The Ingenuity of the Market: A Primer on the Subprime Crisis

If the current financial turmoil leads to a full blown crisis, future historians will likely include last year's Subprime Mortgage Financial Crisis as one of its main precursors. The above video provides a clear and concise explanation of that key episode. Watch to get an insight on what the U.K.'s former Chancellor of the Exchequer and current Prime Minister Gordon Brown calls "the ingenuity of the market".

Update Jan-25-2008 4:09AM: To reinforce the above, via the comments section of CrookedTimber, a pointer to David Einhorn's remarks a few months ago on the credit market crisis:

"What strikes me the most about the recent credit market crisis is how fast the world is trying to go back to business as usual. In my view, the crisis wasn't an accident. We didn't get unlucky. The crisis came because there have been a lot of bad practices and a lot of bad ideas. Securitization is a mediocre idea. Re-securitization of securitized assets into a CDO [Collateralized Debt Obligations] is a bad idea. Re-securitization of CDOs into CDO-squared is really a bad idea...And as I will get to in a moment, it is a horrendous idea to delegate most of the responsibility for assessing credit risk to a group of credit rating agencies, paid for by the issuers rather than the buyers of bonds."

On Securitization

"Avocates of securitization say it disperses risk. However, it does so by separating the loan originator from the eventual outcome of the loan. The originator gets a fee up front. The risk is held somewhere down the line in an alphabet soup of structured vehicles called CDOs, CMBs or CLO..."

On Credit Rating Agencies

"Why would anyone blindly lend to an opaque structure full of loans or pieces of pools of loans that they didn't underwrite or even evaluate? Because the structures come with credit ratings from Standard & Poor's, Moody's and Fitch."

Read the whole thing here (PDF file).

The Poor: Two Narratives (Part 2)

As a follow-up to my previous blog entry, i was looking for the best way to describe the second narrative. I've come across some good ones, but i think this quote linked to by Urbano de la Cruz nails it:

"the people who come to the city [and live in squatter developments] are the cream of the crop with the highest ambitions and aspirations."

As he says, it's something to think about.

Thoughts on Trade: Effect on Prices, Output and the Relevant Moral Communities

As reported by Tyler Cowen of Marginal Revolution, there is currently an exchange of blog posts on International Trade among eminent economists. Following the chain of entries, i believe this latest round was started by Dan Drezner which is itself a reaction to a thought experiment by the recent Albert Hirchsmann prize awardee Dani Rodrik on Trade and Procedural Fairness. Basically, Drezner pointed out that Rodrik's thought experiment was incomplete. Rodrik responded by scoring Drezner on the claim that Free Trade Lowers Prices.

"Consider your typical Argentinian for example, who consumes a lot of wheat and beef. Since these are export products for Argentina, free trade implies a rise in the relative price of the Argentine consumption basket. (The gains from trade are still there, of course, but they derive from the usual allocative efficiency improvements, not from lower prices across the board.) And in the U.S., the Wal-Mart effect has to be qualified to take into account the fact that the relative price of the goods that the U.S. exports (including for example agricultural commodities) is higher than it would have been absent trade. Similarly, when the U.S. gets better market access abroad for its agricultural exports (a key demand under the Doha round), you can be sure that this will raise domestic prices for these goods, not lower them."

In the Philippine context, i guess it's similar to our experience in buying local products that are supposed to be for export or export quality.

To the above Tyler Cowen responds that the above discussion is not nearly as relevant as the output effect of trade:

"The real gain from trade is the additional output; it should not be surprising if the pecuniary externalities (higher and lower prices) should prove a wash rather than an additional net gain." [Emphasis mine]

More trade results in more economic growth (something which countries like South Korea and Taiwan took advantage of as i will discuss in my next entry) regardless of its effects in terms of greater inequality and poverty for some.

The discussion comes to a sort of full circle when Alex Tabarrok, also from Marginal Revolution reflects upon the question of what is the Relevant Moral Community to consider when discussing the winners and losers of trade. He makes a distinction between the individualist, nationalist and liberal internationalist viewpoints.

Along the way economist Greg Mankiw shares his thoughts on the various trade models, i.e. the Ricardian Model which emphasizes Comparative Advantage as the reason behind international trade, the Stolper-Samuelson_theorem and the Heckscher-Ohlin model. (Incidentally, my previous entries on Political Coalitions and Free Trade is based on the latter two models.) Mankiw still favors the first trade model:

"As a tentative conclusion, therefore, I am inclined to think that in a world with significant capital mobility, the Ricardian theory of trade is more useful than Heckscher-Olin."

Paul Krugman (as published in the Economist's View) blog, counters...

"For those who like their jargon, by the way, I'm basically saying that the right model for thinking about this has gone from many-good specific factors to Heckscher-Ohlin."

