Thursday, February 12, 2015


In 1988 my old friend, teacher and mentor Luigi Spaventa was made Treasury Minister in the Italian government.  The Communist Party had been offered a few posts in the government, including Vincenzo Visco at the Ministry of Finance, but had refused; Luigi belonged to the left but was not a party member, and fortunately accepted.  On that occasion, I sent him a postcard with the following verses:

Visco al Fisco! Noo? Peccato,
Il Partito s’e’ imbranato.
Per fortuna c’e’ Spaventa
Che al Tesoro s’arroventa,
E la fine e’ ormai per via
della Cachistocrazia.

[Visco at Finances! No? Pity./The Party has goofed./But fortunately Spaventa/At the Treasury is getting fired-up,/And at last we are on the way/To end our kakistocracy.]

Naively I thought I had coined the word, from the Greek kakistos, superlative of kakos(bad), government by the worst citizens, but on googling the word there are almost half a million entries: kakistocracy was first used in 1829 by the English satirical writer Thomas Love Peacock. The American poet James Russell Lowell wrote in a letter in 1876: "Is ours a government of the people, by the people, for the people, or a kakistocracy rather, for the benefit of knaves at the cost of fools?"

Luigi, a wonderful teacher and a great economist, died prematurely in 2010.  Had he lived longer he might have been appointed premier in 2012 instead of Mario Monti (for he was President Napolitano’s economic adviser), or to even higher office later: Italian recent history would have taken a turn for the better.  In any case I was patently wrong: not only does kakistocracy – the mafia in collusion with the political Casta- still rule Italy, now it has spread to the entire world.  Whenever the best men come to power in a country, the global kakistocracy tries to squash them.  This is the case right now in Greece.

All that Alexis Tsipras is asking of the European and global rulers is six months of breathing space to prepare an alternative plan for debt management and economic recovery.  After all, the elections of 25 January had been called only on 14 December and he could not conceivably have been expected to have a plan ready when his outstanding surprise victory was proclaimed.

His first moves were directed at reassuring the global community: Greece would honour its debts in full, without insisting on a debt haircut; the country would remain in the Eurozone, as preferred by a large majority of its citizens; it would fight tax evasion and raise the living standards of those who had suffered most from the austerity imposed by the Troika (the ”Memorandum” issued by the EC, ECB and IMF): the unemployed, especially those unfairly dismissed, the poor, old age pensioners and the other economically weak groups.  ”If the country’s sacrifices were conducive to recovery and growth I would be the first to advocate them” – he said to Parliament last week (I am quoting from memory) – ”if the bitter pill was necessary to recover health I would readily swallow it”.  But the austerity imposed by the European and globalist kakistocracy demonstrably leads only to cumulative impoverishment and ruin, as it has already done.  Thus Tsipras rejected at once the continuation of the programme agreed with the Troika by his predecessor, renouncing the €7.2bn aid that Greece otherwise expected to receive at the end of February, asking only for the €1.9 bn repayment of ECB profits made on its Greek bonds, with a view to using the next six months to negotiate a new agreement and in the meantime to meet all outstanding obligations by issuing around €10bn short-term Treasury bonds. 

So far the Kakistos and Tsipras are set on a collision course. The Greek Finance Minister Yanis Varoufakis and German Finance Minister Wolfgang Schäuble would not even “agree to disagree”.  On 11 February in Brussels at a meeting of Eurozone Finance Ministers talks collapsed after six hours.  There is no way the debt owed to the ECB or the IMF can be cut, under penalty of losing access to assistance from these institutions – though Greece might be allowed to repay ECB credits by borrowing on very long terms from EFSF, the Eurozone bail-out fund.  Moreover Tsipras has promised that private investors will not be hit.  The only room for debt renegotiation is with European governments, to whom Greece owes directly or indirectly about €195bn, around 62 per cent of its total debt (of which almost 148bn or 45 per cent to the bail-out fund EFSF). True, Greece has already benefited from a debt cut in 2010 and 2012, and from the lengthening of maturities right up to 2057; and from a reduction of interest on its debt down to 2.6% of GDP, equivalent to that paid by Italy or France (and only 1.5% on its debt with the EFSF, which could not possibly be cut further).

But according to the Troika Memorandum Greece is committed to running a primary surplus (before paying interest) of 4.5% of GDP a year, which is an exceedingly heavy burden on an impoverished country.  Such a surplus requirement could very well be cut at least temporarily, by an interest moratorium until growth is resumed, back to earlier income levels, to the 1%-1.5% primary surplus that Syriza’s current plans would require. This is the purpose of the proposal put forward by Yanis Varoufakis, of swapping debt owed to European governments with new bonds indexed to the Greek growth rate.  

