Fall 2009 - Harvard Economics Review

HARVARD
Should Governments Regulate Sin?
C OLLEGE
Page 5
Policy Challenges and Finance
Economics Review
FALL 2009 ¤ VOL IV ISSUE 1
Finance
and
Regulation
Page 7
Prices and Crisis
Page 17
Letter From the Editors
Dear Reader,
EDITORIAL BOARD
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Yuriy Shteinbuk
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Content
Regan Bozman–Content Associate
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Han He–Content Associate
Kwon-Yong Jin–Content Associate
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Channing Spencer–Content Associate
BUSINESS
In this issue, we hope to shed light on the role of regulation in the modern economy.
The financial crisis has brought regulation, or the lack thereof, to the forefront of
public discussion. This issue provides a few different perspectives that we hope will
help you better understand the issues involved in the debates.
We have also included a number of articles in this issue that span a variety of topics,
from the history of recessions to the economics of hip-hop and geochemical engineering. In the Cover Theme section, you will find an interesting argument regarding sin taxes by Jeffrey Miron, as well as a discussion of financial growth policy by
Ross Levine.
We have also introduced a new section in this issue focusing on issues relating to
International Economics. Additionally, we have as usual included a series of student
articles in an effort to engage disparate groups on the Harvard campus.
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Harvard College Economics Review
VOL. 4 ISSUE 1
On the Cover:
Economics and Regulation
The HCER brings together academics, practitioners,
and students to analyze the changing nature of regulation and its implications for policy, industry, and
economic growth.
HARVARD
Should Governments Regulate Sin?
CO L L E G E
Page 5
Policy Challenges and Finance
Economics Review
FALL 2009 ¤ VOL IV ISSUE 1
Page 7
Prices and Crisis
Page 17
Finance
and
Regulation
Should Governments Try To Reduce Sin?
Prices and Crises
The Forgotten Recession: Lessons from 1937-38
4
6
Ross Levine
9
11
Stephen G. Brooks
The Culprits Behind India’s Income Inequality: Neoliberal
Economics and Globalization?
13
Channing Spencer
Latin America Fights Back
Omar Garcia
ISSN: 1946-2042
ISBN: 978-0-9823780-1-4
Book Review
End the Fed
22
Siddhant Singh
23
Han He
Kiran Gajwani
Has America Lost the Capacity to Lead?
19
Kwon-Yong Jin
Book Review
This Time is Different: Eight Centuries of Financial
Folly
International
Poor People Helping Themselves
16
Hyun Song Shin
Jeffrey Miron
Finance, Growth, and Opportunity: Policy Challenges
Special Focus: Finance
15
Interest
Hip-Hop and the Recession
24
Regan Bozman
Interview with David Keith
Interviewed by Regan Bozman
26
Jeffrey Miron
Should Governments Try to Reduce
Sin?
The costs and benefits of sin taxes
M
ost governments attempt to reduce the consumption of “sinful”
goods like alcohol, tobacco, drugs,
gambling, and prostitution. The most aggressive approach is prohibition: a ban
on the production, distribution, and consumption of the good in question. A less
extreme approach is sin taxation, which
raises the price of the targeted good but allows legal production and use. Numerous
other policies, such as drunk-driving laws
or minimum purchase ages, target specific
negatives associated with sin.
Economists offer two justifications for
policies that target vice. First, that certain
goods or activities cause externalities. Second, that some consumers make irrational
choices about the goods usually thought
of as sins. Each of these views has an element of truth, and well-designed policies
aimed at reducing vice might be beneficial
on net. In practice, such policies can have
significant unintended negatives, so the
case for reducing sin is not compelling.
The externality argument for reducing vice holds that consumption of these
goods can harm innocent third parties,
implying the privately chosen amount of
such goods is socially excessive. For example, driving under the influence of alcohol
can cause traffic accidents that injure not
only the driver but other cars and passengers, pedestrians, and property. Smoking
cigarettes generates second-hand smoke,
which bothers many non-smokers. Drug
abuse can diminish health, which negatively impacts others through a “fiscal externality” if government pays for health
care. Gambling might cause financial ruin,
implying more people living on welfare,
and prostitution might spread sexually
transmitted diseases.
The externality logic for reducing vice is
sound, but several caveats apply.
First, while some people consume sin
in ways that generate externalities (e.g.,
driving under the influence), many others do not. The ideal policies discourage
consumption only in circumstances that
generate externalities. Thus, penalties for
drunk driving make sense because they focus on behavior that might harm others,
and bans on smoking in public places address an externality directly. Prohibitions
and sin taxes, however, impose the same
penalty—a higher price—on consumers
who do and do not generate externalities.
The second problem with the externality framework is that determining what
constitutes an externality and which
ones society should reduce, is difficult.
Washing one’s laundry causes water pollution, a classic externality. Eating too
much ice cream can cause heart disease,
thereby increasing the costs of publiclyfunded health care. Watching late night
TV means less sleep and lower workplace
productivity the next day, which can adversely affect one’s co-workers. In other
words, a great many activities generate
externalities. Since society does not have
the resources to control them all, it must
figure out which are most significant.
This complicated and subjective exercise, however, often comes with problematic implications. Smoking, for example,
causes elevated health costs, some of which
are paid out of public funds. Thus, smoking causes a “fiscal” externality, and this
might seem to justify policies to reduce
smoking. At the same time, many smokers die younger than non-smokers, which
means they collect less in Social Security
and Medicare benefits. This is a benefi-
HARVARD COLLEGE ECONOMICS REVIEW
cial externality because it reduces taxes on
everyone else. The externality reasoning
taken to its logical end thus implies that
if smoking reduces Social Security and
Medicare payments by more than it raises
public health costs, governments should
subsidize smoking.
Few people would endorse such a policy. Yet, if society is unwilling to apply the
externality logic consistently, the concept
becomes a tool of special interest groups
who use it to promote their own goals.
Academics, for example, emphasize the
externalities from education and use these
claims to justify government support, but
the evidence for such externalities is modest. The externality argument must therefore be applied with caution.
A different argument for targeting vice
holds that many individuals make bad decisions when left to their own devices, especially regarding “sins” like alcohol or gambling. This might occur because people are
short-sighted, ill-informed, undisciplined,
or in some way not rational. Relatedly, it
might occur because certain sins are addictive. Thus, according to the paternalism
perspective, governments can make such
people better off by encouraging or requiring different choices than these people
would make on their own.
No one denies that some individuals are
not fully rational and do not seem to act in
their own self-interest. The paternalistic
defense of anti-vice policies, however, is
problematic.
To begin, paternalism can seem to justify an enormous range of government
intervention. Paternalism might suggest,
for example, that government should
discourage not only sins like drug use or
prostitution, but also saturated fat, lack
of exercise, excessive television, certain
books, and particular religious preferences. In each case, a plausible argument exists that some people consume the wrong
amount of the good in question, yet most
people would be wary of intervention that
dictates religious choices, dietary restrictions, or jogging regimens. More broadly,
paternalism opens the door for interventions that would horrify those who invoke
paternalism in other contexts. Paternalism might suggest, for example, banning
abortion because most women prevented
from obtaining an abortion nevertheless
end up loving their kids.
Even without slippery slopes, government attempts to prevent every bad decision would consume enormous resources.
Thus, politics and prejudice can play a large
role in determining which goods come in
for paternalistic considerations. Marijuana use, for example, carries health risks,
but even heavy, long-term use appears to
generate less harm than obesity.
Thus, the standard arguments for policies aimed at vice, while logical as far as
they go, are not necessarily compelling.
Whatever the merits of these arguments,
a full analysis must examine the costs of
the specific policies used to reduce vice.
For prohibition, the costs are enormous.
Prohibition drives markets underground,
generating violence between rival suppliers, diminished quality control for users,
and corruption of police and prosecutors.
Prohibition enriches those who supply the
good despite the law, and the widespread
non-compliance teaches everyone that
laws are for suckers. Because violations
of prohibition do not generate a natural
complainant, prohibition diminishes civil
liberties as police rely on intrusive tactics
such as warrant-less searches and racial
profiling. Prohibition, moreover, does not
appear to substantially reduce vice.
Sin taxation is a better policy than prohibition for addressing externalities or
irrationality, but it generates several adverse side effects. Excessive sin taxation
amounts to de facto prohibition, so it creates a black market and all the attendant
negatives. Sin taxes do not necessarily
reach this level, but the risk is always present.
Even moderate sin taxes have unwanted
effects. Sin taxes penalize those who can
engage in drug use, prostitution, or gambling without hurting themselves or others, so the net impact on consumer welfare
is ambiguous. The choice of which goods to
regard as sins is not obvious and in practice reflects politics more than good economics. Watching late night TV, for example, might reduce productivity more than
marijuana allegedly does, but demonizing
marijuana users is politically than imposing a tax on late-night talk shows.
Similarly, designating some goods as
sins might signal that people should not
worry about the non-sins, but many of
these, like an unhealthy diet, generate real
harm. Sin taxation also means that governments promote sin even while trying
to discourage it (e.g., by banning private
gambling while airing television ads that
glamorize government lotteries).
Even mild anti-vice policies do not necessarily generate greater benefits than
costs. A minimum purchase age for alcohol, for example, might reduce irresponsible drinking by teenagers. Yet the same
policy might encourage binge drinking by
teens who decide to consume heavily on
occasions when they do get access.
The bottom line is that government
efforts to reduce sin are harder to justify
than conventional wisdom assumes. A few
interventions, such as drunk-driving laws,
almost certainly make sense, but overall
anti-sin policies can easily generate more
cost than benefit. H
Jeffrey Miron is the Director of Undergraduate Studies at Harvard University.
5
Ross levine
Finance, Growth, and Opportunity:
Policy Challenges
The contributions of financial systems to economic prosperity and
what we can do to boost them
T
his article first describes the connections between the functioning of the
financial system and both the rate of
long-run economic growth and the availability of economic opportunities. The article
next discusses how financial innovation affects economic prosperity. The article concludes with an analysis of financial regulation, describing the lessons that have been
learned over the last few decades and how
those lessons should be reevaluated in light
of the recent financial crisis.
1
Finance matters for growth
A large and growing body of research
shows that the operation of financial markets and intermediaries exerts a first-order
impact on the rate of long-run economic
growth: (1) Countries with better functioning financial systems grow faster over many
decades, and (2) Improvements in the operation of financial systems accelerate the rate
of economic growth within particular economies.
Financial markets and intermediaries
provide particular services that affect longrun rates of economic growth. They mobilize
savings, choose where to allocate capital,
monitor the use of that capital once it is allocated, and provide mechanisms for pooling and diversifying risk. To the extent that
the financial system performs these services
well, economies tend to grow correspondingly faster. To the extent that a financial system simply collects funds with one hand and
passes those funds along to cronies and the
politically connected with the other hand,
the economy tends to grow more slowly.
Moreover, consistent with the focus of the
new growth literature, finance affects longrun growth by altering the rate of technological change and the efficiency with which
resources are allocated. Finance is not very
strongly linked with savings rates. Rather,
finance shapes the rate of economic growth
by affecting the flow of capital to more or less
efficient ends.
Indeed, recent research shows that financial policy reforms that enhance the competitiveness of the financial system spur entrepreneurship in the non-financial sector.
