Golden fetters and paper chains

In various posts over the years I’ve mentioned how countries finally got out of the Great Depression.  Generally that involved breaking the link between their respective currencies and gold and then being able to adopt more-expansionary macroeconomic policies.  That was relatively easy to do as a purely technical matter, but it took a long time for countries to get there (a handful of significant countries not until 1936).  I’ve worried aloud that given how low the starting point for nominal interest rates was going to be that in the next serious downturn the refusal of central banks –  and it is simply a refusal –  to take policy rates deeply negative would end up as much the same sort of fetter as gold once was.

The definitive book-length treatment of this angle on the Great Depression is Berkeley professor Barry Eichengreen’s  Golden Fetters.  It was published in 1992 – decades ago now – and going by the marks in the margin of my copy I seem to have read it once a crisis since then.  It is one of those books that repays rereading, partly because the contemporary context against which one reads it is different each time.  I read it again last week.

What follows is informed by Eichengreen, although refracted through my lenses.  There are places where Eichengreen’s argument isn’t fully persuasive (and he has one or two facts wrong about New Zealand).

Much of the book is scene-setting for the experience of the Great Depression.  That includes a perspective on the pre-War Gold Standard, which tied together most of the major (and many of the minor) economies of the time, with a leadership role played in particular by the Bank of England.    In many of the core countries –  UK, France, Germany notably –  central banks played an important role, but in other countries operating on a gold standard there was no central bank at all (most importantly, the United States, but also countries like New Zealand and Canada-  all three of whom were net capital importers).    Price levels didn’t change much over time (the British price level was about the same in 1914 as it had been in 1834), capital flowed freely, trade (and migration) was extensive, and if there were periodic crises or threats to the system, central banks worked together to maintain stability.

World War One greatly disrupted the picture.  Some countries formally went off gold, others didn’t formally but there were enough interventions that the pre-war parities didn’t act as any sort of constraint on price levels.  Huge debts –  internal and external – were run-up in the process, and the US moved from being a net borrower to being a net lender to the rest of the world.  And in the aftermath of the war there were reparations obligations established, huge distributional fights (inside countries) as to who should cover what portion of the accumulated costs, and some countries collapsed into hyperinflation sooner (Austria) or later (Germany).   All manner of other countries had much higher price levels than pre-war, and in some –  notably France –  high inflation remained an issue well into the mid-1920s.

Against that backdrop, in many quarters a return to a money convertible to gold was seen as partly as a key confidence-building commitment, and partly as a return to something like normality.  It took a long time –  in one case, Japan, it din’t actually happen until early 1930 – and for good reason.  There were debates about which rate to restore parity at –  the UK eventually, perhaps unnecessarily, chose to re-peg at the pre-war parity, which implied several more years of moderate deflation.  For France, having had so much inflation, the pre-war peg quickly became unrealistic and they stabilised at a considerably devalued exchange rate to gold.  For Germany, of course, hyperinflation made a nonsense of the pre-war parity.

There hadn’t much gold mined in the previous few years, and yet global price levels were much higher than they had been.  That in itself posed some challenges.  But international cooperation and trust wasn’t what it had been pre-war either.  And particular policy choices made by the US and France meant that those two countries’ central banks accumulated an increasing share of the world’s gold are were unwilling and/or unable to let those inflows flow into much looser domestic monetary conditions (France, for example, having just stabilised was understandably averse to a fresh wave of inflation).  The UK –  still operating as a major global financial centre, significant source of long-term foreign lending –  operated with low gold reserves.  Germany, with a populace only too conscious of hyper-inflation just a few years previously, had high minimum gold cover requirements, but those buffers couldn’t be cut into.  Higher interest rates in the US – as in 1928/29 – forced both the UK and Germany to adopt tighter domestic monetary policy.   And so on.

The Depression itself got underway in a variety of countries influenced by various factors, domestic and international.    The 1929 sharemarket “crash” wasn’t particularly important, except perhaps in shaping the mindset of various US policymakers (including at the Fed) who were uneasy about much looser monetary policy because they reckoned the excesses of speculation needed to be purged.    Some countries were affected worse than others early on –  Australia for example on the worse side, and France on the more positive side.

Generally, however, monetary conditions did ease as the respective economic conditions deteriorated.  But the fixed exchange rate system, underpinned by convertibility to gold, severely limited what could be done with either fiscal or monetary policy –  and that was true even in the countries with large gold holdings, the US and France.