The ECB was certainly within its rights to cancel the waiver allowing Greek banks the use of Greek government bonds as collateral, thus denying Greece access to liquidity at 0.05% interest, once Tsipras had indicated his unwillingness to continue on the agreed course at the end of February.  But it was certainly not ”legitimate and opportune” as declared by Matteo Renzi, who presented Tsipras with an elegant tie instead of solidarity (”So that he could go and hang himself with it”, commented Giorgia Meloni, leader of the right-wing party Fratelli d’Italia).  As long as Greece has access to Emergency Liquidity Assistence (even at the higher cost of 1.55%) Greek banks can cope even with the slow run on deposits that has already begun (€15 bn in the two months preceding the elections); but such access has to be confirmed every fortnight and its possible suspension is a Damocles’ sword. Greece really needs the Tsipras really needs the €10bn Treasury bonds that Tsipras wishes to issue.

The trouble is that Greece is already right up against the €15bn limit to short term indebtment that has already been imposed by the Troika, and the additional €10bn bonds have to be, but have not been, authorised.  Yet this is the only and therefore the best way out of the Greek-Troika confrontation.  Wolfgang Schäuble declared that ”Europe is not in the business of granting bridging loans”, but the €10bn would be no skin off his nose, they would be raised – at a price, that current delays make rise all the time – in the international market.  By giving up its entitlement to €7.2bn under the Memorandum surely Greece can have its €15bn borrowing ceiling lifted at the same time?  The Troika cannot have it both ways, tying Greece to its borrowing limit when it is renouncing some of the benefits of its current deal with the Troika.

Germans display the memory typical of elephants when they evoke the ghost of their 1922-23 hyper-inflation to justify their opposition even to ECB quantitative easing.  But they have a shorter memory than goldfish when it comes to the 1953 cancellation of German debt of over 200% of its GDP at the time, much in excess of the current Greek debt burden of under 180%.  According to the economic historian Albrecht Ritschl (LSE), Germany was ”the “biggest debt transgressor of the twentieth century”;Robert Skidelsky recently reminded us that“Germany experienced eight debt defaults and/or restructurings from 1800 to 2008. There were also the two defaults through inflation in 1920 and 1923. And yet today Germany is Europe’s economic hegemon, laying down the law to miscreants like Greece.”

Tsipras’ mention of war reparations was not commented on by Merkel but both vice-Chancellor Sigmar Gabriel and Wolfgang Schäuble immediately said that the issue was definitively closed years ago, and its re-opening was out of the question.  Tsipras mentioning the War was treated as an inappropriate gesture in bad taste.  Shades of Basil Fawlty of Fawlty Towers, shouting at the Hotel’s Spanish waiter Manuel: ”Don’t mention the War!” when German guests arrived.  But why ever not?  If memories of 1922-23 hyper-inflation are not buried, a fortiori neither should more recent and tragic ones.  Such a combination of a good memory for distant events with forgetfulness of recent ones is typical of dementia.

A secret Greek Finance Ministry report is said to provide detailed evidence of ”atrocities and forced loans during Nazi occupation of Greece in World War II”.  Apparently ”in 1960 Germany paid DM 115 million in reparation payments to victims of the Nazi terror regime in Greece in accord with a bilateral reparation agreement”. But 1) the Netherlands suffered much less and received a much larger compensation; 2) “the 1953 London Agreement on German External Debts, between the Federal Republic of Germany and creditor nations, stipulated that payment obligations from World War II were to be deferred until ‘after the signing of a peace treaty’", and 3) apart from the cost of war suffering, casualties and loss of material assets, there was a loan the GreekCentral Bank was forced to give the Nazi regime in 1942, 476 million reichsmarks which the occupiers not only acknowledged but had actually started repaying shortly before the end of the war.  Even at a modest interest rate of 3% a year (though German loans after the War generally had a 6% interest rate) after 70 years that loan would have built up to a handsome three digit billion sum in today's euros.  Professor Hagen Fleischer, a historian from Athens University, explains that "Before 1990, Germany tended to point out [that] it was too soon, because Germany was divided and it was the entire country that had gone to war, not just one half. So the issue was supposed to be canned until Germany was again reunified".  After reunification, however, "Germany's response was suddenly, 'So much time has passed - now it's too late’".  Clearly the Greek Ministry of Finance should publish its secret report in full on the Internet at once, together with all the body of evidence of post-2009 Greek negotiations with the Kakistos of the Troika that led to the ”Memorandum”.

There is a perfectly feasible solution to the otherwise potentially catastrophic losses involved in the confrontation between Greece and the Troika: lifting the €15bn ceiling on short-term debt in exchange for Greece renouncing the aid otherwise payable under the Memorandum.  Paradoxically, Angela Merkel is standing firm and and wisely stopping Europe from joining the USA and its jejeune warmongering President Barak Obama in arming Ukraine and fighting Vladimir Putin.  Let’s hope that she might come to her senses also in her dangerous confrontation with Greece. 

