Tuesday, December 31, 2013

Did income inequality lead to the collapse of ancient Rome?

In 2013 a consensus developed among American liberals that the problem of income inequality should be a top priority. President Obama stated that income inequality was the 'defining challenge of our time'.

Income inequality was also a major issue when ancient Rome was at the height of its power.  Political struggles over income inequality destabilized the Roman system, and lead to irreversible political changes that fatally undermined Roman civilization.

The Roman city state was founded in the eighth century BC as a kingdom. After a particularly obnoxious king, the monarch was overthrown in 509 BC. Instead of replacing him with another king, the citizens of Rome did something revolutionary.  They swore an oath that no one man would ever again be allowed to rule Rome. They set up a system where no man had absolute power and where the government was accountable to the people. It was similar in many ways to our modern American system. They called it a Republic.

The Republic seems to have been very good for business. Modern science has given us some insight into Roman economic activity through the study of shipwrecks and ice cores. What is really interesting is that both unrelated datasets tell the same story. The Roman economy grew for about 500 years from 500 BC to a peak at 1AD, and then shrank away to nothing by 500 AD.

The data on lead production comes from Greenland ice cores. Lead smelting released pollution, which found its way to the Greenland icecap. The Romans were mining lead so they could use that lead to extract silver from its ore. The Romans needed silver because their monetary system was based on silver coins.

The growth in the Roman economy roughly coincides with the existence of the Roman Republic, which started with the overthrow of the king in 509 BC  and came to an end in 27 BC when the Republic was overthrown. Good institutions are vital to economic growth in the third world today, and the Republic was likely key to the success of Rome.

Much has been written about why Rome fell. What the modern data reveals, is that the economy had been shrinking for centuries before the final collapse of the Roman state. When the last Roman emperor was overthrown in 476 AD, the economy had withered away. The data also shows that the economy peaked around 1 AD, so the cause of the eventual collapse of Rome dates to that era.  The replacement of the Republic with emperors seems to be the most likely reason. Kings and emperors are very common in history, while republics are rare.

Why did the Republic fall?

What seems to have destabilized the Republic was growing income inequality.  By the middle of the second century, the economic situation for the average Roman was declining. The backbone of Rome was small farmers who owned their own land. These small farms started going bankrupt, and they sold their land to aristocrats who set up  large estates worked by imported slave labor. The displaced farmers went to the cities looking for work, but they didn't find many jobs, and ended up dependent on government welfare.

In 133 BC these unemployed people elected a populist called Tiberius Gracchus who promised them land reform. The wealthy elite resisted the reforms, and Tiberius was assassinated. This started a series of political assassinations and military coups which lead to the dismantling of the Republic by 27AD. The whole process took over a hundred years.

Tuesday, July 17, 2012

Who's afraid of inflation?: Part 2

This chart covers the US economy  from 1960 through to the present day. Core inflation is shown in red, and year over year wage growth is shown in blue.

The first point here is that inflation problems go hand in hand with stong wage growth. In the high inflation period of the 1970s, wage growth was never less than 7.5% per year. Strong wage growth in the late 60s preceded the slide into high inflation. Inflation is a problem that tends to appear in the late stages of an economic boom, not when the economy is deeply depressed. Wage growth at present is very low.

The second point is that the Fed's current target for inflation, at 2.5%, is far lower than the 3-5% inflation that prevailed during Reagan's presidency. Nobody saw inflation as a problem at the time, even though it was far above the level which the Fed now regards as acceptable. And job growth in the Reagan recovery was far better than anything which we have seen in the past few years.

Clearly the Bernanke Fed has prioritized low inflation over fighting unemployment. I believe this reflects a lack of accountability to the American public.

Wage growth isn't likely to be a problem any time soon

This chart shows wage growth in blue and the unemployment rate in green. Wages seem to take off when unemployment gets below about 5%. There is no chance of that happening in the near future because unemployment remains far too high. If wage growth stays low, so will inflation.

Saturday, July 14, 2012

Who's afraid of inflation?

Central banks continue to point to fears of inflation as their justification for not doing more to generate growth and fight unemployment. I find their concern about inflation almost impossible to understand and in this post I will explain why.

Inflation: A problem of the past

As this chart shows, inflation has been dormant since the mid-90s. It hasn't been a serious problem for 30 years, since 1982. Inflation is in red, while unemployment is in blue. And unemployment remains far above the 5% level which has sometimes sparked inflation in the past.

Global conditions don't favor inflation

When inflation was last a serious problem, in the 1970s, it wasn't just a US issue. As the next chart shows, it was a global problem. Japan is in red, the UK in green, France in orange and Germany in blue. Japan and the UK had even more serious inflation than the US. Today, global inflation is lower than at any time in the past 50 years.

