Is Education About Learning or Signaling?

What is the point of education, college or otherwise?

This is related to a discussion we had back in March. At the time I tabled it pending coverage of some growth theory.

We hear a lot that education, as a cultural phenomenon, is important for growth. The macroeconomic evidence on this is actually fairly weak. There is a positive effect, but it isn’t big.

And, of course, you’ve all heard people complain about the weak K-12 educational system in America, and how this will lead to the sky falling, cats living with dogs, and so on.

Macroeconomists are not sure what to make of this. Broadly, the relative unimportance of education in growth accounting is similar to what happens with other variables we think are important: growth seems to be inelastic with respect to most of them.

This relates back to the underlying problem that we really don’t know what people do or should get out of school.

Is it learning new stuff? In favor of this position is the observation that people who know more tend to make more money, and regions where average education is higher tend to have higher earnings. Against this is the common observation of cramming, and the well-known fact that most of us forget what we “learn” shortly after the class ends.

Alternatively, some view education as mostly about signaling. Taking classes signals to employers that you may be more productive than your peers. Actually finishing classes (and degrees) sends an even stronger signal. In favor of this view is the observation that income tends to be more highly correlated with completing degrees rather than what you actually majored in. You have a lot of experiences with this in a business school: accounting majors have better job opportunities, but don’t end up getting paid more on average. Against this common observation is that if it’s all about signaling, why does anyone learn anything at all? Couldn’t we just signal our conformity and ability to finish tasks by, say, doing volunteer work?

The signaling view is really difficult to reconcile with the folktale we tell each other that more education is always a good thing.

But, here’s a thought for you. If learning is so important, why are incomes higher for people who take classes, get grades, and forget everything later on than for people who never took the classes at all?

It gets worse! Market outcomes suggest that it is worse to take a class and fail than to never take the class at all. How can that be so if education is about learning?

These arguments make it hard to visualize where education falls in a growth model, and how we should measure it. If we can’t figure out what it is, we probably can’t measure it, and if we can’t measure it we won’t be able to figure out if it’s important. In practice, what we do now is include variables like average years of schooling into our growth accounting. Obviously, that’s missing a lot.

It’s not even easy to see where education would fit in the growth model if we could measure it.

If education is about learning, then it is probably a form of capital. Certainly what we know seems to depreciate like capital does.

But, if education is about signaling our ability to conform, follow directions, and finish tasks, then it is more like a technology. So, society improves when it accumulates a bigger stock of people who get things done.

One thing we do know is that the plausible size of exponents in a simple production function, like the Cobb-Douglas, suggest that technology is a lot more important to well-being than capital is.

But, that’s probably personally discomfiting: the typical contribution of an individual to the well-being of us all is then to be less like an individual and more like an automoton that finishes what it starts.

I bet you didn’t think that this is the sort of thing you’d end up having to think about when you started this macroeconomics class.

If you want to learn more about this, and follow the debates, you should read the stuff that Bryan Caplan writes at EconLog. Here’s a bunch to start out with for your summer reading.

Increasing Income Inequality, the Great Moderation, and the Great Recession

You all know what the “Great Recession” is.

The “Great Moderation” is what people were calling the 25 years right before that … basically right until the recession started. The reason is that we’d had 3 strong expansions and 2 moderate recessions in the 1983 to 2007 period. Really, this was a period to rival any other in our macroeconomic history.

But, there the inequality problem. It’s an axiom of Democratic political belief that inequality has gotten worse over that period. This is true, but as shown in earlier posts, it’s true of all developed countries … including many that did not share America’s generally conservative policies in that period. And the progressive position has been that this is a problem that we need to do something about. That’s more of a political than an economic position, so I’ll just set it out there and leave it alone.

The problem here is that casual observation of life in America should suggest that the lives of the poor have gotten a lot better over the last generation. Think about it: most of you students are officially poor. And yet you have snowboards. And cars. And air conditioning. And x-boxes. I think I’ve made my point: there’s an inconsistency between what people say about the lifestyles of the poor and the reality on the ground.

Economically, a lot of research has been done on this, and the leaders in this field are Piketty and Saez. They are featured in a front page article in The New York Times on April 17 entitled “French Duo See (Well) Past Tax Rise for the Richest.”

“The United States is getting accustomed to a completely crazy level of inequality,” Mr. Piketty said, with a degree of wonder. “People say that reducing inequality is radical. I think that tolerating the level of inequality the United States tolerates is radical.”

As much as Mr. Piketty’s and Mr. Saez’s work has informed the national debate over earnings and fairness, their proposed corrective remains far outside the bounds of polite political conversation: much, much higher top marginal tax rates on the rich, up to 50 percent, or 70 percent or even 90 percent, from the current top rate of 35 percent.

Trust me on this … go to an HSS professor and ask them to name some current economics researchers, and Piketty and Saez will be the first ones off their lips.

