31 March 2008

The Gold Standard-2

Part 1

In part 1 I briefly outlined the periods of gold standards and gold exchange standards.

Oddly, the concept became significant with the introduction of paper money, since pure commodity money had entirely different dynamics. In fact, the period of commodity money naturally begat the widespread use of bimetallism, since many of the world's financial systems prior to 1800 had evolved out of coins with different alloys and constituent metals. The masters of the royal mint were typically concerned with maintaining a fairly high local price of gold and silver, the one so that private reserves of gold would accumulate domestically, the other so that there was an ample supply of small denomination coins for daily use.

Braudel (1992, p.357) suggests that the connection between a trade surplus and inflows of gold were discovered after Gresham ("Gresham's Law" being roughly dated 1558). The discovery that a strong currency could be used to strengthen the revenues of the kingdom produced a strong incentive by princes to focus very narrowly on foreign/trade policy that favored trade surpluses and offset Gresham's law.1

The period of pure commodity money seems to have been accompanied by wars explicitly over access to markets and resources. Explaining the frenzy of pre-ideological wars of the 15th-18th centuries is otherwise fairly difficult. After the French Revolutionary wars of 1792-1815, major conflicts within Europe became rare and ideological; balances of power were no longer invoked by diplomats trying to form coalitions.2 While British state expenditures had grown very fast prior to and during the Revolutionary epoch, they fell from about 23% of gross product (1810) to about 8% (1890); there followed an arms race in Europe that drove British state expenditures to 14% (1900) and then to historic highs after 1929.3 The British experience was not sharply different from other European nations, although Germany and the USA had the bulk of their government expenditures at the local level until the early 20th century. Also, there was the extremely important financial role of the colonies (India, Latin America), which had—or were compelled to have—extreme "hard" moneys. In the 19th century, these countries tended to mop up extra liquidity in the system, and internationalized the generally high real interest rates.

The gold exchange standard of the interwar years was extremely unstable. Within literally months of returning to the gold standard, many governments introduced "gold devices" to suppress the bleeding of gold from state reserves. For example, the government of Canada prevented sales of gold by permitting them only in Ottawa, rather than in the financial centers of Montreal or Toronto, and effectively left the standard in 1929 (Powell, 2005, Ch.7 ). The last major countries to leave the gold standard were Italy (1934) and France (1936).4

The postwar period 1946-1971 has some aspects of a GXS; the US dollar was pegged to gold, and the US government had treaty obligations to defend that value through sales of gold. Other national currencies were pegged to the dollar; usually these pegs were determined under pressure of the IMF. Generally speaking, changes in valuation of non-US currencies under the Bretton Woods Agreement were made under negotiation with the IMF, and the IMF was usually interested in getting a stand-by agreement repaid reliably. This, of course, meant erring on the side of a low effective exchange rate for the currency, and thereby ensuring the country's current account balance would improve against that of the USA. It also meant the terms of trade would worsen for that country.

An effect of this was that, in the 1960's, the US dollar came under inflationary pressure. Because the US guaranteed the value of the dollar against gold, and this guarantee was taken seriously, the effect was to push the value of gold relative to all other things downward (not enough; US gold reserves shrank anyway, as trades continued to exchange dollars for gold). Other countries therefore complained that the USA was "exporting inflation" through the use of the dollar as their reserve currency.5 The problem was that the US was obligated to run a deficit in the balance of payments in order to accommodate expansion of the global economy. This was because foreign holdings of US dollars (plus gold, which was not in adequate supply) were needed as reserves if a country was to expand its money supply, which of course was necessary for economic expansion. This meant the US economy had to consume beyond its means, or the world economy would deflate.

Click for larger image

Blue bars indicate inflation-adjusted net influx of foreign investment to US (financial account balance); red bars indicate current account balance. The red and blue bars are nearly mirror images of the other. The white line indicates the difference between the two.

Note the sharp rise in imbalances following the collapse of Bretton Woods (15 August 1971) . It's possible the Triffin Dilemma may have continued to operate long after that time, as the linked article explains.

European critics of this tended to demand a return to a pure gold standard, which would require massive monetary contraction by the US government (and depression). US persistence in the Bretton Woods Agreement would likewise respond to the 1970's Oil Embargo by imposing a recession sufficient to disinflate, but leave intact the European complaint that they were unwilling lenders to Washington. In the event, money was allowed to float in a chaotic fashion, rather like an immense raft hitting a rapid. Weaker, and newer, currencies of the world (e.g., Brazil's, Sri Lanka's) were subjected to devastating shocks, but probably would have fared worse under either BW or the pure gold standard. That's because defending their own peg to gold—if they had one—would have been prohibitive and ultimately impossible, and only added to the debt burden they faced in 1980-86. And without the income from post-BW exports, such countries would likewise have had no way to rebuild sovereign credit.