The financial crisis aspects really intensified in mid-1931, in Austria and Germany (where there were significant domestic banking system issues) initially, and then spilling over to the UK, where the economic slump itself had been relatively mild –  relative being the word –  but the pressure eventually told on gold parity.   The re-formed National government –  still led by former Labour Prime Minister Ramsay McDonald –  decided not to impose further pain on the domestic economy (which might have been insufficient anyway) and went off gold.    The break in the parity was initially envisaged as temporary, and it was some months before domestic policy itself became much more expansionary.  But the consequence of the lower exchange rate –  although many smaller countries moved to peg to sterling, giving rise to the “sterling area” which persisteed for several decades) and easier domestic monetary conditions meant that the UK was the first significant economy to recover from the Depression.

The US held on to the old gold parity until April 1933, and while that old parity held it acted as a real and binding constraint on the ability of domestic authorities –  including the Fed – to run much easier policy.   Fear of devaluation sparked capital (and gold) outflows.   But as Eichengreen records, many of the senior Fed officials were not that keen on much easier policy anyway, and some saw the roots of the Depression primarily in past speculative excesses.  Even in the US, concern about possible inflation risks – in the depths of a deflation –  were heard, and were evidently sincere.  The US later returned to a gold parity (while prohibiting for decades citizens from holding gold) but at a much-devalued exchange rate.

Those inflation concerns were all the greater on the Continent.  Germany never abandoned the old gold parity, but just rendered it non-binding with an increasing complex of exchange controls and other payments restrictions.   But for the remaining gold countries –  most notably France, Belgium, Netherlands and Switzerland –  the tensions grew between the desire to maintain the parity –  whether as symbol of normality or (more strongly in the French cases) ran increasingly up against the losses of competitiveness producers in those countries faced as other countries devalued, and the market recogmition of those pressures (thus capital flight).  It wasn’t until 1936 that those parities were finally abandoned.

As Eichengreen notes, at the end of it all, by the late 1930s, real exchange rates among the major economies had not changed that much at all.  Some countries had got the initial advantage of moving earlier (the UK notably) but in the longer-term the beneficial effect was not breaking the gold parity and getting a lower exchange rate, but breaking the constraints (domestic and international) on domestic macro policy (fiscal and monetary).  As he also notes, it wasn’t enough just to break from gold, since countries also had to be willing to break with the Gold Standard ethos, and allow/adopt looser macro policies.  One obstacle to that had been the fear of inflation.  That fear might look unreasonable –  whether from this standpoint, or contemplating a country with a deep deflation in the early 1930s –  but the hyperinflationary and high inflation experiences really weren’t that far in the past, and had been utterly destructive for many.

Eichengreen has a nice table late in the book illustrating how industrial production –  the main macro variable at the time, before quarterly national accounts were a thing –  responded in different groups of countries.

eichengreenLook at the last two columns and you can readily see the difference of experience in the countries that went off gold/devalued (sterling area and the “other depreciated currencies” lines) with the experience in the gold bloc countries, where even by 1935 industrial production was still 20 per cent lower than in 1939.

It need not have been.  It wasn’t as if the 1920s and 1930s were a period of underlying economic stagnation.  The US –  by then the world’s leading edge economy – experienced really strong total factor productivity growth in both the 1920s and the 1930s.  I’m sure some economic ups and downs were inevitable, but nothing on the scale and duration of what actually happened in the 1930s was in any way inevitable –  it was largely the consequence of a succession of choices, of almost entirely well-intentioned people, working against the backdrop of presuppositions, presumptions about normality, and the backdrop of some deeply unsettling experiences, that led to those savage and prolonged losses.   When countries broke the golden fetters –  and for many it was regretted initially or felt to be hugely risky – economies started to recover, and the gains in an increasing number supporetd a sustained global recovery in demand.

(You might be wondering where New Zealand fits in all this.  That is mostly another post.  We had no central bank.  We went off gold in 1914.  That left our banks issuing their own currency, in practice loosely pegged to sterling (but not legally so), with banks managing domestic credit based on their holdings of London funds.  Our exchange rate – managed by the banks – was allowed to depreciate a bit, but the big movements were in September 1931 when the UK went off gold and their exchange rate depreciated against the rest of the world and so, thus, did ours, and –  more importantly –  then in January 1933 when the government initiated a formal devaluation against sterling (still not having a central bank) over the objections – and resignation –  of the Minister of Finance (and with not a little domestic unease and debate).  In 1931 and 1932 even after the UK went off gold our economic policy options were very very few, and our devaluation was much more of a turning point (probably helping that it was followed a couple of months later by the beginnings of the US reflation).  I have an old post on New Zealand and the Great Depression.)

Of course, the point of the post is to draw some loose comparisons between the golden fetters of the early 1930s, which proved so costly in the specific circumstances of the time, and what I’ve taken to calling the paper chains, the refusal of the world’s central banks now to do anything about taking official interest rates deeply negative, even though standard macroeconomic prescriptions –  such as the Taylor rule –  suggest that is exactly what should be done.

