Political change in Malaysia
I was woken up this morning in Kuala Lumpur by what sounded like fireworks. Checking the news, it could well have been – the first democratic change in the 60-year-long history of the country. A former prime minister – Mahatir Mohamad – made common cause with his former opponents to defeat the current prime minister (and his former protégé) Najib Razak. Having talked to my colleagues at the University over the past days, there has been clearly a desire for change but also a certain feeling of resignation, given all the gerrymandering the (now past) government undertook to stay in power (and this gerrymandering makes Republicans in the US look like early-stage learners). It will be exciting to see what will happen in the next months and years. Malaysia has achieved a lot over the past 60 years, economically, but also socially, by keeping a multi-ethnic society peacefully together. However, it is also clear that Malaysia has not exploited its potential quite yet. I wish my Malaysian friends lots of luck!
10.May 2018
Immigration: when populism meets bureaucratic incentives
Before Brexit there was the immigration goal. Reducing immigration down to several tens of thousands was an objective announced by David Cameron in 2010/11. Never mind that as part of the Single Market and thus free movement of people across the European Union this objective was all but unachievable. Politicians are obviously aware of this, so as diversion mechanism illegal migrants have been targeted through the hostile environment policy and removal targets. However, the problem is that the UK does not have a proper registration system and there are thousands of legal migrants (e.g., Windrush generation) that do not have proper documentation. Result: since illegal immigrants are hard to track down, bureaucrats go for low-hanging fruits – legal migrants with no or doubtful documentation. These could be member of the Windrush generation, foreign students who supposedly have cheated on their English exams, and even highly skilled non-EU migrants who are applying for permanent residence and get rejected on shady grounds. While one might find this approach by bureaucrats to go after legal migrants despicable, it can be easily explained by the incentives given to bureaucrats – quantitative targets (number of people to be removed) in times of reduced resources (courtesy of the coalition’s austerity policies). It is definitely not the agents’ but the principal’s fault, in this case the Home Secretary and the government, more generally.
Unfortunately, my family had to experience the Home Office’s hostile environment policy ourselves, when my wife (non-EU-citizen but as my wife with the right of residence in the UK) tried to get a visa to enter the UK and then secure the residence permit. Everything turned out well, but there were stressful moments of dealing and having to pay an anonymous bureaucracy that is supposed to serve the people and not fight and blackmail money out of them. I already fret the day when we have to renew her residence permit and when I have to secure settled status for our teenage boys and myself. And all of this obviously pales in comparison with what members of the Windrush generation and other legal migrants had to go through.
Coming from a family of civil servants and counting many civil servants among my friends, I appreciate their hard work and cannot blame for the current disaster. It was a political decision to create unachievable migration targets, it was a political decision to create a hostile environment for illegal migrants, it was a political decision to cut resources for the Home Secretary and thus turn the immigration environment hostile for both illegal and legal migrants. This is when populism meets bureaucratic incentives – an important lesson for the implementation of Brexit.
6. May 2017
More on financial inclusion
Last week saw the third Finance and Development workshop at the DIW in Berlin. Fascinating programme - as in previous years – this time with an emphasis on financial inclusion and RCTs. There was some overlap with the financial inclusion conference at the IMF in March I reported earlier on, but also some additional insights. One thing I immediately noticed was the emphasis on non-credit service provision and the use of mobile phone (as delivery channel or as platform for financial services). We have indeed come a long way since the Year of Microcredit in 2005.
Several papers focused on the effects of financial management training and show that they can work if delivered smartly. Shawn Cole presented evidence on India and Philippines where training was delivered through mobile phones; Sandra Sequeira showed evidence on Mozambique, where financial management training helped female traders somewhat close the productivity gap with male traders as well as the complementarity of financial management training and offering savings services through mobile phones; and Tim Kaiser showed in an experimental setting in Uganda that active learning rather than pure lecture style teaching had more of a positive effect on entrepreneurs. It is interesting to see that after a lot of research showing ambiguous and inconclusive results on what works (or more often what does not work) and for whom there finally seems to come a wave of research that give us better insights into what works. And consistent with the three papers mentioned above is a recent metastudy by Tim Kaiser and Lukas Menkhoff showing that teachable moments are critical .
An expanding literature has shown that expanding access to formal savings accounts can increase investment by micro-entrepreneurs. Lore Vandewalle showed for an experimental setting in India that savings accounts help wage earners to smooth consumption though she did not find any effect on overall income. Finally, and while not an academic paper, Dorothe Singer’s (full disclosure: I was her PhD supervisor in Tilburg) presentation was one of the highlights for me as she shared with us the findings of the latest Global Findex. The survey results indicate that in 2017 69% of adults across the globe had an account (up from 62% in 2011), with an increasing role of mobile money account. I will write more about this in late June, when the project’s lead economist Leora Klapper will present the findings here in London.
