Macro-International-Growth Lunch: Wed Dec 6 2006: U.C. Berkeley Department of Economics: Banerjee, Duflo, and Munshi (2003) "The (Mis)allocation of Capital"

Macro-International-Growth Lunch: Wed Dec 6 2006: U.C. Berkeley Department of Economics

Notes on Abhijit V. Banerjee, Esther Duflo, and Kaivan Munshi (2003) "The (Mis)allocation of Capital," Journal of the European Economic Association 1(2–3), 484–494 http://www.mitpressjournals.org/doi/pdf/10.1162/154247603322391125?cookieSet=1

How economists use the neoclassical benchmark:

• At Chicago: Assume that the economy is at the neoclassical benchmark, and demonstrate that whatever exists is, in some subtle sense, constrained Pareto-optimal efficient--except where ham-handed government intervention has caused messes.
• At Berkeley: Investigate the deviation from the neoclassical benchmark that can be caused by one single but significant market failure, demonstrate that this deviation matches up to some important feature of the real world, and demontrate that a clever, subtle, and strategic government intervention can move us to a situation that is constrained Pareto-optimal.

Banerjee, Duflo, and Munshi set out to hunt down this neoclassical benchmark, and show that the real world is so far from it that the benchmark's utility as a base of operations--in either the Chicago or the Berkeley sense--is... severely limited.

Their claim: capital markets in India simply don't work. Firms employing less than 50 people where the marginal product of capital is on the order of 100% per year can't get additional financing to exploit these opportunities.

---

And now to the paper: Abhijit V. Banerjee, Esther Duflo, and Kaivan Munshi (2003) "The (Mis)allocation of Capital.: Journal of the European Economic Association 1(2–3), 484–494 http://www.mitpressjournals.org/doi/pdf/10.1162/154247603322391125?cookieSet=1

Simple implications of the theory of credit markets:

• A firm is credit constrained if the marginal product of capital in the firm is higher than the rate of interest that firm is paying on its marginal rupee of borrowing.
• If a firm that is not credit constrained is offered some extra credit at a rate below what it is paying on the market, then the best way to make use of the new loan must be to pay down the firm’s current market borrowing, rather than to invest more.
• By contrast, a firm that is credit constrained will always expand its investment to some extent.
• For unconstrained firms, growth in revenue should be slower than the growth in subsidized credit.
• If we do not see a gap in these growth rates, the firm must be credit constrained.

Priority sector rules in India:

• All banks in India are required to lend at least 40 percent of their net credit to the “priority sector,” which includes small scale industry (SSI), at an interest rate that is required to be no more than 4 percent above their prime lending rate.
• In January, 1998, the limit on total investment in plants and machinery for a firm to be eligible for inclusion in the small scale industry category was raised from Rs. 6.5 million to Rs. 30 million. [Rs. 1 = $0.02; GDP/capita = Rs. 40,000 per year]

Data obtained from one of the better-performing Indian public sector banks:

• From the loan folders maintained by the bank.
• Data on profit, sales, credit lines and utilization, and interest rates.
• 253 firms (including 93 newly eligible firms
• Including 175 firms for which we have data from 1997 to 1999.
• We can allow small firms and big firms to have different rates of growth
• The rate of growth to differ from year to year
• We assume that there would have been no differential changes in the rate of growth of small and large firms in 1998, absent the change in the priority sector regulation.

The change had an impact:

• Credit limits granted to firms below Rs. 6.5 million in plant in machinery (henceforth, small firms) grew by 11.1 percent during 1997
• Credit limits granted to firms between Rs. 6.5 million and Rs. 30 million (henceforth, big firms) grew by 5.4 percent.
• In 1998, after the change in rules, small firms had 7.6 percent growth while the big firms had 11.3 percent growth.
• By 1999 new equilibrium.

