Who Pays the Bills?

Sovereign Debt Guarantees and Default: Lessons from the UK and Ireland, 1920-1938

By Nathan Foley-Fisher (Federal Reserve Board) and Eoin McLaughlin (St. Andrews)

Abstract We study the daily yields on Irish land bonds listed on the Dublin Stock Exchange during the years 1920-1938. We exploit structural differences in bonds guaranteed by the UK and Irish governments to find Irish events that had long term effects on the credibility of government guarantees. We document two major events: The Anglo-Irish Treaty of 1921 and Ireland’s default on intergovernmental payments in 1932. We discuss the political and economic forces behind the Irish and UK governments’ decisions. Our finding has implications for modern-day proposals to issue jointly-guaranteed sovereign debt.

URL: http://EconPapers.repec.org/RePEc:sss:wpaper:2015-11

Distributed by NEP-HIS on: 2015-05-16

Review by Sarah Charity (Queen’s University of Belfast)

This working paper abets us in shedding some light on the financial implications for current economic events. One that dominated the headlines most prominently was Scotland’s decision to vote on independence in their recent referendum. Hard-line fiscal policy makers held their breath while questions simmered such as; would an independent Scotland continue debt repayments to Britain? What if they defaulted on these payments? The authors investigate how public debt in Ireland was dealt with during their severance from the political state of the United Kingdom in the early 20th century, focusing on the implementation of UK- and Irish-backed land bonds over this period of significant Irish land reform, when ownership was transferred from landlords to tenants. From this episode in Irish history, we can draw comparisons and learn lessons for today.

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Foley-Fisher and McLaughlin look to previous studies in which yield spreads between UK and Irish government bonds are analysed, such as that of Nevin (1963) and Ó Gráda (1994). They contribute to the existing literature by concentrating on land bonds. They base their methodology on the idea of particular structural breaks occurring in their time-series data. They build on the discoveries of Willard et al. (1996) who defined breaks as a change in the intercept of the time series – ‘a shift in the mean’ (p.11-12), while Zussman et al. (2008) also searched for ‘breakpoints’ (p.4) in their methodology. They analyse the shifts in ‘perceived value of sovereign guarantees’ (p.11) by looking for changes in the mean of the yield spreads.

The impact of bond spreads ‘diffused’ (p.15) around three significant events. The first break coincides with the Anglo Irish Treaty passing in 1921 while the second occurred a decade later when the default by Ireland on land bond payments beckoned. Around this time, Eamon De Valera, founder of Irish political party Fianna Fáil, announced the ‘Free State would not honour the bi-annual payments due under various financial agreements between Ireland and the UK’ (p.14). The final break came at the end of the sample period, however this is discounted as irrelevant due to trade war negotiations being ‘unlikely…(to be) sufficient’ (p.15).

Parliamentary acts sanctioned the used of generous government guaranteed land bonds to finance state mortgages, rather similar to the volatile mortgage backed securities of the recent credit crisis, allowing farmers to borrow significant amounts of credit at lower rates. The idea was to curtail the Irish Nationalists, however it proved unsuccessful and the ‘hardline republicans’ (p.6) received independence through the signing of the Treaty in December 1921. A new dawn was on the horizon, bringing with it the promise of a new government – but it was lamentably overshadowed by the onset of the Irish Civil War. The newly established Free State was released from its obligation towards UK public debt in return for permanent partition; however it agreed to maintain annuity payments along with issuance of more land bonds.

The authors calculate the credibility of UK guarantees, otherwise known as sovereign risk, post-independence using yield spreads controlling for risks of inflation and exchange rate alternations. They acknowledge other scholars in assessing the importance of credibility in economic features such as the ‘cost of government finance’ (p.5) as investigated by Flandreau & Zumer (2009) and the estimated behaviour of the government as a ‘counterparty in other contracts’ (p.5) as seen in Cole & Kehoe (1998). Foley-Fisher and McLaughlin found the spread over UK government bonds to be 60 basis points indicating a low credit risk for the UK- and Irish-backed land bonds. Through their estimations they suggested that the increased yield spread of the land bonds during the ‘benchmark’ years from 1921 to 1932 was highly significant. After Ireland defaulted, the land bonds were no longer considered risky and the spread on UK-backed land bonds returned to zero. The authors are perhaps slightly restricted by their sample period. Mercille (2006, p.3) tells us little research exists on the significant long-term costs related to yield spreads, forcing us to seek answers elsewhere.

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Foley-Fisher and McLaughlin suggest that the cost of Ireland’s default was greater for their British counterparts. They give reasons for the UK’s intervention such as the insignificant cost to the UK Treasury, who continued making interest repayments to ensure bond holders remained intact; UK war loan negotiations and the fact land bonds were mostly held in the UK ensured Whitehall was an interested party. The authors provide us with a contrasting government reaction to default in another commonwealth country, using the contemporaneous case of Newfoundland, whose debt profile bore echoes of Ireland’s. As previously mentioned, the cost for the UK government of bondholders’ losses through passing on Ireland’s default far outweighed the benefits. In the Newfoundland example, the UK government’s reaction was to withdraw from the imminent burden of financial instability and force confederation of the Dominion with Canada, thus shedding the burden for bondholders’ losses – a consequence independence-seeking Scotland may have wanted to consider.

