Saturday, July 7, 2012

Krugman and Layard Launch Manifesto for Economic Sense

At the end of June, 2012, Nobel Laureate Paul Krugman and Richard Layard, a distinguished British economist launched a manifesto calling for a more rational policy dialogue with respect to the economic crisis and plans for crisis recovery across the major economies. 

In the two weeks that the manifesto has been in existence, it has been endorsed by economists from across academia in the US, Europe, and Canada, and from such established institutions as Cambridge, Yale, Oxford, Columbia, LSE, Sorbonne, Dartmouth, and Harvard. Economists from the IMF, World Bank, and several of the world's stock exchanges have also signed. With over 7700 signatures spanning 180 pages thus far, a large number of ordinary citizens from various walks of life have also endorsed the Krugman-Layard Manifesto for Economic Sense. 

Let's Avoid Repeating the Mistakes of the 1930s
The Manifesto calls for an end to the focus on austerity, asserting that in the case of most countries - but not Greece- public borrowing was not at the source of the crisis, nor the subsequent ballooning of public deficits across the OECD. Rather, the source of our massive public deficits was actually the collapse of output and then revenue, which followed the onset of the crisis. It would therefore be a mistake to try to address the problem by dismantling the part of the economy that isn't broken. The manifesto calls this failed policy a repeat of the the mistakes of the 1930s, when reductions in public spending lead to economic contraction in many of the world's largest economies, thereby exacerbating the crisis. In fact, the IMF has individually studied the national-level economic effects of budget cuts in 173 cases, and found that the consistent result is economic contraction. 

What is called for according to the manifesto, is counter-cyclical fiscal policy that would dampen then economic shock rather than exacerbate it. At the moment, the private sector is simultaneously trying to cuts its spending, lower its leverage levels, and reduce its borrowing. The manifesto also calls on governments to focus more attention on unemployment figures and loss on borrowing costs. At the moment, most major economies face high unemployment levels compared to the recent past, while borrowing costs are near all time lows for most major economies. 

The Manifesto concludes by saying that in order to be able to address our economic problems correctly, correct analysis of the problems will be necessary and indispensable. 
About the Author:
Max Berre is a financial-regulatory economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) and economic correspondent for Capital-Life, who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands. 

Friday, July 6, 2012

For China, Trade is not Simply About FDI

An empirical study undertaken at the University of Hong Kong examining the phenomenon of trade and foreign direct investment in mainland China has demonstrated a key policy point of China's FDI policy. Namely, its not about how much FDI China can attract, but about maximizing productivity spillovers. Its about how much wealth actually remains in the domestic hands and how much productivity growth the domestically-owned Chinese economy experiences as a result of foreign investment.

Typically, when we talk of trade with developing countries and emerging economies, we think of a number of key concepts, all of which have their roots in western academia. Talk of trade-based economic growth and development turns to focus on Foreign Direct Investment, whose sheer volume is simply supposed to be broadly good for growth. Good policy would therefore focus on simply a maximization of FDI-lead growth. Or so we in the global north - two centuries removed from our own actual history of economic development during the industrial revolution - are told.

Necessary but not Sufficient
For China however, FDI is not universally considered as unambiguously positive. While economic growth is certainly considered to be a positive aspect of FDI, this is "necessary but not sufficient" in determining whether or not foreign investment is actually positive for the country. After all, The question then, is what precisely would be sufficient?

For China, perhaps the real question is not one of how much wealth can be generated in China with foreign investment, but rather, how much wealth actually remains in the domestic hands as a result of foreign investment. The key ingredient seems to be spillovers. That is, improving the productivity of the locally-owned economy. Presumably, this involves modernization in technological level, managerial practice, and employee know-how in the domestically-owned share of the economy.   

The Study and its Meaning
This study is an empirical examination of the productivity spillovers at the firm level. The central question it asks its quite straightforward: Are domestic Chinese firms affected by the presence of international firms in China? The study finds evidence that the technology gap leads to large productivity spillovers. In fact, the larger the technological gap, the larger the potential spillover. What this all means of course, is that FDI policy is not really a question of quantity. Sound FDI policy should revolve around bringing the most sophisticated possible firms to China, then maximizing spillover effects on domestically-owned firms by maximizing capture of technology, know-how, and managerial practices.

Foreign direct investment (FDI) is believed to bring positive spillovers to domestic firms in the host country. Empirical studies, however, have found conflicting evidence on the effects of FDI. In this study, we use a firm-level industrial census to estimate the relationship between the intensity of foreign presence and performance of domestic firms in China. More specifically, we attempt to answer the following questions. First, are Chinese domestic enterprises affected by the presence of foreign invested firms operating in the same industry which they do business in? Second, are Chinese domestic enterprises affected by the presence of foreign invested firms operating within related industries at the same locality where they conducted their businesses? It is a fact that a substantial portion of FDI in China are originated from neighboring economies, especially from the three most Chinese populated economies Hong Kong, Macao and Taiwan, that are technologically much less advanced than industrial countries. Finally, we examine whether foreign investment firms from these economies affect the Chinese domestic firms differently compared to those from other investing countries. The estimation results offer some support for the existence of positive spillovers. There seems to be stronger evidence that domestic industries benefit from foreign presence in the related industries within the province. Employment shares of foreign affiliates, especially those with investors from advanced countries, are associated with higher productivity. The impact of foreign presence within the industry is rather mixed. Employment shares of firms with investment from greater China area are negatively associated with domestic productivity while those with other foreign investment are positively associated with domestic productivity. It supports the argument that larger technology gap provides large potentials for technology spillover. For investment from greater China area, smaller technology gap present less potential gain. More over, they may be in direct competition with domestic firms and result in shrinking market share for domestic firms.