The economic legacy of Mrs Thatcher

Nicholas Crafts 08 April 2013

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The policies of the Conservative governments led by Margaret Thatcher between 1979 and 1990 remain highly controversial more than 20 years later. In many respects, they represented a sharp break with the earlier postwar period and this was certainly true of supply-side policies relevant to growth performance. Reforms of fiscal policy were made including the restructuring of taxation by increasing VAT while reducing income-tax rates and, notably, by indexing transfer payments to prices rather than wages while aiming to restore a balanced budget.

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Topics:  Macroeconomic policy

Tags:  Margaret Thatcher, Thatcherism

Modelling and Forecasting Inflation: Recent Approaches

17 - 17 December 2012, Henley Business School, University of Reading

Event Type

Workshop

Long Title

International Research Workshop on Modelling and Forecasting Inflation: Recent Approaches
Dates

Start Date

Mon, 12/17/2012

End Date

Mon, 12/17/2012

Institution

Department of Economics, University of Reading

Location

Henley Business School, University of Reading

Attendance

Yes

More information

https://sites.google.com/site/modellingforecastinginflation/
Organizer

Organizer(s)

Alexander Mihailov and Kerry Patterson, University of Reading, and Fabio Rumler, Austrian National Bank

Contact Email

a.mihailov@reading.ac.uk

Disclaimer: Vox is not responsible for the accuracy of this information.


Topics

Financial markets Frontiers of economic research Global crisis International finance Macroeconomic policy Monetary policy

Fault lines: how hidden fractures still threaten the world economy

Raghuram Rajan interviewed by Romesh Vaitilingam,

Date Published

Fri, 08/06/2010

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See Also

Related research here [1]. [1] http://press.princeton.edu/titles/9111.html

Transcript

View Transcript

 

Romesh Vaitilingam interviews Raghuram Rajan for Vox

July 2010

Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/5381]

 

Romesh Vaitilingam:  Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Raghuram Rajan of the University of Chicago's Booth School of Business.

Raghuram and I met in London in July 2010. We spoke about his new book Fault Lines: How Hidden Fractures Still Threaten the World Economy.

Raghuram Rajan:  I think people have focused on the problems in the financial sector. And clearly there are some big problems there that need fixing. But we have to ask why these problems emerged now. Why they emerged in what is thought to be the most sophisticated financial sector system in the world. And why the institutions let permit this, the regulators, political structures ‑ all of them failed in preventing this crisis.

I think it's important because we have a theory of growth, we have a theory of development which says: You fix the institutions and then you are there, and the problem with emerging markets is they don't have these good institutions and that's why they keep getting held back and poor developing countries never created them in the first place.

So, this book is an attempt to first understand what happened and second to say that therefore this casts some suspicion on our moral of institution‑based development that creates the institutions and then you are there. It's saying institutions in many ways are a creature of the political consensus. And they are not outside the political consensus, though we would like to think of them as outside. That when the political consensus gets fractured, sometimes the institutions get pushed, maybe don't break, but get pushed in a certain direction.

So, what do I mean? I argue that the political forces in the United States over this time will pretty strongly motivate it in certain directions. So, where do the political forces come from?

One, growing inequality. Now, this is to some extent a function of the technological change which is pretty steady which requires people to have higher skills. But it is also a function of the fact that the supply of people with higher skills, with graduate degrees for example, has not kept pace with the demand for them.

So, what we've seen in the United States is the educated segment of the population, the ones with bachelor's degrees and higher, have been growing in income at a much faster rate than the people who don't, the people who have only a high school education.

So, the top is running away from the middle and this is in many ways a problem. To some extent the middle is not just losing in relative terms, sometimes it's losing in absolute terms. As a result there is a fair amount of anxiety in the United States. The stagnant median wage has been an issue for a long time.

Well, what is the natural response to growing inequality in many countries? It's tax and redistribution. Tax the rich, redistribute towards the less well off. And so you get consensus and growth. Well, in the United States, over the eighties and nineties there has been very strong opposition to taxing and redistribution.

Remember this is the Reagan era moving into the Clinton era. You are trying to get people off welfare and not a whole lot of desire to do tax and redistribution.

My argument is credit was another way that politicians sort of found their way into as a way of dealing with this problem of growing anxiety of the people left behind. Credit, especially housing credit, had number of positives. And housing? This was the great American dream, owning a house. When you lent to them, people could borrow against that house. They could essentially fund better lifestyles and after all, we economists think, consumption is what matters rather than income. So, consumption could be kept high. But it wasn't necessarily consumption with your feeling that you were borrowing a lot, because after all your house was growing in value, so your debt, net debt, was not that high given the assets that you had.

So, it gave the illusion of progress. It gave households the ability to ignore the stagnant wage and made everybody sort of better off, so from the Democrats, this was good thing. It was money going to their favorite constituencies. From the Republicans, this was an attempt to make people property owners and therefore vote Republican.

