Author: John Sloman

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A J-curve for Japan?

The new Japanese government under Shinzo Abe, which took office on 26 December 2012, has been pursuing a policy of weakening the yen. Using a combination of low interest rates, quantitative easing, expansionary fiscal policy and a declared aim of depreciation, the government has succeeded in driving down the value of the yen.

Since mid-November last year, the yen has depreciated by 28% against the dollar, 30% against the euro and 21% against sterling. The effective exchange rate index has fallen by 22% (see first diagram below: click here for a PowerPoint of the diagram).

But will this depreciation succeed in stimulating the Japanese economy and will it improve the balance of trade? The hope is that the falling yen will boost export sales by making them cheaper abroad, and will reduce the demand for imports by making them more expensive in Japan. The balance of trade will thereby improve and higher exports (an injection) and lower imports (a withdrawal) will stimulate aggregate demand and economic growth.

Traditionally Japan has run balance of trade surpluses, but since July 2012, it has been running monthly deficits – the longest run of deficits since 1980. But depreciation cannot be expected to turn this position around immediately. Indeed, theory suggests that the balance of trade is likely to deteriorate before it improves. This is known as the J-curve effect and is illustrated in the second diagram below. As page 768 of Economics, 8th edition states:

At first a devaluation or depreciation might make a current account deficit worse: the J-curve effect. The price elasticities of demand for imports and exports may be low in the short run (see Case Study 25.1 in MyEconLab). Directly after devaluation or depreciation, few extra exports may be sold, and more will have to be paid for imports that do not have immediate substitutes. There is thus an initial deterioration in the balance of trade before it eventually improves. In Figure 25.12 [the second diagram], devaluation takes place at time t1. As you can see, the diagram has a J shape.

Evidence suggests that the first part of the ‘J’ has been experienced in Japan: Japan’s balance of trade has deteriorated. But there is debate over whether the balance of trade will now start to improve. As the article by James Saft states:

But a look at the actual data shows Japanese companies, like British ones during a similar bout of currency weakness in 2008, appear to be more eager to use a newly competitive currency to pad profits through higher margins rather than higher export volumes. Thus far, Japanese exporters appear to be doing just that. Despite yen falls the price of Japanese exports in local currency has barely budged.

“Japanese companies have not actually cut the foreign currency prices of their exports. Just as with the UK exporters, the Japanese have chosen to hold foreign prices constant, maintain market share, and increase the yen value and thus the yen profit associated with yen depreciation,” UBS economist Paul Donovan writes in a note to clients.

The extra profits earned by Japanese companies from export sales may be stockpiled or paid out in dividends rather than reinvested. And what investment does take place may be abroad rather than in Japan. The net effect may be very little stimulus to the Japanese economy.

As stated by Saft above, the UK had a similar experience in the period 2007–9, when sterling depreciated some 27% (see the second diagram). The balance of trade improved very little and UK companies generally priced goods to markets abroad rather than cutting overseas prices.

But times were different then. The world was plunging into recession. Now global markets are mildly growing or static. Nevertheless, there is a danger that the upward slope of the J-curve in Japan may be pretty flat.

Articles
Weak yen a boon for investors, not Japan Reuters, James Saft (14/5/13)
Japan’s Trade Data Suggest Even Lower Yen Needed Wall Street Journal, Nick Hastings (22/5/13)
2 Misunderstandings About Japanese Trade Seeking Alpha, Marc Chandler (22/5/13)
Japanese trade deficit widens Financial Times, Ben McLannahan (22/5/13)

Data
BIS effective exchange rate indices Bank for International Settlements
Japan’s balance of trade Trading Economics
UK Trade, March 2013 ONS

Questions

  1. Explain the J-curve effect.
  2. Why is there some doubt about whether the Japanese balance of trade will improve significantly?
  3. What will be the consequences for Japanese growth?
  4. If foreign currency prices of Japanese exports do not change, what will determine the amount that Japan exports?
  5. What other measures is the Japanese government taking to stimulate the economy? What will determine the size of the multiplier effects of these measures?
  6. Using data from the ONS plot the UK’s quarterly balance of trade figures from 2007 to the present day. Explain the pattern that emerges.
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GDP and development

The link below is to an article by Bill Gates, founder of Microsoft. He argues that per-capita GDP is a poor indicator of development, especially in Sub-Saharan Africa.

The problems with using GDP as an indicator of the level of development of a country are well known and several alternative measures are in common use. Perhaps the best known is the United Nations Development Programme’s Human Development Index (HDI), where countries are given an HDI of between 0 and 1. HDI is the average of three indices based on three sets of variables: (i) life expectancy at birth, (ii) education (a weighted average of (a) the mean years that a 25-year-old person or older has spent in school and (b) the number of years of schooling that a 5-year-old child is expected to have over their lifetime) and (iii) real gross national income (GNY) per capita, measured in US dollars at purchasing-power parity exchange rates (see Box 27.1 in Economics 8th edition for more details).

