Nobel Prize – much ado about what?
This year’s Economics Nobel Prize drew as much attention because of the research area where it was awarded (auctions) as it was for the reaction to it. There were two strands of negative criticisms to it, which I would like to address. One, two old white men from one of the top US elite universities shared the prize, putting in focus yet again the lack of diversity in economics. While I share the concerns on diversity, it seems ludicrous to demand that there be gender and ethnic/national/school quota on Nobel Prizes. The diversity problem cannot be resolved by starting an affirmative policy programme at the Nobel Prize award level, but progress rather has to be made at the bottom of the pyramid of our profession, undergraduate and post-graduate students in economics, followed by biases in publication and tenure processes and ultimately biases in the appointment processes for senior positions (full professors, editors, presidents of professional associations etc.).
The second criticism is on the topic, auction theory (best illustrated by Branko Milanovic’s twitter thread). First, there is the point that the insights provided by Milgrom, Wilson and others are simply not relevant for today’s problems – here I would strongly disagree (much better documented here and here). Obviously, there will always be debates about what fields are most relevant for humanity’s future and welfare, but dismissing the progress that has been made in this field seems a bit simplistic if not simply wrong. Second, there is the point that the Nobel Prizes are mostly (though not always, as last year’s award shows) backward looking. Here I am of split mind. The tradition has been to wait for the award of a Nobel Prize until the dust has settled on new path-breaking insights. Not all new attention-catching findings stand the test of time (take the example of the relationship between inequality and growth or the effectiveness of development aid), so the delay in awarding Nobel Prizes might be a healthy one. Such a time gap might also avoid politicising the Nobel Prize – the Peace Nobel Prize has been the opposite: awarding it to President Obama (and I write here as a supporter of him and – in broad terms – his policies) in 2009 was certainly too early. Awarding it in 2016 to the Colombian president for the peace process in his country was premature, given the rejection of the peace agreement shortly afterwards in a referendum and the struggle this process still encounters. One might think that the COVID crisis calls for an award decision that reflects the current policy challenges – this, however, ignores that we won’t know until five or ten years down the road of what has worked and what has not. Similarly, insisting that the prize be awarded for research on currently “hot” topics – artificial intelligence, the future of work, climate change – ignores that this research is on-going and is being vetted as we speak.
In summary, there are trade-offs in such an award. As I detailed above, I would argue that most of the critiques are simply wrong. Maybe one solution is to simply reduce the focus on such award and go back to celebrate the rigour of on-going and existing research and focus on on-going research and policy debates and treat the Nobel Prize as the equivalent of a life-time Oscar award.
15. October 2020
One cap to bind them all
Every year, the Ieke van den Burg prize recognises outstanding research conducted by young scholars on a topic related to the macroprudential mission of the European Systemic Risk Board. The members of the Advisory Scientific Committee decide on the winner. This year’s award goes to Marcus Mølbak Ingholt from the Danish National bank for his paper “Multiple Credit Constraints and Time-Varying Macroeconomic Dynamics”. It is a great piece that combines theory and empirical work to advance our thinking on the use of different macroprudential tools across the business and credit cycles.
Among the many macroprudential tools that have been the focus of research, two borrower-targeted policies – the loan-to-value (LTV) and the debt-to-income (DTI) ratios – are often interchangeably used. But more likely than not, only one of them is actually binding. Marcus constructs a tractable New Keynesian dynamic stochastic general equilibrium (DSGE) model with long-term fixed-rate mortgage contracts and two occasionally-binding credit constraints: an LTV constraint and a DTI constraint.
Calibrating his model for the U.S. economy between 1984-2019, Marcus finds the LTV constraint is more likely to bind during and after recessions, when house prices are relatively low, while the DTI constraint mostly binds in expansions, when interest rates, which impact debt service, are relatively high. This results in the policy implication, that a countercyclical DTI limit would be effective in curbing increases in mortgage debt, as these increases typically occur in expansions, while a countercyclical LTV limit cannot prevent debt from rising. Countercyclical LTV limits can, however, mitigate the adverse consequences of house price slumps on credit availability by raising credit limits.
Marcus further uses a county-level panel dataset covering 1991-2017 across the US to test two key predictions for homeowners facing both LTV and DTI requirements. The predictions are that income (house price) growth predicts credit growth if homeowners’ housing-wealth-to-income ratio is sufficiently high (low), as they will be DTI (LTV) constrained. His results provide evidence for these hypotheses.
