This week we had several assigned readings - including chapters 11 and 15 from the text and chapter 5 from Sen and lastly, the Paper by Eichengreen on interest rates and capital flows. I will go through the Eichengreen paper in detail when we meet on Thursday, so for this blog assignment I would like you to comment on the interdependent roles of the state and markets in promoting development.
You may discuss anything from fiscal policy to rules of law to financial institutions - go for it....
In Barry Eichengreen and Ashoka Mody's paper "Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?" they seek to reconcile the disparity between the empirical and qualitative evidence that rising interest rates in developed countries, namely the U.S., negatively affects capital flows to developing countries. The qualitative evidence shows that when interest rates in the U.S. rise, the demand for foreign investment decreases, whereas the empirical evidence did not prove that thought to be true.
ReplyDeleteTo me it makes perfect sense that when interest rates are high in the U.S. people would clearly rather keep their money at home and earn a higher interest than to go abroad where the default risk is higher and the interest earned is equal or less. Unfortunately developing countries have very little control over U.S. interest rates because the Fed is obviously more concerned with the economy at home than the economies of developing countries. So I propose a potential solution. During times of low interest rates in the U.S. and high foreign investment, developing countries' governments should take advantage of the demand for their bonds and put away a portion of profits as reserve. If this economic plan is well thought out and executed, then they can provide a cushion of sorts for when U.S. interest rates fall and the demand for their bonds decreases. Therefore if and when U.S. rates fall, these governments could provide an economic stimulus to buy back their bonds during these times. They could use the reserves that they build up to finance this as to help to not increase inflation too much. This would be temporary because U.S. interest rates have historically fluctuated and most likely will continue to increase and decrease. If their is a time to start implementing a plan such as this, the time is clearly now as U.S. interest rates are practically zero. I'm obviously oversimplifying how this would work in practice however the general idea seems to make sense and could be effectively implemented if structured the right way.
Barry Eichengreen and Ashoka Mody use empirical analysis to show that the global credit conditions have had an important impact on the market for developing-country debt in their paper "Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?"The authors find higher U.S. interest rates decrease demand for lower fixed-rate issue bonds in developing countries, particularly in Latin America. The effect of US bond issues was also large for East Asian fixed-rate issuers, as they were best able to time their bond issues to coincide with favorable market conditions for bonds. The difference between Latin American and East Asian issuers is consistent with their overall development trajectories. It makes sense that higher interest rates in the US would decrease foreign investment in developing countries. Low rates in the US fueling investors to borrow in Japan to purchase high-yielding fixed income securities is an example of South East Asian states taking advantage of market conditions in a way Latin American was never able to.
ReplyDeleteSen also notes the important role of borrowing and advocates for financial prudence when thinking about macroeconomic instability. Sen's chapter indicated that there must be at least some link between the state and markets because the "state can continue to spend more than it earns, through borrowing and other means." Developing countries have little to no influence over the larger market for bonds and financial institutions, like the Fed. Given their relative lack of market power compared to developed countries, developing countries are subject to the market for the dollar, pound or yen when seeking to borrow and must work with the incentives created by larger institutions. Sen correctly identifies large systematic inflation as debilitating and counterproductive development goals. Although the Eichengreen and Mody’s paper explains that developing country's credit is dependent on interest rates in the US and other major economic powers, developing states and markets must work toward existing in harmony to promote economic stability and development.
As we see in Eichengreen and Mody's paper, "Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?", the state and market rely on each other when it comes to development issues. The chapters in the textbook and Sen’s commentary on market efficiency and effectiveness all point to the complicated interdependent relationship of the state and the market in development. Eichengreen and Mody give us a specific example- they analyzed what happens to cash flows (through bonds) to developing countries when interest rates in an advanced, industrial country are lowered. If there is less return on investments at home, lenders are likely to look elsewhere, thus leading to an increase in investment in developing countries. There was more of an incentive to lend to developing countries when recent structural and institutional reforms were in place there, Eichengreen and Mody reported. All of these factors show the complex relationship between state and market. As Eichengreen and Mody state, “you have to look at both blades of the supply-demand scissors” (23). This means looking at decisions from the perspective of the investor and the borrower, and the state can play very different roles in this shared market experience. Institutional reform, economic policy, availability to goods and services- all can have an effect on decisions made in the market. Sen points to the dependence of a fair market on many social and political factors. Participating in the market effectively means that fair opportunities need to be promoted by making sure that an advantage does not fall to a more powerful player because of inequities in information, knowledge, or regulation. All of these factors play a role in policy making, which is covered in great detail in the textbook. Effective policy has to take into account the deeply intertwined roles of the state and market, and many other institutions, or improvement in developing countries will be minimal.
