The Return of Depression Economics and the Crisis of 2008

In what follows, I will be reviewing this book, written by the Nobel awarded economist, Paul Krugman. I will start with a short summary, I will continue with the main raised problems and then with a short reflection of my own on the book.


The main countries that Krugman focuses on are the following: Mexico (along with other Latin American countries), Japan, Thailand, Hong Kong and the USA.

Mexico


The emphasys of the book is on the "Tequila Effect". Just for the record, the name has nothing to do with tequila. What did lead Mexico into the crisis were the following factors:

• the industry had been developed by national companies
• high tariffs
• high barriers for foreign companies

These policies are wrong because a country needs foreign investment to grow, the era of isolated economies has ended a long time ago, now all the countries are interrelated. After a few years, Mexico did set a free trade zone with the USA and Canada. However, this put the country to a disadvantage as its national currency, the "peso" was very strong, making its exports expensive and imports cheap.

Therefore, Mexico didn't manage to grow, although between 1990 and 1993 there were massive capital flows. In 1994, to go out of the crisis, the country decided to devaluate its currency. However, when doing so, two rules need to be obeyed to:

• making the devaluation large enough so that speculators wouldn't go for a bigger decrease and cause it to devaluate even more
• the goverment showing that it is in control of the situation so as to reinstall confidence in the economy

Mexico failed to obey to these two rules and as a consequence entered the crisis. It was saved by the USA, with a loan of 62 billion dollars.

Japan

Japan grew rapidly from 1953 to 1973, as it changed itself from an agricultural country to an industrial one. This was due to a good system of education, a superior form of capitalism, the establishment of keiretsus etc. However, they made the mistake of deregulating the banks more and more, which allowed them to take more risks. This wasn't the reason why Japan entered the crisis. It was because of over-investment, an ageing population and the liquidity trap. Japan's economy wasn't able to respond the growth it experienced in production capacity, it had a gap between the retired and the labour market and finally people weren't willing to spend, even with a null interest rate. In the end, Japan managed to go out of the crisis through its exports.

Thailand

The case of Thailand's crisis is yet another one of confidence and speculation. When it devaluated its currency as a solution to go out of the crisis, it only reduced it by 15%, the final reduction being 50%. As an additional factor, what made the country bankrupt was the fact that its debt was in dollars (same happened to Argentina). What it did was change its exchange system to variable exchange rates and increase the interest rates.

Hong Kong

In 1998, Hong Kong had an expensive currency, as Japan and China were in crisis. Obviously, the speculators thought it would devaluate and acted accordingly. However, Hong Kong made them lose their money on their bet by getting money from the Hong Kong Monetary Authority.

USA

Krugman develops here on two main aspects: the stock exchange boom, caused by the dot com boom and the real estate boom, caused by the rating agencies.

Problems and solutions

In the analysis of the above mentioned countries, two main causes appeared: the confidence loop and the necessity of more regulation. What the first one means is that if there is confidence that an economy is going well, the financial markets will respond positively and this will influence the growth of the economy, which will feed even more the confidence of the stakeholders. However, if there are signs of problems and the confidence disappears, the financial markets will respond and the economy will suffer causing even less confidence for the stakeholders. 

The second cause is the lack of regulation of financial institutions that produced the crisis in the first place. The rating agencies took too much risk and led to the collapse of Lehman Brothers. Although it is difficult, it is essential to regulate whatever could lead to such an effect.

Finally, as Krugman is pro-Keynes, he suggests that more goverment spending is needed, as part of demand-side macroeconomics. That is to say, he advocates for the use of tools like interest rates, taxation and public expenditure. The other side of the coin is supply-side macroeconomics, which advocates for lowering barriers for people to produce goods and services (by adjusting income tax and capital gains tax).

Own reflection

I enjoyed reading this book and I recommend it to anybody who wants to get general Economics knowledge. From a writing point of view, I wasn't too fond of its structure. I think I would have liked the contemporary crisis to be better linked with the reasons for past ones. A comparison of the causes and solutions would have offered the perfect ending to the book. However, the book remains a good read.

