Mr. President, Please Meet Professor Clark

30 01 2014

In his State of the Union Address, President Obama vowed to do more to fight the growing gap between rich and poor and falling rates of social mobility. There is, of course, abundant evidence that the gap between rich and poor is widening in the United States, that inequality is more pronounced in that country than in other advanced economies, and that it is harder in the US for someone with poor parents to achieve social mobility that for poor children in other advanced economies. Inequality has been a hot issue ever since the rise of Occupy Wall Street.

With exquisite timing, the economic historian Greg Clark has published a book showing that social mobility is very limited even in the most redistributive welfare states. By searching for rare surnames in historic census and tax data in a variety of countries, Clark has been able to compare the rates of social mobility. He found that even in Sweden, most families have achieved little social mobility over the last few hundred years. People with noble surnames in Sweden still earn significantly more than the people with the most common surname (Andersson) despite economic upheavals such as war, rapid industrialization, and the emergence of a welfare state supported by high inheritance and income taxes.

The really interesting data in Clark’s book relates to China, which has seen a massive change in its social system since the Manchu dynasty was overthrown in 1911. After the Communist takeover of China, people of noble and merchant ancestry were frequently subjected to discrimination and even persecution that sometimes led to execution. There was a form of affirmative action for the children of peasants and workers. Despite this radical social engineering, people in noble and other pre-1911 upper class surnames tend to be wealthier than other Chinese. They have come out on top. There are, as of yet, no clear explanations for why inter-generational inequality persists despite huge changes in the social order and the outright confiscation of property.

It’s nice to see that the most economically and historically literate journalists have sought out Professor Clark. Matt Yglesias reported on Clark’s findings. Dylan Matthews of the Washington Post did a great interview with Greg Clark, which you can read online here. In the course of the interview, Clark said this about Sweden:

And that’s where Sweden’s system does provide advantages over the U.S.’s. They haven’t changed mobility rates, but they’ve changed the consequences, strongly, of ending up at various points in the distribution. It’s a much better place for people who end up at the bottom of the distribution.

P.S. There is some interesting data showing that the rate of social mobility varies considerably between US counties. As you would expect, the old slave states have low social mobility but some of the other findings shown on this map are harder to explain.

A Few Quick Thoughts About the Presidential Debate

4 10 2012

I don’t normally comment on electoral politics, since it isn’t my main area of expertise. However, I just want to put Obama’s performance in last night’s debate into some historical context. The general consensus is that his debating skills have deteriorated since 2008. There is, however, a fairly large body of historical research to show that presidential debates simply don’t have much on an impact on voter intentions.  Consider the data in this chart, which was recently posted on the excellent MonkeyCage political science blog.

U.S. presidential debates rarely change a candidate’s polling figures by more than the margin of error. With the possible exception of 2000, no debate since 1988 has had more than a trivial impact on voting intentions. (Support for Gore fell during the debate period in 2000, but there were other things going on in the campaign and the economy that may explain it_.

The only presidential debates that have really mattered were 1960, when the election was a very close and Kennedy’s superior performance helped to swing many female voters, and 1976, when Gerald Ford discredited himself by stating that the Soviet Union did not dominate the countries of Eastern Europe, a misstatement that made him seem ill-informed about foreign affairs.

The debates have produced a few memorable moments. Many readers will remember the 1988 debate when Michael Dukakis was flustered by a (really stupid) question by CNN anchorman Bernard Shaw.  Shaw asked Dukakis, who opposed capital punishment, whether he would continue to be against it if his own wife was raped and murdered. Dukakis, who obviously hadn’t prepared for this question, gave a poor response.

However, the  whole incident had little impact on how folks actually voted. The vice-presidential debates, which have been even more entertaining, have had an even smaller impact on voting intentions.