In the absence of case studies, Ireland’s historical sovereign break up ensures Foley-Fisher and McLaughlin’s ‘simple empirical strategy’ (C.R, 2014) is applicable to and useful in multiple current financial situations whether it be the aforementioned Scottish referendum, or the pending disintegration of Catalonia from Spain. Moodys (2014) discovered that 75% of the 17 country break ups which have occurred since 1983 resulted in sovereign default by the preceding or the new state – albeit these implications ‘cannot be easily applied’ (p.3) to more recent breakups, paving the way for this exploration of Ireland as the model to follow.

This paper describes apportioning fiscal liabilities as ‘complex’ and provides advice for states in the process of seeking dissolution – uncertainty is persistent. Debt must be paid and it may be guaranteed by the Treasury of the former union in the wake of default, but the ambiguity in the outcome remains. According to the blogger C.R., writing in The Economist (2014), it seems as if partition is more straightforward politically rather than financially or economically. From what Foley-Fisher and McLaughlin have taught us in their empirical study, the cost of default and fiscal uncertainty lingers long after secession. In conclusion, the exploits of our Irish ancestors from the previous century are what we, alongside other state governments, must contemplate when the sword of political state break-up strikes again.

References

Cole, H. L. & Kehoe, P. J. (1998), ‘Models of Sovereign Debt: Partial versus General Reputations’, International Economic Review 39(1), 55–70.

C.R (Feb. 21st 2014) The economics of Scottish Independence- a messy divorce, Blighty Britain Available at: http://www.economist.com/blogs/blighty/2014/02/economics-scottish-independence (Accessed: March 22nd 2015)

Ferguson, N. (2006), ‘Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War’, Economic History Review 59, 70– 112

Flandreau, M. & Zumer, F. (2009), The Making of Global Finance 1880-1913, Paris: OECD Publishing.

Hancock, W. (1964), Survey of British Commonwealth Affairs. Volume I Problems of Nationality 1918-1936, Oxford: Oxford University Press.

Mauro, P., Sussman, N. & Yafeh, Y. (2006), Emerging Markets and Financial Globalization, Oxford: Oxford University Press.

Mercille, J. (2006) ‘The Media and the Question of Sovereign Debt Default in the European Economic Crisis: The Case of Ireland’, University of Sheffield, Available at: http://speri.dept.shef.ac.uk/wp-content/uploads/2013/06/Mercille-J-The-Media-the-Question-of-Sovereign-debt-default-in-the-European-Economic-Crisis-the-case-of-Ireland.pdf (Accessed August 18, 2015).

Moodys (May 21st. 2014) When countries broke up, sovereign default risk spiked, Available at: https://www.moodys.com/research/Moodys-When-countries-broke-up-sovereign-default-risk-spiked–PR_299968?WT.mc_id=NLTITLE_YYYYMMDD_PR_299968 (Accessed: March 23rd. 2015).

Nevin, E. (1963), ‘The Capital Stock of Irish Industry’, Economic and Social Research Institute(ESRI) paper No. 17, Dublin. Available at: http://econpapers.repec.org/bookchap/esrresser/grs17.htm (Accessed August 18, 2015).

Ó Gráda, C. (1994), Ireland: A new Economic History 1780-1939, Clarendon Press, Oxford.

Willard, K. L., Guinnane, T. W. & Rosen, H. S. (1996), ‘Turning points in the Civil War: views from the Greenback market’, American Economic Review 86, 1001–1018.

Zussman, A., Zussman, N. & Nielson, M. O. (2008), ‘Asset Market Prespectives on the Israeli-Palestinian conflict’, Economica 75, 84–115.

By failing to prepare, you are preparing to fail

The European Crisis in the Context of the History of Previous Financial Crisis

by Michael Bordo & Harold James

Abstract – There are some striking similarities between the pre 1914 gold standard and EMU today. Both arrangements are based on fixed exchange rates, monetary and fiscal orthodoxy. Each regime gave easy access by financially underdeveloped peripheral countries to capital from the core countries. But the gold standard was a contingent rule—in the case of an emergency like a major war or a serious financial crisis –a country could temporarily devalue its currency. The EMU has no such safety valve. Capital flows in both regimes fuelled asset price booms via the banking system ending in major crises in the peripheral countries. But not having the escape clause has meant that present day Greece and other peripheral European countries have suffered much greater economic harm than did Argentina in the Baring Crisis of 1890.

URL: http://EconPapers.repec.org/RePEc:bog:spaper:18

Circulated by NEP-HIS on: 2015-01-26

Reviewed by: Stephen Billington (Queen’s University of Belfast)

Summary

In this paper Bordo and James seek to analyse the impact of the financial crisis of 2007-8 in the context of previous crisis. Specifically by comparing the experience of periphery countries of the Eurozone with those of the “classic” Gold Standard.

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In their paper Bordo and James give a synopsis of the similarities which emerged between both monetary regimes. By adhering to a gold parity there was an expansion in the banking system, through large capital inflows, which was underpinned by a strong effective state to allow for greater borrowing. A nation was effective if it held an international diplomatic commitment, which in turn required them to sign into international systems, all the while this played into the hands of radical political parties who played on civilian nationalism[1]; these events combined lead to great inflows of capital into peripheral countries which inevitably led to fiscal instability and a resulting crisis. Similar dilemmas occurred within the EMU, but much more intensely.

