Wars as a tragic learning opportunity in Economics (and beyond)

Wars (the World Wars, the Spanish Civil War, the Balcan Wars...) are a tragic learning opportunity about history, politics, economics and their interaction (there is free coverage in the Financial Times of the War in Ukraine). These notes are based on what I tried to share with my students on Introductory Economics in my last class session.

Peace is the ultimate public good: it is non-rival and non-excludable (the provision of public goods requires external intervention or cooperation). Well-functionning markets for private goods rely on this and other public goods.

Wars are a reminder that markets are not the only mechanisms of resource allocation (there is also central and military planning, among others).

Multidisciplinary studies can contribute to better understanding (and preventing) wars:

•Wars are treated as exogenous if one studies the economy as isolated: an external shock that triggers economic crises through lower growth or de-growth and higher inflation with corresponding pressure to increase interest rates (and many other changes).

•As endogenous if one (correctly) studies the economy as part of society and history. The best economists know this (Keynes wrote “The Economic Consequences of Peace,” about the factors that could lead to a second world war)

Wars (through market disruption: destruction, supply chain bottlenecks, sanctions –should oligarchs be better targeted as suggested by Zucman and Piketty? Russia is one of the countries in the world where the richest 0.01% concentrates a higher proportion of wealth, and most of it is off-shore) have an impact on 

•Energy and Commodity Markets: oil, gas...

•Asset prices (the expectation about the profitability of firms changes, for example Gazprom).

Sadly, we’ll have to talk much more about this in the immediate future.

Cheques and unbalances in institutions: the example of sports

All organizations and institutions should have checks and balances, to avoid concentrations of power and risk in a few -or even in a pair of-  hands. Sports organizations and institutions are no exception.

Simon Kuper in his book “Barça,” wrote about the rise and fall of FC Barcelona, the soccer club. The book ends with the departure of Leo Messi, with the institution unable to keep paying his high salary. The management debacle that led to that financial disaster is not clear that has been rectified by the current club officials. Head coaches (of first and youth teams) and CEOs have shorter and shorter tenures, and the elected president shows no sign of resisting populist pressures and of running the club in a professional way.

The agents of the most promising young players, Gavi and Araujo, do not undestand the high expenses of the January transfer window before negotiating the new contracts with them, the talented young stars who are sustaining the team in this transition period. The club will suffer to retain them. Too much looking to the past glory days makes it difficult to commit to renovating the roster and tell the old stars that their time has come.

Continuous managerial changes mean that nobody takes responsibility for the time until the last change. Meanwhile, the club has taken an enormous loan to rebuild the stadium, something that is long due, but which will require a degree of financial and managerial discipline that is nowhere to be seen.

The same need for discipline and commitment is required for Olympic Games and other big sports events. As the special issue of the journal “Nature Sustainability” argued last year, the proposition that Olympic Games can be environmentally and financially sustainable is not totally an illusion, but it is very difficult to verify. It requires very serious reforms that can only take place under strong discipline and cooperation. The importance of alliances, inside the public or the private sectors, and among the two sectors, goes hand in hand with the need for strong governance.

In British English, a cheque is a printed form on which you write an amount of money and say who it is to be paid to. In American English, this word is spelled check. Too many cheques and too few checks and balances in Sports institutions.

Training Foxes

Isaiah Berlin distinguished between hedgehogs (those who know one big thing in depth) and foxes (those who know a little bit of everything). In the new degree on Contemporary History, Politics and Economics at my university, we train foxes (I am a fox myself)... trying to improve the terms of the trade-off between scope and depth.

Our very motivated and endogenously self-selected students have a predisposition to look at the multidimensionality of social phenomena, and have the opportunity to be exposed to the basics of the three disciplines in four years. To improve the terms of the trade-off, more than teaching them a bit of everything, we try to focus on some key issues. I teach them introductory economics with the CORE materials, which have themselves a multidisciplinary approach.