1. October 2020
Climate and ethical finance – a conference report
Last week saw the virtual ADBI-JBF-SMU joint conference on green and ethical finance. 13 papers over three days, ranging from banks and mass shooting, to private prisons and institutional investors, and the pricing of environmental risks, plus exciting keynotes by Ross Levine and Laura Starks. Herewith a short summary with some of the most exciting papers; unfortunately, I do not have the time/space to discuss all of them.
Varun Sharma and co-authors gauge the effect of environmental activist investing on corporate environmental behaviours, using as identification strategy an initiative in 2014 by the New York City Pension System to request the inclusion of proxy access bylaws in targeted firms’ corporate charters. Using plant-level data in a quasi-experimental setting, they find that firms targeted for their environmental impact reduce their toxic releases, greenhouse-gas emissions, and cancer-causing pollution through preventative efforts, compared to comparable firms that were not targeted. So, activist investing can have an effect, though one wonders about decreasing marginal returns.
Kathrin de Greiff, Torsten Ehlers and Frank Packer test if the risks of climate policy change are priced in the syndicated loan market and find that (i) the premia for environmental risk, as measured by firm-specific CO 2 emissions, are significantly priced, but only since the Paris accord agreement in 2015; (ii) there is a difference in risk premia due to CO2 emissions within as well as across different industries; (iii) only greenhouse gas emissions directly caused by the firm are priced, and not those indirectly caused by production inputs, transportation or use of final products; and (iv) “green” banks—either self-identified or those that lend less to carbon-intensive sectors—do not appear to price such risks differently from other banks. Another interesting contribution to the literature on pricing environmental risks by financial institutions and markets.
Focusing on the ethical part of the conference theme, Eyub Yegen finds empirical evidence that privatization of prisons in the US deteriorates the quality of prisoners’ lives, leading to higher prisoner suicides and unexpected deaths. However, privatized prisons with higher passive institutional ownership see significant improvements compared to other private prisons. But why would that be? Eyub shows that an increase in passive institutional ownership leads to a rise in the number of health, education, and suicide-prevention programs offered in prisons. Very innovative work, relying on detailed data collection through freedom of information requests!
Following the conference, the JBF will open the call for submissions for a special issue on green and ethical finance between 1 November and 31 December. Check back on the JBF website in November!
20. September 2020
Surrounded by zombies?
There is an intense debate among economists on zombie firms. In Germany, this has been framed as a renewed conflict between Keynesians and ordo-liberals (for non-Germans: card-carrying membership in schools of economic thoughts is still seen as important among some German economists, but even more so in the press). But for obvious reasons, this debate will come across the globe, as we look beyond the COVID-19 recession. Many firms entered the crisis overleveraged and have added further to their debt due to fiscal support schemes and low interest rates, primarily with the objective of surviving. And as revenues in some industries are still depressed and/or highly volatile, large parts of the revenues have to be used for interest and principal payment. It is clear, however, that there are important differences across industries and firms: some will emerge out of this crisis as (if not more) efficient and with as much (if not more) demand as before, while others will not – the walking zombies. How can we distinguish between the two and what is to be done with the latter?
On the one hand, if all firms are being supported for an extended period, independent of their survival chances, this does not only increase the overall costs for society, but also prevents the necessary resource allocation, i.e., Schumpeter’s creative destruction. Subsidising unviable jobs and locking capital in unviable companies delays reallocation of labour and capital to industries and firms that will drive the recovery process. On the other hand, there is the hysteresis argument: withdrawing support in the middle of a crisis can cause long-term damage in the form of long-term unemployment and, more generally, idle resources. Support across industries and firms is thus not only necessary for social reasons, but also for economic efficiency.
At the core of the tension is – beyond philosophical differences on the role of government – uncertainty. One, nobody knows when this crisis will be over. When can the market resource allocation process function again? When will the market again allow for the necessary signals? Two, no one really knows what the structural change will look like once the pandemic is over and how it will interact with many other factors that drive structural change, including climate change and a changing international trading environment.
Withdrawing support now seems the wrong moment; the world is still in the middle of the pandemic and (non-financial) markets are certainly not even close to functioning properly. Take the labour market as example– how easy is it to interview and hire new employees, how easy is it for people to move across borders within the Single Market? And who is willing to make long-term investments before the dust of the COVID-19 turmoil has settled?
