Thanks, Dr.DeLong!

At the beginning of this month, Richard Posner published an extreme criticism for Christina Romer's prediction about the stimulus package. That article even questioned the ethical responsibility of Romer and some prominent progressive economists (Stiglitz's name was missing!!)

But there was a basic mathematical mistake in the criticism. Posner compared annual GDP with quarterly spending. Although I observed this, my inferiority complex did not allow me to publish this in my blog. After all, I am not a professional economist. I am an engineer who loves macroeconomics and in fact who loves anything that can be derived from reason.

On the other hand, Brad DeLong has no such inhibition to spot this flaw and other mistakes in Posner's article.

Posner is trying to get his readers to compare the number 5 (the percentage-point swing in the growth rate between the first and the second quarter of 2009) to the number 2/3 (the percentage share of second-quarter stimulus expenditures to annual GDP). He hopes that they will conclude that Christina Romer's claims are wrong because the effect is disproportionate to the cause: $1 of stimulus could not reasonably be expected to produce $7.5 of boost within the same quarter. But the stimulus money spent in the second quarter was spent in one quarter, so the right yardstick to use to evaluate it is not annual but rather quarterly GDP--stimulus spending in the second quarter was not 2/3 of one percent but 2.6% percent. And the level of production in the economy in the first quarter was not 6% but rather 1.5% below its level in the fourth quarter--the 6% number is not the decline from one quarter to the next but rather the rate of decline, how much the decline would be after a year were it to go on for four quarters. So the right comparison is 1.5% to 2.6%[1].

Posner is off by a factor of 16.

I am glad that my observation was right that Posner was wrong in comparing the annual GDP with quarterly fiscal spending. Thanks, Dr. DeLong for bringing it up.

Germany might loose two decades

A few days ago, I wrote an article on how Germany's current account surplus may help its economy. But a more careful analysis shows that its entire economy is grounded only on the exports and the domestic market is extremely week. This is not a good sign, if what they are looking for is a fast recovery. This is what happened with Japan in 90s. Here is Paul Krugman in an interview to The Guardian:

Germany has huge inadequacy of domestic demand. Their economic recovery in the first seven years of this decade rested on the emergence of gigantic current account surplus.

How is it possible that Germany, which did not have a house price bubble, is having a steeper GDP fall than anyone else in the major economies?

The answer is that they depended upon exporting to the bubble regions of Europe, so they actually got side-swiped by the loss of those exports worse than the bubble regions themselves got hit.

It's Germany on a global scale that is the concern. We worry about the drag on world demand from the global savings coming out of east Asia and the Middle East, but within Europe there's a European savings glut which is coming out of Germany. And it's much bigger relative to the size of the economy.

Germany can still get a better recovery, if it does not commit the mistakes of Japan, like inadequate fiscal stimulus, premature quantitative easing, etc. But Germany already did the first of the two specified mistake. And it is highly likely that it would do the second mistake in near future.

Bad news is, there is a big chance that Germany will loose two decades.

Cash for clunkers - Does India need one such scheme?

The US congress has approved the "Cash for clunkers" bill. Under this bill, the government buys in the old gas guzzling vehicles (both cars and trucks) for a reasonable amount and gives the seller incentive to buy new environmentally-friendly vehicles. By environmentally-friendly vehicle I don't really mean a hybrid car, but any car with a better mileage. This bill is based on the proposal made by the Princeton economist Alan Blinder, an year ago in the New York Times Op-Ed.

According to Alan Blinder, this scheme brings out multiple advantages. The most important of them: a cleaner environment, as we can get rid of the old polluting vehicles easily; an effective stimulus for the auto manufacturing industries, since the people who sell the old car usually buy a new car with a better mileage; reduced dependence on fossil fuels.

This scheme has been criticized by the University of Chicago professor, Steven Levitt:

If any vehicles are going to qualify under this program, I suspect it will be because enterprising people who already plan to buy new cars will go out and buy old junkers on the used-car market and then trade them in under the program. But those transactions won’t represent incremental new car sales; it will just be a way for people who were already going to buy a car to rip off the government.

One thing will happen: entrepreneurs will play the role of the middleman, buying old beaters and then reselling them to people who are about to buy new cars, skimming off a little profit along the way.

But of course, every scheme and every bill would have exploiters and scope for abuse. During the implementation, the US government has to bring in restrictions to ensure that some greedy miscreants do not cash in on this.

Now for the bigger question. Does India need one such scheme? The problem is smaller and different in India compared to the US. There has been a huge increase in the number of cars only after 2000, so there are not many gas guzzling cars on Indian roads. The graphs below (Courtesy: Automobile India) show the sales of cars in units after 2000, until 2006-07.



In 2007-08, the domestic car sales increased by nearly 12%. In 2008-09 the growth has shrunk to 3.44%, in spite of the 54% increase in the car export. So even though the Indian car industry needs a stimulus to catch up with its old figures, it is still better off compared to the rest of the world. Moreover much of our environmental pollution is attributed to the bad roads, adulterated petrol and clogged up traffic rather than the cars themselves.

What about trucks in India? There are still a lot of old, polluting trucks in India (I don't have any statistics to back this up. Readers, help). I would also assume that cumulatively trucks in India travel more miles in a year than all cars in India put together. So India can still introduce a Cash-for-clunkers scheme to encourage the truck owners to refurbish their clunkers. It would certainly help the truck industry and the environment. Additionally if the truck owners replace their clunkers with a new truck having a better tonnage, it would speed up the goods movements within India. With proper regulation, if India introduces Cash-for-clunkers scheme for trucks, I am confident that it would be welcome by environmentalists, All-India Interstate lorry owners association, truck makers, and more importantly the citizens of India.