Personally, I don't know which is the best solution to solve the crisis. I think that the situation is too complex and the world completely different to have a right answer. I do not doubt the capacity of analysis of these renowned economists, but I wonder their capacity to adapt to the world as it is today. I don't think it's in their natural instinct to use the Internet or communicate through Twitter. These might be trivial examples, but they do show a radical change in the competencies required nowadays. In addition to this, I am sure that these competencies are accompanied by certain expectations and behaviours. Therefore, creative solutions need to be found.

Finally, I promise to give this more thought and come back with another post about the best solutions to the crisis from my point of view. This post was just to review a book that I read and about which I would like to keep a summary.

Tasks for 2011

From now on, at every beginning of a new year, I shall be doing the following:

1. Read the predictions of "The Economist" for the upcoming year.
2. Read the book of the previously awarded Nobel prize winner, section Economics.
3. Read the book of the previously awarded Nobel prize winner, section Literature.
4. Set 2 target destinations to visit.
5. Update recipe book.
6. Update address book for sending postals.

Happy New Year, may all the worst be gone with 2010 and all the best greeted with 2011!!

Capitalism and current trends

In what follows, I will be talking briefly about the history of capitalism (a theoretical basic approach), what it is and finally some current trends.


History


The capitalist system has around 250 years. It has started with the Industrial Revolution in Great Britain, when there was a big step in production, by automatization. The fact that production was greater than consumption and that there was a necessity of raw materials, led to exports of surplus and imports of deficit.

In 1776, Adam Smith saw the need for trade and global markets, in order to keep a certain type of dynamism in production. About a century later (1866), Karl Marx defined the world as an ocean of products, claiming that there already existed a global market. In 1936, John Keynes stated that the capitalist system was in crisis, as there was not enough demand for the production back then. That was because capitalism offered the biggest capacity of production that the world had ever seen.

Characteristics of capitalism


The two main tenets of capitalism are competition and markets. First of all, there is competition between the firms, which determines a certain dance between them. What this implies (as a novelty to prior currents) is that labour is yet another asset that is sold and bought, its price being the salary. Second of all, markets are the main mechanism of capitalism. It is where products are sold and bought, where prices are set and where finally it is decided what to produce and what not to produce; what can be bought will be produced.

The question now pending is why is it important to study capitalism? Well, because most of the countries have this system and the ones that don't, trade with the ones that do have it. In order to study its evolution, I will be developing on trade, finance and production, which are its main drivers.

Trade


As far as trade goes, I will stick to a very basic description of it. I will be developing more on its importance in future posts on my blog. For the moment being, I will describe it as the exchange of goods and services. Somebody buys products cheaply and then sells them at a higher price. It becomes international when there are imports and exports to other countries.

Finance


Financing allows people that have financial resources to borrow to the ones that are in need of them. This way, it is possible to produce and consume. If trading is done without resources, it will be just an economic activity. Finally, it becomes international when the financial source is international (loans, bonds) etc.

Production


Production refers to the process of buying raw materials and turning them into something more complex. However, in order to obtain profits, firms need to go outside their domestic countries. This way, they can take advantage of cheaper labour, transportation costs, legal barriers and others.

Trends


Internationalization


The three drivers of evolution previously described (trade, finance and production) obey to this trend. They become more and more international, which is why I developed a little bit on them.

Cyclical Evolution


The economy has a cyclical evolution. That is to say, it obeys to the following stages: growth, detachment, recession and recovery.

Business concentration


This trend is centered around the idea that there are fewer firms and a lot bigger. This happens through mergers, acquisitions, agreements etc.

On the basis of the previously explained, I will continue with further topics that I will be analysing in more depth.

Keynes vs Friedman

This short article simply posts the contradicting theories of Friedman. I researched this yet again because I read the book of Paul Krugman (summarised here ), who is an advocate of keynesism.


In what way is contradicting Friedman Keynes' theories? His main concept is that the government should not intervene in the markets. He had many theories, but probably this is the one that opened a lot of debate. One of his other more famous policies was the monetary one. Based on the equation (MV=PT), he deduced that an increase in the money supply will result in an increase in prices. He is also famous for this phrase: "inflation is always and everywhere a monetary phenomenon."


Now, I think that inflation is not really a disaster. On the one hand, it helps labour market respond to the economy and on the other hand, it is a sign of progress.