The Dark Side of Brazil’s Economic Rise

Over at the Wall Street Journal, John Lyons delves into some of the economic challenges facing Brazil, including the strong real I mentioned yesterday:

But while foreign investment is mostly a good thing, there are downsides. The abundance of cash has helped fund riskier bank loans and fueled a potential real-estate bubble. By some measures, the Brazilian real is now the world’s most overvalued currency, and many local factories aren’t competitive in global markets.

Daily life has become so expensive that movies, taxis and even a can of Coke cost more in São Paulo than in New York. Rio de Janeiro apartment prices have doubled since 2008, and office space in São Paulo is suddenly more expensive than Manhattan. In many cases, investment banks must pay their Brazilian bankers and analysts more than they would get doing the same job in New York.

Some executives in Brazil fret that the cost of doing business has risen so fast that their country may be unable to become the manufacturing power it has aspired to be for generations. “Ever since I was a little girl I always heard Brazil was the country of the future. Now that the future is here, I am starting to fear it will be brief,” said Cynthia Benedetto, the chief financial officer of Brazil’s flagship manufacturing firm, Embraer SA, the world’s No. 3 jet maker. Embraer, a major exporter, says it is investing in equipment to lower its labor costs at home and opening more plants abroad.

If you are interested in Brazil’s economy, please read the whole thing.


A Synchronized Slowdown in Developed Economies

Which of the following nations recorded the strongest economic growth in the second quarter? France, Germany, Italy, Japan, or the United States?

This nice chart from today’s Wall Street Journal provides the answer (click for larger version):

The U.S. expanded at a tepid 1.3% annual pace in Q2, but that was still better than many other developed economies. Italy grew at a 1% pace, Germany at 0.5%, and France at 0.0%. And then there’s Japan, which contracted at a 1.3% pace.

The chart also nicely illustrates just how sharp the GDP declines were in late 2008 and early 2009.  Both Germany and Japan, for example, had quarters in which economic activity contracted at a 15% annual pace or more. By contrast, the worst U.S. quarter saw declines at “only” a 8.9% pace.

Spain’s 1575 Default

If all goes according to plan, the hoopla over the debt limit will soon recede. Policymakers and analysts will move on to the next new thing. And, sadly, some fascinating questions will forever go unanswered. For example, which president would appear on the trillion-dollar coin?

 But if you are up for one last article about default, yesterday’s piece by Christophe Chamley at Bloomberg is a good one (ht: Donald M.). Chamley recounts Spain’s intentional bond default way back in 1575:

Spain, at the time, was the world’s sole superpower. Contemporaries described it as an empire “over which the sun never sets.” Yet the king needed the cities’ consent to borrow at a reasonable rate. And he needed it for a reason: The cities collected the taxes.

Each of the 18 main cities of Castile levied a special tax earmarked for long-term debt service. The level of this tax was set every six years through negotiation with the king. Tax collections were used first to pay off local long-term bondholders, with the rest sent to the central government. The local long-term bondholders were, in large part, the elderly living in the area. So local taxpayers realized that if they didn’t pay, their parents would be hurt. Thus, this precursor to Social Security had an effective enforcement mechanism — the ire of the elders.

But the king could only exploit this confluence of interests so far. The Cortes set the earmarked tax rate by majority rule, and that limited the king’s issuance of what were, in effect, his AAA securities. The king also issued other bonds secured by other, non-earmarked revenue. These securities were of a lower grade and sold at lower price.

Thanks to Philip’s expensive military adventures in the Netherlands and the Mediterranean, Spain’s debt had reached half of gross domestic product by 1573. At that point, the cities balked at paying higher taxes. For the next two years, they refused to budge in their confrontation with the king.

Finally, in September 1575, Philip took a circuitous route to outmaneuver the Cortes. He suspended payments not on the long-term debt, but on the short-term debt, which was owed primarily to Genoese bankers. The people cheered. Resentment against bankers ran as high then as now — perhaps higher, because the bankers were foreigners. The upshot, however, was default and a full-blown credit crisis.

 And then what? Well, as Chamley recounts, it wasn’t pretty.