… Mr. Obama’s election, brought the issue back to the fore. Peter R. Orszag, the former Obama budget director, has said the Piketty-Saez work “helped to point the way for the administration in its pledge to rebalance the tax code.”

The problem, for me as a macroeconomist, is that Piketty and Saez’s work is pretty good stuff. I can take some shots at it, but I have trouble denying that there’s not a kernel of truth in there.

The problem for the broader profession, including people who specialize in this stuff, is how do they get their numbers (which seem to be done correctly) when the evidence you obtain by just looking around seems to contradict it.

Now, there’s new and improved research. What Piketty and Saez did was create new and comprehensive data sets to establish their point. Now, Richard Burkhauser from Cornell has created a new data set that encompasses the Piketty and Saez data set. This is good because he should be able to match their results, and perhaps add new ones.

This he does.

It turns out that Piketty and Saez’s results depend on 4 features of the unit whose income they are measuring. First, they are measuring units that pay taxes: basically, households. Second, they are measuring income pre-tax. Third, they are measuring income pre-transfers. Fourth, they are not counting in-kind payments of health insurance.

Burkhauser’s data allows them to group data by those 4 measures. Or not.

And the not case is interesting. It turns out that all 4 of those measures serve to make inequality appear to be worse.

First, tax units. Households have gotten smaller over the last 40 years. A large part of this is the number of adults who live on their own: singles, divorced people, widows and widowers, and college students. Smaller households tend to have less income because they have less people in them. Is that inequality? I don’t think so; my gosh, I think it’s nice that so many people can live on their own rather than having to pool their resources.

Secondly, our tax system is progressive. To the extent that people live in smaller households, the taxes paid by those households go down faster than their income does … leaving more to spend.

Third, transfer payments work in much the same way. These are based on households, and it is possible to split a household that would not be on welfare into two households that would both qualify.

Fourth, obviously, the costs of healthcare have gone up. Most people receive this as a payment in-kind: you get it as part of your job, but you don’t actually see the cash in your paycheck. Again, bigger health costs (and benefits) means … raises your boss can’t afford to give you in cash.

So, what does Burkhauser conclude?

First, that his data supports Piketty and Saez, provided that he matches Piketty and Saez’s assumptions that we should look at pre-tax, pre-transfer, healthcare excluded incomes of tax units. For this data, there has been a 3% increase in income over the last 30 years. That’s stagnation.

Second, once Burkhauser accounts, with the same data, that people are choosing to live in smaller households (and can actually pull this off), that they live in a system with progressive taxes, an ample social safety net, and healthcare primarily provided as a benefit, that incomes are up 36% over the last 30 years. Note that this is not a huge increase. But, it isn’t stagnation. And, it is most directly comparable to per capita real GDP growth (of 1.5% per year, on average) than to aggregate real GDP growth (of 3.5% per year, on average).

The bottom line is that there’s new, strong, evidence that the Republican position that life has been improving for just about everyone over the last generation is not contradicted by the data.

Labor Camps In Hungary?

In class about a month ago, we talked about the idea of requiring national service, or service in exchange for welfare payments. Both policies are commonly mentioned as possibilities in the U.S.

I mentioned briefly that I thought this violated the

• 13th Amendment’s ban on involuntary servitude (because you might be required to do work against your will), and
• 14th Amendment’s ban on unequal treatment (because you might be singled out to do work when others were not).

But, other countries aren’t bound by our laws.

So I also raised the point that local governments are currently doing just this in Hungary: forcing Roma (aka gypsies) to do work assigned by the government, coercively, and often in remote camps:

For the long-term unemployed – a disproportionate number of whom are Roma – this means taking part in the government's new public work programme. According to Jeno Setét, a Roma activist, between 70% and 80% of Hungary's Roma population do not work (the rate for the whole population is around 10%). This scheme aims to get 300,000 people into work by 2014 via a sort of community service scheme for which participants are paid less than the national monthly minimum wage (around 80,000 HUF – £214 – for unskilled workers) but slightly more than they would receive in benefits.

Anyone unemployed for 90 days is offered a place on the programme, which administers projects cleaning streets or sewers, cutting down trees or building football stadiums or dams. Refusal to accept a placement will result in all social security benefits being stopped to the refusenik and family. Gyöngyöspata was chosen last year to run a pilot scheme. Unemployed locals – almost exclusively Roma – were deployed to cut down trees in a nearby wood.

For Setét, the public work scheme is a "smokescreen" that will do little to help Roma get "real" jobs and will reinforce their position at the bottom of Hungarian society. "If people on the scheme were paid properly and trained properly, I'd be all for it," he added. "But they are not. Right now it's a way of humiliating people and paying them a slave wage."