History of Bond Rating Agencies

30 07 2011

“I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

James Carville, Wall Street Journal (February 25, 1993, p. A1)

There has been a lot of discussion recently about the possibility that the United States might lose its triple-A bond rating as a result of the standoff between President Obama and House Republicans. For press coverage see here, here, here, and here. For blogosophere reaction, see here, here, and here.

Speculation about the results of a rating downgrade was fueled when Mohamed El-Erian, chief executive of bond trading giant Pimco, said that the debt-ceiling political crisis in the United States has hurt that nation’s reputation in the financial markets and that the loss of the triple-A credit rating would have dire consequences.

El-Erian wrote:

America’s already-fragile economic psyche and its global standing have taken a material hit. Forget about “animal spirits” for now. Instead, worry even more about an economy that is already having tremendous difficulty sustaining an acceptable growth momentum, and that already suffers from an unemployment crisis that is increasingly protracted in nature. Analysts will now scramble to again revise down their projections for growth, and up those for unemployment… America’s friends and allies are bewildered at what is going on here (and its enemies rejoicing).

Read more here.

El-Erian’s piece in the Huffington Post generated lots of discussion. There has, however, been relatively little discussion of the history of the agencies that issue these ratings.

An excellent paper by Richard Sylla on this subject is available online. Sylla is the Henry Kaufman Professor of the History  of Financial Institutions and Markets and Professor of Economics at the Stern School of Business in New York. Anway, here is the first paragraph of his paper.

When the business of bond credit ratings by independent rating agencies began in
the United States early in the twentieth century, bond markets—and capital markets
generally—had already existed for at least three centuries. Moreover, for at least two
centuries, these old capital markets were to an extent even ‘global.’ That in itself
indicates that agency credit ratings are hardly an integral part of capital market history. It
also raises several questions. Why did credit rating agencies first appear when (1909)
and where (the United States) they did in history? What has been the experience of
capital market participants with agency credit ratings since they did appear? And what
roles do agency ratings now play in those markets, which in recent decades have again
become global, to an even greater extent than previously in history.

As Sylla shows, it is entirely possible to have a lively bond market without rating agencies. Like many people, I am skeptical of the predictive value of bond ratings because they come from for-profit companies that have conflicts of interest that undermine their credibility. The 2008 Global Financial Crisis destroyed much of the reputational capital of these agencies. As we all know, the credit rating agencies granted very high ratings to dodgy subprime mortgage securities. As one observer pointed out, “a primary cause of the recent credit market turmoil was overdependence on credit ratings and credit rating agencies.”   Read more about the role of the rating agencies in the subprime crisis  here.

If the rating agencies turn on the United States government and downgrade its credit rating at this critical moment in the history of the American empire, it would be a rather ironic turn of events, since the global political clout of the bond rating industry is largely a creation of regulations put in place by American officials during the New Deal era. These regulations were strengthened in the 1970s, after which an increasing number of financial professionals were forced to use the ratings produced by a small group of government-approved ratings agencies. These agencies are known as “National Recognized Statistical Rating Organizations”. Read more here.

The NRSRO business is rather uncompetitive with considerable barriers to entry. As of 2011, American companies are allowed to use the ratings produced by just ten such agencies. See here. To the credit of the US SEC, which licences the NSRSOs, not all of these agencies are American. There is one Japanese firm and one Canadian company on the list, which shows that the Americans aren’t being protectionist here. In other ways, however, these agencies are remarkably homogenous in terms of their corporate structure and underlying business model. All are in the private sector. All of them are for-profit businesses. In all ten cases, the agencies make their money from payments from bond issuers rather than from the people who make decisions based on their ratings. (Holy conflict of interest Batman!)  None of these agencies is a non-profit organization and it is unlikely the US SEC would designate a non-profit agency staffed by disinterested volunteers as a NRSRO. For one thing, such an agency wouldn’t have the money for the required campaign contributions to members of Congress.