ReplyDeleteI think that even the most laissez-faire economist will agree that the state has a role to intervene in promoting development in some instances of market failure. When no market exists due to high barriers of entry, there is a coordination or structural failure, monopolies thrive, or there are excessive externalities, it is often assumed the state will intervene to realign market forces. This mentality of necessary government intervention is a shift from the Washington Consensus of the 1980s to a more modern “New Consensus” way of thought. However, the text makes several interesting cases in which the government could actually cause or exacerbate market failure through intervention: if there is separation between the planning agency and real-life day-to-day happenings, over-ambition, a lack of supporting political will, or insufficient data, government economic policy could be for the worse. The trick is to ultimately determine, through the expertise of policymakers and the will of the public, a balance between respecting natural market forces and necessary government action.
ReplyDeleteSen, though recognizing the need for government intervention especially in the realm of providing public goods, makes an interesting argument regarding government’s ultimate policy goals. Should the criteria used to evaluate a goal reflect priorities of maximized utility, in terms of the traditional goal of market efficiency, or be restructured to take into account the expansion of individual freedoms? This view brings up the conflict between efficiency and equity in government policy (and in national values), but recognizes that recipients of government aid tend to “pay more attention to functionings and capabilities achieved (and the quality of life that goes with them) than to just earning more money.” This perspective challenges many current methods of devising and evaluating public policy that designs government intervention, especially in developing countries.
Barry Eichengreen and Ashoka Mody address the issue, explored by Todaro and Smith, regarding the impact of relationships between developing and industrial countries. Eichengreen and Mody’s article however, takes a different approach that addresses interest rates, willingness to borrow and lend, and capital flows relevant to development. The potential for LDCs to develop rests in the policy decisions of industrial countries. The US clearly makes financial decisions to intrinsically yield optimum gain; however financial decisions of the least developed countries are completely dependent on the status of current world market. The questions that this article raised consist of: How do interest rates affect willingness to borrow? What are the incentives behind lending and investing in developing countries? And what is the relationship between the world market and the ability for LDCs to develop. There is not ultimate consensus as to weather or not industrial counties interest rates positively or negatively impact investment in LDCs.
ReplyDeleteThere will always be a market for “creditworthy” borrowers, despite the status of the world economy. However, in order to achieve development in this realm, it is necessary to develop policies that provide assistance to developing countries regardless of the current status of the economy, willingness to lend or interest rate. LDCs cannot be completely dependant on the whimsical pattern of the economy because it makes it impossible to sustain growth. As important as it is to promote push factors to begin the process of development, it its vital to come up with a way to make LDCs independent enough to where they can sustain growth on their own no matter the current status of developed countries.
As stated in the previous five comments, Eichengreen and Mody address the discrepancy between qualitative and empirical analyses in terms of the effects of external financial conditions on emerging markets, specifically the impact of industrial-country interest rates on emerging market capital investment. According to the authors, they find more evidence of U.S. interest rates affecting emerging-market spreads than other recent studies. Unlike previous studies, Eichengreen and Mody attempt to reconcile the differences between qualitative and empirical analyses by noting that supply and demand responses vary by region and between fixed and floating-rate issues, pointing toward the idea that for these types of studies to be able to reveal market trends, they will need to be specialized to reflect the structural and market tendencies of each region or country.
ReplyDeleteIn terms of the role of government and the state and markets in promoting development, I side with Sen when he describes the the wide variance of difficulties and successes in development achieved by developing countries. According to Sen, this variance relate "the need for balancing the role of government--and other political and social institutions--with the functioning of the markets" (26). Ben Bernanke echoes this relationship in a recent article in The Wall Street Journal, advocating policy makers to relax policies inhibiting currency appreciation. Many developing countries "systematically resist currency appreciation as a means of promoting exports and domestic growth." The cost of this endeavor, however, is that whenever industrial countries (for example,the U.S. in the WSJ article), print money, developing economies with underappreciated currency are vulnerable to "imported inflation". In this case, the government should enact policies that would allow for the market to take care of the issue of foreign inflation. Exports might take a hit, but the developing economies will be more monetarily independent which I believe in the long run is a much more viable option. And the policy makers don't even have to completely reverse current policies to keep currency appreciation stagnant. I think allowing a moderate amount of appreciation would still allow for the promotion of exports and economic growth as well as putting the economy on the track to monetary independence. Given this example, it seems that the role of the state would be to promote policy that corrects for market failures and not necessarily to artificially create stabilizers.
In their article connecting the role of interest rates in industrialized, wealthy countries to capital flows to LDC's, Eichengreen and Mody utilize empirical data to explore the relationship between markets and the role of the state in development. The paper expands on the concepts also identified by both Todaro and Smith and Amartya Sen, and all three groups of authors seem to be agreeing on the complicated duality of both institutions. Through these writings we can see the need to balance the efficiency which markets can bring to economic exchanges with the potential for unequal access to those same markets.