The most controversial aspect of the programme is the introduction of what Roma activists call "labour camps". If there is no suitable project near enough for someone to commute to, they will be offered "accommodation" near or on site, said Kovács. "They are not labour camps," he said. But to the Hungarian Roma, many of whose relatives perished the last time they were sent off to "labour camps", during the Nazi era, the merest whiff of anything similar is spine-chilling, said Gábor Sárközi from the Roma Press Centre: "People are absolutely terrified at the prospect."

You may read more about this in a piece entitled “Poor, abused and second-class: the Roma living in fear in Hungarian village” that appeared in the January 27 issue of the English newspaper The Guardian. This article also links to video of Hungarian paramilitaries wearing Nazi themed outfits.

Why Are Governments of Developing Countries So Hung Up On Oil?

This is a million dollar question that every one should have to answer — because most of the answers floating around out there aren’t very good.

The first wrong answer is that developed economies are oil dependent. This is, at best, partially true. Developed countries use a lot of different energy sources, of which oil is just one. Further, developed country’s economies have also gotten less energy dependent with the passage of time: technology and services just don’t consume that much energy. And then there’s price: as economics majors you should all recognize that if we pay less for gas than we do for bottled water or Starbucks, that it just isn’t that scarce.

The second wrong answer is that oil reserves have made a lot of countries wealthy. Not so. Yes, there are places like Saudi Arabia and Kuwait. But, there are also one like Iraq and Venezuela where oil drilling has been going on for 75-100 years … without too much to show for it. The list of OPEC countries has some names you’ve probably never heard of — like Gabon — and places you wouldn’t normally think of as rich: like Nigeria and Ecuador. At the other end are places like the U.S., the U.K., Norway, and Canada, who are all rich and developed … but not from oil.

Once again, the reason has to do with explaining per capita income differences with capital, high tech, and low tech.

The exponents that the data suggests for the Cobb-Douglas indicate that technology is a lot more important than capital.

And … oil reserves are clearly not technology or labor, so they must be a form of capital.

High tech easily flows across borders, so it explains richness, but doesn’t do a good job explaining variation in richness.

Low tech does not easily flow across borders, and since technology is a bigger component than capital, this ends up being a big determinant of international differences in per capita incomes.

The thing is .. growth in low tech is hard for governments to pull off. Especially if your government is corrupt or authoritarian.

Which leaves capital growth as the way to get improvements in well-being. And what better way to grow your capital stock than to find it under the ground just waiting to be drilled.

So there you have it: the obsession with national oil reserves reflects a substitution away from low tech because the government lacks vision and capability. Many social scientists assert that it is resource exploitation that leads to government corruption. I’d turn that around: corrupt governments choose resource exploitation because it’s the only card they have to play.

One More Tidbit About Argentina and Brazil

Argentina is trying to steal an oil company.

Brazil is threatening one with stiff penalties.

But, even the Brazilians think the Argentinean government is nuts:

“Argentina’s capacity to err seems unlimited,” said Míriam Leitão, one of Brazil’s most influential columnists on economic issues …

…

… “Crazy queen” was how one prominent Brazilian humor columnist described Mrs. Kirchner this week.

In a different tone, Chile’s economy minister, Pablo Longueira, said the nationalization could be harmful for Latin America as a whole, turning it into a “less trustworthy region” compared with Asia. “Capital flows exit to those places where there is more investor confidence,” he told Reuters.

Drawn from an article entitled “In Brazil and Elsewhere, Dismay at Argentina’s Nationalization Move” in the Apirl 16 issue of The New York Times.

South Sudan

The newest country on the globe is South Sudan: it’s been independent for about 10 months.

South Sudan isn’t terribly interesting in and of itself. But it is relevant to class for two reasons: 1) the fixation on oil in developing countries, and 2) this video that I posted last year which is relevant to class discussions of “low tech”.

First, historical some background to help you out as you think about macroeconomics in the future.

Most developing countries do not have logical borders. These borders were set on colonies about a century ago by bureaucrats in European capitals who’d never been to those places or who cared about the facts on the ground. So, South Sudan was carved out of Sudan, which had became independent of the U.K. in 1956, but which had no earlier history as a viable country.

To get this independence, South Sudan fought two civil wars: a failed on from 1955 to 1972, and a successful one that started in 1983.

The reasons for the civil war are geographic, political, demographic, and religious.

The geographic reason is that northern Africa is dominated by the Sahara desert, which ends about 2/3 of the way down Africa’s “top”. Below that is a narrow band of dry grasslands running across the continent called the Sahel. Below that, you start to get into very green, tropical Africa. The Sahel runs across the top of South Sudan, separating the green, tropical, South Sudan, from the arid Sudan.

