Finance: Research, Policy and Anecdotes

Last week saw the first two stops of our road show of the Ordoliberalism eBook, edited by Hans-Helmut Kotz and me.  The first one scheduled on Monday in Washington DC at the Peterson Institute.  Courtesy of snow weather in Toronto I missed the presentation, but contributor Jeromin Zettelmeyer did an excellent job in introducing ordoliberalism to a mostly American audience. For anyone who wants to read a “personalized” introduction into ordoliberalism, I recommend reading his chapter.


On Friday, an event at the Austrian National Bank, with governor Nowotny and the chief economist  Doris Ritzberger-Grünwald.  Hans-Helmut and I both did a general introduction on the difference between the German rule-based approach and Anglo-Latin pragmatism and then narrowed in onto one specific policy area – bank regulation and banking union.  The lack of any national bank resolution framework nationally and on the Eurozone level was clearly the weak link in the Eurozone in 2007/8.  This area has also been one where notable progress has been made over the past years.  Bank resolution shows very clearly the conflict between the ex-ante optimal solution of no-bail-out (to avoid moral hazard and aggressive risk taking) and the ex-post optimal solution of bail-out (to minimize negative effects of bank failure on the financial system and real sector).  All national authorities in Europe decided for bail-outs in 2008, especially for large and systemically important financial institutions, including the German government, certainly in violation of any ordoliberal principles. The banking union with its bail-in principles and more strict regulatory and supervisory frameworks was designed to avoid such violations in the future and minimize both moral hazard and negative effects for the remaining financial system and the real economy. While the case of Banco Popular (sold to Santander over a weekend with no costs for taxpayers) was certainly an example of how the banking union can work effectively, two other examples show that we are still far from an ideal world.  The limited bail-in of senior bondholders in the case of Veneto Banca and Banca Popolare di Vicenza and support with taxpayer money might not have violated the letter but certainly the spirit of the banking union. Behind this failed resolution, however, hides the ugly truth that the new regulatory regime was put in place before the legacy problems were resolved.  Applying rules where they do not makes sense, is certainly not a useful economic policy approach. Even worse, when Deutsche Bank was rumoured to be in trouble a few months ago, there was little public discussion on how to resolve such a large fragile bank in line with the new rules, but rather how the German government would bail-out its national champion.  Teutonomics trumps Ordoliberalism again! 


Not all economists in Germany are ordoliberals, as Adalbert Winkler made very clear in his discussion of German Angst on loose monetary policy and quantitative easing, resulting in persistent predictions of imminent hyper-inflation, warnings of uncontrollable asset bubbles and a focus on the rules of monetary policy (e.g., purchase of government and corporate bond papers) rather than the outcome (currently sub-target level of inflation). This has also resulted in a clear reputation loss for the ECB in the largest Eurozone economy, which can only be damaging for future monetary policy conduct  In my opinion, there is a clear contradiction in the German view on this – after all it was them (together with other national governments) who refused the use of any other policy tools to address the Eurozone crisis (such as fiscal policy, more aggressive bank restructuring on the Eurozone level), which in turn imposed a bigger burden on the ECB as the only functioning Eurozone wide policy authority.


If there was one surprising insight for me from the meeting in Vienna, then it is that most people in the room seemed to agree with us.   We were clearly missing a staunch supporter of the current teutonomic/ordoliberal approach.  We hope to get this at our next discussion round in Berlin, in March!  

The Doing Business database has come again into the headlines, but again for the wrong reasons.  Some five years ago, there was quite a heavy discussion, which resulted in a task force recommending reforms and which led me to write this Vox column.   


It is the Chief Economist of the World Bank who seems to have started the latest controversy by focusing on the changes in the ranking of a specific country, Chile, where he notices a rather interesting correlation of these changes with political changes: the ranking goes up during the most recent right-wing administration (2010-2014) and goes down during left-wing administration (2014-2018). A few days afterwards he all but retracted his accusations, blaming communication failures.  Interestingly, the Independent Review Committee recommended in 2013 (among others) to drop the aggregate rankings.


I do not want to comment on the politics of this controversy (neither the Chilean aspect nor the internal WB aspect), though I can imagine quite some serious conversations at 1818 H Street on this matter (and how it was made public).  On the other hand, it is good that these things are being discussed openly.  Supporters of rankings point to positive effects on political discussion and the necessary reform impetus they can provide. On the other hand, and as has become clear with this latest controversy, changes in rankings can be explained by all kind of factors, including changes in the methodology. One interesting metric provided by the Doing Business database can be useful in the context of the discussion: the distance to the frontier (DTF) which indicates how far a country is away from global “best practice”, and which – as in the case of Chile – is not necessarily correlated with the ranking.   More importantly, however, is that the frontier might not necessarily be “best practice” in all circumstances; whether it is or not is ultimately an empirical question.


This controversy brings me back to the main point of my earlier Vox column. The Doing Business database is an extremely useful and rich data source for researchers and analysts.  The rankings, however, have to be taken, with lots of grain. As pointed out by others (here and here), there is also a high standard error around these rankings, a country that ranks 42nd does not necessarily have a worse business environment than a country that ranks 40th.   


I think it is really time to move completely away from any country ranking but rather limit the Doing Business report to data and distance to the frontier for individual areas.  Obviously, the authors of the DB database (and the World Bank) cannot prevent others from using the raw data to construct rankings, but it should not be the World Bank Group that takes the initiative on this.