On Thursday 13 February it was announced that fiscal revenue for the month of January was €1bn lower than forecasts (a shortfall of 23%). The ECB extended another EUR5bn in emergency loans to banks in Greece after fears that a spate of bank withdrawals could dry up funding. In fact according to JP Morgan withdrawals from bank deposits since the beginning of 2015 amounted to €21bn.  But ELA is subject to fortnightly verification and is not a permanent solution.  On Friday 14 it was announced that in the fourth quarter of 2014 the Greek economy had contracted slightly, reversing the trend after nine months growth.

The Greek government claims that it does not need any fresh cash: “We do not want new loans, we need time, not money to implement reforms” – the Greek premier said in an interview to the German weekly Stern.  But a spokesman for the Commission commented: “We fear that the available liquidity is shrinking faster than anticipated”.

Monday 16 February was supposed to be the day of reckoning. But the Brussels meeting of Eurozone Ministers of Finance with Tsipras and Varoufakis ended with a bitter row, with general recriminations and yet another postponement of the final decision until no later than Wednesday next.  The Union offered Greece only the extension of the pre-existing agreement, at the same conditions; the Greeks rejected the proposal as “absurd and unacceptable”

Time is running short, for some countries, like Germany, the Netherlands, Finland and Estonia, need parliamentary approval not only for a new Memorandum but also for an extension of the last one.

One might think that the difference between the positions of the two antagonists is minimal and purely formal. After all, what big difference there might possibly be between the extension of a pre-existing agreement subject to consensual renegotiation within six months, and a slightly different stipulation also subject to consensual renegotiation within the same term?

The difference however is immense.  The extension of the current agreement would involve the acceptance not only of the general principle of austerity but also of new privatizations of public assets at derisory prices, and the reversal of policy measures already taken by the Tsipras government, such as the reinstatement of public employees especially if unfairly dismissed, the adoption of a higher minimum wage and higher pensions.  It would be a capitulation on the part of the Greek government, involving the rejection of the main principles of their electoral campaign and popular mandate.  And for the kakistos European leaders it is a serious question of asserting who is really Master in Europe.

We could say that the Troika, like Shylock The Merchant of Venice, is demanding of Greece its pound of flesh in payment of its debt, whereas Greece is willing to pay a pound of its flesh only on condition that it does not include any of its blood.  This Shakespearean drama is being replicated next Wednesday, with an open ending. 

Greeks and eurozone agree bailout extension

“Greece and its eurozone bailout lenders agreed an 11th-hour deal to extend the country’s €172bn rescue programme for four months, avoiding bankruptcy for Athens but setting up another potential stand-off in June when a €3.5bn debt payment comes due”. Financial Times, 20 February 2015, 8.18pm

Hip Hip Hip! Hooray!

Thursday, February 5, 2015

Moderate optimism

The month of January 2015 gave us several, interlocked reasons for moderate optimism about the prospects for economic recovery in the Eurozone and in Italy.

First, the further fall in oil prices, strengthening the trend already present from last summer. From mid-June 2014 to the end of January 2015 the price of crude oil fell by as much as 60 percent, reducing the energy costs of Eurozone producers in spite of the parallel but much lower depreciation of the euro against the dollar (on which more below). Quantitative estimates of the effect of this cost reduction on the rate of GDP growth are uncertain and vary around 0.5% -0.8%, but undoubtedly the positive effect is present and is not negligible.

The second reason for moderate optimism is the ECB decision on 22 January to implement Quantitative Easing, albeit with the disapproval of the Bundesbank president Jens Weidmann and a minority of other representatives of the Nordic  member states of the Eurorozone: € 60 billion per month for 19 months, from March 2015 to September 2016, and if necessary even further, until the Eurozone inflation target "below but close to 2 percent" is reached.  This amount however includes other interventions already decided previously, so that the additional amount really is not €1,140bn but only about €900bn, and the surprise effect (important for example in the Swiss frank large appreciation of 15 January) had been diluted by months, indeed years, of announcements, discussions and debates. However the size of the intervention was still greater than earlier expectations, of the order of €500bn, and therefore there still was some element of surprise. The provision that National Central Banks should take on 80% of the risk of default on 80% of their country’s bonds purchased by the ECB is an important limitation of the Monetary Union but an acceptable price for this massive intervention.

Third, the depreciation of the euro down to a rate of $ 1.11, then stabilized at $1.13 (below the rate of $ 1.17 at which the euro was first introduced and a far cry from its peak of $1.47), for several reasons: ECB Quantitative Easing; the expectation of the Fed raising interest rates, repeatedly announced and now postponed probably to next June; expectations - rightly or wrongly - of the worsening of the Greek crisis and even a possible exit of Greece from the Eurozone (Grexit).  Such devaluation should have a significant impact on the competitiveness of all member countries and therefore their exports and growth, improving the relative position of those who like Italy have seen labour productivity stagnate or even decline over the last decade. Predicting the quantitative impact of euro devaluation on the rate of GDP growth is difficult and risky, but this effect could have an order of magnitude of 0.8-1%.