Table 1: http://delong.typepad.com/images/20061206_misallocation_image003.png

Results

• Bank credit as the outcome for the firms where there was a change in credit limit: The coefficient of the interaction BIG-POST is 0.24, with a standard error of 0.09.
• Whether or not a file is brought out for a change in limit has nothing to do with the needs of the firm, but the internal dynamics of the bank.
• This additional credit in turn led to an increase in sales. The coefficient of the interaction BIG-POST in the sales equation, in the sample where the limit was increased, is 0.21, with a standard error of 0.09 [column (5)].
• By contrast, in the sample where there was no increase in limit, the interaction BIG-POST is close to zero (0.05) and insignificant [column (8)].
• The effect on profit is even bigger than that on sales: 0.75, with a standard error of 0.38.
• The IV estimate of the impact of bank credit on profit is 2.7. This is substantially greater than 1, which suggests that the technology has a strong fixed cost component. We can use this estimate to get a sense of the average increase in profit (net of interest) caused by every rupee in loan. An increase of Rs. 1,000 in the loan corresponds to a 1.04 percent increase. Using the coefficient of loans on profits, an increase of Rs. 1,000 in lending therefore causes a 2.7 percent increase in profit. At the mean profit (which is Rs. 37,000), this would correspond to an increase in profit (net of interest) of Rs. 999. Consistent with firms being credit constrained, this suggests a gap between the marginal product of capital and the interest rate of about 100 percent.
• This data does not tell us anything about the efficiency of allocation of capital across firms—it remains possible that capital does have the same marginal product in all its uses.

Tirupur is a smallish town in Southern India which dominates the Indian knitted garment industry:

• Through a good part of the 1990s the industry in Tirupur was growing at 50 percent or more.
• The industry was traditionally dominated by a single local caste group, the Gounders.
• Our basic strategy is to compare the investment behavior of Outsiders with that of the Gounders.
• Gounders are a small, wealthy, agriculturist community from the area around Tirupur who have moved into the local knitted garment industry over the last three decades because there is not much scope for more investment in agriculture. They have virtually no industrial presence outside Tirupur. Going into local knitted garment business, or helping a family member or friend get set up in the business, is therefore one of the best ways to use their considerable wealth.
• Outsiders have few strong ties in Tirupur, being from hundreds and even thousands of miles away. Moreover, they are from communities that have many alternative opportunities for investing their money. We would expect the Outsiders not to have the kind of capital access enjoyed by the Gounders.

Data: A survey of 147 exporters in 1995:

• Gounders own about twice as much capital and maintain capital-production and capital-export ratios 1.5 to 2.5 times as high as the Outsiders
• Columns (2) and (3) tell us that Gounders start with a higher capital-output ratio, and maintain that advantage at every level of experience.
• Do Gounders simply simply make better use of capital? The data on exports and production clearly rejects the possibility that the Gounders are more productive in general.
• Outsiders start out producing and exporting less but grow faster and overtake the Gounders by the time they have been in business about five years. Average output for Outsiders who have six years or more of experience is significantly higher than that of the Gounders.

Table 2: http://delong.typepad.com/images/20061206_misallocation_image006.png

Conclusion

• Capital markets in India are very far from the neoclassical ideal.
• The gap between the marginal product of capital and the market interest rate seems to be at least 70 percentage points.
• The gap between the marginal product of capital and the rate paid to savers is even larger.
• Investors who on average are less productive may invest as much as three times more than their more productive counterparts.
• All this is not necessarily surprising given that the legal system is slow, inefficient and sometimes corrupt, and defaulters usually get off lightly.
• But it does raise questions about the usefulness of the neoclassicalbenchmark.

Comments

[shah8]

Capital markets are inherently redistributive. A free and fair capital market is revolutionary, in a way that overturns older economic orders. Only capital markets with any kind of real social entrenchment is at all fair, and the NYSE and their like aren't really all that fair. The japanese system of capital markets is a pretty good example of how one *doesn't* work, and is made to NOT work on purpose because a functional market would upset relationships...

It's not a surprise the Indian market doesn't work. You have to have public defenders of the public trust to get capital markets to truly work.

[Dave Parker]

"Capital markets are inherently redistributive. A free and fair capital market is revolutionary, in a way that overturns older economic orders. Only capital markets with any kind of real social entrenchment is at all fair, and the NYSE and their like aren't really all that fair. The japanese system of capital markets is a pretty good example of how one *doesn't* work, and is made to NOT work on purpose because a functional market would upset relationships...

"It's not a surprise the Indian market doesn't work."

So that's three (out of er, three) that don't "work". Is there one that does?

[Bruce Wilder]

Kind of makes me that a new economist joke might be in the offing:

Two economists are walking down the street and spot a twenty dollar bill lying in the roadway. One says to the other, "That couldn't be a real twenty. Some would already have picked it up." The other replies, "But its appearance does raise questions about the usefulness of the neoclassicalbenchmark."

A sociologist walking in the opposite direction, scoops up the twenty, without breaking stride, while wondering what economists talk about.