4. May 2018
Economic Policy panel in Zurich
I am off to Zurich for the next Economic Policy Panel meeting. As always an exciting programme. One important highlight will be four papers on populism, a critical issue for policy makers and social scientists on both sides of the North Atlantic (and increasingly in Latin America as well). To better understand the challenges, several papers by political scientists are included in the programme. And one interesting paper, which has already made headlines, is by Patrick Kennedy and Andrea Prat on where people get their news, especially relevant in the current political environment. Also on the programme two papers that look at the effect of zombie enterprises and misallocation of resources – one cross-country and one on Italy. The final three papers will focus on the extent to which the expansion of education can make up for negative consequences of an aging population on growth; the effect of monetary policy on banks’ profits at the zero lower bound; and the effects of national borders and thus secession on trade. An exciting and diverse set of papers! I will be tweeting from the panel meeting!
12. April 2018
What is new in the financial inclusion literature
Last week, I had the honour and pleasure of co-organising a conference on financial inclusion at the IMF with Andrea Presbitero and my former colleague Sole Martinez Peria. Nine papers, mostly work in progress, were presented and together gave nice insights on where the financial inclusion literature stands. Together, these papers also show how the literature has matured over the past ten years, with big questions no longer receiving simple, but rather qualified answers, and new questions arising.
While evidence from multiple randomized control trials across the world have shown “a consistent pattern of modestly positive, but not transformative, effects” and aggregate evidence points more to distributional rather than growth-enhancing effect, a new paper presented by Cynthia Kinnan shows that when considering the impact of microcredit, heterogeneity is key. One of the differentiating factors is whether borrowers are entrepreneurial and thus use the loan receipts for investment rather than consumption. As so often in economics, one size does not fit all and targeting of broad population groups with credit will certainly not give the expected return in investment and growth. The uptake of microcredit might also be constrained by religious beliefs and a paper by Dean Karlan and co-authors shows that offering a Sharia-compliant lending product increased the application rate by religious people in Jordan and that such borrowers are also less “interest rate” sensitive. Interestingly, the uptake does not seem to depend on who the entity authorizing the Islamic product is. This might show the tolerance of religious Muslims for different authorities or the importance of labelling a lending product as Sharia-compliant.
Several papers used observational data to explore the impact of financial inclusion programmes. Sumit Agarwal and co-author study the Pradhan Mantri Jan Dhan Yojna (“JDY”) programme launched in India in 2014, the world’s largest financial inclusion program so far, resulting in 225 million new accounts. While usage of these account increased only slowly after account opening, the authors document a shift away from informal sources of finance and provide indications of more consumption smoothing and savings. Claire Celerier and Adrien Matray show that branch expansion following deregulation between 1994 and 2010 in the US resulted in higher wealth accumulation by low-income people, suggesting that geographic access matters. Finally, another paper by Sumit Agarwal and (other) co-authors shows that a financial inclusion program establishing saving and credit associations (SACCOs) across Rwanda resulted in a high take-up of new loans and positive real effects. More importantly, however, it also led to making some of these new SACCO borrowers bankable, allowing them to switch to banks an initial loan with the SACCOs. Given the frequently lamented fragmentation of African banking systems, such “integration” of different segments of the financial system, supported by the credit registry, is welcome.
There were also two papers on mobile money in Kenya. In one, my former Tilburg colleagues show that sometimes small (administrative or monetary) barriers can prevent the uptake of more efficient payment tools by small businesses; once they adopt these tools, however, they seem to use them frequently. In a second paper, Billy Jack and co-author show that encouraging parents to use formal savings accounts via mobile phone increases savings for high school tuition and makes it more likely that kids are sent to high school.
While none of these findings might seem ground breaking, they help us make progress in understanding the barriers to the use of financial services and the impact of using them. Personally, I have three take-aways from these papers. First, the distinction between credit, savings and payment services has become fluid and the fear that the improvement in access to simple mobile money-based transaction services will not lead to the use of other financial services might not be overstated. Second, interventions to increase access to financial services have to go beyond monetary and geographic barriers and also address behavioural constraints (including nudges). Finally, a methodological point – I think we are beyond the point where one methodology can be declared the gold standard in this literature. Only a combination of randomised control trials, use of observational data combined with natural or policy experiments, and theory-motivated structural models can provide us the necessary insights and policy recommendations to push the financial inclusion agenda forward. Plus data – and as so many, I am looking forward to the next round of the Global Findex, to be released in a few weeks.