Fourth, the resounding victory of Alexis Tsipras and his party Syriza in the Greek elections of 25 January, which has called into question the austerity policy adopted by European institutions under the hegemonic influence of Germany as the only strategy response to the Great Recession of 2007, along with so-called "structural reforms".  These last are a euphemism for the dismantling of the welfare state, privatization of under-valued public assets and the cancellation of decades of achievements of the labour movement.

The first moves of the new Greek government were reassuring: Greece has no intention to leave the euro (a choice supported by 60% of the Greek population), nor to press for further cancellation of public debt, nor to request additional aid.  At the end of February Greece expected to receive €2 bn aid from the European Union and €5 bn from the IMF, conditionally on reform implementation.  Now the Greek government requests only €1.9bn from the ECB as reimbursement of the additional interest earned by the Bank on the Greek bonds in its portfolio. As Finance Minister Yannis Varoufakis rightly said, "A Monetary Union responding to a serious financial crisis by granting more loans to deficit countries on condition that they shrink their national income is not sustainable”.  Varoufakis proposes a " menu of swaps " of Greek bonds with new bonds of two types: one indexed to nominal economic growth, whose service therefore would be conditional on the resumption of growth, and the other a "perpetual bond" that would replace the Greek government bonds in the hands of the European Central Bank. The Greek budget would remain in primary surplus, but only on a more modest scale of 1-1.5%, thanks to the decision to pursue big tax evaders.  In this way Greece could effectively honour existing commitments, while creating a fiscal space sufficient to finance the reconstruction of the welfare state, to increase the minimum wage and pensions, as well as to grant the benefits in kind or subsidies (for example in electricity and transport) promised and partly already introduced by the new government.  Otherwise, Varoufakis says, "Greece will become deformed rather than reformed." Varoufakis' plan was received favorably at its presentation to the City of London, and provides an excellent and credible basis for discussions and negotiations with the European institutions.

Why, then, the "moderate" nature of optimism rooted in so many positive developments?

First, the fall in the oil price is the result of lower demand in the recession, the Saudi decision not to cut production to match lower demand, and the significant growth of the US production obtained from bituminous shale.  But the price reduction undermines its causes: not only does it stop investment in the development of alternative energy sources, but at the current price of around $ 50 per barrel it makes most of the production to be sold at a loss and therefore not sustainable. On 30 January the announcement of the closure of one hundred high-cost wells in the United States raised the price of oil by more than $ 8 in a single day although production had continued to rise. And if the low oil price were maintained there would be - and are already experiencing them - negative effects on the demand for imports by oil-producers and therefore on income and employment in the non-oil-exporting countries.

Second, in the opinion of many observers and businessmen, monetary easing by the ECB was "too little too late", in comparison with the $ 4.5 trillion mobilized by the Fed already commenced in 2008, and further, in view of the greater use by US companies of credit and securities to finance investments, compared to the larger component of profit reinvestment by companies in Europe and especially in Italy.  But there is no doubt that monetary easing - in addition to its impact already mentioned on euro devaluation - will facilitate the recapitalization of banks that have an excess of government bonds in their portfolios.

Third, the devaluation of the euro could unleash a war between currency areas with rounds of competitive devaluations, and the associated de-stabilization of financial markets.

Finally, European and German economic authorities have immediately taken rigid and hostile positions adverse to any form of restructuring of Greek debt.

Matteo Renzi has been likened to Alexis Tsipras but unfortunately we are not so lucky, all they have in common is their young age; Italy also has €40bn credits towards Greece, and our excellent Pier Carlo Padoan has neither the imagination nor the tenacity of Yanis Varoufakis.  If anything Alexis Tsipras has something more in common with our new President Sergio Mattarella: immediately after their election both went to visit a monument to the victims of Nazi atrocities, a gesture that cannot have been greeted with enthusiasm by Angela Merkel.  The French are watching from the sidelines; in order to widen the breach in European austerity opened by Syriza we will have to wait for a parallel Podemos victory in the next elections in Spain.

The danger is that the game of chicken played by Germans and Greeks might lead to a lethal crash, perhaps in the form of an "accidental Grexit" (an expression coined by Wolfgang Munchau): the expiry of any deadline before a new agreement is reached, the loss of Greek access not only to Quantitative Easing but also to emergency liquidity provided by the ECB, capital flight and a panic run on the banks by the public seeking to withdraw cash from their accounts.  At that point, a severe liquidity crisis could force Greece to issue some form of national currency, perhaps initially notes issued by the Treasury circulating in parallel with euro cash now in short supply: from there to a formal exit is only a small step. Cyprus came within a breath of this predicament.

Marcello De Cecco noted that while a Greek exit from the Eurozone could very well happen in the way I described, it would be the result of a deliberate policy of not wanting to help Greece, instead of a series of casual fatalities, when there is will there is always a way, and if deadlines are not met this means that Greek exit is not so much feared but wanted.