Better, more efficient financial systems both
ease the entry of excellent new firms and also
ease the exit of relatively poor old firms.
Because there are winners and losers, not
everyone wants a better functioning financial
system. Some will fight vigorously against
policy reforms that improve the functioning
of the financial system and hence the rate of
economic growth. Thus, political economy
considerations are obviously paramount in
reforming financial policies, either for the
better or for the worse.
2
Finance matters for the poor
But, who actually benefits from a better financial system? Does financial development
induce an increase in per capita GDP only because the very rich get even richer? Or, does
finance expand economic opportunities for
the bulk of society?
Economic theory suggests that the operation of the financial system could have a major impact on the distribution of economic
opportunities.
The financial system influences who can
launch a new business venture and who cannot, who can acquire education and who
cannot, who can live in a neighborhood that
fosters the cognitive and non-cognitive development of their children and who cannot,
and who can pursue one’s economic dreams
and who cannot.
Thus, the financial system affects the
degree to which a person’s economic opportunities are bounded by individual skill and
initiative or whether familial wealth, social
status, and political connections delineate
the contours of one’s economic horizons.
Though much less well-developed than
the literature on finance and growth, a growing body of research indicates that more competitive, better functioning financial systems
HARVARD COLLEGE ECONOMICS REVIEW
exert a disproportionately positive impact on
relatively low-income families.
With greater competition among financial institutions, banks lower interest rates
and are pushed to become better at screening projects and monitoring managers. By
boosting competition and efficiency in the
non-financial system, financial development
spurs economic activity and increases the demand for labor. Empirically, this manifests
itself as an increase in the relative demand
for lower-income workers. The relative working hours and relative wage rates of lowerincome workers increase as improvements
in the financial system accelerate economic
growth.
This evidence raises an obvious question:
if finance is so beneficial for accelerating the
rate of economic growth and expanding economic opportunities, what are the barriers to
creating well-functioning financial systems?
I believe the answer is also obvious: some
people do not want well-functioning financial systems that give the economically disenfranchised greater opportunities. They do
not want to compete on more equal terms.
Thus, generating financial reforms that accelerate economic growth will involve much
more than identifying which financial sector
policies are good for economic growth.
Financial innovation is indispensable for
3
growth
Before turning to a discussion of the
types of policies that help in the creation of a
growth-enhancing financial system, it is crucial to discuss financial innovation.
The literature on economic growth over
the last two decades, if not the last six de-
cades, has placed technological innovation
in the starring role. Yet, the literature on finance and growth has largely ignored financial innovation. History suggests that this is
a mistake: financial and technological innovations are inextricably linked.
Financial innovations have been essential
for permitting improvements in economic
activity for several millennia. Whether it was
(I) the design of new debt contracts six thousand years ago that boosted trade, specialization, and hence innovation, (2) the creation of
investment banks, new accounting systems,
and novel financial instruments in the 19th
century to ease the financing of railroads, (3)
or the development and modification of venture capital firms to fund the development
of new information technologies and innovative biotechnology initiatives, financial
innovation has been a critical component of
fostering entrepreneurship, invention, and
improvements in living standards.
The evidence does not imply that financial innovation is unambiguously positive.
Financial innovations are frequently implemented simply to avoid regulations, and they
played prominent roles in triggering our current suffering.
At the same time, the evidence does imply that financial innovation is important in
fostering economic growth and expanding
economic opportunities.
These observations—that (a) finance
shapes the rate of long-run economic growth,
that (b) finance affects the distribution of
economic opportunities, and that (c) financial innovation is a pivotal input into the
quality of the financial services provided to
the non-financial sector—have at least three
policy implications:
1. Improvements in the financial system will generate winners and losers,
suggesting that the political power
of particular constituencies will play
a central—if not the central—role
in determining the degree to which
a country selects growth-enhancing
financial policies.
2. The financial regulatory regime
should not focus exclusively on stability since financial development
and financial innovation influence
human welfare by shaping economic
growth and the distribution of eco4
nomic opportunities .
3. The regulatory regime must adapt
to financial innovation or well-reasoned, well-intentioned, and wellstructured regulations will become
obsolete and potentially detrimental
to economic prosperity as a country
innovates.
Existing evidence on which financial regu5
lations work best
I now discuss evidence on which financial
regulations work best in creating a financial
system that boosts economic growth and expands economic opportunities.
First, in the name of economic growth, we
should be wary of recent calls for more regulation and greater government intervention
in financial systems. We should be very concerned about the form of regulation and the
nature of government intervention and not
just focus on the quantity.
In particular, an enormous body of research suggests that financial regulations are
frequently used to help a small group of powerful elites, not to promote economic welfare
in general. Whether it is Brazil or Mexico,
India or Pakistan, Italy or the United States,
publicly owned, government-controlled, and
state-protected banks are associated with
slower growth, not more rapid rates of economic development. Moreover, these government-influenced banks do not typically
lend much to the poor; rather, they lend the
bulk of their funds to politically connected
firms.
In terms of official supervision, a large
literature finds that official supervisory
agencies that exert a direct, powerful influence over banks typically use that power to
alter the flow of credit toward political ends.
Around the world, in countries with supervisory agencies that exert an influential hand
over the affairs of banks, we observe much
7
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fall 2009
higher rates of corruption in lending, along
with declines in bank efficiency.
The evidence, however, does not advertise the efficacy of a laissez-faire approach to
regulating financial systems.
The evidence instead indicates that countries that force financial institutions to disclose information in a transparent, easily
comparable manner enhance the functioning
of their financial markets. Moreover, the evidence indicates that legal and regulatory systems that both facilitate and compel equity
and debt holders to oversee the management
of financial institutions create more efficient, competitive financial systems that foster economic prosperity. Or, put differently,
growth-promoting financial intermediaries
arise with a greater probability when governments refrain from enacting and implementing regulations that interfere with the ability
and incentives of shareholders and creditors
to monitor financial intermediaries.
The crisis and financial policies: Lessons
for promoting growth
Does the recent U.S. financial crisis conflict with these policy conclusions?
No. I think it reinforces the earlier findings. A series of regulatory policies in the
United States (1) hindered transparency, (2)
erected barriers to shareholders and creditors effectively monitoring the activities of
financial institutions, and (3) created incentives for financial institutions to take excessive risks. Thus, the United States did not
follow the basic lessons about financial regulations that have been learned from the last
few decades of research. It is inaccurate and,
ultimately, unhelpful to view the crisis as a
failure of the market. The United States had
and has lots of regulations and very powerful
regulators. It is both more accurate and more
useful to identify the regulatory and political
failures that produced the crisis so that the
United States and other countries can enact
more growth-enhancing policies.
For example, the U.S. Congress made it
difficult for market participants and government regulators to acquire information
on exposure to credit default swaps (CDSs).
For many years, the Federal Reserve was
very well aware—and very concerned—that
it could not assess the counterparty risk of
CDSs. Yet, it still let banks dramatically reduce capital through the purchase of CDSs.
This was a bad choice, potentially influenced
by the political power of bankers.
As a second example, the Securities and
Exchange Commission (SEC) and Federal
Reserve knew for over a decade that the Nationally Recognized Statistical Rating Organization (NRSRO) would have overwhelming incentives to sell high credit ratings on
securitized mortgages for over a decade.
They knew that the explosive growth of securitization and collateralized debt obligations
would dramatically intensify the conflicts
of interest inherent in credit rating agencies. Basically, these credit rating agencies
might not sell their reputations for a few
million dollars, but for many billions of dollars, they energetically produced whatever
ratings the banks needed. Yet, the SEC and
Fed themselves still relied on the ratings of
these agencies in evaluating the riskiness of
intermediaries supervised by the SEC and
Fed. This was not a lack of regulatory power.
Rather, there was an institutional and political unwillingness to adapt the discretionary
implementation of regulations in the presence of new financial innovations.
As a final example, consider the horrible
incentives created by the behemoths Fannie
Mae and Freddie Mac in conjunction with
the policies of the Department of Housing
and Urban Development and the Federal Reserve. For a host of political reasons, these
institutions pushed banks to participate
in sub-prime mortgages. Yet, even though
these institutions and Congress knew for
over a decade that the situation was deteriorating, politics trumped sound policy.
Over the course of many years, policy-
makers and regulators made choices, bad
choices, in the United States. They did not
adapt regulations in response to financial innovations to help and induce shareholders
and creditors to monitor financial intermediaries and, instead, maintained policies the
interfered with the ability and incentives of
investors to govern financial institutions effectively. A more publicly responsible—and
responsive and accountable—regulatory
system could have captured the benefits to
economic growth and economic opportunity from securitization, collateralized debt
obligations, and credit default swaps, rather
than turning them into malignant tools of
financial destruction.
Conclusion
In conclusion, the operation of the financial system exerts a first-order impact on the
rate of long-run economic growth. Moreover, research has produced useful guidelines
regarding which financial policies have been
most successful at creating growth-promoting financial institutions.
With regard to actually enacting and
implementing growth-enhancing policies,
however, the greatest difficulty lies in creating regulatory agencies that are powerful
enough to facilitate and compel shareholder
and creditor oversight of financial institutions while also obliging powerful regulatory
agencies to act in the best interests of the
H
public.
Ross Levine is the James and Meryl Tisch Professor of Economics and Director of the William
R. Rhodes Center for International Economics and Finance at Brown University.
Endnotes
1.
2.
3.
4.
5.
The section draws on Ross Levine (2005), “Finance and growth: Theory and evidence,” in Handbook of Economic
Growth, ed. P Aghion, S Durlauf, 1A:865--934. Amsterdam: North-Holland Elsevier.
This section draws on the literature review by Asli Demirguc-Kunt and Ross Levine (2009), “Finance and Inequality: Theory and Evidence,” Annual Review of Financial Economics, 1. The literature considers three related,
though clearly distinct and potentially contradictory, definitions of inequality. Many researchers stress equality
of opportunity. Others emphasize the intergenerational persistence of cross-dynasty relative income differences.
Still others concentrate on income distribution because (1) they use income distribution to proxy for equality of
opportunity or intergenerational persistence or because (2) income distribution is an independently worthwhile
focus of inquiry, as relative income directly affects welfare. Since my goal is simply to note that a considerable
body of research relates the operation of the financial system to various concepts of the distribution of economic
opportunity, I do not distinguish among these different views of economic inequality, but see Demirguc-Kunt
and Levine (2009).
This section draws heavily on Stelios Michalopoulos, Luc Laeven, and Ross Levine (2009), “Financial Innovation
and Endogenous Growth,” National Bureau of Economic Research, working paper, 15356.
I am not suggesting that crises are unimportant. Indeed, crises are exceptionally costly. In developing economies,
the fiscal costs of banking crises in the last two decades of the 20th century were greater than all of the nonmilitary international aid provided to developing countries during the 20th century. In the United States, the IMF
estimates the cost of the financial crisis at about $3 trillion, which is about $20,000 per US taxpayer and exceeds
educational expenditures by federal, state, and local governments during the last decade. We obviously should
care about financial stability. Yet, reducing the risk of systemic crises is not the only goal of financial regulation
and therefore is not the only consideration in rethinking the governance of financial regulations.
This section draws heavily on James R. Barth, Gerard Caprio, Jr., and Ross Levine (2006), Rethinking Bank
Regulation: Till Angels Govern, New York: Cambridge University Press.