Internal Effects of the Gold Standard

The gold standard was a technical improvement over either prior forms of paper money or over specie. While the term "fiat money" was apparently first used as an insult, the fact was that states were not always able to exchange even their coins for the par value in gold or silver, and therefore long relied on quite rigorous laws enforcing its use as legal tender. The ability of the state to "will" value into existence, therefore, was used with metal coins for centuries before the French Revolution. True "fiat money," though, requires that the actual purchasing power of the money be also fixed by the state: hence, the money must be inconvertible into other potential monies, such as gold or foreign currency. This is, naturally, quite rare; there are a few cases, such as the use of assignats in France during the Revolution, the Soviet ruble, and so on. More commonly, however, alternative monies are just very difficult to use. Ironically, therefore, the gold standard represented a new technology for defending paper money, one that had been unavailable to earlier forms of quasi-fiat money.

As mentioned in footnote 1, when rival moneys circulated ad libitum in the same country (during, say, periods of free banking), Gresham's Law did not apply: bad money was, in fact, likely to be driven out by good, rather than vice versa. But if that were so, it was not immediately obvious why gold was at all valuable as a reserve. Banks were vulnerable mainly to illiquidity, rather than insolvency, which was what "conservative" management methods were supposed to prevent; and extremely well-managed banks, in effect, drove out gold (whose power in the inter-regional economy of 19th century USA was concentrated by history, not by shrewdness or prudence.) They did this through anti-competitive measures, such as teaming up with other larger banks and threatening weaker, local banks with runs (usually around harvest time, when demand for cash was brisk). Eventually, notes of issue from a small number of large state-chartered banks became required as reserves, instead of specie.

The gold standard, finally, played a major role in the history of panics and "crises" during the 19th century. This is not necessarily an indictment of the GXS, incidentally; the financial system had to evolve out of something, and it's reasonable to argue that the GXS was the most feasible option of the day. But it was not remotely trouble-free. National governments played a massive role in their countries' financial life by maintaining, or failing to maintain, adequate liquidity. Gold strikes typically led to unsustainable booms in credit and economic expansion, while declines in gold output--or major wars--led to irrational contractions in economic activity. This was globalization avant la lettre, and it intruded into every hamlet and tenement of the world.

(Part 3)

  1. Link goes to George Selgin, "Gresham's Law," EH.Net Encyclopedia (9 June 2003). Note there was some controversy over what Gresham's Law actually says. Per Selgin, Gresham's Law applies to cases in which coins have their value fixed by state fiat, regardless of the metallic content; therefore, in cases where the coin is not legal tender, and where they may circulate well below par value, Gresham's Law does not apply.
    Gresham's Law can hold, on the other hand, where both good and bad coins enjoy similar legal-tender status and where non-trivial sanctions can be applied to persons who insist upon discriminating against bad coin and in favor of good coin. In such cases all coins must be accepted by tale, and the employment of bad coin becomes a dominant strategy in what amounts to a "Prisoners' Dilemma" game in which both sellers and buyers participate. Buyers, knowing that sellers must accept either good and bad coins at their official face value, offer inferior coins, while hoarding, exporting, or reducing better ones; sellers, anticipating buyers' dominant strategy, price their wares accordingly.
    The significance was that a government could not attempt to control exports of gold by debasing its currency, and it could not do it by developing an exceptionally strong currency. (In theory, a very dependably excellent currency would eventually pay for itself in increased seigniorage, but getting there would ruin law-abiding citizens holding bad coins at par). In the event, Elizabeth I did devalue ("decry") bad shillings, and this did create severe economic hardship for those who had heretofore obeyed English tender laws. The effect was to "harden" the pound, since there were now fewer pounds in circulation, but the recession more than offset this.

    "Offsetting Gresham's Law" refers to the inexorable increase in bimetallic fiat money in the expanding economies of Europe, 1600-1800. In such countries, the ratio of the lower-valued coins to higher ones was fixed by royal prerogative; but lower-valued coins were usually silver, whose value was [usually] declining relative to gold. This created a tension between the expanding demand for money and the state's strategic need for expanding gold reerves, which could only be expanded by an aggressive trade policy.
  2. The major military events in Europe were in 1832 (Anglo-Russian support of Greek struggle for independence; see Frank Smitha), 1848 (conservative reactions; see James Chastain's site), 1852-54 (Crimean War, preserving Ottoman Turkey; see Victorian Web introduction), the Risorgimento or Unification of Italy (Robert Avery, Victorian Web), and the series of German wars 1864-1870 (see "The Process of Unification," Professor Gerhard Rempel, Western New England College).
  3. Roger Middleton, Government versus the market: the growth of the public sector, economic management, and British economic performance c. 1890-1979, Edward Elgar Publishing (1996), p.90-91, cited in Martin Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799-1914, Cambridge University Press (2007), p.40.
  4. Marc Flandreau, Carl-Ludwig Holtfrerich, & Harold James, International financial history in the twentieth century: system and anarchy Cambridge University Press (2003), p.95ff. Prior to being corrected (20 Oct 2010), this paragraph alleged that France "defaulted on its sovereign debt." This was an error for which I apologize. France has not defaulted on its debt since the Revolutionary Epoch, a fact noted by Carmen M. Reinhart & Kenneth Rogoff in This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press (2009), p.88.
  5. For example, President Charles de Gaulle of France leveled this allegation in 1965.
    In 1965, de Gaulle also attacked U.S. monetary policy. The American deficits, he charged, were exporting inflation to Europe, In his celebrated press conference that dealt with the monetary question, held on February 4, de Gaulle attacked the whole currency reserve system. By permitting endless American deficits, he argued, the system was unsound as well as unfair... Under the gold exchange standard, American deficits that other countries were expected to hold made those countries, in effect, America's unwilling creditors. This involuntary extension of credit coincided with heavy American direct investment abroad. Certain countries were thus experiencing... take-overs that they were themselves financing by holding the surplus dollars.
    Robert O. Paxton, Nicholas Wahl, De Gaulle and the United States, Berg Publishers (1994), p.242-243. De Gaulle was advised by Jacques Rueff, an enthusiast of the strict gold standard. Point made in blue typeface was basic premise of Jean-Jacques Servain-Schreiber, Le Defi Americain (1968); ironically, Rueff and Servain-Schreiber represented opposite sides of the political continuum in France. See also Brian Reading, "International Monetary Instability since 1968" , Lombard Street Research (Nov 2008).

