MIT Sloan Professor Simon Johnson gave a talk here at MIT today – with the cheery title of “The Next Financial Crisis.” Johnson, a former IMF chief economist who blogs about the economy at the Baseline Scenario website, wasn’t referring to a specific crisis he sees brewing right at the moment so much as systemic problems with the financial system that make another financial crisis, in his view, inevitable at some point.
In particular, Johnson mentioned a recent paper by Andrew G. Haldane, Executive Director, Financial Stability, for the Bank of England. Haldane wrote about the idea of a “doom loop” in the financial system. According to Johnson, the “doom loop” concept “is actually just another term for a cycle in which you have a boom, a bust and bailouts” — except the bailouts are done “in a sufficiently unconditional way” so that “the core structure of the financial system remains the same.”
The problem? Such a bailout may incentivize bankers to take excessive financial risks in the future. ”State support,” Haldane writes, “stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits.”
And the risk, according to Johnston, is that a future financial crisis could lead to a second Great Depression.
Johnson’s advice? Make megabanks smaller. He drew an interesting analogy to the development of antitrust law; in 1890, Johnson said, the idea of proposing a cap on the size of private business would have seemed ”ludicrous” in mainstream thinking. But then, over the next 20 years, Johnson argued, “we learned the hard way that having massive monopolies or trusts –as they were then called — develop was bad for society.”
Similarly, today, when it comes to the banking system, “I think we have to extend our thinking,” Johnson said.
Harvard economist Kenneth Rogoff gave a fascinating guest lecture at MIT earlier this week — looking at commonalities in a number of financial crises. Rogoff, who recently coauthored a new book, This Time is Different: Eight Centuries of Financial Folly with Carmen M. Reinhart, is a former chief economist of the International Monetary Fund. Together, Reinhart and Rogoff compiled a database looking at financial crises in 66 countries over a period of 800 years.
The biggest surprise that data revealed, according to Rogoff? The universality of financial crises. More specifically, Rogoff in his talk compared the current financial crisis in the U.S. to a number of other post-WW-II financial crises. (Interestingly, he pointed out, there’s little difference in the frequency of banking crises in advanced economies and emerging ones.)
Here are some of the features of the aftermath of a typical post-WW-II financial crisis, according to Rogoff:
• From peak to trough, housing prices go down a historical average of 35.5% in a financial crisis — and the duration of the downturn in housing prices is an average of 6 years.
• Similarly, peak-to-trough real equity prices drop an average of 55.9% — and the average duration of the downturn in equity prices is 3.4 years.
• The unemployment rate in the aftermath of a financial crisis goes up an average of 7 percentage points — and the duration of the employment downturn is an average of 4.8 years.
• In the aftermath of financial crises, central government debt often “explodes” in amount, Rogoff noted. On average, central government debt increases 86%.
Not a cheery picture overall. But Rogoff pointed out that it could be worse. Six to eight months ago, he observed, you could have worried with a straight face that we might have another Great Depression. But, Rogoff indicated, he thinks the chances of that happening now are small.
For more on Rogoff and Reinhart’s findings and analysis, check out this recent segment from The NewsHour with Jim Lehrer:
The nations of the world are in a “peaceful competition” to develop the energy technologies that will power the 21st century – and the nation that wins that competition will be the nation that will lead the global economy, U.S. President Barack Obama told an audience at MIT today. “And I want America to be that nation. It’s that simple,” Obama added.
Obama visited the MIT campus to deliver an address about American leadership on clean energy. In his speech about the topic, Obama evoked the pioneer history of the U.S., noting that the American people have always sought new frontiers. Todays’ pioneers, he suggested, include entrepreneurs, inventors and researchers. As a nation, Obama said “we have always been about innovation. We have always been about discovery.”
Obama noted that the stimulus bill represented the largest single boost in scientific research in history. He discussed the need to transform our energy system into one that’s far cleaner and more efficient – and said that transformation will be made as swiftly and carefully as possible. Obama said that the Pentagon has declared dependence on fossil fuels a security threat.
Too often, discussions of contemporary economic issues end up either overly simplified for popular consumption — or too jargony and technical to be followed by anyone but economists. A new book, Offshoring of American Jobs: What Response from U.S. Economic Policy? avoids both extremes — and instead finds an informative, nuanced middle ground on an important issue. This brief but thought-provoking book offers insights into economists’ thinking about offshoring.
In the book, edited by Benjamin M. Friedman of Harvard and published by MIT Press, two prominent economists –Jagdish Bhagwati of Columbia University and Alan Blinder of Princeton — debate the impact that the offshoring of jobs (particularly white-collar jobs, such as computer programming) will have on the American economy. (The book includes commentary from other economists, as well.)
