Transition

After the Global Crisis

2011-10-03T19:15:00.004+02:00

Conjectures about the post-crisis future of the global economy are path-dependent, i.e. they necessarily depend on the course of events envisaged for getting out of the crisis.

The current global crisis was the consequence of financial de-regulation and the general dominance of hyper-liberal policies in the United States, in the UK and in the global economy. It started around August 2007 as a US banking crisis arising from toxic sub-prime assets in banks’ balance sheets; it turned into a credit crisis that depressed enterprise investment; it spread globally through the decline of foreign trade and the slowdown and often reversal of capital flows, including Foreign Direct Investment; and then - with the large scale cost of rescuing financial institutions by government budgets, the rising cost of labour unemployment and the decline in governments revenue - it grew into a fiscal crisis and, ultimately, a widespread crisis of sovereign debt, particularly in the Euro-zone.

Initially the decline in industrial output, foreign trade volume and stock exchange values replicated the scale and the pattern of the 1929-32 crisis. Soon the impact of the crisis and cross-country contagion were mitigated by simultaneous, internationally co-ordinated, monetary expansion and fiscal stimulus, introduced at the end of 2008 and early 2009. But monetary expansion failed to re-launch economic growth, while concern about fiscal sustainability soon led to a simultaneous, premature exit from fiscal stimulus in most countries. Current prospects - apart from those of BRICS (China, Russia, India, Brasil, South Africa, now accounting for 18% of world GDP and the bulk of its growth) - are of widespread stagnation and double-dip, indeed of a second and even more serious recession.

The macroeconomic policies followed appeared to have a keynesian flavour, stimulating aggregate demand via tax cuts, monetary expansion and low interest rates. But keynesian remedies would have required public investment instead, whereas tax cuts temporarily fuelled private consumption, and the effectiveness of low interest rates - which mostly were not passed on to borrowers and simply involved higher profits for financial intermediaries - was limited by liquidity preference.

The rescue of financial institutions involved a massive transfer of wealth from taxpayers to bank creditors, including depositors and shareholders. This solution was clearly inferior to any of the alternatives, whether support for bank debtors, or partial nationalization of supported financial institutions, or outright loss-taking by imprudent lenders. Income inequality, whose depressive effect on effective demand had been reduced by credit expansion - one of the contributory factors of the crisis - increased further as a result of labour unemployment and continued payment of managerial super-bonuses awarded mostly to those responsible for the financial debacle not by markets but by a semi-feudal process of self-serving decisions by a managerial caste.

The current generalized advocacy of strict fiscal discipline, demanded by international financial institutions and often enshrined in national constitutions as a balanced budget obligation, is particularly anti-keynesian, and is bound to be counter-productive in the middle of a recession.

First, a balanced budget is neither sufficient nor necessary to the sustainability of government debt, because a primary surplus (net of interest payments) may or may not be necessary to debt sustainability - depending on whether the economy grows at a rate slower or faster than the average interest paid on government debt.

Second, the keynesian lesson has been forgotten or ignored, that the balance of government expenditures minus revenues, plus the balance of private investment minus savings, plus the external balance of exports minus imports, must necessarily add up to zero as a matter not of theory but of accounting consistency. Therefore the budget balance cannot be a policy instrument, but only a target that may or may not be achievable depending heavily also on the behavior of national economic agents and of global trade partners (including the elimination or large reduction of Germany’s trade surplus vis-à-vis the rest of Europe, and China’s gigantic trade surplus). Generalized efforts by all governments to balance their budgets simultaneously might actually result in a perverse combination of budgetary (and trade) imbalances as well as a lower level of employment and income worldwide than would be the case without such efforts.

By the same token, generalized efforts to promote employment and growth via higher international competitiveness - whether achieved by external devaluations or by domestic deflation of wages and prices - can also be competitively self-defeating: another clear keynesian lesson is that lower wages can raise employment through higher exports in one country, but cannot resolve unemployment as a world problem. Nor can world unemployment necessarily be reduced by a generalized reduction of employment tenure and other labour welfare provisions, or the replacement of collective bargaining by firm-level bargaining: the only certain effect of such policies, also very popular in anti-crisis policy packages under the pretext of “structural reforms” (e.g. see the European Central Bank’s guidelines to the Italian government in their letter of 5 August 2011) is the deterioration of the quality of work and labour incentives.

