Don’t bet on a real appreciation of the renminbi

It rarely happens, but Scott Sumner and I do sometimes disagree on something.

Not surprisingly this time it is on a (mostly) non-monetary matter – the long-term outlook for the Chinese economy.

In my recent post I argued that China might NEVER become the largest economy in the world. Scott – a self-proclaimed Sinophile – strongly disagree with my claim. Here is Scott:

I have several problems with this argument.  First, if Lars really feels PPP is wrong, and that we should use nominal figures, then he should not be talking about China having recently grown at 7 to 7.5% per year.  In PPP terms China may have been growing at 7.5% vs. 2% in the US, but in nominal terms the gap is far wider, due to the Balassa-Samuelson effect.  China’s real exchange rate has appreciated strongly over the past decade.  So if Lars is right that nominal exchange rates are the right test, then China’s been catching up to the US at a rate far faster than either Lars or I assume. And in that case China’s nominal growth could slow dramatically and yet still be growing far faster than the US (where trend NGDP growth is now about 3%, in my view.)  Lars avoids this problem by assuming the Balassa-Samuelson effect will suddenly come to a screeching halt, whereas I think the yuan is headed to 4 to the dollar.  He also assumes a 3% RGDP growth rate for the US, whereas I believe it will be closer to 1.2%, growing over time to perhaps 2% in a few decades.

Other than it is a bit paradoxical that Scott aka Mr. NGDP is so eager to dismiss using nominal terms rather than real terms when it comes to comparing the absolute size of an economy the real disagreement comes down to whether there is a Balassa-Samuelson effect or not. According to the the BS effect relatively poorer countries – such as China – will see its exchange rate appreciate in real terms relative to richer countries such as the US.

In my China-post I assumed that there was no BS effect – and that the relative exchange rate between China and the US in the future would be determined by the Purchasing Power Parity (PPP). This assumption of course means that there is no difference whether we use real or nominal growth rates in GDP when comparing the relative size of the Chinese and the US economy (both measured in US dollars).

I acknowledged in my post that my no-BS effect assumption was a bit brave and I would happily agree that there is nothing theoretically wrong with the Balassa-Samuelson effect. However, I would also say that having worked professionally with forecasting Emerging Markets currencies for nearly 15 years I would be extremely skeptical about its importance of it from an empirical perspective. I will return to that below.

Scott often argues that the markets is the best thing we have to predict the future. I strongly agree with that. Despite of that Scott makes a bold prediction on the outlook for the Chinese renminbi.

Hence, Scott not only predicts a real appreciation of the renminbi, but he also argues “I think the yuan is headed to 4 to the dollar” – hence significant nominal appreciation.

That is an extremely bold prediction given USD/CNY today is trading around 6.15. Said in another way Scott is basically predicting a 50% appreciation of the renminbi! This is in direct contrast to what the markets are predicting. If we for example are looking at a 1-year forward for USD/CHY the market is now predicting around 2% depreciation of the renminbi. So we should ask Scott – do you believe markets are efficient or not?

A look at South Korea and Taiwan tells us we should not expect Chinese real appreciation

There is also another way to think about whether or not we will see a real Chinese appreciation or not in the coming decades and that is by looking at the experience of similar countries. China’s transition and its catching-up process is often compared to South Korea and Taiwan. Therefore, I have looked that the historical development in in the South Korean won and Taiwan dollar.

I have chosen 1990 as my “reference year”. The reason is that at that time South Korea’s and Taiwan’s GDP/capita relative to the US were more or less where Chinese GDP/capita is today compared to the US.

Lets first have a look at South Korea.

Real won.jpg

The first thing we see it that PPP seems to have been a pretty good “predictor” of the long-term development in the won over the long-term. I have calculated PPP based on the relative development in the GDP deflators in South Korea and the US.

But lets return to the question of real appreciation. Has there been a real appreciation of the won (against the dollar) since 1990? The answer is NO. In fact there has been a slight depreciation of the won in real terms.

But of course South Korea went through a major crisis in 1997 so it might be special. So lets instead look at Taiwan.

real TWD

Guess what? Since 1990 the Taiwan dollar has actually depreciated significantly in real terms against the US dollar. Maybe exactly because it has appreciated in the years ahead of 1990.

No matter the reason both the Taiwanese and the South Korean experience tell us that real currency appreciation is no given or automatic part of the catching up process for economies like South Korea, Taiwan or China.

A closer look at the renminbi’s recent real appreciation

In his comment Scott makes the following comment China’s recent appreciation of the renminbi:

“China’s real exchange rate has appreciated strongly over the past decade”

The graph below shows that Scott’s claim is correct.

Real CNY

But the graph also shows that the renminbi was more or less flat against the dollar in real terms from the early 1990s until 2005-6. Hence, we had at least 15 years of economic catch-up without any real appreciation of the CNY at all. Hence, again it is fair to argue that real appreciation does not automatically follow from economic catch-up. The period from 1990 to 2006 shows that quite clearly.

Furthermore, we want to ask ourself whether the real appreciation over the past decade really is a result of economic transition and catching up or something else. Hence, it is quite clear that over this period the People’s Bank of China have tried to curb inflationary pressures by undertaking a managed strengthening of the renminbi against the dollar – both in nominal and real terms. That process might now be coming to an end as the Chinese economy has slowed rather dramatically and inflationary pressures clearly have eased as well – particularly since 2011-12.

Finally let us again return to the examples of South Korea and Taiwan. The graph below shows the real exchanges of South Korea, Taiwan and China (against the US dollar). ‘Year zero’ is 1990 for South Korea and Taiwan, while ‘year zero’ is 2014 for China. Hence, the graph is “calibrated” so all three countries are at a similar income level versus the US in ‘year zero’.

Real KRW TWD CNY

 

I think the graph is quite telling – the appreciation of the renminbi over the past decade has been fairly similar in size to the appreciation in the in won and the Taiwanese dollar in the decade ahead of 1990. However, as also illustrated above that real appreciation didn’t continue. In fact a decade later both KRW and TWD had depreciated more than 10% in real terms against the US dollar.

This of course is not a prediction for what will happen – it is just an illustration that based on the experience of Taiwan and South Korea there is no reason to expect continued real appreciation of the renminbi.

So my message to Scott is – don’t bet on a real appreciation of the renminbi!

PS Scott uses the term yuan and I here have used the term renminbi. Renminbi is the official name for the Chinese currency and yuan is the main unit of currency.

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China might NEVER become the biggest economy in the world

It is often assumed that given China’s remarkable growth rates over the past three decades – around 10% real GDP per year – China is on the way to soon becoming the largest economy in the world. In fact earlier this year it got a lot of media attention that when the World Bank argued that China already had overtaken the US as the largest in economy in the world. However, the argument was completely bogus as it was based on Purchasing Power Parity (PPP) rather than on actual exchange rates (To be fair we should blame the media rather than the World Bank for this interpretation of the data).

PPP based measures of GDP (per capita) might make sense if we want to measure how much an average citizen can buy for given an average income, however, it does not make sense when we want to measure the size of the economy. There we have to use measures based on actual exchange rates and if we do that then it turns out that the Chinese economy is still significantly smaller than the US economy. Hence, total Chinese GDP today is around 10 trillion USD, while US GDP is around bn 17-18 trillion USD. Said in another way the US economy is still nearly double the size of the Chinese economy.

And what I will argue in this post is that China might never overtake the US as the biggest economy in the world.

Chinese growth set to slow dramatically in the coming decades

There is a broad consensus among long-term macroeconomic forecasters that the Chinese economy is likely to slow significantly in the coming quarters – starting today!

There are overall three reasons why this is the case:

1) The catching-up process means less and less: A very large part of China fantastic growth performance over the past three decades is due to a “natural” catching up process. When poor economies – like the Chinese economy three decades ago – is freed up a catching up process is started. This means a lot for low-income economies, but as income levels increase the catching up process slows down. This is already the case for China.