The bond market isn't worried

The next chart shows the yield on ordinary 10-year Treasuries in green, and on inflation protected bonds in blue. Bond rates are lower than at any time in the past 50 years. Real interest rates are negative. The difference between ordinary and inflation protected bonds gives an implied inflation forecast of 2.5%.

Demand is very weak

The next chart shows housing starts in red, and GDP in blue. In past recoveries, falling interest rates would encourage home building, and that added demand would pull the economy out of recession. The housing market is badly broken, and housing starts remain at very low levels despite very low interest rates. In the past month there have been a few stories indicating an upturn in housing, which is a rare piece of good economic news, but there is a long ways to go to get back to normal levels.

When inflation was a problem, in the 1970s, demand was much stronger, with housing starts running at over 2 million units.  Growth surged to over 5% back then.

Today, growth is extremely weak by comparison with past recoveries. It is below 2.5%, which is unusual for an economy that is not in recession.

Car demand is also unusually weak.

Unemployment in catastrophically bad

Not since the Depression have so many been unemployed for so long, yet Ben Bernanke and the Federal Reserve don't seem to care. The longer people stay unemployed, the more skills they lose.

We have an economy with surplus capital, industrial capacity and labor, and very weak demand. This is not the sort of economy that generates inflation. Yet the Bernanke Fed appears to have given up on its mandate to fight unemployment.

Saturday, July 7, 2012

A divided Europe

The European crisis is often framed in terms of 'wealthy' Northern Europe bailing out 'poor' Southern Europe. Reality is more complicated.

Regional GDP as a percent of EU average (2009 data)

This map shows economic output by region. Dark greens show the regions of highest output, light green shows regions close to the EU average, while the poorest regions are colored pale yellow. The north-south divide runs right through the middle of Italy, and parts of northern Italy and northern Spain have output levels comparable to Germany.

Meanwhile, parts of eastern Germany have output levels comparable to Greece and southern Spain. Despite 20 years and vast amounts of aid, East Germany is nowhere near matching West Germany's economic performance. East Germany has never really recovered from having an overvalued currency after unification
Chart source: Eurostat

Judging by the very slow improvement of East Germany, it seems very unlikely that the PIGS (Portugal, Ireland, Greece, Spain) will be able to solve their problems by raising competitiveness. German experience with reunification probably explains why Germany is reluctant to give the PIGS large amounts of aid. They tried that with East Germany and it didn't work.

Regional unemployment (2010)

Chart source: Eurostat

In this map dark green shows high levels of unemployment while light yellow shows low unemployment. Southern Germany and Northern Italy are doing very well, while most of Europe struggles.

Given the divergent economic performance, a single currency no longer seems to make sense. Of course the USA also struggles with large regional differences in wealth. However, it is the vast differences in unemployment rates which will probably make the Eurozone unworkable. Salzburg region, Austria has 2.5% unemployment, while Andalucia region, Spain suffers from 30% unemployment.

Source: Eurostat


Sunday, July 1, 2012

Eurofail: Ireland vs Arizona

The financial crisis in Europe just won't seem to go away. While the US is still struggling to get out of the recession that started in 2008, we have at least managed to stabilize our financial system.

There are surprising similarities between Ireland, one of the first European countries to be engulfed by the crisis, and the American state of Arizona. The differences in the way the crisis was handled contain a lot of lessons about what is necessary for a successful currency union.

NamePopulation   2007 GDP per capita (2010$) Homeownership rate (2004)
Arizona 6.3 million $44,200 69%
Ireland4.6 million $46,138 81%

Annual economic growth in Ireland and Arizona was very similar before the crisis
Orange: Arizona, Green: Ireland

Unemployment rates were also very similar before the crisis, but post-crisis Arizona has done much better.
Orange:Arizona, Green:Ireland

Irish house prices have lost half their value from their peak.

House prices in Phoenix have also lost a little over half their peak value. Arizona house prices fell faster, and have now stabilized.

The lesson for Europe

Arizona and Ireland had very similar housing bubbles. Yet Arizona is now on the road to recovery, while Ireland remains stuck with very high unemployment. Both are small economies which are part of much larger currency areas.  In the US, mortgage related losses were dealt with at the Federal level.  Bank failures were dealt with via FDIC. Arizona also benefited from payouts from Federal anti-poverty programs, like unemployment insurance and food stamps.

In Ireland, all these costs had to be borne by the Irish state. The Irish state is now broke.

If the Euro is to have any chance of survival, the cost of cleaning up failed banks needs to be paid at the European level.  Money for programs like unemployment insurance also needs to come from Europe. To pay for all this, some form of European tax system will be needed.

European governments should remain free to raise their own taxes and spend money as required. Arizona doesn't need budget approval from the Federal government in Washington, DC. The  US does not have anything similar to Europe's growth and stability pact.

Wednesday, June 27, 2012

A reason the Euro failed?

The Euro is failing because of chronic current account imbalances between Northern and Southern Europe. But what is the reason for these imbalances?