HARVARD COLLEGE ECONOMICS REVIEW
Kiran Gajwani
Poor People Helping Themselves
Membership-based organizations of the poor are an extreme form of
decentralization…and a potentially useful development strategy
D
ecentralization of governance—in
the sense of shifting power and responsibilities from national to subnational levels of government—has been a
popular policy initiative in many developing countries over the past few decades.
The goals of such a policy are generally to
fill in the failures of central governments in
achieving poverty reduction, public goods
provision, and overall provision of basic necessities to some of the poorest individuals
in developing countries. In theory, locallevel governments and government officials
may better know individuals’ preferences
and be better able to target anti-poverty
programs. India, China, Brazil, Indonesia,
and Uganda are just a few of the many developing countries that have undertaken
major decentralization policies in the last
few decades.
There are certainly decentralization success stories. For example, decentralization
in Bolivia has done well to gear public sector investment towards the needs of municipalities (Faguet, 2004). And, looking
across several countries, there is some evidence that decentralization may lead to less
corruption (Fisman and Gatti, 2002).
Decentralization policies, however, also
have their fair share of problems. In China,
fiscal decentralization may have hampered
provincial economic growth (Zhang and
Zou, 2001). There is also some evidence
that decentralization of land use authority in northern Kenya has interfered with
some traditional pastoralists’ migration
routes, causing them to be more susceptible
to drought (Munyao and Barrett, 2007).
The disappointment with decentralization strategies in some developing countries
has therefore led to continued efforts to figure out ways to reach the poorest people in
some of the poorest countries in the world.
One area that has recently been garnering
much interest is membership-based organizations of the poor (MBOPs)—an extreme
type of decentralization in a sense, where
power and decision-making are put in the
hands of poor individuals themselves.
MBOPs are tricky to precisely define, but
generally include any group where a ‘membership requirement’ exists; the vast majority of members are poor individuals, those
poor members are largely in control of the
group’s organization and governance, and
the group is formed around some activ1
ity to improve the livelihood of the poor .
MBOPs have existed in developing countries for years and can be in the form of
cooperatives, self-help groups (SHGs), or
savings and loans groups, for example. The
Uganda Shoe-Shiners Industrial Cooperative Society was started by five shoe-shiners
in Kampala in 1975 and has now expanded
to roughly 400 members (Birchall, 2003).
They provide access to polish and brushes,
as well as training programs and savings and
credit services. SHGs are very common in
Kenya, particularly in the form of women’s
2
groups , where they can take on functions
ranging from agricultural projects, to childcare, to insurance (Udvardy, 1998; Gugerty
and Kremer, 2004).
MBOPs range in size from very small, to
hundreds, or even thousands of members.
One very large-scale, successful example of
an MBOP is the Self-Employed Women’s
Association (SEWA) in India. SEWA is a
trade union comprised of women in the
3
informal sector , which are a significant
subgroup of India’s population: more than
90 percent of India’s female labor force is
in the informal sector (International La4
bour Office, 2002) . SEWA began as a way
for informal women workers to organize
themselves and to increase their empow-
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erment in society. Members of SEWA fall
into four broad informal employment categories: 1) manual laborers and service providers, 2) home-based workers, 3) hawkers,
vendors, and small-business women, and
4) producers. Within SEWA, the women
are organized into cooperatives based on
their trade and are able to access markets
for their goods and services that are otherwise beyond reach. From their origins
in 1972 with 1,070 members in Gujarat
state, SEWA’s 2008 membership stood at
close to one million informal women work5
ers, across nine states in India . SEWA is
almost entirely governed by its poor, informal working members, who pay an annual
membership fee of five rupees (about 11
cents at the time of this article).
As its mission is to empower women as
well as to improve their employment situation, SEWA offers many complementary
services to its members, such as banking,
health care, child care, insurance, legal services, housing, and even a “SEWA Academy”
that provides basic education for members
as well as leadership and technical training. In addition to organizing the women,
SEWA works to influence government policies regarding informal female workers.
SEWA has been crucial in increasing the
visibility of informal workers in India and
the world: it was a key actor in the recognition of informal workers in India’s census,
aided in bringing home-based workers and
self-employed persons to the attention of
India’s Planning Commission and subsequent goals (Datta, 2000), and participated
in a September 2009 meeting of the International Labor Organization on strategies
to provide all workers with social security
coverage. In fact, SEWA refers to itself as
not only a trade union, but a movement towards the empowerment of women and the
informal sector of the economy.
SEWA’s achievements have been so profound that they were awarded a “MacArthur Award for Creative and Effective Institutions” in 2009. Such success has made it
very tempting to try to replicate this MBOP
6
in other developing countries , and to expand this model to individuals other than
informal laborers.
However, development practitioners
must think long and carefully about what
makes SEWA—and other successful ‘selfstarted’ MBOPs—tick before trying to duplicate them elsewhere. Indeed, attempts
by outsiders to start new MBOPs or aid
existing MBOPs have led to some disap-
pointing results. The success of self-started
MBOPs is one reason for the World Bank’s
strong pursuance of “community-driven
development” projects (which generally involve creating MBOP-type groups geared at
certain aspects of development) in recent
years—to the tune of $2 billion in 2003
(Platteau, 2004). However, evaluations
of some of these projects indicate disappointing results, such as low achievement
of objectives, poor sustainability without
World Bank involvement and funding, and
individuals acting for their own personal
gain (Alsop, 2005; Alsop and Kurey, 2005).
There is also some evidence that provision of funding from a non-governmental
organization (NGO) to women’s self-help
groups in western Kenya had the unintended consequence of attracting younger, more
educated, wealthier women into the groups
and into positions of authority, and potentially alienating older, poorer women who
might need the group the most (Gugerty
and Kremer, 2004).
Nevertheless, something is definitely
working well with SEWA, and with many
other home-grown MBOPs. In fact, it’s
working so well that it’s worth trying to understand better so that governments and
NGOs can fully harness the potential of
MBOPs as a successful development stratH
egy.
Kiran Gajwani is a College Fellow in the Department of Economics at Harvard University and
a part-time researcher with the International Food Policy Research Institute. She received her
Ph.D. from Cornell University in 2008. Her area of specialization is in development economics,
with a focus on governance, public goods provision, and inequality.
Endnotes
1. A thorough discussion on defining MBOPs can be found in Chen et al. (2007).
2. Regarding the size of Kenya’s SHGs, Udvardy (1998) states that groups typically have 35-45 members (p.
1751).
3. While having a union for informal workers who have no formal employer may seem puzzling, SEWA argues
that the purpose of a union is not only about filing grievances with an employer, but also about bringing people
together in support of a common cause.
4. Even after excluding agricultural work, more than 80 percent of all women in non-agriculture employment in
India are in the informal sector (International Labour Office, 2002).
5. More than half of the members are from Gujarat state (approximately 519,000 in 2008).
6. The Self-Employed Women's Union (SEWU) in South Africa, established in 1993, is one example of a SEWAinspired group.
References
Alsop, Ruth. 2005. “Community-Level User Groups: Do They Perform as Expected?” In Martha Chen, Renana Jhabvala, Ravi Kanbur, and Carol Richards (eds.), Membership-Based Organizations of the Poor. Abingdon, UK:
Routledge.
Alsop, Ruth and Bryan Kurey. 2005. Local Organizations in Decentralized Development. Their Functions and Performance in India. Washington, DC: The World Bank.
Birchall, Johnston. 2003. “Rediscovering the Cooperative Advantage: Poverty Through
Self-Help.” Geneva: International Labour Office.
Chen, Martha, Renana Jhabvala, Ravi Kanbur, and Carol Richards. 2007. “Membership-Based Organizations of the
Poor. Concepts, Experience and Policy.” In Martha Chen, Renana Jhabvala, Ravi Kanbur, and Carol Richards (eds.),
Membership-Based Organizations of the Poor. Abingdon, UK: Routledge.
Datta, Rekha. 2000. “On Their Own: Development Strategies of the Self-Employed
Women's Association (SEWA) in India.” Development, 43(4): 51-55.
Faguet, Jean-Paul. 2004. “Does Decentralization Increase Responsiveness to Local Needs? Evidence from Bolivia.”
Journal of Public Economics, 88(3-4): 867-893.
Fisman, Raymond and Roberta Gatti. 2002. “Decentralization and Corruption: Evidence Across Countries.” Journal
of Public Economics, 83(3):325-345.
Gugerty, Mary Kay and Michael Kremer. 2004. “The Rockefeller Effect.” Poverty Action Lab Paper No. 13, April
2004.
International Labour Office. 2002. “Women and Men in the Informal Economy: A Statistical Picture.” Geneva: Employment Sector, International Labour Office.
Munyao, Kioko and Christopher B. Barrett. 2007. “Decentralization of Pastoral Resources Management and Its Effects
on Environmental Degradation and Poverty: Experience from Northern Kenya.” In C. B. Barrett, A. G. Mude, and
J. M. Omiti (eds.), Decentralization and the Social Economics of Development. Lessons from Kenya. Wallingford,
UK and Cambridge, MA: CAB International.
Platteau, Jean-Philippe. 2004. “Monitoring Elite Capture in Community-Driven Development.” Development and
Change, 35(2): 223-246.
Udvardy, M. L. 1998. “Theorizing Past and Present Women’s Organizations in Kenya.” World Development, 26(9):
1749-1761.
Zhang, Tao and Heng-fu Zhou. 2001. “The Growth Impact of Intersectoral and Intergovernmental Allocation of Public
Expenditure: With Applications to China and India.” China Economic Review, 12(1): 58-81.
Stephen G. Brooks
Has America Lost the Capacity to Lead?
U
ntil very recently, there was widespread agreement that we were
living in a “unipolar” world – that
is, one with a single superpower. Yet in
the past year or so, many American analysts have begun to question whether the
“unipolar moment” is about to end, if it
hasn’t ended already. In a recent article,
Christopher Layne aptly describes this
dramatic mood shift: “Until fall 2007,
most members of the American foreign
policy
establishment—policymakers,
scholars and pundits alike—still took it
for granted that U.S. primacy would last
far into the future...By late 2007, however, whispers of American decline...and
incipient multipolarity began to creep
into the foreign policy debate. As a result
of the financial and economic meltdown
that hit with full force in autumn 2008—
plunging the U.S. and global economies
into the worst downturn since the Great
Depression—these sotto voce doubts
have given way to open speculation that
the era of America’s post-Cold War hegemony is waning.”
This is not the first time that American analysts have been pessimistic about
the country’s global standing. The current American decline scare is actually
the fourth since 1945—the first three
occurred during the 1950s (Sputnik), the
1970s (Vietnam and stagflation), and
the 1980s (the Soviet threat and Japan
as a potential challenger). In all of these
cases, real changes were occurring that
suggested a redistribution of power. But
in each case, analysts’ responses to those
changes seem to have been overblown.
Multipolarity—an international system
marked by three or more roughly equally
matched major powers—did not return
in the 1960s, 1970s, or early 1990s, and
each decline scare ended with the United
States’ position of primacy retained or
strengthened.
Will things be different this time? No
one knows how rapidly the U.S. will recover from this crisis and what its economic prospects will be over the next
decade. America might spiral downward
for many years—like Japan in the 1990s.