Now forthcoming in the Journal of Development Economics, my paper with Haki, Ravi and Burak on how access to mobile money allows small and micro-enterprises better and cheaper access to trade credit and ultimately higher (productivity) growth.     While recent papers (most prominently by Billy Jack) have explored the impact of mobile money on household welfare, we look at its effect on firms’ productivity growth.   Specifically, constructing a dynamic general equilibrium model, we assess how payment mechanisms interact with trade credit in increasing growth.  Using Kenyan firm survey data, we calibrate the model and provide evidence for our theoretical model.  For a non-technical summary, see this Vox column.


In the model, mobile money dominates fiat money as a medium of exchange, since it avoids the risk of theft, but comes with electronic transaction costs. We show that entrepreneurs with higher productivity and access to trade credit are more likely to adopt mobile money as payment instrument vis-a-vis suppliers. Calibrating the stationary equilibrium of the model to match firm-level data from Kenya (which we collected jointly with FSD Kenya), we show that the use of M-Pesa (the most successful mobile money technology so far) by enterprises can explain 10% of Kenyan growth between 2007 and 2013, thus a significant macroeconomic effect. 


This paper is part of an expanding literature that has shown that more efficient retail payment services (such as mobile money) can have important positive macro-economic effects and thus speaks to the literature on financial inclusion (which has shown much more ambiguous effects of expanding credit services to the poor).  It thus also adds to the debate on which financial service to focus when expanding access to financial services. 


This paper is dedicated to our friend Ravi, who was to become a PhD student in Tilburg in 2013, but was killed in the atrocious attacks in Westgate Malls in Nairobi, on 21 September 21, 2013.  For a wonderful obituary, see Koen Schoors in this eBook.

I really liked this comic – makes me wonder how my PhD students talk about me when I am not in the room…..


Sometimes one appreciates his former colleagues only after leaving.  Ben Vollaard from Tilburg University has been doing great research on “crime” and honesty, such as on how to “facilitate” honesty and how the Dutch herring competition is being rigged. Speaking about economics being useful in daily life….               


Yesterday was my last official day as (Co-) Editor of Review of Finance though I will continue to handle papers that have been submitted before yesterday and/or have received an R&R. The three years for the Review of Finance have been incredibly rewarding, though not always easy. I certainly have learnt a lot for my own research!   I might write up some lessons on these three years later this year.


2018 shapes us as interesting year – more visits to Malaysia, some road trips for the Ordo-liberalism eBook and – after some delay – finally the Handbook of Finance and Development (co-edited with Ross Levine) will be published.  I will continue as (co)-Managing Editor of Economic Policy, with exciting special issues coming up, on populism and the Gig economy.  And February will see our first task force meeting on the effect of Basel III on emerging markets.


The first phase of the Brexit negotiations has concluded and I think it has become clear which strategy has won: it was not the Brexiters’ strategy of “an afternoon tea in Berlin” or “we’ll pay our way into a great new relationship” or “the EU can whistle away”, but rather the more formal if not formalistic approach the EU has taken: long-term commitments made before have to be honoured, people’s lives and rights have to be protected, and the Brexit cannot create new political hotspots.


There were three main agreements: first, the rights of EU citizens in the UK and UK citizens in the EU being protected after Brexit (with a prominent role for the EJC – here goes the first red line of the Brexiters); second, payment by the UK for existing EU commitments: if you leave the restaurant after the third course of a set five-course menu, you are still expected to pay for the whole menu, no matter how much you whistle; third, the Irish border has to remain a soft one.  This turned out to be the trickiest but also most consequential one. The compromise seems to imply that the UK will stay in all but name in the Customs Union and (possibly) Single Market, for a simple reason – if you want to avoid a hard border between Northern and the Republic of Ireland, they have to be part of the same market.  If you want to avoid any border in the Irish Sea (between Northern Ireland and the rest of the UK), this would by extension imply that the whole of the UK stays in customs union and single market, but without having any say in making the rules.    There might still be a way out of it, courtesy of modern technology, but it would for the UK government to propose such a solution.  A third solution – more decentralization and allow Northern Ireland go a separate way – would be possible, but politically difficult, as it would open the floodgates for the Scottish independence drive.



If the past nine months have revealed anything new than it is the utterincompetence of the Brexiters.  Suggestions such as “let’s just leave the Irish border open” are so far from reality that one wonders whether these people have any clear idea on basic international law. Similarly, declaring the first phase agreement is a letter of intent rather than a binding agreement is quite amazing for a country, which has established the concept of sovereign credit worthiness, and now considers defaulting on such commitments. On the other hand, lots of red lines have turned pink for the better of the UK’s future.  But behind it is a more general mistake of populists: win with easy promises and leave the details to others.   Taking back control for a mid-sized economy (even one with nuclear powers) is not as easy as promised.


The question remains when will the British political class finally have the courage to tell voters the truth: that the myth of taking back control is simply that: a myth; and that the cake either has to be had or has to be eaten.   Will it be in a few days, when the British government for the first time discusses what kind of Brexit it actually wants? No, this is not a typo – the British government has so far not agreed on what kind of relationship it wants with the EU after Brexit apart from generalities including lots of pluses and minuses, such as Canada plus plus plus or Norway minus minus.  Will it be in the final days of the Brexit negotiations when even the Morduch media will realize that the cake is gone and there will be no taking back control? Or will the government manage to go all the way to the next General Elections before the fraud is revealed?  


And what will the reaction be by electorate and hardline Brexiters – a push for a No Deal Brexit, which might send UK into the diplomatic desert or breaking one of the agreements – the first phase agreement or the Good Friday agreement?  The fall of the May government, with possible new elections?  It is this uncertainty that will make the European Union reluctant to go all in and will push all participants into a compromise, but it will also put pressure on the UK economy until this uncertainty is resolved.