Sources & Additional Reading

Fernand Braudel (Siân Reynolds, translator), Civilization and Capitalism, 15th-18th Century: The perspective of the world, University of California Press (1992)

Sam Y. Cross, All About... The Foreign Exchange Market in the United States, Federal Reserve Bank of New York (1998), "Chapter 10: Evolution of the International Monetary System"

James Laurence Laughlin, The history of bimetallism in the United States, D. Appleton & Co. (1895)

Barbara Oberg. "New York State and the "Specie Crisis" of 1837" , Business and Economic History., 2nd Series, Vol. XIV (1985)

Lawrence H. Officer, "Gold Standard" EH.net (26 March 2008)

James Powell, A History of the Canadian Dollar (complete text online), Bank of Canada (2005)

Bruce Smith, "The Relationship Between Money and Prices" Quarterly Review, Federal Reserve Bank of Minneapolis (Fall 2002)*

* In order to read, right click link and select "save link as," then open in PDF reader.

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30 March 2008

The Gold Standard-1

There is actually a surprising amount of confusion about the gold standard, what it meant, where it was applied, and why it was eventually abandoned everywhere. In this post, I'd like to clear up what I regard as a few misconceptions about it. First, I want to point out that a brief introduction to the subject could easily fill a book of >400 pages. Therefore, I'll be linking to sources that substitute entirely for a detailed discussion. Chief among these is Lawrence H. Officer's 2008 essay, "Gold Standard."

The second point is that this post will be using some economic terms in unusual ways. These are:
  • Gold standard: currency regime characterized by commodity money; money is either physical gold (specie), or certificates matching some physical quantity of gold. In a gold specie standard, banks may issue credit but international balances of payments are restored by reductions in the deficit country's money supply, and concomitant reductions in the general price level (and hence a recession).
  • Gold exchange standard: currency regime in which paper money is in circulation, but the central bank maintains a fixed ratio of the national currency to gold. In some cases this may mean the monetary authorities maintain a "gold window" in which gold is bought and sold freely at a permanently fixed price.
  • Run on currency: a crisis caused by massive public sale of a particular currency. For example, in 1907 there was a panic during which investors demanded huge amounts of gold in exchange for dollars, bringing the US Treasury to the brink of illiquidity. In another case, viz., Argentina (2002), holders of australs demanded euros or US dollars, forcing the Argentinean currency board to abandon the peg of 1 austral = 1 US dollar. The risk of a run is especially severe when the authorities maintain an official peg.
  • Fiat money: a currency regime in which the value of the currency is fixed by the authorities by decree; there is a state monopoly on foreign exchange, and rates are likewise set by decree. In most countries where fiat money regimes are in force, commerce in gold is illegal or at least tightly regulated.

    In some cases, authors use the term "fiat money" to refer to any money whose value is not pegged to anything else, even when deep markets exist for alternative monies. Hence, the US dollar is called "fiat money" despite the fact that open markets exist for most other currencies and for precious metals. The US Federal Reserve is obligated to maintain whatever exchange rate it finds desirable through interest rates and reserves (Open Market Operations); it is "backed" by the productive potential of the United States, and not hoards of gold or silver. Nevertheless, most common usage insists that the US dollar is a fiat money, as if it were the Soviet ruble.
Prior to the Napoleonic Wars (1799-1815), paper money was rare and money mainly took the form of coins or or letters of credit. In marginal areas of European settlement, such as North America, paper money was used as script—as an IOU rather than legal tender.1 Subsequently, in the early 1700's, John Law was retained as a financial adviser to the French throne and introduced securities backed by shares in the Compagnie des Occidents, which were (in turn) given the status of legal tender for some transactions.2 In effect, Law's scheme leapfrogged the next 150 years of monetary evolution to create a currency based on a complex network of transactions. The scheme was a debacle.