ReplyDeleteSen expounds on this topic, specifically in relation to the labor market. He states the need to balance the role of governments and markets, emphasizing the need for government changes to effectively utilize liberalizing economic strategies. Sen uses examples such as India's market liberalization, where the failure of the government to make institutional changes in education has wrought a more "idealized" market but one that half of the population cannot fully participate in due to rampant illiteracy. Overall, these readings help to realize the complication associated with the relationship between markets and the role of government. All of the authors seem to agree on the conclusion that within this functioning of economic development there is no "easy answer".
Barry Eichengreen and Ashoka Mody’s “Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?” addresses the lack of empirical support for the claim that, “Qualitative accounts have long emphasized the state of global financial markets, as proxied by interest rates in the advanced industrial countries, as a determinant of capital flows to emerging markets and the pricing of external debt” (23). There is an ongoing debate over the push and pull factors of international capital flows, and Eichengreen and Mody examine both sides of this debate by assessing the effects of reform and interest rates on capital flow to less developed countries. Using Latin America as an example, Eichengreen and Mody credit the Brady Plan for attracting capital bank to emerging markers. In addition, “The boom in lending followed a decade in which Asian countries had implemented structural reforms, boosted domestic saving and investment, and moved strongly in the direction of export-promoting policies” (7). However, on the other side of the debate “A number of observers have noted that capital-flow reversals and emerging-market financial crises appear to coincide in time with increases in industrial country interest rates” (2). Going back to the example of the Brady Plan, there seems to be an external factor associated with the growth, as shown when Eichengren and Mody say, “capital flooded back to different emerging markets at more or less the same rate irrespective of the pace of domestic reform. This suggests that external factors, namely, declining interest rates in the major money centers, played an independent role in triggering the recovery of lending” (5-6). This logic does make sense because with high interest rates, investors are going to keep their money invested in their home country to earn better returns to it. But, once interest rates begin to fall, it would make sense to invest or lend to other countries.
ReplyDeleteArmartya Sen addresses the complimentary relationship between market mechanisms and reforms in his chapter, “Markets, State and Social Opportunity”. According to Sen, “The market mechanism…is a basic arrangement through which people can interact with each other and undertake mutually advantageous activities” (Sen 142). The problems that arise are usually from other sources including unregulated activities and concealment of information. These problems can; however, be resolved through policy reforms. According to Sen, “the provision of basic education, the presence of elementary medical facilities, the availability of resources that can be crucial to some economic activities call for appropriate public policies. Even when the need for ‘economic reform’ in favor of allowing more room for markets is paramount, these nonmarket facilities require careful and determined public action” (142-143). Sen sums it up best by saying, “The far-reaching powers of the market mechanism have to be supplemented by the creation of basic social opportunities for social equality and justice” (143).
The Eichengreen and Mody paper sheds light on the correlation between the market for developing countries' debt and interest rates in the US, particularly the fact that previous analyses do not measure the relationship in an accurate manner and that, once this change is accounted for,their research suggests that increasing US interest rates have a negative impact on bonds sold in developing countries. As they write, "An increase in US Treasury yields will raise spreads when it mainly affects the demand by investors for developing-country bonds, but reduce them when its main effect is to stimulate the supply." They acknowledge that the effects can change in relation to the regions of the developing economies (i.e. US interest rates have a stronger effect on Latin American bonds than East Asian bonds).
ReplyDeleteSen's chapter "Markets, State, and Social Opportunity" offers valuable insight into the complexities of broad development schemes. The inherent number and complexity of decisions made in each specific developing country studied is so great that no specific, uniform development formula can have an equally effective result on every country it is applied to. As Sen suggests, this complexity has, in part, led to the change in attitude from one of a "search for a single all-purpose remedy" to one along the lines of James Wolfensohn's "comprehensive development approach" that can, if needed, be tailored to specific countries and include "an integrated adn multifaceted approach" that works to develop multiple sectors rather than a single policy element or initiative. In the context of freedom and capability through which he frames his book, Sen compared these multidimensional economic approaches to specific "instrumental freedoms" that offer benefits through "their respective roles as well as their complementarities."
Both the Eichengreen paper and the chapter by Sen titled "Markets, State, and Social Opportunity," reinforce the idea that there is no "cure all" for world poverty. Even though this isn't the focus of the Eichengreen paper, he demonstrates indirectly that different regions respond uniquely to economic forces like interest rates. Similarly, Sen explains that existing conditions in a country have a significant effect on the type and magnitude of institutions that will be most effective at alleviating poverty. This is where respecting the relationship between market forces and state institutions is paramount. We all learned early in our study of economics that markets fail all the time. Therefore we cannot count on a purely free market to bring nations out of poverty. At the same time, institutions cannot exist in a vacuum. Markets need to exist for two main reasons. Sen emphasized the freedom of transactions that markets provide and Eichengreen showed that actions taken by an institution are transformed by the markets that the action affects. For example, the U.S. government sets interest rates on treasury bonds, but this action affects other countries borrowing decisions because of the influence of the U.S. as a money center. This effect differs in Latin America compared to East Asia because the two regions have different histories and prevailing characteristics. When creating development policy, it seems to be necessary to try and predict the state action's affect when interpreted through the existing market forces in a particular nation, given its strengths and weaknesses.