2) Investment growth is likely to slow significantly: Fixed investments as share of GDP in China is extremely high – well above 40% of GDP. This is at least 10-15 %-point more than in other countries with a similar GDP/capita level. This to some extent reflect capital misallocation in the Chinese economy as investment decision in the Chinese economy to a large extent still is a result of quasi-central planing. It is therefore natural to expect investment growth to slow quite significantly in the coming decades.

3) China is facing serious demographic challenges: You can blame the Communist Party’s one-child policy or come up with other explanations but the fact is that the Chinese labour force is now already in decline and the decline will continue in the coming decades and soon the Chinese population will be in outright decline.

So from a growth-accounting perspective we have it all – less Total Factor Productivity growth – as the catch-up process slows, a slower increase in the capital stock and finally a declining labour force.

It is therefore hardly surprising that most long-term forecasts made for the Chinese economy forecast a rather significant slowdown in Chinese growth in the coming decades (See for example here.)

Closing in on the US, but China might never make it

It is commonly argued that trend growth presently is around 7-7.5% in China, however, it is equally common to argue that we will see a slowdown in real GDP growth to an average of around 5-6% in the coming 10-15 years. But the real slowdown comes after 2030 where the Chinese economy is expected by most long-term forecasters to start to approaching Japanese style growth rates and outright negative trend-growth should not be ruled out in the 2050s based on reasonable expectations about demographics, the investment ratio and the catching-up process.

Obviously it is difficult to make any macroeconomic forecasts. However, I would actually argue that it in many ways it is easier to make forecast 10-20 years ahead than 1-2 years ahead. When we do short-term forecast the shocks will always mess up our forecasts, but over a 10-20 years horizon the positive and negative shocks tend to even out. Furthermore, in the long-run it is all about supply side factors and with the growth rate of the labour force being a major factor we already know quite a bit. Hence, we have a pretty good idea about the growth of the Chinese labour force in 15-20 years as the people entering the labour force as young adults in 15 or 20 years already have been born.

I have gone through a number of studies of the long-term growth perspectives for the Chinese economy and based on that we can make a simple “simulation” of how the level of Chinese real GDP will develop from now and until 2060. I should stress it is not a forecast as such and lets therefore just stick with the term “simulation” of future Chinese real GDP under reasonable assumptions about the development in technology and in productions factors.

The graph below illustrates my argument that China might never overtake the US as the largest economy in the world. Here is my assumptions (and they can certainly debated, but they are not much different from the “consensus” forecasts for long-term growth in China and the US). I assume that trend real GDP growth in China over the next 15 years will be 6% – slowing from presently 7.5% to 4.5% in 2030. Hereafter the negative demographics in China really kick in and as a result trend growth drops to an average of just 2% for the period 2030-2060.

I have indexed Chinese real GDP at 55 in 2014 – reflecting that Chinese GDP (in USD) is around 55% of US GDP. In my simulation I have assumed that US trend real GDP growth is 3%. This is probably slightly optimistic compared to the “consensus” among long-term forecasters, but it is basically the growth rate we rather consistently have seen in the US economy since the early 1960s. The American demographic challenges are somewhat smaller than is the case for China and I find it rather likely that the US gradually will adjust immigration policies so meet these challenges (I certainly hope so…)

It is important to stress that I here assume that the there is no real appreciation or depreciation in the USD/RMB exchange rate (no Balassa-Samuelson effect). Hence, the exchange rate development is determined by relative inflation in the US and China. This might twist the results slightly against China. On the other hand I have also assumed that the output gap is zero in both countries. In fact the output gap in the US is still negative, while the output gap in China likely is close to zero or even positive. This twists the results against the US. Lets just (completely unreasonably) say that these factors even out each other.

China will NEVER catch up

So there you go. You see under these – simplistic – assumptions the Chinese economy will continue to gain on the US economy over the next two decades. However, under these assumptions (and I again stress it is assumptions) it will be close (around 90%), but no cigar for the Chinese economy – the Chinese economy will never be the largest economy in the world – or at least not in my life time and I do plan to live to at least 2060.

Furthermore, starting around 2040 China will stop catching up and instead see its economy decline relative to the US and in 2060 we will be more or less back where we started with Chinese GDP being around 60% of US GDP.

Now you might say that these results are too negative in terms of China or too positive in terms of the US and that might very well be the case. However, I do think that my simulations illustrate that China is not automatically set for global economic and financial domination. So while China – for a period – might become a bigger economy than the US – if we for example assumption 2.5% US trend growth rather than 3% – the negative demographics will start to kick in soon and that will ensure that the US economy will remain the biggest economy in the world – also in 50 years. This also means that it is quite hard to imagine in my view that the “financial centre” of the world will move to China and I find it extremely hard to imagine that the Chinese renminbi will take over of the role as the leading reserve currency of the world from the US dollar.

But there is no reason to cry for the Chinese

So China might never become the biggest economy in the world. However, that should really not be important for the Chinese. It might be for Chinese policy makers, but the average Chinese should instead celebrate the fact that outlook for his/her income level remains very bright and income growth for the individual Chinese is likely to remain very high in the coming decades. So the discussion above should not really be seen as being “bearish” on China. In fact I am rather optimistic about the Chinese “miracle” continuing in the coming decades. We should celebrate that, but we might never be able to celebrate the day the Chinese economy overtakes the US in absolute size.

Guest post: What an Enlightened Immigration Policy Would Look Like (Nathan Smith)

Guest post: What an Enlightened Immigration Policy Would Look Like

-By Nathan Smith

Lars suggested that I follow up on my guest post about the global economic impact of open borders, with some policy advice about what advanced nations ought to be doing. Maybe that sounds like a short post blog. Mustn’t an open borders advocate’s advice on immigration policy be simply… “Do nothing”? Send the employees of ICE and USCIS home. Stop checking passports at the airport. Lay off the State Department’s consular officers. Fire the Border Patrol. Laissez faire.

Well, no, it’s not quite that simple. Being a sort of Burkean conservative, I prefer, even when justice ultimately demands a radical departure from the status quo, to arrive at justice by a path of gradualism and compromise. I prefer to leave traditional privileges intact as much as possible, and not to make anyone worse off than he is accustomed to be. That said, the moral law prohibits certain actions, and governments today do many things in the name of immigration enforcement that are morally impermissible, things which have the moral character of crime. For example, the US government separated an estimated 1 million family members by deportation in 1997-2007. Governments must recognize that absolute control over who resides in their territory, which the hubris of the 20th-century state has claimed as part of “sovereignty,” cannot be achieved by morally permissible means, and must be abdicated.

But first, what would an efficient immigration policy look like? The slogan Don’t restrict immigration, tax it (DRITI) expresses the core of my answer to this question, and I use “DRITI” as the umbrella term for policy proposals in Chapter 9 of my book (also see here).

It was in 2006 that I first published the idea of taxing rather than restricting migration. For an economist, it is rather obvious. The standard prescription in trade policy is to embrace free trade, and if you’re concerned about the fate of people in import-competing industries, tax the winners to compensate the losers. This works even better in the case of migration, because one major group of winners—the immigrants themselves—is easily identifiable and has a distinctive legal status. Many, including Richard Vedder and Gary Becker, have proposed replacing arbitrary bureaucratic discretion with an explicit pricing mechanism as a means of regulating migration. An economist cannot but be appalled at seeing decisions highly consequential for individuals’ lives being made on the basis of meaningless criteria such as (to quote USCIS) whether “there are insufficient available, qualified, and willing U.S. workers to fill [a given] position at the prevailing wage.” Other advanced nations, too, try to tailor migration to meet specific labor market needs, as if they were Gosplan. Some sort of price mechanism is obviously the rational substitute. I compared these proposals in an Open Borders: The Case blog post, “Auctions, Tariffs, and Taxes,” but I am convinced that Vedder’s and Becker’s proposals are suboptimal and mine is the best approach.