A semi-modern scheme of paper money appeared in 1789 with true fiat money: the assignats, backed by land expropriated from the Church (also in France). This was badly managed and resulted in an episode of hyperinflation. It did lead to an interesting brush with totalitarianism when the state was obligated to use force to induce markets to accept the currency. The revolutionary government of the USA (the Continental Congress) issued negotiable bills of credit which bore 4% interest, called "Continental dollars." These also suffered from galloping inflation.3

The issue of coins in England was under the control of the Royal Mint, which had long fixed the pound to sterling silver (not gold).4 Owing to its peculiar economic relationship with the Continent, gold was overvalued in England and flowed to London. As a result, London was on a de facto gold standard by the 18th century, and an official gold standard by 1816. In 1821, Britain resumed convertibility of the pound (which had been suspended since 1797); it was now convertible to gold, not silver, and Britain remained on the gold standard to 1914. The USA adopted a bimetallic standard in 1792, which lasted until 1853/73.5 Spanish-speaking nations also mostly had bimetallic standards at some time during the 19th century. France had a bimetallic system from 1803 to 1865 (free coinage of silver ended in 1874).6

Between 1873 and 1898, most of the Western powers adopted a universal gold specie standard. Using the USA as an example: in 1879 the US adopted a gold exchange standard in which the dollar was fixed at $20.67/ounce of gold, and £4.24/ounce.
The “gold specie” standard called for fixed exchange rates, with parities set for participating currencies in terms of gold, and provided that any paper currency could on demand be exchanged for gold specie at the central bank of issue. The system was designed to bring automatic adjustment in case of external deficits or surpluses in transactions between countries, that is, balance of payments imbalances. The underlying concept was that any deficit country would have to surrender gold to cover its deficit, with the result that the volume of its money would be reduced, leading to lower prices, while the influx of that gold into the surplus country would expand the volume of that country’s money and lead to higher prices.
(Cross 1998)
The gold specie standard had permitted issuance of credit under rigorous accounting standards: banks were required to maintain large reserves, and the entire national banking system had supplies of reserves tightly restricted by each nation's system of accounts. Under the gold exchange standards set up between the Wars (1924-1931) and under Bretton Woods (1946-1971), national governments had a much less rigorous set of accounting constraints: they were obligated to maintain balances of payments such that they could defend pegs to gold (or, in the Bretton Woods framework, to the US dollar). The IMF existed to facilitate such defense provided national governments ran their fiscal affairs responsibly and avoided inflationary policies.

(Part 2)

  1. See Prof. Michael Sproul, "A Quick History of Paper Money and Banking" CSU Northridge (undated)

  2. John Law's scheme was actually very complicated:
    On 6 January [1718]... Law ...presented the overall plan to solve France's dual crises, the monetary crisis and the financial crisis... To solve the monetary crisis he... recommended that the General Bank be converted into a state bank and that all transactions above 500 livres would be obligatorily made in banknotes. To address the problem of the financial crisis he proposed developing the Company of the West in such a way that the public would convert its state debt into equity of the company: 'and to form a powerful trading company whose shares would interest the public the capital of which would be subscribed in paper owed by the King would thereby be discharged of it.'
    (Antoin E. Murphy, John Law: economic theorist and policy-maker, Oxford University Press (1997), pp.176-177). Law was apparently surprised by the bubble in shares of the Company, whose tangible assets consisted of the then-undeveloped coast of Louisiana (p.216). Law had not only pioneered the speculative share, he also introduced the call option, which made the collapse of the Mississippi Bubble a profoundly complicated affair.
  3. For assignats, see Florin Aftalion (Martin Thom, translator), The French Revolution : an economic interpretation, Cambridge University Press (1990), p.65-173. For continentals, see Jerry W. Markham, A financial history of the United States, M.E. Sharpe (2002), pp.60-68.

  4. The pound was pegged to a pound of sterling silver by Henry II in 1158, but underwent a massive debasements under Henry VIII ('43-51, in which the silver content of pounds was reduced by 73%). Elizabeth I and her adviser, Thomas Gresham restored the silver content at great cost to the public.

    See Fernand Braundel (1992), p357ff.
  5. James Laurence Laughlin, History of bimetallism in the United States (1895; complete text available online at link); the periods of metallic standards are clearly indicated in the table of contents. Bimetallism requires that governments define the exchange ratio between the two metals; for the USA, this was 1 oz. Au = 15 oz Ag until 1834, when the ratio was boosted to 16. The real ratio in 1834 was 15.6 or so; gold was hence overvalued, and silver disappeared from circulation. In 1853, Congress adopted a de facto gold standard, in that it reduced the amount of silver in small denomination coins so that the silver content conformed to the market ratio relative to gold. The result was that silver coins resumed circulation, but price ratios were now determined by that of gold exclusively.