Often it is believed that the impelling necessity of environmental improvements, required by the reduction of global warming and of general pollution, and the forthcoming exhaustion of natural resources, will create a new important opportunity for investment and growth. However - apart from the observably controversial nature of global warming - these are all opportunities for public or public-funded investment, desirable in itself (not absolutely but up to some point) but competing with alternative uses of scarce public funds whose expenditure today is supposed to be kept under control in the interests of fiscal sustainability.

The chances of world leaders suddenly learning keynesian lessons, and implementing them with the speed and on a scale adequate to propel the global economy out of stagnation are remote, indeed would amount to a miracle. Even those who would like to do it are prevented by the electoral challenge of populist competitors (as is Barack Obama by his Tea-Party Republican challengers). By comparison the prospect of Wealth Sovereign Funds coming to the rescue of highly indebted governments might seem a more normal occurrence, but this would be the true miracle and is simply not going to happen: it worked in 2008 to the advantage of financial stabilization, but now WSFs have run out of trust.

The fact that the US can always “print” the dollars it owns to pay its creditors does not make the US debt indefinitely sustainable: at some point the resulting dollar inflation will make dollar bonds unpalatable at less than crippling interest rates so high that they would necessarily involve eventual insolvency. Other countries face even stricter debt sustainability conditions, without the same initial room for manoeuvre. Where private wealth largely exceeds the difference between current debt and its sustainable level, it is always possible to apply a once-and-for-all or recurring wealth surcharge to achieve solvency. Italy, for instance, has a public debt of euro 1,900 bn, but in 2008 it had a household wealth of euro 8,600 bn, 45% of which was concentrated in the top 10% of households; but wealth taxation is unpopular and the political will to introduce it is scarce. Privatization of public assets is often considered as a way to reduce sovereign debt, but the potential revenue obtainable from this source is usually overstated with respect to the depressed values realizable during a crisis, when it is infelicitously timed.

An insolvent country, like Greece, has only three alternative options: 1) instant orderly default with significant “hair-cuts” negotiated with creditors; or 2) instant dis-orderly default; or 3) delayed default, whether orderly or dis-orderly, preceded by roll-over of debt with the assistance of international financial organizations (like the IMF, or the European Financial Stability Fund soon to become the European Stability Mechanism, or the European Central Bank with its controversial purchases of government bonds in secondary markets) followed eventually by actual default, as in all schemes of pyramid banking, to which such rollover of uncovered debt has been likened.

The three default options are ranked above in order of increasing cost. However it should be remembered that non-default by insolvent debtors is also very expensive, as witnessed for instance in the large scale fall (of the order of 25%-30% in just one quarter in mid-2011) in the capitalization value of stock exchanges in temporarily solvent Euro-zone countries with uncertain longer-term solvency.

Partly the probability of default, assessed by Rating Agencies (like the oligopolistic three: Standard and Poor’s, Moody’s, Fitch), reflected in the interest spreads with respect of bonds regarded as totally secure (like German Bunds) and in the price of insuring bonds against default by buying Credit Default Swaps, expresses political as well as economic judgments (as in the recent case of Italy, handicapped by a corrupt, disreputable and divided government short on credibility).

Of course Rating Agencies have proven to be highly fallible and often biased, for they have their own agendas to drive forward, have positions of conflict of interests (“issuer pays” instead of “buyer pays”) and opportunities for insider trading. Alternative, public Rating Agencies have been advocated, for instance in Europe, but such institutions could not be regarded as independent and therefore their credibility would be low. Better still, “the use of ratings in financial regulations should be significantly reduced over time” (as was suggested in the de Larosière Report of 2009 under Recommendation 3, but never acted upon by European authorities).