Or it could muddle along with lackluster
growth—like Europe in the 1990s. Finally, America might rebound and achieve
impressive economic growth—like it did
in the 1990s. It is unclear which of these
three pathways America will follow, but
given America’s past 150 years of impressive economic performance and its penchant for remaking itself, it would seem
premature—and unwise—to assume that
America will flounder economically in the
years ahead.
What we do know for certain is that
America’s lead over its competitors is
12
fall 2009
very, very large. The latest figures from
the International Monetary Fund show
that the U.S. economy is three times as
large as the next largest economy (Japan)
and is almost as large as the second, third,
fourth and fifth largest economies combined. The picture presented by military
data is even starker, where the United
States continues to account for about half
of the world’s defense spending. Relative
power is the bread and butter of international politics, and it shifts slowly. The
significance of trends depends greatly
upon the starting point; because the U.S.
now has such a dramatic lead over other
states, it will not be replaced as the sole
superpower for a very long time.
Consider China, which is generally seen
as the country best positioned to emerge
as a superpower challenger to the United
States. Yet given where China is now relative to the United States—somewhere
between a slightly less than 30% the size
of the U.S. economy (if you measure GDP
using market exchange rates) and a little
more than half of the size of the economy
(if you measure GDP using purchasing
power parity)—it still has a very long way
to go before it can come close to equaling America in economic terms, let alone
military and technological capacity. Of
course, China in recent decades has been
growing at around 10% per year. But no
country in history has been able to sustain anywhere near this kind of growth
rate once it becomes wealthy (right now,
China’s GDP per capita is less than 10% of
the U.S. level now, regardless of how you
measure China’s GDP). China will not be
in position to be a peer competitor of the
U.S. if it does not become wealthy (and
thus lags in terms of technological capacity). But if China does eventually become
rich, it is hard to see how it will continue
to grow as quickly as it does now—even if
all goes well.
Of course, whether all goes well over
the next decades in China is hardly a given. Although the United States certainly
will confront many significant long-term
vulnerabilities, those American analysts
who portend a rapid U.S. decline often
seem to overlook that this is true of China as well. Consider demography. It has
become commonplace for U.S. analysts
to bemoan that U.S. fiscal prospects are
gloomy in the years ahead due to the expected high costs associated with an aging U.S. population. Yet population aging
will have an even greater negative effect
on China in the upcoming decades. As
Mark Haas argues in a recent comprehensive analysis, “Although the U.S. is growing older, it is doing so to a lesser extent
and less quickly than all of the other great
powers. Consequently, the economic and
fiscal costs for the United States created
by social aging (although staggering, especially for health care) will be significantly lower for it than for its potential
competitors.”
The bottom line is that the world is
and will long remain a “1 + X world” with
one superpower and X number of major
powers. Of course, being the sole superpower hardly makes the U.S. omnipotent
and it would be a mistake to overestimate what it can accomplish on the world
stage. The early part of the 2000s were
certainly marked by irrational exuberance among analysts and policymakers
about the degree to which the U.S. could
shape outcomes in the system. Yet today
many analysts seem to err in the opposite
direction: understating the U.S. capacity
to influence world politics as much as it
was exaggerated just a few years ago. The
financial crisis notwithstanding, America
remains in a strong position to act as the
leader of the system. It is hardly insignificant that President Obama concurs with
this position. As he stressed in a recent
news conference, “We remain the largest
economy in the world by a pretty significant margin. We remain the most powerful military on Earth. Our production of
culture, our politics, our media still have...
enormous influence. And so I do not buy
into the notion that America can't lead
in the world.” Obama then noted further
that although America should not dictate
to the world, it “can continue to show
H
leadership for a very long time.”
Stephen G. Brooks is an Associate Professor of Government specializing in international relations and globalization at Dartmouth College.
Channing Spencer
The Culprits behind India’s Income
Inequality: Neoliberal Economics and
Globalization?
A
s the second-most populous country
in the world, with a population of
over 1.3 billion, India is a vast country with an economic structure that has
undergone various transformations. In the
1980s, the Indian economy mirrored that
of a socialist economy crippled by strict
protectionism and extensive governmental
regulation. It was characterized by a slow
growth rate and agricultural dominance.
Today, many would say that India is the picture-perfect image of a developing country.
It now has a market economy with a GDP
of $1.2 trillion and a labor force that is sec1
ond only to China's . What lies beneath the
surface of the Indian economy, however, is
an image that contrasts starkly with common perception. Closer observation paints
a picture of a country with large income
inequality and more poverty. Because of
the complexity of the Indian economy, this
article will approach the title question—
“What are the ‘culprits’ behind India’s income inequalities?”—by undertaking a
multifaceted approach that examines: (i)
India’s past economic policies, (ii) present
economic policies, (iii) current indicators of
growth, inequality, and poverty.
1980’s: Regulation and Protectionism
As a result of socialist-based policies in
the 1980s, economic growth in India was
largely dependent on government expendi-
tures for fiscal stimulus. Government spending accounted for 26.3 percent of GDP in the
period from 1980-1981 and a staggering
2
32.3 percent in the period from 1986-1987 .
These government expenditures, which were
not coupled with increases in taxes, were financed through foreign loans (investment
-WC)—leading to high demand and, ultimately, inflation. To control inflation, the
government liberalized trade to allow for
imports. However, rather than allowing the
exchange rate of the rupee to be determined
by the market, the government administered
the exchange rate to avoid price fluctuations
and maintain a degree of economic stability.
India’s imports have consistently exceeded
their exports (Figure 1).
These imports, which were largely technological products, allowed for the production
of many goods geared towards the upper
figure 1
!
14
fall 2009
class. Despite the apparent “betterment” of
the upper class in the 1980s, the poor also
reaped the benefits of increased government
expenditures in the form of projects intended
to reduce poverty. A substantial amount of
government expenditures were in the form
of subsidies and transfer payments to rural
households in India and largely benefited
the poor. The increase in transfer payments
led to an increase in employment and overall
growth of the Indian economy. It therefore
stands that the socialist policies of the 1980s
contributed to some degree of growth, although slow, as well as economic benefits to
3
all segments of the population .
1990s: A period of Reform
The 1990s saw unprecedented changes in
the Indian economy in the form of economic reforms. Beginning in 1991, neoliberal
economic theory, which asserts that giving
greater freedom towards the private sector
leads to more efficient economic outcomes,
was heavily implemented. These reforms included:
• Allowing market forces to influence
investment decisions
• Permitting international competition
and the resulting prices to prevail
• Reducing the role of the government
in production and trade
• Reducing regulations on teh banking
system to permit foreign entrance
into the financial market
The reforms of the 1990s have also resulted in an Indian economy that relies much
less on government spending. Government
expenditures as a percentage of GDP have
fallen substantially to around 15-17 percent
over the period from 1995 to the present
(Figure 2).
While the economic growth of the 1980s
was due to the fiscal stimulus, that of the
1990s was a result of an expansion of goods
and services. The increase in the variety of
services led to an increase in consumption
by the top quintile of the population and,
ultimately, to a consumer-driven economic
4
boom . It should also be noted that unlike
the economic growth of the 1980s in which
both the highest and lowest quintiles of the
population benefited, the growth of the
1990s benefited only those who were “wellto-do.”
Globalization
Let us now turn our focus towards the
second “culprit” responsible for India’s economic disparities: globalization. Proponents
figure 2
!argue that globalization has many benefits
that range from economic prosperity to a
wider variety of goods within the market.
For some, however, the term "globalization"
conjures images of sweatshops, exploited
5
workers, and overworked child laborers .
Examination of India’s embracement of globalization has painted a picture much like
the latter. Globalization has had unfortunate
ramifications for India’s poor. Analyzing the
impact of India’s shift towards globalization
on the poor proves that the saying “the rich
get richer while the poor get poorer” is truly
timeless. Globalization has largely benefited
certain businesses and contributed to the
growth of the middle class. As a result, the
purchasing power of the country has increased, which has lead to an overall increase
in prices—a fact that does not bode well for
India’s impoverished. Price increases have
made it difficult for the poor to afford basic
necessities, such as education. Because the
poor are not even able to invest in education
for their children, an unfortunate cycle in
which the poor remain at the bottom of the
economic pillar persists.
!
Conclusion
So, where does the responsibility for India’s income inequalities and lack of progress in the reduction of poverty lie? Indeed,
culprit number one is neoliberal economics.
The implementation of this economic theory
in the early 1990s decentralized India’s economy and led to a spike in consumption. Although this sounds like the perfect economic
remedy, it most certainly was not because the
spike in consumption resulted in consumerdriven price increases. These price increases
had consequences that exacerbated inequalities inasmuch as they widened the income
gap. Culprit number two, globalization, has
also had rather unfortunate consequences for
the Indian economy. With the acceptance of
globalization, India’s labor force has become
increasingly divided as some areas benefit
while others are exploited and their income
gaps widen. Perhaps the most pressing question is whether or not there is an imminent
solution to these problems. Unfortunately,
this is a question that only time and the Indian government can answer. H
Channing Spencer is a freshman Government concentrator at Harvard College.
Endnotes
1. United States CIA
2. Panagariya, Arvind: India: The Emerging Giant, USA: Oxford University Press,03-31-2008, p.353.
3. Chandrasekhar, C.P and Ghosh, Jayati, “Macroeconomic Policy, Inequality and Poverty Reduction in India and
China,” The IDEAs Working Paper Series (05/2006):1-17
4. Ghosh, Jayati, Income Inequality in India, People’s Democracy, 02-17-2004, http://www.countercurrents.org/
eco-ghosh170204.htm
5. Globalization Income Inequalities and Regional Disparities in India <http://business.mapsofindia.com/globalization/income-inequalities-regional-disparities-india.html>
HARVARD COLLEGE ECONOMICS REVIEW
Omar Garcia
Latin America Fights Back
In the midst of an American recession, nations in Latin America are
making a strong rebound to prosperity
I
t is said that when America catches a cold,
Latin America catches pneumonia, but
this time around it’s different: Brazil, Argentina, Chile, and Bolivia are rebounding
from the global economic recession while
America struggles. Annual Gross Domestic
Product has shrunk by 2.5 percent, caused by
a decrease in exports (1.5 percent) due to the
fallen price of commodities including copper,
oil, soy beans, and agricultural products. According to the IMF, Brazil’s GDP is expected
to grow by 3.5 percent, Argentina 's by 1.5
percent, Chile's by 4 percent, and Bolivia's by
3.4 percent. These South American countries
have been able to ride smoothly through this
economic recession partly by decreasing their
dependence on U.S. trade.
Brazil is the first G20 country to come
out of the global recession. Over the last few
years President Luiz Ignacio Lula da Silva has
expanded its diversity of exports to include
transportation equipment, iron ore, and soybeans, accounting for total revenue of $197.9
billion. As a result, Brazil has decreased its
dependence on foreign markets. Its decisions
to resist buying and selling mortgages in the
secondary market have strengthened its
political credibility—which allowed it to attract greater Foreign Direct Investment (FDI)
and sustain strong domestic demand. As a
result, Brazil has amassed $200 billion in international currency reserves, allowing it to
continue current economic polices of investing in railroads, housing, and transportation
as it envisions supporting an industrialized
nation and providing new jobs, while many
nations face record unemployment rates.