  6. William A. Scott, Money And Banking, Henry Holt And Company (1903)

Sources & Additional Reading

Fernand Braundel (Siân Reynolds, translator), Civilization and Capitalism, 15th-18th Century: The perspective of the world, University of California Press (1992)

Sam Y. Cross, All About... The Foreign Exchange Market in the United States, Federal Reserve Bank of New York (1998), "Chapter 10: Evolution of the International Monetary System"

James Laurence Laughlin, The history of bimetallism in the United States, D. Appleton & Co. (1895)

Barbara Oberg. "New York State and the "Specie Crisis" of 1837" , Business and Economic History., 2nd Series, Vol. XIV (1985)

Lawrence H. Officer, "Gold Standard" EH.net (26 March 2008)

Bruce Smith, "The Relationship Between Money and Prices" Quarterly Review, Federal Reserve Bank of Minneapolis (Fall 2002)*

* In order to read, right click link and select "save link as," then open in PDF reader.

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29 March 2008

Femto Cells

(via Lunch over IP)

There's Wi-Fi, there's Bluetooth, and there's now femto cells. Femto cells are a (currently rare) form of cell phone enhancement, in which a cell phone subscriber can receive a home "tower" to enhance reception (and possibly supply 3G services). As of this writing, Sprint has the only femto cell service in the nation, in Colorado.

The name is taken from the term for 10-15, or one quadrillionth. (The sequence is milli [10-3], micro [10-6], nano [10-9], pico [10-12], femto [10-15], and atto [10-18].) This corresponds to the various sizes of transmission cell:

Femto cells piggyback on broadband connections, are relatively inexpensive, and form a distributed high capacity network. Moreover, femto cells can provide coverage where ordinary cells cannot, in highly populated areas where propagation issues are a concern.

We can safely assume the main application of femto cells in North America will be to upgrade the primitive network to some form of European-style 3G functionality. But so far, the technology has been implemented slowly, probably because the initiative has to be taken by the phone user. Also, when your PCS provider advertises femto cells, there's a good chance users will wonder why they have to pay a premium for the basic level of service that subscribers could reasonably expect.

Sources & Additional Reading

Dimitris Mavrakis, "Do we really need femto cells?" Vision Mobile Blog (1 Dec 2008)

Ed Sutherland, "Femtocell FAQ: Is it time for your own 'personal cell-phone tower'?" Computerworld (November 2008)

"Femto Cells: Personal Base Stations" , Airvana (July 2007)

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19 March 2008

Import Substitution

Import substitution is a policy for stimulating economic development in which the immediate object is to stimulate the domestic production of items the country usually imports. An example would be an African nation whose authorities try to replace imports of furniture with local production of furniture.

The purpose of import substitution is manifold. First, a country may well be stuck exporting only items with a low value-added content, such as raw lumber. Such a country might have a ruling elite (indeed, it almost certainly would) for whom a large volume of foreign luxuries are imported, such as cell phones and motorcars. Such a country would suffer from chronic unemployment (with no industries) and current account deficits. The local currency would be worth so little that one could, for example, buy an immense amount of land with euros and expel the subsistence farmers living there, perhaps for use as a game preserve; or one could build a large, extremely polluting factory, contaminating vast amounts of the local groundwater. This was a common thing in the late 1950's, and naturally motivated a lot of independence struggles. But with foreigners or agents of foreigners owning virtually everything, independence was meaningless unless there was some way the local population could get out of debt to the foreigners. Hence, both development economists (in rich countries) and nationalists (in poor ones) favored import substitution because it incorporated a plan to pay the bills.

Another purpose of import substitution, mainly of interest to nationalists, was the development of a middle class. Underdeveloped countries suffer from a weak or nonexistent manufacturing sector, which means any middle class (urban professionals, middle managers, and small entrepreneurs) will be both small and wholly dependent on the government. Such a county will have no constituency for any public investment, no sense of national solidarity, and no civil society. The economy will consist solely of getting raw materials out of the country with as little obstruction as possible from anyone who happens to live there. As it happens, this is a problem endemic to underdeveloped nations and tends to be self-perpetuating.

There are two alternative concepts to IS:
  1. A generalized rejection of modern industry or economic growth; this usually takes the form of a decentralized insurgency;
  2. A neoliberal policy of export stimulation, in which the country's authorities foster existing industries as a comparative advantage."
Alternative one is usually an ad hoc reaction to colonial/neocolonial degradation or social collapse; I am not aware of any state actually adopting this as a policy (because states are inherently expensive and need development to exist); it's a philosophy adopted by conservative insurgents, such as Deobandis or Salafists.1 Alternative two is usually based on the doctrinaire application of abstract economic doctrines to policymaking, while disregarding plausible market conditions. It assumes that the demand for any good can expand indefinitely, provided its production becomes more efficient.