So, I think inequality was the first fault line, created a push for credit and that push for credit was something politicians on both sides of the aisle supported, but also used the instruments of the government ‑ Fannie, Freddie, the FHA. That eventually created problems for the economy and we'll come to that.

Second fault line:  I talked about just now the structural desire for the US to consume. There is also the fact that recessions in the US have changed in nature. Recovery used to be very fast. Eight months from when you had the bottom of the recession, all the jobs that were lost were back typically in past recessions.

From 1991, it became increasingly jobless. It took 23 months for jobs to come back in 1991. It took 38 months in 2001. Again, the political pressure from people who've lost jobs, given the thin safety net in the United States, six months on unemployment benefits. Typically, you lose medical benefits immediately. Political pressure to create jobs has been tremendous.

Now, politicians initially didn't respond. '91, remember George Bush the elder won the first Gulf War but lost the presidential election because he was out of touch. Didn't put stimulus after stimulus package. James Carville had that inimitable phrase, "It’s the economy, stupid." Everybody has recognized that now.

So, politicians understand if you don't get the jobs back, you are toast. So, what we have is stimulus package after stimulus package. But also, perhaps more problematic, the Fed stays on hold. Remember the Greenspan Fed stayed on hold at one percent for a sustained period.

Why was that? Not because they didn't know the Taylor rule. They were seeing unemployment numbers were high, and no Fed chairman could raise rates with Congress staring at him. And with the mandate, the Fed mandate is maximum sustainable employment. And given that mandate, they had little ability to move away, especially given the frameworks that we are using which was inflation targeting effectively which suggested that there is no inflation in sight.

So, we might as well keep on hold. Of course, that led to asset price booms and so on, which eventually created problems. But the point here is the second fault line is the US not only has a structural desire to expand consumption, it also has a cyclical propensity to push growth and consumption.

Romesh:  With both these fault lines, Raghu, I wonder is this a kind of blame the government story or blame the policy makers or blame the politicians? Because in a way you're saying it's the politicians’ response to the problem of inequality and the safety net and they are going for the easy option because they can't tax and redistribute, they can't establish a bigger safety net.

Raghuram:  I'm not saying it’s so much blame as it’s what comes naturally when you are trying to help people given the alternatives that you have. Expanding the safety net--we've just had a horrendous fight over the health care bill--is a major long‑term project and it's not clear those enough evidence to warrant moving in this direction before. And so people did the short term stuff that came naturally. But you're right, that it's not so much blaming the government as the government has become a much bigger player, implicitly or explicitly, in a number of industrial countries. And we expect the government to be a bigger player.

I am not saying the financial sector’s faultless, in fact I am going to argue that they bear much of the blame in the chapters six, seven and eight in the book, but what I am going to argue is what we haven't worked out well in capitalistic economies: It's not the government or the private sector but how the two interact. Especially how the private financial sector interacts with an activist government, because a private financial sector is always looking for an edge. In an activist government, especially in an activist government which is motivated by concerns other than the financial, gives it that edge, and that's what I think to some extent happened in sub‑prime and took the economy over the cliff.

So let me add this last piece which is the global macroeconomics. The global macroeconomy again is sort of a Greek tragedy where people are doing what comes naturally.

We have a bunch of countries that have focused on exports. I think they're structurally now sort of focused on exports, because even as they've built very muscular export sectors ‑‑ Germany, Japan, Taiwan, Korea, and now China ‑‑ they have neglected their domestic sectors. In fact I argue in the book, there might actually be a relationship, that the same interventions which occurred on the export side in order to built export champions, they were constrained by the foreign competition, so you had to have efficient producers there. But that intervention on the domestic side ended up with a lot of regulation, a lot of constraints and competition in an attempt to protect incumbents and was unconstrained by the discipline of external competition.

So you've you got weak domestic sectors, look at the service sector in Japan, look at the service sector in Germany. I mean, can you name a Japanese restaurant chain for example? The point is that you've got very muscular exporters but not the same muscularity in the domestic side. That makes these countries structurally export‑dependent on the world economy, implies there has to be importers somewhere else.

That's where the third piece comes in ‑‑ the US pushing this stuff, pushing consumption, stimulating in the downturn of 2001. And of course, response to that stimulus is there's a whole lot of goods from outside searching for markets, looking for people willing to spend, and willing to finance it.

So you've got a flood of outside money coming in. The German banks which participated so heavily in the sub‑prime crisis, but also from elsewhere. The Chinese Central Bank’s holding agency paper, lots of money coming into the US.

So where does this all tie into the financial sector? I think two ways. One, the flood of money coming in looking for assets, especially guided by policy into low income segments of the market meet a response from the financial sector. “You want assets? We'll get them for you. And if you don't ask the questions about the quality of assets, we want to give you anything that you’ll buy.” I mean, caveat emptor, right?

And I want to argue that, especially the arm’s-length financial sector is extremely prone to situations where huge amounts of money come in with few questions. That tends to distort prices and take these guys completely off track. In other words, the arm’s-length financial system depends lot on checks and balances, much like the US economy.