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This brings me to the main point that the authors emphasize, that of the contingency rule of the classic gold standard. The latter allowed member countries a “safety valve for fiscal policy”. Essentially this was an escape clause that permitted a country to temporarily devalue its currency in an emergency, such as the outbreak of war or a financial crisis, but would return to normalcy soon after, that is, they would return to previous levels. Bordo and James’ argument is that this lack of a contingency within the EMU allowed for a more severe financial crisis to afflict the periphery countries (Greece, Ireland and Portugal) than had affected gold standard peripheries (Argentina, Italy and Australia) as modern day EMU countries did (and do) not have to option to devalue their currency.

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Bordo and James point out that crisis during the gold standard were very sharp, but did not last as long as the 2007-8 crisis. This because the exclusion clause during the gold standard enabled a “breathing space” and as a result most countries were back to growth within a few short years. The EMU story is quite different, say Bordo and James. Mundell (1961) argued that a successful monetary union requires the existence of a well-functioning mechanism for adjustment, what we see in the EMU are a case of worse dilemmas due primarily to this absence of an escape clause.

“Gold outflows, and, with money and credit growth tied to gold, lower money and credit growth. The lower money and credit growth would cause prices and wages to fall (or would lead to reductions in the growth rates of prices and wages), helping to restore competitiveness, thus eliminating the external deficits”

The above quote provided by Gibson, Palivos and Tavlas (2014) highlights how the gold standard allowed a country to adjust to a deficit. This point reinforces how Bordo & James argue that due to the constricting nature of the EMU there is no “safety valve” to allowed EU countries to release the steam from increasing debt levels. With respect to the Argentine Baring Crisis of 1890, while the crisis was very sharp in terms of real GDP, pre-crisis levels of GDP were again reached by 1893 – clearly a contrast with the Euro as some countries are still in recession with very little progress having been made as suggested by the following headline: “Greece’s current GDP is stuck in ancient Greece” – Business Insider (2013).

The following graph highlights the issue that in Europe most countries are still lagging behind the pre-crisis levels of GDP.

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Bordo and James clearly support this argument. Delles and Tavlas (2013) also argue that the adjustment mechanism of core and periphery countries limited the size and persistence of external deficits. They put forward that the durability of the gold standard relied on this mechanism. This is reinforced by Bloomfield (1959) who states it “facilitated adjustments to balance of payments disequilibrium”.

Vinals (1996) further supports the authors’ sentiments by arguing that the Treaty of Maastricht restricts an individual member’s room to manoeuvre as the Treaty requires sound fiscal policies, with debt limited to 60% of GDP and annual deficits no greater than 3% of GDP – meaning a member cannot smooth over these imbalances through spending or taxation.

Gibson, Palivos and Tavlas (2014) state “a major cost of monetary unions is the reduced flexibility to adjust to asymmetric shocks”. They argue that internal devaluations must occur to adjust to fiscal imbalances, but go on to argue that these are much harder to implement than in theory, again supported by Vinals (1996).

Comment

Bordo and James focus primarily on three EU periphery countries which are doing badly, namely Greece, Ireland and Portugal. However they neglect the remaining countries within the EU which can also be classed as a periphery. According the Wallerstein (1974) the periphery can be seen as the less developed countries, these could include further countries such as those from eastern Europe[2]. By looking at a more expansive view of peripheral countries we can see that these other peripherals had quick recoveries with sharp decreases in GDP growth, as in the case of the Gold standard countries, but swiftly recovered to high levels of growth again while the main peripheral countries the authors analyse do lag behind.

Untitled2See note 3

Bordo and James do provide a strong insight into the relationship between an adjustment mechanism to combating fiscal imbalances as a means of explaining the poor recovery of certain peripheral countries (i.e. Greece, Ireland, Portugal) and highlight the implications of this in the future of the EMU. If the EMU cannot find a contingency rule as the gold standard then recessions may leave them as vulnerable in the future as they are now.

Notes

1) This process can be thought of as a trilemma, Obstfeld, Taylor and Shambaugh (2004) give a better explanation. In the EU the problem was intensified as governments could back higher levels of debt, and there was no provision for European banking supervision, the commitment to EU integration let markets believe that there were no limits to debt levels. This led to inflows in periphery countries where banks could become too big to be rescued.

2) Latvia, Lithuania, Slovakia, Slovenia, and even Cyprus can be included based on low GDP per capita which is equivalent to Greece.

3) Data taken from Eurostat comparing real GDP growth levels of lesser developed countries within the Eurozone who all use the euro and would be locked into the same system of no adjustment.

References

Bloomfield, A. (1959) Monetary Policy under the International Gold Standard. New York: Federal Reserve Bank of New York.

Business Insider (2013). Every Country in Europe Should be Glad it’s Not Greece. http://www.businessinsider.com/european-gdp-since-pre-crisis-chart-2013-8?IR=T [Accessed 19/03/2015].

Eurostat, Real GDP Growth Rates http://ec.europa.eu/eurostat/tgm/graph.do?tab=graph&plugin=1&pcode=tec00115&language=en&toolbox=data [Accessed 21/03/2015].