I plan at some point to estimate numerically the economic consequences of adopting DRITI in the US or the UK, but for the moment, I can only offer back-of-the-envelope calculations. Suppose the USA adopts DRITI, and 200 million immigrants arrive. They pay an average $10,000 of migration taxes per annum. The US government receives $2 trillion annually in migration tax revenue, enough to finance an average transfer of about $7,000 per US citizen. Since the 2012 poverty line for a family of four (in the 48 contiguous states and DC) was $23,050, DRITI could, under this scenario, eliminate “poverty,” in the official sense of that word, among US natives. For the UK, a Gallup poll finds that at least 45 million want to emigrate there. If they came, and paid an average of ₤6,000 per person per year in migration taxes, these revenues could finance an average of ₤4,500 in extra transfers, tax cuts, and public services per British citizen.

In addition to migration taxes and transfers to natives, my plan would have a forced saving aspect to it. Money would be deducted from migrants’ paychecks, and deposited in savings accounts, from which it could only be withdrawn, by the migrant, on the physical territory of his or her home country. If not withdrawn, these savings would accumulate up to a certain threshold, say $50,000 or ₤30,000, at which point the migrant could apply for citizenship, at the cost of forfeiting their forced savings.

Migrant savings accounts serve two purposes. First, they would channel more of the gains from freedom of migration into lifting poor countries out of poverty, by encouraging many migrants to go home, bringing with them the skills, savings, connections, and new social norms and values they’ll gain as sojourners in more advanced countries. Second, it should help to allay rich countries’ fears about their institutions being “swamped.” Migrants would only vote after first showing their value to the host country by earning money in it, then showing by a financial sacrifice the value they place on citizenship in it. The new citizens could be expected to be disproportionately skilled, productive, and patriotic for their new homelands.

The world is too complex and random for a criterion like “Pareto improvement” ever strictly to apply, but in rough terms, DRITI would be a Pareto improvement over the status quo. Many natives in rich countries, especially the unskilled, would earn less under DRITI due to competition from immigrants. But lost earnings would be offset by government transfers. Immigrants would presumably be better off, despite the taxes and forced savings, else they would not come. Those who stayed behind in poor countries would benefit from reduced wage competition and the beneficent impact of return migrants and diasporas on capital formation, institutions, and technological diffusion.

But is it just? Under DRITI, citizens and immigrants would be treated unequally. Why should a person receive transfers from the government just because they had the good luck to be born in the US or western Europe? Why should a person have to pay special taxes just because they were born abroad? While that may not be fair, DRITI is clearly fairer than the current system, which excludes most potential migrants altogether. Enormous differences in one’s access to the good life based on the accident of where one was born are one of the most appalling and indefensible features of global capitalism today. DRITI would not eliminate that inequality, but all its impact would be in the direction of mitigating it.

If DRITI is such a good idea, why isn’t it already the law of the land? Why would anyone oppose a policy Pareto-superior to the status quo? For one thing, I believe people are addicted to the border as blindfold. They want the government to keep poverty out of their field of vision so that they can be prosperous in a world full of dire poverty, while feeling morally upright. To mention this motive is to discredit it.

Many also seem to have an odd notion that a nation’s people are morally obligated to take care of people who happen to be physically located on the national territory, but not otherwise, so they can exclude people physically, in order to avoid incurring moral obligations to give them material aid. At Open Borders: The Case, we call this fallacy “territorialism.” I don’t know how to argue against it, since I am not aware of any argument in its favor against which to direct my fire. I regard its falsity as self-evident. But I tried to argue against it indirectly in my 2010 book Principles of a Free Society, by re-exploring the moral and historical foundations of political freedom.

There would be a national security exception to the principle of open borders—terrorist suspects and career criminals may legitimately be excluded, for citizens’ safety—and maybe for carriers of contagious diseases. It is also important to insulate the welfare state from immigration, by making immigrants ineligible for welfare and perhaps various other government benefits. If Milton Friedman really said that you can’t have open borders and a welfare state, it was an uncharacteristic blunder on this part. You can have a welfare state for natives and freedom of migration for foreigners who want to come and work for a living, or possess independent means. But to make open borders fiscally sustainable, rich countries’ governments would probably have to target taxpayer-funded benefits to natives and a few naturalized citizens, and have ways to deny them to most resident foreigners. My DRITI proposal requires immigrants, upon receiving a visa, to make a deposit sufficient to pay for the cost of sending them home if they become destitute.

Under DRITI, deportation would be abolished. Minor exceptions aside, foreigners would have a right to be on US soil, and illegal immigrants would breach the law only by failure to pay the deposit. The logical penalty would therefore be a fine. Since it’s much cheaper, pleasanter, and safer to come to the US legally on a bus or plane, than in a shipping container or on foot through the Arizona desert, making a legal option generally available could be expected to render illegal immigration a negligible phenomenon. So DRITI would restore the rule of law, which has proven so elusive under the status quo.

Some deny that I’m an open borders advocate, because they don’t think a universal DRITI regime would qualify as “open borders.” I think it would, because people would be allowed to move anywhere, even if they wouldn’t necessarily be treated “equally” (whatever, if anything, that means) with the locals everywhere they went. Semantics aside, I would rather see a universal DRITI regime established than “pure” open borders (with no migration taxes), at least in the short run, in order to safeguard social institutions and prevent a negative economic shock to the Western working class. Yet DRITI is still rather a rather radical reform, and I might favor gradualist approaches even to this compromise policy, but human rights considerations give me pause.

Human rights is a difficult subject, but too important to neglect. In discussing them, I am partly handicapped, but perhaps partly helped, too, by my lack of legal training. Legal knowledge would help me to think clearly and foresee the ramifications of rights-claims, but what one most needs to discern human rights is a conscience, and conscience is blunted in some lawyers by the habit of flattering the powerful and defending any and every party that might hire them.

I see the history of human rights—formerly called “natural rights” or (by Adam Smith) “natural liberty”—as a tug-of-war between (a) a growing appreciation of what human beings need, in order to flourish and realize the potentialities of their nature, persistently fostered by art, philosophy, religion, and civil society, and woven into the scruples and sensibilities of classes and nations, and (b) many factors, including moral laxity, coarse cynicism, corruption, tyranny, religious or revolutionary enthusiasm, the exigencies of war, the envy of the poor, and the acquisitiveness of the rich, which induce people to wrong their fellow human beings. Moral progress must perpetually struggle against backsliding, and often has a reactionary character. We codify and sanctify human rights when we are determined to say “never again” to a French Revolution or a Nazi genocide.

Indeed, while mankind really has made moral progress in the course of history—the abolition of slavery and polygamy, and the establishment of freedoms of religion and speech, are the most important advances—the assumption that moral progress is natural and inevitable is dangerous and corrupting. People often slip into feelings of complacent superiority to ancestors who were better than themselves. They may also commit terrible crimes for the sake of a misguided vision of moral progress, as in the case of the Soviets, who would have perpetrated such great evils had they not had before their eyes a lofty vision of socialist utopia. The most durable advances of human rights are made in a spirit of reclamation and restoration, not revolution. The slaveless world for which William Wilberforce and the abolitionists strove had already been a solid societal fact in the European Middle Ages, still largely intact on the European continent itself, though betrayed in the new European dominions of the New World. Open borders advocates, too, do not champion something new, but rather, seek to reverse disastrous innovations by the 20th-century state. We want little more than to restore freedom of migration as it existed in the Victorian era.

An example of the kind of anxieties that can give rise to moral progress is furnished by the contemporary United States, where a feeling has grown in recent years that it is unacceptable to deport people who, though never authorized by the government to live in the USA, came here as children and have no other home. Obama’s DACA policy, though legally anomalous, seems to be driven by the moral necessity of halting the deportation of innocent child migrants. But by appearing to recognize a right of minors to stay in the US, DACA has probably helped to trigger the “unaccompanied child” crisis at the border. When Americans see thousands of children being held by force in detention camps along the border, they feel that it is wrong, but why exactly? What moral principles are being trespassed? What ought we to do? Such efforts to understand what conscience is demanding of us can enrich our understandings of human rights, and lead to moral progress.