The guy originating the mortgage, in a traditional financial system he’ll hold it to maturity, has strong incentives to make the right loans. In the arm’s-length financial system he is selling it off, he is securitizing it to a bunch of buyers elsewhere. His only incentive to pay attention to quality is if the guys at the end of the line pay attention to the quality.

Once they stop paying attention to quality he securitizes any garbage because after all what keeps him honest? He doesn't walk past the house every day, he doesn't walk past the borrowers every day and have to face them. His main interest is, do they want the loan, can I get them the loan, are the guys at the end of the line willing to buy? When there is the huge amount of price-insensitive money coming at the end of line, he securitizes any thing.

So I think discipline broke down in the market. It broke down because guys at the front of the line had poor incentives, that's part of the problem. But the guys back of the line make those incentive worse by being willing to buy anything and who are the guys at the back of the line? It was entities like Freddie and Fannie. It was foreign investors who didn't ask, you know…the Landesbank had similar kinds of incentives, "Go out and buy." They were told, "Don't compete with our domestic banks here, you need to take your money outside," because that was the nature of what was happening in Germany.

The bottom line here is that the financial sector was corrupted. It was not an innocent victim, it was part of this whole process and it went into it with eyes wide open. We need to fix those problems. And I talk in the book also about the second question that you want to ask: why do the banks who knew all this garbage was being created hold onto so much of it. That’s a further breakdown in incentives and we need to fix that.

But I do want to say if we don't fix these other problems we have the possibility of a crisis somewhere else. Maybe not in sub‑prime but somewhere else. It may not even be a financial crisis but there are these deep problems which are complicating the world economy, and we don't have ways without recognizing them of actually dealing with these problems. I think it’s important we come to terms with them and start acting on them.

Romesh:  Well we need to talk about some potential solutions and sense that there is one set of solutions focused on the US economy dealing with these biggest issues of high inequality and lack of a safety net putting pressure on policymakers to come up with quick solutions. You say basically the solution there is about education and that's a really long‑term one. How can you square that circle, if you like?

Raghuram:  Well this is the whole problem, right? This is the whole problem that we are looking for silver bullets, and there may not be any. And some people look at the identification of the problem and say, "Aha. Now you've identified the problem, what's your solution?" They expect you to have an immediate solution.

Well, there are lots of experiments under way to improve education and so on. It's a complicated issue and it's going to take time. And there are people who are not going to benefit from this. The 47‑year‑old GM worker who’s lost his job is not going to be reeducated into a commensurate job somewhere else, for the most part. There will be some who will.

So what do you do about them? I think first thing is to recognize we do have a problem and recognize that we have to start looking for creative solutions.

One is the long‑term fix, and we need to put that in place now. I think education across industrial countries, but especially in America, is falling behind and the only way standards of living are going to keep up, giving the enormous competition that's going to emerge from the emerging market is if in fact you move upscale.

This is Dornbusch Samuelson Fischer, not all the population needs to move upscale, there will be a role for service providers to the upscale population. A role for cooks, chauffeurs, gardeners etc, but also a need for people to be generating that income. We need more of people to generate that income, which means more kids from the ghettos have to get a good education, rather than be a permanent underclass.

That is an enormous problem to solve, but in the meantime we are also going to have another problem, which is that you are going to have these people who are used to a comfortable standard of living. But whose jobs are no longer competitive jobs and therefore they have made redundant and they have to find some way out.

Now I don't think there is an appetite, either on their part or on the part of the governments to put them on permanent dole. They will in many cases, have to adjust downwards to a lower standard of living. But is there a way that we can make their transition easier? Can we use some of their skills, in ways which are better than what the private sector can offer now?

Now there is a role for thinking about clever ways of retraining. Retraining has not proved particularly successful so far, but can we think about it? Can the universities play a role on this? Can the vocational schools play a role on this? These are all things we need to think harder about. And sometimes the "what can you do for me now" tends to come in the way of, we need to also think about the bridge to the medium and long‑term.

In terms of what can we do now, I think may be part of the answers we need to accept some pain. That we have been trying to reflate the economy, every time there is a downturn and say, "Oh we got to pump it up, we got to pump it up." And we have the hubris of economists of saying, "We have the tools, market policy and fiscal policy, just do it and we will get back." But in the whole point of stimulus of this kind is you are pumping up aggregate demand again.

But what about supply, was supply the right kind, was demand the right kind, are we pumping up demand which is unsustainable, for example, for housing and should we in a sense let the economy adjust? There is no appetite for letting economies adjust, without constant intervention because we think, ah, the government has to play a bigger role, and this across the political spectrum.

But in fact we may need to let the economy adjust and focus on age‑old issues such as trying to make it more flexible, more competitive. There might be some government money involved in some of this in allowing the adjustment process. But trust a little more that the adjustment will take place over time, instead of saying, we have to pump it up all over again.

Romesh:  So intractable problems at the national level, but perhaps even more intractable problems at the global level. How do we confront this second big set of fault lines you mentioned around global imbalances. That's something you said you were very much focused on when you were chief economist of the IMF and it's very much of the heart of this of this process. How do you deal with it?