...and ends with a humble plea to Americans on which relevant moral community to consider:

"I don't have answers to this. The moral case for open markets is their importance to poor countries: America would do OK even in a highly protectionist world, but Bangladesh wouldn't. The domestic politics of trade, however, are now very hard, and getting harder."

Brad de Long, weighs in with his two-cents and by way of conclusion states:

"The narrow pure-economics case for freer trade is harder to make these days because it is less true than it was in the 1960s or the 1950s or the 1930s or the 1910s. But the broader political-economy case for freer trade is still strong and true."

Mark Thoma of the Economist's View blog has been keeping track of the discussions in more detail and depth so you can continue to follow it over there.

All i can say is that having the opportunity to listen in to these economists via their blogs, today is a great time to be alive.

Abe Margallo on the American Free Market Model

Here is Abe Margallo's take on the Cult of Market vs. Myth of State discussion that Manolo Quezon and John Nery started over at Inquirer's Current blog and which i commented upon in this post.

(I'll update this entry with my reactions as soon as time permits.)

Update (05-02-2007): My update is here.

Globalization and the Trifurcation of the State

Over at the PDI's Current blog, Manolo Quezon and John Nery have an ongoing debate on whether the traditional role of the State is being replaced by the Cult of the Market and whether such a development is desirable or not.

Manolo, for his part, is troubled:
"THE Cult of the Market is something that’s been bothering me for some time. To me, this is the idea that politics has become less relevant to people’s lives, because it can’t deliver change or an improvement in lives better than attending to business -and letting the “free market” sort the things that politics used to consider its mission to sort out....But it seems to me that the most troubling thing remains: the growing belief that the market is the solution, not politics (whatever kind it is that floats your boat)."

On the other side, it is clear that John Nery laments that the process has not gone far enough:
"I happen to believe, not only in a smaller government, but in a smaller role for government. The Ramosian techno-speak of level playing fields, to give just one example, appealed to me — as long as the idea was sustained; that is, the government saw its role as allowing other players onto the level field too."

What Manolo worries about and what John looks forward to can be understood as a consequence of society's acceptance of the narrative of globalization, which has redefined the nature and role of the State as explained by Cameron and Palan in The Imagined Economies of Globalization. Within the globalization story "the 'idea of state' itself has moved from a 'public' principle of universal inclusion (implying an identification of and engagement with a single population of citizens) to a 'private' principle of competitiveness".

Cognitively speaking, the state (and society) has been reimagined and split into three economies, two of which share in the benefits of the system while the third remaining excluded. The table below (as presented by Cameron and Palan in their book) maps these three spaces*, i.e. the offshore, private and anti-economies in terms of its representative institutions, processes and normative characteristics.

Cognitive Map of the Imagined Economies of Globalization and Social Exclusion**

Private Sector		Third Sector / Social Economy Public Sector
Offshore Economy	Private Economy	Anti-Economy
Institutions:	Institutions:	Institutions:
World/Global economy Global markets Global firms Merchant banking Global cities Media corporations Global governance (WTO, UN, OECD, World Bank, etc.) TNCs Alliance capitalism	National economy National state bodies Formal labour market Local state bodies Domestic firms Borders Domestic market Retail banking	Local/peripheral economy, Community Family Neighbourhood Welfare state Informal labour market
Processes:	Processes:	Processes:
Globalization Technicization Securitization Virtualization Growth	Privatization Liberalization Deregulation Modernization Globalization Growth	Dependency Stagnation Decline Exclusion Marginalization Obsolescence
Normative Characteristics:	Normative Characteristics:	Normative Characteristics:
Economic Dynamic Site of Competition Impersonal Apolitical Fluid Future-oriented Developing Expanding Technological Real	Political Dynamic Competitive Entrepreneurial Flexible Globalizing Privatizing Enabling (business) Modernizing Market-led Employed Onshore	Static Uncompetitive Inflexible Pre-global Residual Dependent (aid or welfare) Un- or de-skilled Outmoded Third World Unemployed Underclass
'MAINSTREAM ECONOMY' ('SOCIAL INCLUSION')		'WELFARE' and/or 'INFORMAL ECONOMY' ('SOCIAL EXCLUSION')

**Source: The Imagined Economies of Globalization, Angus Cameron & Ronen Palan

While John Nery celebrates the benefits and hopes for the expansion of the first and second columns above (via expansion of the 'market'), he laments the continued reliance of many on government. Once we are able to see the three economies above, we begin to see why those who have been excluded, i.e. consigned to the anti-economy, continue to be dependent on government. The exclusionary mindset of those who belong to the offshore and private economy has also tranformed Civil Society's values:

"Civil society, therefore, is no longer identified by a set of core values, rights and responsibilities but by levels of access to, and participation in, 'opportunities' in the mainstream economy...the key distinction made in the mainstream debate over social exclusion is not between exlusion and inclusion, but between exclusion and 'competitiveness'."