ReplyDeleteIn looking at the article, I agree with Mac in that it definitely makes perfect logical sense that when interest rates are high in the US there is no need to risk sending money and capital elsewhere. As the article authors state a few times, this is rather "intuitive" and from a theoretical standpoint it definitely follows a logical train of thought. As we have discussed in class however, the challenge here is to model this theory and I don't think I was completely convinced by their empirical work. To be honest, there were parts I didn't fully understand and I'm sure we will clear them up in class tomorrow and that will potentially change my mind, but I just didn't feel like the work was thorough enough. For example, the data set they used was over a 5-year period and across this time period there were only 1328 fix-rate bonds and 540 floating-rate bonds. This seems like a pretty small data set for such a significant and wide spanning study. Especially when you look at the country break down of these bonds, for example with Latin American having only 76 floating rate bonds across that period. That seems like a stretch to make credible inferences from that data set. Though again, I could be way off base and look forward to discussing it tomorrow.
ReplyDeleteOn the issue of interdependent roles of the state and markets in promoting development, like others who have already blogged I think this issue is definitely demonstrated the best by Sen. I particularly liked how he discussed the difference between efficiency and equity. Efficiency is something that we like the think the market would achieve by itself in a perfect world. We would end up at that optimal point where everything is perfectly allocated and we realize a situation of pareto optimality. As we have discussed in class, Sen notes that even though this idea requires some pretty significant assumptions, it still is a worthwhile model to study. Especially when we take this Arrow-Debreu efficiency theory and look at it from a freedom allocation standpoint. Of course here, we are using Sen’s definition of freedom. In this way, he notes that a “situation could be efficient in the sense that no one’s utility or substantive freedom can be enhanced without cutting into the utility of freedom of someone else, and yet there could be enormous inequalities in the distribution of utilities and of freedoms” (119). We have also devoted class time to discussing the dangers of income inequality, and this inequality of freedom is no different. This is where markets cannot work without state influence to promote development. The overlap between efficiency and equity is something the markets discussed by Sen cannot deal with if separated from the state.
In Eichengreen and Mody’s paper they begin by classifying the two groups of thought surrounding international capital flows. The first group is more internal, as in decisions within the country, involving “macroeconomic stabilization, economic liberalization, and enterprise privatization” (1). The other group, focused more externally, has ideas that revolve around interest rates in the creditor countries over international capital flows. Eichengreen and Mody determine that the evidence on the effects of creditor countries interest rates in lacking and this evidence is needed because it will answer key questions such as, does the success of a developing country depend on internal or external financial conditions or a steady balance of both.
ReplyDeleteContrary to other studies, Eichengreen and Mody found that U.S. interest rates do have an effect on emerging-market spreads. Additionally, the effects depend on the region and fixed- and floating-rate issues. For example, the economic transitions of East Asia and Latin America have differed greatly in response to the same changes in U.S. interest rates. Higher U.S. rates increase spreads on Latin American issues while discouraging new placements for East Asian fixed-rate bonds (4). Finally, Mody and Eichengreen link internal and external financial conditions. From 1989-1993, the Latin American economy made a complete turn-around. Capital was attracted back to the emerging markets for multiple reasons. First, tariffs and quotas were reduced and many industries were privatized. Second, U.S. interest rates fell by 50% between 1989 and 1992, which many claim brought half the increase in capital inflows. Therefore, developing countries should address timing with external financial conditions as well as create the best internal environment for capital flows.
In Amartya Sen’s piece he explains that, “the role that markets play must depend not only on what they can do, but also on what they are allowed to do” (120). This speaks strongly towards the interdependence of the state and markets. His argument extends his thesis that although we should not assume markets are associated with failure, it is necessary to critique the market system.
The various readings this week all give an important look into the crucial relationship between the state and the market in promoting sustainable development. I believe that these readings highlight the importance of the state's role in promoting policies that improve markets and grow the financial sector. This recognition of the state as a major factor in promoting economic growth and intervening in the markets is a relatively new understanding that separates from the previously revered Washington Consensus. The new understanding of development that recognizes the role of the state in the market is often referred to as the New Consensus. This New Consensus not only recognizes the state's role but warns of the possible negative effects governments may have on developing nations.
ReplyDeleteEichengreen and Mody examine this interesting relationship between not only the market and the government of developing countries but also between the interplay between developed and developing countries' financial markets. These authors show that global credit conditions have in fact had a very substantial effect on the market for developing country debt. In this paper the authors also attempt to explain why so many studies have overlooked the positive association between high U.S. interest rates and emerging-market spreads. This paper does a great job of helping us grasp the extremely globalized market that we live in today and the significant effects that our financial policy has on the global economy.