Kindred Concepts: The Developmental State

The policy recommendations for the expansion of a nation's economy take two general forms. One is based on the minimalist state, and is regarded as economically orthodox. It assumes that any nation has a comparative advantage in certain goods, and therefore will benefit by specializing in producing those things for which it is already strong. Accordingly, a country which already exports mainly raw lumber needs to focus on becoming better at exporting raw lumber. This may involve a favorable tax structure favoring investment in logging and barge loading, gutting of environmental regulations, and minimal government services. Economists usually advocate such policies regardless of a country's state of development.

The other policy recommendation is for a developmental state in which state revenues are channeled into some strategic program for economic growth. Developmental states usually include import substitution because a current account deficit or poor terms of trade pose the greatest threat to the less-developed economy.

The Decline of Import Substitution

Import substitution flourished during the 1950's through the 1970's. In regions where it was attempted, results could be categorized three ways.
  1. In countries with a ruling military establishment, such as Brazil (1964-1985), Thailand (1936-present, with interruptions), and Indonesia (1965-1999), import substitution mainly targeted strategic items such as weapons, metallurgy, chemicals, and specialized machinery. Some consumer goods were protected and pressure was applied to foreign companies to add some value domestically. This would be a source of illicit revenue for the ruling elites.
  2. In countries with a civilian political establishment, or those sharing power with the military, IS tended to target consumer goods, such as furniture and some electronic components (e.g., TV sets). The motivation was logical, i.e., it served the general economic needs of the nation rather than the narrow needs of the ruling elite. Over time, these industries stabilized and became competitive. When protection was withdrawn, the substitute industries survived.
  3. In countries with a very weak, precarious political establishment, such as many African nations, IS was determined mainly by urgent conditions; for example, where unemployment was a serious problem, IS targeted labor intensive industries like textiles. The preservation of local jobs was a form of patronage that became more valuable as the jobs themselves became more vulnerable. At a certain point, the regime was compelled to withdraw protection, and the substitute industries collapsed (e.g., textiles in Zambia).
These three distinct patterns have strongly reinforced older distinctions between LDCs. The contrast between regions with rising levels of wealth (China, India) and those with stagnating levels (much of Africa, Latin America) has become more pronounced largely as a result of IS being withdrawn as a viable policy option.

1 Salafism is usually referred to as "Wahhabism," after its founder; it is the state religion of Saudi Arabia. See "Salafism," Hobson's Choice. The Deoband movement that has come to dominate in Pakistan’s seminaries can itself be traced to the reformist Deoband movement established in 1867 in Deoband in Northern India. See Prof. Barbara D. Metcalf, "Traditionalist" Islamic Activism: Deoband, Tablighis, and Talibs," Social Science Research Council (2002?)

Deobandism and Salafism are closely identified with the Taliban of Afghanistan, Lashkar-e-Toiba, and al-Qaeda. Unlike other forms of radical Islam, the Deobandi and Salafism represent hard right movements in their respective societies: movements generally favorable to the established economic elites, if not their current political lackeys. They are also obscurantist and violently oppose developmentalist policies. It is my view that terrorist groups such as Lashkar-e-Toiba, et. al., are motivated chiefly by anti-developmentalism, obscurantism, and dread of a strong nation-state; and Islam is co-opted so that such ideologies can compete ideologically with earlier reformist movements such as al-Ikhwan Muslimun (Muslim Brotherhood).

Bruce G. Carruthers & Sarah L. Babb, Economy/society: Markets, Meanings, and Social Structure, Pine Forge Press (1999)

Susan Margaret Collins & Jeffrey Sachs, Developing Country Debt and Economic Performance: Country Studies--Indonesia, Korea, Philippines, Turkey, University of Chicago Press (1989)

Interesting subtopic:
A.C.M. Jansen, "The economics of cannabis-cultivation in Europe," 2nd European Conference on Drug Trafficking and Law Enforcement, Paris, (Sep 2002)

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15 March 2008

3G Generation

The automobile ultimately shuttled in an era when teenagers could go on dates far from watchful chaperones. And the computer, along with the Internet, has given even very young children virtual lives distinctly separate from those of their parents and siblings.

Business analysts and other researchers expect the popularity of the cellphone— along with the mobility and intimacy it affords— to further exploit and accelerate these trends. By 2010, 81 percent of Americans ages 5 to 24 will own a cellphone, up from 53 percent in 2005, according to IDC, a research company in Framingham, Mass., that tracks technology and consumer research.
"Text Generation Gap: U R 2 Old" New York Times (9 Mar 2008; via Textually)

Mostly the linked NYT article treats the advent of widespread intimate computing favorably, but it mentions issues like secretiveness on the part of teens towards their parents, contrasted with a keenness to publicize their intimate lives to the entire internet under pseudonyms. This is not really unusual or surprising, since people are naturally inclined to worry about what their parents will think of their pleasures and adventures.

While the NYT avoids falling headlong into the trap of moral panic, it does adhere to a set of shopworn clichéd surprise. Quelle horreur!
AS president of the Walt Disney Company’s children’s book and magazine publishing unit, Russell Hampton knows a thing or two about teenagers. Or he thought as much until he was driving his 14-year-old daughter, Katie, and two friends to a play last year in Los Angeles.