Finally, the above map also helps in explaining the typical Filipino middle class mindset that is the source of Iniibig ko Ang Pilipinas' critique. Ultimately, Gawad Kalinga and other community based efforts are limited at the local and community level (i.e. the third column above) which as Cameron and Palan explain, is typical of the scope of anti-exclusion projects:

"Despite the enormous range of different places, peoples and problems included in these databases," [of anti-exclusion projects as compiled by the UNESCO] "their one constant feature is that social exclusion is assumed to ber manifest at the local level. Furthermore, by suggesting that the local scale is most salient and, in practice, the only scale at which social exclusion ought to be tackled, the possibilities for intervention in poverty are similarly restricted."

The Cult of the Market and the Myth of the State is the direct offshoot of the prevailing Globalization narrative that has literally captured our imagination.

*These three economies are explained in this post.

Reverse Foreign Aid and Reverse Globalization

Related to my previous post on foreign debt payments, here's an article from the NY Times (via 3quarksdaily), on how the poorer countries subsidize their richer counterparts. It reports that "According to the United Nations, in 2006 the net transfer of capital from poorer countries to rich ones was $784 billion, up from $229 billion in 2002." The article goes on to explain that reverse foreign aid happens through the following:

1. Investment in US Treasury Bills
2. Honoring international intellectual property agreements.
3. Tax holidays for foreign investors
4. Brain drain (e.g. OFW doctors and nurses)
5. Subsidies to First World agriculture
6. Environmental damage due to global warming.

...and how above phenomenon is a burden to the third world countries like ours.

#1 above seems more relevant to China and the US Budget Deficit, and less relevant to us (unless this eventually leads to a dollar crisis). On #2, i mentioned over at mlq3 that:

"While the focus of the law has been on the pirates, the greater danger lies with the corporations (and their allies in government), who, as agents of Empire, seek to close off the intellectual frontier through strict interpretation and aggressive enforcement of intellectual property laws, in the name of profits. Among scientific and medical communities where open collaboration and information sharing is the key to new discoveries and innovation, restrictive intellectual property laws and practices are emerging as a real threat." (This led into further discussion in that comments section with DJB on this matter.)

On #3, i don't have the article on hand now so i may be mistaken, but i seem to remember that Mar Roxas saying something about giving too much tax holidays to foreign investors. #4 is a known, much discussed issue related to the OFW phenomenon. #5 is a key point of contention when it comes to WTO-related negotiations and #6 is an unfortunate reality that has a lot to do with geography.

A comment in that same post in 3quarksdaily also links to Brad Setser's web blog, who has an article on a more benign (to the third world), but related phenomena they call reverse globalization which is a situation where "Emerging markets will be buying companies – not just bonds – in the developed world.". The participants in this are the rapidly developing and relatively capital-rich developing countries like China and the Gulf States.

Abe Margallo on Foreign Debt & Development, Sparks on State Reform

Here's a proposal by Abe Margallo, on a strategy for handling foreign debt and implementing industrial development.

"Our economic elites (who own half of the debt burden), imbued with a deep sense of country, consider the possibility of entering into some form of “forbearance” with the national government with a view to a short-term moratorium on debt service payment, say, an 8-year temporary cessation. (This indulgence by the elites is in a way a matching counterpart to the acknowledged sacrifices of the OFWs, serving to keep the ship of the nation afloat.)

During the moratorium, the government in partnership with the same forbearing private sector, or vice versa, ventures into vigorous investments, targeting specific industries such as: the manufacture of the imported component of the electronic exports; bio-fuel as alternative source of energy; or exploration in the extractive sector. (I’d prefer to treat the forbearance as some sort of passive investment on the part of the economic elites; after all, the first beneficiary of dependable institutions and infrastructures, productive workforce and booming economy would be none other than the elites themselves.)

What’s withheld as otherwise rent payment, which, doubtless, is a considerable sum, may now be available for physical and social (certainly together with educational) infrastructure outlays as well as for state support for R&D. On the other hand, appropriate incentives like “tax holidays” for entrepreneurs directly involved in these targeted sectors are worked out.

Aside from moratorium on debt service and on capital strike, similar challenge is posed to the labor sector to bite the bullet by committing to a moratorium on labor strikes and other concerted actions during the experimental phase.

Foreign creditors and investors, not being importuned to make a change of position, are expected to regard the arrangement as a real honest-to-goodness resolve for internally driven strategic economic plan. On the other hand, in virtue of its ownership by local leaderships, the initiative is perceivable as one designed with a visceral sense of stewardship (to have lasting positive consequences for the next generation of Filipinos); hence, stabilizing and producing the effect of strengthening the country’s creditworthiness and standing in the world economy."