Raghuram:  Well we see the debate alive today in Europe, I mean Germany, should it be spending more? Does it have a role to play given its large surpluses or is it fine? Again, the short‑term fix seems so obvious, but doesn't seem to me that it is the long‑term fix. The short‑term fixes will say, Germany should open the coffers and spend more.

But I am not sure that at this stage, the response of German consumers, will not be to retrench even more, saying if our government is spending so much, it must be they are going to tax us down the line.

We know that there's more regarding equivalence closer to fiscal limits, then when you're far away from it. But also I think Germany's real problem, is its underdeveloped domestic sector. That has to become more competitive.

I think what this means is, increasing competition in services, reducing the regulations, I mean as you know, until recently there were substantial regulations on shopping hours in Germany.

I mean, that's the kind of change I think which will add to German growth. Make the domestic focused economy productive, move employment to those areas away form export‑led employment, and essentially allow Germany to have more internal growth in that sense, because it relies less on world growth for its own growth. Make it a bigger contributor to world growth.

These are all long‑term again. The problem of course is that, countries don't have an incentive to move away from existing strategies, especially if the strategy involves short term pain and competition is always painful.

So for Germany or Japan, I mean Japan has been doing stimulus package after stimulus package has had low interest rates for 10 years. I think the lesson from Japan is unless you do the reforms to make the uncompetitive parts of the economy more competitive ‑‑ I am using the word competitive in both ‑‑ you need to increase competition, as well as make it more efficient.

Japan has shown in some sense the difficulty of using government-aided stimulus to pump an economy which has deep structural problems back into growth. If you look at when Japan's grown over the last 20 years typically in the world has pulled it out, rather than when it has pulled it out itself.

So these countries has to change. What is going to force them to change? Unfortunately I don't think our international organizations are up to the task. And so change is going to come almost by default, either because they wake up, they understand the deep problem. Maybe Japan after 20 years of zero growth ‑‑ zero nominal growth at least ‑‑ is going to start thinking of what it needs to do.

But I think that we need to rethink our international organizations and how they might function. One of the points I argue in the book is, it's not clear to me that a rules‑based approach is going to work. Because the Indias and the Chinas are asking who set the rules. And it is also not clear to me that you can have one-size-fits-all set of rules for the economy.

If you say China is manipulating the exchange rate, couldn't you on the same token argue that the US is manipulating its interest rate? And are both fair game or are neither fair game or is one fair game and the other not?

I think these are questions that in our framework, we sort of say, "Oh China manipulating it's exchange rate is bad. Interest rate policy is good." But both are interventions, right? And so what is allowed and not allowed? I don't think we can get agreement on such an international framework.

And so to me, it seems as if the only hope is sort of to try and persuade countries. Persuasion is not just at the top because if you persuade at the top, without persuasion at the middle, you know, the intelligentsia, the influential, I think you are not going to get very far. So what I talk about in the book is the hope that we can create an organization. Or rather than an organization, a structure that can work within countries, on the broader task of persuading them about global policies.

It's not just macro imbalances that we are talking about, it's things like water. Water is going to become a source of major conflict over the years. How do we persuade countries, internally, about the need for cooperation on this?

Investment, trade, these are all issues that are going to become bigger sources of frictions over the next few years. We need more global cooperation on this. But, for some of these issues, global cooperation needs domestic support.

When Hu Jintao walks into that room, he has to know that more people in the country support the kinds of international policies, as with the U.S. I mean, there is no constituency for the global economy in the U.S. right now, even though the U.S. is such a big part of the global economy. It's: “Those guys out there. Why should we order our domestic monetary policy in order to benefit them?”

Romesh:  Well, I wonder if the appetite for this kind of fundamental reforms that you're calling for is going to be there. I mean, in a way, there's a feeling that 2008 was a terrible time, but the governments and central banks and international organizations of the world responded, and, as some politicians said, "saved the world".

Saved the world, and financial regulation, to some extent, has happened, as you said, in the US, healthcare regulation, huge battles to do those. Is their appetite going to be there for fundamental reform?

Raghuram:  There is no appetite. So, I mean, one way to end the book is to say, "Look, these are deep problems, we're never going to fix them, all hell will break loose at some point." I'm a little more optimistic.

I do think it's hard to see silver bullets, and people are always looking for silver bullets, one neat, simple thing we can do. I think that's part of the problem. I think we've been too focused on silver bullets, and I think, unfortunately, a fault of economics, especially macroeconomics, is that we've promised those silver bullets. We can have the Great Moderation. We can have our cake and eat it, too, and there's going to be no problem.

And this has prompted greater activism, and I think the activism gives us the sense that we've solved the problem, when, in fact, the problems are festering in deeper. And so, I'm going back to an older school, which is saying that, "Look, activism is well and good, in small doses, but there are also structural issues we need to take care of, and that will require deeper reform." And we've been able to postpone those reforms, for a long time.