26. March 2018
The trilemma of Brexit
The UK and the European Commission have agreed on a transition period for the UK after March 2019. However, this “agreement” still has many open points, most notably the question of Norther Ireland. The conundrum Theresa May finds herself in right now can be framed with the concept of a policy trilemma. Three political objectives are at the top of the agenda: (i) take back control (of money, border, laws), (ii) prevent a hard border to arise in Ireland (and thus honouring the Good Friday Agreement) and (iii) keep the UK together as political and economic unit. Only two of these objectives can be met as I illustrate below. Taking back control and maintaining the Good Friday Agreement would require Northern Ireland to effectively stay in Customs Union and Single Market, imply a border in the Irish Sea and thus undermine the unity of the UK. One might see this not only as constitutionally questionable, but also politically infeasible as the DUP (currently in a confidence and supply agreement with the Tory government) would not agree to this. However, if the UK wants to avoid a border in the Irish Sea and take back control (i.e., leave Custom Union and Single Market), this would imply constructing a hard border in Ireland and thus violating the Good Friday Agreement. Any alternative plan focused on technological solution is currently in the realm of dreams and visions. Finally, maintaining the unity of the UK and avoiding any hard border in Ireland would require the whole UK to stay in the Customs Union and Single Market, a solution also known as Soft Brexit to some and as Brexit in Name Only to others. The UK would stay closely linked to the EU, with no option to do independent trade deals, having to accept free movement and having to pay, BUT: without any formal say. Which raises the question: what does Brexit mean in this case?
So, far the British government has fudged with this trilemma, mostly with platitudes (Brexit means Brexit, taking back control, red lines etc.) and the firm intention to keep the peace within the conservative party. However, the trilemma cannot be talked away: something has to give. Which will it be? And when will the decision be taken? And by which Prime Minister?
19. March 2018
Brexit – how the political class has failed its people
At some point in the future, historians might look back in surprise at the 2010s in the UK and the rather convoluted Brexit process. In the back-and-forth between Commission and the British government one really wonders whether the British government simply does not know better or whether they have reached the point where they realized that the envisioned Brexit strategy is simply not feasible and are looking for an organized retreat. The hostile reaction of politicians and right-wing press to the EU draft of the Brexit treaty was surprising, as all it did was to put into legal language the political agreement from December. More realistic Theresa’s May latest speech last Friday where she finally acknowledged that the UK might after all not have its cake and eat it.
The main tension between London and Brussels seems to stem from a fundamentally different approach: for the UK government, Brexit is a political process, for the European Commission a legal-administrative process. One might also think that the difference between principle-based Common Law and bright-line based Civil Law/Continental European approach shines a bit through, but I would put more weight on the political explanation. From the viewpoint of the EU, it is very simple: the EU cares primarily about the interest of its remaining 27 countries and their people (important if you think about the issue of the Irish border). The EU has no business to solve internal policy conundrums in the UK or help the UK government to resolve problems stemming from Theresa May’s mistake of drawing red lines for Brexit before thinking through the implications. For the UK government, on the other hand, this process is as much about managing expectations with its electorate and internal Tory critics on both sides as it is about negotiating with Brussels. It is more, the UK government seems to negotiate more with itself than with the European Commission. Therefore it is not surprising that even though it was the UK government that started the divorce process, it is the European Commission that has produced a first draft of a divorce document.
The best example is the stand-off on the border between Republic of Ireland and Northern Ireland. The EU’s suggestion of leaving Northern Ireland within the Single Market and Customs Union is a fall-back position to prevent a hard border from have to emerge after Brexit; it is up to the UK to come up with an alternative if they insist on the UK leaving the customs union and not having a border in the Irish Sea. The technological solution so much advertised by Boris and Co. has so far been nothing but an ambition and a slogan. And since the final trade agreement between the UK and the EU will not be agreed upon before Brexit, a fall-back position to avoid a hard border and thus endanger the Good Friday Agreement is necessary. Again, this is the logical consequence of a legal approach to Brexit.
So far, nothing has gone according to the Brexiters’ plan. Instead of a leisurely afternoon tea in Berlin to agree on a new EU-UK deal, long negotiations with Eurocrats in Brussels have awaited the British government. Ignorance on how the EU works and the utter lack of preparation has not helped. It was not until this past week, that the British and Irish governments have agreed on a study how to avoid a hard border in Ireland after Brexit, one year after triggering Article 50 and almost two years after the Brexit referendum.