However, it is also clear that now is the time for preparation to deal with a wave of necessary insolvencies of unviable firms in the near future. It seems unlikely that the regular insolvency regimes can deal with this. And even if they did, not all overleveraged firms are unviable; restructuring (as under chapter 11 in the US) might be more efficient than liquidation (as under chapter 7 in the US). As discussed by Martin Sandbu in a recent FT article, there are different ways to go about this insolvency wave. One would be to convert emergency loans – either direct ones or bank loans guaranteed by the government – into grants; however, this would be costly and might be mis-targeted. A more targeted measure would be government equity support for viable but overindebted firms; however, this will be difficult to manage given the large number of firms and the limited if not negative track record of governments to pick winners. A third option would be a bank-based restructuring process, as especially for smaller firms in Europe the largest part of their debt will be bank loans, so that banks have the right information and capacity to restructure debt; the doubt I have is whether banks have the right incentives to undertake this role in the societally most efficient way; provide too much debt relief and borrowers might jump ship to other banks afterwards, provide too little and you have the walking zombies, but tie clients to your bank. Regulatory rules (as well as taxation) might influence banks’ actions. Having a central role for banks in this process, however, might also divert their resources from the necessary funding of new companies and thus the economic recovery process. Asset management companies have therefore been proposed; while they have been successful in some cases (e.g., Sweden with mortgage loans), it is uncertain whether they can deal efficient with the heterogeneous bank portfolios of SME loans, especially as it might be unlikely that these assets – unlike real estate – will increase in value back to pre-crisis levels.
Which brings us to the next complication. Corporate overindebtedness and insolvencies will be reflected in non-performing assets on banks’ balance sheets. Allowing banks to delay the recognition of these losses can lead to zombie lending as we have seen it in Japan in the crisis of the 1990s (and will again prevent the necessary reallocation of resources). Forcing them to recognise these losses, however, can result in undercapitalised if not failing banks. Are regulators and resolution authorities ready for this shock? I will leave the question of bank resolution to another blog entry.
This points to an important coordination problem awaiting policy makers in 2021: withdrawing fiscal support measures will inevitably result in corporate distress, which in turn can result in banking distress. This interdependence of sectors and interaction of policies requires coordination between governments, legislators/court systems, and regulators. And given the limited fiscal space in some euro area countries, there is also a strong case for coordination on the EU or euro area level.
Finally, this discussion brings us to the broader question on loss allocation. Aggressive fiscal policy has helped stabilise aggregate consumption while income has plummeted, with the result of rapidly increasing debt levels (primarily government and corporate). Who will bear the losses of this crisis and how will they be allocated? One principle of banking crisis resolution is to “recognise losses, allocate them and move on”. For economies to come out quickly from this crisis (and thus avoid further losses), we need a similar approach. Forcing banks to work out large number of non-performing loans to unviable firms and/or providing perverse regulatory incentives to roll-over and keep lending to the zombies will prevent banks from supporting the recovery process. While now is not the time to panic about corporate, bank and government debt, now is the time to prepare for the day of reckoning.
16. September 2020
Doing Business – again in the (wrong) headlines
When a data collection team is in the news, it is typically not good news and that is certainly the case of the Doing Business team at the World Bank. The Doing Business report has been in unfavourable news coverage quite a lot in the past years and I have written extensively about it (here and here). Two years ago , Paul Romer had to resign as Chief Economist as he (wrongly) accused the team of changing Chile’s numbers for political reasons; ultimately, it turned out to be methodological changes unrelated to political changes in Chile. The latest alleged infringements, however, are much more serious – data were “adjusted” in return for paid advisory work in the respective country. If true, this is corruption. The publication of the latest report has been delayed while an investigation is taking place. Beyond this specific incident, however, there are broader governance and policy challenges.
First, the governance challenge: If one looks at the shake-up in the auditing profession a few years ago, one can see clear parallels – auditing a firm’s financial statements while at the same time providing consultancy services to this firm results in a conflict of interest. However, it took a scandal for reforms to be undertaken. Similarly, if the same institution ranks countries and provides paid advisory services (that can help improve this ranking), this clearly creates a conflict of interest. One way out of this is to create Chinese walls within the institution between different groups; I am not privy to the institutional details of the Doing Business unit in the World Bank, but given that with few exceptions (such as the Independent Evaluation Group) all units are part of the same hierarchical structure (and under the same Executive Board where shareholders, i.e., countries, have representatives) it seems unlikely that such a structure would really work. So, unless data collection and ranking are either strictly separated with Chinese walls from the rest of the Bank or are outsourced, this governance problem is hard to solve.