Mexico has not fared as well as Brazil
has. Its strong ties to the United States have
caused it to experience more economic hardship than other Latin American countries.
Maquinas, Mexican factories that import
raw materials to be converted into exports to
the United States, have been hit hard by the
reduction in America's demand.
The Mexican economy has endured further damage due to the 2009 flu epidemic.
The Mexican government has reported that
tourism—its largest source of revenue—
has decreased drastically. To add to its mis-
fortunes, escalating violence in Mexico has
caused fear among foreign investors, making
them even more reluctant to channel their
funds into the troubled country.
Although it appears that 2009 has not
brought any good news to Mexico, the IMF
has approved the first flexible credit line
of over $48 billion to be given to Mexico.
The flexible credit line is a fund that will be
used to prop the current economic situation
against the global recession. As many economists begin to speculate when the recession
will end, many Latin American countries are
starting to change their economic policies as
they see fit and reject the principles of the
Washington Consensus, a set of major economic policy prescriptions penned by representatives of major multi-national organizations like the IMF and World Bank.
As of 2009, Latin America has outperformed the market in comparison with Eu1
rope . This can be attributed to the nations'
conservative economic policies. As a result,
he IMF expects a moderate economic growth
in Latin America in the areas of agriculture,
2
oil, and mineral production in 2010 . H
Omar Garcia is a freshman at Harvard College.
Endnotes
1." M&A Outperformed Market in 2009." The Wall Street Journal. January 18, 2009.
http://online.wsj.com/article/SB10001424052748704541004575010690772470332.html?mod=WSJ_Bonds_
RIGHTMoreInMarkets
2. "Chile expect 2010 GDP 4.4 % growth." The Latin America Post. January 10, 2010.http://www.latinamericanpost.
com/index.php?mod=seccion&secc=2&conn=5903
References
"Brazil out of Recession - New Records in Brazilian domestic Tourism ." Brazil out of Recession - New Records in Brazilian
domestic Tourism : 2. Web. 31 Oct 2009. <(http://www.propertybrazil.com/news/brazil-out-of-recession---newrecords-in-brazilian-domestic-tourism-12)>.
"Brazil ." October 28 209: n. pag. Web. 31 Oct 2009. <https://www.cia.gov/library/publications/the-world-factbook/
geos/br.html>.
"Brazil Pushes for bigger G20 role." March 26 2009: n. pag. Web. 31 Oct 2009. <http://news.bbc.co.uk/2/hi/7963704.
stm>.
Gould, Erik, and Hugh Collins. "Mexico Violence Sap 3 % as Gangs Flourish." Bloomberg n. pag. Web. 31 Oct 2009.
<http://www.bloomberg.com/apps/news?pid=20601087&sid=ad1bsEmsnLqw>.
"IMF Approves 47 billion Credit line for Mexico." IMF. April 17, 2009. IMF, Web. 31 Oct 2009. <http://www.imf.org/
external/pubs/ft/survey/so/2009/car041709a.htm>
15
Hyun Song Shin
Prices and Crises
The double-edged sword called price
F
inancial crises are often accompanied
by large price changes, but these large
price changes by themselves do not
constitute a crisis. Public announcements of
important macroeconomic statistics, such as
the monthly employment report, are often
marked by large discrete price changes at
the time of announcement. But the market
typically finds composure quite rapidly after
such discrete price changes, which are arguably the signs of a smoothly functioning
market that is able to incorporate new information quickly.
Stung by criticism that they failed to warn
of the financial crisis, many economists have
clung to the mantra that in a well-functioning financial system, price changes cannot be
predicted beforehand. They see the financial
crisis in the same terms as the one-off shock
that results from the announcement of new
employment numbers. The market adjusts
to the news, prices quickly incorporate the
new information, and life goes on as before.
With this sleight of hand, the economists
have turned the failure to predict the crisis
into a virtue. You may not have known it,
but the apparent failure is actually a success,
and the failure to see the crisis coming is the
sign of a well-functioning price system.
If you feel short-changed by this sleight
of hand, you are in good company. Indeed
many economists share the sense of unease
at the glib brush-off. One source of the unease is that the analogy with the one-off jump
in prices associated with macroeconomic announcements does not capture the key features of a financial crisis. The distinguishing
feature of crisis episodes is that they seem
to gather momentum from the responses of
the market participants who themselves run
for cover. Rather like a tropical storm over a
warm sea, a financial crisis appears to gather
more energy as it develops. Financial crises
could almost be defined as episodes where
the allocational role of prices breaks down.
Crises highlight the dual role of prices.
Not only are prices the reflection of underlying economic fundamentals, they are
also an imperative to action—they make
people “do stuff.” Some actions induced by
price changes are desirable, not only from
the point of view of the individual, but also
from the system’s perspective. Bottom fishing where buyers enter the market to buy
under-priced securities will be a stabilizing
influence. However, some actions borne out
of self-defeating constraints or actions that
exert harmful spillover effects on others are
undesirable when viewed from the perspective of the group. When markets turn hostile and prices move against you, prudence
dictates shedding exposure and selling the
loss-making position instead. The question
is which group holds sway. When markets
turn hostile, is it the bottom fishers who
hold sway or are those the ones who run for
cover?
One of the consequences of financial development is that those who run for cover
are becoming increasingly important in dictating the course of market events. When
balance sheets are marked to markets and
loans are packaged into securities and traded in the market by highly leveraged players,
the self-reinforcing nature of shocks injects
an additional, endogenous element of market fluctuations. The prudent shedding of
exposures by the creditors to Bear Stearns is
a bank run, when viewed from Bear Stearns’
point of view. As financial conditions worsen, the willingness of market participants
to bear risk seemingly evaporates. Such
episodes have been dubbed “liquidity black
holes.” The terminology is perhaps overly
dramatic, but it conveys the sense of freefall. As prices fall or measured risks rise or
previous correlations break down (or some
combination of the three), previously overstretched market participants respond by
cutting back, giving a further push to the
downward spiral.
It is when the action-inducing nature of
price changes holds sway that the doubleedged nature of prices comes into its own.
It is as if the reliance on market prices distorts those same market prices. The more
HARVARD COLLEGE ECONOMICS REVIEW
weight is given to prices in making decisions,
the greater are the spillover effects that ultimately undermine the integrity of those
prices. When prices are so distorted, their allocational role is severely impaired. Financial
crises could almost be defined as episodes
where the allocational role of prices breaks
down. The global financial crisis of 2007-8
has served as a live laboratory for many such
distress episodes, but the mechanism is universal and impacts every financial crisis.
Imagine an emerging market country
defending a currency peg in adverse circumstances in the face of deteriorating macroeconomic conditions and hostile capital
markets. Defending the peg is often dictated
by political goals more than economic ones,
such as eventual accession to the European
Union, the adoption of the euro, or keeping
the peg in tact in order to shield domestic
borrowers who have borrowed in dollars, euros, Swiss francs, etc.
However, defending the currency also
entails raising interest rates and keeping them high. The costs of defending the
currency bear many depressingly familiar
symptoms—collapsing asset values and a
weakened domestic banking system that
chokes off credit to the rest of the economy.
Regardless of the perceived political benefits
of maintaining a currency peg and regardless
of their official pronouncements, all governments and their monetary authorities have a
pain threshold at which the costs of defending the peg outweighs the benefits of doing
so. Speculators understand well that their
job is almost done when the finance minister
of the stricken country appears on evening
television vowing never to devalue the currency.
Facing the monetary authority is an array
of diverse private sector actors, both domestic and foreign, whose interests are affected
by the actions of the other members of this
group, and by the actions of the monetary
authority and the government. The main
actors are domestic companies and households, domestic banks and their depositors,
foreign creditor banks, and outright speculators—whether in the form of hedge funds
or the proprietary trading desks of the international banks.
Two features stand out. First, each of
these diverse actors faces a choice between
actions that exacerbate the pain of maintaining the peg and actions that are more
benign. Second, the more prevalent the actions which increase the pain of holding the
peg, the greater the incentive for an individual actor to adopt the action that increases
the pain. In this sense, the actions that tend
to undermine the currency peg are mutually
reinforcing.
Imagine that we are in Thailand in the
early summer of 1997 just prior to the onset of the Asian financial crisis. Domestic
financial institutions or companies that had
borrowed dollars to finance their operations
can either attempt to reduce their dollar
exposures or hang tough. The action to reduce their exposur—of selling baht assets
to buy dollars in order to repay their dollar
loans, for example, is identical in its mechanics (if not in its intention) to the action of a
hedge fund, which takes a net short position
in baht in the forward market. For domestic banks and finance companies that have
facilitated such dollar loans to local firms,
they can either attempt to hedge the dollar
exposure on their balance sheets by selling Baht in the capital markets, or sit tight
and tough it out. Again, the former action is
identical in its consequence to a hedge fund
short-selling baht. As a greater proportion of
these actors adopt the action of selling the
domestic currency, the greater is the domestic economic distress, and hence the greater
is the likelihood of abandonment of the peg.
Everyone understands this, especially the
more sophisticated market players that have
access to hedging tools. As the pain of holding on to the peg reaches the critical threshold, the argument for selling baht becomes
overwhelming.
The action-inducing nature of price
changes turns up in this scenario through
balance sheet stress. The precipitous decline
in the exchange rate means that the baht
value of foreign currency debts balloons past
the value of baht assets that were financed
with these loans. At the same time, the
higher domestic interest rates put in place to
defend the currency undermine the baht value of those assets. Assets decline and liabilities increase. Equity is squeezed from both
directions. As the Thai baht collapses, the
mutually reinforcing nature of price changes
and distressed actions gathers momentum.
As domestic firms with dollar liabilities experience difficulties in servicing their debt,
the banks that issued these loans attempt
to cover their foreign currency losses and
improve their balance sheet by contracting
credit. For foreign creditor banks with shortterm exposure, this is normally a cue to cut
off credit lines, or to refuse to roll over short
term debt. Even for firms with no foreign
17
18
fall 2009
currency exposure, the general contraction
of credit increases corporate distress. Such
deterioration in the domestic economic environment exacerbates the pain of maintaining the peg, thereby serving to reinforce the
actions which tend to undermine it. To make
matters worse still, the belated hedging activity by banks is usually accompanied by a
run on their deposits, as depositors scramble
to withdraw their money.
To be sure, the actual motives behind
these actions are as diverse as the actors
themselves. A currency speculator rubbing
his hands and looking on in glee as his target country descends into economic chaos
has very different motives from a desperate
owner of a firm in that country trying frantically to salvage what he can, or a depositor
queuing to salvage her meager life savings.
However, whatever the motives underlying these actions, they are identical in their
consequences. They all lead to greater pains
of holding to the peg and hence hasten its
demise.
The action-inducing nature of market
prices is most dramatic during crisis episodes, but is arguably most damaging during economic booms when it operates away
from the glare of the television cameras. Financial crises don't happen out of the blue.
They invariably follow booms. As the central
banker Andrew Crockett puts it,
“The received wisdom is that risk increases in recessions and falls in booms. In
contrast, it may be more helpful to think
of risk as increasing during upswings, as
financial imbalances build up, and mate1
rialising in recessions."
During a boom, the action-inducing nature of market prices does its work through
the increased capacity of banks to lend.