Finally, Sen brings up another interesting point. He argues that the state has a role to play in correcting the inconsistencies and injustices in a market economy but then asks the question, should we be focusing on simply improving utility when giving government aid or also on improving capabilities and functionings. Sen looks at the issue on a much more human level then some of our other readings and really seeks to address what we look to achieve when giving government assistance to other countries. It is important for governments to remember that when they intervene they must also have the quality of life of those they help in mind.
Eichengreen and Mody’s paper, “Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?” presents an interesting discussion on whether internal factors and institutions or outside interest rate environments lead to changes in capital flows. Contrary to some other papers, Eichen and Mody find that “that a rise in U.S. treasury yields consistently reduces the quantity of bonds brought to the market,” (4-5). In other words, changes in developed nations interest rates have an impact on the issuance of debt in less-developed countries. Particularly interesting about this is how the effect was not universally as strong but rather less indebted countries fixed rate bond issuance, particularly in east Asia, was more effected as those borrows could wait for more ideal conditions. One important discussion I thought the paper left out though was why would investors reduce lending to developing world countries in times of higher domestic interest rates if the spread remained the same and also there was not a focus on how the individual decision of investment are made. By that I mean institutional investors generally do trade solely on macroeconomic changes, rather each security is individually researched with investors seeking the highest possible return with the lowest possible risk. In theory then, as long as the “premium” for increased risk the rate may change but the spread should remain the same. This though brings in the discussion of financial rules and regulations and this may be one of the widest divides between develop financial markets and those still developing. For most developed world countries it is relatively safe to assume (except in exceptional cases such as Enron) that required financial reporting is accurate such an assumption is not always the case in developing nations. For example a few years ago it came out a fund former Treasury Secretary Hank Paulson was heavily invested in had a large stake in a Chinese timber company but it was disclosed that the forests the company claim to own property in did not even exists. With higher financial reporting standards developing countries may be able to avoid the increase in perceived risk of fraud.
ReplyDeleteThis week's readings dove into a macro approach to development by linking financial institutions and government policy to emerging markets in developing countries. Eichengreen and Mody's paper takes a look at development through emerging markets and the correlation to interest rates, inflation, and investments. I think an interesting observation of the Eichengreen and Mody paper is their analysis of the Brady Plan restructurings in Latin America from 1989 to 1993. It shows that even with government reforms (reduced tariffs and quotas, privatization, bringing inflation under control) to help the emerging markets, the capital that was attracted to these markets was attracted "more or less at the same rate irrespective of the pace of domestic reform". So is fiscal policy reform in developing countries really an avenue to take? Indeed it is when it comes to interest rates. The E&M paper looks at different cases of interest rates, how typically low interest rates in industrial countries encourage capital flows to emerging markets. The U.S. clearly plays a significant role when it comes to interest rates, as the interest rates affect investors' demand for bonds. The higher the US rate, the incentive to invest abroad (and encourage growth in developing countries) is reduced. But then higher interest rates are incentive for American investors to keep their money in the States which is good for our own economy but has negative effects on the economies of East Asia and Latin America. But as we adjust interest rates in the US, is our priority really worrying about the emerging markets in other countries? No, but maybe it should become more of a consideration when dealing with monetary policy.
ReplyDeleteAs is the case with many economic issues, the course of moderation seems to be the best choice when it comes to the optimal roles of the state and of the market in promoting development. As Sen points out, markets have followed the fate of other truths “to begin as heresies and to end as superstitions.” As the intellectual climate has changed in the past decades, markets are now generally praised without much consideration of their limitations or the qualifications that are needed for markets to function efficiently. Just as those in past decades dismissed markets without exception, it is important today not to dismiss either markets or the state as vital contributors to the development process, especially because the relationship between the market and the state is certainly very interdependent. For instance, Sen explains that economic liberalization policies can be very beneficial to many developing countries, but only if paired with the appropriate actions by the state. As we have discussed extensively in class, the role of capabilities plays an enormous role in the true development of societies and nations. The state is needed in almost every case to provide the appropriate institutions and resources necessary so that people can actually develop in meaningful ways. Even Adam Smith saw the need for nonmarket institutions to supplement markets. Although the “magic of the market” can actually do much in the way of development, in practice it must be supported and held up by policy of the state.
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ReplyDeleteIn his book, Sen attempts to identify the best role of the state in promoting economic development. He points out that government should design a plan that encompasses all major social issues to maximize the social benefit. Sen hints that governments might initiate a social commitment to ensuring baseline salaries or high levels of employment, provisions such as health care, education, and job training for the unemployed, impoverished, and disabled. These interventions are designed to supplement the market and correct its shortcomings. Sen wants us to realize that the social benefits of government instituted safety nets are crucial to overall economic development. These programs and initiatives coupled with the idea that markets should be prudently constrained. One such regulation that Sen details, is the manipulation of an interest rate ceiling.