[Tom Womack]

This is something you notice all over India; people working stone with Iron Age tools, or making poor-quality textiles by hand as if Arkwright had never lived. The country feels absolutely starved of capital; you feel that throwing ten thousand dollars at any given small piece of it would make it bloom as when one pours iron sulphate into the mineral-impoverished Southern Ocean.

But you fear that putting ten thousand dollars into a small piece of it would have the same sort of effect as giving a random beggar ten thousand dollars; enrich the local thug and kill the beggar, or if you're lucky merely allow the beggar's ten most aggressive near relatives to drink themselves to death.

What's the technical economic term for 'pressure to dissipate wealth by distribution among your relatives'?

[anne]

Shah:

"Capital markets are inherently redistributive. A free and fair capital market is revolutionary, in a way that overturns older economic orders. Only capital markets with any kind of real social entrenchment is at all fair, and the NYSE and their like aren't really all that fair. The Japanese system of capital markets is a pretty good example of how one *doesn't* work, and is made to NOT work on purpose because a functional market would upset relationships...

"It's not a surprise the Indian market doesn't work. You have to have public defenders of the public trust to get capital markets to truly work."

Excellent.

[andres]

"Their claim: capital markets in India simply don't work. Firms employing less than 50 people where the marginal product of capital is on the order of 100% per year can't get additional financing to exploit these opportunities."

Which of course brings to mind the old point that the return to capital will (most of the time) be less than the marginal product of capital because of any number of social aspects that most economists don't want to get into because of troubling political implications. Shah8's point is fully relevant--established, market dominant firms don't want to see small competing firms being able to expand, among other difficulties.

For developing countries, the political instability, corruption, and iffy law enforcement at both the national and local level (legacies of colonialism, ethnic rivalries, and even feudal privilege in the case of Japan) indicate that there is a _huge_ risk premium to investing in already large, well-established firms as opposed to new startups, especially if the latter are in more remote locations.

Capital allocation in developing countries, I think, needs to give up hope of meeting any standard objective benchmark such as pareto-optimality and simply aim at redistribution from established/developed metropolises towards rural areas or poorer cities. This means that either the state, or some external agent if the state cannot be trusted, will have to do some capital allocation on a non-profit basis. Microfinance is only the first step.

[anne]

Andres:

"Capital allocation in developing countries, I think, needs to give up hope of meeting any standard objective benchmark such as pareto-optimality and simply aim at redistribution from established/developed metropolises towards rural areas or poorer cities. This means that either the state, or some external agent if the state cannot be trusted, will have to do some capital allocation on a non-profit basis. Microfinance is only the first step."

There is much of the reason for what I take as China's success.

[anne]

Brad DeLong, only a few years ago, first worried about why poorer countries had shown so little relative development over a century, then Brad came to understand that China changing the prospects of development success. Even as recognition grew of how profound China's development was and could be, there were continual complaints about poor capital allocation by Chinese banks. But, there was a reason for forcing the supposed poor capital allocation and emphasizing infrastructure development in poorer areas of China.

[anne]

What is especially impressive about China's development is the general nature, the broadness. I would have it be broader still. Mexico, richer than China, by contrast, shows little concern with capital allocation in poorer areas, rural or urban, and Mexico suffers for market driven capital allocation and will continue to suffer.

[anne]

Where China has generally protected farm communities, Mexico has been indifferent to all but the largest of farm product producers allowing for continual rural frictions and lack of development. Chinese agricultural production as a result is a substantial strength for the country and migration from rural to urban areas in China has been generally controllable as well as hopeful.

[Barkley Rosser]

China has "protected its farm communities."
Really? Why then are riots regularly going on the countryside there? Yes, the freeing up of prices at the beginning of the Dengist period brought large gains to the countryside, but more recently they have been having a "scissors crisis," and things are not going well there at all, worsened in many places by the shutdown of many of the old socialist safety net systems. A non-trivial portion of the Chinese population, more than 10% has been experiencing declining real incomes recently. Most of these folks are in rural areas in the interior.

And who on earth thinks China has some kind of well-functioning capital market? Its is at least as arbitrary and weird as India's, if not more so.

[anne]

Yes; there are frictions in China as there have been for centuries in translating a sense of leadership whether helpful or harmful to rural regions. China is after all a vast country of 1.3 billion people. So demonstration is continual in the countryside, and demonstration is a way that a benign leadership has of understanding the need to redress grievances. This is just what is happening now, and the process will have to continue.