I’m not suggesting it is some sort of allegory for our age, in which every detail of the 1930s can be mapped to something now.  It can’t.  It is really just about a single point: that self-imposed constraints, which can seem very very important to preserve at the time, can actually in some circumstances prove incredibly costly, and in those circumstances the sooner they are jettisoned the better.

One area in which the parallels certainly aren’t exact is around fiscal policy.  Most countries in the 1930s had very little freedom of fiscal action initally, precisely because of the monetary/gold parity constraints  –  increase your fiscal deficit and the resulting increase in demand will also result in increased current account outflows (of gold).    In some cases – New Zealand –  there was just no effective borrowing capacity at all –  thus, Keynes’s advice to Downie Stewart that I’ve quoted here previously (“if I were you I’d try to borrow; if I were your bankers I would not lend to you).  We have nothing like those sorts of technical constraints.  But that doesn’t mean there are no limits in practice –  as we saw after 2008/09, public tolerance of continued very large ongoing fiscal stimulus, even in badly affected countries, was really quite limited.  In the real world, fiscal policy isn’t any sort of fully adequate substitute for monetary policymakers choosing to sit on the sidelines –  dealing, perhaps, with market liquidity issues, but not doing much about the overall stance of monetary policy, even as deflationary risks mount (thus, real retail interest rates have not fallen at all in New Zealand and Australia this year, despite the huge economic slump).

There is a, perhaps understandable, sense in some quarters that there wasn’t too much wrong with economies last December.  Perhaps, but things have now changed, and if one strand of macro policy – typically the most important for cyclical purposes, and easiest to adjust –  is allowed to sit on the sidelines doing nothing –  and elected ministers have the power to change thatg –  there is risks that this economic downturn ends up much more severe and protracted than it needs to be.  All because central bankers won’t break free of their paper chains and their old mindsets (aggravated in New Zealand’s case by the stunning negligence of a Reserve Bank that talked modestly negative interest rates for some time but did nothing at all to ensure there were no technical/systems obstacles): we pay the price for both lack of preparation and the reluctance/refusal to break the paper chains and put in place quickly the sorts of rules and practices that could allow official rates to be taken deeply negative for a time, in turn supporting demand (directly and via the exchange rate) and supporting medium-term expectations about the economy and inflation.




More states or fewer?

I was going to write something today about monetary economics, the 2008/09 crisis, and reform options for financial systems and economies, but….the Brexit aftermath is pretty much all-absorbing, at least to a politics/economics/geopolitics junkie.   So far, it is difficult to see why anyone would be very surprised about what has happened since Friday, but of course it is very early days.  Media coverage seems dominated by perspectives from those –  including the journalists writing the stories – almost personally affronted that the populace of a major, quintessentially moderate, country could have voted as they did. The stories highlight, without really needing to try, the disconnect between what might be loosely described as a metropolitan urban liberal mindset that downplays the local in favour of a network of internationalist rule-setting, and what might loosely be described as a more small-c conservative mindset that puts a greater emphasis on the local and the national as the basis for rule-setting and governance.  Peter Hitchens highlights this contrast in his column here – highlighting how detached the majority of MPs of both main UK parties have become from the views and attitudes/priorities of very large shares of their voters.  The situation probably isn’t much different in a whole variety of advanced countries.

But what got me particularly interested over the weekend was talk of the United Kingdom itself breaking up.  Of course, that started a long time ago.  The Irish Free State (as it was then called) became independent in 1922.  If Northern Ireland should eventually reunite with the Republic of Ireland –  and frankly I would be surprised if it happens in the next few decades, given the risk of reigniting the decades-long civil conflict – it would only be the culmination of the Home Rule movement that was convulsing British politics as far back as the 1880s, and which saw Britain facing the possibility of an army mutiny and civil war on the eve of World War One.

The chances of Scotland becoming independent seem somewhat higher –  after all, the Out vote got 45 per cent in the last referendum only two years ago.  If the headline-grabbing opportunity to push for a new referendum is the desire to stay in the EU –  and for all the hype, even 38 per cent of Scots wanted out –  they had better hope there is still an EU to belong to a decade hence.  But even if not, is the idea of Scottish independence so different from that of Irish independence –  which we all now take for granted, even if (at the time) it probably came at a considerable economic cost?  Scotland had been independent for hundreds of years, and if it did well economically from the Union and its people played a huge role in the British Empire, who could begrudge them the right to govern themselves?

After all, although it wasn’t always so, the people of England and Wales make up 90 per cent of the population of today’s United Kingdom.   Even without Scotland and Northern Ireland, England and Wales would be the fourth most populous country in Europe, just a little behind Italy.