Civil disobedience is often the midwife of insights about human rights. A person like Martin Luther King in the civil rights era, or Jose Antonio Vargas and my co-blogger Michelangelo Landgrave in our times, openly does what is against the law, but is not morally wrong, and thereby becomes a walking, talking reductio ad absurdum of the law, a proof that the law and the right have parted company, and the law is therefore illegitimate. But to understand why the law is illegitimate, and how it must change to recover its legitimacy, involves an inquiry into human rights.

Now, I have sometimes written of a “right to migrate,” but, strictly speaking, I do not assert a general right to migrate across international frontiers just because one wishes to. (I assert rather that there is a liberty of international migration, using a distinction between rights and liberties which I learned from Anthony de Jasay, because there is generally no one with a proper right to use force to prevent it… but I won’t venture into those subtleties here.) However, conscience compels me to assert a human right to international in certain cases.

First, I believe the human rights consensus has come to recognize a right to emigrate, yet even as the international community condemns regimes that prohibit emigration, it fails to guarantee the right to emigrate by ensuring that everyone has somewhere to go. How can it be a human rights violation when Soviet Russia, or Communist China, or North Korea, forces citizens to stay home, but not when the rest of the world conspires to force people to stay home by denying them visas? Countries that, by refusing to accept people as immigrants, force them to live under regimes that oppress and persecute them, are serving as jailors for those regimes, and share in their guilt. This ought to change.

Second, families have a right to be together. Attachments to spouse and children often are, and should in any case be presumed to be, as central to a person’s identity and needs as the integrity of the body itself. To deprive a mother of her children, even for a short time, might be a crueler form of torture than severe physical pain, and other family separations can also cause extreme distress. Governments whose migration restrictions prevent parents and children, brothers and sisters, spouses, or those desiring to marry, from being together, violate human rights. People’s mutual needs for one another’s society may extend beyond family to friends and communities, such that governments wrong such people by forcibly separating them.

Third, the right to use and develop one’s own personality and property may sometimes entail a right to invite certain people. For example, a community chorus might need to recruit a pianist from Korea, a farmer to recruit harvesters for his crops from Mexico, or a parish to recruit a priest from Russia or Africa. Governments that prevent migration by force in such cases wrongfully interfere with hospitality and the flourishing of their subjects.

Now, a universal DRITI scheme would satisfy both the desideratum of efficiency, and that of respecting human rights. But, if I am told that DRITI is too radical, and that I must compromise further, or if I am asked to propose intermediate steps by which the world might establish a universal DRITI scheme by gradual steps, I would split my advice between measures to achieve efficiency by partially implementing DRITI, and measures to bring policy into line with the urgent moral imperative to respect human rights. On the one hand, I would reserve welfare benefits to natives, introduce migration taxes, implement DRITI through bilateral and multilateral deals, perhaps among relatively close or similar countries like the USA and Great Britain, and curtailing bureaucratic discretion in migration control wherever possible. On the other hand, I would call for a worldwide archipelago of passport-free charter cities, in order to make the right to emigrate a global reality, even if many continued to be denied access to the developed democracies. I would call for a major expansion of citizens’ rights to invite and sponsor international visitors. I would call for family reunification to be recognized as a natural, prepolitical entitlement that states must accommodate without delays and discretionary obstacles. I would demand a complete, permanent, and global prohibition on the forcible separation of families by deportation. I would demand that long-term residency in a country, and especially residency that starts during childhood, be recognized as conferring permanent residency and a right to work, though not to citizenship or political representation. But as this human rights agenda would make comprehensive migration restrictions even more unenforceable than they already are, the destination of the changes could only be open borders.

Ultimately, the efficiency case for open borders and the human rights case for open borders converge and supplement one another, a little like the Good Cop and the Bad Cop in police movies. The Utilitarian Advocate shows why we should want to open the world’s borders to migration, the Human Rights Advocate shows why we must. The Utilitarian Advocate lures us on with glittering promises of prosperity. The Human Rights Advocate goads us forward with the whip of a guilty conscience.

The intelligent restrictionist says: “I can see that it seems very wrong when deportation forcibly separates families, or when children are deported who grew up here and have no other home. But suppose we let them stay. Amnesty sets a precedent. If we let these ones stay, others will want to come, in order to benefit from the next amnesty. You’ll make the same objections to deporting those people as you do to deporting these. Then, if we listen to you, and let those people stay too, the precedent will be reinforced, and people will expect the next amnesty all the more confidently. In the end, we’ll lose control of the border altogether. What will that lead to?”

Here the Utilitarian Advocate answers: “Well, at most, it will lead to open borders, and that’s probably a good thing. There’s a lot of uncertainty here, but as best we can guess, open borders will roughly double world GDP, with the benefits falling disproportionately to the poorest members of mankind. Human geography will be transformed forever, as billions of people will migrate in search of a better life, and find it. In the West, investors and landowners, and probably some skilled workers too, will see big gains. It’s true that a lot of people in the Western middle and working classes will face a difficult transition and may end up worse off than before. But for mankind as a whole, open borders will be very beneficial.”

To this, the intelligent restrictionist replies: “All right, fair enough. I know you have reason to think open borders will be good for the world. But the best that can be said for these projections is that they’re the best on offer right now. They’re still very tenuous, simplistic, and even jejune. Surely one runs at least a slight risk of societal collapse, by adopting policies that, according to you, will triple the West’s population, and make Westerners minorities in their own countries. Open borders could fray the social fabric beyond repair. There are risks of crime, of terrorism, of contagious disease, of class alienation, of new and dangerous ideologies spreading, of revolution. Democratic norms could be undermined, with incalculable effects on the legitimacy of governments and the maintenance of civil peace. We in the West have built a remarkably peaceful and prosperous society, and our peace and prosperity seem to be spreading to the rest of the world, if more slowly than one might wish. Are we supposed to gamble all that solid good for the sake of your castle in the clouds?”

And here the Human Rights Advocate answers: “And to appease these vague fears of yours, you would seize innocent children, and send them to countries they hardly know? You would separate families by force? You would lay waste to verdant agricultural landscapes, so that in a world not free from hunger, good fruit will rot upon the ground for lack of harvesters? You would deny people living in terror under totalitarian tyrants the chance to escape from living nightmares? It would be easier to forgive these cruel and destructive actions, if you did them in the face of some dire, immediate peril. But while you speak of crime, crime has been plummeting in your country, so that on the vast majority of your streets one may walk without fear, not only in broad daylight, but in the middle of the night. You speak of threats to civil peace, but there has hardly been a country in the history of the world where the civil peace is as secure as it is in yours today. You speak of contagious diseases when modern medicine has vaccinated you against the great plagues of the past, and few of you have suffered a contagious disease much worse than the flu. You speak of the social fabric being frayed, but what does that mean? Do you mean that in a world of open borders, you might be less likely to invite the neighbors over for a beer and the Saturday night football game? Aren’t you ashamed even to suggest that such a minor harm could be set in the balance, when the alternative includes people being forced to live in terror under totalitarian tyrants, parents being separated indefinitely from their young children, and destitute people being denied the chance to earn their daily bread? You speak of class alienation as a danger to be avoided, yet today, a favored fifth of humanity is born to privilege in wealthy countries, while billions around the world are born to lifelong poverty, political repression, and/or fear of violence, which your migration restrictions make it difficult or impossible for them to escape. What moral evil can you possibly see in any class-stratified society that might emerge in the West, which is not exceeded ten-fold by the injustices of our current system of global apartheid?

“By all means, let us be vigilant for any sign of the dangers you fear. If we see such signs, let us consider what precautions to take. If at some time in the future, there really is strong evidence that we are on the brink of catastrophe, we might even condone desperate measures, such as the forcible separation of families, the ruination of valuable property, and the exile of innocent people to countries they hardly know. But you are carrying out these extreme measures when you are well-fed, well-housed, and in no fear of violence, from a mere ideological obsession, unrelated to any real, solid, substantive human good, with ‘sovereignty.’ Come to your senses now, and do the right thing. It may not prove so difficult and dangerous in reality, as you have painted it in your dark daydreams.”