Dellas, Harris; Tavlas, George S. (2013). The Gold Standard, The Euro, and The Origins of the Greek Sovereign Debt Crisis. Cato Journal 33(3): 491-520.

Gibson, Heather D; Palivos, Theodore; Tavlas, George S. (2014). The Crisis in the Euro Area: An Analytic Overview.Journal of Macroeconomics 39: 233-239.

Mundell, Robert A. (1961). A Theory of Optimum Currency Areas. The American Economic Review 51(4): 657-665.

Obstfeld, Maurice. Taylor, Alan. Shambaugh, Jay C. (2004). The Trilemma in History: Trade-Offs among Exchange Rates, Monetary Policies and Capital Mobility. National Bureau of Economic Research (NBER working paper 10396).

Vinals, Jose. (1996). European Monetary Integration: A Narrow or Wide EMU?. European Economic Review 40(3-5): 1103-1109.

Wallerstein, Immanuel (1974). The Modern World-System I: Capitalist Agriculture and the Origins of the European World-Economy in the Sixteenth Century. New York: Academic Press.

“Empire State of Mind”: The Land Value of Manhattan, 1950-2013

What’s Manhattan Worth? A Land Values Index from 1950 to 2013.
by Jason Barr, Rutgers University (jmbarr@rutgers.edu), Fred Smith, Davidson College (frsmith@davidson.edu), and Sayali Kulkarni, Rutgers University (sayali283@gmail.com).
Abstract: Using vacant land sales, we construct a land value index for Manhattan from 1950 to 2013. We find three major cycles (1950 to 1977, 1977 to 1993, and 1993 to 2007), with land values reaching their nadir in 1977, two years after the city’s fiscal crises. Overall, we find the average annual real growth rate to be 5.1%. Since 1993, landprices have risen quite dramatically, and much faster than population or employment growth, at an average annual rate of 15.8%, suggesting that barriers to entry in real estate development are causing prices to rise faster than other measures of local well-being. Further, we estimate the entire amount of developable land onManhattan to be worth approximately $825 billion. This would suggest an average annual return of 6.3% since the island was first inhabited by Dutch settlers in 1626.

URL: http://d.repec.org/n?u=RePEc:run:wpaper:2015-002&r=his [this link will download a Word copy of the paper to your computer]

Review by Manuel A. Bautista González (Columbia University)

“All cultures have their creation myths, and according to cherished New York legend, the Manhattan real estate market was born when the Dutch paid $24 in shells to the Indians for an island that is today worth billions of dollars. The persistence of this story tells us more about the justifying strategies of our own times than about the past. The Manhattan real estate market, the myth implies, is as natural as its bedrock and harbor, and real estate magnates who today pursue “the art of the deal” are only fulfilling their forefathers’ vision of the profits embedded in Manhattan land. The conditions of Manhattan’s land and housing markets, far from being part of the natural order of things, are rooted in a social history. It is, after all, people who organize, use, an allocate the benefits of natural and social resources, and the value they assign to land depends on the larger set of social relations that organize property rights and labor. […] How did land become “scarce”? […] Who profited, who lost, and what difference did the flow of rents make to New Yorkers’ understanding of their social responsibilities within a shared landscape […] The myth that celebrates a real estate deal as New York’s primal historical act lends an aura of inevitability to the real estate market’s power to shape the city landscape and determine the physical conditions of everyday life. New Yorkers today live in the shadows of deals that have produced the glitter of Trump Tower, the polished facades of renovated brownstones, and the shells of abandoned buildings. These shadows especially darken the paths of those who are getting a bad deal: the more than 50,000 people who have been displaced onto the city’s streets and sleep in doorways, subway stations, railroad terminals, or temporary shelters. Contemporary politicians invoke this landscape of light and shadows to point to the contradictions of of our time: a city that can indulge extravagant displays of wealth cannot afford to house its people.”

(Blackmar 1989: 1, 12)

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Debates over the high market value of real estate and the unaffordable price of housing occupy a constant place in the public spheres of the major cities of the world, especially in those where land is already a very scarce factor and vertical, intensive urban development takes place in the form of tall buildings, towers and skyscrapers. However, historical perspectives on the real estate and housing markets are for the most part lacking in these discussions. In their paper, Jason Barr, Fred Smith and Sayali Kulkarni attempt to fill the gap for New York City, a capital of capital like no other, to borrow from the title of the book by financial historian Youssef Cassis (Cassis 2007). In their work, published in NEP-HIS 2015-04-11, the authors develop a land value index between 1950 and 2013 in Manhattan, the island that defines the Big Apple like no other borough does.

According to the deflated value of their index, the real value of real estate in Manhattan since 1950 has increased at an (otherwise impressive) average annual growth rate of 5.1%. The authors identify three long cycles: the first one, 1950-1977, roughly coincided with the golden era of Western capitalism, a skyscrapers boom and the demise of urban industries; the second one, 1977-1993, began with the consequences of white flight to the suburbs and fiscal crises in the city and lasted until the financial Big Bang of the late 1980s and early 1990s; and the third one, 1993-2007, manifested the impact of financialization of the U. S. economy, the rise of Manhattan as a services powerhouse, and the emergence of New York as a truly global city, in the sense proposed by the sociologist Saskia Sassen (Sassen 2001).