But although indicators such as this capture more elements of development than simple per-capita GNP or GNY, there are still serious shortcomings. A major problem is the lack of and inaccuracy of statistics, especially when applied to the rural subsistence and informal urban sectors. The problem is recognised and some countries are trying to address the problem (see the second article below), but the problem is huge. As Gates says:

It is clear to me that we need to devote greater resources to getting basic GDP numbers right. … National statistics offices across Africa need more support so that they can obtain and report timelier and more accurate data. Donor governments and international organisations such as the World Bank need to do more to help African authorities produce a clearer picture of their economies. And African policymakers need to be more consistent about demanding better statistics and using them to inform decisions.

Another problem is how you convert data into internationally comparable forms. For example, how are inflation, exchange rates, income distribution, the quality of health provision and education, etc. taken into account?

How GDP understates economic growth The Guardian, Bill Gates (8/5/13)
States’ GDP computation report out soon, says Nigeria statistics bureau Premium Times (Nigeria), Bassey Udo (9/5/13)
Michael Porter Presents New Alternative to GDP: The Social Progress Index (SPI) Triple Pundit, Raz Godelnik (13/4/13)

Questions

  1. By accessing the Human Development Index site, identify which countries have a much higher ranking by HDP than by per capita gross national income. Explain why.
  2. Why is expressing GNY in purchasing-power parity (PPP) terms likely to increase the GNY figures for the poorest countries?
  3. Explain the following quote from the Gates article: ‘I have long believed that GDP understates growth even in rich countries, where its measurement is quite sophisticated, because it is very difficult to compare the value of baskets of goods across different time periods’.
  4. Why is GNY per capita, even when expressed in PPP terms, likely to understate the level of development in subsistence economies?
  5. Explain whether the rate of growth of GNY per capita is likely to understate or overstate the rate of economic development of sub-Saharan African countries?
  6. Why are the challenges of calculating GDP or GNY particularly acute in sub-Saharan Africa?
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It could be you

An excellent learning exercise for students of economics is to take a journal article that uses data to model the economy and then try to replicate the authors’ results. You may well be given an assignment like this in future years of your degree.

One such exercise is used on the University of Massachusetts Amherst’s doctoral programme in economics. Thomas Herndon is a student on that degree and chose to examine a well-known and highly influential paper, Growth in a Time of Debt by Carmen Reinhart then of the University of Maryland and Kenneth Rogoff of Harvard University and former chief economist of the IMF. Professors Reinhart and Rogoff used new data on 44 countries spanning about 200 years.

A key finding of their paper, published in 2010 in the American Economic Review Papers and Proceedings, is that once a country’s government debt exceeds 90% of GDP, growth rates fall considerably: the median across countries by about 1% and the mean considerably more.

The paper has been hugely influential. It has been used to justify the austerity programmes being pursued in many countries, including the UK and the eurozone. Cutting the government deficit to GDP ratio, and ultimately the government debt to GDP ratio, has been seen as a way of achieving higher growth over the longer term, and justifies the adverse effect on short-term growth from the dampening of aggregate demand.

Well, this seemed an interesting paper for Thomas Herndon to examine, and he was keen to show just how Reinhart and Rogoff’s data led to their conclusions. But try as he might, he could not replicate their results. His initial reaction was to think he had made an error, but each time he checked he came back with the same conclusion: they must have made errors in their calculations.

His supervisor at Amherst, Professor Michael Ash, after Thomas had checked and checked again, realised that something was wrong. He encouraged Thomas to write to Reinhart and Rogoff to request sight of their dataset. They duly obliged and it was then that Thomas spotted various errors. These are explained in the articles below, but the overall effect was to alter the conclusion. Although high debt may undermine growth to some extent, the effect is much less than Reinhart and Rogoff concluded, and there are several exceptions to this rule.

On 15 April 2013, Thomas, along with his supervisor, Michael Ash and his colleague, Robert Pollin, published a response to the Reinhart and Rogoff paper. In the abstract to their paper, Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff they state that:

… coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. They find that when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not –0:1 percent as published in Reinhart and Rogoff. That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower.

The authors also show how the relationship between public debt and GDP growth varies significantly by time period and country. Overall, the evidence we review contradicts Reinhart and Rogoff’s claim to have identified an important stylized fact, that public debt loads greater than 90 percent of GDP consistently reduce GDP growth.

So could this be you in the future? Will you take a famous paper and, by re-examining and reworking the data, find that its conclusions are wrong? Could you end up changing the world? Exciting stuff!