Again, historians will look back at these years in surprise and/or despair. Having lived and worked in this country for over four years and being an anglophile by upbringing, education and conviction, I can only hope the best for the UK. But I am no longer optimistic. The political class in the UK has failed its population miserably!
3. March 2018
The economics of supranational supervision
Consuelo, Wolf and I have been working on this paper for quite some time, but finally have a version that we feel comfortable with to publish as CEPR Discussion Paper. It is the third (but not last!) of a series of papers that Wolf and I have co-authored on the tension between national bank supervision and cross-border banking, a tension that comes out especially during the failure and resolution of banks, as we show in our 2013 paper with Radomir Todorov, published in Economic Policy. Does that imply that supranational supervision is a better solution – not so fast, we argue in our theory paper, published in the International Journal of Central Banking, where we formalize the trade-off between cross-border externalities from bank failure and heterogeneity in the cost of bank failure, where the former makes cooperation if not supervisory integration welfare improving and the latter welfare reducing.
In the latest paper with Consuelo we take this model to the data. We first hand-collected data on supervisory cooperation among a global sample of countries over the period 1995 and 2013. The information is at the country-pair level and was gathered from the supervisory bodies' websites and official documents available online. Supervisory cooperation can take many different forms and degrees of intensity. In our work we distinguish between four (and increasingly intense) forms of cooperation: a Memorandum of Understanding for information sharing and onsite inspection, a College of Supervisors, a Memorandum of Understanding on crisis management and resolution and a supranational supervisor. We then regress these gauges of supervisory cooperation on measures of cross-border externalities (including foreign bank share, financial market integration and currency unions or peg) and heterogeneities (structure and level of financial development, political structure, historic links, geographic proximity etc.).
Consistent with theory, we find that higher cross-border externalities between two countries increases both the likelihood of cooperation and the intensity. Distinguishing between different dimensions, we find that it is all three – cross-border externalities through bank ownership links, spill-over effects through financial markets and linkages within a currency union – that increase the probability and intensity of cooperation. We also find that higher heterogeneity between countries decreases the likelihood and intensity of cooperation, again consistent with theory, though the economic effect of heterogeneity is less prominent than that of externalities. In summary, economics matters! Countries are not only driven by politics and history when agreeing to cooperate among regulators, but also by the net benefits of doing so.
We can also use the exercise to predict which countries are likely to cooperate with each other. Take the European Union. The banking union is currently limited to Eurozone countries, but is – in principle – open to non-euro countries of the EU. Using our model to consider externalities and heterogeneity of non-euro EU countries vis-à-vis the banking union countries, we would predict most of them not to join the banking union, maybe with the exception of Bulgaria and Denmark, countries with a currency board and a peg to the euro, respectively.
2. March 2017
Ordoliberalism on the road – DC and Vienna
Last week saw the first two stops of our road show of the Ordoliberalism eBook, edited by Hans-Helmut Kotz and me. The first one scheduled on Monday in Washington DC at the Peterson Institute. Courtesy of snow weather in Toronto I missed the presentation, but contributor Jeromin Zettelmeyer did an excellent job in introducing ordoliberalism to a mostly American audience. For anyone who wants to read a “personalized” introduction into ordoliberalism, I recommend reading his chapter.
On Friday, an event at the Austrian National Bank, with governor Nowotny and the chief economist Doris Ritzberger-Grünwald. Hans-Helmut and I both did a general introduction on the difference between the German rule-based approach and Anglo-Latin pragmatism and then narrowed in onto one specific policy area – bank regulation and banking union. The lack of any national bank resolution framework nationally and on the Eurozone level was clearly the weak link in the Eurozone in 2007/8. This area has also been one where notable progress has been made over the past years. Bank resolution shows very clearly the conflict between the ex-ante optimal solution of no-bail-out (to avoid moral hazard and aggressive risk taking) and the ex-post optimal solution of bail-out (to minimize negative effects of bank failure on the financial system and real sector). All national authorities in Europe decided for bail-outs in 2008, especially for large and systemically important financial institutions, including the German government, certainly in violation of any ordoliberal principles. The banking union with its bail-in principles and more strict regulatory and supervisory frameworks was designed to avoid such violations in the future and minimize both moral hazard and negative effects for the remaining financial system and the real economy. While the case of Banco Popular (sold to Santander over a weekend with no costs for taxpayers) was certainly an example of how the banking union can work effectively, two other examples show that we are still far from an ideal world. The limited bail-in of senior bondholders in the case of Veneto Banca and Banca Popolare di Vicenza and support with taxpayer money might not have violated the letter but certainly the spirit of the banking union. Behind this failed resolution, however, hides the ugly truth that the new regulatory regime was put in place before the legacy problems were resolved. Applying rules where they do not makes sense, is certainly not a useful economic policy approach. Even worse, when Deutsche Bank was rumoured to be in trouble a few months ago, there was little public discussion on how to resolve such a large fragile bank in line with the new rules, but rather how the German government would bail-out its national champion. Teutonomics trumps Ordoliberalism again!