The Supply and Demand for War

Wars are becoming more common. Writing at History Today, Kathryn Hadley reports (ht: The Browser):

New research by Professors Mark Harrison from the University of Warwick and Nikolaus Wolf from Humboldt University has revealed that between 1870 and 2001, the frequency of wars between states increased steadily by 2% a year on average.

“Steadily” might be overstating it, but there is a decidedly upward trend in a graph of their findings (from this paper):

What explains this increase?

Economic growth and the proliferation of borders.

The effect of borders is intuitive: more borders = more potential conflicts. Doubly so, in fact, since the researchers define wars as between separate states. A new border can thus transform a civil war, which isn’t counted, into a war between states, which is.

But why would economic growth encourage wars? Because it makes them cheaper:

In Harrison’s view, political scientists have tended to focus too much on preferences for war (the ‘demand side’) and have ignored capabilities (the ‘supply side’). Although increased prosperity and democracy should have lessened the incentives for rulers to go to war, these same factors have also increased the capacity of countries to go to war. Economic growth has made destructive power cheaper. It is also easier for modern states to acquire destructive power because they able to tax more easily and borrow more money than ever before.

Mark Harrison concluded that: ‘The very things that should make politicians less likely to want war – productivity growth, democracy, and trading opportunities – have also made war cheaper. We have more wars, not because we want them, but because we can.

In short, wars are up for the same reason that our offices aren’t paperless: progress sometimes increases supply more than it reduces demand.

Avoiding Road Kill in Ghana

In Washington’s economic circles, the only animals we usually have to worry about are hawks and doves. (And the occasional raccoon or vole.)

If you’re doing development research in Ghana, however, things are more complicated.  Zipping from village to village on her motorcycle, my friend Liz has become intimately familiar with the behavior — often stochastic — of different animals when confronted with a moto rider:

Goats are the ideal animal to encounter on the road in Northern Ghana. Street smart and properly aware of their place in the road hierarchy, they will run away and off the road at the approach of a vehicle. …

While goats are the ideal animal to encounter on the road, sheep are bane of Ghanaian drivers. Dismally stupid, they will invariably run directly into traffic. … The difference in behavior between sheep and goats makes distinguishing the two a key survival skill in Tamale. Remember: tail up, goat; tail down, sheep.
If only it were that easy to distinguish the real budget hawks and doves.

Moral Hazard, Pakistan Edition

The United States can’t pursue al Qaeda alone. We need help from other nations. To encourage nations to provide that help, the U.S. created the Coalition Support Fund to reimburse coalition partners for the costs they incur fighting terrorism.

As Adam Entous reports in the WSJ, the prospect for such “reimbursement” creates an obvious incentive: our partners may exaggerate how much they are really spending:

The U.S. and Pakistan are engaged in a billing dispute of sizable proportions, sparring behind closed doors over billions of dollars Washington pays Islamabad to fight al Qaeda and other militants along the Afghanistan border.

Washington, increasingly dubious of what it sees as Islamabad’s mixed record against militants, has been quietly rejecting more than 40% of the claims submitted by Pakistan as compensation for military gear, food, water, troop housing and other expenses, according to internal Pentagon documents. Those records, reviewed by The Wall Street Journal, detail $3.2 billion in expense claims submitted to the U.S. for operations from January 2009 through June 2010.

According to the documents and interviews with officials, Pakistan has routinely submitted requests that were unsubstantiated, or were deemed by the U.S. to be exaggerated or of little or no use in the war on terror—underscoring what officials and experts see as a deep undercurrent of mistrust between the supposed allies.

Rainfall, Human Capital, and Democracy

To what extent do natural environments explain political development? A lot, according to a recent paper by Stephen Haber and Victor Menaldo. They find that rainfall and democracy go together like porridge and Goldilocks – to get democracy to flourish, it shouldn’t be too wet or too dry:

Why are some societies characterized by enduring democracy while other societies are persistently autocratic? We show that there is a systematic, non-linear relationship between rainfall levels and regime types in the post-World War II world: stable democracies overwhelmingly cluster in a band of moderate rainfall (550 to 1300 mm of precipitation per year); persistent autocracies overwhelmingly cluster in deserts and semi-arid environments (0 to 550 mm per year) and in the tropics (above 1300 mm per year). We also show that rainfall does not work on regime types directly, but does so through the its impact on the level and distribution of human capital. Specifically, crops that are both easily storable and exhibit modest economies of scale in production grow well under moderate amounts of rainfall. The modal production unit is a family farm that can accumulate surpluses. In such an economy there are incentives to make intergenerational investments in human capital. A high level and broad distribution of human capital makes democratic consolidation more likely.

ht: Roger K., who referred me to a recent Amity Shlaes column that cites this research.