I have nothing against homogeneity in an industry if the industry is functioning properly. But it seems to me that in the NRSRO business, it would be beneficial to have some heterogeneity. Why not have a mixture of non-profits, profitable companies, and government departments issuing bond ratings?

Very few people actually believe that the rating agencies have much predictive power, so by themselves their ratings wouldn’t have much impact on investor behaviour. What makes the ratings produced by these agencies so damn important are US laws that require financial institutions to take the bond ratings produced by these agencies into account.

Here is an analogy. Suppose there was a notoriously unreliable weather forecaster who worked for a particular TV station. In the normal course of events, nobody would trust his forecasts. They make decisions about travel plans, clothing choices, bringing umbrellas, etc based on the weather forecasts on competing TV stations or some other method. But if the government passed a law saying that only the predictions of this one forecaster could be used to make decisions about, say, when it was unsafe for a scheduled flight to go ahead,  then this forecaster would have a captive market in the country’s airport and airlines. Moreover, if the weather forecaster had a financial stake in say, a particular airport, he or she might be inclined to say “Yeah, it’s ok to fly today” than would otherwise be the case. At the very least, there would be an obvious conflict of interest, since an airport loses money every day it is closed.

Image of a weather forecaster randomly selected from the Wikimedia Commons

At this point in the crisis, it would be worthwhile for all players and commentators to pay more attention to the history of the rating agencies and to financial history more generally. We should also think long and hard about why the ratings issued by these NRSROs matter so much.

Further Reading

Flandreau, Marc, N. Gaillard and F. Packer, (2009), “Ratings Performance, Regulation and the Great Depression: Lessons from Foreign Government Securities”, CEPR Discussion Paper 7328.

Goodhart, Charles A.E. (2008), “The Financial Economists Roundtable’s statement on reforming the role of SROs in the securitisation process”,, 5 December 2008.

Partnoy, Frank (2001), “The Paradox of Credit Ratings”, UCSD Law and Economics Working Paper.

Partnoy, Frank (2006), “How and Why Credit Rating Agencies Are Not Like Other Gatekeepers”, in Yasuyuki Fuchita, and Robert E. Litan (eds.), Financial Gatekeepers: Can They Protect Investors?, Brookings Institution Press and the Nomura Institute of Capital Markets Research.

Portes, Richard (2008), “Ratings agency reform”,, 22 January 2008.

How the Iraq War Weakened the USA: Lessons for Canada

1 09 2010

“The Real Cost of the War in Iraq: What seven years of fighting has done to American society”  is  the title of a recent article by historian Anne Applebaum.  She enumerates the obvious and non-so-obvious ways in which the war reduced American power, such as increasing the price of America’s oil imports. I think that her list in incomplete, but it is still a good article.

I thought that this bit of the piece is particularly relevant to Canadians:

America’s ability to organize a coalition has also suffered. Participation in the Iraq war cost Tony Blair his reputation and the Spanish government an election. After an initial surge of support, the Iraqi occupation proved unpopular even in countries where America is popular, such as Italy and Poland. Almost no country that participated in the conflict derived any economic or diplomatic benefits from doing so. None received special U.S. favors—not even Georgia, which sent 2,000 soldiers and received precisely zero U.S. support during its military conflict with Russia.

Canada got precisely nothing from the US for sending a similarly sized contingent to Afghanistan. Zero, zilch, nada.   It is true that the US has, so far, refrained from cancelling NAFTA, but Mexico’s NAFTA privileges also got extended as well, even though President Vincente Fox was a vociferous opponent of the Iraq War. Perhaps if the US were had  a parliamentary regime instead of a congressional one, there would be more commercial rewards for being an obedient ally, but under the current arrangement American economic diplomacy doesn’t seem to be connected to its military alliances.