[anne]

China's capital market has functioned well enough to, say, amass a trillion dollar foreign currency reserve, interestingly enough, and to be providing an infrastructure base that India dreams about. Education in China is becoming increasingly general and impressive, and currently focusing on rural opportunity. Ecology is becoming ever more a concern.

There are problems, amny problems, and many wishes, but the successes are impressive indeed.

[anne]

Significant rural problems in China are the loss of health care as health care services are market driven, protection of land rights, protection of the environment, and provision of free education. I do not consider these problems lightly, but I am especially hopeful in the response of Chinese leadership.

[Barkley Rosser]

anne,

The accumulation of forex reserves is a matter of manipulating the exchange rate and foreign flows, with dual rates until recently and lots of restrictions on capital flows, only now being loosened.

Government funding of infrastructure has little to do with private capital markets, in fact, nearly zero.

I grant that they have been good at providing education, again, not a matter of private capital market functioning, and that the current leadership is at least expressing concern about rising inequality.

[anne]

Ah, but the gaining of foreign currency reserves speaks to the trading success of China which is not manipulating currency but rather has tied its currency as has Japan and as have other countries to the dollar. The trading success is interestingly reflected in success in trading agricultural products which are heavily subsidized in developed countries including our own. China is becoming an agriculatural power, which is stunning.

[Maynard Handley]

I with anne on this one.
Whenever you read about the horrors of China, you have to remember that the relevant comparison is not with the US today but with China of the recent past. I mean, christ, they were footbinding till the 1920's. The Cultural Revolution only ended 30 yrs ago, not to mention the 50 yrs of war and famine in one form or the other before that. Just read any of myriad novels by Chinese-American authors about life in "the old country", eg _Wild Swans_, and its clear that, bad as today is, it's better, for most people, than pretty much any time in the last 100 yrs.

Of course the details of what is happening in China are awful, but I take heart by comparing the country to the US in say 1890 which was likewise a pretty horrifying place for farmers and workers. In an ideal world, you wouldn't have to go through this stage; but in the real world it appears to be mostly impossible to avoid it. At least there is progress to a better world, unlike, say, Africa, where the same horrors seem not to be leading to anything much better.

[anne]

As for infrastructure, including education from beginning through university, and especially free education, infrastructure development provides the base for successful enterprise. There is always the worry in China about blocks to development due to infrastructure limits, but the forming of infrastructure continues and blocks are unblocked.

Think of how much might be gained in Mexico with emphasis on education in poorer regions and communites, accompanied by solid infrastructure construction. Think of what free schooling means in Ghana or Kenya or South Africa. Infrastructure allows for enterprise.

[Fine minds even spell creatively, "agriculatural."]

[anne]

[I do not know this work....]

http://query.nytimes.com/gst/fullpage.html?res=9E0CE4DF143EF930A25753C1A967958260

October 13, 1991

When Nuances Meant Life or Death
By SUSAN BROWNMILLER

WILD SWANS
Three Daughters of China.
By Jung Chang.

Mao Zedong was dead and the Gang of Four had been toppled when a young woman from Chengdu in Sichuan Province made use of a small opening to the West to study English abroad on a Government scholarship that took her to Britain in the fall of 1978. Her given name had been Er-hong -- Second Wild Swan -- and she was the second daughter born to a family of high Communist officials. More than a decade earlier, on the eve of the Cultural Revolution, she had prudently changed it, on her father's suggestion, to Jung -- Martial Affairs. In the Sichuanese dialect, Er-hong could be taken for "faded red," signifying, in those perilous times, a dangerous lack of revolutionary ardor. She had learned before puberty that nuances mattered.

Jung Chang now lives in London and returns to her homeland for family visits. She has put her English studies to commendable use in a quirky, ambitious, occasionally amateurish but thoroughly engrossing memoir. "Wild Swans: Three Daughters of China" is her family's story over three-quarters of a century of turbulent change. The sprawling canvas is held together schematically by narrative accounts of her maternal grandmother, who was a concubine to a warlord in the 1920's; her mother, who chose a radically different life for herself in the 1940's as a Communist organizer married to a zealous functionary higher up on the party ladder; and Jung Chang's own peripatetic adventures, before her departure, as a Red Guard, peasant and factory worker.