In any case, a possible Greek exit from the Eurozone – whether accidental or deliberate - cannot be ruled out completely, and would be catastrophic for the entire Eurozone, with contagion spreading first to Portugal, then to the other southern countries including Spain and Italy, eventually turning against Germany itself and the other Nordic countries. That is enough to temper anybody’s optimism.


On 4 February the ECB Governing Board decided that Greek government debt will no longer be accepted as collateral starting next week.  This appears to be like undue ECB interference in Greek negotiations with the EU, but 1) it is well within the Bank’s discretionary powers; 2) it is likely to be part of the price paid by Mario Draghi for the large size of his Quantitative Easing and 3) it is also a way of raising the stakes which might, in the end, favour Greece by raising the cost of a Greek exit for Germany and the hawks as well as for Greece.  After all, Yanis Varoufakis is an accomplished game theorist and should know what he is doing (see Varoufakis Y., Rational Conflict. Oxford, Blackwell, 1991; Varoufakis Y. and S. Hargreaves-Heap, Game Theory: A critical text. London and New York, Routledge, 2004).  At least, this is what we might still hope.

For assessments supporting this last point see the excellent post by Frances Coppola, What on Earth is the ECB up to? and the other posts listed at the end of it.

Thursday, December 18, 2014

Europe is a Cow

The Greek etymology of Europa (ερυ- "wide" or "broad" and ψ"eye(s)" or "face"), suggests that as a goddess she represented a cow (with a wide face). See also Antonio Carracci (b. ca. 1583, Venice, d. 1618, Rome),The Rape of Europe, currently being shown at the exhibition "From Guercino to Caravaggio", Palazzo Barberini, Rome. 

1. Costs and benefits of the Euro

The introduction of the Euro involved for all the EMU member states significant benefits and costs.  Benefits include: a greater economic and financial integration of trade and investment; a rate of inflation lower than the Bundesbank best performance with the DM; and ten years of an interest rate on public debt rapidly converging to a common, decreasing level.

At the same time national governments lost the use of several instruments of economic policy: monetary policy, delegated to the ECB; the nominal exchange rate of the national currency (the alternative “internal” devaluation through lower price and wage inflation than competitors being conflictual and impopular), and fiscal policy now subjected to a much stricter discipline (Maastricht, Growth and Stability Pact, followed by the Fiscal Compact).

Italy had the additional cost of a fiscal squeeze undertaken in order to approach the required pre-requisites – an excellent investment in view of the benefits obtained as a result.  In the transition to the Euro, Italy and Greece recorded an initial burst of inflation caused by the lack of price monitoring and control on the part of the government; this immediately eroded the international competitiveness of both countries, which could no longer be restored through devaluation.  Monetary sovereignty had already been surrendered by the government to the Italian Central Bank in 1980.  A greater financial integration turned into a channel of contagion in the subsequent crisis.  And, above all, on 19 October 2010 in Deauville, Angela Merkel and Nicolas Sarkozy decided that ESM bailouts would inflict losses on government creditors – a position ethically unimpeachable but infelicitous, because it caused a further widening of the spreads of long term interest rates on the public debt of member states with respect to German Bunds.  Thus began the Eurozone tribulations, characterized by stagnation, record unemployment, deflation, still today in the grips of the deepest crisis ever experienced by modern capitalism.

In fact the Great Crisis of 1929 had seen a rapid recovery already from 1933 thanks to the public investment of F.D. Roosevelt’s New Deal, while the crisis that began in 2007 and is still rampaging has been aggravated and prolonged by the perverse austerity policies imposed by International Financial Organisations and the European Union.

2. Euro’s diseases

The Euro suffered from policy errors by various national governments, including the fiscal profligacy of Southern members, but above all from two congenital diseases and a subsequent degenerative disease.

First, the Euro’s premature birth, before political and fiscal integration (and before defence and foreign policy integration): the Euro should have been the very final stage of European integration, its crowning, instead of which it was used to accelerate integration processes, pushing la finalité politique through the tensions generated by monetary dysfunction.

Second, the ECB was born incomplete, not to say mutilated, not so much because of its independence, which is common to the major central banks in the world, but because it was modelled on the Bundesbank, and even more than the latter was totally separated from fiscal policy, without the virtually unlimited power to buy government bonds enjoyed by other central banks otherwise equally independent (as the Fed or the Bank of England or the Central Bank of Japan). Moreover the ECB was born without the usual powers of supervision, recapitalization/consolidation/liquidation of commercial banks, and without the safety net of a common European insurance of bank deposits (the amount nominally insured today is the same throughout the Eurozone, but is the responsibility of national Treasuries, and is therefore worthless in case of a country’s default).