The political reasons involve the Ottoman Empire. This is the Turkish empire, based in Istanbul (then Constantinople) that dominated the Moslem middle east from the 15th to the early 20th century. The Ottoman Empire didn’t have strong central control. Local, often hereditary governors, called pashas held most of the power. As the Ottoman Empire’s central control weakened, first France, and then the U.K. started to take shots at it: first in Egypt in the 1790’s, then in Greece, later across North Africa. The barbary pirates that America fought in the first decade of the 19th century (famous for the line from the Marine’s Hymn about the “shores of Tripoli”) were breakaway pashas from the Ottoman Empire. At this time, the U.K. and France were the big colonial powers trying to gobble up as much of Africa as they could. The U.K. effectively got Egypt, although there were still Ottomans nominally in charge, and they wanted to claim the entire valley of the Nile River as a British colony. The problem is that no one had ever sailed up the Nile, which is not only long, but has a series of waterfalls (called cataracts on the Nile). In the 1890’s there was a race between the U.K. and France to get to a remote Ottoman army post called Fashoda (now known as Kodok), on the Nile in what is now South Sudan. Whoever got there first would claim east central Africa as their own. The French went up the Congo River from the South Atlantic, portaged into the upper reaches of the Nile Basin, the floated downstream, and made it there first with a small expedition. But, the British built steam gunboats that they could portage around the waterfalls, and showed up with a small fleet a few months later and took over (what could the French do when it would take a year just to call for reinforcements?).* From that claim, the British created their colony of Sudan. What’s important is that what became the country of Sudan was based on geographic and political realities, not demographics.

The demographic problem is that the northern part of Sudan, dominated by the Sahara, has been the land of sparsely populated, richer, “brown” Arab Moslems herders for a thousand years. But, the southern part is dominated by more populous, “black” Africans farmers (basketball players Manute Bol and Luol Deng are from this region). Given the difficulty of communication northwards up the Nile, and the distances involved, the people identify more with neighboring countries to the South — like Kenya, Rwanda, Burundi, and Congo.

Those people in the South also converted readily to Christianity in the 20th century.

But, in 1956, the U.K. set Sudan free with unrealistic borders, and Arab Moslems in charge of more populous, poorer, and remote “black” Christian Africans. As you can imagine, hilarity did not ensue. But, with some western support, the blacks started to win the civil war. A lot of the reason for the current problems in Darfur (in northwestern Sudan) that are so popular with celebrities like George Clooney is that Sudan has created a generation of violent thugs without a lot of central control, and needs something to do with them after South Sudan started winning the civil war about 10 years ago.

It looks like this region is going to heat up again, now that substantial oil reserves have been found in the border region between the two countries. And this war got a lot hotter just today.

Anyway, the refugees in the linked video clip are from South Sudan.

* If you want to read a good history book about this, I highly recommend The Race to Fashoda: European Colonialism and African Resistance in the Scramble for Africa.

The Pace of Technological Improvement

About a month ago you students brought up The Shawshank Redemption, and I brought up an old Looney Tunes cartoon. Neither is required.

The context was the rate of technological change.

I got Shawshank from Netflix and watched it over the weekend. It’s very good, but I don’t know why it’s on so many peoples’ list of their favorite films.

Anyway, it’s relevant here because I remarked that there’s some evidence that the rate of technological change was fastest from 1880 to 1920. The movie features a convict who is paroled after being in prison from 1905 to 1954. He can’t handle the pace of life on the outside and commits suicide.

This is related to the topic we covered last week: that the level of technology is a positive for well-being, but that the growth rate of technology creates problems because it has to be “fed” with more capital.

The Looney Tunes short I mentioned is from 1944 and is entitled “Old Grey Hare”. What interested me about it is that it shows Elmer Fudd falling asleep only to awake in 2000 (other than that, it is clearly not one of Looney Tunes best offerings):

There isn’t too much new high technology shown. It’s interesting that they were familiar enough with television in 1944 to make a joke about it (consumer sets didn’t become common until the late 1940s). I also liked the vision of the city of 1960: it looks a bit like Vegas. And when Elmer wakes up, his rifle has turned into a “Buck Rodgers Lightning Quick Rabbit Killer”.

But, I also found this interesting for this week’s discussion of “low tech”. The vision of 2000 produced in 1944 includes a high tech innovation (the ray gun), but completely misses the possibility of low tech innovation: that rabbit hunting is no longer popular, broadly accepted, or even practiced much.

More On Chevron and Brazil

Brazil doubled the amount it is seeking in fines from Chevron since I last posted on this. They are now looking at $22B.

Refinery margin is the name given to the incremental profit a firm makes between getting the oil out of the ground and selling it to a refinery. It runs about $10/barrel.

So, Brazil is looking for the entire profits on just over 2 billion barrels of oil. Brazil currently produces 2 million barrels a day, so what they are looking for is all the profit from 1,000 day of production. Those numbers are for the country as a whole: to the extent that Chevron in only one player in Brazil, the fine on Chevron will be considerably more than the thousand-day equivalent.

Another way of looking at this is that the projected fine is 4 years of net profit from all of Chevron’s operations.