Something very clever Bryan Caplan wrote in 2007 on “Anti-Foreign Bias”

I must admit that I am somewhat depressed by the state of the world today. Deflationary monetary policies in Europe, increased protectionist tendencies and war and geopolitical tensions around the world. It is no secret that I think it is all connected.

But why do voters around the world rally behind the cries for closed borders and even more military build-ups? Why do policy makers – democratic and non-democratic – find it in their interest to stir up anti-immigrant sentiment, geopolitical tensions and to introduce protectionist measures?

Bryan Caplan might provide the answer – the “anti-foreign bias” of rationally irrational voters – this is from a piece Bryan wrote for Reason from 2007: 

A shrewd businessman I know has long thought that everything wrong in the American economy could be solved with two expedients: 1) a naval blockade of Japan, and 2) a Berlin Wall at the Mexican border.

Like most noneconomists, he suffers from anti-foreign bias, a tendency to underestimate the economic benefits of interaction with foreigners. Popular metaphors equate international trade with racing and warfare, so you might say that anti-foreign views are embedded in our language. Perhaps foreigners are sneakier, craftier, or greedier. Whatever the reason, they supposedly have a special power to exploit us.

There is probably no other popular opinion that economists have found so enduringly objectionable. In The Wealth of Nations, Adam Smith admonishes his countrymen: “What is prudence in the conduct of every private family, can scarce be folly in a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry.”

As far as his peers were concerned, Smith’s arguments won the day. More than a century later, Simon Newcomb could securely observe in the Quarterly Journal of Economics that “one of the most marked points of antagonism between the ideas of the economists since Adam Smith and those which governed the commercial policy of nations before his time is found in the case of foreign trade.” There was a little backsliding during the Great Depression, but economists’ pro-foreign views abide to this day.

Even theorists, such as Paul Krugman, who specialize in exceptions to the optimality of free trade frequently downplay their findings as abstract curiosities. As Krugman wrote in his 1996 book Pop Internationalism: “This innovative stuff is not a priority for today’s undergraduates. In the last decade of the 20th century, the essential things to teach students are still the insights of Hume and Ricardo. That is, we need to teach them that trade deficits are self-correcting and that the benefits of trade do not depend on a country having an absolute advantage over its rivals.”

Economics textbooks teach that total output increases if producers specialize and trade. On an individual level, who could deny it? Imagine how much time it would take to grow your own food, while a few hours’ wages spent at the grocery store can feed you for weeks. Analogies between individual and social behavior are at times misleading, but this is not one of those times. International trade is, as the economic writer Steven Landsburg explains in his 1993 book The Armchair Economist, a technology: “There are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seeds, which are the raw materials from which automobiles are constructed. You wait a few months until wheat appears. Then you harvest the wheat, load it onto ships, and sail the ships westward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them.”

How can anyone overlook trade’s remarkable benefits? Adam Smith, along with many 18th- and 19th-century economists, identifies the root error as misidentification of money and wealth: “A rich country, in the same manner as a rich man, is supposed to be a country abounding in money; and to heap up gold and silver in any country is supposed to be the best way to enrich it.” It follows that trade is zero sum, since the only way for a country to make its balance more favorable is to make another country’s balance less favorable.

Even in Smith’s day, however, his story was probably too clever by half. The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost.

Anti-foreign bias is easier to spot nowadays. To take one prominent example, immigration is far more of an issue now than it was in Smith’s time. Economists are predictably quick to see the benefits of immigration. Trade in labor is roughly the same as trade in goods. Specialization and exchange raise output—for instance, by letting skilled American moms return to work by hiring Mexican nannies.

In terms of the balance of payments, immigration is a nonissue. If an immigrant moves from Mexico City to New York and spends all his earnings in his new homeland, the balance of trade does not change. Yet the public still looks on immigration as a bald misfortune: jobs lost, wages reduced, public services consumed. Many in the general public see immigration as a distinct danger, independent of, and more frightening than, an unfavorable balance of trade. People feel all the more vulnerable when they reflect that these foreigners are not just selling us their products. They live among us.

It is misleading to think of “foreignness” as a simple either/or. From the viewpoint of the typical American, Canadians are less foreign than the British, who are in turn less foreign than the Japanese. From 1983 to 1987, 28 percent of Americans in the National Opinion Research Center’s General Social Survey admitted they disliked Japan, but only 8 percent disliked England, and a scant 3 percent disliked Canada.

Objective measures like the volume of trade or the trade deficit are often secondary to physical, linguistic, and cultural similarity. Trade with Canada or Great Britain generates only mild alarm compared to trade with Mexico or Japan. U.S. imports from and trade deficits with Canada exceeded those with Mexico every year from 1985 to 2004. During the anti-Japan hysteria of the 1980s, British foreign direct investment in the U.S. always exceeded that of the Japanese by at least 50 percent. Foreigners who look like us and speak English are hardly foreign at all.

Calm reflection on the international economy reveals much to be thankful for and little to fear. On this point, economists past and present agree. But an important proviso lurks beneath the surface. Yes, there is little to fear about the international economy itself. But modern researchers rarely mention that attitudes about the international economy are another story. Paul Krugman hits the nail on the head: “The conflict among nations that so many policy intellectuals imagine prevails is an illusion; but it is an illusion that can destroy the reality of mutual gains from trade.” We can see this today most vividly in the absurdly overblown political reactions to the immigration issue, from walls to forcing illegal workers currently in America to leave before they can begin an onerous procedure to gain paper legality.

 

 

At 25 Bob Hetzel had become a Friedmanite. At 80 Milton Friedman had become a Hetzelian

Watch this after 11:35.

…yes, Friedman went further than Bob. Friedman had also become a market monetarist. He wanted to use the market not only to evaluate monetary policy, but also to implement monetary policy.

HT Sassa

Talk about being disappointed…By the Bundesbank

Take a look at this list of Bloomberg headlines coming out today:

*BUNDESBANK: INFLATION EXPECTATIONS NOTICEABLY BELOW ECB MANDATE

Wauw will the Bundesbank advocate monetary easing?

*BUNDESBANK DOESN’T SEE TURN IN GERMAN ECONOMIC FUNDAMENTALS

Yeah it sure looks like that!

*BUNDESBANK SAYS RUSSIA SANCTIONS LIKELY TO DAMP GERMAN EXPORTS

Yes, yes the Bundesbank is surely dovish

*BUNDESBANK SAYS GERMAN ECONOMIC OUTLOOK HAS CLOUDED

This gotta mean the Bundesbank will support QE

*BUNDESBANK SAYS DATA CAST DOUBT ON GERMAN 2H ECONOMIC REBOUND

Increadibly dovish Bundesbank…

*BUNDESBANK SAYS ECB PACKAGE ACCEPTABLE GIVEN LOW INFLATION

Yes, yes… have the market monetarists taken over in Frankfurt?

*BUNDESBANK SAYS EURO-AREA REBOUND TO BE WEAKER THAN EXPECTED

Yeah! Now the Bundesbank surely will endorse QE! No doubt!

*BUNDESBANK SAYS EXPANSIONARY POLICY MAY HARM REFORM EFFORTS

Or maybe not! Talk about being disappointed…

“If goods don’t cross borders, armies will” – the case of Russia

Recently I have been thinking quite a bit about the apparent rise of protectionism across the globe and in my quest to find data on the rise of protectionism I found some very interesting comments regarding the Global Trade Alert‘s annual report for 2013 (here reproduced from the Moscow Times January 11 2014):

Russia enacted more protectionist trade measures in 2013 than any other country, leaving it as the world leader in protectionism, according to a new study.

Furthermore, Russia and its partners in the Customs Union, Belarus and Kazakhstan, accounted for a third of all the world’s protectionist steps in 2013, said the study by Global Trade Alert, or GTA, a leading independent trade monitoring service.

A total of 78 trade restrictions, almost a third of all those enacted by Group of 20 countries, were imposed by Russian legislators last year, the study said.

With the new restrictions, Russia now has 331 protectionist measures in place, or a fifth of all protectionist policies registered worldwide .

Belarus is ranked second, with 162 measures.