ReplyDeleteSen calls for the participation of the state in these ways as well as others to compliment and assist the market in promoting economic development, as evidence he calls on the historical evidence from various countries in the past decades. He also furthers the ideas of the World Bank that a “multifaceted approach is needed” to instill progress among various issues that will complement each other and galvanize extended growth because the market fails to provide public goods such as education and health care that have social benefits that outweigh private benefits; therefore, public goods will be underinvested in and society will remain less than optimal. These social provisions are called to provide individuals with the capabilities necessary to live what Sen considers to be a dignified life.
Barry Eichengreen and Ashoka Mody explore the issue of capital flows to the south in relation to interest rates in the north. It seems very logical that interest rates would inversely affect capital flows to developing countries. When interest rates rise Americans are more likely to save their money and not invest it in other developing economies. The natural question that this paper addresses is, what is the role of government in a free market? Should governments step in to artificially lower interest rates for more capital flows? A free market needs to have government intervention in areas of promoting and enforcing contracts, competition, and information. In some situations this could include manipulating interest rates.
ReplyDeleteThis article got me thinking about comparative advantage and the reasons why price manipulation and interest rates are so important in todays society. It is important to remember the overwhelming amount of farmers, and unskilled labor who need to be protected by the American government. For example, Latin America is abundant in fresh produce but California farmers/lobbyist make sure that we do not overwhelmingly import from those countries because it would put American farmers out of a job. Even though the story of "comparative advantage" is that "everyone gains from trade", it is simply not the case.
The world gains, because Americans can buy avocados, bananas, or apples cheaper, Mexican farmers gain from higher demand, but Californian farmers lose. Americans have a competitive advantage in skilled labor and services. In theory, America should import all of its agriculture from other countries and export technical services but that is a hard case to make to farmers. My grandparents are two of the few actual farmers left in the United States. My grandfather used to always tell me that he "has his hand out to the government." They control positively or negatively the price and demand for his work. It is a hard case to make that we should do away with American farmers and rely strictly on the philosophical modeling of comparative advantage, when there are struggling Americans like my grandfather producing in this country.
As we know from principles of microeconomics, competitive markets tend to yield the most efficient results. However, even as Adam Smith recognized, the free market still provides the possibility of the "diminution in what otherwise would have been the productive funds of society." Sen interprets this more succinctly to mean "the possibility of social loss in the narrowly motivated pursuit of private gains." In these cases, the state has a responsibility to intervene on behalf of its citizens. Most economists seem to think that the state should take a utilitarian approach to this intervention, minimizing all forms of social costs and optimizing market efficiency. Sen, however, takes a different approach, which in my opinion is more on target with what the liberal democracy will strive towards. Rather than create policy aimed at market efficiency in terms of utilities, he argues that we should seek efficiency in terms of "individual liberties." In other words, policy should try to increase both the number of options individuals have and the attractiveness of those options. If we look at market efficiency in this way, the maximization of individual liberties, then many policies that may be very efficient from a utilitarian standpoint would not hold up. Sen uses slavery in the deep south as an example of this. I would argue that Nazi Germany also gives us a good example of a state that implemented policy that was very efficient from a utilitarian standpoint, but was atrocious from an individual liberty standpoint. By considering freedom to be the goal of policy rather than economic efficiency, I think Sen more accurately targets the preferred policies that a liberal democracy should implement to drive economic development. Such policies would be better targeted at reducing inequalities and promoting agency amongst groups with limited freedoms.
ReplyDeleteThe paper by Barry Eichengreen and Ashoka Mody represents a new way for me to think about the international flow of capital. The initial discussions of the two different camps provided a solid base for understanding the ideas floating around the current debate. Overall, the explanation that US/industrialized interest rates strongly influences the supply of lending to developing countries is appealing and the theoretical model makes sense. Upon a general glance, the international experience supports this US/industrialized countries dominance theory. In the early 1990s interest rates were extremely low in the US and lending to developing countries was at a high level; when the interest rates rose in 1994, capital quickly fled South America and came back to the US. This world experience for developing countries strongly encourages them to distance themselves from the US bond market. It appears that keeping the financial market of developing countries limited to outside exposure could help protect them from being held at the whims of modernized economies. Several prime examples of this are South Korea and Tawain.
ReplyDeleteAmartya Sen describes markets as another freedom people's lives. Though the effectiveness of a market has various factors. The state takes a role in helping to make these options attractive to consumers and sellers. They help the effectiveness as well as increases utilities for public use. The state controls the flow of capital because it can implement laws and regulations to markets and labor. Sen, like Eichengreen suggests “ in many countries in Asia there are persistent denials of basic freedom to seek wage employment away from one’s traditional bosses.”