View of Manhattan from Top of the Rock Observation Deck, Sunday, May 20, 2012, 5:13 PM EST. A gift from the author to the loyal audience of the NEP-HIS blog.

View of Manhattan from Top of the Rock Observation Deck, Sunday, May 20, 2012, 5:13 PM EST. A gift from the author to the loyal audience of the NEP-HIS blog.

The authors go through the methodological problems of developing a land value index. The first problem has to do with whether one assesses the value of undeveloped land or whether one incorporates the constructions on it. The second problem is that of using either market prices or assessment of values for taxation purposes, for example. A third problem derives from the divergence of market prices and assessed values, a divergence which is considerable in the case of New York City during this period.

Continue reading

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The Neoliberal Model is not Sustainable but State Driven Models have not Proven to be Any Better: How About We Just Redistribute the Wealth?

State Versus Market in Developing Countries in the Twenty First Century

by Kalim Siddiqui (University of Huddersfield)(k.u.siddiqui@hud.ac.uk)

Abstract:
This paper analyses the issue of the state versus the market in developing countries. There was wide ranging debate in the 1950s and 1960s about the role of the state in their economy when these countries attained independence, with developing their economies and eradicating poverty and backwardness being seen as their key priority. In the post-World War II period, the all-pervasive ‘laissez-faire’ model of development was rejected, because during the pre-war period such policies had failed to resolve the economic crisis. Therefore, Keynesian interventionist economic policies were adopted in most of these countries.

The economic crisis in developing countries during the 1980s and 1990s provided an opportunity for international financial institutions to impose ‘Structural Adjustment Programmes’ in the name of aid, which has proved to be disastrous. More than two decades of pursuing neoliberal policies has reduced the progressive aspects of the state sector. The on-going crisis in terms of high unemployment, poverty and inequality provides an opportunity to critically reflect on past performance and on the desirability of reviving the role of the state sector in a way that will contribute to human development.

URL: http://econpapers.repec.org/paper/peswpaper/2015_3ano96.htm

Revised by: Stefano Tijerina (University of Maine)

This paper was distributed by NEP-HIS on 2015-04-19. In it Kalim Siddiqui indicates that the global economic crisis that began in 2007 “provides an opportunity” to reconsider Keynesian interventionist models, thus “reviving the role of the state sector” for purposes of protecting the interests of the majority. Siddiqui centers his argument on the modern economic development experiences of the developing world, juxtaposing it with the experiences of advanced industrialized nations. He particularly emphasizes the economic development experiences of the United States and the United Kingdom, in efforts to advance the argument that Keynesian interventionist policies and protectionist agendas are instrumental in securing a transition into advance industrialization. He argues that the developing world needs to experience a similar transition to that of the UK and the US in order to achieve similar levels industrial competitiveness. However the neoliberal discourse promoted by the industrial powers and the multilateral system after World War Two, and the implementation of neoclassical liberal policies after the 1980s, impeded the developing world from moving in the right direction.

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Siddiqui begins the construction of his argument by providing a brief history of the modern economic development patterns of both the UK and the US. This lays the foundation for his main argument that developing nations should return to the Keynesian patters of economic development in order to achieve advanced levels of industrialization that will eventually allow them to correct present market failures, reducing unemployment, poverty, and environmental degradation.

He points out that in the 1970s and 1980s the UK and US moved away from interventionist policies and adopted a neo-classical model of economic development in response to “corruption, favoritism, and other forms of self-seeking behavior,” that lead to the economic crisis of the times. This model would then be promoted across the international system by the economists of the World Bank and the IMF who found in the same neo-classical model an explanation for the failed Import Substitution Industrialization (ISI) policies implemented across the developing world to cope with the crisis of the 1970s and 1980s.

Kalim Siddiqui

Kalim Siddiqui

What Siddiqui does not address is that the failure of the implementation of the ISI policies across the developing world were the direct result of the same corruption and self-centered tendencies of leadership that forced a move away from interventionist policies in countries like the UK and the US. I agree with Siddiqui that the structural changes introduced by the multilateral financial agencies did more damage than good, however I disagree with his idea that the developing world should return once again to Keynesian solutions, since the implementation of these structural adjustment programs were in fact forms of interventionism that catapulted most of these economies into debt.

Siddiqui then lays down a series of reasons why the role of the state should be reconsidered across the developing world, highlighting that greater interventionism would be more beneficial than an increasing role of the market system. He uses the recent success stories of state driven capitalist experiments such as China’s, Brazil’s, India’s, and Malaysia’s, disregarding the fact that these state driven models continue to be tainted with problems of corruption and self-rewarding management styles that are inefficient and wasteful. For example, he points out the success of Petrobras in Brazil, not following up on the fact that the state-run oil company is now under investigation for high levels of corruption that has sent its stock price in a critical downward spiral.

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At the end Siddiqui’s argument is debunked by more contemporary realities; including decreasing global unemployment patters, economic recovery, and the downfall of state run economies such as those that moved to the Left in Latin America during recent times. Moreover, the bailout policies implemented by the United States and the European Union during the peak of the latest financial crisis contradicts Siddiqui’s argument that neoliberal economies “do not countenance any economic intervention by the state.” I argue that interventionism is an integral part of the advancement of neoliberal agendas; the question that Siddiqqui should be asking is what degree of interventionism is ideal for the developing world under a global neoliberal reality that is inevitable to avoid?