But then I got thinking about other countries.  Hasn’t a move towards more countries been underway for some considerable time?  The unification of Germany and of Italy were huge developments in the mid 19th century, but they were largely completed by 1870.   Our own Land Wars finished around the same time, securing a single state entity on these islands. The US grew hugely (in territory) during the 19th century, but had largely reached its current size with purchase of Alaska (from another large state) in 1867.  Even the acquisition of Hawaii was almost 120 years ago now.

I found a list of countries ordered by population in 1900.  Here was the 25 largest:

China 415,001,488
Indian Empire 280,912,000
Russia 119,546,234
USA 75,994,575
Germany 56,000,000
Austria-Hungary 51,356,465
Dutch East Indies 45,500,000
Japan 42,000,000
United Kingdom 38,000,000
France 38,000,000
Italy 32,000,000
Ottoman Empire 30,860,000
Spain 20,750,000
Brazil 17,000,000
Mexico 12,050,000
Korea 12,000,000
Northern Nigeria 8,500,000
Egypt 8,000,000
Morocco 8,000,000
Philippines 8,000,000
Southern Nigeria 7,500,000
Siam 7,200,000
Persia 7,000,000
Romania 6,630,000
Belgium 6,136,000

Of these, the two parts of Nigeria (both then administered by the UK) are now one country.  Quite a few of the other countries are much the same as they were then, subject to some (mostly relatively minor) border adjustments (eg the return of Alsace-Lorraine to France).

But the bigger story surely is the break-ups.   What was the United Kingdom is now two countries, the UK and Ireland.  What was Korea is now –  at least for the time being –  two countries, North and South Korea.  India as it was is now Sri Lanka, India, Pakistan, Bangladesh and (depending where the boundary lines were drawn) Burma.  And the erstwhile Russian, Austro-Hungarian, and Ottoman Empires have split into dozens of new independent countries between them.

What of today’s 25 most populous countries?

China 1,376,048,943
India 1,311,050,527
USA 321,773,631
Indonesia 257,563,815
Brazil 207,847,528
Pakistan 188,924,874
Nigeria 182,201,962
Bangladesh 160,995,642
Russia 143,456,918
Mexico 127,017,224
Japan 126,573,481
Philippines 100,699,395
Ethiopia 99,390,750
Vietnam 93,447,601
Egypt 91,508,084
Germany 80,688,545
Iran 79,109,272
DR Congo 77,266,814
Turkey 78,665,830
Thailand 67,959,359
United Kingdom 64,715,810
France 64,395,345
Italy 59,797,685
Tanzania 53,470,420
South Africa 54,490,406

Of these countries, only the last two comprise what were smaller entities in 1900 –  and neither is, perhaps, an advert for the cause of ever-larger unions.   Tanzania was previously the colony of Tanganyika and the protectorate of Zanzibar (ruled by a Sultan, under British oversight).  Zanzibar was granted independence in 1963, but this was quickly followed by a bloody revolution, at the end of which Zanzibar was absorbed (semi-autonomously) into the new Tanzania.  And, of course, South Africa in its current legal form was the fruit of the Boer War, essentially a war of conquest in which –  at great cost –  the British Empire and the British colonies beat the Afrikaaner states.

Have there been other mergers attempted?  Well, yes, after World War One the artificial state of Yugoslavia was created by the powers.  That has now long gone.  Czechoslovakia also emerged from that settlement –  also (peacefully and successfully) gone.  In the 1950s there was political union between Egypt and Syria: it last for all of three years.  The British created the Federation of Rhodesia and Nyasaland in the 1950s, and it was also gone a decade later.

Can one think of exceptions?  No doubt.  Various colonial enclaves have been reabsorbed by the surrounding power, peacefully or otherwise –  Goa, Hong Kong, Macau.    But there isn’t much else for more than 100 years, and none that I can think of where the voluntary choice of the respective populaces has led to the formation of larger states from smaller states (happy to hear if I have forgotten any).  Germany reunited –  but then it never separated voluntarily, and indeed in 1945 the intention was never two separate states.

None of this should really be very surprising.  The other great trend of the last couple of hundred years has been towards democratic government. People clearly  seem to want to rule themselves with – and be governed by  – people with whom they feel some significant sense of common identity and shared perspectives (which might be ethnic, or religious, or linguistic, or simply historical).  Little really –  in the scheme of things –  divides New Zealand and Australia, and yet there is no great appetite for the two to become one.   The metropolitan elites might wish it were otherwise –  and might even believe quite genuinely that everyone could be better off it only things were done their way –  but the citizens of the world show little sign of being convinced by their story.  Are the people of the world poorer as a result?  Possibly –  despite the huge volumes of cross-border trade –  but some things seem to matter more to most of them.