In the first term, we covered in sequence the eight first chapters of the (excellent, and free) e-book "The Economy," which finish with the standard graph of market supply and demand (the starting point of tradititonal textbooks), after discussing the importance of inequality, history, social interactions, institutions or the environment. In the second term that will be starting this week, more on macro issues (but emphasizing the connection to micro), I will do more than mechanically follow the structure of the e-book. I will cover together units 10, 11 and 12, to emphasize financial markets and financial market imperfections, so that they have an introduction to money and monetary institutions in the context of financial markets and other assets. Then we'll do units 9, 13 and 14, to explain in a sequence labor markets, unemployment, business cycles and fiscal policy. Next we'll go back to monetary policy and inflation with units 15 and the capstone unit 17 (on the great depression and the global financial crisis, and I will ask them to do work on the macroeconomics of the coronavirus crisis). After this, we'll do technological change, growth and the global economy (unit 16 and capstone unit 18, where I will ask them to do work on the European Union and the eurozone as a particular response to Rodrik's trilemma; perhaps we'll make some reference to the capstone unit on the digital economy), to finish on the last days discussing political economy (the interaction between politics and economics) with capstone unit 22. The capstone units on climate change and inequality have to some extent been covered in the first term but we may go back to parts of them.

I will also ask them to choose to do one of the empirical projects from the e-book "Doing Economics" units 4, 8-10 and 12, which are more related to the contents of this second term. I know it sounds ambitious, but as I said, we are foxes, and we are not embarrassed by it.  Reality does not have academic departments. There must be both foxes and hedgehogs, but it's more fun to be a fox. Hopefully, we'll have a good time learning together.

From independent central bankers to central bank politicians

The theory says that Independent Central Banks are an institutional innovation that facilitates commitment to make the fight against inflation credible, in democratic contexts where there is constant pressure to run expansionary policies. Complemented with arguments that have to do with expertise, the idea of setting up technocratic agencies insulated form day-to-day politics has expanded its field of influence to reach regulatory institutions, fiscal authorities and other agencies.

The political scientist Marver Bernstein introduced some decades ago a number of qualifications to the virtues of the institution of "independent" authorities, one of them being that unpopular but necessary policies in democracies require political skills.

Some recent developments show that Bernstein was correct, and they show it in a way that was perhaps not anticipated by Bernstein and other critics. These developments have to do with the transition from Central Banks (CBs) to governments by some prominent central bankers.

Mario Draghi, the former Chaiman of the European Central Bank, is now the Italian Prime Minister (and will soon perhaps be the President). Admittedly, this is in an Italian tradition, since it is not the first central banker to become Prime Minister in times of crisis in that country, except that Draghi comes from the European CB, and not from the Banca d'Italia.

Janet Yellen in the US used to be the Governor of the Federal Reserve and is now the Treasury Secretary, and a prominent member of President Biden's cabinet. Finally, it was yesterday announced that the current Governor of the Central Bank of Chile (appointed by the Socialist Michelle Bachelet and confirmed by the conservative Sebastián Piñera), Mario Marcel, will soon become the new Finance Minister, a key position in the government of the newly elected progressive President, Gabriel Boric.

These are not extravagant examples from hidden countries, but cases from very important economies: the US, the European Union (and one of its largest and more economically problematic countries, Italy), and Chile (for many years the poster child of the Washington Consensus).

These are not exaclty conservative central bankers, but they have self-defined themselves as center-left (although Draghi presides over a very broad coalition). Yellen is part of the Democratic Party government of President Biden, and Marcel is an independent close to the Socialist Party, that will be part of the leftist coalition of Boric.

Can this trend be extended to authorities in other fields becoming politicians? That is the case of the Spanish José Luis Escrivá, the current minister for Social Security and Inclusion in the progressive coalition government. Escrivá was the first Chair of the Independent Fiscal Authority, set up by Spain under the recommendation of the European institutions after the Euro Crisis, where he was appointed by the then conservative government.

All these individuals have the credentials of well-trained and experienced economists, some of them with academic experience at the highest level. It will be interesting to see how they develop their role now as political and technical managers to keep populists (from the left and right) at bay.

But faced with this kind of revolving doors, now when we see an "independent" authority, perhaps we don't have to think of him o her as an apolitical technocrat, but as a technocratic politician.

Under-scrutinized parochialism

All the books by Amartya Sen have a common thread, and this is going beyond Arrow’s Impossibility Theorem. I have recently re-read substantial parts of his books on justice and on identity, I read in summer his partial autobiography, and I have always handy the re-edition of his book on Social Choice. Arrow reached the somewhat pessimistic result that from a set of individual rankings of social outcomes, it was not mathematically possible to reach a collective ranking that fulfills a minimal number of reasonable properties (such as transitivity). One example of this is that there is no voting rule that is not vulnerable to breaking one of a few such reasonable criteria. Sen took this result not as a final destination, but as a starting point for a research program to explore partial possibilities that could deliver imperfect but practical solutions. This could be in terms of voting rules, measurement of economic well-being or other aspects of social organization.