So … Chevron is clearly guilty of a spill … but what is macroeconomically relevant here is whether or not the scale of this fine amounts to expropriation — just of future profits rather than current assets (as in Argentina or Sakhalin).

More Continental Shelf Drilling Deals

Here’s an example of an offshore drilling deal, much like the one that has gotten Chevron in trouble with Brazil, and Argentina rattling sabers at the U.K.

The risks of fines or expropriation are big enough to still make this sort of deal worthwhile. Shell invested a huge amount in developing fields near Sakhalin that were expropriated by Russia (technically, Shell gave up its ownership of fields in Sakhalin just before they were ready to produce, in exchange for rights to a different undeveloped oil field).

Marginal Product of Labor

The Solow growth model shows us that per capita output depends on per capita capital and aggregate technology.

This means that people can get richer just by moving where the technology is.

The fact that high tech seems to move quickly across borders but low tech does not means that much of the reason for emmigrating has to do with better access to low tech.

So, what should we make of this piece entitled “For Many Immigrants Children, American Dream Lies Abroad”, from the April 16 issue of The New York Times. It’s about how children of immigrants are moving back to the old country. Why?

Their decisions to leave have, in many cases, troubled their immigrant parents. Yet most said they had been pushed by the dismal hiring climate in the United States or pulled by prospects abroad.

“Markets are opening; people are coming up with ideas every day; there’s so much opportunity to mold and create,” said Mr. Kapadia, now a researcher at Gateway House, a new foreign-policy research organization in Mumbai. “People here are running much faster than the people in Washington.”

…

“These are the fleet-footed; they’re the ones who in a sense will follow opportunity,” said Demetrios G. Papademetriou, president of the Migration Policy Institute, a nonprofit group in Washington that studies population movements.

A Conservative Opinion On China

Bret Stephens is one of the most provocative columnists for The Wall Street Journal. Like me, he also sees more than meets the eye:

But a simple murder mystery implicating a senior provincial official should not be enough to shake the foundations of a state as accustomed to violence as China. It should not set rumors flying of a palace coup. It should not prompt urgent warnings from outgoing premier Wen Jiabao of the threat of another Cultural Revolution. It should not lead to an "anti-corruption" campaign that has all the trappings of a factional struggle.

Above all, it should not provoke a highly public re-education campaign within the People's Liberation Army to instruct the ranks on Mr. Bo's "wrong thinking" and secure their fealty to the Communist Party, thereby calling attention to just how attenuated that fealty may have become of late.

Yet Mr. Bo's abrupt downfall caused all of this, and then some. Why?

Perhaps this is all related to institutions and what I’ve called in class: “low tech”:

But even then the scandal wouldn't resonate among Chinese if it were an isolated case. In reality it's the norm.

…

All this suggests that the Chinese aren't politically quiescent. They're furious. And their leaders—otherwise busy jockeying and horse-trading for position in the next government—need to figure out how they can allay that fury without also whetting it.

In the case of Mr. Bo and his wife, the regime will probably manage it: Show trials are, after all, a Communist specialty. …

But patterns of authoritarian behavior—particularly nepotism, corruption and rent-seeking—are hard to put down in the absence of the accountability mechanisms China so notably lacks: a vigorous free media, periodic elections, economic competition, a bias toward transparency, the rule of law. Instead, the only mechanism the regime has is the purge. It may work in the short-term …

Meantime, China's economy is slowing as income inequality grows—historically an explosive combination. … Wealthy Chinese are leaving the country in growing numbers, a de facto vote of no-confidence in an economy whose prospects are supposedly limitless.

Read the whole thing, entitled “The China Myth Unravels” in the April 17 issue of The Wall Street Journal.

The Latest On China

N.B. I updated the post on the Chinese political crisis with some graphics that might help you keep track of the names and political alliances.

It turns out that Bo Xilai, the purged Communist governor of Chongqing was … a Keynesian.

It seems he spent a lot of government money on big projects:

The moves signal a challenge to an opaque state-guided economic model—reliant on heavy injections of finance, showcase infrastructure projects and huge social-housing developments—that Mr. Bo was championing in the southwestern city.

Sounds like Obama, eh?

The popularity of Mr. Bo's programs had raised the prospect such policies could gain traction nationwide, which could have clouded prospects for what economists say are needed reforms in China.

These reforms were covered in the earlier post on the China 2030 report put out by the World Bank. My post on the crisis explored how the designated incoming leader Xi is politically related to the now-disgraced Bo:

… Perhaps the most pressing task for leader-designate Xi Jinping is rebalancing the country's economy away from debt-fueled state investment, as exemplified in Chongqing, toward private consumption.

That will involve raising households' incomes and helping small and midsize businesses, which would mean directing funds away from the type of state-owned enterprises that Mr. Bo favored. Critics of Mr. Bo say that under his watch, private entrepreneurs—the real drivers of a consumer economy—were forced to pay for some of the excesses of government-directed spending, in some cases through outright expropriation.