Siddiqui’s work represents yet another criticism to neoliberal capitalism, centering on the agendas set by the administrations of Margaret Thatcher and Ronald Reagan in the 1980s. It does not provide a convincing method or strategy for reviving state driven capitalism under an increasingly intertwined global economic system. It is rich in criticism but short of offering any real solutions through state interventionism. Current case studies that have returned to interventionist models, as in the case of Brazil or India, have failed once again to resolve issues of poverty and income inequality. I agree with the author’s conclusion that the implementation of neoliberal models across the developing world has distorted inequality and social justice even further but disagree with the simplistic solution of increasing state interventionism in the management of market driven economies for the sake of it. More so when the historic evidence indicates that the leadership across the developing world has consistently pursued self-interests and not the interests of the masses. From my point of view, the revival of interventionist models across the developing world will just complete the vicious cycle of history one more time, particularly now that the interests of private global actors has permeated the internal political economy decision making processes of the developing world. If in the early stages of the modern economic development of the developing world foreign political and business interests directly and indirectly penetrated local decision making, thanks in part to the intervention of the World Bank and the IMF as it was pointed out by Siddiqui, then it is inevitable to impede such filtrations under a global system, unless the nation state is willing to pay the high costs of isolationism.

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Siddiqui indicates that self-marginalization from the market system worked for the UK and the US, allowing them to strengthen their internal market and generate the technological and human capital capabilities necessary for advanced industrialization, but that was more than one hundred years ago when the globalization of the market had not reached the levels of sophistication of today. If these industrial powers were to try this same experiment today, the outcome would have been very different. In the past decade developing nations such as Venezuela, Argentina, Bolivia, and Ecuador have experimented with Siddiqui’s model and the results have been no different than the old experiments of Import Substitution Industrialization and other interventionist approaches of the post-Second World War Two era. Corruption, political self-interest, lack of internal will to risk investment capital, lack of infrastructure, lack of an internal sophisticated consumer market, the absence of technology and energy resources, and the inability to generate short-term wealth for redistribute purposes in order to guarantee the long-term projection of the interventionist model has resulted in failed revivals of the Keynesian model. It is the reason why Cuba is now willing to redefine its geopolitical strategy and reestablish relations with the United States; clearly the interventionist model is and was not able to sustain a national economy under a market driven international system.

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The solution lies inside the market system. It is futile to denigrate neoliberalism unless the developing world leadership is willing to construct a parallel market system, as once envisioned by Hugo Chavez, but we are far from that reality. Instead each nation state should reevaluate its wealth distributive and resource allocation policies, moving away from defense spending and refocusing on infrastructure, technology, human capital, health, and the construction of a solid and self-sustainable middle class. Van Parijs’s pivotal work, Real Freedom for All speaks to this idea, indicating that the solution to securing policies that center on what Siddiqui calls the majority, lies in capitalism and not in socialism. If, through a more equal distribution of capital across all sectors of society, capitalism is able to outperform any socialist or interventionist model, then there is no need to attack capitalism and its neoliberal ideas. A replication of this model across the developing world would boost economies into a more sophisticated level of economic development. More competition among states’ private sectors would lead to a more efficient international system, a dynamic that would be enhanced even further by less and not more government intervention. However, the current realities pointed out by Siddiqui indicate that political and corporate elites are not willing to redefine their views on capitalism and therefore we need greater government intervention for redistribute purposes. The redistribution of the pie is the only way to avoid Marx’s inevitable revolution, I agree with Siddiqui. But I do not trust the role of the state as a redistributive agent. I am more in favor of what Michael Howard calls “basic income capitalism” that secures sustainable expendable income in the hands of all consumers through the market system. The dilemma of interventionism continues to be at the forefront, yet it could easily be resolved by the market itself, as long as the actors, workers and owners of capital, are willing to redefine the outreach and potential of capitalism; as long as the social construction of freedom of capital is redefined?

References

Michael W. Howard, “Exploitation, Labor, and Basic Income.” University of Maine (work in progress).

Kalim Siddiqui, “State Versus Market in Developing Countries in the Twenty First Century,” Institute of Economic Research (working paper), submitted at VIII International Conference on Applied Economics, Poland, June 2015, p.1.

Van Parijs, P. Real Freedom for All: What (If Anything) Could Justify Capitalism. Oxford: Oxford University Press, 2005.

Does Technological Progress Lead to more Human Capital Formation? Evidence from the French Industrial Revolution

The Complementarity between Technology and Human Capital in the Early Phase of Industrialization

By Raphael Franck (Bar-Ilan University and Brown University, raphael.franck@biu.ac.il) and Oded Galor (Brown University, Oded_Galor@brown.edu)

URL: http://d.repec.org/n?u=RePEc:bro:econwp:2015-3&r=his

Abstract

The research explores the effect of industrialization on human capital formation. Exploiting exogenous regional variations in the adoption of steam engines across France, the study establishes that in contrast to conventional wisdom that views early industrialization as a predominantly deskilling process, the industrial revolution was conducive for human capital formation, generating broad increases in literacy rates and education attainment.