In order to contain the unavoidable disruption and turmoil involved by a country’s default, it would be essential to anticipate its adverse effects and counteract them beforehand, by re-capitalizing commercial banks exposed to the cross-effects of default, including central banks and above all the European Central Bank that has been acting (probably exceeding its mandate) as Lender of Last Resort to the governments of “peripheral” (meaning “high spread”) countries. An experience of default is bound to depress the price of, and thus raise yields on, old and new government bonds for the whole area; therefore contagion would worsen the sustainability conditions of debt, and therefore slow down the speed of subsequent recovery.

Furthermore, a post-crisis global economy should have renewed efforts to establish some form of global governance rather than have in place the many and inadequate ad hoc institutions cobbled together to, at present, provide some semblance of governance. But in order to be established global government now would have to be universally accepted not only in its initial form, but also in all its rules for the continuous adjustment to future, unforeseen and unforeseeable, circumstances: such acceptance now is probably out of the question. Besides, the demotion of the nation state is not necessarily desirable. For the nation state provides a layer of authority that can protect citizens from global corporations as well as from a necessarily monopolistic global governance authority that could easily misbehave out of democratic control, and without any remaining territory to which one could run for cover.

Eventually the post-crisis economy - sooner or later - will begin to recover, thanks to the profitability of production and investment being raised by depressed wages (due to mass unemployment), the accumulation of new profitable technical inventions and opportunities, the progressive depletion of existing inventories and production capacity. Once started, recovery would tend to be amplified by indirect effects, such as the usual interaction between multiplier and accelerator, until potential capacity constraints are met again and some cyclical mechanism is set in motion again in reverse. Such is the inexorable logic of the market economy. But reliance simply on market self-regulation will most probably lead to recovery much later than possible with government intervention and jump-starting. It is unfortunate that the inadequate policy responses of 2008 and their premature withdrawal should have grossly diluted their effectiveness thus making the implementation of growth policies harder today.

Changes must also be attempted in order to prevent the operation of factors that facilitated the last global crisis, or to better cope with them. The increase in banks’ capitalization, envisaged by the Basel-3 new rules, will have an initial adverse effect on the volume of lending but longer term benefits for financial stability. A new composite currency is bound to emerge, in place of the US dollar or the euro.

Regulations on the separation of credit and investment operations of banks (à la Glass-Steagall Act) are bound to be reintroduced, as already proposed in the UK by the Vickers Commission. The Over The Counter derivatives trade might be subjected to stricter regulations, such as the requirement of an underlying “insurable” interest for taking up a position in that market, or the prohibition of short-selling, temporarily introduced in the European Union on shares and government bonds. The traditional principle of Central Bank independence in the exclusive pursuit of inflation targeting - based on the now discredited theory of rational expectations and the consequent de-coupling of inflation and unemployment - is bound to change into the even more independent pursuit of multiple targets including employment and competitiveness. We might witness attempts to protect domestic industries and stop immigration - largely unsuccessful in view of the irresistible force of underlying trends.

Currently, by and large, the economic system emerging from the crisis is bound to be substantially very similar to the pre-crisis one, improved in some respects, but worsened by large scale cuts in welfare expenditure made necessary by the (debatable) purpose of achieving fiscal balance. The post-crisis system will be more conflictual and insecure, more unequal and less cohesive, less rather than more “green” - basically a more unpleasant world in which to live. It need not be so.

Los Indignados

2011-06-18T16:05:00.022+02:00

These days indignation is a right and proper, indeed compelling, not to say compulsory, sentiment. It was forcefully advocated by Stéphane Hessel, the 93-year-old former French resistance fighter, in his influential though somewhat over-rated pamphlet Indignez-Vous (2010). “ In this world of ours – Hessel writes - 'there exist intolerable things… Indifference is the worst of all possible attitudes… One of [man’s] indispensable capacities is the capacity to feel outraged, and the commitment that derives from it”. Gramsci said it long before him.