By keeping her focus on three generations of female kin and their practical adaptations to the shifting winds of political power, Ms. Chang gives us a rare opportunity to follow the evolution of some remarkable women who not only reflected their times, but who also acted upon them in order to change their individual destiny. On the minus side, her macro-micro approach to historic events, a formula pioneered in nonfiction by Alex Haley in "Roots," is marked by chronological lapses that are likely to frustrate a reader with a limited knowledge of the tortuous ideological campaigns inside the Chinese Communist Party.

Ms. Chang is riveting in her description of a strenuous six-month journey through five mountain passes undertaken by a group of party veterans and their wives during the war against the Kuomintang in 1949....

[anne]

From Shah to Andres to Barkley to Maynard, the comments here raise critical question for us to think through and argue about and think again.

Brad DeLong went from being discouraged, even depressed, about the limits on development of poorer countries to sharply encouraged and hopeful in noticing what we little noticed for years, in noticing China. I am thinking, for all the criticism, China is a development model.

[dale]

"In an ideal world, you wouldn't have to go through this stage; but in the real world it appears to be mostly impossible to avoid it."

Interesting comment Maynard. I've thought about that from time to time myself. It seems to me that a progressive, social democratic type trade regime would help the developing world ease through those stages, with less inequality, destruction of culture, and put them on a path to environmentally sustainable development.

Otherwise it put backward pressure on the already developed nations and dooms the ordinary people of both worlds to (preventable?) hardships.

[Barkley Rosser]

anne,

The point may well be that economic growth does not necessarily depend upon well-functioning private capital markets, the neoclassical benchmark, although I do not think that this is what Brad DeLong intended to say or mean. India is now growing at 8% per year, despite its lousy capital markets, and, again, virtually none of what you are talking about in China, all this infrastructure development that has been occurring, has anything to do with private capital markets.

BTW, Japan does not and had not tied its currency to the US dollar. The Chinese do, although they claim that the peg has been loosened.

[anne]

Essentially and decidedly Japan has tied the value of the Yen to the dollar, though allowing a narrow range may mask that for some. The Yen is as tied as the Yuan, and those who ply the carry trade have understood in taking loans from Japan. But, somehow Japan all sluggish growth and stock-market-of-death seems less worrisome to us than China.

Care to buy some cheap Japanese stock, Little Girl?

As for India, I am increasingly hopeful and excited but hold that India has been increasingly copying China. Infrastructure, including free education, is developmentally essential, and critical for enterprise blossoming as Indians even in Bangalore are increasingly aware.

[anne]

Dale:

"It seems to me that a progressive, social democratic type trade regime would help the developing world ease through those stages, with less inequality, destruction of culture, and put them on a path to environmentally sustainable development."

[krishna cherukuri]

china is no where close to a developmental model. do you realise the environmental damage that this economic growth has caused? 400000 people die prematurely every year from air pollution. 70% of lakes and rivers are declared polluted. 50% of groundwater resources are polluted. according to chinese govt there is atleast one water polluting incident every 2 days.
In the coming years, China's working-age population will be shrinking in proportion to retirees. In 2001 China had 88million people age 65 or older. By 2025, China's population will include over 200 million people in this age group.
and the wealth distribution in china is just as horendousas in india.
80% of the population is in rural areas and 90% of the wealth is held in urban areas.
to top this no labor unions and highest number of coal mine accidents .
china has paid to high a price for the economic gains in the last decade.

[Barkley Rosser]

anne,

I really do not want to get in a cat fight with a great bird-watcher, but the Japanese yen floats, admittedly with substantial intervention by the MOF from time to time. But it floats. It is not pegged to the dollar. I can provide you with a large set of sources, including recent editions of basic textbooks on international finance, if you really wish to keep repeating this non-fact.

BTW, if you wish to see a more extended discussion of my perspectives on the history and current economics of both India and China, see _Comparative Economics in a Transforming World Economy_, 2nd edition, 2004, MIT Press, by me and Marina V. Rosser.

[Barkley Rosser]

And it is not pegged to the Yuan/rmb, even if the symbol for both is identical.

[Barkley Rosser]

I should hav said that their ideogram is identical, not their "symbol" (referring to the Japanese yen and the Chinese yuan).

[Keith]

It seems a bit like wishful thinking to suppose that China's central state direction of investment, particularly to rural areas, has been the driver of China's growth. Hasn't the vast majority of China's growth occurred in non-rural areas, and isn't a lot of China's growth a mean-reverting reflection of Mao's disastrous policies that went before?

In fact, much of China's current self-destructive subsidization of exports through foreign exchange policies appears to be driven by China's lack of a capitalist financial market.

