Brad de Long confesses to being a weekend antiglobalist.

I come down on the pro-mobility side on five days of the week (the other two I wake up in a cold sweat), but that is primarily because of my judgment that late-nineteenth century large-scale international capital mobility was profoundly helpful in spite of all its drawbacks, and I cannot see a difference between then and now that would lead to a different conclusion.

I guess, by the same token, that I’m a weekend globalist. My Golden Age is not the 19th century but the Long Boom from 1945 to the early 1970s, a period of unparalleled prosperity brought to a close by the pressures of capital mobility. Like Brad, but for the opposite reason, I wake up two days a week worrying that it was all an illusion and the capital mobility was the red pill that enabled us to see the truth.

But mostly, I think that the long boom failed because of avoidable mistakes, and that our best hope is a modernised and refurbished version of the Keynesian/social democratic policies that gave us that boom. In this context, the relevant issue is not so much capital mobility as the role of capital markets in general. I see capital markets as essential but dangerous, requiring tight regulation at all times. As Keynes said “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

Brad’s views are confirmed by the experience of the 1980s, when capital markets acted as the enforcer of fiscal discipline on wayward governments, notably in Latin America, and broke down the power of entrenched interest groups. These experiences gave rise to the famous ‘Washington consensus’.

Mine are confirmed by the experience of the late 1990s, when financial market panics produced a string of apparently unnecessary financial crises in Mexico, Thailand, Indonesia, Argentina and so on. In every case, the countries affected had been financial market darlings up to the day the panic struck.

Even more, I’m struck by the failure of the world’s most sophisticated financial markets in their basic task, that of allocating funds for investment. Governments have wasted a lot of money on silly projects, but the dissipation of a trillion dollars in the space of a couple of years on valueless dotcoms and redundant optical fibre is a record that is not going to be matched any time soon. And as far as rent-seeking goes, the amount creamed off in this process by people whose contribution was entirely negative gives the Mobutus and Saddams of this world a fair run for their money.

Update “Jane Galt” replies. However, her most specific counter-point, the observation that during the 1990s, “Japan spent over 100% of its GDP on redundant construction projects and similarly ineffective stimulus” seems to me to be singularly ill-chosen as a response to my observation about speculative bubbles. However ineffectual Japan’s policies of stimulus may have been (they have, after all, kept the economy afloat and unemployment around 5 per cent) they were only adopted in the first place as a response to a speculative bubble and bust in land and stocks comparable to that of the dotcoms/telecoms in the US a decade or so later.

Brad de Long joins the debate over the gains from trade, responding to earlier posts by Kieran Healy and me, with a typically thoughtful and thought-provoking contribution.

I’m hoping this will be the start of a sustained debate/discussion, and I’m going to start by responding to a simple point. Brad says “1.24 percent of current consumption is nothing to be sneezed at ” and he’s right. It’s about $A 8 billion per year, which is a lot of money. For example, assuming government got about half of the gain this would be enough to restore most of the cuts made to post-secondary education over the past decade.

Brad goes on to make an argument I’m less happy with.

In the context of the Australian economy today… Gourinchas and Jeanne’s numbers say that (at a five percent per year safe real interest rate, and with a three percent per year economic growth rate) the value of international capital mobility to the Australian economy is on the order of a one-time present of some 400 billion $A.

To spell it out, with Brad’s numbers the present value of any flow that grows in line with GDP is fifty times (1/(.05-.03) its initial annual value. Multiply the initial $8 billion by fifty and you get Brad’s $400 billion.

I have two problems with this. The first is that, with such a low effective discount rate (2 per cent) a lot of these gains accrue a long way in the future (about half the PV refers to the period after 2040) and I think the impact of any given policy change is hard to predict that far into the future. For example, it may turn out that an approach taken to capital market liberalisation today turns out in 20 years time to preclude some better arrangement that would yield greater benefits.

The second is more important. Suppose, you think there are costs of capital mobility that outweigh the 1 per cent benefit. To take a really simple illustration, suppose you believe that capital mobility destroys national pride and that national pride is worth more than $8 billion per year. It doesn’t alter the argument to say that the benefit of capital mobility in PV terms is $400 billion. If your willingness to sacrifice consumption for national pride is proportional to your income, as seems reasonable, the cost of giving up your national pride can be multiplied by the same factor of fifty to get a present value greater than $400 billion.

The present value conversion is only useful if we are comparing a long-lived flow of benefits to a once-off cost, for example, the need to shift workers into more capital-intensive industries to take advantage of a capital inflow.

An issue where this kind of comparison is important is that of the cost of squeezing inflation out of an economy. Monetary hawks sometimes argue that you shouldn’t worry too much about the unemployment and loss of output associated with a very tight policy because the present value of a permanent reduction in inflation will nearly always outweigh any temporary losses.

I disagree for a couple of reasons. From my first point, I doubt the claim about permanence. The contractionary policies of the 1980s have been followed by a decade or more of low inflation, but it’s easy to see the possibility of a resurgence in inflation in a few years time, particularly in the US.

On the second point, it’s not at all clear that the economy returns to its long-term growth path after a recession. There’s clearly some rebound in the typical recovery, but if you look at an economy like New Zealand, where hawkish monetary policy produced a series of recessions in the 80s and 90s, it seems as if a fair bit of the output loss is permanent, or at least long-lived. There are similar points to be made about unemployment and hysteresis.

Kieran Healy links to a paper by Pierre-Olivier Gourinchas and Olivier Jeanne in which a calibrated growth accounting model is used to show that the gains from unrestricted capital mobility are likely to be of the order of 1 per cent of GDP. Gains from risk sharing aren’t mentioned but other papers are cited to say that these are of a similar magnitude.

Those who listen to the general pronouncements of economists might be surprised by the modest size of the estimated gains. But for those who have looked at similar exercises in the past there is no surprise here. One of the better-kept secrets of economics is the fact that most studies suggest that the replacement of a typical high-tariff regime (say Australia’s in the 1960s) will yield long run benefits of about 3 per cent of GDP.

Those who raise questions about this point are likely to be brushed off with a reference to supposed dynamic gains, not captured in this ‘static’ analysis. This brings us to an even better-kept secret. These ‘dynamic gains’ have about as much basis in neoclassical economic theory as the Tooth Fairy.

To complicate matters a bit further, there is a theoretically respectable category of dynamic gains, arising from the removal of distortions in intertemporal resource allocation, but these are even more modest than the static gains. In fact, the gains looked at by Gourinchas and Jeanne.

The last line of defence is the idea of X-efficiency, or the ‘cold shower’ effect of competition. As Chicago stalwart George Stigler was the first to point out, this idea is based on the fallacious assumption that additional work effort is costless. This fallacy is hard to kill, but anybody who’s experienced 1990s-style ‘workplace reform’ knows it for what it is. I’ve been hammering away on this point for at least a decade, for example here and here (PDF), but with very little impact.