Not all economists in Germany are ordoliberals, as Adalbert Winkler made very clear in his discussion of German Angst on loose monetary policy and quantitative easing, resulting in persistent predictions of imminent hyper-inflation, warnings of uncontrollable asset bubbles and a focus on the rules of monetary policy (e.g., purchase of government and corporate bond papers) rather than the outcome (currently sub-target level of inflation). This has also resulted in a clear reputation loss for the ECB in the largest Eurozone economy, which can only be damaging for future monetary policy conduct In my opinion, there is a clear contradiction in the German view on this – after all it was them (together with other national governments) who refused the use of any other policy tools to address the Eurozone crisis (such as fiscal policy, more aggressive bank restructuring on the Eurozone level), which in turn imposed a bigger burden on the ECB as the only functioning Eurozone wide policy authority.
If there was one surprising insight for me from the meeting in Vienna, then it is that most people in the room seemed to agree with us. We were clearly missing a staunch supporter of the current teutonomic/ordoliberal approach. We hope to get this at our next discussion round in Berlin, in March!
12. February 2018
Doing Business – time to dump the rankings
The Doing Business database has come again into the headlines, but again for the wrong reasons. Some five years ago, there was quite a heavy discussion, which resulted in a task force recommending reforms and which led me to write this Vox column.
It is the Chief Economist of the World Bank who seems to have started the latest controversy by focusing on the changes in the ranking of a specific country, Chile, where he notices a rather interesting correlation of these changes with political changes: the ranking goes up during the most recent right-wing administration (2010-2014) and goes down during left-wing administration (2014-2018). A few days afterwards he all but retracted his accusations, blaming communication failures. Interestingly, the Independent Review Committee recommended in 2013 (among others) to drop the aggregate rankings.
I do not want to comment on the politics of this controversy (neither the Chilean aspect nor the internal WB aspect), though I can imagine quite some serious conversations at 1818 H Street on this matter (and how it was made public). On the other hand, it is good that these things are being discussed openly. Supporters of rankings point to positive effects on political discussion and the necessary reform impetus they can provide. On the other hand, and as has become clear with this latest controversy, changes in rankings can be explained by all kind of factors, including changes in the methodology. One interesting metric provided by the Doing Business database can be useful in the context of the discussion: the distance to the frontier (DTF) which indicates how far a country is away from global “best practice”, and which – as in the case of Chile – is not necessarily correlated with the ranking. More importantly, however, is that the frontier might not necessarily be “best practice” in all circumstances; whether it is or not is ultimately an empirical question.
This controversy brings me back to the main point of my earlier Vox column. The Doing Business database is an extremely useful and rich data source for researchers and analysts. The rankings, however, have to be taken, with lots of grain. As pointed out by others (here and here), there is also a high standard error around these rankings, a country that ranks 42nd does not necessarily have a worse business environment than a country that ranks 40th.
I think it is really time to move completely away from any country ranking but rather limit the Doing Business report to data and distance to the frontier for individual areas. Obviously, the authors of the DB database (and the World Bank) cannot prevent others from using the raw data to construct rankings, but it should not be the World Bank Group that takes the initiative on this.
17. January 2018
Mobile Money and Firm Growth
Now forthcoming in the Journal of Development Economics, my paper with Haki, Ravi and Burak on how access to mobile money allows small and micro-enterprises better and cheaper access to trade credit and ultimately higher (productivity) growth. While recent papers (most prominently by Billy Jack) have explored the impact of mobile money on household welfare, we look at its effect on firms’ productivity growth. Specifically, constructing a dynamic general equilibrium model, we assess how payment mechanisms interact with trade credit in increasing growth. Using Kenyan firm survey data, we calibrate the model and provide evidence for our theoretical model. For a non-technical summary, see this Vox column.
In the model, mobile money dominates fiat money as a medium of exchange, since it avoids the risk of theft, but comes with electronic transaction costs. We show that entrepreneurs with higher productivity and access to trade credit are more likely to adopt mobile money as payment instrument vis-a-vis suppliers. Calibrating the stationary equilibrium of the model to match firm-level data from Kenya (which we collected jointly with FSD Kenya), we show that the use of M-Pesa (the most successful mobile money technology so far) by enterprises can explain 10% of Kenyan growth between 2007 and 2013, thus a significant macroeconomic effect.