And it isn’t as if the trend towards more and smaller states looks like having run its course.  Even in Western Europe, there is Scotland, demands from Catalans for independence, and the ever-present question of what unites Belgium other than, say, a football team.

In that light I was quite puzzled by Wolfgang Munchau’s FT column today. In many ways it was a hardheaded piece, noting that the risk from the UK referendum for the rest of Europe may be greater than those for the UK.  Highlighting Italian risks in particular –  and Italian stocks fell savagely on Friday –  he ends

To prevent such a calamity, EU leaders should seriously consider doing what they have failed to do since 2008: resolve the union’s multiple crises rather than muddle through. And that will have to involve a plan for the political union of the eurozone countries.

How he imagines that the citizens of the Eurozone countries will ever agree to political union, especially now, is beyond me.    I guess the traditional European elite approach is not to give them a say.

UPDATE: For anyone wanting a more systematic treatment of some of these issues, see Alesina and Spolaore The Size of Nations (my copy of which I finally found on my shelves).  They devote an entire chapter to the EU.  In a book published in 2005 – with an expanding EU, and the general contentment with the early years of the euro –  they seem (perhaps understandably) slightly  uncomfortable with how the EU fits with their general model in which lower trade barriers and fewer wars would typically result in more states, not fewer.  But they conclude their EU chapter boldly: “Quite simply, it is not possible for Europe to become a federal state”.


Thoughts prompted by an old book

It is a good rule after reading a new book, never to allow yourself another new one till you have read an old one in between.”       C S Lewis

Over the weekend I was reading the 2nd edition of Portrait of a Modern Mixed Economy: New Zealand, published in 1966.  The original Portrait, by Professor (at Canterbury) C  Westrate had been published in 1959, and the second edition was a simpler, shorter, updated version completed by Westrate’s son after his father’s early death.  I’m fascinated by anything on New Zealand and its economy from this period, because it was a time when New Zealand was widely regarded as still having some of the highest material living standards anywhere in the world.  There were already intimations of uncomfortably slow productivity growth (relative to other advanced economies) appearing in official and quasi-official reports, but no real hint of the deep decline in our relative living standards that was to follow.

To read such a book is also to be reminded just how remarkable the unemployment record was.    For all the distortions that went with it, there was something impressive about sustaining an unemployment rate at around 1 per cent or less for decades (on the Census measure, which approximates the current HLFS approach).  And they weren’t, mostly, make-work public enterprise jobs.

Of course, the distortions were numerous.  Westrate quotes data that in 1964 government consumer subsidies were equivalent to 35 per cent of the retail price for butter, 40 per cent for milk, 55 per cent for bread and  65 per cent for flour.  The subsidies were a bit lower than they’d been a decade earlier, but it was to be another couple of decades before they were completely removed.  And while I’d come across the (statutory) raspberry marketing body previously, I hadn’t known that we had a monopolistic Citrus Marketing Authority, which controlled all imports and the sale of all local production.  Odd as those measures now seem, I wonder what of the current regulatory state people in 2066 will look back on in puzzlement?  How could they, our grandchildren may wonder.

In the 1960s, the Reserve Bank –  and monetary policy –  was firmly under the control of the government of the day.  But I was reminded of the way that wage-setting was then officially delegated to unelected bureaucrats – in this case, the Arbitration Court where employer and employee representatives usually neutralised each other, leaving key decisions on basic wage structures to a single judge.  As Westrate notes, it is debatable quite how much sustained impact the Court had, since labour market fundamentals matter and the Court only set minima.  But in some respects the same could be said for the Reserve Bank: interest rates are ultimately set by fundamental forces shaping savings and investment preferences, but the administrative choices of officials matter in the shorter-term.

But what I really wanted to comment on today was the discussion of New Zealand’s external trade.

Westrate notes that exports accounted for a higher share of national income than in most trading countries –  “consistently near the top of the list”.  So far, so conventional –  I wrote a while ago about Condliffe’s observation a few years earlier that New Zealand in the 1950s had had among the highest per capita exports in the world.  But what caught my eye was that Westrate introduced a explicit discussion of how external trade might be even more important in New Zealand than it appeared, because of the high share of domestic value-added in New Zealand exports, mostly “agrarian commodities”.  Westrate was Dutch and had previously been a professor at one of the Dutch universities, and he notes that although the Netherlands, for example, has a higher export share of its economy than New Zealand “it is known that  exports from the Netherlands contain a good deal of foreign value.”  As he notes, the data didn’t exist to do the calculations, and indeed it is only in the last few years that the OECD and WTO have started producing good cross-country data in this area.  The story about the high domestic value-added share in New Zealand’s gross exports is now conventional wisdom, but probably wasn’t in the 1960s.