...The back-seat chattering stopped. When Mr. Hampton looked into his rearview mirror he saw his daughter sending a text message on her cellphone. “Katie, you shouldn’t be texting all the time,” Mr. Hampton recalled telling her. “Your friends are there. It’s rude.” Katie rolled her eyes again.

“But, Dad, we’re texting each other,” she replied with a harrumph. “I don’t want you to hear what I’m saying.”
If this surprises Mr. Hampton, he doesn't understand chordates, let alone, teenagers. Although I strongly suspect the journalist thought this would be a terribly clever way to begin a social trend story.
Baby boomers who warned decades ago that their out-of-touch parents couldn’t be trusted now sometimes find themselves raising children who — thanks to the Internet and the cellphone — consider Mom and Dad to be clueless, too.
Right, 76 million Americans born between 1946 and 1964 spoke with one voice and said, in rapt seriousness, "Never trust anyone over 30." No irony, no self-mockery, no humorous exaggeration. Moving right along, there's a serious paradox in the story that I think escaped the author. It's a human interest story about "technology," so naturally the journalist wants to interview the very most au courant people on the planet. But then she has to infer from her sample that they represent an oncoming wave--like comparing the demographic characteristics of Usonians born in 2008 to those born in, say, 1971. Observing that children born in 2008 are more likely to be, say, ethnically Chinese or Bosniak than those born in 1971 makes some sense; they are more likely to grow up in Hindu households or be exposed to heavy metals before age 5, may also be worth noting. But they're not more likely to be small, cute, chubby, gurgling cherubs than people born in 1971 were in 1972. It is a universal tendency of babies to be thus, and there's no need to make arch remarks about how kids today are forever soiling their diapers, and waking up at random times of the night to shriek, or whatever, because children born in 1971 did the same thing in 1972.

By the way, I picked the year 1971 because the median age of Usonians is 37.9 years. Also, I selected Hinduism because, according to the National Survey of Religious Identification, it is by far the fastest growing large religion in the United States.
Additional Reading (added 31 Jan 2009):

Judith Warner, "The Myth of Lost Innocence";


12 March 2008

Enterprise Groups: Notes

This post is dedicated to notes from Aoki & Patrick (1994; see "Sources" below). Note the book is now 14 years old and it's mainly of historical interest, since the Japanese financial system has experienced such drastic transformation since. For future reference, I have used the terms "business group" and "enterprise group" interchangeably.

The enterprise group (held together largely by the financial system) is not merely a Japanese phenomenon:
In Korea, for instance, the top thirty business groups, known as chaebols, accounted for 40 percent of Korea's output in the mining and manufacturing sectors and 14 percent of GNP in 1996. In Thailand, Malysia, Singapore, and Taiwan, business group affiliates [...] that were listed on these countries' stock exchanges accounted for 24.3, 24.9, 39.6, and 56. percent, respectively, of those exhanges' total market capitalization in 2002. Further, many East Asian business groups have a significant international presence.
(Chang, 2006-p.1)
My interest in business groups (or enterprise groups) arises from their great importance in economies outside of the USA. Except for the USA and a few other countries, enterprise groups have been the predominant means of business organization.

Since the 1997 Asian Financial Crisis, the Japanese galaxy of enterprise groups has been severely disrupted.1 Likewise, several of Korea's major chaebols have been sharply reduced in size and cohesion.2

However, outside of Japan and Korea, enterprise groups have been paramount to national development strategies.3 In most cases, this seems to reflect later "globalization" of the economy: while Japan went through a century-long period in which its economy was dominated by enterprise groups, it has now been a global trading nation for even longer and enterprise groups are in decline. Korea, likewise, experienced five decades of enterprise group-dominated development, which is gradually winding down. China's enterprise group experience dates back to 1987. India has long experience with enterprise groups, but South Asia is generally a special case; Russia's "oligarchs" are defined by their mastery of large industrial agglomerations similar to business groups.4

Japan and Korea (and Taiwan?) as B-Group Killers
While the most famous and powerful business groups in the world are from Korea, Japan, and Taiwan, several defining features of their host countries made them particularly vulnerable to reform. One was technical sophistication of the economies: Japan and Korea, dominated by high-tech industries, require transparent administration. The USSR could function with both a space program and opaque business governance because it didn't export consumer goods into competitive markets, and because it had vast natural resources. In some cases, a highly disciplined management and labor force can do without transparency, but eventually the bad decisions become insuperable.

In the 1980s, serious literature on the Japanese "miracle" acknowledged a distinction between effectiveness and efficiency: Japanese enterprise seemed capable of absolutely anything, provided cost was no object--and it never was. It was effective, but burned through resources. The export sector, in particular, was reliant on an indirect subsidy from the rest of the economy (in the form of a severely undervalued yen). In 1986-87, this subsidy was abruptly withdrawn, but instead of "market pressure" maneuvering Japan's economy away from exports, enterprise management "tried harder" against unfavorable winds. It broke into more technically demanding sectors by substituting capital for labor. Eventually the strain was more than Japan's industrial system could manage.5

The effect of endaka on Japan's kigyō shūdan was complex. First, Japanese firms were compelled to adapt to remain competitive, and most did--heroically.6 In other words, the firms became even better at their old jobs than they had ever been. It was the financial engineering required to make this possible that instigated the bubble.