This paper is part of an expanding literature that has shown that more efficient retail payment services (such as mobile money) can have important positive macro-economic effects and thus speaks to the literature on financial inclusion (which has shown much more ambiguous effects of expanding credit services to the poor). It thus also adds to the debate on which financial service to focus when expanding access to financial services.
This paper is dedicated to our friend Ravi, who was to become a PhD student in Tilburg in 2013, but was killed in the atrocious attacks in Westgate Malls in Nairobi, on 21 September 21, 2013. For a wonderful obituary, see Koen Schoors in this eBook.
16. January 2018
Random thoughts and links on New Year’s Day
I really liked this comic – makes me wonder how my PhD students talk about me when I am not in the room…..
Sometimes one appreciates his former colleagues only after leaving. Ben Vollaard from Tilburg University has been doing great research on “crime” and honesty, such as on how to “facilitate” honesty and how the Dutch herring competition is being rigged. Speaking about economics being useful in daily life….
Yesterday was my last official day as (Co-) Editor of Review of Finance though I will continue to handle papers that have been submitted before yesterday and/or have received an R&R. The three years for the Review of Finance have been incredibly rewarding, though not always easy. I certainly have learnt a lot for my own research! I might write up some lessons on these three years later this year.
2018 shapes us as interesting year – more visits to Malaysia, some road trips for the Ordo-liberalism eBook and – after some delay – finally the Handbook of Finance and Development (co-edited with Ross Levine) will be published. I will continue as (co)-Managing Editor of Economic Policy, with exciting special issues coming up, on populism and the Gig economy. And February will see our first task force meeting on the effect of Basel III on emerging markets.
1, January 2018
Brexit – the first phase is over
The first phase of the Brexit negotiations has concluded and I think it has become clear which strategy has won: it was not the Brexiters’ strategy of “an afternoon tea in Berlin” or “we’ll pay our way into a great new relationship” or “the EU can whistle away”, but rather the more formal if not formalistic approach the EU has taken: long-term commitments made before have to be honoured, people’s lives and rights have to be protected, and the Brexit cannot create new political hotspots.
There were three main agreements: first, the rights of EU citizens in the UK and UK citizens in the EU being protected after Brexit (with a prominent role for the EJC – here goes the first red line of the Brexiters); second, payment by the UK for existing EU commitments: if you leave the restaurant after the third course of a set five-course menu, you are still expected to pay for the whole menu, no matter how much you whistle; third, the Irish border has to remain a soft one. This turned out to be the trickiest but also most consequential one. The compromise seems to imply that the UK will stay in all but name in the Customs Union and (possibly) Single Market, for a simple reason – if you want to avoid a hard border between Northern and the Republic of Ireland, they have to be part of the same market. If you want to avoid any border in the Irish Sea (between Northern Ireland and the rest of the UK), this would by extension imply that the whole of the UK stays in customs union and single market, but without having any say in making the rules. There might still be a way out of it, courtesy of modern technology, but it would for the UK government to propose such a solution. A third solution – more decentralization and allow Northern Ireland go a separate way – would be possible, but politically difficult, as it would open the floodgates for the Scottish independence drive.
If the past nine months have revealed anything new than it is the utterincompetence of the Brexiters. Suggestions such as “let’s just leave the Irish border open” are so far from reality that one wonders whether these people have any clear idea on basic international law. Similarly, declaring the first phase agreement is a letter of intent rather than a binding agreement is quite amazing for a country, which has established the concept of sovereign credit worthiness, and now considers defaulting on such commitments. On the other hand, lots of red lines have turned pink for the better of the UK’s future. But behind it is a more general mistake of populists: win with easy promises and leave the details to others. Taking back control for a mid-sized economy (even one with nuclear powers) is not as easy as promised.
The question remains when will the British political class finally have the courage to tell voters the truth: that the myth of taking back control is simply that: a myth; and that the cake either has to be had or has to be eaten. Will it be in a few days, when the British government for the first time discusses what kind of Brexit it actually wants? No, this is not a typo – the British government has so far not agreed on what kind of relationship it wants with the EU after Brexit apart from generalities including lots of pluses and minuses, such as Canada plus plus plus or Norway minus minus. Will it be in the final days of the Brexit negotiations when even the Morduch media will realize that the cake is gone and there will be no taking back control? Or will the government manage to go all the way to the next General Elections before the fraud is revealed?