In Spain at the beginning of March, a minor social network connected via e-mails, Facebook and Twitter, that called itself Democracia Real Ya, gathered mounting consensus and called on its adherents to take to the streets on 15 May. Which they did, punctually and massively, over 60,000 of them, in spite of the extant prohibitions due to the coming administrative elections of 22 May. They became El Movimiento 15M; they called themselves Los Indignados. In Madrid they occupied Plaza del Sol, in Barcelona Plaza de Catalunya, as well as the main squares in most of Spain’s provincial cities. They responded to provocations with peaceful and orderly meetings, discussions and free collective catering. They left on the last week-end, after cleaning up the square after themselves, but planning repeat action.

On 15 June they met again in front of the Catalan parliament in Barcelona. El Pais reported that “the protests were among the most violent since the restoration of democracy”, but a Youtube video provides incontrovertible evidence that the violent demonstrators were agents provocateurs. An identifiable small group of young people who turned nasty, in the end left 'under police escort' (sic); the peaceful demonstrators had chanted at them “Secreta, idiota, te crees que no se nota” [You are from the secret police, you are idiotic if you think we don’t know].

Who are Los Indignados? They are “the excluded” ( Los excluidos) – mostly educated, unemployed youth and those in precarious short-term employment – and their sympathizers. Los mileuristas (as christened by Espido Freires) and los zero-euristas, i.e. those earning 1,000 euro a month, or nothing at all. El Pais celebrated cartoonist El Roto – who is also a very good economist judging from his take on the global crisis - sums it up thus:

- The excluded are rebelling
- Sack them!
- No way, they don’t have jobs
- Cut their subsidies!
- We can’t, they don’t get any
- Demolish their homes!
- Impossible, they haven’t one
- Then, we are lost!

The socialist government led by Zapatero since 2004 initially made good economic and political progress, with a booming economy, high employment, secular distance from the Catholic Church, the protection of civil rights, and income redistribution. But in 2009 the global crisis hit Spain particularly hard, in spite of its earlier record of virtuous fiscal policies (as was Ireland’s). It was its worst setback since EU accession: real estate and the construction boom came to an abrupt end, investment fell by a quarter, consumption and exports were badly hit. In 2009 GDP fell by 3.6%, in 2010 GDP growth was only 0.8%; the Economist predicts 0.6% in 2011 and 1.1% in 2012.

The crisis had a devastating impact on the labour market. In the last three years Spain, with a population of 46 million, has lost more than 2 million jobs - 623,000 in 2008, 1.21 million in 2009, and 238,000 in 2010. By the end of 2010 Spain had 20.3% unemployed, or 4.69 million – more than twice the European Union average of 9.6%. In the first quarter of 2011 Spain had 21% unemployment, and youth unemployment reached 45% (860,000 people among 16-29 year-olds; 15% of youth in the 16-24 age bracket are the "ni-ni generation”, short for ' ni estudian, ni trabajan' —neither study, nor work). Those employed hold precarious, short-term jobs. They are educated, they are “the lost generation”. In their view, power is in the hands of “markets” and the bankers (as exemplified by Santander President Emilio Botin), in whose hands, they believe, politicians are simply puppets.

Zapatero’s expenditure cuts (recortes), aimed at reducing the government deficit from 11.1% in 2009 to 5.5% by the end of next year, have destroyed the confidence of the Indignados. Furthermore, in 2010 pensions were frozen and retirement age raised from 65 to 67, civil servants salaries were cut, the cheque bebé of €2500 and a planned €426 increase in unemployment benefits were shelved. A labour legislation reform that made layoffs easier to carry out generated Zapatero’s first general strike last September. The long-term viability of the banking system, and especially the savings banks (the cajas) is in doubt. The rich become richer, while there is no money for education and health. The Partido Popular would be no better. On the eve of the elections Zapatero declared that Spain would “very probably” have needed a bail-out by the European Union last year without the government’s imposition of a harsh austerity plan, but the Indignados did not accept that this was the case.