While it may be imaginable that central state redirection of investment may overcome some bad social norms, it certainly looks far more likely that central governments on average intensify, rather than alleviate, social norms that reflect cognitive biases.

I might also point out that the destuction of harmful social norms and their effects through international competition and deeper international markets is a major non-Ricardian benefit of trade.

One important point: As Ernst Fehr has shown, financial markets are much more robust and rational if they have "short selling"/"put option" capabilities. This could prove to be very important for China's future development.

[anne]

"In fact, much of China's current self-destructive subsidization of exports through foreign exchange policies appears to be driven by China's lack of a capitalist financial market."

Say what?

[anne]

Barkley, you are of course right. The Yen floats, while the Yuan is tighly controlled day to day. But, the Bank of Japan has shown that it can and will react severely to control price swings in the Yen and is so doing the float of the Yen has actually been minimal for years.

I really have difficulty understanding or rationalizing Japanese economic policy, though. Japanese growth has been anemic since 1992, though fiscal policy has protected the Japanese middle class. The Japanese stock market, the market-of-death, has been in the worst, the very worst, bear market of the last century since 1989.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=4778&exhibition=84&pass=public&size=default&lang=eng

Gray Catbird Feeding on Crabapple
New York City--Central Park, Andrew Hasswell Green Bench.

How about a catbird fight?

[anne]

http://www.calvorn.com/gallery/photo.php?photo=3653&exhibition=84&ee_lang=eng&u=61470,9

Gray Catbird Eating Berry
New York City--Central Park, Harlem Meer.

Thanks Barkley.

[dale]

Norms are the very definition of an area of human social life that are, for the most part, not readily addressed by economic relations. The benefits gained by freedom of economic behavior are better seen as being norm free in some ways.

If cognitive biases are sometimes cultural norms that inhibit orthodox capitalist social relations, the pushing aside of such norms by economic rationalization doesn't even attempt to redeem whatever core truths those vanquished norms may have contained.

That said, if your point is that trade and all sorts of cross cultural relationships have the tendency to get folks to think critically about the basis of their particular sets of background assumptions, I agree.

But if you're saying that technocratic economic rationalization trumps other forms of self relection and cultural rationalization- then I disagree.

[Keith]

"That said, if your point is that trade and all sorts of cross cultural relationships have the tendency to get folks to think critically about the basis of their particular sets of background assumptions, I agree."

More than that; competitive capitalism tends to punish those whose economic decisionmaking is based on the falsest and most destructive beliefs and social norms. Hence, it performs a positive good of destroying negative aspects of various cultures. Note, this belief that I advance is informed by a combination of economics and cognitive psycology, and is not standard neoclassical economics.

The problem comes in when you consider: how can a negative and vicious culture stomach the tolerance that capitalism requires? Maybe capitalism could have eliminated segregation in the South if people could have opened lunch counters that voluntarily served members of all races, but in reality, what would have happened to those lunch counters and those enlightened lunch counter owners? One shudders to think.

In some sense, it's good for a society to have a visceral attachment to the institutions of private property and free entry, in order to overcome its other visceral attachments that would undermine capitalism. Then, those institutions can themselves work to undermine a society's negative aspects.

That doesn't deny that governments can foster market development through important investments in infrastructure and primary education, by the way.

[andres]

anne: In a sense, Barkley is mistaken. It's technically true that the Yen is not pegged to the dollar. Leaving the issue of BOJ intervention aside, however, it is also true that the BOJ sets monetary policy and interest rates always with one eye firmly fixed on the exchange rate in order to keep it stable and within a well-defined ceiling-floor boundary. This style of monetary policy has been labeled in the international economics literature as "Fear of Floating" (apparently the labeler had a fondness for Erica Jong novels).

The central banks of many countries, especially those heavily dependent on international trade and foreign capital, have to play a fine game of avoiding the twin traps of unstable interest rates and unstable exchange rates. It's quite difficult, and also explains why monetary policy seldom conforms to the abstract models of floating or fixed exchange rates.

[andres]

"I might also point out that the destuction of harmful social norms and their effects through international competition and deeper international markets is a major non-Ricardian benefit of trade."

Keith: free-market capitalism tends to develop in societies that have a political commitment to egalitarian democracy.

Not the other way around.

The US was a country made up mainly of agricultural and urban proprietorships (ie self-employment without labor markets) before its commitment to liberty and equal rights created a free working class and mass industrialization.