The degenerative disease of EMU has been the progressive economic divergence of member states, not only in terms of monetary and fiscal parameters for which a statutory convergence was envisaged but not observed, but also in terms of other real and financial parameters whose convergence should have been a condition of entrance and continued membership of the Eurozone but was not, such as the unemployment rate, the share of non-performing loans, international competitiveness.  Such progressive divergence created strong and increasing centrifugal tensions.

3. Possible solutions

Monetary policy on its own is not sufficient to re-launch the European economy, in spite of the original and courageous initiatives of the ECB President Mario Draghi (LTROs, OMTs and other unconventional initiatives), also because of the policy constraints imposed by Treaties and/or by the pressures of Northern member states.  It is enough to consider the failure of Japanese policies of Abenomics, i.e. monetary expansion accompanied by modest fiscal stimuli and structural reforms.

International trade, which since the 1970s had been a dominant factor of global economic growth, in the last years has slowed down more than global GDP; the IMF confirms that it has reduced considerably its earlier role in growth promotion.

Many quarters invoke “structural reforms”.  A reform by definition ought to be a change for the better, and a structural reform a significant change for the better, which therefore should be politically uncontroversial and unanimously acceptable. But such reforms raise three serious problems.  There is no agreement on the desirability of this or that reform, in view of their re-distributive effects; any positive effect, if any, can only accrue in the long run (5-10 years); and there are structural reforms that, although clearly beneficial in the long run, in the short run can have strong negative effects. For instance, a competition increase reducing prices today would promote undesirable further deflation; this kind of structural reform is like an investment that although beneficial is not always sufficiently profitable to be recommended.

A reduction of public expenditure in order to reduce taxation (as anticipated but not yet implemented by the Italian spending review) has a positive effect only if it reduces the waste of resources, but otherwise a balanced reduction of both public expenditure and taxation can only have a recessionary impact on income and employment, as demonstrated by Haavelmo.  What might be desirable is an increase of public investment funded by the reduction of current public expenditure.

A superior solution would be a collective large-scale public investment undertaken at the European level. The trouble is that Europe’s so-called virtuous countries, which would be in the best position to undertake a growth-promoting role – thanks to the low interest rates at which they can borrow and their greater margin for fiscal manoeuvre – are stubbornly reluctant to do it.  And the Union budget, at a miserable 1% of European GDP (compared to 20% in the USA), does not allow any large scale initiative.

It might seem that the recent Juncker Plan, with investments of the order of €315bn over three years beginning in the autumn of 2015, represents an important progress in this direction.  But in truth these investments include a presumed and unrealistic multiplier effect on private investments, of the order of almost 15 times.  European Union funds would be only €21bn, of which 8bn diverted from other important uses, 8bn consisting only of guarantees, and 5bn provided by the EIB and unlikely to be fully available without its re-capitalisation.  It is believed that at the moment the funds really available for the Plan are of the order of €2bn – a sick joke (“Europe’s alchemist”, “Laughingly inadequate” The Economist 29 November. See also Mazzucato and Penna, The Guardian, 27 November). 

Jacques Drèze and Alain Durré (CORE 2013) have proposed the issue of bonds indexed to average growth rate of the Eurozone on the part of the ECB or other EU agency, which would then swap them with government bonds issued by member states indexed to national growth rates, in proportion to their share in European GDP.  In such a way the EU agency would be able to insure member states against macroeconomic shocks, paying a subsidy to under-performing states out of the profit made on the bonds of over-performing states, at zero cost.  This is a brilliant scheme, which however in case of default by countries participating in the scheme would inflict serious capital losses on the emitting European Agency.

Pierre Pâris and Charles Wyplosz (2013, 2014) have proposed a scheme called PADRE – Politically Acceptable Debt Reduction in the Eurozone, similar to a proposal of mine of 2013 – consisting in the mobilization of ECB seigniorage for the purchase and retirement of government debt of all countries holding shares in the ECB (including 10 countries that are members of the EU but not of EMU), in the same proportions of the shares they hold.  Therefore even a possible default by a large country would not damage other members and would not involve a Transfer Union.  In his Caffè Lectures of 2011 Willem Buiter estimated the present value of ECB seigniorage at about €3300 billions, but seigniorage mobilization for Eurozone debt reduction is unlikely to be acceptable to the Northern members of EMU.

4. Disintegration of the Eurozone?

Over the last years there has been frequent discussion of the possible disintegration of the Eurozone, with the return to national currencies by the weaker or the stronger members.

The recovery of national monetary sovereignty would allow weaker members the use of all the instruments of monetary policy, and the ability to recover international competitiveness through exchange rate devaluation.  However European fiscal discipline would continue to apply to all EU members even after ceasing to be members of EMU, by virtue of the Growth and Stability Pact.

The initial exchange rate between the Euro and the new national currency would be irrelevant, because the same rate would apply to prices.  But its use as an instrument of economic policy would involve for the weaker members the cost of successive devaluations, higher inflation and higher interest rates, as well as the revaluation of debt; exiting stronger members would face the cost of revaluations making them lose international competitiveness.  All exiting countries would also face the large scale cost of exit from the entire European Union, that requires the single currency as a part of the obligations of membership – the acquis communautaire (except for Denmark and the UK that negotiated a derogation from the Maastricht Treaty before signing it).