It is clear that subservience to the US doesn’t pay. I’m not a Canadian nationalist, I’m a realist.  Sometimes subservience to our big powerful neighbour may be the practical thing to do, so philosophically I wouldn’t be opposed to offering up a token contribution of troops as a way of generating goodwill in Washington, provided it translates into some tangible benefit. Call me a poodle by convenience. But US foreign policy isn’t coherent. Canada wisely opted out of the Vietnam War and that had zero impact on our trade relations with the US.  British people now get fingerprinted when entering the United States, even though Tony Blair was a cheerleader for the US. Being a poodle isn’t terribly lucrative nowadays. This is one of the reasons why people in the British Conservative Party are now distancing themselves from the United States and no longer fond of the “special relationship”. See here.

Canadians should honour the memory of Jean Chrétien, who kept us out of the Iraq War. Lest we forget.

The cost of the Iraq War has been estimated at $900 billion. One of the broad lessons of economic history is that a country should hold down the proportion of money it spends on its military to an absolute minimum. In the business history field there is a big debate about why United States rather than European companies were able to dominate the world economy for much of the twentieth century. There is a general agreement that by say, 1920 or so, the United States had clearly overtaken the western Europeans in many technical and economic fields. American living standards were higher than those in the UK, the first industrial nation. By 1950, the approximate peak of US relative power, roughly half of the world’s economic output took place in the USA.  Why was this the case? Why do we drink Coca-Cola, an American invention and watch Hollywood films rather than consume equivalent European brands?

Scholars have provided a whole catalogue of reasons for the rise of US business. Some scholars argue that the slightly different form of company organization adopted in the US was the key to success. Other suggests that American culture is somewhat more supportive of entrepreneurs than British or German culture. Such explanations overlook the fact that Europeans periodically slaughtered each other and wasted vast sums on their militaries. Europe’s nationalists also ruined that continent’s economy by drawing tariff frontiers across it.  The US, in contrast, fought few wars and was one big common market. It did fight the Civil War, which was costly, but it only lasted a few years. The Indian Wars lasted a long time, but they were cheap to fight because they were fought against neolithic peoples.  Traditionally, the US was very skeptical of foreign wars. It did get involve in the two world wars, but only reluctantly and after great provocation. Millions voted with their feet in favour of the anti-militarism of the United States– hence Ellis Island.

Until two generations ago, Americans heeded the advice offered by George Washington in his 1796 farewell address:

avoid the necessity of those overgrown military establishments which, under any form of government, are inauspicious to liberty, and which are to be regarded as particularly hostile to republican liberty…

As a very important source of strength and security, cherish public credit. One method of preserving it is to use it as sparingly as possible, avoiding occasions of expense by cultivating peace, but remembering also that timely..

Observe good faith and justice towards all nations; cultivate peace and harmony with all. Religion and morality enjoin this conduct; and can it be, that good policy does not equally enjoin it – It will be worthy of a free, enlightened, and at no distant period, a great nation, to give to mankind the magnanimous and too novel example of a people always guided by an exalted justice and benevolence.

The great rule of conduct for us in regard to foreign nations is in extending our commercial relations, to have with them as little political connection as possible.

Good advice, by George.

Flash forward to 2010. The European Union, which is home of many of the companies that rival American ones, is fast demilitarizing itself. France and Sweden are just two of the countries which have abolished conscription in the last few years. Most Europeans were totally against the Iraq and Afghanistan wars and have punished politicians who supported them. European countries are cutting spending on their militaries. France is closing military bases in its former colonies in Africa. It no longer wants to pay for the luxury of pretending to be a great power. American firms and households, in contrast, have to shoulder the burden of the imperial ambitions of the Washington elite. The EU countries do, of course, have a lot of problems. For one thing, they squander an obscene amount of money on agricultural subsidies.  There are too many regulations that make it hard to hire young people. But you can say this about them– they are cutting spending on their militaries and are making it easier for people and goods to move around the EU. Historians should not make predictions, but if I had to bet money on whether the USA or the EU will be an economic superpower in 50 or 75 years, right now I would go with the EU, since they are getting the deep fundamentals right. As Canadians, we need to ask why Canada’s trade talks with the EU are stalled. Needless to say, we should be negotiating free trade agreements with other regions of the world as well– anything to reduce our dependence on the nation to our south. Sadly, progress on the proposed deal, called the Comprehensive Economic and Trade Agreement has been slow, in part because the government of Ontario has been foolishly obstructing the negotiations.