But now that countries... I think the growth of India and China is asking big questions on adaptation for the industrial economies. So now that's happening. And now that we're becoming more integrated and our problems are spilling over, what processes do we have to solve these problems? And I think we are coming up against the inadequacies of the processes we have in place.

I mean, the G20 meeting last week, essentially, was a non‑event. Much as we can put gloss on it and say that nobody fought with each other, nobody threw a pie at each other, they were really polite to each other, and we had this statement which suggested they were all on board. Yes, they all want growth, they all want trade, they want all the good things.

But how do we get there, and keep that stuff going? Of course, once you get to the details, you find that there's not a whole lot of detail, and a whole of agreement on pleasant stuff.

So, I think that we do really need to think about whether we have the reforms in place and the institutions in place. And we can't be complacent, I think, in industrial countries, that just because we've reached development, it will continue that way.

I don't want to be alarmist, but I do think that there is a potential for much greater social conflict down the line than we have right now. There is also going to be that potential, without the government having the capacity that it had until recently. I mean, one of the things the crisis has done is insure there's limited government capacity going forward.

So how do you deal with all these issues? And I think it's just plain hard work. First, point out the problems, which I'm trying to do, and second, start working on them. There are no silver bullets, but there are lots of small things one can do, which, when added up, make a big difference. And that's what I hope we see.

Romesh:  Final question, Raghu. You say in the book, basically, we're all to blame; we're all complicit in this crisis. But I'd like to ask you particularly about the role of the economics profession. In 2005 you foresaw some of the things that might happen, and then did come to pass, and the economics profession rather scoffed at you. They’ve treated you as a Cassandra. Where was the profession at fault, do you think?

Raghuram:  Well, I have to say, it's not so much the economics profession, I think it was more regulators and so on for the most part. But the problem with the economics profession is not that it was complacent; it wasn't engaged, in my view. That's really the problem, that we've got a separation of much of the profession from the practical economists.

In fact, none of us would want to be known as one of those practical economists who forecast, "Are we going to have a double‑dip?" The problem is, every time we venture into the public arena, those are the kinds of question we are asked. Rather than questions we actually know the answers, or at least some of the answers, to.

And, as a result, I think, economists, by and large, don't engage in the public discourse. Yes, a few do. Paul Krugman does, to his credit, and a few others do, but it's a very small set of people who engage in the public discourse. And as a result, I think that we are largely irrelevant.

We do affect that discourse through research, which feeds into central bank thinking, which sometimes feeds into fiscal policymaking, but only in a very limited way. And most of us don't really opine on the problems of the day and how to solve them. We're happy talking to each other, but we don't talk more broadly.

I think that crisis is changing some of that pretty dramatically. I'm not saying that every junior professor should now go and talk about his latest paper, in an attempt to get everybody to do what that latest paper suggests. But I do think that we have a responsibility to engage more widely, and I think Vox is part of that process, to engage more widely and not leave the field to those who, perhaps, have spent less time on these kinds of issues.

By all means, we will be forced out of our level of comfort, out of our zone of comfort, by questions that we don't really know the answer to, but we have to make guesses. But I would say that so long as you make an honest effort at trying to do that, the profession shouldn't see anybody who goes out as tainted by the real world, and, therefore, an outcast, a pariah. We used to do that in India, anybody who had crossed the seas and therefore was now tainted and could never come back.

That notion that if you cross into the public domain, ever, you are too loose for the profession, I think it just diminishes the influence of the profession. It's terrible, and I think we should do more to engage. Not sell our souls to the public demand for information and so on, but at least engage more.

Romesh:  Raghu Rajan, thank you very much.

Raghuram:  Thank you.

 

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Topics

Financial markets Global crisis Poverty and income inequality
Tags
financial crises, US inequality, systemic problems

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Walking wounded: The British economy in the aftermath of World War I

Nicholas Crafts 27 August 2014

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World War I was not over by Christmas of 1914. It was a prolonged, brutal, and expensive conflict.  Britain incurred 715,000 military deaths (with more than twice that number wounded), the destruction of 3.6% of its human capital, 10% of its domestic and 24% of its overseas assets, and spent well over 25% of its GDP on the war effort between 1915 and 1918 (Broadberry and Harrison, 2005).  Yet that was far from the sum of the losses that the Great War inflicted on the British economy; economic damage continued to accrue throughout the 1920s and beyond. 

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Topics:  Economic history

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It’s time to deploy macroprudential policy: results from the Centre for Macroeconomics July Survey

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The Centre for Macroeconomics (CFM) – an ESRC-funded research centre including the University of Cambridge, the London School of Economics (LSE), University College London (UCL) and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of its fourth monthly survey.1 The surveys are designed to inform the public about the views held by leading UK-based macroeconomists on important questions about macroeconomics and public policy.