And what will the reaction be by electorate and hardline Brexiters – a push for a No Deal Brexit, which might send UK into the diplomatic desert or breaking one of the agreements – the first phase agreement or the Good Friday agreement? The fall of the May government, with possible new elections? It is this uncertainty that will make the European Union reluctant to go all in and will push all participants into a compromise, but it will also put pressure on the UK economy until this uncertainty is resolved.
16. December 2017
Research in Islamic finance – looking forward
I just attended a very interesting conference on Islamic finance in Dhahran, Saudi Arabia. For me the highlights were the paper I discussed as well as a discussion on the future of research in Islamic finance.
The paper I discussed, by Nicola Limodio, identifies the effect of deposit volatility on loan maturity using a natural experiment in Pakistan, where volatility of silver prices influences the outflow of deposits around the date of Zakat (religious donation, similar to the Christian tithe). The author shows a dampening effect of deposit volatility on long-term lending, which results in less fixed asset investment by firms. While one can see this as Islamic finance paper, one can also simply regard the exogeneity of the liquidity withdrawal as helpful identification strategy and the results as being applicable beyond the specific setting. A great paper addressing an important question across the developing world (lack of long-term finance), with rather unique data (credit and corporate registry, branching map and religious composition map).
There were many other interesting papers in the conference on different aspects of Islamic finance – banking, corporate finance, household finance and regulation. Which brings me to a more general point – the basic laws of finance – asymmetric information resulting in agency problems – hold in Islamic as much as in conventional finance. There are some innovative solutions to the problems in Islamic finance, though also a lot of more nominal adjustment to standard financial contracts to thus make them compatible with Sharia law. Most importantly, there is an astounding variation in Islamic finance across countries. Many papers in the conference referred back to my 2013 paper with Asli and Ouarda on Islamic banking, but the most interesting result in this paper was for me the enormous cross-country difference in efficiency and stability indicators of Islamic vs. conventional banks across countries. To put it simply, the difference between Islamic banks in Sudan and Malaysia seems larger than the differences between conventional and Islamic banks in Malaysia. This is also consistent with other work. In recent research (with Zamir Iqbal and Rasim Mutlu) we gauged whether a higher share of Islamic banking is associated with higher consumption smoothing. Our finding – no significant results. However, there are some weak results that a higher share of risk-sharing products within Islamic banking is associated with higher consumption smoothing. This certainly calls for a much more differentiated view on Islamic banking, going from the bank- down to the product level.
Where does the future of research in Islamic finance lie? There has been a general trend to move away from cross-country work across finance research and I think this is even more needed for Islamic finance, given the cross-country differences mentioned above. There is a need to go down to micro-level data, for example from credit registries (such as used by Nicola, but also by Lieven Baele, Moazzam Farooq and Steven Ongena in this paper). Similarly, data from individual banks (possible one with both conventional and Islamic financial products) might be useful. Survey data from firms and households could be explored. Finally, randomized control trials focusing on the role of religion might be useful, as for example in this paper by Martin Kanz and co-authors. Of course, there are still big questions to be answered – to which extent can Islamic finance contribute to financial inclusion and development and to real sector outcomes, but the future seems to be really in micro data to explore these questions.
Islamic finance is often seen as marginal field, which makes publishing papers in this area rather difficult. However, one can see Islamic finance also in the broader context of non-profit maximizing banking across the globe. Profit-maximizing banking is not as widespread as finance academics often assume; in Germany, for example, more than 60 percent of the banking system are either state-owned or cooperatives. Similarly, there has been an increasing trend towards double or triple bottom-line banking around the world, taking into account both social and environmental sustainability as objectives. Behavioural constraints and effects are increasingly being recognized as important also in finance. If one sees Islamic banking in the same vein, research on Islamic finance also moves into the mainstream of finance research rather than staying on the margins.
29. November 2017
German politics – time to take risks
The coalition negotiations between Christian Democrats, Greens and Liberals have broken down. There is talk of reviving the “grand” Coalition (grand as in comprising the largest two parties, but with a very small g, as far from having a dominating majority, just 56%, compared to over 90% in the first edition in the 1960s). Having yet another grand coalition (after both parties lost 14% between the two), does not just send the wrong signal to voters, it makes the right-wing AfD the biggest opposition party. A look south of the border to Austria shows the danger of such an arrangement.
Protracted coalition talks are common in other European countries (e.g., Netherlands and Belgium). In both countries, public administration continues as normal with little change noted for citizens and residents of these countries (except that painful budget cuts might be delayed). Germany does have a special role in the Eurozone and European Union, however, so that a full-functioning German government would indeed be important.