When asset prices rise or measured risks fall,
less capital is needed to act as a loss buffer
for a given pool of loans or securities. At
the same time, higher bank profits also add
to the bank's capital. In boom times, banks
have surplus capital.
When balance sheets are marked to market, the surplus capital becomes even more
apparent. In the eyes of the bank's top management, a bank with surplus capital is like
a manufacturing plant with idle capacity.
Just as good managers of the manufacturing
plant will utilize surplus capacity to expand
their business, the bank's top management
will expand its business. If they fail to expand their business, they know that the
ranks of bank equity analysts will start to
castigate them for failing to achieve the 20
percent return on equity achieved by some
of their peers.
For a bank, expanding its business means
expanding its balance sheet by purchasing
more securities or increasing its lending. But
expanding assets means finding new borrowers. Someone has to be on the receiving
end of new loans. When all the good borrowers already have a mortgage, the bank has to
lower its lending standards in order to lend
to new borrowers. The new borrowers are
those who were previously shut out of the
credit market, but now suddenly find themselves showered with credit. The result is the
ballooning of subprime mortgage lending.
The pressure on the bank's managers to
expand lending reveals an important feature
of the capital constraint that banks face. As
with any meaningful economic constraint,
the capital constraint binds all the time—in
booms as well as in busts. Binding capital
constraints during bust phase is (by now)
well understood. However, less appreciated
is the binding nature of the capital constraint
during booms. In boom times, the constraint
operates through channels that appear more
benign, such as the pursuit of shareholder
value by raising return on equity.
The action-inducing effect of market
prices derives their potency from the apparently tangible nature of the wealth generated when asset prices appreciate. Consider
the following passage from a commentary
published in the Wall Street Journal in May
2005, at the height of the housing boom in
2
the United States .
“While many believe that irresponsible
borrowing is creating a bubble in housing, this is not necessarily true. At the end
of 2004, U.S. households owned $17.2
trillion in housing assets, an increase of
18.1 percent (or $2.6 trillion) from the
third quarter of 2003. Over the same five
quarters, mortgage debt (including home
equity lines) rose $1.1 trillion to $7.5 trillion. The result: a $1.5 trillion increase
in net housing equity over the past 15
months.”
The argument is that when the whole U.S.
housing stock is valued at the current mar-
ginal transactions price, the total value is
$17.2 trillion (although it was subsequently
to rise much more). Although household
debt had increased by over a trillion dollars
in the meanwhile, this still left them an increase in net worth of $1.5 trillion.
One can question how tangible this increase in housing wealth is in the face of a
possible downturn. But for banks and other
financial institutions that mark their balance sheets to the market continuously, the
increase in marked-to-market equity is very
tangible. The surplus capital generated by
asset price appreciation and greater profits
weighs on the bank's top management and
induces them to take on additional exposure. Risk spreads fall, and borrowers who
did not meet the necessary hurdle begin to
receive credit. The seeds of the subsequent
downturn are thus sown.
The action-inducing nature of asset price
booms is strongest for leveraged institutions
such as banks and securities firms since leverage magnifies the increase in marked-tomarket equity. Thus, the reasoning quoted
above in the Wall Street Journal commentary ripples through the financial system
through the actions of leveraged financial institutions. John Cassidy, in his recent book
3
How Markets Fail , does a magnificent job in
sketching the forces at work.
The action-inducing nature of market
prices during booms operates away from
the glare of the television cameras and away
from the chorus of politicians complaining about the effects of mark-to-market accounting rules. But the insidious effects of
marking to market are at their most potent
during the booms. Andrew Crockett's statement that risks increase in booms and materialise in busts is an important lesson that is
relearned after each financial crisis.
The challenge for economists and policy makers is to reduce the frequency with
which we relearn these lessons. The most
important lesson is that prices are doubleedged in crises and in the boom that precedes them. Crises and prices are inseparable, but not always in the ways one reads
in the textbooks. H
Hyun Song Shin is the Hughes-Rogers Professor of Economics at Princeton University.
Endnotes
1. Andrew Crockett (2000) "Marrying the micro- and macro-prudential dimensions of financial stability" <http://
www.bis.org/speeches/sp000921.htm>
2. “Mr. Greenspan's Cappuccino” Commentary by Brian S. Wesbury, Wall Street Journal, May 31, 2005. The title
makes reference to Alan Greenspan's comments on the "froth" in the U.S. housing market.
3. John Cassidy, How Markets Fail, November 2009.
Kwon-Yong Jin
The Forgotten Recession:
Lessons from 1937-38
I
n many respects the current recession
is without precedent in modern United
States history. For one, it is one of the
worst, if not the worst, recession in the
last half century, surpassing the grim conditions of the recession of 1980s in many
areas. Furthermore, never before have
America’s fiscal and monetary authorities
implemented such innovative measures
to revive the slumping economy. Reaching the limits of the traditional monetary
and fiscal policy, the Federal Reserve and
the Treasury have resorted to extraordinary measures—lending facilities, massive asset purchases to name a few—that
have tested the limits of their authority,
more than doubling the Federal Reserve’s
balance sheet to over two trillion dollars,
and leading the Administration to execute
one of the largest fiscal stimulus plans in
American history.
That is not to say, however, that history cannot teach us lessons regarding this
recession. Many have turned to the study
of the Great Depression for guidance on
how to rescue our economy from stagna-
tion. But a majority of these studies have
focused heavily on the years leading up to
and immediately following the Stock Market Crash of 1929. As important as these
studies are, most do not model the period
of recovery after the recession. Since the
United States economy is showing signs of
a potential, albeit not definite, recovery, it
is time to examine a model describing the
recovery period. In particular, the double-
figure 1
!
20
fall 2009
dip of 1937-38, dubbed the “Roosevelt Recession,” provides valuable lessons on the
dangers of fiscal and monetary authorities’
premature exit from the economy.
The Recovery and the Double-Dip
One common misconception about
the Great Depression is that the American economy languished throughout the
1930s and returned to vibrancy only after
1939. In actuality, however, the recovery
from the economic collapse in 1929 occurred far before World War II. Supported
by extraordinarily expansionary policies in
both the fiscal and monetary spheres, the
American economy grew at a fast pace after the trough in 1933. From 1929 to 1933,
real GDP tumbled by 27 percent, but from
1933 to 1937, it grew at an astonishing
annual rate of 9.4 percent, surpassing its
1
1929 level by 1936. Other indicators kept
pace with the GDP during the recovery of
1933-1937; the Dow Jones Industrial Average tripled and industrial production
2
doubled during this period . By 1937, it
seemed as if a full-fledged economic recovery was in place and the Great Depression
was ostensibly over.
With rapid recovery came discussions
of the fiscal and monetary authorities’ exit
strategies. The federal deficit had ballooned
from 1932 to 1937 owing to the Roosevelt
Administration’s large expenditures (see
Figure 2), and ending the Administration’s
expansionary fiscal policy seemed necessary to balance the budget. The Administration’s top priority, promoted by Treasury Secretary Henry Morgenthau, became
balancing the federal budget, even if that
meant reducing government expenditures.
In his speech to the Congress in April of
1937, Roosevelt expressed this view clearly, saying, “I am convinced that the success
of our whole program and the permanent
security of our people demand that we adjust all expenditures within the limits of
3
my Budget estimate” . As a result, in 1937,
the Administration sharply cut its expenditures, and this step, along with implementing the Social Security Tax in 1936, led to a
drastic reduction in the government’s contribution to total expenditures.
The triumph of economic hawks was
not limited to the fiscal sphere. The Federal Reserve, concerned about the rising
level of excess reserves, also implemented
a highly contractionary policy as well. Excess reserves rose from $35 million in early
1932 to $3 billion in late 1935, thanks to a
figure 24
!
5
rapid inflow of gold from abroad . To curtail this exponential rise in excess reserves,
the Federal Reserve, over the course of ten
months from August 1936 to May 1937,
raised reserve requirements by 100 percent, reducing the supply of credit in the
market.
The end result of contractionary policies
in both the fiscal and monetary spheres was
a sharp downturn in the economy in 1937.
From 1937 to 1938, the economy retreated
back to its 1934 level, undoing three years
of recovery. Many indicators saw a sharper
drop during this period than they did during the four years immediately following
the collapse in 1929. The Dow Jones Industrial Average fell by 30 percent, real GDP by
3.5 percent, and industrial production by
21 percent–all in just a year–leaving a pain6
ful mark on the American economy .
Responsibility for the Double-Dip: Fiscal
Policy and the Business Cycle
There is no doubt that the contractionary policies by the Federal Reserve and the
Roosevelt Administration contributed to
the sharp downturn in 1937. The question,
then, however, is not whether the government’s contractionary policy contributed
to the recession, but the question is by how
much. On the fiscal side, debate rages over
the effect of sharp reduction in government
expenditure in 1937 on personal income
and total expenditure. There is no doubt,
despite this fierce debate, that fiscal policy
is not entirely to blame for the recession
in 1937. Six months elapsed between the
reduction in government spending in early
1937 and the drop in personal income in
mid-1937. According to Roose (1954), this
is proof that the decrease in government
expenditures affected the economy “only
7
indirectly” .
Therefore, there must be another accomplice to the recession of 1937: the business
cycle. In order to capitalize on the recovery
from 1933 to 1937, businesses invested
heavily in inventory, becoming more and
more unprofitable in the process. As wages and prices of commodities galloped far
ahead of the price of finished goods, corporate profits fell to dangerously low levels,
prompting a downturn in early 1937. Furthermore, the majority of the investment
spending in the years preceding 1937 had
been on short-term projects, compounding the cyclical nature of the downturn.
Investment stagnated in long-term projects such as construction, which are key to
sustainable growth; even in 1937, total private construction expenditure remained at
8
one-third of its 1929 level . Thus, it is this
unfortunate overlap between the reduction
in government expenditure and the downturn in the business cycle that compounded the effects of both and precipitated the
catastrophic double-dip.
Monetary Policy as a Cause of the 1937
Recession
The debate over how much contractionary policy is to blame for the recession
of 1937 is no less fierce in the monetary
sphere. Those who downplay the effects of
HARVARD COLLEGE ECONOMICS REVIEW
contractionary monetary policy argue that
even after the Federal Reserve raised reserve requirement, credit was still plenty.
Hardy (1939) wrote, “even immediately
after [the Federal Reserve’s increase in reserve requirement] the margin of excess
reserves was far greater than it ever was
9
before 1932” . While it is true that excess
reserves of financial institutions remained
ample, the effect of the Federal Reserve’s
actions was not uniform across regions.
Banks in major cities, such as New York
and Chicago, faced the need to raise more
capital in order to meet the increased reserve requirement and resorted to reducing loans for investment and selling their
government securities. Even the banks
that did not need to raise more capital
wanted to hold on to a significant quantity of excess reserves for cushion and thus
10
reduced lending . The sudden increase in
the supply of Treasuries in the market had
the effect of depressing the price of government securities, in turn lowering the price
of corporate bonds. Corporations found it
harder to raise capital through the issuance
of bonds, and coupled with a reduction in
loans for investment, this newfound difficulty in raising capital led to a decrease in
overall expenditure and output.