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Topics:  Macroeconomic policy

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Untangling trade and technology: Evidence from US labour markets

David Autor interviewed by Viv Davies,

Date Published

Fri, 05/02/2014

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See Also

David H. Autor, David Dorn, Gordon H. Hanson, Untangling Trade and Technology: Evidence from Local Labor Markets, MIT Working Paper, March 2013

 

 

 

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Productivity and Innovation
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Love it or hate it... the dollar's here to stay

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Date Published

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See Also

Prasad, Eswar S (2014) The Dollar Trap: How the U.S. dollar tightened its grip on global finance , Princeton University Press.

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Debt-for-equity swaps offer Greece a better way

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Last week, Eurogroup finance ministers in their wisdom decided that there would be no debt relief or restructuring for Greece until the end of the summer. Evidently they wish to avoid exciting voters in the European Parliament elections in May. This is regrettable, since it only puts off the inevitable and forces the Troika to use smoke and mirrors to fill the government’s funding gap.

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Topics:  EU institutions International finance

Tags:  Greece, greek crisis, Greek debt, debt-equity swaps

Collective cooperation: The phenomenon of open source

Josh Lerner interviewed by Viv Davies,

Date Published

Fri, 02/18/2011

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See Also

See also

The Comingled Code: Open Source Software and Economic Development by Josh Lerner and Mark Schankerman, at Amazon.co.uk