Second, the policy challenge: This latest scandal brings to light broader concerns on the Doing Business database. One is the philosophical tendency towards ‘less regulation is always better” (which the Doing Business founder Simeon Djankov defended – loosely speaking – by classifying critics as Marxists). Two is the fact that rankings are taken at face value, although each country’s ranking depends on reforms (or reversal thereof) in other countries. Three, there is the Goodhart critique: when a variable becomes a policy target, it is no longer a good gauge of what it is trying to measure. When reforms are undertaken just to improve rankings (as shown in this interesting piece on India, but certainly the case in other countries), they might not be the most important ones. I have therefore argued previously, that the ranking should be taken out and the focus should be on the underlying data. However, even now the first graph one sees when checking on a specific country on the doingbusiness.org website are rankings. One step further than Goodhart’s law is Campbell’s law (per Justin Sandefur): “The more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor."
Beyond Doing Business, this controversy has implications for other databases. In the mid- to late 2000s, when I was part of a group of World Bank researchers starting data collection on financial inclusion, we discussed whether we should aim for a country ranking. Back then, I argued strongly against it, for several reasons (some of the following is discussed in more detail in this paper). One, policy makers should care about efficient and sustainable financial inclusion, not just a number. Two, the Goodhart critique also applies to the Global Findex headline indicator of the share of adults with a financial account. It is relatively “easy” to open an account for everyone in an economy through a state-owned bank; this does not imply that these are accounts are being used and that account holders are thus financially included in a meaningful way. While the Global Findex has wisely decided not to rank countries, its headline indicator is often seen as critical policy target in many developing countries. The underlying report, however, provides a balanced discussion, drawing on many different indicators collected. Further, the Global Findex has developed over its three rounds, with the focus expanding from bank accounts to mobile money accounts and from account ownership to use. In summary, data are critically important – if you want to reform something, you have to measure it first. It is also clear that data collection does not and cannot take place in a completely agnostic and a-priori neutral way. We collect data on the business environment because we think it is important; we collect data on financial inclusion because we think it is important. The World Bank is in a unique position to host such data collection efforts and I would argue that one of its main contribution to development (as part of its broader development research effort) has been exactly this. However, the World Bank has also an important responsibility in the use of these data; the use by others of World Bank data is obviously outside its control, but the way data are being presented and being used in World Bank reports sends an important signal to policy makers across the globe and other stakeholders.
10. September 2020
Brexit – new excitement!
So, here we are, hurtling towards a new season finale in the Brexit soap opera. Latest twist: the oven-ready Brexit deal, approved just a few months ago by (freshly elected) Parliament “never made sense”, according to the Tory House Newspaper The Telegraph. And if you read the article, it gets even better: the WA “would leave Northern Ireland isolated from the rest of the UK, something that was ‘unforeseen’ when [Boris Johnson] agreed to it last year”. Never mind that many commentators, including Chris Grey, pointed to the consequences of the Northern Ireland frontstop, agreed to by Johnson (I wrote about it here). To claim that this was unforeseen is either perfidious or stupid!
The reason that this comes up now is directly related to the dire state of the trade negotiations between the UK and the EU. While controls in the Irish Sea will be necessary with or without a trade deal, a no-trade-deal scenario (or trade deal with tariffs) will complicate things further, as goods coming from Great Britain into Northern Ireland will attract tariffs if at risk of being exported to the Republic of Ireland (to be reimbursed if they do not cross the non-border into the Republic). As the Telegraph quotes a senior government source, “the administrative costs would be considerable.” This statement is a bit odd, though, because the UK government just proudly announced that it is working to increase red tape (“growing the customs sector”). It should have become obvious by now that the whole Brexit soap opera is an exercise in creating red tape, not removing it, so this complaint about administrative costs is a bit odd, indeed.
Ultimately, we are back in the Brexit Trilemma: The UK decided to exit Single Market and Customs Union – this would require a customs border between Northern Ireland and the Republic of Ireland – as this is seen contrary to the Good Friday Agreement, there will have to be a customs border in the Irish Sea. Over the past four years, lots of myths have been created on how the UK can get around this (alternative arrangements, GATT article 24, Article 62 of the Vienna Convention on the Law of Treaties), but it seems Brexiters are back at their favourite past-time: staging a tantrum in the sandbox and throwing out the toys: threatening that if Withdrawal Agreement (on which Johnson won the last election) is not being changed, they will simply undermine it with domestic legislation. As pointed out by lawyers, this would simply end in a tit-for-tat with the EU, resulting in penalties and sanctions and worsening the relationship.