In a later comment, he added his thoughts on development models, particularly the ones followed by South Korea, Taiwan and China:

"I have also considered as viable alternative the South Korean route. South Korea, a highly homogeneous society, took the innovative route of (officially) embracing crony-capitalism while subjecting it to strict discipline by imposing performance standards, down to the activities in the shop floor, upon business recipients of state largesse. The chaebols then assumed industrial leadership by risking into productive enterprises instead of simply preserving their rent-seeking activities. The state subsidy (from borrowed foreign funds) for diversification into new industries proceeded in tandem with the decision to invest heavily in education. Official cronyism and education, while still conforming to market mechanism, lay at the heart of the late-industrial expansion of South Korea. With fewer multi-national corporations in Korea than in any late-industrializing countries, its economy took off on the basis of nationally owned firms.

I’ve likewise looked at Taiwan as another best practice model. Through broad distribution of land ownership and capital, and high returns to labor (this may be address what cvj calls as “a program of promoting equality”) the individual Chinese was greatly motivated to produce much of the rapid growth of Taiwan’s economy. Taiwan’s small-scale capitalism (“letting a thousand flowers boom”?) as a base for industrial development can indeed serve as just another paradigm for accumulation.

There certainly are other economic models that could be investigated for the best practices we can learn from or from which we could “indigenize” our own. (The China model, playing the globalization game by the Hamiltonian or Keynesian rule-book, stares us in face today.) But the ones that appear to stand out as common denominators for success are:

1) the reciprocal relations between the state and the private sector (businesses, as well as civil societies I wish to add),
2) extensive investment in education and
3) the grandiose ambitions of their pioneering leaders." [emphasis mine]

The above models obviously require active participation by the State to which Sparks, in this comment poses a valid challenge:

"If we assume that the State must play a central role in development, as it has in countless other examples, then we have two tasks:

1. Reform the state
2. Selectively eschew the neoliberal orthodoxy to which we have blindly subscribed through our WTO and IMF commitments.

The question is how do we first reform the state, then enable the state, when neoliberal policies have weakened the state in favour of the private sector? Can we reverse a process that has gone on for 20 years?"

I have taken a stab at a response, but i realize that this is a complex issue and much more is required before we can resolve these interconnected questions.

The Poor: Two Narratives (Part 1)

The SWS' survey findings on record levels of hunger has spawned discussions on whether the poor are victims of the government's (and society's) neglect or whether it is the poor who are, at least partially to blame due to their lifestyle, attitude and consumption habits. In a reaction to a self-confessed aristocrat's comment, I mentioned that 'blaming the poor for their misery' is an integral part of the ideology of globalization. Let me clarify where I’m coming from. As part of the narrative of globalization, Cameron and Palan in their book The Imagined Economies of Globalization explain that what we call globalization is made up of three 'economies'.

One is the Offshore economy of Multinational Corporations, Export processing zones, Banks and global institutions such as the IMF, WB and the WTO. These are the elements that we are able to closely associate with globalization. In a sense, though, 'offshore' is a misnomer if taken to mean that it exists outside the State for it is precisely the State (or States around the world) that has carved out this sphere (through laws, regulations and guidelines especially in the area of banking, trade and industrial policy). It has done so as part of a strategy of economic development, which brings us to the second 'economy' in the globalization narrative which is the Private Economy whose emergence, in the words of Cameron and Palan, has led to a...

"...shift in the orientation of state activity, indeed a change in the very principle of statehood, away from established functions associated with the nation - the latter viewed as a spiritual, political and cultural community - towards a more outward-looking, competitive and fundamentally economic principle."

This shift away from the previously established role of the State has led to the creation of the third 'economy', which is the 'anti-economy' of social exclusion. It is characterized, in the words of the authors with...

"...the idea that poverty and marginality are 'personal deficits' [that] implies that those unable or unwilling to live up to the emergent norms of the global labor market are in some way pathologically deviant. It also implies that responsibility for becoming more employable lies in the first instance with the unemployed themselves and not with the institutions of the mainstream labor market from which they are excluded."

While this third economy redefines what it means to be poor, it also transforms the character of those who are more fortunate:

"Civil Society, therefore, is no longer identified by a set of core values, rights and responsibilities but by levels of access to, and participation in, 'opportunities' in the mainstream economy. As John Lovering has pointed out, the key distinction made in the mainstream debate over social exclusion is not between exclusion and inclusion, but between exclusion and competitiveness."

This, as described above, is the place of the poor within the narrative of globalization and is what shapes the guilt-free mindsets of the Tim Yaps, Gloria Arroyo's and various aristocrats of this world. Personally, i find such a worldview distasteful to say the least.

Update 03-27-2007:From Expectorants, a compilation on thoughts regarding the poor (and the middle class).