and

The Economist review of The Comingled Code

Transcript

View Transcript

<p><em>Viv Davies interviews Josh Lerner for Vox</em></p>
<p><em>February 2011</em></p>
<p><em>Transcription of a VoxEU audio interview [http://www.voxeu.org/index.php?q=node/6123]</em></p>
<p><strong>Viv Davies</strong>: Hello, and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from the Centre for Economic Policy Research. It's the 14th of February 2010, and I'm speaking to Professor Josh Lerner of Harvard Business School about a book he has recently co authored with Professor Mark Schankerman, titled, &quot;The Comingled Code: Open Source and Economic Development.&quot; The book presents a rigorous economic analysis of the impact of open source software on consumers, firms, and economic development. I began the interview by asking Professor Lerner to explain exactly what open source is and why the authors suggest in the book that the impact of open source software has generated more heat than light.</p>
<p><strong>Josh Lerner</strong>: We might begin by just thinking about what open source is. And when you think about the key elements that make a software an open source project, certainly one of the most important aspects is that the code itself is available, in other words, that as people make contributions to these projects, there is an expectation that much of the contributions will be placed into the public domain for others to see. Now, the specific rules and the ability of people to take the software code and reuse it for commercial purposes varies, but the essential principle is that these projects are ones that are being done for the common good, and that for contributors to be able to take and use under the licensing rules is certainly a critical element. It's fair to say that open source has several other aspects, which may not fit into the formal definition but are certainly very important as well, which have to do with, often, the sort of strong sense of community, the self organizing principles behind them that lead to a very strong sense of commitment, in many cases, to the open source development process.</p>
<p>And I think this brings us to the second half of your question, which is why these things have proven to be controversial. Certainly, it's fair to say that in many instances, established software companies have found these things to be somewhat threatening, because it represents a very different way of developing software. And it's also fair to say that in many cases, people who are enthusiasts about open source make very broad claims about the superiority of the software development.</p>
<p>So, despite the fact that this is a really economic phenomenon, and one which has a lot of economic importance, a lot of the discussion has been in more what you could describe as ideological or emotional tones, rather than really taking a critical look of what's involved in open source and how does it work and what are its key features.</p>
<p><strong>Viv</strong>: You describe the main purpose of the book as being to try to understand the role of open source software in economic development, its relationship to growth and innovation and so on. And I guess this is why the subject will be of interest to economists. Could you perhaps expand a little on this, and also explain how you approached the research and writing of the book?</p>
<p><strong>Josh</strong>: I think that you can sort of begin by going back to one of the very famous essays in the economics of technological change, which was by Ken Arrow in 1962, and in it he really laid out the fundamental paradox associated with the development of new technologies. On the one hand, the new technology is a non rival good, which means to say that if one person figures out how to use it, it's not like a piece of property, a house, which only one person can live on. Essentially, this technology can now be used by any number of people. It's essentially a recipe that can be broadly disseminated. The problem is that to provide people with incentives to develop the recipe, or to do this, we have to give them some degree of exclusivity, or else they won't be inclined or tempted to go out and develop new recipes. So one has this paradox of: here we have this thing which is sort of very broadly applicable and could be used in many, many different settings, yet we, in some sense, have to limit its spread to provide incentives to develop the next generation of technologies.</p>
<p>And I think if we now turn to open source, at least at first blush, it seems that this resolves Arrows paradox, because, here we have something that, on the one hand, is certainly a technology which can be broadly applied in many different settings, and yet the people who are contributing to it seem to be, at least in large part, immune from the sort of traditional concerns of saying, &quot;I need to protect my contributions here.&quot; In point of fact, in many instances it seems the more widely spread a project is, the more people want to contribute to it, because of the recognition they'll get from it.</p>
<p>So, in a way, the power and the appeal of open source is that it essentially allows a new technology to be developed without the traditional mechanisms of intellectual property protection and keeping these things closed in, as we so often see among new technologies. So it is a fascinating area, and certainly one which is extremely intriguing for economists to think and write about.</p>
<p>Now, in terms of the methodology of the book, I think we're at a very early stage in terms of understanding open source. And in particular, I think, if you think back about alternative methods of developing technologies, like patents, there have been literally thousands of both empirical and theoretical articles looking at this. So, I very much feel that this book is a first look at a large and complicated phenomenon.</p>
<p>What we largely did is combine both careful thought, and particularly taking some frameworks developed elsewhere in economics, and applying them to the open source context, with the development of some new data, and particularly two surveys we did, of both software developers and software users, to understand the extent to which they were involved with open source software. So those were really the two key elements or two key aspects of the recipes. We also did a number of case studies to better understand the issues in the field.</p>
<p><strong>Viv</strong>: Would you say it's fair to say that the most successful examples of open source software are those that have been originally conceived and designed by one person who has then opened out the idea for others to contribute to? And if that's the case, do you think that this will continue to be so, or could we start to see genuinely collective innovations in open source development?</p>
<p><strong>Josh</strong>: I guess I would say that it's clear that an open source project needs structure to be successful. When you look at the successful ones: well disciplined, well organized efforts. And it's certainly clear as well that there is an important role for a charismatic leadership, the kind of leader who, when there is a fork in the road, when there's two different approaches and feelings are running high, can step in in that kind of situation and say, &quot;Well, we could do it this way, we could do it that way. There's a good case for going either way, but we're going to do A. And I think we should all follow this way because we're better off all sticking together than being in a situation where we splinter and end up with two much smaller projects.&quot; So I think that leadership is something that's very important. Now, it's interesting, when you look across the groups, that I think you can see a variety of different models there. Certainly, you'd point to Linux as a sort of classic example of a charismatic leader having very much put their initial stamp on the project and then institutionalizing it. I guess you could also point to some other projects, like Apache, which became institutionalized much earlier in their development and which were less reliant on one key leader in the way that, for instance, Linux was.</p>
<p>So I think there's certainly not a one size fits all element, but the importance of having a clear structure and having a clear leadership process is a certainly very essential element of the success of these projects. Going forward, I think it's a really interesting question, and I think you could imagine it going either way, becoming, as you say, more corporatized, or else still having a sort of important role for entrepreneurs in terms of creating these projects.</p>
<p><strong>Viv</strong>: You touched a little earlier on the issue of patenting. I'd like to ask you a little bit more about that now, and particularly how open source software code is protected from theft from companies who may want to profit from integrating the code into their products. We've recently seen, for example, how this can create quite significant problems, and even major lawsuits. I'm thinking here in particular of the recent Oracle versus Google case. First of all, it's important to emphasize that the treatment of corporations taking, or others taking, software and essentially privatizing it very much varies with the license that's being used. For instance, if you look at the boot up of a typical Apple device, they will acknowledge in the lines of code that stream in front of you as it boots up, that they've got BSD software. Which refers to an operating system often known as the Berkeley Software Distribution, which is essentially licensed under a relatively permissive license that allows companies to essentially privatize it to use the code, as long as they acknowledge that they are doing so in the program itself.</p>