Having said that, if the story that New Zealand was one of the countries with the highest trade share in the world had once been true –  and quite possibly it was in the 1920s –  it doesn’t look as though it was in fact true by the time Westrate was writing –  which should not be too surprising given the heavy cloak of industrial protection New Zealand had put in place, that tended to reduce both the import and export shares of our economy.  Books and official reports from the period often compare New Zealand with the US, UK, Australia, Canada, France and Germany.  And for many purposes, comparisons with those countries might have been quite enlightening.  But when it comes to foreign trade, it is now well-recognised that large countries typically do less external trade as a share of GDP than the small ones do.  There are more markets, and more suppliers, at home than is likely to be the case for a small country.  When a large country has a very large trade share –  China pre 2009 and Germany now – it is often a sign of other imbalances.

Finding comparable long-term historical data is always a bit of a challenge.  But I had on my shelves a 1990 OECD compilation volume of historical statistics, with data on a wider range of variables (including exports of goods and services as a share of GDP) for 1960 for the “old” OECD countries.

For New Zealand exports as a share of GDP in 1960 were 22 per cent.

For the smaller Europeans (Netherlands and smaller), the proportions were:

Exports (good and services) as a % of GDP, 1960
Austria 24.3
Belgium 38.4
Denmark 32.2
Finland 22.5
Greece 9.1
Iceland 44.3
Ireland 31.8
Luxembourg 86.7
Netherlands 47.7
Norway 41.3
Portugal 17.5
Sweden 22.9
Switzerland 29.3

With a median of 31.8 per cent. (By contrast, for the G7 countries, the median was 14.5 per cent.)

As Westrate noted, we don’t have the data to know what the share of domestic value-added was in exports in 1960.  The first OECD date are for 1995.  But even by then, when domestic value-added of New Zealand’s exports was 83.2 per cent, the median for those smaller European countries was 76.4 per cent – lower than New Zealand, but not an order of magnitude different.  If –  heroically, and really only illustratively –  the same value-added shares had prevailed in 1960s, New Zealand’s export value-added would have been around 18 per cent of GDP in 1960, while the median European country would have been around 23 per cent of GDP

What of the present?  The latest OECD-WTO value-added data are for 2011 (I wrote about them here).  Over the intervening 16 years, the domestic value-added share of New Zealand’s exports barely changed, while the median of that same sample of smaller European countries had fallen sharply, to 67.3 per cent, as the importance of global value chains (especially within continental Europe) has increased sharply.

For the more recent period, we have much larger set of OECD countries to look at (many of them also quite small).  The data for exports as a share of GDP is available for 2014.  If we apply the 2011 domestic value-added share of exports, to the 2014 data on total exports, we get this pattern of domestic value-added in exports as a share of GDP.

domestic value add all oecd

But what about “small” countries?  If we rank the OECD countries, there is a natural break between Belgium with 11 million people and the Netherlands with 17 million.  Here is the chart for the 19 OECD countries with populations of 11 million people or fewer (nothing would be altered by including the two countries with around 17 million).

domestic value added small oecd

New Zealand isn’t the lowest ranking country on the chart, but those that are worse aren’t generally ones we would want to emulate.  Greece and Portugal speak for themselves –  and, indeed, the export shares for those countries are flattered by the weakness of the domestic economy at present.  Israel has had as poor a productivity record (and as modest per capita GDP) as New Zealand.  Finland had been performing well until 2008, but since then it has been one of the worst-performing economies in Europe, and its exports as a share of GDP have fallen sharply.

A customary response to the New Zealand data is to point out that remote countries tend to do less international trade that less remote ones.  By almost any measure, New Zealand is among the most remote of these countries.    But if trade with the rest of the world is a significant part of how smaller countries get and stay rich –  maximising the opportunities created by their ideas, institutions and natural resources –  shouldn’t we be more bothered about the implications of our remoteness?   New Zealand just isn’t a natural place to build lots of strong businesses, unlike – say – Belgium, Denmark, Austria or Slovakia.  That doesn’t mean such businesses can’t be built at all here, but it is an uphill battle.

And it has probably become more of an uphill battle in the last 20 to 25 years.  Gross exports have risen hugely among many of the European countries since 1995, but so has domestic value-added from exports (all as shares of GDP).  And it isn’t just the former communist countries emerging –  in Denmark export value-added as a share of GDP has risen by 7 percentage points,  and in Austria the increase has been 12 percentage goods.  In New Zealand, by contrast, there has been almost no change.  This isn’t some mercantilist story in which exports are good for their own sake –  but finding more markets for more stuff, enables people at home to import and consume more of other stuff.