Conclusion: Lessons from 1937
In order to examine the lessons we can
learn from the Roosevelt Recession of
1937, we must first understand the mis-
takes made by fiscal and monetary authorities. Perhaps the greatest mistake that
the United States government made was
contracting the economy based on a false
illusion of recovery. The economic growth
from 1933 to 1937 was mainly driven by
massive government spending and shortterm investments on inventory and could
not be sustained. Although industrial production and overall output rose, long-term
investment remained low and unemployment hovered at 14 percent. The recovery
was not based on improvements in the
fundamentals of the economy—a bullish
outlook from entrepreneurs or low unemployment—but on short-term business
cycle movements. Thus, it is no surprise
that when the government pulled out in
early 1937, expecting investors in the private sector to take the baton, the latter—
feeble and already in a downturn—could
not do so.
On the monetary side, the critical mistakes lie in the Federal Reserve’s underestimation of the financial market’s fear of
illiquidity. With the memory of the 1929
Stock Market Crash still fresh in their
minds, banks were unwilling to lend out
their excess reserves, and money velocity
remained low. The Federal Reserve overestimated the bullish nature of the market
and prematurely contracted the money
supply, driving the economy back into a
recession.
Of course, comparing the 1937 Recession to the current one, we must keep in
mind that our economic situation has
changed drastically over the past seventy
years. New financial instruments have
emerged and the American economy has
become much more dependent on its foreign counterparts, altering the economic
landscape of the nation. Yet the current situation is strikingly similar to that of 1937.
The current economy is showing some
signs of a recovery, but unemployment
remains high and the business outlook is
bearish. In the monetary sphere, excess reserves have reached a historic high of $800
billion, but money velocity and the multi11
plier remain depressed. As promising as
the current situation may look, the fiscal
and monetary authorities must keep in
mind that we still have a long way to go before achieving a full recovery. Until private
investment and consumption are ready to
take the baton from the government sector, premature exit would only prolongHand
Kwon-Yong Jin is a freshman Economics concentrator at Harvard College
Endnotes
1. Bureau of Economic Analysis
2. Dow Jones & Company (DJIA); The Board of Governors of the Federal Reserve System, “Industrial Production,”
Federal Reserve Bulletin (1941): 934.
3. “Message to Congress on Appropriations for Work Relief for 1938”, American Presidency Project, University of
California at Santa Barbara.
4. United States Office of Management and Budget, Historical Tables, Budget of the United States Government,
Fiscal Year 2009 (Washington, D.C.: U.S. Government Printing Office, 2009), 24.
5. Federal Reserve Bulletin (1932): 274; Federal Reserve Bulletin (1936): 130.
6. Bureau of Economic Analysis; Dow Jones & Company; Federal Reserve Bulletin (1941): 934.
7. Kenneth D. Roose, The Economics of Recession and Revival: An Interpretation of 1937-38 (New Haven: Yale
University press, 1954), 71.
8. Ibid, 47.
9. Charles O. Hardy, “An Appraisal of the Factors (“Natural” and “Artificial”) Which Stopped Short the Recovery
Development in the United States,” American Economic Review 29, No. 1 (1939): 171.
10. Christina Romer, “The Lessons of 1937,” Economist, 18 June 2009.
11. Federal Reserve Bank of St. Louis, “M1 Multiplier,” U.S. Financial Data.
21
22
fall 2009
Book review
End the Fed
“T
o the young people who powered my
presidential campaign and who are the
heart of the anti-Fed movement. In your
hands is the hope of a free and prosperous society."
Thus reads the dedication of Representative Ron Paul’s End the Fed, a book aiming to
achieve exactly what its title suggests: doing
away with powerful central banks and bringing back the gold standard.
In his latest offering, Ron Paul angles for
the bestseller shelves with his fierce critique
of the U.S. Federal Reserve. Consistent with
Dr. Paul's firm adherence to a policy of putting
every aspect of the government through the
"Constitution filter", a policy that earned him
the sobriquet of "Dr. No." in Congressional
circles, his newest book pulls no punches. Following a trajectory that his supporters must
be familiar with, the book touches upon basic
economic analysis, constitutional precedent,
Dr. Paul's personal experiences, and--most enlightening--his interactions with the barons of
the Federal Reserve.
The book owes its title to the chant adopted by students protesting at the University
of Michigan in 2007. The book deals broadly
with three subjects: the first five chapters
serve to introduce the system of central banking and the gold standard, interspersed with
the author's anecdotes. Paul lays out his intellectual cards right at the beginning, giving the
reader the opportunity to see the argument in
the context of the author's ideologies and influences. There is a distinct emphasis on Paul's
desire for tangibility when it comes to economics. Simplifying banking theory down to
his experiences as a child hoarding coin, Paul
deals extensively with gold and silver: the imagery of solid money as opposed to a fiat currency. There is little confusion as to which he
prefers. Bringing in the Founders, Paul quotes
verbatim their objections to "paper money"
as the foundation for his argument against
debased currency. He thus begins to outline
his quest for a return to the gold standard and
his skepticism for the goals of the Federal Reserve.
Having laid a broad base from which to
mount his attack, Paul moves on to a systemic
analysis of the Federal Reserve in his next five
chapters, detailing his conversations with Volcker, Greenspan and Bernanke, three prominent Fed chairmen. He lays out the processes
involved in fractional reserve banking, the
very premise of which Paul seems to find unethical. His exchanges with Bernanke are interesting, Paul's characteristic probing and the
Fed Chairman's mollifying rhetoric leading to
somewhat nervous interactions.
The final part of the book deals with Paul's
recommendations for banking reform. Relying heavily on the Austrian school of thought,
which he champions throughout the book.
Paul extols the gold standard and urges a return to it. He mounts a blistering assault on
the opacity of the Fed and Congress' intellectual and moral disinterest in regulating it.
Thereby rounding off his critique, Paul asserts
that his call is not for hyper-regulating the
Fed, but doing away with it to enable an absolute free market, where currency too is subject
to the price equations a "truly capitalist" market imposes.
The doctor is earnest and sincere, and
most of his arguments carry strong academic
weight. The touches of personal and national
history imbue the book with personality, but
some arguments rely too heavily upon such anecdotes. Paul seems too quick and eager, with
minor disclaimers, to idealize the economic
acumen of the founding fathers, and fails to
convincingly dissociate pre-Fed economic crises from the boom-and-bust cycle he claims is
a purely central banking phenomenon.
There are, without a doubt, strong basic
inquiries to be made of the Federal Banking
System of the United States, and the book
serves to outline and explore them with admirable focus. Paul's passion for the subject is
infectious and his research diligent. The book
should prove highly useful to everyone invested in the nation's economy.
—Reviewed by Siddhant Singh, a sophomore
Economics concentrator at Harvard College
HARVARD COLLEGE ECONOMICS REVIEW
Book review
This Time is Different:
Eight Centuries of Financial Folly
T
he economy was cruising: the
Dow reached an all-time high
of over 14,000, unemployment
was below 5 percent, and credit was
easily accessible and plentiful. We
had reached a new era of prosperity,
but suddenly, everything changed.
The Dow dropped below 7,000 and
the unemployment rate rose above
9 percent. President Obama warned
us that this could become the worst
recession in our nation’s history.
While most people thought this recession was unprecedented, the authors of This Time is Different: Eight
Centuries of Financial Folly differ.
In This Time is Different, Carmen
Reinhart (University of Maryland)
and Kenneth Rogoff (Harvard University) conclude not only that many
countries have experienced similar
crises before, but also that well-informed economists could have predicted and controlled the current
situation well before it turned into
a crisis.
The two professors state, “Our basic message is simple: We have been
here before. No matter how different
the latest financial frenzy or crisis
always appears, there are usually
remarkable similarities with past experiences from other countries and
from history.”
Their claim is backed by a detailed
analysis of eight centuries of financial data from across the globe, inflation rates, banking crises, and international capital flow. In fact, the
majority of the book is a case-by-case
analysis of this data and its impact
on history. This approach provides a
compelling argument that nothing
new can ever occur in the economic
world and makes it painfully obvious that the current crisis could have
been prevented.
As enticing as it may be to cover
eight centuries of economics turmoil, the two academics produced a
work that may be difficult to understand for the general public. However, to those with experience with
economics, the legalistic and economic terms will not prove to be detrimental. The book carefully displays
its mountain of data. The last two
parts (chapters 13-17) neatly tie the
past cases to today’s crisis in a concise and approachable way. In these
self-contained chapters, Reinhart
and Rogoff use past recessions to
predict how things are likely to pan
out in the next few years for both the
American and global economies.
Overall, This Time is Different provides a systematic and organized
explanation of why recessions occur,
the events following recessions, and
measures that can be taken to prevent them. While the book may be a
bit difficult to understand for some,
it provides a good deal of depth and
information for both policy makers
and economic enthusiasts.
—Reviewed by Han He, a freshman
aman Applied Mathematics concentrator at Harvard College
23
Regan Bozman
Hip-Hop and the Recession
Superpower, hegemony and the recession
I
f you were to open the newest issue of
The Source or XXL, two of the biggest
publications in the hip-hop industry,
you probably would see very few references to the economic crisis. Aside from
a few mentions of rappers wearing less
and smaller jewelry, the financial crisis has
been largely absent from discussions of the
hip-hop industry. Even when the downsizing of jewelry is mentioned in hip-hop
publications, it is almost always overshadowed by news like Florida rapper T-Pain’s
new 10 lb, 197 karat necklace, which cost
an estimated $410,000 (Hip Hop RX).
In actuality, however, hip-hop has been
hit hard by the recession. Sales of hip-hop
records declined nearly 20 percent between 2007 and 2008, more than most
other genres (CNN) Between July 2008
and July 2009, the top 20 earners in the
industry made $300 million, down 40 percent from the previous 12-month period.
It’s a difficult time, even at the top. For instance, Jay-Z, the top earner in the industry, recently felt the financial crisis’ sting
when his $66 million hotel venture stalled
due to a lack of funding (U.S. News).
The hip-hop industry isn’t generally
known for thriftiness. In fact, many hiphop artists have lost fortunes because
they simply couldn’t manage their money.
Case in point is Scott Storch, a hugely successful hip-hop producer who reportedly
spent $30 million in six months (Hip Hop
Chronicle). Purchases included a 90 foot
boat and a car collection worth over $5
million. In early 2008, Rolling Stone estimated his worth at $70 million (Rolling
Stone); today, Storch is in bankruptcy (Hip
Hop Chronicle).
But this time is different. It’s not just
a few artists who are going bankrupt. The
entire industry is downsizing. One accurate bellwether for the industry has been
the size and quality of rapper’s jewelry.
Indeed, since the beginnings of rap music,
artists have worn jewelry to “signify that
they have risen above humble origins to
become ghetto royalty (Bustillo)." When
times were good, rappers were able to
purchase spectacularly large diamonds. In
2006, when the industry was doing well,
Lil Jon, a rap producer, bought the largest
diamond pendant on earth (Bustillo). Today, as the industry faces difficult times,
the quality and quantity of jewelry is de-
clining. Rappers are having chains built
with less-precious stones and metals,
including cubic zirconia, a synthetic diamond stand-in (Bustillo).