Unlike the Economist, I do not think that new elections are the right way forward. Rather a minority government of CDU/CSU is called for, with varying support by other parties (as also recommended by the FT). This would help overcome one big weakness of 12 years Angela Merkel – limiting decisions to a small circle and selling them as without alternative. It might slow down decision making, but might make for more discussion among parties, in the Bundestag and in the public. The other centrist parties will certainly be happy to play ball. While minority governments have a bad reputation in Germany (given the experience during the interwar Weimar Republic), it is a much safer option than in other countries, as the chancellor can only be replaced by an absolute majority (which would involve cooperation of the three other centrist parties with either left or right extremists to elect a different chancellor, rather unlikely). So, once Merkel is re-elected as chancellor with simple majority, the only way to terminate the minority government early would be if the CDU/CSU can pass little or none of its programme and/or cannot pass a budget. It might then force new elections. Certainly, an experiment worth undertaking.
29. Noember 2017
Ordoliberalism – understanding German economics
Whenever in conversations on the Eurozone crisis people refer to my nationality, I always state that I am German and an economist but not a German economist. This is not to downplay or ignore my many links with German economists, professional and even personal, but more a clear indication that I work in a different conceptual framework than my Germany-based colleagues. There have been many occasions where I have been reminded of that; most prominently at a CEPR workshop some five years ago, where one (non-German) European economist working in the US openly asked: what’s wrong with German economists?
Fresh of the press, Hans-Helmut Kotz (Frankfurt and formerly Bundesbank) and I have edited a Vox eBook, which tries to explain what is different (though not necessarily wrong) about German economics. Starting from the premise that markets know best, but that competition has to be protected by a strong state, a strong focus on rules, on ordo follows. Ordoliberalism’s origin were founded in strong opposition to the interventionist and cartelist economic policies of the Nazis but also the macroeconomic chaos of the Weimar Republic. This implies a strong focus on monetary stability and macroeconomic rules but also on supply- more than demand-side economics. There is little space for aggregate demand-side policies in ordoliberalism.
The strong focus on rule has led critics to accuse ordoliberals of focusing more on principled rules than caring about the ultimate outcome. And contracts (as much as they are to be followed) are necessarily incomplete, so that discretion is necessary. While this can easily turn into a slippery road towards moral hazard and kicking the can down the road, a degree of sustainable flexibility is required and rules that can actually be enforced.
The eBook combines short chapters by both academics and (former) policy makers on both sides of the debate. Across the chapters, one can sense a certain urge to bridge the gap, critical not only to address global imbalances and help defeat the rise of populism, authoritarianism and economic nationalism, but even more critical within a monetary union where one important adjustment tool –exchanges rates – has fallen away.
23. November 2017
Populism meets McCarthyism meets authoritarianism
Recent elections and referendums have been casted as a choice between establishment and populism. As more and more evidence suggests, these contests have been partly influenced by outside forces interested in undermining democracy through social networks and fake news. But there is another problem with these contests and that is what populists do with their wins. Strong democracies are characterized by amicable change in power; today’s winner can be tomorrow’s loser. Looking at the reaction of some of the successful populist politicians (which includes the Leave campaign) one wonders whether they play by the same rules. The governments of Hungary and Poland have shown clear authoritarian tendencies, trying to undermine the independence of institutions such as the Central Bank and the judiciary, but also waging a more general war against non-conformist civil society, including the academic world. Exhibit A: The Orban regime closing the Central European University, under the pretence that it was funded from abroad, as they dislike its main funder, George Soros.
And the most recent exhibit in the UK: MP Chris Heaton-Harris writing to universities asking for names of academics teaching on Brexit and asking for the course material. While one might think of this as innocent inquiry, the fact that the MP did not just ask for course material but in the first instance for the names of the academics makes this a rather chilling request! And this comes on top of a campaign by the Morduch press against anyone critical about the consequences of Brexit (e.g., Bank of England governor Mark Carney) branding them as Enemy of the Brexit (or if they dare to hold up the constitutional framework, as the Supreme Court did, Enemies of the People) and calls by Tories for more patriotic reporting by the BBC.
I have a strong belief in the strength of democratic institutionality of the UK (and definitely more than in the case of some Central European countries). However, these are scary trends. It also puts the idea in perspective to let the populists show their incompetence by having them win elections and forcing them to govern. We have to be careful what we wish for. The spectacle from the other side of the Atlantic where the president is trying everything possible to undermine 200 years of democratic institutionality should be a warning sign. Democracy has not only to be achieved, it has to be defended.
6. November 2017