Is there contagion from the North-African Arab spring? Avenue Habib Bourguiba in Tunis, Tahrir Square in Cairo, and the Pearl Roundabout in Bahrain provide images similar to those of Madrid’s Plaza del Sol, but there is a significant difference: “In the Arab world, they are demanding the vote,” former Socialist prime minister Felipe González said on Spanish television. “Here they say there is no point in voting.” As in Italy, in Spain voters cannot pick and choose among individual candidates.

Their slogans are telling:

Adopt a politician. Educate him!
Violence is 600 euro per month.
We are excluded by neo-liberal decree; we are rebels by human dignity.
They piss on you then tell you it’s raining.
When the doors of justice close, those of revolution open.
Democracy now is voting for those you despise to stop government by those you fear.
Parliament is on brain strike.
Politics for the people, but … without the people?
To kick them out, do not vote them.
Wanted – a decent politician.
Bankers!!! As we did not vote for you, why do you govern us?
Problems do not arrive by boat, they arrive in limousines.
If you don’t let us dream, we won’t let you sleep.
We are not anti-system, we want system-change.

What do they want? At first they didn’t know. Slowly they hammered out some kind of manifesto in their open assemblies, committee and sub-committee meetings and working groups. On 19 May, Los Indignados put up their proposals to re-generate Spain, calling for: the elimination of the privileges of the political class; measures against unemployment; housing rights; quality public services; control of banking; a more egalitarian taxation; greater participation, and reduced military spending.

Some of their proposals are straightforward and desirable, such as the expropriation of unoccupied houses to be let out at a controlled rent, or the proposals on the elimination of privileges for the political class: sanctions for absenteeism and dereliction of duty by political appointees, abolition of privileged tax regimes, pension and pensionable services, indexation of their salaries to the average wage, abolition of immunity for actions taken on duty, and of proscriptions for corruption charges. But nobody really knows how to limit corruption of politicians. Should they be banned from working in the private sector (as so many do) once they leave office? The US have a two-year ban, which really does not achieve much. Perhaps they should be banned for life, but this creates a real caste of politicians, like in India and Greece, which is no better.

Some of the proposals are ambiguous, if not outright economically naïve, for instance work-sharing and a reduction of working hours to reduce unemployment – without specifying a parallel earnings reduction without which higher unit labour costs would raise unemployment instead of reducing it. Most proposals are expensive: the welfare state of Western Europe of the 1960-70s, i.e. 40 years ago, has been unsustainable for some time, given both globalization, i.e. the mobility of capital and the willingness of poor people elsewhere to work for much lower real wages, and the public debt accumulated by maintaining the welfare state under such adverse conditions. Some complaints are contradictory: you cannot have Europe and complain of a European democratic deficit and then ask that every EU decision be subjected to a national referendum. And what does “street democracy” (democracia de la calle) mean? Are we to reproduce Soviets? And how on earth can abstentions and spoiled ballots achieve “representation in the legislature”?

Four comments are in order:

First, the Spanish Indignados mis-timed their demonstrations terribly, just in the run up to administrative elections in which they could – and many did – demonstrate their feelings without occupying public space.

Second, there were large scale abstentions (34%) and the number of spoiled ballots doubled to 4% representing the third largest “party” in Spain after the Socialists and the People’s Party, which contributed to the PP victory.

Third, the Spanish electorate – as happened virtually everywhere after the crisis, with the exception of Turkey – was not particularly discerning and did not match its votes with its aspirations. Indiscriminately electorates have voted against the incumbent government, right or left, in debtor as in creditor countries (in Greece, Ireland, Portugal, as well as in Germany and Finland), supporting, instead, parties which were most unlikely to pursue their desiderata. They cut off their noses to spite their faces. Thus in the regional and municipal elections of 22 May José Luis Rodríguez Zapatero’s PSOE lost 19% of votes with respect to the previous round, and was resoundingly defeated by the opposition conservative People’s Party led by Mariano Rajoy, that gained 7% involving a 10% lead that gave them control of 9 out of 17 regional governments, and 36 out of Spain's 50 provincial cities, including several traditional PSOE strongholds like Barcelona and Seville and the regions of Castilla La Mancha and Aragon; while in the Northern Basque country a new radical separatist party, Bildu, won 25% of the vote. Last April Zapatero had announced that he would not lead his party into the general election next year, but any repeat performance by the PP is bound to hand them a parliamentary majority.