Even under unchanged current policies, sooner or later the economic crisis might well come to an end thanks to the automatic mechanisms that always operate in the course of any economic cycle in a capitalist system.  Once the floor of zero gross investment is reached, further falls of investment come to an end, stabilizing national income; at that point net investment is negative and gradually eliminates excess capacity; gross investment resumes first to replace excessive capacity losses, then to exploit the superior technical opportunities accumulated during the crisis; and the ensuing multiplier/accelerator interaction boosts growth further.  Growth revival, however, might happen too late to prevent the disintegration of the Euro (just as it happened with the ruinous disintegration of the USSR and the rouble in 1992).

If this happens this Europe of ours will have betrayed the vision and the values of its Founding Fathers.  And we would not even be able to cry over the inglorious end of the European project because the Europe we have today is no use to us, and it most certainly does not deserve our tears.

[Note: An Italian version of this paper was presented at a Round Table on “Perspective of European Economic Policy”, at the Conference for the Centenary of Federico Caffè’s Birth, Sapienza University of Rome, 4-5 December 2014].

Friday, November 14, 2014

What if… Gorbachev had succeeded?

On 7 October 1989 Mikhail Gorbachev visited Berlin for the celebration of the GDR 40th-anniversary, and said: “History punishes those who come too late” (Childs 2000): the statement criticised Honecker but was best suited as his own epitaph. 

But let’s try and imagine what might have happened if Gorbachev’s perestroika had actually succeeded.  Five years ago I wrote a paper developing this theme and presented it at a Conference in Warsaw. The paper illustrated how Gorbachev might have succeeded in achieving the radical reform of the Soviet political and economic system, the construction of market socialism, the re-structuring and acceleration (uskoreniye) of the Soviet economy, and the possible though unlikely continued existence of the USSR.

I should stress that this was not, or at least was not meant to be, an exercise in 20/20 hindsight. Alternative courses can be formulated without the possession of perfect foresight of the state of the world in 1985-1991.  Nor is a change in Gorbachev’s initial conditions required, of the kind “If only he had come to power in 1974, at the height of the fourfold rise in the oil price ...”. This exercise was meant as a genuine counterfactual alternative. Its purpose is that of damning Gorbachev’s disastrous economic strategy and showing that he and his economic policies, more than anybody else’s doings, are ultimately responsible for the collapse of  socialism in the Soviet Union, for the failure of an alternative design of market socialism, and for the immense human cost of post-socialist Transition.  A similar exercise, considering counter-factual alternatives to the actual course of Transition in Cental-Eastern Europe, is only outlined to suggest that Transition might have been handled at a lesser human cost. 

In order to succeed, Gorbachev would have had to act swiftly, instead of practically wasting his first two years in power (1985-87), and lay down sound economic foundations for perestroika: eliminate repressed inflation, preferably through a confiscatory currency conversion; break state monopoly of foreign trade, introduce rouble convertibility on current account, liberalise trade, foster competition. By 1991 he would have also legalised private ownership and enterprise, given state managers bonuses geared to market performance, implemented small privatisation, commercialised state enterprises, begun some privatisation of large enterprises and banks. On Christmas Day 1991, instead of resigning as President of the Union, he could have celebrated the victory of economic perestroika.

What next? There would have been still thorny choices and therefore possible mistakes to be made, before completing Transition and after. Gorbachev would have needed continued vigilance and sound economic advice, for instance to avoid too rapid dis-inflation at inordinately high real interest rates, as happened in 1994-95, and the consequent recession; to avoid an unsustainable combination of overvalued exchange rate, high interest rate to support it, and a public debt increasing as a result of high debt service, as happened in 1998 under the IMF’s watch; to avoid the unnecessary cost to the budget of switching the pension system from PAYG to a funded system.

As a result of the good economic foundations of economic perestroika, and the avoidance of these kinds of subsequent pitfalls, income losses from the Transition recession would have been lower, and growth would have accelerated earlier and faster than it actually was and did. The welfare of Russians would have improved significantly and continuously as a result. The same reasoning applies to all other Transition economies that to a greater or lesser extent followed stabilisation and Transition paths out of sequence or to excess. It is impossible to have unanimity about whether the measure taken were or were not mistakes, and how serious, let alone quantify the gains. But pretending that there were no serious unnecessary mistakes in the Transition is neither reasonable nor respectable. 