Which brings me to my final point: anyone who thinks that this soap opera is over one way or the other by the end of the year, should think again. The relationship between the EU and UK will be dominating UK politics for a generation to come. If there is no trade deal this fall, eventually there will have to be fresh negotiations, but with the UK in an increasingly weak position. If there is a bare-bones deal, then there will be pressure on both sides to extend such an agreement to other areas. This is a scenario that the Swiss are well familiar with. In the case of the UK, however, this will come with the British hubris and sense of exceptionalism and with the rabid belief of Brexiters that the EU (whoever that is) is out to get them and take away their wet dreams of sovereignty.
8. September 2020
Emergency loans and consumption: evidence from Iran
I have just finished my third COVID-19 paper, this time on the effect of emergency loans on consumption in Iran. In this paper, joint with Mohammad Hoseini, we assess the impact of emergency loans the Iranian government offered in April to all but the richest 5% of households on consumption across different types of consumption. Specifically, we use daily data in April/May (the Iranian month of Ordibehesht) of POS (in-store) and on-line transactions across provinces and across different types of consumption and services and different retail segments. Our treatment period is the first week after the first (and largest) loan wave, with the first three weeks as robustness test. Our control period are other days in the same month and the same month in 2019. We find that emergency loans are positively related with higher consumption of non-durable and semi-durable goods, while there is no significant effect on the consumption of durables or asset purchases, suggesting that the emergency loans were predominantly used for their intended purpose. Our coefficient estimates suggest that two thirds of the emergency loans went into non-durable rather than semi-durable consumption, with the largest increase in absolute value in consumption of food and beverages. The effects were strongest in the first few days and then dissipated over time. We find effects only for in-store but not online transactions and in poorer rather than richer provinces, suggesting that it is the poorer who reacted more strongly with higher consumption to the emergency loans.
So, all in all, the emergency loans seem to have met its objective. The fact that consumers react to temporary income changes (and even though they have to be repaid) clearly shows the existence of liquidity and credit constraints. Our findings, however, raise further questions, such as: as these support payments are in the form of loans, to be repaid starting in July-August 2020 there are concerns of repayment burdens on the lower income segments, which calls for assessing the effect of repayments (out of income subsidies) on consumption patterns. We will assess this in future work, data permitting.
A longer discussion of the paper is in this Vox column and the paper will come out shortly in the next issue of Covid Economics.
28. August 2020
A Hamiltonian glimpse in Europe
The European Council has come to a compromise on the European recovery support, after four days of negotiations. The main pillars as proposed by Macron and Merkel some time ago still stand – joint financing and an important grant element. But the grant amounts have gone down and several forward looking programmes, including support for climate change, have been reduced. So, is this a glass half empty or a glass half full? Taking the viewpoint that a year ago none of this would have been even imaginable is a valid point if one takes the long-term view towards a slow move towards European fiscal policy integration. As my good friend Sony Kapoor points out, however, this does not take into account that the COVID-19 crisis constitutes an enormous risk to the whole European project, starting with the euro, if there is asymmetric recovery and divergence across the EU (and again, especially the euro area). Many economists, including yours truly, have therefore called early on for a joint recovery effort on the European level, on economic, political and social grounds. And as ten years ago with the banking union, when these calls were first dismissed as unrealistic, it ultimately did happen. Angela Merkel and Emmanuel Macron have stepped up to the challenge.
But the same economists (and other observers) would have preferred a bigger and more courageous deal; the GDP drop is too large for a minor effort. And though 1.75% GDP stimulus per year over the next three years sound large, it pales in comparison to a GDP drop of up to 10% this year and a potentially sluggish recovery. So, economically it might indeed not be sufficient and thus might not achieve the objective by itself.
In addition, there was the rather unpleasant picture of 27 heads of governments haggling over little details (a million here, some rebates there) and fighting tooth and nail for their national interests. This did not really inspire any positive feelings for the European project, when they are needed most. However, this is not necessarily that surprising; positive cross-border externalities of a big joint COVID-response are not taken into account by governments responsible to national electorates. And the fact that this was ultimately a political compromise among 27 governments (and to be ratified by 27 national and the European parliaments) clearly puts to the rest the accusation (often heard on this side of the English Channel) that the EU is already some kind of super-state that imposes its will on individual countries. Rather, this compromise ensures that there is ownership for this common recovery effort across the 27 countries of the EU!