In “The Idea of Justice” he applies this notion to the exploration of a comparative theory of justice, where the objective is not to reach a perfect ideal of justice, but to correct injustices in a practical way, not focusing only on institutions, but also on social outcomes ("what happens to people"). He connects this program of practical justice to the notion of “Democracy as public reason.” That is, the possibility of deliberation and discussion allows societies to uncover injustices and correct them. Sen’s sentence that “Outrage can be used to motivate, rather than to replace, reasoning,” which was perhaps written fifteen years ago, resonates today very loudly.

Once we understand that democracy goes beyond ballots and elections, one key aspect to be confronted is that a danger for democracies is to remain trapped in local interests and prejudices. Arguments may be enriched by a global impartial spectator or more practically by the view of others in other lands. This is for two reasons: one is that the interests of people in different societies, countries or regions are more and more interconnected. One decision in one country affects what happens in another country. In other words, there are significant externalities. Another reason has to do with perspectives and ideas. Others may have thought about something that affects us. I see that in communities (like mine) that are over-exposed to nationalist rhetoric: we could learn a lot not only from a better knowledge of our own history, but also from a better knowledge of the (mostly tragic) consequences of nationalism elsewhere.

Other examples come from the US: knowledge from what happens and what is discussed in other countries could help that particular democracy to understand why the death penalty, or the reluctance to embrace public health, are very exceptional among developed democracies. 

Similarly, why phenomena such as famines are not the same as sectarian identity conflicts, makes it possible to understand why the manipulation of identities poses such a threat to democracies and especially to the respect of minorities or the respect of voiceless majorities. In a famine, the non-affected majority can feel empathy for those that suffer, once they are exposed to the relevant information. However, in a sectarian conflict, one community may not feel any empathy for another one, even when they are confronted with the relevant facts and data.

The Paradox of "Don't Look Up"

OK, I already watched “Don’t look up,” the Netflix movie that presents a caricature of the relationship between scientists, politicians, business tycoons and the media in the hypothetical event of the extinction of Planet Earth. It is a bad movie with very famous actors and actresses (my opinion, but also the opinion of the experts on cinema that I read).

The paradox is that so many people has taken the caricature seriously. The social media and the traditional media are these days full of pieces of very serious journalists or even scientists stressing the “lessons” that can be learned from the film. Most (not all) of them acknowledge that “Don’t Look Up” is not a realistic description of what would happen in similar circumstances (if similar circumstances could ever happen), but after this brief acknowledgement, they go on with some very serious thoughts about the need of evidence-based policies, of a rigorous media, of scientists that communicate well, of honest politicians… I read in a local newspaper, for example, that “it is one of the works of fiction that best describes what we call the world of today.”

It is a paradox because although the film doesn’t have any more rigour than a cartoon to make children laugh, the really interesting story (the meta-film, perhaps) is that, in a way that maybe Orson Welles would have enjoyed, it has been taken seriously by relevant sectors of the scientific, political and media community.

In the Spanish newspaper El Pais (also in its English version) there is a very good piece by Javier Salas, who usefully reminds the reader that the film is a comedy, and that in the real world, it wouldn’t be precisely lone scientists like the character interpreted by Leonardo Dicaprio to warn us about an apocalyptic event. The human species, as explained by Salas, has actually developed quite sophisticated global public goods that work very differently from what is explained in the movie. It could be added that most politicians in democratic countries and international institutions are not like the character interpreted by Merryl Streep, and even when they are (like it happened with Trump), there are still relatively well-functioning checks and balances that address the issue, and perfectly dressed scientists like Anthony Fauci who remain in their positions even after the democratic mechanisms dispose of the disfunctional president. It could also be added that there are media institutions like the CNN or the BBC (or El Pais) who do a pretty decent task of communicating the scientific truth and who are not neutral between posttruth and democracy. It could also be added (and many examples could be given of it) that there is a fluid relationship between the realms of politics and science, with many scholars (for example, in my discipline, economics) crossing the boundary between both from time to time in one form or another. Needless to say, this does not mean that we leave in a perfect world, but we are not going to find clues about how to seriously improve upon it in this absurd movie.