Bhagwati complains of ”episodes of media frenzy” despite economists’ consensus about the benefits of free trade, while Blinder worries about the impact of offshoring of service jobs on the American populace and American politics. Here’s a small sample of what each has to say in Offshoring of American Jobs:
BHAGWATI: “In an op-ed titled ‘Technology, not Globalisation, Is Driving Wages Down’ in the Financial Times (January 4, 2007), I argued that the vast numbers of empirical studies…had shown that trade with poor countries had a negligible impact on our workers’ absolute real wages (as against the relative wages of the skilled and the unskilled)….The New Democrats who continue to believe nonetheless in this imaginary downside of free trade are not doing anyone any good.”
BLINDER: “I can’t help believing — and this is what makes me a worrywart rather than a relaxed, business-as-usual guy — that the gross job losses [from offshoring] in the rich, English-speaking countries will a) continue for decades, b) eventually be huge, c) pose a variety of difficult adjustment problems and d) dominate the political landscape for years.”
Whatever your own views on offshoring and its economic and political impact, chances are good you’ll learn something from the discussion presented in this book.
Here’s a sign of the times: McKinsey & Company’s ‘What Matters” site hosted an online debate about innovation — except both of the expert authors, Iqbal Z. Quadir and Robert Atkinson, agreed on the central topic of the debate: that Asia could become the world’s innovation center in the 21st century. (Quadir, who directs the Legatum Center at MIT and founded GrameenPhone, focused more on Asia’s strengths, Atkinson more on shortcomings in U.S. industrial policy.)
Meanwhile, Aneesh Chopra, the Obama administration’s chief technology officer, said in an interview this week with the San Jose Mercury News that he is concerned about the U.S.’s competitive position in technology innovation. Asked in the interview if he was worried about U.S. competitiveness in business and technology, Chopra responded: “Absolutely.”
Heard an interesting talk about energy innovation today by Charles Weiss and William B. Bonvillian, authors of Structuring an Energy Technology Revolution, a new book from The MIT Press. In their talk, Weiss and Bonvillian discussed the challenges the U.S. faces in achieving the kind of energy innovation needed to address climate change.
Some key points from the talk:
Americans have a “covered wagon culture” (think pioneers heading west to new territories) that, in innovation, involves finding open territory and creating radical innovations. We’ve got an economy that operates at the technology frontier, observed Bonvillian. Our innovation system does biotech — but we don’t go back and innovate in health care delivery.
However, innovation in a complex, established sector like energy is much more complex — and requires a different approach to policy, he said.
To address the challenge, the U.S. needs a public strategy for energy technology that should be very large in scale and scope — comparable to the Manhattan Project in scale and scope, but not in form or organization, Weiss said. Because energy technology involves innovation in an established sector, “you want to organize it around obstacles to market launch,” involve public-private partnerships and be as technology-neutral as possible, Weiss said. That, he explained, is rather different from the traditional “pipeline” approach to U.S. technology policy, which stresses basic research as the key ingredient to radical innovation.
Ready for an unsettling interpretation of the financial crisis? MIT Sloan School professor Simon Johnson’s new article in the The Atlantic is titled “The Quiet Coup.”His argument? As a former chief economist for the International Monetary Fund, Johnson observes striking similarities between the current financial crisis in the U.S. and earlier crises that affected emerging markets. One common factor, he indicates, is a too-cozy relationship between a country’s government and its business elites. Writes Johnson:
Elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.
The Role of Financial Innovation
According to Johnson, one of a number of symptoms of the financial sector’s political influence over the last decade was “an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.” In a speech last week, Federal Reserve Chairman Ben Bernanke addressed the relationship between financial innovation and consumer protection.
In his speech, Bernanke acknowledged that the last two years have shown that financial ”innovation that is inappropriately implemented can be positively harmful.” He later added that “the difficulty of managing financial innovation in the period leading up to the crisis was underestimated.”
Bernanke concluded that, rather than prevent innovation, regulators should allow “responsible innovation” that increases consumer welfare. How to do that? Bernanke suggested that regulators, in effect, weed out harmful financial innovation before it is implemented — by asking more questions upfront. (One example: ”How will the innovative product or practice perform under stressed financial conditions?” )
Reflecting on Bernanke’s speech, James Kwak, who blogs with Simon Johnson at The Baseline Scenario website, draws a distinction between two different types of financial innovations: those that make consumers’ lives easier — such as ATMs — and those that increase access to credit — which may or may not be beneficial, depending on the circumstances.
On the other hand, Kwak notes, many innovations — not just financial ones — have a “double-edged” quality – in that they offer both benefits and drawbacks. For example, he points out that the development of plastics has had great benefits — but has also led to problems such as “ an enormous amount of garbage that is now collecting in giant pools in the middle of our oceans.” (For more on that topic, see MIT Sloan Management Review‘s sustainability blog.)
Looking for a better understanding of the challenges facing the economy? In a sobering talk at MIT in February, Harvard professor Martin Feldstein gave his analysis, as did MIT Sloan School professor Simon Johnson:
U.S. Federal investments in basic research transformed life and commerce in the 20th century….The United States can anticipate comparable world-changing innovations in the 21st century if we adapt our education and research funding strategies to capitalize on new opportunities emerging at the convergence of the life sciences with the physical sciences and engineering.
