I’ve had this post in mind for quite a while, and never got in finished to my satisfaction, but it’s been stimulated to a significant extent by reading Clay Shirky, so I thought I’d pop it up now, somewhat half-baked, since Clay is currently visiting Crooked Timber, where I’ve crossposted this.

The biggest single question in political economy is whether and to what extent we can achieve social equality without sacrificing other goods like liberty and prosperity. Neoclassical economics (a project in which I’m a participant) begins with models which imply that, with competitive markets, all factors of production will earn their marginal product. This in turn implies that any intervention that shifts wages or returns to capital away from their marginal product must imply a loss in aggregate income (there are some complex technical issues here which I’ll skip over)

There are all sorts of problems with simple-minded applications of this result. Still, in an economy that fits the standard model of lots of competing firms, all operating in a region where constant returns to scale apply, the standard neoclassical analysis has considerable force. But the growing part of the economy centred on the Internet doesn’t fit this model at all. The Internet is a network and the economies of networks are different, in critical ways, from those of the standard neoclassical model.
Read More »

Over the fold is my article in today’s Fin, drawing on a blog post from a while back. Thanks to everyone who contributed to the discussion

Read More »

Unlike national central banks, the Bank for International Settlements doesn’t have to worry too much about the effect of its statements on business and consumer confidence or on the possibility of political flak. Hence, it has usually tended to give a less rosy view of the economic outlook than other official and quasi-official institutions. The latest assessment is particularly gloomy .

The full annual report has the cheery title “The unsustainable has run its course and policymakers face the difficult task of damage control” (Overview here).

The money quote:

Perhaps the principal conclusion to be drawn from today’s policy challenges is that it would have been better to avoid the build-up of credit excesses in the first place. In future, this could be done through the establishment of a new macrofinancial stability framework, which would call for both monetary and macroprudential policies to “lean against the wind” of the credit cycle

It’s hard to disagree with this, but equally hard to imagine such a framework (reminiscent of the “new global financial architecture” proposed in the late 90s) being introduced without the stimulus of a truly dire financial crisis.

The news that the unemployment rate in the United States has risen from 5.0 to 5.5 per cent makes it clear that the US economy is now in recession, even allowing for all the usual qualifications about one months’ data, possible revisions and so on. Unemployment tends to be a lagging indicator, and the housing downturn still has a long way to go before it turns around. The long-overdue downgrading of the main mortgage insurers, MBIA and Ambac, and of course the further depreciation of the US dollar and increase in the price of oil add to the picture. Not surprisingly, this produced a big drop on Wall Street last Friday. What are the implications for Australia.

The most direct, I think, is for the Reserve Bank. It’s now virtually impossible for the US Fed to raise interest rates, so the prospects for US inflation staying low depend on the assumption that high prices for food and oil, and increasingly for US imports, won’t be reflected in prices more generally or in wages. The Australian economy is sufficiently fragile that it seems sensible to take a similar view here and not increase interest rates further (of course, that still leaves Australia with much higher interest rates, and lower inflation, than the US).

The second is for the sustainability of the economic model pursued by the whole English-speaking world for the last couple of decades with large trade and current account deficits and low to zero rates of household savings in traditional terms, offset by capital gains on housing and equity investments. Australia has followed this model even more enthusiastically than the US in some respects, and so far has not suffered any serious consequences. But a sudden loss of confidence in the US could easily spread here. I’d be a lot happier if our current account deficit was declining as a result of the mining boom. Instead, it’s now at record levels.