Thursday, April 29, 2010

"Fabulous Fab," E.J. Dionne and Marx

The devil and development, indeed.

Growing anti-market rhetoric deserves some answer. No one is seriously suggesting we shutter Wall Street, the danger is still reform being watered down, but rhetoric painting Wall Street's problem as greed and the complexity of derivatives a con man's sleight of hand could unintentionally distort the reformist agenda.

Hernando De Soto has shown that the majority of the world's poor are trapped because they are unable to leverage their own assets through capital markets and thereby provide themselves with the resources to start and expand small businesses. They're less victimized by globalization than left without access to the markets generated by globalization (by the way, microfinance isn't the solution to this problem).

E.J. Dionne argues "Fabulous Fab" is a living critique of unregulated capitalism. He's not wrong, but while making the argument he taps into an old, anti-finance current that is tempting to call populist, except that E.J. explicitly grounds it in Marx:

Perhaps Fab once read the Karl Marx who wrote: "The more abstract money is, the less natural its relationship to other commodities."

If money is an abstraction, the investment industry's creative inventions are abstractions of abstractions of abstractions. Banks no longer just give people loans to buy houses. Now Wall Street's geniuses -- and they are ingenious -- trade bizarre financial products in which the original loan is packaged with thousands of others and buried under piles of equations and economic gibberish.

One of the challenges encountered by the poor De Soto identifies is actually relevant to the current reform debate - access to information. Since many of the poor outside the formal property system property document ownership in idiosyncratic ways (e.g. oral tradition) without centralized collection and standardization of data (e.g. your real estate agent's Multiple Listing Service) they cannot take out an optimally designed loan on their property to invest in their own business.

That's right, we live in the internet age and the problem both the public and even Wall Street traders have is a dearth of information. The problem with the financial industry on Wall Street, the beating heart of global capitalism, is the lack of a proper market.

Since derivatives aren't traded on an open exchange no one can identify their objective value, leaving the Wall Street a Hobbesian world where the worth of a bond is contingent on personal trust in the issuer rather than clear market signals. This is part of why a large amount of financial capital hasn't resulted in more loans. And that's why reform legislation establishing an exchange is so vital. The marginal loss in "creativity" is worth it. Think of the exotic derivatives as equivalent to a bond on a property in Tanzania whose legal foundation is contingent on a Swahili oral tradition concerning ownership. If you don't speak Swahili, you probably shouldn't be getting involved. Reform legislation will allow investors to return to the market, and banks to make loans.


Tuesday, April 20, 2010

Bureaucracy and economic development (and yes, Afghanistan)

Reagan once observed that "the most terrifying words in the English language are: I'm from the government and I'm here to help." Turns out if you're trying to build a market economy the only thing worse than too much government is not enough, according to a study by Brown, Earle and Gehlbach.

Counterintuitively, their examination of privatized firms in post-Soviet Republics found that larger bureaucracies did better at creating an environment conducive to successful economic growth than smaller bureaucracies. Having enough bureaucrats to administer business permits and prevent power from becoming concentrated in the hands of just a few bureaucrats who can extort bribes at whatever price they choose turns out to be important.

Another finding may offer solace to your inner Jeffersonian. National-level bureaucracies did little to improve firm success. Having a reasonably sized bureaucracy at the regional and local level is what's important. Those are the bureaucrats that work most directly with small businesses, and are most closely engaged in constituent services.

If we look to Afghanistan we've reason to be supportive of much of the population (read constituent service) Gen. McChrystal and Amb. Eikenberry's population-centric strategy calls for. Bit of a leap? If we hope to make Afghans' lives better, we need to focus on - well, the Afghans themselves. It's a cliche by now, but higher employment reduces incentives for young men to seek their fortune with the Taliban.

The danger of this cliche is some make the leap that we could simply employ Afghans in work programs for less than the cost of our war effort there. Unfortunately that's untenable so long as the state, or a third-party enforcer like the U.S., is unable to protect the population from coercion. Think LRA-style child soldiers.

Typically only around 5% of a population takes active part in civil wars. Given how little it takes to upset the applecart, we should be sensitive to how big a challenge the stabilization project is, and how skeptical we should be that economic development alone can solve our problems in Afghanistan.

The National Solidarity Program (NSP) is an interesting experiment in improving both local governance and providing funding for local level programs that directly impact Afghans. Rather than foreign assistance being funneled through expensive contractors and foreign-national run NGOs, it goes directly from an Afghan ministry (there are pockets of competence within the government of Afghanistan) to locally-elected Community Development Councils (CDCs). CDCs are one of the few mechanisms for local governance that has escaped politicization by Karzai's government (though recent leadership changes may have endangered its independence). MIT's Andrew Beath is conducting an impact study that has found NSP to be an effective program in ways few other programs can claim.

For more on governance capacity-building in Afghanistan listen to the Institute for State Effectiveness's Clare Lockhart.


Friday, April 16, 2010

Balancing the National Security Budgetary Pie

How do we know when we've hit that "sweetspot" where we've adequately invested in our civilian foreign policy tools (e.g. diplomats and foreign assistance "carrots") versus how much we've spent on defense or homeland security. Unfortunately there's no complex quantitative model that can offer us a refined account of what that balance should look like - though considering the lack of trust we have in technocrats, that's just as well. Our best resource is looking at real world trends, and looking at simple investment metrics to give us a sense of whether or not 1) we need a course correction, and 2) whether or not we've achieved a course correction. This post deals with the second challenge.

It's helpful to look at changes in funding from one year to the next for the Department of Defense, compared to State and Homeland Security. It gives you a much stronger sense of how real world events impact the distribution of resources across our national security system, and how much political reality insulates budgets from real world requirements. By looking at whether one account gets a bigger bump in a given fiscal year, we can evaluate whether reality has kept up with rhetoric.

2009 was the first year where the increase to the State and International Affairs Budget was greater than greater than what DOD experienced, an important driver of which was the Obama Administration's supplemental request. Unfortunately the FY11 budget won't be accurate until we know how much money will appear in supplemental requests. But at first blush it appears the Obama Administration has taken seriously its own pledge to strengthen the civilian instruments of national power. What remains unclear is whether this will be sustainable in the face of the current economic crisis.

At a Congressman's fundraiser last month a donor asked, "how are we able to find money for Haiti on such short notice, when we still don't have funding for emergency communications systems back in the district?" A valid question, and one that will have to be answered by Congress as it handles the State Department and Foreign Operations bill this year.

In the graph above, if a data point is at "0" on the vertical axis, there was no budget change from the previous year. If it's at $20 billion, then the given department experienced a $20 billion bump up from the previous year. I highlight major events driving fluctuations in spending. For instance, the 2007 bump in DOD spending was largely driven by the "surge" in Iraq. The 1991 dip in DOD spending is driven by the U.S. government catching on to the fact the Cold War had ended.

Typically discussions of Defense versus State Department budgeting become difficult to parse because of the differences in scale. An Abrams tank or F-35 is simply much more expensive than a foreign service officer, rendering direct comparisons of DOD and State Department budgets slightly absurd. Visual representations of absolute spending levels or shares of the budget pie become insensitive to changing priorities, and fail to capture what's really going on.

By controlling for the base budget of previous years we begin to see how seriously different Administrations and Congress regard spending on State or the DOD. Since Secretary Gates announced that a "dramatic increase in spending on the civilian instruments of national security" was required in his 2007 Kansas State University speech, he has continued to advocate for a strong State Department and other civilian institutions to take on roles that the DOD hasn't built institutional competency in - reconstruction, conflict resolution, institution building, etc.

If we follow the money, we know we're not there yet.