The Russian-led Customs Union, which the Kremlin has presented as an alternative to the European Union, came under harsh criticism from the report’s authors.

“The Customs Union was responsible for 15 times as many protectionist measures as China while having only an eighth of the population,” said GTA coordinator Simon Evenett, in comments carried by Reuters.

He described Russia’s policy of economic restructuring as “nothing more than a potent mix of rampant subsidization and aggressive protectionism,” which contradicts the World Trade Organization’s principles.

Russia joined WTO in 2012.

The other members of the Customs Union, Kazakhstan and Belarus, are negotiating entry into the WTO.

Of Russia’s protectionist policies, 43.4 percent were targeted bailouts and direct subsidies for local companies, the report said. Tariff measures accounted for 15.5 percent, while anti-dumping, countervailing duty or safeguard provisions constituted almost 10 percent. Other steps included cuts in foreign worker quotas, export subsidies and restrictions, and sanitary measures

A surge in protectionism occurred around the world starting in 2012, the report said. The 2013 data indicate that the trend, which could slow down international economic growth in the next several years, is likely to continue.

Given recent events in Ukraine it is hard not to come to think of the old free trade slogan normally attributed to Frédéric Bastiat “If goods don’t cross borders, armies will”.

—–

PS if you want to think of a “model” of the recent rise in geopolitical tensions around the world then think of this causal relationship: Monetary policy failure => deflationary pressures => rising political populism and an increase in protectionist measures => increased geopolitical tensions. I will try to return to this topic in later posts as I increasingly think there is a relationship between monetary policy failure and increased political uncertainty and geopolitical tensions.

PPS 14 years ago I wrote a short article on the relationship between protectionism and war. You will find it here (page 25-26). It is unfortunately in Danish, but Google Translate might help you.

PPPS a couple of posts on monetary policy failure in Russia. See here, here, here and here.

Recommend reading:

Doug Irwin

 

 

Another argument for Open Borders: It is good for the quality for football!

There is no doubt that I strongly favour a policy of removing restrictions on immigrations. Nathan Smith in his recent guest post on my blog showed that a policy of global Open Borders would significantly boost global GDP. However, there might be even better arguments for Open Borders.

My friend Ben Southwood, Head of Policy at the Adam Smith Institute, in a new paper argues that the “crackdown on foreign players hurts English football”. You might not buy Nathan’s arguments, but you should certainly buy Ben’s arguments for Open Borders in international football (to my American readers: Soccer).

This is the abstract from Ben’s paper:

It is a very common view that “importing” foreign football players into the UK to play in the Premier League leads to less opportunity for English players to play for these teams. This means that English players get less high-level experience, and consequently aren’t as good as the players of Spain, France, Italy or Ger- man, who make up a larger fraction of the players playing in their home leagues. This, the argument runs, is an important factor in explaining the English national team’s perceived underperformance in international competitions. I review the literature and present novel data establishing a negative relationship between current performance (as measured by FIFA ranking) and the current amount of football played in a league by native players (across Spain, England, Germany and Italy). Further, I find no relationship between minutes played by English players in the Premier League five or ten years ago and current performance. Finally, I find strong evidence that a league’s overall strength (as measured by its UEFA coefficient) is predicted by the current amount of foreigners playing in it. To restrict foreign players would not directly benefit the English national team, but it would risk substantially curtailing the overall quality of the world’s most popular football league.

PS in my favourite team FC Copenhagen there are very few Danish players and the best “Danish” players have immigrant background. Thank god for immigration and free trade in footballers!

PPS this is my son’s favourite (now former) FC Copenhagen player Igor Vetokele.

Igor

Guest post: The Global Economic Impact of Open Borders (Nathan Smith)

On my blog I mostly writes about monetary policy issues. However, I from time to time I venture into other areas. Among the areas I would like to give more attention to is the economics of immigration. I used to teach immigration economics at the University of Copenhagen and have done research on the topic while working at the Ministry of Economic Affairs in Denmark 15 years ago. However, I have not worked professionally with immigrations economics for well over a decade and I have only followed the new research in this area from a bit of a distance.

However, since I started my blog I have had a tradition for inviting economic scholars and others to write guest posts on my blog. I am now continuing the tradition as I have invited Nathan Smith to write a guest post on a very interesting paper that he has been working on.

Nathan in his paper is trying to give an assessment of the Global Economic Impact of Open Borders. His results are extremely interesting and in my view illustrates just how big the economic potential benefits are if we moved towards a world of free movement of labour across borders.

This obvious is a very controversial topic so it is very welcomed that professional economists are contributing to a better understanding the topic. It is certainly about time that we start basing immigration policy around on a sound economic understanding of the topic rather than on emotions and populist rhetoric. I am therefore tremendously happy that Nathan has accepted my invitation to contribute to my blog on this very important topic.

Nathan would like to use this opportunity to welcome comments on his ideas and his paper. I would very much suggest that everybody interested in Nathan’s work and the economic of immigration in general leave comments here at the blog or drop Nathan a mail (see e-mail address below). You are obviously also welcome to drop me a mail (lacsen@gmail.com). It would be great if we could make this an example on a ‘real-time peer review’ of an academic paper.

- Lars Christensen

Guest post: The Global Economic Impact of Open Borders

by Nathan Smith (nathan_smith@ksg03.harvard.edu)

First, a little about me. I’ve been an open borders advocate for nine years now, first publishing in an online journal call Tech Central Station (see here, here, here, here, here, here, here, here, and here), then in my 2010 book, Principles of a Free Society, and most recently at the blog Open Borders: The Case and The Freeman. My work experience includes the Cato Institute and the World Bank. My education includes a Masters in International Development from the Kennedy School of Government at Harvard (2003), and a PhD in economics from George Mason (2011). Now, I teach economics (macro, public finance, investments, international trade, research methods) at Fresno Pacific University, a small Christian college in California. The website Open Borders: The Case was founded by Vipul Naik and is dedicated to describing and developing the case for open borders in a rational and balanced way.

Open borders is a question both of ethics and of positive economics. There are non-utilitarian arguments that deportation of illegal immigrants, exclusion of peaceful migrants, forcible separation of families, or other aspects of border enforcement violate human rights, are morally impermissible, and must cease regardless of the consequences. But even those who accept these arguments will be curious about what the consequences of doing our moral duty are likely to be. For utilitarians, the whole question will turn on what would happen under open borders. Others may accept that there are such things as rights, and that they may forbid some policies that would be adopted on the basis of a merely utilitarian calculus, but think that a substantial amount of migration restriction is consistent with rights. Open borders would then be evaluated on the basis of its consequences. So, putting my knowledge of development economics to work, I’ve just finished a draft of a paper, “The Global Economic Consequences of Open Borders,” in which I’ve been trying to guess what would happen if all migration restrictions were abolished. Lars was kind enough to offer me the chance to give a glimpse of my methods and results here.

Under the status quo, markets for labor and human capital clear at the national level. Under open borders, they would clear at the global level. At any rate, that is how I model the main difference between the status quo and open borders. Everything else, initially, is either held constant—total factor productivity (TFP), country risk premia on investment capital, the total world population, the total world human capital stock—or changes because of the way global labor and human capital markets clear—the population and GDP of different countries, the global stock of physical capital, the wages of raw capital and the premium paid to human capital around the world. But before solving for a new global equilibrium in the labor and human capital markets, I had to develop a description of the world under the status quo. That is, I had to develop a stylized description of the current world economy, which was consistent with a theoretical model that could subsequently be solved for a new, open borders equilibrium, and which, at the same time, fit tolerably well with the data.

At the heart of my description of the status quo are the factors of production. I follow Mankiw, Romer, and Weil (1992) in explaining international income differences primarily by differences in physical and human capital per worker. TFP still plays an indispensable role, but it varies across countries much less than does average human capital. It is indispensable because—as was pointed out by critics of Mankiw, Romer, and Weil (1992) such as Paul Romer—to explain international income differences entirely by international differences in physical and human capital per worker, requires one to claim that these differences are very large, with counter-factual implications for the marginal product, and therefore the price, of these factors of production across countries. As Lucas (1990) observed, if international income differences depended on physical capital alone, the marginal product and price of physical capital would be orders of magnitude higher in poor countries vis-à-vis rich ones, and if capital is internationally mobile, all new investment would occur in poor countries.