Funny how what is probably a new word to most of your, expropriation, can come up twice in one week. Hmmm. Isn’t that also part of the constitutionality problem with Obamacare: whether some of your income can be expropriated by the government to fund national healthcare?

And then this sounds like the way America privately financed many of its mortgages and then shifted the risk to Fannie Mae (and implicitly, taxpayers):

The Chongqing finance bureau is also looking into developments funded upfront by banks or other investors, then sold to the government upon completion …

Please keep in mind that I’m not stating categorically that any of this is a problem. What I am stating is that there are disturbing similarities.

But, the test of whether or not those are important is the behavior of prices out in the market. For Chongqing, the message from the markets sounds like the same one that the PIIGS are getting in Europe:

Think about how bad this really is: Chongqing, which has some ability to expropriate funds to make its interest payments, is not thought as likely to make repayments as private firms that don’t have that ability.

Whatever faults you find with former President Clinton, he was known to complain that bond markets limited his ability to pursue projects that he wanted, but based on his advice from Treasury Secretary Robert Rubin, he deferred to bond markets when rising interest rates showed him that investors were unhappy. And … it isn’t even a contest for who produced the best results between Clinton, W, and Obama.

Read the whole thing entitled “Chinese Investigate Spending in Scandal ” in the April 19 issue of The Wall Street Journal.

The Latest on Argentina

Argentina has decided to nationalize and/or partially expropriate the national oil company.

Argentina is the macroeconomists best example of how not to choose appropriate macroeconomic policies.

Argentina used to be a top 10 country in terms of per capita real GDP (our best proxy for well-being).

But, for 90 years, they’ve had generally bad leaders and bad policies.

After experimenting with freer markets in the late 80’s and 90’s, Argentina’s political system collapsed early last decade. First, the defaulted on their international debt. Then power was taken over by a provincial governor, Nestor Kirchner. He groomed his wife to succeed him (given this inheritance, you may call them King Nestor and Queen Christina if you like … more people probably should).

As part of those reforms from a generation ago, the state oil company was privatized. Until last week, the majority owner was a Spanish firm, Respol.

The government of Argentina took over executive control of the company earlier this week.

They are claiming they will pay a fair price for those shares. If they do, this is called a nationalization. This is akin to eminent domain.

The government doesn’t have much money to do this. So, if they pay nothing for the firm’s shares, this is called an expropriation. This is akin to theft.

This move is no doubt part of the same strategy of claiming the Falkland Islands for their oil resources.

Both moves buy time for an autocratic government that is not making life better for its citizens.

Read about it in the article entitled “Argentina to Seize Control of Nation’s Biggest Oil Firm” in the April 17 issue of The Wall Street Journal, and “Argentina’s Oil Raid Can Only End Badly” in the April 18 issue of The Financial Times.

I Told You So (and Yes, a Lot of Other People Told You So Too)

The Euro rescue plan … is already running out of money.

The good news is that this took months instead of weeks or days.

The bad news is that this was so easily predictable.

In theory, lending the local banks money they could in turn lend to the government at a profit buys time for the governments to enact overhauls that can lure back foreign investors.

That is essential: Both the Spanish and Italian economies run deficits with the rest of the world; their businesses and citizens don't generate enough surpluses on their own to finance the government.

But enticing foreigners has proved hard. Spain has relaxed its fiscal targets amid worries about the effect of austerity on its economy, and the International Monetary Fund projected Tuesday that Italy wouldn't meet its 2012 deficit target.

This isn’t hard. In a nutshell, here’s what the plan was:

… Banks' borrowing from the ECB in order to lend to their governments …

Umm … where did the European Central Bank (ECB) get the money? From governments.

This is childish.

Here’s what happens in my household: I control most of the earning power, my wife controls most of the spending. Typical, right? So, if I say the family needs to cut back because short on money, my kids volunteer to do extra chores (for which my wife would pay them), and then offer to contribute it to me to pay for, say, a vacation.

Obviously, this sounds like a good plan to a kid, but the flaws to an adult are fairly easy to spot.

But, this is exactly what Europe is doing: the government of, say, Spain is me, the ECB is my wife, and the private banks are my kids. The analogy seems to be lost on politicians.

You might add the detail that Germany is a rich relative. Then the analogy is that the rich relative refuses to loan any more money to me because I’m irresponsible, so they loan to my wife instead.

And then they wonder why their problems don’t go away. Solving this sort of problem isn’t rocket science; failing to address it in this particular way is … fraud.

Read the whole thing, entitled “Europe’s Rescue Plan Falters” in the April 18 issue of The Wall Street Journal.

China

UPDATED around 12:45 on Monday.

Do you like movies or books about political intrigue?

It’s going on right now, live, big time, in China.