Podcasts

Austerity: A Spreadsheet Error? BBC, More or Less, Tim Harford (20/4/13)
Austerity justification study ‘inaccurate’ BBC Today Programme, Robert Pollin (18/4/13)

Articles

UMass Student Exposes Serious Flaws in Harvard Economists’ Influential Study The Atlantic Wire, J.K. Trotter (18/4/13)
Shocking Paper Claims That Microsoft Excel Coding Error Is Behind The Reinhart-Rogoff Study On Debt Business Insider, Mike Konczal (16/4/13)
How a student took on eminent economists on debt issue – and won Economic Times of India (19/4/13)
Meet the 28-Year-Old Grad Student Who Just Shook the Global Austerity Movement New York Magazine, Kevin Roose (19/4/13)
An economist’s mea culpa: I relied on Reinhart and Rogoff Confessions of a Supply-Side Liberal blog, Miles Kimball (22/4/13)
The Rogoff-Reinhart data scandal reminds us economists aren’t gods The Guardian, Heidi Moore (18/4/13)
Reinhart, Rogoff… and Herndon: The student who caught out the profs BBC News Magazine, Ruth Alexander (20/4/13)
George Osborne’s case for austerity has just started to wobble The Guardian, Polly Toynbee (18/4/13)
The error that could subvert George Osborne’s austerity programme The Guardian, Charles Arthur and Phillip Inman (18/4/13)
The Excel depression Sydney Morning Herald, Paul Krugman (19/4/13)
Europe: Retreat from austerity BBC News, Gavin Hewitt (23/4/13)

Guest post by Thomas Herndon
The Grad Student Who Took Down Reinhart And Rogoff Explains Why They’re Fundamentally Wrong Business Insider, Thomas Herndon (22/4/13)

Papers
Growth in a Time of Debt NBER working paper, Carmen M. Reinhart and Kenneth S. Rogoff (January 2010)
Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogo ff PERI Working Paper 322, Thomas Herndon, Michael Ash and Robert Pollin (April 2013)

Questions

  1. What were the particular errors made by Reinhart and Rogoff?
  2. How has their paper been used as a basis for the design of macroeconomic policy?
  3. What are the limitations of using even accurate time-series data as the basis for policy measures?
  4. How might the work of Herndon change the direction of future macroeconomic policy?
  5. In his guest post in Business Insider (see link above), Herndon wrote: ‘The implication for policy is that, under particular circumstances, public debt can play a key role in overcoming a recession.’ What might this role be?
  6. Why might we have to be cautious in drawing policy conclusions from Herndon’s work?
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Conscious capitalism: realism or a dream?

On 5 and 6 April, there was a conference on conscious capitalism in San Francisco. In January, a new book, Conscious Capitalism: Liberating the Heroic Spirit of Business, by John Mackey and Rajendra Sisodia, was published. Many in the business world are enthusiastic about this seemingly new approach to business, which focuses on broader social, environmental and ethical goals, rather than simple profit maximisation.

As the Washington Times review linked to below states:

“Conscious Capitalism” promotes a business culture that embodies “trust, accountability, caring, transparency, integrity, loyalty and egalitarianism.” The management ideal of “Conscious Capitalism” contains four key elements of “decentralization, empowerment, innovation and collaboration.” Above all, this exemplary form of business practice relies on careful attention to four tenets: higher purpose and core values, stakeholder integration, conscious leadership and conscious culture and management.

So how realistic is this vision of caring capitalism? There may be a few inspiring businesspeople, truly committed to improving the interests of the various stakeholders of their business and society more generally, but could it become a model for business in general? And if so, does this require education, monitoring and regulation? Or can a libertarian approach to business generate an environment where conscious and caring capitalists flourish and succeed better than those with a more narrow focus on profit?

The following videos and articles discuss conscious capitalism and the arguments of those, such as John Mackey, founder and co-CEO of Whole Food Market, who advocate it.

Webcasts

Conscious capitalism The Economist, John Mackey (15/3/13)
Conscious Capitalism: Heroes of the Business World Conscious capitalism, April in San Francisco (5/4/13)
It’s Not Corporate Social Responsibility Conscious capitalism, John Mackey (Jan 13)

Articles, reviews and information
Conscious Capitalism: Creating a New Paradigm for Business Whole Planet Foundation, John Mackey
Companies that Practice “Conscious Capitalism” Perform 10x Better Harvard Business Review, Tony Schwartz (4/4/13)
4 Ways to Become a (More) Conscious Capitalist Inc., Francesca Louise Fenzi (8/4/13)
The New Management Paradigm & John Mackey’s Whole Foods Forbes, Steve Denning (5/1/13)
Book Review: ‘Conscious Capitalism’ Washington Times, Anthony j. Sadar (20/3/13)
Book Review: Whole Foods Co-CEO John Mackey’s Conscious Capitalism Huffington Post, Christine Bader (28/1/13)
Chicken Soup for a Davos Soul Wall Street Journal, Alan Murray (16/1/13)
Conscious business Wikipedia

Questions

  1. What are the features of conscious capitalism?
  2. Do firms “get the shareholders they deserve”?
  3. How might firms that are not pursuing conscious capitalism be persuaded to become more conscious and more caring?
  4. How does conscious capitalism differ from corporate social responsibility?
  5. What would you understand by “conscious consumers”? How might their behaviour differ from other consumers?
  6. Why might firms engaging in conscious capitalism become more profitable than firms that have a simple aim of profit maximisation?
  7. What reforms, both internal within a firm and in the legal environment, does John Mackey advocate? Do you agree with his suggestions? What else do you suggest?