<p>Certainly in some cases, there has been a deliberate decision made to make the software available under permissive licenses which allows corporations to use it. But, certainly the most famous of the open source licenses, the general public license or GPO, is a much more restrictive license and particularly has the ability or the requirement that companies cannot, except under very, very limited circumstances, essentially take the code and incorporate it into their commercial products. Unless they're willing to essentially take their commercial product and open up all the source code to the public and make it available at nominal cost, which of course the typical company would be very unwilling to do.</p>
<p>Now, as you can imagine, this does pose a variety of issues. There&rsquo;s clearly the issue around observability &hellip; even if a company does this kind of process of illegally appropriating some software code, is it going to be possible for people to see it. In other words, how difficult is it to be policed.</p>
<p>This, of course, is not unique to open source. It is also a problem with process patents as well, where essentially you may see that a competitor is producing a chemical and you may think that it's infringing your process patent. But unless you can get inside the factory, it may be very hard to prove it.</p>
<p>The other issue, of course, is one of litigation. This has been an area that still relatively unproven, unlike patent law where patents have been litigated for literally centuries. This is a very new area of the law. And in most cases where there have been disputes like this, they've ended up in settlements.</p>
<p>So really understanding the scope of these licenses, where the boundaries are drawn and so forth, still remains a little bit of a murky area with some very real challenges.</p>
<p><strong>Viv</strong>: I guess some of those settlements have been settled by trading patents. In the case of Oracle and Google, for example, Google have far less patents at their disposal than Oracle.</p>
<p><strong>Josh</strong>: Right. Certainly cross licenses are a common way many of these disputes do get settled.</p>
<p><strong>Viv</strong>: What does your research reveal about the compatibility of open source and proprietary software, and to what extent would you say that firms are co mingling the two?</p>
<p><strong>Josh</strong>: I think this was certainly one of the big surprises for us in terms of what we found in our research. Which was really across the board, the extent to which there was co mingling between the commercial and open source software was really quite striking. This was certainly true among users. That essentially in many cases, users would have when you looked at the various scales of corporations, the governments that we talked to had very mixed set of applications on their machines, including both open source and proprietary. But what's even more surprising was the extent to which one saw the mix on the part of developers. That in many, many instances, we saw firms basically doing both open source and commercial development, often with closely related products. I think we all knew of examples along these lines.</p>
<p>For instance, when you walk to the offices of something like Sendmail and there's basically sendmail.org right next to sendmail.com, essentially both the commercial and the open source project living right next to each other. But the extent of that co mingling, particularly on the developer side, was really quite striking and certainly very much came through both the surveys as well as the studies.</p>
<p><strong>Viv</strong>: What do you think the implications of open source software are for low and middle income countries? Do you think it helps the sector grow more rapidly in those countries, allowing them to catch up more quickly with developed countries?</p>
<p><strong>Josh</strong>: I think that you can say that the answer is undoubtedly the potential benefits of open source software in developing countries are going to be substantial. Essentially, it clearly is able to - given not always our large software companies are able to price discriminate in a way that price at a level where users can afford them - it certainly provides an avenue for broader diffusion of legal software in a very attractive way. You also have the appeal of the training aspect - that people can actually get into the software code and actually work with it. Which may position people for opportunities down the road, and so forth. At the same time, there is a little bit of a caution which is that I am not... I don't think we're comfortable with some of the policies which have sought to really help table in a way that very dramatically favor open source vis a vis proprietary software.</p>
<p>I think when we look, given what we see in the world out there which is this really strong co evolution between the two forms of software, it probably shouldn't be seen as &ldquo;either or&rdquo; but as&rdquo; and&rdquo;, where these two forms of development are really complimentary with each other rather than being substitute.</p>
<p><strong>Viv</strong>: I guess you're answering the question I was going to ask next. That is, that one of the questions posed in the book is how governments can develop a policy framework that enables competitive interactions between open source and proprietary software in a way that boosts efficiency and innovation. What is the answer to that?</p>
<p><strong>Josh</strong>: Well, as I was sort of hinting at, it probably does not involve very one sided things; &ldquo;we're just going to favor this kind of software or the other kind of software&rdquo;. The crucial elements seem to really lie, certainly in terms of allowing and encouraging the development of standards which are where the specifications are quite open and which as a result, allow the sharing of technologies and allow software to work with each other, regardless of the corporation or the project that originates it. Of course, keeping a firm eye on antitrust considerations to ensure that essentially an established player isn't somehow shutting the door or making it very hard for competitors, whether commercial or open source, to get a foothold in the environment.</p>
<p>My sense is that if there is a right, the appropriate ground rules that in many instances, we'll see open source take off and grow in many of these economies without any added help in a way that will really be quite beneficial to the economy.</p>
<p><strong>Viv</strong>: What would you say are the main messages from your research for firms and for the research community more generally?</p>
<p><strong>Josh</strong>: Let's start with the research community because I think there, the lesson is pretty clear that there has got to be very much a focus on this area in terms of understanding these issues. In particular, while there has been a variety of stuff looking at motivation of contributors and open source project and so forth, the interaction between the commercial and the commercial and open source world remains very, very poorly understood. It's also clear that our understanding has largely been derived from looking at the experience from the US and to a certain extent, Western Europe, and that much more work needs to be done in terms of understanding the experience of open source in emerging economies. What both the barriers and the opportunities that it poses are.</p>
<p>In terms of firms, I guess the most important thing I would emphasize is the extent to which open source has to be seen as a really critical, strategic decision and thinking about how it fits in with the commercial strategy.</p>
<p>Now, for the very largest of software firm, this may be nothing new. But, for many other firms, it seems often that open source strategy is almost an afterthought and hasn't really gotten the prominent, key strategic variable that it really deserves.</p>
<p><strong>Viv</strong>: Josh Lerner, thanks very much for talking to us today.</p>
<p><strong>Josh</strong></p>
<p>: I really appreciate the invitation. Thanks again.</p>

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Topics

Competition policy Productivity and Innovation
Tags
intellectual property rights, Competition policy, Open source software, patents technology

Related Article(s)

Should governments promote open source software? Standardisation in high-tech sectors IBM and Microsoft: Tying + dominance = abuse? When a merger softens competition: the Oracle-Sun Case Why so many low-quality patent applications in Europe?
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Week Ending 28 March 2010

THE GLOBAL CRISIS: WHY WERE SOME COUNTRIES HIT HARDER?
S. Pelin Berkmen, Gaston Gelos, Robert Rennhack, James P. Walsh, 28 March 2010

Despite the global reach of the financial crisis, some countries fared better than others. This column argues that this was due to differences in trade or financial openness, underlying vulnerabilities to external forces, or the strength of their economic policies.

Read article: http://www.VoxEU.org/index.php?q=node/4806

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