Tag Archives: political economy

Russia’s Economic Miscalculation

The continuing conflict between the West and Russia over Ukraine is beginning to cause a larger toll on Russia.  Putin is placing its global reputation ahead of its economy.  The Russian market plunged at the threat of new sanctions from the EU and the US while its currency hit a record low.  US politicians have recommended further sanctions aimed at Russia’s petrochemical and banking sectors due to increased violence among the Ukraine-Russian border.  Russia’s recent actions have been viewed as antagonistic and imperialistic these past few months.  Unfortunately, while it may appear that Russia looks strong, its economy is beginning to hurt.  Russia has already earmarked $7 billion for economic aid to give to Crimea.

As I’ve mentioned in previous posts, one of the key determinants of foreign direct investment and capital flows is political risk.  Russia’s actions and potential sanctions makes it an increasingly risky investment.  The Central Bank of Russia recently released a report stating that Russia had a capital outflow of at least $51 billion in the first quarter of 2014.  If the trend continues, Russia could stand to lose around $200 billion, or 1% of its total GDP.  The World Bank believes that Russia’s economy could shrink around 2% in 2014.  The confidence of Russia’s economy in Russia is deteriorating rapidly as well.  There has been an increase in emigration and the cost to import in response to Russian people’s lack of confidence in the market.  The fear of stagnation is extremely real with Russia’s low growth and high inflation.  Russia’s central bank at the beginning of April said that growth would most likely fall below 1% with the lending rate staying at 7% and the inflation rate at around 6.64%.  Unfortunately, Russia most chose between strengthening the ruble through high interest rates or lower interest rates in hopes of spurring growth.  Russia foreign policy has drastically hampered its monetary policy.  The large capital flight is due to the political risks and the central bank of Russia had to reply with higher interest rates in order to maintain some of the investment that it needs for growth.  The high inflation rate and high interest rate makes it difficult for the Central Bank to control inflation unless it wants to increase the interest rate further, slowing growth even more.  Russia’s low, decreasing growth increases the chance that Russia could face another recession.

Russia’s main hope in protecting their economy has been the gas they supply to the EU and Ukraine but as Russia raises prices, these countries begin to search for alternative options.  Ukraine recently stopped purchases of Russian gas and is actively searching for alternatives.  With the US becoming one of the largest producers of oil and gas, Ukraine could look to the West for help with its energy problem.

Russia’s actions right now provide a great case study about politics versus economics.  Russia is playing a political game right now and it’s drastically hurting its economy.  Interestingly enough, Putin’s approval rating is at 72% after the annexation of Crimea.  It will be interesting to see how high it stays as the economy continues to deteriorate and as the West increases sanctions.

 

Election Years, Inflation and Government Spending

Today I would like to discuss a relationship between election years, inflation and government spending. During class last week, professor Kimball was discussing the correlation between crime rates and the number of police hires. And he used election year as a third factor that positively  affect the number of police. Some political economist argue that it is not only the number of police, but the overall government employment and government spending. And the magnitude depends on which party is in power.

First of all, I would like to introduce two political economic theories. In his book “Political Control of the Economy” Tufte shows empirical evidence that there is a biennial government stimulus largely due to elections. He goes as far as to analyze the months right before the election, and sees statistically significant results of spending hikes in those months. Another theory is by Douglas Hibbs Jr. in his book “The American Political Economy: Macroeconomics and Electoral Politics in the United States.” Hibbs argues that right wing party will be more likely to control inflation during election years whereas left wing party is more likely to control unemployment. He also argues that controlling inflation and unemployment both going down is possible because senate and presidential election both take place in november. Therefore, the delay in heating up of economy will only show after the elections are over. The assumption in both theories is that voters are more likely to award / punish the most recent economic event

I am curious as to how much this would spill over in the face of senate election this year. Although the theories above have been validated with empirical data from 1940 to 1980 for Tufte and from 1950 to 1989. Sure, there was an oil crisis in the middle, but with the recent recession and the recovery, how much of these control might we see? I conjecture that there is no need for too much politically motivated control. US economy has been recovering steadily as seen in many past posts that classmates and I have posted. It has been less than a year since the concern for fiscal cliff lead to an eventual congress shutdown. In one of the Wall Street Journal today, there was a hint at government spending cut as well as decrease in government employment by 3% in January. It is hard to say at this point because the election is not here for another 8 to 9 months, but I believe with so much attention on the overall economic performance right now, neither party might be so bold and “play” with the fiscal policy tools for their benefit.

Labor Union, Democracy and Economics

I came upon an article in the Wall Street Journal regarding labor union participation rate. While the participation rate in the private sector rose 0.1% from 6.6% to 6.7%, the participation rate among public sector workers declined from 36.7% to 35%. Last semester, I wrote a paper regarding the relationship between voter participation rate and union labor participation rate within the United States. I would like to reiterate my thoughts on labor unions.

The idea of modern labor union as we know today became popularized during the post-war period, where working conditions were dreadful, but political atmosphere was facing the red scare against the communist party. The aggregate membership was at 35% in 1954, which was its highest in US history, but the participation rate is in steady decline since then (see chart below for trend since 1983).

membership erosion

 

How might this still correlate with economics then? Labor unions are not only hold power against their employers, but also against the policy makers. There has been consistent positive correlation between states with higher union participation rate with higher voter participation at state level and national election. This is not to say that there is a perfect cause and effect relationship. However, here are some of the data that suggests states with higher participation rate benefits more.

union tax union ssn

 

wage

 

As we can see, states with higher unionization enjoy higher minimum wage, higher social safety net policies and more progressive tax system.

These trends are somewhat predictable deducing from the median voter theorem and the skewness of wealth distribution. We first assume that in a democratic state, there is one vote per person, and the candidate with the majority vote wins the election. We also assume that capitalist states have income inequality with skewness to the left. Integrating these two assumptions, we can infer the following: (1) mean income is always going to be higher than the median income, (2) the median income voters are going to be less wealthy than are mean income voters, (3) since the median voters have more political power, there are going to be policies that will benefit the relatively poor workers.

We can see that the theoretical approach above could only work if there is a full participation among voters. Each less voters from the left end of the spectrum will result in weaker bargaining power–or political power– for low income families. Another is that political candidates who are elected must carry out their promises in order to win the next coming election. As an extension of Adam Smith’s assumption that people will act in self-interest and bring about positive effects in the market, I believe this wielding of political power could also lead to a better society. As median voters more progressive, wages, social safety nets, etc, the foundation of stronger middle-class may lessen these effects eventually, not needing to much tax for the poor, not needing too much social safety net, all the while enjoying their own freedom with what they have earned. And I believe first step to this process could be joining the union at the workplace to tell employers and policy makers that the working class are aware and in want for changes.