Fourth, Los Indignados did not really know what they wanted and – as indicated above – most of their proposals were vague, or infeasible, or outright contradictory.

These may sound highly critical, even adverse comments on Los Indignados, but they are not. Their approach and strategy may be debatable, but are perfectly legitimate and right and proper political behaviour. Lack of intra-party democracy debases the contest between parties leaving the electorate feeling unrepresented and frustrated. Abstentions and spoiled ballots are a wasted opportunity – and there is little point claiming that they should be counted and count – but, again, a perfectly respectable strategy, though not one that most voters (including me) would advocate. Alternation in power facilitates renewal of the political class – though not enough by itself; Gordon Brown's re-election would have been as much a tragedy for the British left as his self-imposition, and for Great Britain at large, though Brown’s protégé Ed Miliband has yet to learn any lessons from Labour’s defeat. At least Zapatero has not, like Blair/Brown Labour, launched an imperialistic war, presided over increasing inequality, liberalized and subsidized the financial sector and attacked civil rights, but he has certainly failed to honour the social contract with those who have elected him. And dissenters have no duty (though it would be in their interest) to provide well-developed credible alternatives: this is what parties, professional politicians and their think-tanks are supposed to provide, garnering and formulating as policy the wishes of their electorate.

Democracy allocates votes to alternative political ends - like markets allocate resources to the production of alternative competing goods and services. And just like markets, democracy can function too slowly or too fast, over- or under-react, produce cycles and unwanted results. At least democratic processes, at their simplest, are égalitarian, one person one vote, in theory, while markets are equivalent to multiple voting weighted by wealth; though in practice income and wealth inequality naturally biases and perverts democratic processes. But both markets and democracy - though defective - are the best instruments we have to organize our societies.

Indignation has proven to be contagious. The Spanish example has been followed across Europe: young people, though in much smaller numbers, have taken to the streets in Hamburg, Vienna and Rome. The lost generation has voiced its indignation in Lisbon, Paris, Athens and elsewhere. In Paris 2,000 young demonstrators occupied the entrance to the Bastille Opera and half the Place de la Bastille, demanding "démocratie réelle" and measures against a 20% rate of youth unemployment. Eventually they were dispersed by tear gas.

In Portugal as early as 12 March, 200,000 people marched down the Avenida de Liberdade in Lisbon - the biggest demonstration in Portugal since the 1974 Carnation Revolution. Again, it started with an appeal on Facebook by students of Coimbra University, calling upon the Geração [à] rasca (or the “troubled generation") to join together in protest. "We, the unemployed, the underpaid and the interns, are the best educated generation in the country's history," they wrote. "We are protesting so that those responsible for our precarious situation quickly change this untenable reality." (See “The Rage of the 'Indignants' - A European Generation Takes to the Streets”, Spiegel Online, 7 June). “Portugal is the fourth-poorest country in the euro zone. Even in Greece, the per capita gross domestic product is higher. Unemployment has almost doubled to 12.6 percent in six years; among people under 25 the jobless rate is 27 percent. Of those who do have jobs, more than half are working in temporary positions. Many are pseudo self-employed, earn very little and must pay a tax rate of up to 50 percent. They receive no social insurance benefits.” (Ibidem).

In Greece resistance to the austerity measures forced on Papandreu’s Socialist government by EU authorities and the IMF, to reassure financial markets, last Sunday elicited the eleventh general strike. More than 50,000 protesters, self-professed “Indignant Citizens” after the Spanish model, gathered around Syntagma Square and were involved in violent clashes. It is certain that this kind of resistance will raise the interest rate spread on Greek sovereign debt over German bonds (already of the order of 15%), and the probability of sovereign default. Yet if this is the cost of popular sovereignty, which is what democracy means, it is still cheap at the price.