This is going almost uncovered in the American legacy media. Remember the point from my Why Is Macroeconomics So Hard? lecture that journalists are availability entrepreneurs? They want to make the most about developing the stories that are available. And hard news out of China is just not that available. So, this has been in the front section of the big national newspapers the last week or so, but it was spotty before then. A lot of information is leaking from microbloggers* inside China.

Is this relevant to our macroeconomics class? Who knows. So this is mostly optional: expect for 1 softball question on the exam on this topic to keep you honest.

But, might it be relevant to macro in the future, and this class next year? I’ll have to post this now, and wait and see.

The reason to watch this is that the desire for political liberalization doesn’t strike most populations until the per capita income gets high enough: in the $5-10K range. It is no mistake that the Arab Spring started in Tunisia last year: the non-oil-producing Arab country with the highest per capita income: economists had actually been watching places like Tunisia and Morocco, rather than places like Egypt or Syria — the revolution might end in Syria but it wouldn’t start there.

And, China is just below that threshold where economic well-being starts to translate into political unrest. Economists have been watching China too: this is why I posted about the World Bank’s China 2030 report in February.

So, what’s going on? Well, there’s a lot of background, so here goes.

Formal Political Background

China is not run by a dictator, it’s more of a junta: a small collection of men who collude politically. Microeconomics teaches us that collusive arrangements are not stable.

Junta’s usually break down around the time that power has to be transferred from one person or sub-group, to another. This is why it is important for successors to be clearly designated, and given a big enough power base to defend themselves.

In China, the Communist Party still runs everything, but the party is run by a group of 9 men called the Central Politburo Standing Committee of the Communist Party of China (aka, Standing Committee). A handsome group, eh:

The Politburo is the traditional Soviet name for the guys at the top, and this is 25 men in China. The top 9 are on the standing committee. These are selected by vote, but the only people that get to vote are those at the top of the party — the 371 people on the Central Committee (and most of the voting is by bloc, and is a done deal). Based on that vote, the members are ranked. Most of the people who move up to the top group of 9 were in the second group of 25 beforehand.

The two most powerful of those are Hu Jintao (the President and # 1) and Wen Jiabao (the Premier and # 3).

The former is the big picture guy, and the latter is the day-to-day operations guy. Basically, a Chairman of the Board, and a CEO. Chinese names are expressed with last name first, so hereafter I’ll refer to these guys as Hu and Wen.

The Standing Committee has a mandatory retirement age of 67. Positions are renewed periodically after deaths, purges, and voluntary early retirement.

The term of a particular Standing Committee is 10 years. So, every tenth year they get together and push the old guys out the door, and get some new blood in.

There’s been exactly one peaceful transfer of power this way; the last one in 2002.

And there’s one coming up this fall. So, 7 guys, including the two at the top, are going away soon.

The successors are already nominally in place: current Vice-President Xi (ranked 6th) who will become President and one of the four Vice-Premiers, named Li (ranked 7th) who will become Premier. Maybe.

But, these two guys need to make sure that they get 7 new guys that will support them.

Informal Political Background

There are no independent political parties in China. But, there are factions, and figuring out the factions can give some insight. The problem is that there are two definitions of factions out there.

The first factional definition focuses on power base. The two factions are the “Crown Prince Faction” and the “Communist Youth League Faction”.

The Crown Prince Faction (aka The Princelings) is composed of the children of the old guys who were in power in the 1980s. In turn, those old guys were often generals or top party officials under Mao going back to the 1920s. They fought in the Civil War, World War II, the Revolution, and the Korean War. This faction has used their power base to get filthy rich.

The Communist Youth League Faction is composed of people who joined the party as teenagers, and worked their way up.

The old guys, Hu and Wen, are both from the Communist Youth League Faction. Li is also from the Communist Youth League Faction.

But, Xi is from the Crown Prince Faction.

The Crown Prince Faction is composed of about 250 people, many of whom are on the Central Committee (of 371)

The other way to break down the politics is to focus on the political choices they make: populist or elitist. Again, there are two breakdowns, but they line themselves up a bit differently.

The “Populist Coalition” looks to make overall life better across China, and wants to reduce social unrest. It dominates the interior provinces. This coalition is about 25% of the Central Committee.

The “Elitist Coalition” is based in the richer provinces on the coast. It is focused on exports and making money.

The old guys, Hu and Wen are both populists. So is Li.

But, Xi is an elitist.

Because of these decade long regimes in power, each group is called a generation. The outgoing guys are 4th generation and are populist. The 3rd generation guys were all elitist. The new guys, Xi and Li, are 5th generation. They have split: Xi is part of the Elitist Coalition and the Crown Prince Faction, while Li is part of the Populist Coalition and the Communist Youth League Faction. They may not get along, and Li doesn’t have Hu and Wen to back him up anymore:

The guys in this generation have been jockeying for position for decades and the finish line is in sight. If they screw up now, it may have all been a waste.

On top of all this, there are also regional cliques based around major cities, like Shanghai, or amongst alumni of the same school, as in the Tsinghua University clique.