Applebaum failed to list one of the less obvious costs of the war in Iraq– loss of trust in government by the American people.  The discovery that there were no WMDs in Iraq had a devastating impact on Americans’ trust in their rulers. A recent poll found that only 21% of Americans believe that the US government has “the consent of the governed”. That is a shockingly low figure for an industrialized democracy.

I mention this point because I follow the literature on social trust and transparency. The basic message of much of this literature is that if people in a country think that their government has lied to them in the past, they will be distrustful of all politicians and all government agencies, from the Post Office to the local town council. I suspect that the rise of the Tea Party in the US and the revival of the old paranoid style in US politics  had something to do with the Iraq War, which has created a crisis of legitimacy in the United States.  Most Americans seem to think that George Bush lied his ass off about WMDs. It is not surprising that many of them think that Obama is also lying when he says that he is not a Muslim. This distrust can carry over into other areas of life– people makes folks less likely to trust their local cop, their doctor, and the random stranger they encounter in the street.

Another cost of the war is the intensification of anti-Muslim sentiment in the US, which had already been exacerbated since 9-11. Even though the leadership of the US has said repeatedly that the US is not at war against Islam, many Americans do not seem to have grasped the fine distinction between Islam and al-Qaeda.  It now appears that some in the US wish to imitate the Swiss minaret ban, since there are campaigns against mosque construction in New York (the famous Ground Zero mosque), Tennessee, and elsewhere. Needless to say, the crusade against mosques in the United States is being reported in the Muslim World, thereby reinforcing suspicions that the US is anti-Muslim. What a great strategy for winning hearts and minds.

Canadians should not gloat about the problems in the United States, since a strong, prosperous, tolerant, and cohesive United States is in our national interest. The Tea Party is a characterized by an intense and somewhat vicious nationalism, so I shudder to think what a Tea Party controlled congress might do to NAFTA.  However, if the US does continue to careen down the road towards an unhealthy amalgam of militarism, nationalism, religious intolerance and sectarianism, there may be a silver lining to the cloud for Canada. Rather than shoulder the burden of US imperialism and militarism, American companies and individuals may elect to move to quiet, peaceful Canada. The tax rates between Canada and the United States are pretty similar– the big difference is that in Canada your taxes buys healthcare for your workforce, while in the US it goes into aircraft carriers and the space shuttle and the like.

Elena Kagan– Commie Agent?

21 05 2010

The early life of Elena Kagan, Barack Obama’s nominee to the Supreme Court, has been put under the microscope by Republicans trying to find dirty linen.

Some conservatives have argued that Kagan’s undergraduate dissertation, which was on the history of the labour movement in New York City, should disqualify her from sitting on the Supreme Court.

Ronald Radosh, a retired history professor of conservative political leanings, has looked at Kagan’s thesis and concluded that the charges that it displays pro-Communist sentiments are bogus. In fact, Radosh reports that Kagan’s thesis shows that she was sympathetic to the non-Communist unions and hostile to the Communists who tried to infiltrate the labour movement. This suggests that Kagan was, at the age of 22 or so, a social democrat rather than a Communist, which isn’t surprising since she is being nominated by the Democratic president.

Radosh writes that: “As a historian who has read widely in socialist and communist history, and written about the topic myself, I found her thesis to be academically first-rate, based on a wide-ranging use of primary and secondary source material, with a thoughtful analysis and sound conclusions that derive from the evidence.”

Elena Kagan Meets Leonid Brezhnev On Top of Lenin's Tomb, Red Square, 1982.

You can read the entire thesis here, if you really want to….