Neither slavery and segregation withered away because of free markets, in part because free markets reward already existing consumer preferences, no matter how vicious. It's not just the owners of restaurants that refused to hire black cooks and waiters, it was also white southerners who refused to frequent restaurants that did hire blacks. Not to mention that such consumer hostility made black-owned businesses much more likely to fail and therefore a much greater credit risk even to non-racist bankers.

Capitalism does not have an answer to such social malaise. Only political activism does.

[Keith]

"It's not just the owners of restaurants that refused to hire black cooks and waiters, it was also white southerners who refused to frequent restaurants that did hire blacks. Not to mention that such consumer hostility made black-owned businesses much more likely to fail and therefore a much greater credit risk even to non-racist bankers."

I think it's more the fact that such businesses would have been burned to the ground.

I also think it's udeful here to note how white Southern labor unions used equal wage laws, ironically enough, to discourage businesses from hiring cheaper minority labor. Thus, labor regulation played a prominent role in keeping capitalism from penalizing the vicious and incorrect beliefs that people held.

And this goes to the debate. I think you overestimate the efficacy of the state and underestimate the efficacy of private property and free exchange in engendering positive social change. I think you also underestimate the degree to which state intervention entrenches negative social mores that private property and fee exchange would otherwise destroy.

[anne]

Interesting comments and argument, but as for Southern integration the key was always federal as opposed to state law and enforcement. The only way to break instutitions the supported and fostered segregation was from without, but that was difficult. Thurgood Marshall and John Hope Franklin are to be looked to especially here.

[anne]

http://www.nytimes.com/2005/11/27/books/review/27oshinsky.html?ex=1290747600&en=eb30e8dfd55f0f36&ei=5090&partner=rssuserland&emc=rss

November 27, 2005

Making History
By DAVID OSHINSKY

JOHN HOPE FRANKLIN is among a handful of scholars who have changed the way Americans view their past. It wasn't so long ago that mainstream histories of the United States ignored the experience of minorities or employed the sort of stereotypes that most readers today would find offensive. An African-American, raised and educated in an era of stifling race prejudice and legal segregation, Franklin, now 90 years old, has spent his career exposing the bigotry that once dominated American intellectual life and continues to infect society at large. His scholarship is his weapon.

"Mirror to America" is a riveting and bitterly candid memoir. Born in an all-black Oklahoma town in 1915, Franklin can remember his mother, a teacher, riding a horse to work "with a pistol in her saddlebag to protect herself from wolves or some vagabond who might attempt to molest her." In 1921 his father, an attorney, moved to Tulsa to open a law practice and buy a home for the family. A few months later, the black section of that city was demolished in one of the bloodiest race riots in American history. His father lost everything, postponing the family move for four years. In Tulsa, Franklin encountered a seething racism that kept the black community in a state of perpetual unease. There "was never a moment in any contact I had with white people," he writes about this time, "that I was not reminded that society as a whole had sentenced me to abject humiliation for the sole reason that I was not white."

A superb student, Franklin won a scholarship to Fisk, a distinguished black university in Nashville, where he intended to study law. There he met the two most influential people in his adult life: Theodore S. Currier, a young, white faculty member who would fuel Franklin's interest in "Negro history," and Aurelia Whittington, the woman who would become Franklin's wife and inseparable companion for the next 60 years. At Fisk, he recalls, "I became known as the person who had disciplined himself to the point of letting nothing interfere with his studies." When Currier learned that his favorite student had been admitted to graduate school in history but lacked the funds to attend, he borrowed $500 and placed it in Franklin's hand. "Money," he declared, "will not keep you out of Harvard!"

Having never lived among whites, Franklin navigated the Harvard campus of the 1930's like an anthropologist on an exotic field trip. On a given day, he might attend Arthur M. Schlesinger Sr.'s seminar in American intellectual history and then walk to the law school to hear Felix Frankfurter lecture about the Constitution. But he can still recall the "darky" jokes that were told in his history classes. And he could hardly believe the shabby treatment endured by the handful of Jewish students in the program (including his friend Oscar Handlin). Prejudice, he discovered, came in many forms....