As I’ve noted before, it looks as though New Zealanders have been responding – for decades now –  by moving to other countries, especially Australia, where the income prospects have been perceived as stronger.  But our governments have wrong-headedly sought to bring in lots more people, to more than replace those who are leaving.  Somewhat to my surprise, the quality of many of those people now seems questionable at best –  recall the most popular occupations for skilled migrants.  But the real issue should probably be whether continuing to aggressively pursue a larger population, as matter of policy, makes sense in a country that is so remote, and where not even the soil is that naturally fertile.  It is, in many respects, a nice place to live, but the ability to generate top-notch advanced country incomes for even the current population must be seriously questioned.  To do so, a small country needs to be able sell a lot more of it makes to the rest of the world than has New Zealand has been managing –  in the 1960s or now.

The government’s exports target rather crudely recognises the issue, but they have no credible economic strategy that might bring about such a transformation.

(And while climate change is not an issue that I pay much attention to, less rapid population growth through reduced immigration targets might also be a rather cheaper way of meeting somewhat arbitrary emissions targets.)

The wealth of nations, and democracy

Yesterday I went to a fascinating guest lecture at The Treasury, by Stephen Haber, a professor at Stanford, who is currently visiting New Zealand as the Reserve Bank and Victoria University professorial fellow in monetary and financial economics.  Haber was the co-author of the very stimulating recent book Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, a comparative study of banking systems. I’ve been meaning to blog about this book for months.  To the extent that Calomiris and Haber are correct (and I’m not sure how far that is) the case for intrusive banking supervision and regulatory restrictions – of the sort the Reserve Bank is increasingly adopting  – in countries like New Zealand is materially undermined.

But yesterday’s lecture was on something quite different.  His topic was “Climate, geography, and the origin of political and economic institutions”.  It is continuing work, building on the earlier observation that stable democracies –  of which there have not been many – cluster in regions of moderate rainfall.  In the words of the abstract of a 2012 working paper:

Why are some societies characterized by enduring democracy, while other societies are either persistently autocratic or experiment with democracy but then quickly fall back into autocracy?  I find that there is a systematic, non-linear relationship between rainfall levels and regime types such that such that stable democracies overwhelmingly cluster in a band of moderate rainfall (540 to 1200 mm of precipitation per year), while the world’s most persistent autocracies cluster in arid environments and rain-forests. This relationship is robust to controls for the resource curse, as well as to controls for ethno-linguistic fractionalization, the percent of the population that is Muslim, disease environment, and colonial heritage. I advance a theory to explain this relationship, focusing on differences in the biological and technological characteristics of the crops that can be grown in different precipitation environments. Variance in the biological and technological characteristics of crops generated variance in producers’ strategies to solve problems of scarcity, giving rise to variance in the distribution of human capital and institutions associated with the protection of property rights. Democracy was more likely to thrive in environments in with a high level and broad distribution of human capital, and with institutions that protected property rights. I test the theory against a unique cross-country dataset, a comparison of democracies and autocracies in antiquity, and a series of natural experiments.

The current work takes these ideas further and builds on the work of plenty of other scholars trying to better understand what accounts for the widely divergent, and apparently deeply-rooted differences in outcomes across countries.   Haber’s claim is that climate and geography explain between a third and a half of the variance across countries in GDP per capita and in where countries stand in democracy rankings.  Here geography is not the ideas of remoteness from the rest of the world I was toying with last week, but something more about the ability to grow, store, and transport (and thus trade) food.  Places with flat land and navigable rivers or coastlines score well.  Rocky valleys don’t.

In Haber’s story, certain climates and geographies pre-condition societies to developing market-based institutions and effective but limited governments that eventually lead to greater prosperity, innovation, and democracy.  In his story, for example,  England is a place where grains can be both grown and readily stored, and transported, and where there are few extreme climate shocks that might historically have threatened whole societies. Trade requires effective enforcement of private property rights.

Others places are more naturally favourable to the development of strong central governments, which can discourage innovation.  Haber here cites both Egypt and China, and argues that the propensity to flooding naturally lead to strong central governments as a risk-management device (the biblical story of Joseph, central managing grain reserves, featured as an example of the “insurance state”). Such societies discourage any innovation that might threaten the perceived self-interest of the state.  Others places again  –  think of Pacific islands –  are prone to severe adverse climatic events, but also have climatic/geographic conditions that don’t allow the production of storable foods (eg grains), and so there are no incentives to develop the institutions that protect property rights and the development of markets.  Stealing vast quantities of grain in northern Europe would have been very valuable – it lasts a long time –  but stealing bananas in Fiji would not.