Review by Natacha Postel-Vinay (University of Warwick)

While human capital is often thought to be at the root of any development process, early industrialization itself is often thought to be de-skilling. Images of children working long hours executing repetitive tasks usually come up when one thinks of the Industrial Revolution (Humphries, 2010). Yet there is also the idea that industrial and technical development might lead to a greater need for skilled labour to maintain, fix and adapt new machinery. In this case industrial development might lead to a greater supply of schooling and might result in significant human capital improvements. Focusing on early French industrialization in a recent working paper (distributed by NEP-HIS on 2015-05-02), Franck and Galor attempt to demonstrate just this.

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Steam engine from Lille (Nord departement)

Making use of data from the 1840s, the authors find a positive correlation across French departements between the number of steam engines and human capital indicators such as the share of literate conscripts, the share of pupils in the population, and the number of teachers (which would be more suggestive if also set relative to population). This correlation is best illustrated in a series of shaded maps (Figure 3), although the strikingly high levels schooling and literacy in the north-eastern part of France remain to be explained. Of course, correlation does not necessarily imply causation: it may be that other factors caused both the number of steam engines and the number of teachers to increase in certain areas, which could render any relationship between the two fortuitous.

Figure 3 in Franck and Oded Galor (2015).

Figure 3 in Franck and Oded Galor (2015).

To tackle this endogeneity problem, the authors make clever use of the fact that the first steam engine was introduced in 1735 in Fresnes-sur-Escaut in the Nord departement, near the northern tip of France. Since technology diffusion can be reasonably assumed to occur first around the region where the new technology was first introduced (which was indeed the case), it seems possible to use each departement’s distance from Fresnes-sur-Escaut as an instrument in the regression. In the first stage of the regression, they successfully show that the shorter a departement’s distance from the first steam engine location, the larger the number of steam engines in the departement, which seems quite reasonable.

To prove the exogeneity of the instrument, the authors have to show that human capital formation was not higher closer to the first steam engine location. This is trickier. To support their case, Franck and Galor investigate the relationship between distance from Nord and economic development indicators from around 1700, such as urban population, literacy rates and university location. They find that there is no correlation (although this may be surprising in light of Figure 1). More importantly, human capital may be quite imperfectly captured by these indicators in the pre-industrial era, when human capital may have developed in ways that are quite difficult to measure: through the transmission of skills from masters to apprentices, or learning-by-doing. It has often been shown that there was no clear relationship between technological progress and literacy rates in the early modern era (Mitch, 1999). Accordingly perhaps more detail should be provided in the paper as to why the steam engine was first introduced in this region and not elsewhere.

Figure 1 in Franck and Galor (2015)

Figure 1 in Franck and Galor (2015)

Which brings me to a broader point about the paper. Although its stated aim is to investigate the causal relationship running from technological progress to human capital formation, causality could run the other way around. Although endogeneity issues are explicitly addressed in the paper from (and confounding factors such as land suitability, rainfall, access to waterways, distance from Paris, and market integration duly controlled for), the specific problem of reverse causality is not explicitly dealt with in the text. Reassuringly the IV model should theoretically take care of reverse causality, but the authors could still discuss this possibility in more detail.

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Boys at school in Nord departement in the 19th c.

Overall though, Franck and Galor rather successfully tackle a very important and highly complex aspect of industrialization processes. By showing that technological improvement led to advances in human capital accumulation, these results in turn trigger a number of questions. Through which mechanism did industrialization lead to better schooling and literacy rates? Was the process demand-driven? Or did parents’ higher wages mean that children no longer had to work to help the family? Finally, could child labour abuse in factories have led to local initiatives to promote schooling? This latter hypothesis is discussed by Weissbach (1989), who emphasizes a particularly strong will to change the status quo in Alsatian and nearby regions — which could partly explain the greater spread of schooling in this part of France. Such inquiries could be the subject of fascinating future research.

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Children in a textile factory in 19th c. Provence

References

Humphries, Jane. 2010. Childhood and Child Labour in the British Industrial Revolution. Cambridge: Cambridge University Press.

Mitch, David. 1999. “The Role of Education and Skill in the British Industrial Revolution.” In Joel Mokyr, ed., The British Industrial Revolution: An Economic Perspective, 2 ed. Boulder, nd CO: Westview Press, pp. 241–79.

Weissbach, L. S. 1989. Child Labor Reform in Nineteenth Century France: Assuring the Future Harvest. Louisiana State University Press.

Help or Hindrance? Business and Welfare Policy Formation

Bringing Power Back In: A Review of the Literature on the Role of Business in Welfare State Politics

by Thomas Paster (Central European University and Max Planck Institute) (thomas.paster@eui.eu)

URL http://d.repec.org/n?u=RePEc:zbw:mpifgd:153&r=his

Abstract What is the impact of business interest groups on the formulation of public social policies? This paper reviews the literature in political science, history, and sociology on this question. It identifies two strands: one analyzes the political power and influence of business, the other the preferences and interests of business. Since the 1990s, researchers have shifted their attention from questions of power to questions of preferences. While this shift has produced important insights into the sources of the policy preferences of business, it came with a neglect of issues of power. This paper takes a first step towards re-integrating a power-analytical perspective into the study of the role of business in welfare state politics. It shows how a focus on variation in business power can help to explain both why business interest groups accepted social protection during some periods in the past and why they have become increasingly assertive and averse to social policies since the 1970s.