If international income differences depended on human capital alone, then human capital ought to have a higher marginal product and earn more where it was scarce, and we should see mass emigration of smart college grads from the US to India, rather than the other way around. But fairly small differences in TFP—say, a factor of three between the most and least productive countries—suffices to reconcile a factor endowments explanation of most international income differences, with plausible factor prices. Table 1 shows, for selected countries: average human capital and the country risk premium on investment capital, as imputed on the basis of data; TFP, a residual used to reconcile GDP per capita with average human capital and the risk premium; and the “wage of raw labor” and “human capital premium,” as predicted when national labor and human capital markets are solved for equilibrium.

table 1 Nathan Smith

Table 1 features very large differences in average human capital across countries. Some of the world’s least developed countries have less than 5% of the human capital of the average American. Average human capital was imputed on the basis of the UN’s Human Development Index (HDI), but the HDI was interpreted as (linearly related to) the log of average human capital. A possibly surprising, but on reflection plausible, feature of the status quo world as described in Table 1 and the underlying model, is that the wages of raw labor differ enormously across countries, but the human capital premium, though it, too, tends to be positively correlated with human capital, differs much less.

Lastly, it must be mentioned that there is a spatial model at work here. Working in Stata, I generate a data set of two million “settlements,” meant to fit major stylized facts about how the human population is distributed among cities, towns, and villages. I imputed TFP at the settlement level. I won’t try to describe the spatial model in detail here, but I do want to mention why it matters. A general problem for open borders models is that it’s hard to give strictly economic reasons why anyone would want to stay in unproductive places when they could move to productive ones.

To address this question, I start by noting that some domestic locations seem more productive than others, and asking why some people live in, say, Elko, NV, instead of New York. My spatial model is based on (a) increasing returns, (b) congestion disutilities, and (c) differences in local TFP. So, Elko, NV has lower TFP than New York, and ends up with fewer people and less physical and human capital per worker, but people still live there for the cheap land and lack of congestion. By the same token, why would anyone stay in Mexico, Indonesia, or Malawi under open borders, when they could live in the USA? Because the best city sites in the USA will get congested, and some places in Mexico, Indonesia, and Malawi may be better than some places in the USA.

So, what are my results? First, let me stress that these are preliminary. After some very helpful real-time peer review from my colleagues at Open Borders: The Case, I plan to refine the spatial model, and somehow I need to come up with better ways to deal with anomalies in imputed TFP, mostly arising from natural resource wealth. The paper describes two scenarios, “Scenario 1” which implements the model in the most literal fashion, and “Scenario 2,” in which I add in some other adjustments, such as human capital growth in response to the new incentives and opportunities of a world with open borders, falling country risk premia due to remittances and generally movements of people facilitating movements of money, and TFP adjustments due to cultural/institutional influences, positive and negative, and to the fact that TFP partly reflects congestible public goods.

In Scenario 1, over 5 billion people migrate, and the world economy comes to be dominated by a few “Countries of Reinforced Dominance” and “New Settler Societies,” while the largest western European countries become “Corridor Countries,” which see much of their native human capital emigrate as they absorb a flood of less-skilled immigrants, and most developing countries become “Countries of Emigration,” losing much to most of their populations to emigration, or “Ghost Nations,” in which less than 2% of the native population stays. While I actually find these large patterns somewhat plausible, the “Countries of Reinforced Dominance” and “New Settler Societies” include too many resource-rich countries like Qatar, East Timor, and Botswana. Since everything else is mobile, high TFP outliers have an outsized impact on global outcomes.

So, I’ll reserve judgment until I come up with a better way to get at “essential” GDP, reflecting the inherent productivity of a place’s institutions, deducting natural resource windfalls. For the record, unskilled workers’ living standards under Scenario 1 converge to 23% of the current US level; the human capital premium rises almost everywhere, converging to $66,535 per annum; average (but not necessarily median) incomes rise for natives of every country in the world; the global capital stock rises more than 100%; and world GDP rises by 80%.

As I say, TFP anomalies are the Achilles heel of the model, and I like Scenario 2 better in part because it deals with them, albeit in a somewhat rough and ad hoc fashion. In Scenario 2, immigrants from low TFP places to high TFP places raise TFP in the places they come from, and reduce it in the places they go to. This is less about negative congestion externalities, which the spatial model has already tried to take into account, as it is about social norms and institutions. Take littering. Citizens of developed countries tend to have a “no littering” norm pretty firmly imprinted in their minds. Citizens of many developing countries do not. So, immigrants from developing countries would probably make litter more common in developed countries, since at least some of them would bring their bad habits with them.

At the same time, the social disapproval and legal penalties they would face for littering in the West would change the habits of some of them, and return migration and letters home would facilitate the spread of a “no littering” norm back to migrants’ countries of origin. The same would apply to many other useful protocols and practices of developed countries, from tipping to not stealing napkins from food courts to not paying bribes to democratic tolerance to culturally valuing literacy and book learning, which open borders could be expected both to dilute at home, and to spread abroad. As it happens, these plausible assumptions about institutional transmission also tame the implausible ascent of high TFP outliers. Since “founder effects” are important, however, I give natives five times the weight of immigrants in determining the TFP, under open borders, of a country of (net) immigration, while emigrants have only one-fifth the weight of those who stay home, in determining the TFP, under open borders, of a country of (net) emigration.

Scenario 2 represents, for the moment, represents my “best guess” of what a world of open borders would “really” look like. Even then, a strange qualifier must be added: I am holding things like world population and TFP constant even as I project the end-point of a transition that would take decades to play out, so the results must be interpreted as if the transition dynamics to open borders are “fast-forwarded” while other changes underway in the world economy are frozen in place. Total migration under Scenario 2 is a little over 3 billion, about 44% of mankind. Interestingly, international geographic mobility under open borders would look similar to interstate mobility in the USA today.

The global human capital stock would rise by 50%, world GDP by 69%, and the global stock of physical capital by 88%. Most developed countries would turn into “host nations,” seeing immigrants from developing countries swell their populations, while most developing countries would see a large fraction of their populations emigrate. However, under Scenario 2, there would be no “ghost nations”: the worst-off countries would be “rescued” by the benign effects of their diasporas, and would see institutions improve, average human capital rise, and investment capital become more available. Some high TFP outliers would turn into “new settler societies,” but (setting to one side the special experience of the USA) these countries would end up with only about 10% of world population. The aggregate experiences of major geographic-cultural regions, shown in Table 2, give a pretty good description of how open borders would change the world under Scenario 2.

Table 2 Nathan Smith

 

The most striking feature of Table 2 is the dramatic rise of the West, defined as the EU plus the English-speaking USA, Canada, Australia, and New Zealand. The West’s population would soar to over 3 billion. It would be home to 43% of the world’s population, but about two-thirds of physical and human capital, and it would generate two-thirds of world GDP. Of course, the West might become less Western as it absorbed billions of immigrants, mostly from East and South Asia, so some might see this as, not the rise, but the end of the West. But polities that represent rival civilizations, such as India and China, would certainly see their relative power decline.

More important, though, is the impact on individuals. And it is here that the strength of the case for open borders really shines through. “The Global Economic Impact of Open Borders” is meant as a contribution to positive, not normative economics. Evaluative judgments are included to keep the prose from being too dry, but are not what the paper is really about. Yet for anyone who cares about the welfare of the foreign-born, Table 3 cannot but be a powerful moral argument. For under Scenario 2, it is precisely the world’s poorest who would benefit most from open borders. Natives of the benighted Democratic Republic of the Congo would see their labor incomes rise, on average, by +1801%. Natives of Ethiopia, Burma, Tanzania, Kenya, and many other very poor countries, would see their incomes rise several-fold, partly because tens of millions of them would emigrate, partly because human and physical capital would become more abundant, partly because the diaspora’s influence would improve institutions. Natives of middle-income countries would see smaller, but still substantial, gains.