Ode to Germany, a Mini-Song by Merle Hazard

Mini is apparently the new thing in popular economics. Tyler Cowen’s new mini-book is getting lots of attention from the blogosphere. And econ-crooner Merle Hazard has released a set of mini-songs about the European debt crisis.

Best so far is Ode to Germany:

For more, click on over to Paul Solman’s page at the PBS Newshour, where you can also find info about their lyric-writing contest.

Europe and the Financial Crisis

Over the New York Times Magazine, Paul Krugman has today’s must-read economics article on the fate of Europe. (Today’s in the physical world; it’s been up electronically for several days.)

Krugman walks through various ways that struggling Eurozone members might adjust to their ongoing financial crisis.

Along the way, he emphasizes a key point: American housing and mortgage markets were not the only cause of the global crisis:

You still hear people talking about the global economic crisis of 2008 as if it were something made in America. But Europe deserves equal billing. This was, if you like, a North Atlantic crisis, with not much to choose between the messes of the Old World and the New. We had our subprime borrowers, who either chose to take on or were misled into taking on mortgages too big for their incomes; they had their peripheral economies, which similarly borrowed much more than they could really afford to pay back. In both cases, real estate bubbles temporarily masked the underlying unsustainability of the borrowing: as long as housing prices kept rising, borrowers could always pay back previous loans with more money borrowed against their properties. Sooner or later, however, the music would stop. Both sides of the Atlantic were accidents waiting to happen.


The Economics of Al-Qaeda in Iraq

Follow the money. From Al Capone to Watergate and beyond, that’s been sound advice for anyone trying to understand the workings of shady organizations. In the latest installment, a group of researchers at the RAND National Defense Research Institute have analyzed accounting ledgers that document the activities of Al-Qaeda in Iraq (AQI) in Anbar province during 2005 and 2006.

In their new report, “An Economic Analysis of the Financial Records of al-Qa’ida in Iraq,” the researchers (Benjamin Bahney, Howard J. Shatz, Carroll Ganier, Renny McPherson, Barbara Sude with Sara Beth Elson, Ghassan Schbley) trace how AQI organized its activities, raised and spent its money, and compensated its members.

For example, they find that during this period, most of AQI’s resources in Anbar came from stolen goods, spoils, and car sales:

From June 2005 to May 2006, AQI’s Anbar administration raised nearly $4.5 million or roughly $373,000 per month (Figure 3.2). AQI in Anbar was financially self-sufficient. This is consistent with the concept of al-Qa‘ida’s franchising strategy as described by [Steve] Kiser (2005), who argued that al-Qa‘ida central provides seed capital to its franchises but pushes them to quickly become financially self-sufficient.

The group obtained more than 50 percent of its revenue from selling what appear to be stolen goods, most of which were highly valuable capital items, such as construction equipment, generators, and electrical cables. In contrast to what has been suggested in much news reporting, the data do not support the claim that the group was largely financed by selling stolen oil, as the revenue garnered from oil appears to be fairly negligible in the context of total group revenues at this level of administration (note that oil revenues are not shown separately in Figure 3.2 but are instead a small portion of the stolen goods entry in the figure). However, it is also entirely possible that oil revenues were garnered by one of the many Anbari AQI sectors that we do not have data on, as well as by the national AQI administration, which had a number of purported ministries and claimed to have a specific “oil minister.”

Another interesting finding: Al-Qaeda’s foot soldiers aren’t in it for the money:

Individual members of AQI made less money than ordinary Anbaris—AQI average annual household compensation was $1,331 compared to $6,177 for average Anbar households—but faced a nearly 50-fold increase in the yearly risk of violent death. AQI compensation included monthly payments for members and their dependents, as well as monthly payments to the families of imprisoned and deceased members. These latter payments constituted a form of insurance unavailable to civilian Anbar households, but still resulted in lower risk-adjusted expected lifetime earnings.