Reviewed by Mark J Crowley

Summary

This paper was circulated by NEP-HIS on 2015-04-19.  It is a meticulously review of a topic that is now becoming a subject of major debate in the developed world’s political culture.  At a time of austerity and belt-tightening in much of the western world in response to the economic crises of recent times, the welfare state has been targeted as an area where potential savings could be made, prompting arguments that the construct itself has become the scapegoat of austerity. Much of the attention in the recent literature on the welfare state has examined the political and social considerations behind the formation of a welfare system and its reform.  This paper hones in on an aspect that has received less attention: the role of business in the formation of welfare state policy.  Although there is still significant literature on this topic, the paper manages to draw the current research together into a coherent whole to present numerous interesting theories about the development and role of big business in public policy formulation that will be of interest to historians.

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Paster embeds his argument in the Marxist critiques of the 1970s that claimed much of the decisions concerning the level of influence exercised by business in state affairs depended on their relative power and individual preferences.  He cites the fact that the state’s dependence on private business for capital does give the latter, by default, a greater level of influence over public policy.  Furthermore, with the development of Marxist theory in the 1980s with the rise of Conservative policies, especially Thatcherism in the UK and Reagan’s economics in the USA, the ‘varieties of capitalism’ approach has led scholars to examine the development and evolution of the welfare state from a different perspective.  Many have now seen a link between the influence of business preferences and the level of support offered to policy options concerning welfare reform.  Moreover, the growth of interest groups in response to the increased size of the state has seen more actors playing a part in the negotiations of public policy, particularly state welfare.

Paster outlines how much of the literature has focused on the nature of power dynamics within the business community, and its relative influence over public policy.  In many nations, leaders of corporations form a major part of the power elite. It could be argued that this was why, in many developed nations there was significant opposition to the legislation proposed for a national minimum wage for low paid workers, primarily owing to the increased costs that this would bring.  This could also have influenced the greater outsourcing of work, primarily service-based industries and call-centre work to nations such as India.  Furthermore, he outlines how there is evidence that during times of economic difficulty, both the public and business are reluctant to see greater state intervention, and that a more cautious approach does led to a relative neglect in the nature of welfare provision for the most vulnerable in society.

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One of the most interesting arguments articulated by Pester in this paper is how big businesses prefer to increase the level of skills among its workforce as a means of protecting against future unemployment.  The argument focuses on how business leaders believe that highly-trained workers, in the event of finding themselves unemployed, would then be easily able to find alternative employment owing to their skills, thus reducing dependency on the state.  This has become more important with globalisation and the internationalisation of the economy.  Yet despite the growing importance of international trade, and the growing economic relationship with not only European countries but developing nations, this has also brought pressure on the development of coherent policies to assist workers.  While the idea of policy transfer could be regarded as positive, with nations comparing its social policy and potentially embracing new ideas in the aim of improving life for its lower paid citizens, international trade has also brought about increased regulation, thus increasing the influence of both businesses and the state over the development of public policy.  This, therefore, is a double-edged sword which carries numerous positive elements but also several complicating factors.

Critique  

This paper is very strong.  It shows a deep understanding of many of the issues concerning public policy development in many European countries, and the USA in the twentieth century.  In focusing on the role of big business in policy considerations, it approaches the issue of welfare reform and development from an interesting angle.

My observation on this paper would be that perhaps in trying to compare so many nations in one short article, perhaps the author is seeking to do too much.  In much of the comparative literature on the welfare state (albeit not from a business perspective) authors seek to compare two nations.  This paper has a much wider remit.  Furthermore, although the primary focus of this paper is on the role of business in the discussions concerning welfare state policy, I do feel that maybe it could benefit from some additional information, maybe only a paragraph or two, to help set the context.  The political culture concerning state welfare is different in each of the countries examined in the research.  The motivations and the political responses to the original formation of the welfare state were different among the respective politicians.  For example, it could be argued that in Britain, the earliest advocate of the welfare state in the government, Prime Minister Benjamin Disraeli, did so because of his fear that if there was no provision for the working-class, it could result in a revolution.  For the USA, the growth in welfare programmes came much later with the development of Roosevelt’s new deal.  Furthermore, the development of such policies in a very politically-conservative nation was ravaged with difficulties.  For the British case in particular, I would encourage the author to consult the numerous works of Pat Thane on the topic, which place the formation of the welfare state into the wider political and international context.  While this is only a minor criticism of an extremely well-researched paper, placing this paper in the wider political context would help strengthen the argument and highlight even more the significance and value of this research to the wider academic community.

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References

Baldwin, Peter, The Politics of Social Solidarity: Class Bases and the European Welfare State 1875-1975 (Cambridge: Cambridge University Press, 1990).

Thane, Pat (ed.) The Origins of British Social Policy (London: Croom Helm ; Totowa, N.J.: Rowman & Littlefield, 1978).

Thane, Pat, The Foundations of the Welfare State, (Harlow: Longman, 1982).