Below I have plotted the homeownership rate versus the current account balance as a % of GDP for a set of major economies. The data is for 2004/2005, so it is before the crisis struck. There looks to be a reasonable correlation here, with high rates of homeownership predicting trade deficits.

The next chart shows the same data in a different style. Note that Greece, Ireland and Spain have some of the highest rates of homeownership in the OECD, while Germany has one of the lowest.

The question here is why high rates of home ownership go along with trade deficits. It's possible that people who own their own home feel more confident and are more willing to spend. I think it is more likely that easy consumer credit is responsible for both the high rate of home ownership and the excessive consumption that leads to trade deficits.

Another point here is that the Euro brought together diverse countries with different economic cultures. Maybe things would have worked better if there had been a single financial regulator for Europe.

Data sources: 2004 Homeownership: from OECD
                           2005 Current account balance from OECD

Thursday, April 19, 2012

Will the European economic crisis lead to the rise of new dictatorships?

In the early 1920s Europe was mostly democratic. Germany, Spain, Portugal, Italy and Greece all had democratic systems. They were all doomed to be replaced by dictatorships. The rise of the extremists who overthrew democracy was greatly aided by the Depression. The current downturn in Europe is the worst since the Great Depression. Budget difficulties have lead to austerity, which has lead to high unemployment. Extremists are once again on the march across Europe.

In Greece, support for the centrist parties that have ruled the country since the end of dictatorship in 1974 has collapsed. In 2009 the right-wing New Democracy and the left-wing PASOK won a combined 77% of the vote. The most recent opinion poll for the upcoming election shows these parties have collapsed to 38% of the vote. Voters have rallied to the far left parties like the communists, and anti-immigrant right-wing nationalists. As the New York Times reports, even neo-Nazi parties like Golden Dawn may pick up enough votes to get into Parliament. While illegal immigrants have replaced the Jews as the favored scapegoat, Golden Dawn has the paramilitary wing, fascist ideology and Holocaust denial typical of neo-Nazis.

However, the biggest risks to European peace and stability come from an extremist take over of a major European country.  The German Nazi Party got going amid the economic chaos of the early 1920s. Germany had been humiliated by defeat in World War One, and the Versailles Treaty demanded huge payments be made to the victors. The German government resorted to printing money and wild hyperinflation resulted. In 1924  the Nazis won 6.5% of the vote. Then, in the late 20s, the economy recovered and their appeal faded. In 1928 they won only 2.6% of the vote.

That might have been the end for them. However, in 1929 the Great Depression hit. Chancellor Bruning adopted austerity policies and the German economy suffered terribly. The popularity of extremist parties like the Nazis and the Communists surged. By 1933 the Nazis won 44 % of the vote.  Shortly afterward the Nazis outlawed other political parties and German democracy was dead.

Today in 2012, France is electing a new President and the center parties  are under enormous pressure. Under the euro, France has suffered from years of poor economic performance.  A double dip recession looks possible, with a growth forecast of only 0.4% for 2012. On the far right, the anti-immigrant, anti-euro Front National is lead by Marine Le Pen. They are polling at 16%. However the real story of the election has been the rise of the America hating Jean-Luc Melenchon. The leader of the neo-communist left front is at 16% in the polls. He is sometimes seen as a French version of Venezuela's Hugo Chavez.  Neither Melenchon nor Le Pen will win the first round of voting on April 22nd. However, it looks as if about a third of the vote will go to extremist parties. Their future chances are excellent if economic conditions don't improve.

The first European democracy to fall may well be Hungary. Like Greece, Hungary has a full on neo-Nazi party called Jobbik, which won 12% of the seats in Parliament in the last election. Meanwhile, the ruling Fidesz party is using the old Fascist trick of winning an election, and then changing the Constitution in order to entrench themselves in power. Professor Scheppele of Princeton writes about them here. The changes don't appear to be as far reaching as those pushed through by Mussolini's Fascists in early 1920s Italy or Hitler's Nazis in 1930s Germany, but the reappearance of this tactic is deeply disturbing. 

The European Central Bank, headquartered in Frankfurt, is currently focused on preventing inflation in Germany. To achieve that end, they have been willing to tolerate very high unemployment in the rest of Europe. Unemployment has reached 21% in Greece, 24% in Spain and 10% in France. This is politically dangerous.

It is true that 2012 is not 1930. The humiliation of defeat in World War 1, together with the Treaty of Versailles,  left some Germans wanting revenge. Nobody in today's Europe is interested in fighting another war.  European democracy today is better established today than it was in the 1920s. However, if the European Union, capitalism and democracy fail to deliver jobs, then people will look to other systems.

Forcing the rest of Europe to adopt austerity will force change, but it may not be the change that the ECB or Germany seeks.

Greek election opinion polls
French election opinion polls
Frum on the French election