However, Hockfield notes, fostering this wave of innovation will require changes — such as an increasingly interdisciplinary approach to funding research and to educating science and engineering students.
The report also suggests that while the United States ranked #6 among 36 nations and four regions considered, the U.S. is losing ground competitively, and ranked last in its improvement of its innovation capacity and competitiveness over the last decade. The report’s authors, Robert D. Atkinson and Scott M. Andes, write:
“Like an aging sports dynasty that has won the Super Bowl for many years but blithely ignores the rising performance of younger teams, many in the United States still persist in believing that the United States is number 1 and that it is its destiny to remain so almost irregardless of what it does.”
“Innovation arbitrage.” That’s a term John Kao uses in an article in the new issue of Harvard Business Review — to describe the way that companies can now parcel out their innovation activity around the globe, to locations with strengths in particular aspects of innovation. (HBR online subscription or article purchase required to read the full article, which is called “Tapping the World’s Innovation Hot Spots.”)
Kao’s analysis — and his description of various countries’ innovation strengths – is intriguing. Readers who live in the U.S. may, however, be discouraged by his description of four trends that are eroding the U.S.’s historical leadership position in innovation — including the fact that numerous countries now have explicit and systematic national innovation strategies.
On the other hand, things can change — and economic downturns can sometimes be a catalyst for change. Kao, who was formerly on the Harvard Business School faculty and is the author of Innovation Nation, praises Finland’s national innovation strategy — and notes that it was born partly in response to a “economic near-death experience” following the breakup of the Soviet Union, which had been a major Finnish trading partner.
Is bailing out banks and automakers bad for innovation? In an interesting new essay on lessons from the financial crisis, MIT economics professor Daron Acemoglu argues — among other things — that bailing out the financial sector, automakers and others “will undoubtedly influence innovation” and the reallocation of resources from less productive to more productive parts of the economy. Notes Acemoglu:
Market signals suggest that labor and capital should be reallocated away from the Detroit Big Three and highly skilled labor should be reallocated away from the financial industry towards more innovative sectors. The latter reallocation is critically important in view of the fact that…Wall Street attracted many of the best (and most ambitious) minds over the past two decades and we now realize that though these bright young minds have contributed to financial innovation, they also used their talents for devising new methods of taking large risks, the downside of which they would not bear….
In other words, the U.S. economy might be better off in the long run if some Wall Street wunderkinds changed careers.
Americans sometimes express concern about the country’s future capacity to innovatein science and technology. But a new survey offers at least one hopeful sign: 85% of U.S. teens surveyed recently by the Lemelson-MIT Program expressed at least some interest in science, technology, engineering and mathematics, and 80% feel that their school has prepared them to pursue a career in one of those fields, if they choose to. One big motivator: Protecting the environment. Thirty percent of students surveyed indicated that the idea of helping and protecting the environment would most inspire them to pursue a scientific/technology-oriented career.
But the survey also highlighted some obstacles. When the teens were asked what would most discourage them from pursuing a career in science, technology, engineering or mathematics the most common answer — chosen by almost one-third of the students — was not knowing anyone who works in those fields.
A recently posted video features Robert Malone, chairman and president of BP America, Inc., speaking during an October visit to the MIT Sloan School about the need for a comprehensive national energy policy for the United States. Interestingly, Malone, who covered many topics, included in his talk a discussion of the benefits of placing some type of price on carbon dioxide emissions.
Noted Malone: “Until every producer and every consumer knows the cost of carbon, then the uncertainty with planning and investing in all kinds of energy projects is going to remain high. Pricing carbon will make energy conservation a lot more attractive, and it’s going to attract dollars into the renewables….It’s also going to allow informed decisions about investments in fossil fuels — and it’s going to make us look hard at the technology that we use, because the ultimate goal will be to reduce the carbon impact of those fuels.”
Here’s Malone’s speech (the section on climate change and pricing carbon begins about 27 minutes into the video) :
Should any U.S. economic stimulus package include an emphasis on spending to promote innovation — such as investments in the country’s digital infrastructure? That’s an argument some are making, according to a recent article in The New York Times. One notable quote in the article was from an interview with Nobel-prize winning economist Joseph Stiglitz of Columbia University. Stiglitz observed:
Bailouts…are aimed at correcting the mistakes of the past, so they are backward-looking. We would be much better off spending our money forward-looking. If we spend $700 billion on new technology and innovation, we’d have a stronger, new, real economy. Up to now, the discussion has focused on the sectors that have been mismanaged rather than the sectors that are creating our future.
Transparency, accidental innovation, trust, collaboration — as sustainability affects how the world works, so will it affect how business works in the world.
The nations of the world are in a “peaceful competition” to develop the energy technologies that will power the 21st century – and the nation that wins that competition will be the nation that will lead the global economy, U.S. President Barack Obama told an audience at MIT today. “And I want America to be that nation. It’s that simple,” Obama added.