ReplyDeleteThe textbook describes the six major functions important to the firms and economy as: “providing payment services, matching savers and investors, generating and distributing information, allocating credit efficiently, pricing, pooling and trading risks and increasing asset liquidity.” These correspond with the ideas carried throughout “Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?” Providing payment services correlates with Eichengreen‘s notions that there is a connection between the markets of East Asian countries and the U.S. market. “For East Asian fixed-rate bonds, in contrast, higher U.S. rates which make borrowing more expensive mainly discourage new placements. “ Thus, the implications of the effectiveness of the U.S. market effects the emerging world markets through the interest rates established and services offered.
The paper by Barry Eichengreen is a very interesting to think about based on the way I would normally have seen the ways in which markets correct themselves. This is because I would normally have seen the loanable funds market as an international market as a whole where the supply and demand for government bonds were measured globally. I would not have thought to measure the investment of individual government bonds separately. In Eichengreen’s paper, he shows us how all of these individual markets do effect each other. He does this by describing the way interest rates in the savings in one countries government will affect the interest rates in savings in another countries government, by changing the original model to incorporate a change in demand for loans in the other country. By doing this he is able to explain that the reason our data shows there is no correlation between interest rates from the first country to the second is that people are less likely to invest in other countries bonds for two reasons: 1) the risk tolerance is so low, that people would rather wait to invest until they see if the government is going to play a role in changing the interest rates before they invest, and 2) people as a whole know more about their countries markets than others, so they feel safer making a decision on whether to invest or not based on what they know more about.
ReplyDeleteDo U.S interest rates have impacts on Capital flows and interest rates in Mexic? The answer is seemingly obvious but the rationality behind this idea is not as obvious. In fact there are camps of people who believe that Mexico's interest rates and Capital Flows are internally determined. On the surface one should be able to reject this idea as international markets are not indifferent to changes in consumption and savings in other countries. For the interest rates of one country to have no effect on the interest rates of another country you would have to have a perfect market failure of information sharing where foreign and domestic investors are not aware of the difference. Since a basic model of loanable funds includes interest rates it should be clear to show the effect of supply and demand of loans based on interest rates ceteris parubis. As interest rates in the US rise interest rates in Mexico rise. However the demand for loans must fall because borrowing becomes more expensive. The total effect of this situation is to have Mexican interest rates fall is respect to the demand fall. This shows that the income effect of an increase in interest rates and the substitution effect essentially cancel each other out.
ReplyDeleteThe Eichengreen and Mody paper discusses the relationship capital flows and interest rates. When the interest rates are high in the developed countries, there is less demand for foreign investment in developing countries so less capital flow into them. This makes sense because there is less risk and more return from investing in developed countries than in less developed countries when interest rates in developed countries are high. This paper looked at internal bonds and found that global credit conditions have an impact on developing countries’ debt markets.
ReplyDeleteSen argues that developing countries need initiatives in public policy to create social opportunities. Public policy should be create some sort of education program, health care, land reform, and more, as can be seen in the wealthy developed nations now. These things will increase the quality of life and the expansion of human capabilities.
Earlier in the course, we considered the question, why is capital staying in developed countries instead of traveling to developing countries. This seemed rather counterintuitive, at least with consideration to basic economic theory (LDC- greater marginal returns with each additional unit of capital vs. HDC- diminishing marginal returns). However in the real world, we observe a growing income distribution gap between developing and developed countries. Eitchengreen and Mody correct for the failure of the loanable funds market model to conjoin empirical analysis with observed behavior. The relationship between supply and demand of the lending and borrowing countries are not complete codependent upon each other's behaviors. That is, a rightward shift of the demand for capital in the United States does not necessarily induce an increase in interest rates and decrease in funds because of a leftward shift in supply of capital. The model makes sense in that an incase in interest rates in the United States make savings and investments much more risky for domestic households. It is also attractive to mexican households because the US is less likely to default on the loans. Hence, supply in Mexico decreases because everyone wants to invest in the US instead. However intuitive this behavior is, the model cannot account for the lack of interest rate increase observed. Eitchengreen and body explain that the demand for capital in Mexico decreases in response to US policy because firms and the government exist the market, at least in the short run. This can be effective because firms do not have to pay a very high premium in order to attract investors. Or, this is damaging to the country's economic growth because firms may not ever go back into the market. The relationship between borrowers and investors is very volatile and without the right kind of structure (ie. government policy regarding foreign investments), a country may never develop at a quick enough pace to begin to narrow the gap. The country must decide its priorities: economic growth as strictly reflected in the numbers, development through improvement of human capabilities, access to public goods...