What about the political repercussions? Yes, a failure would have strengthened populists in the South further and enabled them to openly campaign against the “useless EU” (which they might do anyway). However, one should not forget the populists in the North (EU-sceptics in the Netherlands, Finland and other countries). Having this deal be owned by 27 democratically elected governments can certainly help; seeing their head of government fight for their supposed national interest counters populist accusations of a sell-out. One may call this dirty politics, but politics has never known to be the cleanest of all professions!
Then there is the kicking the can down the road (often an outcome of EU/euro summits) – how will the joint effort be funded (to be more precise: how will the borrowing be repaid)? There is talk of Own Resources, new taxes, but no firm agreement. More haggling and more compromises ahead, but also more possibilities for a common fiscal policy. It is clear that this was a first step and nothing else; a very small step indeed, but looking back in the future it might have been a very big step, indeed!
So, at the end, I am coming down on the glass half full side – no, this is not the big f*** deal (to quote VP Biden), it is not enough to overcome the COVID-19 challenges in the EU and even less so in the euro area. There will have to more. BUT: it is an important first step! It clearly shows that fiscal policy makers are willing to step up and not leave the ECB alone. It might not have been the Hamiltonian moment, but at least it is a Hamiltonian glimpse behind the curtain, at new fiscal policy possibilities.
21. July 2020
Covid-19 in emerging markets: firm-survey evidence
With Burton Flynn and Mikael Homanen, my current and former PhD students, respectively, I just published another COVID-19 paper, this time on the impact of the COVID-19 crisis on firms in emerging markets and their reaction.
Using survey responses across 488 listed firms in 10 emerging markets from early April, we find that the vast majority of firms were negatively affected by COVID-19. Firms have reacted primarily reducing investment spending and much less through layoffs. Meanwhile, some firms cut back on executive compensation, and more firms expanded employee benefits than cut them. The large majority of firms have acted before their governments imposed measures and there is a surprising degree of support vis-à-vis employees, customers, other stakeholders and broader society, in line with hypotheses stressing the importance of informal long-term relationships in emerging markets. Although stock prices initially reacted to the impact of the crisis, delayed stock price reactions suggest evidence of inefficient markets. Furthermore, we find evidence that stakeholder-centric firms (which showed flexibility vis-à-vis business partners and made donations related to the pandemic) experienced lower stock price declines during the crisis drawdown, suggesting that the financial markets valued these stakeholder-centric corporations more than their counterparts during the crisis.
This paper was made possible by ground work of Burton who is in his real job is a portfolio managers of a Finnish-based emerging markets fund, spending a month each between June 2019 and March 2020 in ten emerging markets and requested one-on-one private meetings with the CEOs of almost 1,500 listed firms. Expect more great research with data from these meetings!
And if you are interested in Burton’s travel collecting all these great data, check out his journal: https://www.terranovaca.com/journal
17. July 2020
Brexit – (almost) any news is bad news!
Over four years after the Brexit vote and as the reality of a “sovereign” UK slowly emerges, even the British government has woken up and started its preparation for the end of the year when the UK will exit the transition period and thus the Single Market and Customs Union. Not that the country will be ready by the end of the year, as recent announcements have shown! It seems for at least 6 months if not longer, sovereignty will not really be enforced after all.
The need for customs arrangements will arise independent of whether or not an agreement with the EU will be struck or how such an agreement will look like, but the aim is still some kind of free trade agreement, with fishing rights and a level playing field (mostly related to state aid in the post-Brexit UK) being the critical issues (both also spelled out in the political declaration, signed by both UK and EU, though it seems only the EU actually read the text, see below). While the opposition against the ECJ and other European institutions having too much control over the UK is understandable (given the lack of British representation), there is little trust left in Brussels in assurances by the UK government to not undermine the level playing field, given experiences over the past year. One recent example is the letter by Mark Francois (head of European Research Group) to Michel Barnier pointing to the desire for complete sovereignty completely, which ignores the special position of Northern Ireland (with EU institutions continuing to have an important role) in the legally binding Withdrawal Agreement and the aspirations for a level playing field (implying a role for the ECJ in interpreting EU law) signed by both UK and EU in the Political Declarations. It seems the ERG did not quite do their research before voting for WA and PD.