Second, the firms faced with the bubble and the challenges it posed performed quite differently from each other. The onset of endemic financial distress (and great financial successes) placed fresh strains on the informal mutual assistance arrangements of the kigyō shūdan, while punishing keiretsu whose leading firms were loyal to 2nd and 3rd tier members. In effect, companies like Sharp, Sony, and Matsushita (which tended to keep production in Japan) lost out to companies like Mitsubishi Electric and Hitachi.7 And the informal mutual assistance arrangements of the Japanese economy tended to become more obvious as they were strained. They were more vulnerable to WTO complaints lodged by major trade partners.

Third, the financial system bore an unusually large share of the damage from the economic crisis.

  1. Lincoln & Gerlach (2004), Chapter 6; Lincoln & Shimotani (2009) is available online. The literature (including my article on enterprise groups) sometimes distinguishes between kigyō shūdan (horizontal enterprise groups) and keiretsu (vertical enterprise groups). Lincoln & Gerlach analyze the evolution and structure of the entire enterprise groups as interlocked. The decline of the vertical component was correlated with the decline of the horizontal one.
  2. Kim, Hoskisson, Tihanyi, & Hong (2004); Lee (2008). Chaebols in the Republic of Korea have never been comparable in size to the kigyō shūdan of Japan; they are closer in size (measured by assets, turnover, or employees) to keiretsu. Informal estimates suggest that the "enterprise group sector" in both Japan and Korea was about 40% of GDP, and this represented a more passive component of enterprise. For example, group affiliates were more risk averse (Lincoln & Gerlach, 2004, "The Structural Analysis of the Network Economy").
  3. For example, in Taiwan, see Chung (2003); Chung, incidentally, cites a far higher estimate of GDP-share for chaebols in the Republic of Korea (p.6) than the one I gave in the previous footnote. Here I will only say that I strongly suspect the lower figure is more accurate. For China, see Ma & Lu (2005) & Huang (2008), who also mention that qiye jituan in the PRC are almost entirely agglomerations of state-owned enterprises (SOEs).
  4. For enterprise groups in India, see Chakrabarti, William L Megginson, & Pradeep K Yadav (2007); for the Russian oligarchs, see Guriev & Rachinsky (2005). The first paper is critical of India's overall business climate, but concludes that business groups facilitate access to credit. The second makes surprisingly favorable judgments of the performance of oligarch-controlled enterprise.
  5. R. Taggart Murphy, The weight of the Yen: how Denial imperils America's Future and ruins an Alliance, W. W. Norton & Company (1997), "Coping with Endaka," esp. after p.198. "Endaka" is Japanese for "expensive yen," which it had become after 1986-87.
  6. Chikara Higashi, Geza Peter Lauter, The internationalization of the Japanese economy, Springer, (1990), "Endaka or the High Yen," p.184. Note the date of publication. Higashi & Lauter were impressed by managers' use of zaitech (financial engineering) to finance the massive technical investments required to do this.
  7. Megumi Oyanagi, "Japanese Global Electronic Companies – Why Winners and Losers?" Those in Media blog (2012). Readers will notice an anachronism here--Ms. Oyanagi was writing about winners and losers in 2011, whereas I am alluding to 1988-1995. But the general idea applies.

Sources & Additional Reading
" , Business History, Vol.51 (1): 77-99 (2008). Tests three alternative (and non-exclusive) motivations for the transformation of Chinese state-owned enterprises into business groups.

  • Sook Jong Lee, "The Politics of Chaebol Reform in Korea: Social Cleavage and New Financial Rules" , Routledge (2008)

  • James R. Lincoln & Michael L. Gerlach, Japan's Network Economy: Structure, Persistence, and Change, Cambridge University Press (2004). This is an exhaustive statistical analysis of Japanese enterprise structure during the high-water mark of the kigyō shūdan (1964-1997). One interesting feature (not discussed here) is the use of blockmodel (network clustering) analysis to determine the connectedness and benefits of various enterprise groups.

  • James R. Lincoln & Masahiro Shimotani, "Whither the Keiretsu, Japan's Business Networks? How Were They Structured? What Did They Do? Why Are They Gone?" Clans for Markets: the Social Organization of Inter-Firm Trading Relations in China's Automobile Industry
  • " ,Korea Institute for International Economic Policy, Seoul National University (August 2006)

  • Xufei Ma & Jane W. Lu, "The critical role of business groups in China" , Ivey Business Journal (May/June 2005)

  • Sea-Jin Chang, Business Groups in East Asia: Financial Crisis, Restructuring, and New Growth, Oxford University Press (2006)
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