The improved economic performance would have generates political consensus, but not necessarily to the point of providing permanent democratic support for a political regime associated with significantly large state ownership and associated political values (of equality, solidarity, participation, etc.). In some Transition countries post-communist parties were returned to power in democratic elections (e.g. Poland, Hungary, Slovakia) after being defeated,  but only intermittently, not permanently; some party alternation in power is an integral part of democracy. But non-persistent, intermittent market socialism cannot deliver its expected economic and social advantages. When democratic support for an ecomic system is lacking or is not permanent, then its maintenance over time requires necessarily forms of political repression. There is a high political price to pay for an economically successful and persistent market socialism – as confirmed by "market socialist" countries such as China, Vietnam, Belarus, Uzbekistan. 

Would an economically successful Gorbachev have been able to hold together the Soviet Union? There would be economic advantages to be shared out, from holding it together.  A continued Union would maintain and promote intra-Union trade volumes thanks to the single currency, and sustain inter-republic imbalances through transfers within the All-Union budget and inter-republic credits.  An early initiative and widespread economic success, including internal and external convertibility of the rouble, would have lessened centrifugal forces. If some political and administrative autonomy was granted to the 15 republics as well, the chances of retaining the Union would have improved. But the Soviets had seldom solved ethnic conflicts, mostly they had only suppressed them (just as they had done with inflation). Independence aspirations would have made it difficult for Russia to retain close ties even with republics that economically had most to gain from continued integration, like Ukraine. The probability of holding together the Union would have been greater than zero, but not significantly greater. 

Would a successful market-socialist Russia have been able to hold together CMEA/Comecon? Arguments similar to those for holding together the Soviet Union would apply, but would be much weaker. The international socialist division of labour had a bad name, in spite of Soviet subsidisation of its Comecon partners since 1974, by supplying oil and raw materials at below world prices. Memories and accusations of earlier Soviet exploitation through trade were still deeply ingrained. In January 1990 Comecon partners de facto destroyed it by trading freely rather than continue the old trade arrangements, even at the cost of paying higher prices for oil and materials. By September 1991 Comecon was officially dissolved. Comecon Soviet trade partners were already negotiating European Association Agreements and aid programmes with the European Community (now the European Union).

Gorbachev's hypothetical successful perestroika would not have led to Comecon survival.  At most, perhaps, a couple of years earlier he might have been able to extract economic assistance from the West in exchange for his acquiescence to the re-unification of Germany – for which he got nothing at all – and for the Finlandisation of Eastern Europe – a prospect overtaken by events in 1989.   

What difference would Gorbachev’s hypothetical successful perestroika have made in Russia? Only an alleviation of the pains of Transition in the 1990s; there would have been not very much difference in the 2000s, considering that in his second presidential term Putin had already reversed enterprise ownership trends, re-acquiring greater state control in many sectors and a majority stake in energy (Hanson, 2008). By comparison with the sensitivity of Russian performance to the price of oil, probably Gorbachev’s success would have been equivalent to a ten-year-long rise of $10 on the price of a barrel. (According to the Bank of Finland Research Department a $10 permanent increase raises Russia’s growth rate by 1%). The recent implosion of the US and global financial system had a far greater effect on Russia’s prospects.

What difference would Gorbachev's hypothetical successful perestroika have made to modern geopolitics? An earlier economically stronger Russia would have probably contained USA bids for the "American Century", thus sparing them the humiliation of their century ending so soon after it had barely begun.  Certainly Georgia would not have responded to encouragement by George W. Bush and Dick Cheney to attack Russia. But the Twin Towers had nothing to do with Russia, and it is impossible to tell whether the major armed conflicts that followed their attack – in Afghanistan and Iraq – would have been prevented by an economically stronger Russia. Most probably not.

Gorbachev’s and the whole Transition’s economic débacle clearly reduced the demand for socialism on a world scale, but his success would have made no difference for European social-democracy, as it would not have prevented the disintegration of the Italian left or the degeneration of British Labour into New Labour, nor favoured Zapatero’s victory in Spain. Probably both the European Union and NATO would have been smaller than they are now.

A Russian economy made stronger by an efficient Transition would have been less vulnerable to the contagion of global financial turmoil, both in the South East Asian crisis of 1997 (that was an important factor in the Russian crisis of 1998), and today. But a stronger Russia would have neither prevented such global financial crises, nor contributed much to their resolution. 

We should leave the future to futurologists. In 1989 Fukuyama’s conjecture  about The End of History was falsified before the ink had dried. All we know for sure, whether Gorbachev had or had not been successful in implementing economic perestroika, is that – as prophesised by a wall graffiti in London in 1991: "The future is not what it used to be".    

I have been asked where the paper referred to above was published and whether it is available on line. "A counter-factual alternative for Russia's post-socialist transition" was presented at an international conference on The Great Transformation, 1989-2029, TIGER at Kozminski University, Warsaw, 3-4 April 2009, published in Conference proceedings, as Grzegorz W. Kolodko and Jacek Tomkiewicz (Eds), 20 years of Transformation Achievements, Problems and Perspectives, Nova Science Publishers, New York, 2011,  
The typescript can be downloaded here.