At the same time, there is a new movement emerging, to revise if not default on the Withdrawal Agreement with the EU (and embarrassingly enough, a colleague from City’s Law School seems to be part of this group). What used to be alternative arrangements and new (non-existing) technologies to avoid a physical customs border in Ireland, followed by GATT Article 24 (tariff-free trade with the EU in expectation of future deal), has now been replaced by Article 62 of the Vienna Convention on the Law of Treaties, which supposedly gives the UK the right to simply withdraw from the Withdrawal Agreement to thus avoid the Northern Ireland front stop (which was agreed with the objective to avoid the need for a border on the Irish island)! While one can only see these as creative (if not ridiculous) attempts to escape the Brexit Trilemma, the latest round takes on a darker notion, as it is basically an appeal to violate international treaties. And while this latest legal Brexiter nonsense has been already debunked, it obviously does not exactly send the signal of the UK being a reliable international partner.
Notwithstanding all this sabre rattling and with the caveat that economists are typically not good at predicting things (at least not before they happen), my bet would still be for some agreement, where (as in late 2019) the Johnson government will yield to some if not most of the EU’s demands while at the same time selling such agreement as major victory against evil Brussels.
The other major news is that the government has now decided to come finally clean with the British population and introduce them to changes after 31 December that many of them won’t like. Packaging new customs control (at a cost to the tune of 250 million Pounds per week for UK’s private sector – what about putting this on a bus?), loss of European Health Insurance Card, and mobile roaming charges as “seizing new opportunities” (as done by Michael Gove), however, seems quite a stretch and reminds me a bit of how the East Germany referred to its armed border with West Germany as anti-fascist protection wall!
On the upside, I have been enjoying over the past weeks a new literary genre – the twitter short story: @archer_rs has been the telling the story of a British family clashing with the reality of Brexit (which they voted for). I am not sure whether or not to believe the story (though parts of it ring true), but I think he paints a realistic picture of the situation which many British will find themselves in, at some point during the next few years, when they realise how many rights they have lost.
15. July 2020
Cass Business School – what’s in a name?
Few used to know the person after whom Cass Business School, Sir John Cass, is named, including yours truly. People often think that CASS is an abbreviation; I was once asked at a conference in Asia, whether I worked for the Chinese Academy of Social Sciences. The reason why Cass Business School bears the name of Sir John Cass is that in 2002 the Sir John Cass Foundation made a major donation to the school.
When news emerged that Sir John Cass was a major actor in the British slavery trade, there were calls to change the name. The foundation itself decided to change its name. So, I was certainly happy to see that on July the university announced to immediately remove the name Cass. Problem: not only was there no decision on a new name, but it was not clear what the name would be during the transition period. It very much was and appeared a panic decision, which did not take into account the operational implications or the impact on stakeholders.
The loudest opposition has been voiced by alumni and students who “invested in a Cass education and degree” and now claim a loss of this investment. Petitions have been started, lots of protest email written, and it has become clear that rather than take the opportunity for positive rather than reactive change, the process has been bungled.
This shows the problems of a purely fee- and market-based university education system, especially for schools that rely so heavily on overseas students. While I have been a supporter of tuition fees, the commoditisation of tertiary education certainly carries its risks, as when investment in a brand name is seen more important than education and public policy concerns. Let me make clear that I am not dismissing the concerns of students and alumni who feel under distress because of their investment, to the contrary! There is clearly a trade-off, which should have been addressed up-front and cannot be ignored! And there is a broader debate to be had about the private and social values of education and its funding and pricing!
It also shows the problem of a business school linked to a university that is significantly ranked below the business school. City University London (now known as City, University of London) does not match the reputation or ranking of Cass Business School, a problem not faced by students of the former Woodrow Wilson School of Public and International Affairs at Princeton, which also just changed its name.
To end on a broader note, universities (including business schools) have a critical role in the public discourse. Their advantage should be that of independence and competence; the Black Lives Matter movement reminds us, however, that we are not just part of the discourse, but of the problem itself. And as this specific event has shown, there are no easy solutions!
13. July 2020
Liquidity creation, growth and investment
I have written a fair share of papers on the real sector implications of financial sector development in the early part of my career, so this new paper provides a bit of a flashback; but then again, as I (and many others) have dug deeper and deeper into the finance-growth relationship, more and more non-linearities have emerged.
In this new paper with Robin Doettling, Thomas Lambert and Mathijs Van Dijk, we focus on one specific function of banks – converting liquid liabilities into illiquid assets, thus providing liquidity insurance to depositors and enabling long-term investment. Using a large cross-country sample of up to 100 countries we show that liquidity creation is positively associated with economic growth, with an effect that is stronger for industries more dependent on debt finance (thus following the seminal Rajan-Zingales technique). However, liquidity creation helps growth by boosting tangible, but not intangible investment, a finding which we confirm both on the country- and industry-level. Finally, we find that countries with a higher share of industries relying on intangible rather than tangible investment benefit less or not at all from higher liquidity creation by banks.