Regional Background

So, what’s happened?

More details …

Chongqing is one of the largest and poorest cities in China. It was part of Sichuan province: big, poor, and interior. Chongqing is big enough that it was made independent of Sichuan.

Think: Houston and Texas, but Houston got made into its own state.

Chongqing has a lot of corruption. This is where work for the Three Gorges Dam (one of the largest construction projects in world history, and a huge environmental disaster) was based.

A couple of years ago, one of the group of 25, Bo, was put in charge of Chongqing and told to clean it up.

Bo is part of the Crown Prince Faction but is a fencesitter between the Elitist and Populist Coalitions. If you’re cynical, you’d probably think he is populist because it is politically helpful to him, rather than out of any personal affinity to that position.

His methods were brutal even by Chinese standards: mass arrests, torture, and execution.

The dirty work was done by Wang Lijun, Bo’s police chief. But, it’s worked, so Bo was popular. Bo was expected to move up to the top group of 9 this fall.

He is too old to eventually be at the top of the heap, but closer to the top of the pyramid is always better, right?

Bo’s successes have been a big plus for the Crown Prince Faction.

Bo is married to Gu, a lawyer and minor celebrity in China.

She is also from the Crown Prince Faction. Both families are fabulously wealthy … from connections.

And they had a British expatriate named Heywood in their entourage who has been helping them out for about 20 years. He was married to a Chinese woman and had lived in China for most of the last 25 years.

Heywood helped Bo and Gu get their kid into a prestigious English boarding school, and eventually graduate school at Harvard.

Gu also apparently holds a residency card for the UK (a real no-no if you’re part of corrupt operation, because it “gives you an out” that others don’t have). The son, Bo Guagua has not lived permanently in China in 10-15 years (but dated John Huntsman’s daughter when he was in Beijing).

The Blow-Up

Now the gory details.

Two months ago, Bo’s police chief Wang, fled to Chengdu — the capital of Sichuan.

He showed up at the American Consulate and asked for asylum to get away.

This is like fleeing from Houston to Austin, and asking the Canadian Consulate to save your butt.

Wang was chased by 70 police cars, and there was a Mexican standoff outside the American Consulate between the Chongqing police loyal to Bo, the local Sichuan/Chengdu police, and national authorities loyal to the Standing Committee.

Wang spilled all the beans, but was denied asylum because he’s a thug — and how would they get him out of there anyway?

So, the Americans pushed Wang out the door, where he was picked up by the national authorities. He’s disappeared —

out of sight for two months now. He’s undergoing “vacation-style† medical treatment”.

Wang alleged that Gu was nuts, she may have had an affair with Heywood, she put too much pressure on Heywood, he screwed up, and Bo had him poisoned.

Heywood had been found dead in a hotel room in Chongqing last fall, and was cremated without an autopsy. He had warned friends that he was in big trouble, and may have secreted sensitive documents outside China. This did not become news until Wang fled to Chengdu.

No one knows why Wang cracked and fled. But, you’ve got to think that if you’re a nationally known police officer getting chased by guys who are supposed to report to you that he must have feared for his life.

The handwriting was on the wall in February: Bo was in big trouble.

Then last month there were rumors that a coup was suppressed in Beijing. It now appears this may have been true, and put on by supporters of Bo (Princelings?). Other reports suggest that Bo called in his Army friends for his own protection, but was not staging a coup.

Bo has now been removed from power. Bo and Gu have been arrested and charged with murder.

They have not been seen for days.

It looks like the Standing Committee has united and decided that these folks have to be pushed overboard. But, how does that work when Bo has connections?

Oh … and there have been nationwide internet outages sporadically. You don’t think this has to do with information control, do you? Certainly those coup rumors were squashed. Either way, the telecom companies have stated publicly that the outages are not with their equipment.

The bottom line of all of this is that it’s a bit like an auto race when parts start to fly off cars: you know something bigger might happen soon. This may turn out to be nothing. Or maybe not. Stay tuned. Here’s The Financial Times view from just this morning. And don’t forget about what I said: as an economist, you need to watch China as prosperity pushes liberalization.

P.S. The son, Bo Guagua, holed himself up in his $3K/month condo in Boston.

Last Thursday, after reporting that he was under surveillance by unknown Chinese nationals, he was removed by uniformed security to a helicopter. It is believed he may have defected.

* I learned something interesting about China this past month. Microblogging (like Twitter) is a much bigger deal there because the 140 character limit allows for much greater information content when you are choosing from 5K Chinese idiograms than from our 26 letters.

† The comedian George Carlin frequently picked on the usage of euphemisms to cover true meanings. One of the points he made that when you hear the word “style” appended to something, it usually means that the something is actually absent. I’m channeling Carlin here a bit, and he used to swear a lot, so what he would have said is that “vacation-style” means no f***ing vacation.