The history of obsessive consumerism
in hip-hop spans decades. Since the 1980s,
when hip-hop legends Eric B and Rakim
released their album “Paid in Full,” rappers
have been concerned with money. However, it wasn’t until the late 1990s when
a large majority of rap artists consistently
started producing works about consumerism and materialism. Not coincidently,
hip-hop became the most popular genre of
music in the United States during the late
1990s (Perry). A focus on material goods
that the rest of American society was familiar with allowed a broader audience to
relate to hip-hop. Rappers weren’t subtle
about their obsession with money. As California rapper Snoop Dogg boasted, “I got
my mind on my money and my money
on my mind.” The industry, as a whole,
seemed to echo his sentiments.
It’s easy to underestimate the economic
significance of hip-hop, but while not often
recognized, hip-hop has a huge influence
on the consumption patterns of a large
HARVARD COLLEGE ECONOMICS REVIEW
majority of youth. The materialistic element of most modern hip-hop urges youth
to “get money at any cost” and flaunt it at
every opportunity they have (Peterson).
Corporations have also managed to influence hip-hop with marketing techniques.
Indeed, many rappers reference products
in their songs. Some of the products mentioned most often include Cadillac cars,
Cristal champagne and Rolex watches.
Rappers can have quantifiable influences
on markets. Indeed, the popularity of
Air Force Ones, sneakers manufactured
by Nike, between 2000 and 2006 was attributed largely to Jay-Z and Nelly—two
popular rappers (Bierman). Jay-Z wore
the sneakers in almost all of his concerts,
while Nelly recoded a song titled “Air Force
Ones,” which detailed his obsession with
the sneakers. Air Force Ones have become
the best selling athletic sneakers ever,
selling more than 10 million pairs a year
(Bierman).
So, has the recession killed the consumerism in hip-hop? It seems unlikely. While
it may have dampened the ability of many
rappers to purchase expensive things,
most rappers seem to have opted to make
themselves look richer than they are,
rather than to admit their loss of wealth.
For example, a rapper who, two years ago,
wore a large diamond necklace but can
now no longer afford it would choose to
wear the same size pendant with less expensive stones rather than wear a smaller
diamond chain. Johnny Dang, a jeweler
in Houston who caters to rappers, notes,
“The look is still big…bling, but people are
going with…lower-karat gold” (Bustillo).
Moreover, while many rappers acknowledge the recession, their main concern seems to be sustaining their lifestyle
during it, rather than cutting back on their
excessive ways. Beating out the recession
has become a bragging point among rappers. As Virginia hip-hop duo Clipse brags
in their latest single, Kinda Like a Big Deal,
“It’s a blessing, to blow a hundred thousand [dollars] in a recession, without second guessing.” Earlier this year, rapper 50
Cent accused his adversary, Miami rapper
Rick Ross, of wearing fake jewelry (Bustillo). Rick Ross has denied the claims.
The hip-hop industry isn’t the only sector of the economy trying to tighten its
belt. Indeed, claims of a newfound American frugality are everywhere. These claims
do have some basis. Indeed, consumer
spending is down sharply, and the nation-
al savings rate has increased substantially.
However, past predictions that frugality
will endure have proven incorrect. Towards
the end of the 1991 recession, Fortune announced the “death of conspicuous consumption” (Surowiecki). After the Internet bubble and 9/11, many predicted that
American frugality was here to stay. Both
were wrong. Indeed, there seems to be little
evidence of recessions permanently altering American consumption patterns. Some
contend that this recession is much longer
and more severe than any other since the
Great Depression. However, the numbers
simply don’t stack up. For example, during the Great Depression, unemployment
numbers were more than twice as high as
they are now (Surowiecki). Moreover, even
the Great Depression did not kill consumerism beyond revival. Less than a decade
later as the 1940’s began, American consumerism soared (Surowiecki).
Similar claims about frugality are be-
ing made about the hip-hop industry. Tamara Connor, a stylist to a host of rappers,
claims that “conspicuous consumption is
gone” in the hip-hop industry, a quote eerily similar to Fortune’s after the 1991 recession. Connor believes, “We're still going
to see some bling, but it's just not going
to be as much (CBS News)." However, just
as claims about a new era of frugality for
consumers are unfounded, claims about
the “Death of Bling” in hip-hop aren’t really based on the evidence.
While temporary declines in finances
have made it difficult for rappers to sustain their previous lifestyles, there’s no
reason to think that as soon as the economy rebounds and rappers (presumably)
have more money, they won’t immediately go back to the hyper-materialistic
lifestyles they once enjoyed. Rappers, it
seems, aren’t too different from the average consumer, and for both, conspicuous
consumption is a habit that’sHhard to kick.
Regan Bozman is a freshman Social Studies concentrator at Harvard College.
References
Bierman, Fred. "The Nike Air Force 1 Sneaker Turns 25 Years Old." New York Times 23 Dec. 2007. Web. 31 Oct.
2009.
Bustillo, Miguel. "Culture of Bling Clangs to Earth as the Recession Melts Rappers' Ice." Wall Street Journal [New York]
26 May 2009. Wall Street Journal. Web. 31 Oct. 2009.
Castro, Kimberly. "Jay-Z's J Hotels Construction on Hold." US News & World Report. 31 Dec. 2008. Web. 31 Oct.
2009.
http://www.hiphoprx.com/2009/06/10/t-pain-and-his-big-ass-chain/
Peterson, James. "Dead Prezence: Money and Mortal Themes in Hip Hop Culture." Callaloo 29.3 (2006). Project
Muse. Web.
"Scott Storch Goes Bankrupt." The Hip Hop Daily Chronicle. 11 June 2009. Web. 11 Oct. 2009.
"Scott Storch's Outrageous Fortune." Rolling Stone, 29 June 2006. Web. 11 Oct. 2009.
Sulter, John. "Will recession dull hip-hop's bling?" CNN. 29 Jan. 2009. Web. 31 Oct. 2009.
Surowiecki, James. "Inconspicuous Consumption." The New Yorker 12 Oct. 2009. Web. 31 Oct. 2009. <http://www.
newyorker.com/talk/financial/2009/10/12/091012ta_talk_surowiecki>.
"T-Pain And His Big Ass Chain!" HipHopRX. 10 June 2009. Web. 31 Oct. 2009.
"Where's the Bling?" CBS News. 16 Apr. 2009. Web. 31 Oct. 2009.
25
26
fall 2009
interview
David Keith
HCER talks with a leading expert in climactic geo-engineering
D
avid Keith, a climate scientist and
environmental engineer who holds
professorships in the Department
of Chemical and Petroleum Engineering at
the University of Calgary and the Department of Engineering and Public Policy at
Carnegie Mellon University, is one of the
foremost experts in the field of climactic geo1
engineering. Geo-engineering, as defined
by the British Royal Society, is “the deliberate large-scale intervention in the Earth’s
climate system, in order to moderate global
warming.” The two forms of geo-engineering
that Keith advocates are (1) carbon dioxide
removal techniques, which remove CO2 from
the atmosphere, and (2) solar radiation management techniques, which reflect a small
percentage of the sun’s light and heat back
2
into space.
Keith spoke to the HCER about geo-engineering and some of its economic implications.
HCER: Since 1992 you’ve argued that
governments need to fund geo-engi3
neering research. In 2008, you published an editorial that made the same
4
argument. Has funding for research increased since you published the article?
DK: There is funding but not from America. The UK government has announced
substantial funding. There’s a million euros
of EU funding. That’s surprising because if
one had the view that this is not a politically
correct thing to do, then your first assumption would be that Europeans would be more
bound by political correctness, and do it after
the Americans.
HCER: Are you saying that the U.S.
needs to take a lead on this issue?
DK: I don’t know about a lead, but the
U.S. needs to get active on this issue. There’s
a very strong argument for the U.S. government funding of a broad research portfolio
on geo-engineering.
HCER: Why exactly do we need to
fund geo-engineering research now?
DK: I don’t think it makes sense to say
that we need to geo-engineer now. Indeed
,no methods are well enough understood
to justify their use today, but we need the
capabilities to do so in the future. However,
given the uncertainty as to how bad the climate impacts might be, an uncertainty that’s
not going to go away anytime soon, and the
huge inertia of CO2 in the atmosphere, we
need a way to manage the climate risk. Cutting emissions is a crucial part of that, but
it’s not sufficient to manage the climate risk,
because even if you cut emissions completely,
a substantial risk remains. Geoengineering is
the tool to manage the risk of CO2 that is already in the air.
HCER: What needs to be done in
terms of developing the capabilities for
geo-engineering?
DK: You need to do work on a variety of
scales. You have to develop the engineering
capability and the regulatory governance capability. That’s what it would mean to have
the capability to do it. Realistically, it could
take decades to develop that capability.
HCER: Does the financial crisis make
it less likely that geo-engineering research will get funded?
DK: Not at all. It’s completely de-coupled.
Geo-engineering actually appears to be a
cheaper way to manage the problem, and,
in any case, the finding needed now is very
small compared to total funding on climate
science and technology.
HCER: You’ve admitted that there are
probably going to be some negative side
effects from the use of geo-engineering.
How should countries be compensated
for those side effects?
DK: In a perfect world, the winners would
compensate the losers. The reality is that that
doesn’t happen very often, and we don’t have
a system of global governance to make that
happen.
HCER: Most economists agree that
climate change is a problem of economic externalities. Specifically, the costs
of carbon dioxide aren’t calculated in
economic transactions. Does geo-engineering help internalize carbon dioxide
emissions?
DK: I don’t think it does. Geo-engineering
doesn’t help internalize the externalities involved in carbon dioxide emissions. It helps
to manage and cap the risks. It does reduce
the worst-case risk from CO2 emissions. The
way to internalize these externalities is to tax
emissions.
HCER: Is there a set date by which we
must geo-engineer the climate?
DK: I’ve never said that we must implement geo-engineering. I’ve said that we must
have the capability to do it. This is a crucial
distinction. We don’t know how sensitive the
climate is to CO2 emissions. Let’s say that we
wanted to hold carbon dioxide levels under
some limit. Given the uncertainty in climate
sensitivity, you can’t do it by reducing CO2
emissions alone. If you’re trying to reach a
specific cap, you need the ability to geo-engineer in case that climate sensitivity is high.
HCER: Do you realistically see any
real regulations on carbon dioxide emissions in the next decade?
DK: Yes. It’s very hard to call. On the
one hand it’s been 40 years since we’ve had
enough knowledge about climate risk so
as to start regulating. On the other hand,
we’ve been successful in solving other environmental problems over the past decades.
Air pollution regulations were a stunning
success. Nobody knows when we’re going
to do it, and I don’t think there’s going to be
any action at Copenhagen [Climate Conference], but I think there’s a good chance we
will regulate. For all previous environmental regulations, securing the said regulation
always looked harder before we got the deal
than after. Companies have an incentive to
overestimate costs. There’s also evidence that
government and NGO estimates of the cost
of regulations tendHto be biased high before
the regulation passes compared to the actual
cost afterwards.
Endnotes
1. The Royal Society. "Geoengineering the climate." Sept. 2009. http://royalsociety.org/geoengineeringclimate/.
2. Ibid.
3. Keith, David W. and Hadi Dowlatabani. “A Serious Look at Geoengineering.” Eos, Transactions, American Geophysical Union Vol. 73, No. 27: 289, 292-293.
4. Homer-Dixon, Thomas and David Keith, “Blocking the Sky to Save the Earth,” New York Times (Sep. 19,
2008).
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