ReplyDeleteIn Barry Eichengreen and Ashoka Mody’s paper, “Interest Rates in the North and Capital Flows to the South: Is there a Missing Link?”, they analyze the issue of capital flows and the two groups that play a role. An example from the paper is the relationship between the interest rates on emerging market capital investments in the US and developing countries debt. The paper uses the example to show how previous analysis inaccurately measured the relationship between the two. Eichengreen and Mody showed that when measured properly one can see that as US interest rates increase there is a direct effect on bonds sold in developing countries. I found this example to be pretty logical because it eliminates volatility by investing in the US if the interest rates are high. I think that there needs to be a larger amount of information looked at, because as Sen talked about there are myriad of decisions and problems in each individual developing country. So there is no one way to tie multiple developing countries together because they each have their own decision making processes and specific goals moving forward.
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ReplyDeleteIt’s interesting to see, throughout the history, how scholars’ opinions have changed and developed on the roles of states and markets. The mainstream theory went from the “Washington Consensus” to the “New Consensus”, from one extreme to the other. After trials and errors, they recognize that understanding both government failure and market failure is crucial in disentangling the myth of development. Although finding the balance between the two roles of states and markets seems to be a pretty obvious solution (at least to me) rather than going for the extremes, the trick is to find out the how much and in what form they are taking place. It is not a easy task and requires high level of scrutiny, close observation of current situation and prompt reaction to changes.
ReplyDeleteThe article "Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?" is an interesting piece. The authors, Eichengreen and Mody, first presents two opposing but both seemly rational arguments over the question if the interest rate of the US influences Mexico’s loanable fund market and how. According to the classical model, the answer is yes for sure. But when econometricians run a regression on gathered data, it suggests that the coefficient is zero. Then the two authors come along and offer an alternative view. They think that both arguments are true in nature, but what really happens is that Mexico interest rate goes up after US interest rate goes up, and then demand for loanable fund in Mexico would also fall on a second stage in response to the rise in interest rate, because firms will postpone their investment plans. The decrease in demand would lead to a decrease in interest rate in Mexico, so the two effects on interest rate cancel out. That’s exactly what we see from the second regression model.
In his chapter “Markets, State, and Social Opportunity”, Amartya Sen discusses the balance between free markets and government intervention needed to provide for the highest level of social freedom possible, while maintaining financial stability and providing social opportunity for the disadvantaged. Sen mentions that although modern thinking favors “pure markets”, this thinking relies on numerous preconceptions that often go unchallenged, but in reality may need to be “partly rejected”. This context indicates that Sen sees a viable role for state intervention in maintaining market stability while providing for social opportunity. However, he points out that the solution does not lie with the camps who are staunchly pro or anti market, but rather in a comprehensive and multisided approach. This is for several reasons, namely that there are positive aspects to each position. For example, despite Marx’s opposition to capitalism, he recognized the benefit of an individual’s freedom to choose his or her employer. On the other hand, a pure market system which prohibits the social advancement of individuals is not desirable, leaving room for state intervention. However, Sen makes it clear that the role of the state cannot be so large that it increases the public burden to an unmanageable degree. He references Adam Smith’s favor of state sponsored educational systems because such a system is needed to improve the social, and ultimately economic, well-being of disadvantaged individuals. In this type of case, when intervention serves for the betterment of society as a whole without excessive public burden, then intervention is merited. However, the role of the state cannot go so far as to interfere with the “incentive system of an economy”. This type of situation might present itself when unemployment insurance is provided to the jobless portion of a population, but is so generous that it actually reduces those individuals incentive to seek out gainful employment.
ReplyDeleteIt is apparent that a balance must be struck between a pure market system and high levels of government intervention, but this a complex problem that requires a multisided approach. Given the tremendous national debt the United States faces, we might benefit from such an approach to address this issue. Unfortunately, the issue is as Sen describes, “multisided”, which has an astonishingly small place in the modern political rhetoric.
The global economic paradigm that is outlined in Barry Eichengreen and Ashoka Mody's "Interest Rates in the North and Capital Flows to the South" bring forth tremendous consequences for both developing nations and large money centers alike. First, the article gives support to Dani Rodrik's "Growth Strategies"- that traditionally progressive social and economic reforms, such as economic liberalization and privatization are only as effective as the prevailing circumstances allow them to be. For example, Cline and Barnes (1997) found that despite economic reforms, capital flight is dictated by external influences rather than domestic ones. Second, Eichengreen and Mody affirm the immense power of the interconnectedness of global markets. They use Japan as a prime example; Japan's economy, one of the advanced in the world, is buoyed not by domestic reforms, but rather by minuscule changes in bond demand from a country thousands of miles away. I found this to be the most powerful illustration of globalization. Finally, Eichengreen and Mody's paradigm seems to raise the question, "Does the US carry a burden to developing nations in shaping its fiscal and monetary policies? The volatility of capital flight has the ability to slow the US economy, but can hold much graver consequences for small nations. Increasingly, developing markets have designed contracts to prevent global investors from withdrawing funds when better opportunities present themselves. However, despite such regulations- I believe the US needs to increase its awareness of the serious ramifications for developing markets in Latin America and East Asia, that a slight shift in interest rates might bring.
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