Table 3 Nathan Smith

Natives of developed countries would have a more ambiguous experience. There, the wage of raw labor would fall. The living standards of unskilled workers worldwide would converge to 44% of the US level. The human capital premium would rise in most places, even in the West, but in the USA, it would actually fall. This would occur because (a) the USA would be such a powerful magnet for skilled workers that average human capital, already high under the status quo, would actually rise slightly, and (b) TFP would fall by about 9%. In the large countries of Western Europe, natives would become minorities in the countries where they were born, but their average labor incomes would actually rise, thanks to gains from trade with immigrants, even as national TFP fell. But the median worker, having below average human capital, would probably earn less than under the status quo, and earnings would become more unequal. But the USA, where even the average worker would earn less than under the status quo, provides an especially good test case for the status quo.

Whether Americans would really be worse off under Scenario 2 is tricky. Their labor incomes would fall, but those who own land—and most Americans are homeowners—would see its value rise more than three-fold. Also, the US government would enjoy a far larger tax base, which it might use to hold natives harmless in the midst of enormous changes. But if we think of open borders as a sacrifice by Americans for the benefit of the foreign-born, it has the merit of being enormously effective on a per dollar basis. Global open borders would reduce Americans’ labor incomes by 10%, while increasing by multiples the welfare of billions of the poorest among our fellow human beings around the world.

While these results are not, in my view, rigged to favor open borders, they are of course highly contestable at the level of positive economics, as well as open, if accepted, to many normative appraisals. Yet I hope they will nonetheless help to dispel the notion that open borders are a “utopian” proposal. Open borders would not free mankind from work, or death, or turn the sea into lemonade, as one early utopian socialist dreamed. There would be major changes, and winners and losers, but on balance the changes would be positive, as well as highly egalitarian. Open borders is probably best compared to the abolition of slavery: a radical but not revolutionary reform, which seems quixotic, but which reason shows is attainable, and which will harm certain powerful vested interests, but benefit most of mankind, especially the worst-off, while expanding human freedom and reducing the amount of violence and coercion in the world.

At any rate, that’s my best guess as to what would happen. But my results are preliminary, and I will be grateful for feedback and criticism.

Three terrible Italian ‘gaps’

Yesterday we got confirmation that Italy feel back to recession in the second quarter of the year (see more here). In this post I will take a look at three terrible ‘gaps’ – the NGDP gap, the output gap and the price gap –  which explains why the Italian economy is so deeply sick.

It is no secret that I believe that we can understand most of what is going on in any economy by looking at the equation of exchange:

(1) M*V=P*Y

Where M is the money supply, V is money-velocity, P is the price level and Y is real GDP.

We can – inspired by David Eagle – of course re-write (1):

(1)’ N=P*Y

Where N is nominal GDP.

From N, P and Y we can construct our gaps. Each gap is the percentage difference between the actual level of the variable – for example nominal GDP – and the ‘pre-crisis trend’ (2000-2007).

The NGDP gap – massive tightening of monetary conditions post-2008 

We start by having a look at nominal GDP.

NGDP gap Italy

We can make numerous observations based on this graph.

First of all, we can see the Italian euro membership provided considerable nominal stability from 2000 to 2008 – nominal GDP basically followed a straight line during this period and at no time from 2000 to 2008 was the NGDP gap more than +/- 2%. During the period 2000-2007 NGDP grew by an average of 3.8% y/y.

Second, there were no signs of excessive NGDP growth in the years just prior to 2008. If anything NGDP growth was fairly slow during 2005-7. Therefore, it is hard to argue that what followed in 2008 and onwards in anyway can be explained as a bubble bursting.

Third, even though Italy obviously has deep structural (supply side) problems there is no getting around that what we have seen is a very significant drop in nominal spending/aggregate demand in the Italian economy since 2008. This is a reflection of the significant tightening of Italian monetary conditions that we have seen since 2008. And this is the reason why the NGDP gap no is nearly -20%!

Given this massive deflationary shock it is in my view actually somewhat of a miracle that the political situation in Italy is not a lot worse than it is!

An ever widening price gap

The scale of the deflationary shock is also visible if we look at the development in the price level – here the GDP deflation – and the price gap.

Price gap Italy

The picture in terms of prices is very much the same as for NGDP. Prior to 2007/8 we had a considerable level of nominal stability. The actual price level (the GDP deflator) more or less grew at a steady pace close to the pre-crisis trend. GDP deflator-inflation averaged 2.5% from 2000 to 2008.

However, we also see that the massive deflationary trends in the Italian economy post-2008. Hence, the price gap has widened significantly and is now close to 7%.

It is also notable that we basically have three sub-periods in terms of the development in the price gap. First, the ‘Lehman shock’ in 2008-9 where the price gap widened from zero to 4-5%. Then a period of stabilisation in 2010 (a similar pattern is visible in the NGDP gap) – and then another shock caused by the ECB’s two catastrophic interest rate hikes in 2011. Since 2011 the price gap has just continued to widen and there are absolutely no signs that the widening of the price gap is coming to an end.

What should be noted, however, is that the price gap is considerably smaller than the NGDP gap (7% vs 20% in 2014). This is an indication of considerably downward rigidity in Italian prices. Hence, had there been full price flexibility the NGDP gap and the price gap would have been of a similar size. We can therefore conclude that the Italian Aggregate Supply (AS) curve is fairly flat (the short-run Phillips curve is not vertical).

The Great Recession has caused a massive output loss in Italy

In a world of full price flexibility the AS curve is vertical and as a result a drop in nominal GDP should be translated fully into a drop in prices, while the output should be unaffected. However, as the difference between the NGDP gap and the price indicates the Italian AS curve is far from vertical. Therefore we should expect a major negative demand shock to cause a drop in prices (relative to the pre-crisis trend), but also a a drop in output (real GDP). The graph below shows that certainly also has been the case.

Output gap Italy

 

The graph confirms the story from the two first graphs – from 2000 to 2007 there was considerably nominal stability and that led to real stability as well. Hence, during that period real GDP growth consistently was fairly close to potential growth. However, the development in real GDP since 2008 has been catastrophic. Hence, real GDP today is basically at the same level today as 15 years ago!

The extremely negative development in real GDP means that the output gap (based on this simple method) today is -14%! And worse – there don’t seems to be any sign of stabilisation (yesterday’s GDP numbers confirmed that).

And it should further be noted that even before the crisis Italian RGDP growth was quite weak. Hence, in the period 2000-2007 real GDP grew by an average of only 1.2% y/y – strongly indicating that Italy not only has to struggle with a massive negative demand problem, but also with serious structural problems.

Without monetary easing it could take a decade to close the output gap  

The message from the graphs above is clear – the Italian economy is suffering from a massive demand short-fall due to overly tight monetary conditions (a collapse in nominal GDP).

One can obviously imagine that the Italian output gap can be closed without monetary easing from the ECB. That would, however, necessitate a sharp drop in the Italian price level (basically 14% relative to the pre-crisis trend – the difference between the NGDP gap and the price gap).

A back of an envelop calculation illustrates how long this process would take. Over the last couple of years the GDP deflator has grown by 1-1.5% y/y compared a pre-crisis trend-growth rate around 2.5%. This means that the yearly widening of the price gap at the present pace is 1-1.5%. Hence, at that pace it would take 9-14 years to increase the price gap to 20%.

However, even if this was political and socially possible we should remember that such an “internal devaluation” would lead to a continued rise in both public and private debt ratios as it would means that nominal GDP growth would remain extremely low even if real GDP growth where to pick up a bit.

Concluding, without a monetary easing from the ECB Italy is likely to remain in a debt-deflation spiral within things that follows from that – banking distress, public finances troubles and political and social distress.

PS An Italian – Mario Draghi – told us today that the ECB does not think that there is a need for monetary easing right now. Looking at the “terrible gaps” it is pretty hard for me to agree with Mr. Draghi.

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