I don’t lay claim to any great expertise in this area, but for what it is worth much of what Haber had to say rang true in understanding some of the differences across some countries –  England vs Egypt/China vs Vanuatu for example.  But then again, it is not so many centuries since China was the richest (per capita) economy in the world.  Plenty of scholars try to explain the subsequent great divergence.

But I was uneasy about two things.  First, democracy is really rather a new thing, at least in its current forms.  Perhaps in a  hundred years from now it will be the established and standard form of governance everywhere, in which case Haber’s work might be useful only in explaining in which countries democracy developed first.  Then again, perhaps democracy will prove to have been a short-lived fragile flower, and the pool of countries with democratic systems could look much smaller than it does today.  After all, 80 years ago many of the countries of Europe were far from democratic, and if anything democracy might have looked to be in reverse.  Who is to say it couldn’t happen again?  Perhaps it just reflects my economics training, but differences in wealth look more persistent that differences in how much democracy there is, and is probably a better focus.  Apparently, Taiwan is less prone to adverse climatic shocks than mainland China, but the contrast –  for now at least –  between a rowdy democracy on one side of the strait, and the Communist Party’s rule on the other side, cautions against too much geographical or climatic determinism.

But closer to home,, I was uneasy was about whether his story –  whether about democracy or prosperity – could usefully explain much about a country like New Zealand (or Australia, Canada, the United States, Uruguay, Chile, Argentina).   By world standards, each of these countries is pretty well-off –  the last three less so than the others.  The first four have been among the world’s most democratic countries, and even the Latin American countries haven’t exactly been China –  Uruguay and Chile had some well-established democracies, with some brief unfortunate interruptions.

The climate and geography of these countries is much the same as it was 200 years ago, or 500 years ago –  ie in Haber’s terms well-suited to the emergence of democracy and prosperity.  And yet I don’t think there is anything in the pre-history of the territories of those modern countries to suggest that the indigenous societies in any of them had the nascent qualities that were about to lead to the emergence of societies that were among the most democratic and prosperous on earth.

Of course, it isn’t that climate is irrelevant. But the channel is different than Haber seems to recognise.   British settlers were willing to settle en masse in New Zealand or Canada because the climate and geography were conducive (by contrast, when British missionaries went to west Africa in the 19th century it was not uncommon for them to take coffins with them, so high was the mortality rate).  But what would modern day New Zealand or the United States look like if, for some reason, there had been no international migration?  Haber’s hypothesis seems to suggest that they should have been rich and free.  I rather doubt it.  Unfortunately, there are no natural experiments –  countries with good geography and climate that remained largely unsettled by Europeans.  Perhaps South Africa is the nearest example, and I wouldn’t have thought it was particularly supportive of Haber’s case.

There were opportunities in New Zealand, Australia, Canada and the United States which people from rich and successful countries (mostly the UK, but not exclusively – see Quebec, or the Spanish influence in the US) forcefully took advantage of.  The riches and success provided Britain with the military and political strength to enable new societies to “invade” and largely replace the cultures and institutions that had been in those societies previously, but which had not developed technologies that enabled them either to flourish, or to fend off the influx from Europe.  There probably wasn’t too much unique about Britain –  had the Napoleonic Wars gone the other way, more of the colonies of settlement might have been French rather than British –  but the influxes at the time when lowering transport costs made mass seaborne migration feasible were inevitably Northern European. It isn’t a particularly attractive picture, but that is what it was –  those who had developed wealth and power (and the associated successful institutions) displaced those who had not utilised the potential of those climatically and geographically favoured lands themselves.

I’ve been attracted to work of Bill Easterly in this field, who has asked “Was the wealth of nations determined in 1000 BC?” He found that differences in technology levels across countries were remarkably persistent over time, even going back as far as 1000 BC (although his focus was on differences in 1500AD).  But as his work developed, he took explicit account of the role that large scale immigration played in transplanting technology and institutions from one geographical location to another.  People make a difference.

Here is his scatter plot of the relationship between the technology levels in each country and current GDP per capita.  New Zealand, Australia, Canada and the US are in the top left hand corner: poor technology in 1500, but high incomes now.


And here is the follow-up chart, incorporating the technologies in 1500 of the peoples who now live in those countries.  Mass migration wasn’t an issue for most countries, but it certainly was for New Zealand, Australia, Canada and the United States.  If you look carefully, you’ll spot a NZL towards the top right hand corner of the chart  (the other colonies of settlement are buried in that cluster too).


I’ve often been critical of the Reserve Bank and even The Treasury on this blog. But credit should go to them for hosting a fascinating visitor such as Haber, and to The Treasury for yesterday’s open seminar.