[anne]

http://www.nytimes.com/2005/11/27/books/chapters/1127-1st-frank.html

November 27, 2005

'Mirror to America'
By JOHN HOPE FRANKLIN

Living in a world restricted by laws defining race, as well as creating obstacles, disadvantages, and even superstitions regarding race, challenged my capacities for survival. For ninety years I have witnessed countless men and women likewise meet this challenge. Some bested it; some did not; many had to settle for any accommodation they could. I became a student and eventually a scholar. And it was armed with the tools of scholarship that I strove to dismantle those laws, level those obstacles and disadvantages, and replace superstitions with humane dignity. Along with much else, the habits of scholarship granted me something many of my similarly striving contemporaries did not have. I knew, or should say know, what we are up against.

Slavery was a principal centerpiece of the New World Order that set standards of conduct including complicated patterns of relationships. These lasted not merely until emancipations but after Reconstruction and on into the twentieth century. Many of them were still very much in place when beginning in the late 1950s, the sit-ins, marches, and the black revolution began a successful onslaught on some of the antediluvian practices that had become a part of the very fabric of society in the New World and American society in particular.

Born in 1915, I grew up in a racial climate that was stifling to my senses and damaging to my emotional health and social well-being. Society at that time presented a challenge to the strongest adult, and to a child it was not merely difficult but cruel. I watched my mother and father, who surely numbered among the former, daily meet that challenge; I and my three siblings felt equally that cruelty. And it was no more possible to escape that environment of racist barbarism than one today can escape the industrial gases that pollute the atmosphere.

This climate touched me at every stage of my life. I was forcibly removed from a train at the age of six for having accidentally taken a seat in the "white people's coach." I was the unhappy victim, also at age six, of a race riot that kept the family divided for more than four years. I endured the very strict segregation laws and practices in Tulsa, Oklahoma. I was rejected as a guide through busy downtown Tulsa traffic by a blind white woman when she discovered that the twelve-year-old at her side was black. I underwent the harrowing experience as a sixteen-year-old college freshman of being denounced in the most insulting terms for having the temerity to suggest to a white ticket seller a convenient way to make change. More harrowing yet was the crowd of rural white men who confronted and then nominated me as a possible Mississippi lynching victim when I was nineteen. I was refused service while on a date as a Harvard University graduate student at age twenty-one. Racism in the navy turned my effort to volunteer during World War II into a demeaning embarrassment, such that at a time when the United States was ostensibly fighting for the Four Freedoms I struggled to evade the draft. I was called a "Harvard nigger" at age forty. At age forty-five, because of race, New York banks denied me a loan to purchase a home. At age sixty I was ordered to serve as a porter for a white person in a New York hotel, at age eighty to hang up a white guest's coat at a Washington club where I was not an employee but a member....

[anne]

John Hope Franklin has been among the treasures of American life, and 'Mirror to America' is especially incisive and poignant though almost in a disinterested sense and strategically important, while reading fluidly as all Franklin's work.

[Keith]

Yes, Anne.

But you still have to acknowledge that white Southern labor unions used equal wage laws, ironically enough, to discourage businesses from hiring cheaper minority labor.

Let's also not forget the role that white labor unions played in supporting (and perhaps even developing) apartheid in South Africa.

In other words, labor regulation and intervention has played a prominent role in keeping capitalism from penalizing the vicious and incorrect beliefs that people held.

Again, my thesis here is that government tends to magnify and exacerbate cognitive problems and baser underlying beliefs, while private property and free exchange penalizes those things.

[Barkley Rosser]

anne,

I don't mind a catbird fight. I think you focus on stock market outcomes too much. What goes on on Wall Street does not always reflect what goes on on Main Street, and the equivalent holds in Japan as well. Yes, Japan has had a pretty flat economy since the collapse of its bubbles, but it is in fact a pretty good place to live for most people, with a low poverty rate, low unemployment, the world's highest life expectancy, and serious technological leads in some important industries, like autos and a lot of consumer electronics. Pretty sneaky of them to pull those leads with a lousy stock market and slow overall growth so nobody noticed and got all hysterical about China.

Much of their slowdown has been a long process of adjustment to their huge demographic shift, an actual negative growth of population they are now experiencing. Arguably they should allow more immigration, but they just don't.

andres,

If your argument is correct, then the US dollar does not really float because the Fed certainly looks over its shoulder at the forex markets when it sets policy. The current slide of the dollar is going to make it harder for them to cut interest rates next year, as many are forecasting and expecting right now.

[andres]

Well, yes. However, I did not say that the US dollar was subject to an indirect fixed band in this manner. From what I can tell, the Fed does not mind the dollar falling steadily in value, provided this fall is steady and not panicky. Japan, which is greatly dependent on exports and therefore on a competitive value of the Yen, is a different story altogether.