Paul Krugman on Economic Hangovers

First of all, congratulations to Paul Krugman for winning this year’s Nobel Prize in Economics, I don’t think anyone expected him to win this year (with most people thinking that he would win after the end of a Bush presidency so that the prize would be entirely focused on his research work, not his political opinions) but I could not be happier.

Of course everyone is writing about him and why he is important now, but what better way to write about someone’s career than to dive straight into his work. Here is an excellent article from Slate on why ‘The Hangover Theory’ that recessions are a necessary part of the economic cycle that follow booms and must be accepted as they are makes little sense when examined more closely. Here’s an excerpt, but do read the whole thing.

The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn’t. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less.

Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore “sham” prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world’s depressed economies at this very moment.

More on Understanding the Surge

I recently wrote a post about the Surge of Troops in Iraq and here is a follow up post with an excellent explanation of why the Surge was so effective that should also leave no doubt that it cannot be simply transferred to Afghanistan as is (though I have no doubt military commanders are fully aware of this). The core point is again that the additional troops helped implement a series of policies but that they were in not the central reason why the surge was successful. Here’s how the Washington Post article put it (article via Tom Barnett):

How did Gen. David H. Petraeus do it? My answer? Bottom line, for the first time since the war began, a U.S. leader decided to address the political motivations of the Iraqi combatants. Petraeus convened a study group that shrewdly analyzed the raging sectarian conflict, then came up with what he called “the Anaconda strategy” to address the underlying dynamic.

I think this is crucial to understand – more than playing politics, General Petraeus took time to understand the different forces at play and why they were fighting and then developed a strategy to counteract this.

On how the insurgency was created (in addition to not having enough troops to secure the situation on the ground and control weapons stashes and the border):

[...] disbanding Saddam Hussein’s Baath Party and the old regime’s security services — had helped create the Sunni insurgency. They produced a critical mass of angry men worried that the Sunnis who had run the old Iraq would wind up on the bottom in the new one.

Larry Diamond talks a lot about the problem of the overly deep debaathification where most of Iraq’s soldiers, civil servants, teachers, etc. were fired in his podcast on Stanford on iTunes U. While removing top level members of the Baath party from the public sphere was clearly necessary, many others were solely party members to be able to keep their jobs under Saddam’s regime.

The importance of winning over the alienated Sunnis:

On June 2, 2007, Petraeus gathered his commanders and told them to engage with influential Sunnis and insurgents and persuade them to stop fighting. “Tribal engagement and local reconciliation work!” he said. “Encourage it!”
As the Sunni insurgents switched sides, they passed vital intelligence to their U.S. partners and paymasters, which enabled Petraeus’s forces to target Sunni holdouts, including diehards affiliated with al-Qaeda in Iraq. U.S. soldiers also employed new techniques to control the Iraqi population and provide for its safety and to identify fighters hidden among the civilians.

How this was achieved:

Why were so many Sunnis — insurgents and civilians alike — ready to respond to the U.S. overture? Because they were getting desperate and saw Petraeus’s outstretched hand as their best chance of surviving a campaign of sectarian violence and ethnic cleansing led by the Shiites and fueled by neighboring Iran. The secular Sunnis’ alliance with the jihadist insurgents had always been an uneasy marriage of convenience, and it broke up when Petraeus made a better offer.

On how Moqtada al-Sadr and his Mahdi Army were brought under control:

That move has been widely misinterpreted as a spontaneous, unilateral gesture; in fact, it came after months of military and political pressure. Iraqi special operations forces, backed by elite U.S. combat advisers, conducted near-nightly raids against the most extreme elements of the Mahdi Army.
That said, the intra-Shiite competition for power will persist for years; the trick is to channel it into politics, not violence — and to continue to make use of the competition between Maliki and Sadr.

An excellent read.

Dealing with Inflation

I found this excellent article on how to deal with the rise in inflation by Frederic Mishkin several weeks ago through Greg Mankiw’s blog and while the worsening financial crisis has shifted attention away from inflation worries I still think that it makes a very interesting point on how central banks should deal with the current spike in inflation:

It is certainly true that central banks should be worried about high headline inflation caused by high commodity prices. After all, households daily pay for energy and food items, and they are a big chunk of people’s budgets. But central banks cannot control relative prices for food and energy. When a cold snap freezes the Florida orange crop or a tropical storm hits the gasoline refineries along the Gulf Coast, monetary policy cannot reverse the resulting spikes in prices for fresh orange juice or for gasoline at the pump that lead to high inflation in the short run. Particularly volatile items like food and energy, which are included in headline measures of inflation, are inherently noisy and often do not reflect changes in the underlying rate of inflation, the rate at which headline inflation is likely to settle and which monetary policy can affect.

If the monetary authorities react to headline inflation numbers, they run the risk of making serious policy mistakes.

Monetary policy should not overreact to headline inflation. It can do little about the first-round effects of a rise in energy prices, which include both its direct impact on the energy component of overall consumer prices, and the pass-through of higher energy costs into prices of non-energy goods and services. But the Fed does have to worry about possible second-round effects associated with changes in the underlying trend rate of inflation. Such second-round effects are likely to be quite limited only as long as the rise in the relative price of energy does not lead to a rise in long-run inflation expectations. Here there is good news as well. Inflation expectations have remained quite well grounded during this recent spike in energy and commodity prices.

Excerpts from a Speech by Robert Gates

One of my strongest convictions is that proper security (and probably foreign) policy should be driven by pragmatism, not ideology. This is one of many reasons I am very happy with Robert Gates, the current US Secretary of Defense. Here are some excerpts from a speech he gave at Oxford (via Tom Barnett).