Our findings thus speak to the role of banks in the new ‘knowledge economy’ and suggest that they will have a more limited role, compared to other types of financial intermediaries and markets. These findings are also consistent with both theory and previous empirical evidence that banks are less well positioned to help innovative industries and firms.
We rationalise our empirical findings with a theoretical model, adding liquidity risk and moral hazard to the seminal Diamond and Dybvig (1983) model. Information asymmetries allow investors to divert assets and default on bank loans, a problem that is particularly strong if asset tangibility is low, for two reasons. First, intangible investments can be more easily diverted as they are harder to assess by outsiders. Second, failing intangible investments leave the bank with relatively low collateral value, reducing the value of claims on the bank. This makes it attractive for investors with successful projects to divert even if the bank can seize their deposit claims. The effect of liquidity creation by banks on investment is thus hampered by asset intangibility, as it is harder for banks to make loans against intangible assets, in line with our empirical findings.
For a somewhat longer summary, here is the Vox-column.
2. July 2020
Politics and finance – a conference report
The past two days saw our first London Political Finance workshop, co-organised by Orkun Saka, Paolo Volpin and I – on-line rather than in person. We had nine excellent papers plus a keynote speech by Sir Tim Besley on the political economy implication of the COVID-19 crisis responses. I will not discuss all the papers in this blog entry but focus on a few that were especially interesting for me.
The first session featured two interesting papers on the rise of right-wing populist parties in the wake of bank failures. First, Hans Joachim Voth and co-authors use micro-level data to relate a banking crisis in 1931 and the electoral rise of the Nazi Party in Germany. Two large banks were at the core of the crisis, Danatbank and Dresdner Bank. Cities with a higher share of firms connected to either bank saw larger income declines, and unemployment rose more. However, only towns and cities affected by the failure of Danatbank (which had a Jewish CEO) show evidence of voting for the Nazis above and beyond economic factors. This can be directly linked to Nazi propaganda blaming the economic and financial crisis on the Jewish population. The second paper in the same session by Emil Verner links borrower fragility post-2008 in Hungary to the rise of the right-wing Jobbik. Before 2008, a mortgage credit boom in Hungary was driven by Swiss-Franc loans (lower interest rates), with both lenders and borrowers counting on the Hungarian Forint to appreciate vis-à-vis the Swiss Franc over time (in line with the Samuelson-Balassa effect). When in the wake of the Global Financial Crisis the Forint depreciated, Swiss Franc borrowers suffered. Using exogenous variation in the attractiveness of Swiss Franc loans, the authors then show how the post-2008 fragility is correlated with the geographic variation in the rise of the right-wing Jobbik party.
Travers Barclay Child and c-authors use the surprise of Donald Trump’s election in 2016 to identify the value of sudden connectedness to the US President among S&P 500 firms with pre-existing ties to the businessman Trump. They show that Trump-connected firms (though only business- and not socially related) had significantly higher abnormal stock returns around the 2016 election than their nonconnected counterparts, which translates to $1.2 and $2.4 billion in wealth creation for shareholders. Since Trump’s inauguration, connected firms showed better performance, were more likely to receive government procurement contracts, and were less subject to unfavourable regulatory actions.
Two interesting papers focused on the role of the media. April Knill and co-authors show that partisanship in television coverage influences corporate decisions. Specifically, Fox News has a clear bias in favour of Republican presidents. Exploiting the fact that the Fox News channel was not available across all of the US, they show that during George W. Bush’ presidency, firms led by Republican-leaning managers headquartered in regions into which Fox was introduced shift upward their total investment expenditures, R&D expenditures, and leverage, compared to firms led by Republican-leaning managers headquartered elsewhere. Ruben Durante and co-authors consider media capture by banks. Specifically, considering a sample of top European newspapers and linking them to their creditor banks, they shows that newspapers’ coverage of bank earnings announcements of their lender banks, relative to other banks, are significantly more likely to be the case in case of profits than in case of losses. This pro-lender bias is stronger for newspapers that are highly leveraged. This bias also carries over to the Eurozone crisis, when newspapers connected to banks more heavily exposed to stressed sovereign bonds are less likely to portrait banks as being responsible for the crisis and to support debt-restructuring measures detrimental to creditors.
29. June 2020