prevalent.  

A great loss (by Pedja dell'Arno)

I just knew that Elinor Ostrom passed away. This is really a great loss. What was impressive of her was how she revolutionized interdisciplinary work in social sciences. Many times, people who claim to do interdisciplinary work take it as an excuse to be a "dilettante" in many fields and none at the same time. Ostrom was a deep scientist. She was one of the non-economists to receive the Economics Nobel Prize, and her Nobel Prize Lecture was a lesson in wisdom. I have come to the conclusion over the years, and after seeing both of them lecturing, that of the two institutionalists Nobel Prize winners of the same year, the really impressive one was Ostrom, despite Williamson being better known among economists.

Amazing list of videos (by Francesc Trillas)

An amazing list of videos by some of the best economists can be watched here. It is a list of special lectures at the LSE, starting by the one recently given by Paul Krugman. You can find Johan Van Reenen and Hal Varian on Management and Growth, Lord Stern on Climate Change, Kahneman on his last book ("Thinking, Fast and Slow"), and Robert H. Frank on his recent book on evolutionary economics, consumption, taxation and inequality (which I will review soon upon request for a journal). It is a great progress that the Internet makes available for everybody the lectures of these people. In the past it would have been impossible to watch all of them in a single life time. And, by the way, the new (2011) edition of Robert Shiller's courses on Financial Markets are also available now. Peer pressure for us, more humble lecturers.

Politics and the crisis (by Pedja dell'Arno)

There is little doubt that the current European crisis has a large political component. Mainstream political parties lose appeal and fringe or extremist parties tend to benefit. An exception so far has been the Hollande campaign in France, which shows that not all hope is lost. The crisis can be seen as a huge collective action problem: there is a potential cooperative solution with a higher sum of payoffs for the sum of agents involved, but the parties (countries or individuals) fail to reach it because they do not trust each other. This collective action problem has at least two components:
-A sovereign component. The only solution is European, but our democracies are national. In addition, minorities that feel uncomfortable in their current member states (in Spain, the UK, Italy) wonder whether it is not worth to take the crisis as an opportunity to break away.
-An organizational component. Citizens trust mainstream political parties less and less, because these are not seen as their true represenatatives.
However, since the only solution to the crisis can be collective, it means that only politics can take us out of it. It can only be a different politics. Good technocrats, even when they are available like in Italy, can win some time, but they are ultimately an impossible shortcut to the only solution: better politics.

Moving the Laffer Curve (by Francesc Trillas)

Teaching taxation in the undergraduate course about Public Economics I explained to my students the Laffer Curve, which associates taxation rates with taxation revenues. According to this curve, there is an optimal level of taxation, beyond which increasing taxes is counterproductive because it decreases taxation revenues. The reason is the existence of behavioral reactions of individuals to raised taxation: working less, sending money to other jurisdictions, tax avoidance and tax evasion. The big empirical debate in many historical circumstances is to assess if we are on the right or on the wrong side of the Laffer Curve. For example, during the Reagan administration, conservative economists won the political debate by persuading the political arena that the US were on the wrong side of the Laffer Curve, i.e., taxes were too high. Recent work from Emmanuel Saez and his co-authors revisits the issue. Their insight is that regardless of what we think in terms of being on one side or the other of the optimal taxation level, the Laffer Curve is not something fallen from heaven, but a relationship that is endogenous and that can be modified by policy. For example, if one takes as given and fixed the level and opportunities for tax avoidance, the optimal level of taxation will probably be low, because high taxes will encourage easy avoidance. However, by eliminating loopholes and enlarging tax bases, policy may discourage the opportunities for avoidance, which makes high taxation possible and on the right side of the Laffer Curve. It seems to me that the idea is more general: many political debates take the context as given, while policy itself should sometimes be about changing the context.