In short, I believe the statesman would be well advised to listen, in contrast to the Roman emperors whose man in the chariot whispered “sic transit Gloria mundi” – all glory is fleeting – to listen to those who simply whisper, “Sir, we’re not sure what the hell is going on here.” 

Today, we face a set of global security challenges that may be unprecedented in complexity and scope – presenting dilemmas that do not lend themselves to a simple choice between popular conceptions of Churchill and Chamberlain.

The period following the collapse of the Soviet Union and the end of the Cold War unleashed old ethnic, religious, and nationalist hatreds and rivalries that had been largely buried since the Great War: The ethnic and religious slaughter in the Balkans; Russia’s seeming return to Czarist habits and aspirations; the fault lines between Sunni and Shia in Iraq and across the Middle East. The cast of characters sounds disturbingly familiar even at a century’s remove.

And after talking about more threats and problems:

Still, even given the jaded disposition of an old spy, there are ample grounds for optimism. First and foremost is the extraordinary growth of political and economic freedom around the world since I last served in government 15 years ago. 

But to secure these remarkable gains, and protect our most vital interests and aspirations in this global environment, the next American administration, working with our allies and partners, will need to employ a pragmatic blend of resolve and restraint to deal with the threats that confront us.

The Surge

With the ongoing election there has been a lot of talk about the Surge in Iraq, mostly in the “They didn’t think the surge would work, bastards!” kind of way. I think that few people would look at Iraq today compared to Iraq 3 years ago and say that things have not improved. I think that very few people out there understand why and I think that understanding the reasons why the surge was successful is going to be extremely important in planning future military action. This has been something I have been interested in for a while and I’ll try to start writing more about this on this blog without veering into politics (which I like to avoid here).

I remember listening to experts around the time the idea of the surge first started circulating who mostly thought that it wouldn’t work due to a lack in sufficient number of new troops. If you compare the pre-surge numbers to the post-surge numbers (which I have to admit I don’t know exactly) you will see that the percentage difference is really not that great, mostly because more troops were simply not available. I think that everyone at the time already agreed that the proper way to go into Iraq (ignoring the question of whether that was a good idea) would have been with a number of troops comparable to what we had then to make sure that non of the instability started in the first place. AT the time of the surge it seemed difficult to fathom how a small increase in troops would be able to stop the insurgency that was then in full force.

I think this relatively small increase is crucial to understanding the actual process: most people think the surge simply meant ‘more troops’ and everything else happened magically. From my current understanding it was quite the opposite: a serious of new approaches that required more people to work but also meant changing the behavior of the troops that were already on the ground. David Petraeus’ counter insurgency manual gave the first indication of how one should deal with the problem and Tom Barnett points out two key reasons for its success:

The surge works for two key reasons, both of which couldn’t have been exploited to the point of solidification without additional bodies: 1) all Iraqis were tired of conflict and were looking for a way out: 2) the “awakening” due to al Qaeda’s over-reach. Fair enough.

Barnett then goes on to point out the lack of a ‘diplomatic surge’ on the political side to further help slow the insurgency and help American lives that I think points to a larger issue with US security policy:

I agreed with the logic of more troops (my SysAdmin-bias allowed me no other opinion). My problem with the surge was the lack of the diplomatic counterpart, now bequeathed to the next president, because I felt the lack of one meant—again—too many American lives needlessly lost and whatever gains we achieved logically held hostage to their neighbors and their willingness to wait us out and start trouble once we inevitably had to draw down, possibly making this whole success a complete illusion and thus wasting more American lives to no good end (not to mention those we waste in the future). 

The United States is fortunate to have an extremely capable military (with many brilliant leaders) that when faced with a new challenge/threat in the field is able to adapt to it and overcome it. David Petraeus deserves all the praise possible for fixing the military’s approach to Iraq, like many in the military he has done an exceptional job of taking a difficult situation and improving it. I think that US military commanders are generally very pragmatic once they are on their ground and troops lives are at stakes: they want to protect their soldiers and make their mission a success instead of worrying about particular ideological approaches. The real problem is what assignments and situations the military is given by its civilian leaders.

Barnett on Big Wars

I’ve been reading Tom Barnett’s blog since seeing his talk at PopTech last year. He is a military geostrategist and his blog links to a large variety of excellent articles from the New York Times, Washington Post, Financial Times, Wall Street Journal, etc. with brief commentary and is currently one of my main ways of discovering interesting articles. Barnett is a big believer in the US military’s need to transform itself to be better adapted towards small wars and ‘sysadmin work’ instead of the current (changing) focus on large wars with other global powers (e.g. Russia and China). I find the following comment to a McClatchy article on the need for big war capabilities the best explanation for why the US doesn’t need to worry too much about the big war capabilities of ground forces:

Here is the missing piece to this argument: America can impose its big-war willpower nicely with air power and air power alone. If we’re not going to own the aftermath, then we can just bomb, bomb, bomb and not care about what comes next. I can do that with air assets from Navy and Air Force. If I’m not going to put my ground forces at risk in small wars, why the hell would I put them at maximal risk in big ones?
If we are going to fight high-end, then it’ll be missiles and drones and high-altitude bombers and guided this and that. It will not be the Marines storming some beach en masse, nor Normandy with the Army. In short, we can have our SysAdmin green force and use it too, while maintaining an appropriate lead in the blue Leviathan force.

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