It is a paradox that some people who pretend to see in the movie a criticism to some negative trends in our society, have given an example of seing in it exactly what one wants to see (also called confirmation bias). Others have complained about the banalization of politics when by taking the movie seriously they have been the first to contribute to the phenomenon. I admit that it is also a paradox that I am wasting my time commenting on this.

I agree with what the young Spanish economist Monica Martínez Bravo has said in a tweet: "What we need is to figure out how to "speak to" the skeptics, those that feel "left-behind" by the political and economic system and find appealing incompentent/populist leaders. Not sure this movie will help on that..."

And to speak to the skeptics some more action will be needed out of the comfort zone, but using the real world as a starting point. To me the movie though has a couple of optimistic messages for middle aged men: Jonah Hill can lose weight and Leonardo Dicaprio can be ugly. And that’s it. Happy new year!

Regulatory commitment in twenty-first century democracies

It is well-known that one of the key challenges in utilities’ regulation (to some, "the" key challenge)  is the commitment problem. Regulated firms have the opportunity to undertake massive long-lived specific investments, and then the regulator, once the investment has been sunk, decides whether and to what extent to remunerate the investment. In democratic societies, regulators face strong political pressure not to remunerate the sunk investments, or at least strong political pressure to remunerate them below the opportunity cost of capital. This is so especially in low or middle income countries, where there is a strong demand to use the utilities’ quasi-rents to fund social programs or to address other urgent political priorities. Anticipating this behavior by representative regulators, the regulated firms are tempted not to invest in the first place, leading to an underinvestment problem. Although there is investment in utilities, for this reason it is almost surely sub-optimal.

Throughout history, different polities have developed different institutions to alleviate this problem, from public ownership to independent regulators. I wrote about it here, among other places. Pablo Spiller and his co-authors emphasized that each country tries to fix this problem according to its institutional endowment. The recent book by Auriol, Crampes and Estache addresses this and other pressing institutional problems in regulation in a specific chapter.

Last week I was in Chile to attend an event on water regulation where I gave a presentation on some ideas about how the Chilean regulatory model may evolve after the crucial presidential election they hold this week on Sunday. Of course, much will depend on which of the two presidential candidates wins in this very polarized vote (between the right-wing Kast and the left-wing Boric), but both the two contenders and the candidate who was third in the first round can fairly be characterized as different brands of populists.

The Chilean case in the Spiller framework about commitment institutions that are adapted to the institutional endowment (in comparison for example with the UK, where commitment is based on licences and independent regulators), consists of achieving commitment through detailed legislation (guaranteeing a safe rate of return to private investors) and legislative institutions where it is very difficult to introduce legal reforms. These legislative institutions are based on the Guzmán Constitution of the General Pinochet years, which has been the main motive of the social mobilizations that have triggered the political changes that is experiencing the country: the Boric movement, the Kast reaction, and the Assembly to write a new Constitution. The text of the current Constitution can be interpreted as just one aspect of a system of extreme protection of private property rights that was the legacy of the military dictatorship.

This framework has not prevented Chile (some may even say that it has facilitated it)  from achieving high levels of service availability in water (and other utilities), although now it faces serious challenges in terms of droughts and climate change. The protection of property rights and the center-left governments immediately after the dictatorship that prioritized the eradication of poverty allowed for the extension of service, but probably are not enough today to guarantee the levels of private and public investment and government intervention that are going to be needed to fight climate change, severe drought and water imbalances.

Chile is a good example where the second best institutional fixes to the commitment problem do not really solve, but they relocate, such commitment problem, which becomes a problem of the political system committing or not to preserve these second best institutions. For example, the straightjacket on Chilean legislators has not proven robust to a generation of citizens that are less ready to support with their votes an extreme level of protection of property rights.

It will be very interesting to analyze how the Chilean regulatory model evolves in this disruptive, but happily democratic, times. Second generation commitment devices will be needed if underinvestment is to be avoided. Some experts on the relationship between populism and economics have claimed that the risks of the current wave of populism are more microeconomic than macroeconomic as they were in the past (perhaps climate change denial on the right, and property fetishism on the left?). The younger and left wing candidate, Gabriel Boric, has been advised for the second round by what the Chilean media has called a center-left technocrat, former Yale academic and current professor at University of Chile, Eduardo Engel, co-author of a widely read book on public-private partnerships. One can see that the existence of a second round is also a commmitment device to avoid extremisms… although the new Constitution could in theory also change that.