Two Generations and Democracy

2011-05-29T09:52:00.008+02:00

Branko Milanovic, who contributed a recent guest post on Inequality and the Global Crisis, spent the last month in Madrid, living at a stone’s throw from La Puerta del Sol. He contributed this guest post on the current rebellion by Los Indignados. This is to start the ball rolling, no doubt others will wish to argue. By all means comment via e-mail if you must, but it is much preferable to comment directly on the post.

Several weeks ago the Spanish newspaper “El Pais”, one of the leading dailies in the world, held a party to celebrate the 35th anniversary of its foundation. "El Pais" has appeared in the days of the Spanish "transition" from Franco's dictatorship to democracy, and has throughout remained consistently pro-democratic and center-left. The daily perhaps best reflects the period of remarkable transformation of Spanish society from dictatorship to one of the most tolerant democracies in the world; from the country of emigrants to the country in which foreigners, coming literally from everywhere, account for 12 percent of the population; from a middle-income and in some respects even an underdeveloped country to an affluent country with first-rate quality railroads and highways. In a display of commitment to democracy and tolerance, the “El Pais” party was attended by all Spanish prime ministers since the transition, whether of the left or the right. The tone of speeches was celebratory and somewhat smug. Praise for democracy and the transformation in Spain was not excessive, considering what was achieved in the previous three decades, yet perhaps a bit deafening", reminding one of rather formulaic declarations about the importance of democracy that can be heard in the United States on every 4th of July. I thought that, except for Poland, the Czech Republic and perhaps the Baltic states, it would be difficult to imagine such optimistic tones on similar occasions in Eastern Europe. The reason is simple: democracy is a good thing and there is reason to celebrate it, but only if it goes together with economic development and higher incomes. And in that Spain was indeed very successful, so the generation that has accomplished this historic feat had many good reasons to celebrate. Or so it seemed.

But just ten days after the celebration and on the eve of local and regional elections in Spain, thousands of young people began rallying in the main squares of Spanish cities. The largest gathering, which attracted the attention of world media, took place on the central square in Madrid, La Puerta de Sol, just a kilometer or so from the headquarters of "El Pais" and the building where its party took place. Young people´s discontent was driven not only by the fact that youth unemployment hovers around 40 percent, that most of those who are employed hold very precarious jobs (working on time-limited contracts), or that salaries are stagnant, but by discontent that has spread to the democratic system itself, as it functions in practice. In contrast to the praise we heard at the "El Pais" gathering, now the speeches were very different: democracy ignores the opinions and interests of a large part of citizenry who have become alienated and no longer participate in the process; all political parties, regardless of their name and professed affiliation, pursue similar economic policies; the real power is in the hands of big capital and bankers who finance all political parties, not in the hands of “people”. These are all criticisms that would be subscribed by most young people throughout both “old” and “new” Europe. So, one might think, there is really something deeply flawed with democracy as we know it, and one of key slogans of los indignados said precisely this: "Real democracy-now!". In other words, "partocracy" and "bancocracy" are not acceptable.

But while the young were attacking the current Spanish "system" from the left, the Spanish right, which, because of the economic crisis and high unemployment which it blames on the socialist government, expected a major victory in the elections, retorted with its own slogan, published on the election day on the front page of a newspaper close to Partido Popular: "Real democracy-today." The message to the youth was clear: if you want to have your voice heard and believe that you have a majority, this is your moment, defend your ideas as everybody else does, go to the polls and see if you can win. "People" is not just you: “people” is others as well.

A lot of young people chose not to go to the polls and these unexpressed votes, that would normally go to the Socialists, made a difference and gave a huge victory to the right. Zapatero´s government is on its deathbed, he will not run again, and early general elections may be called. Here, then, the weaknesses in the position of los indignados began to be revealed. While they, on their posters, did not associate themselves with the soixante-huitards (of which they strongly reminded me) but to the demonstrators in Cairo and Tunis, the differences between them and the Arab youth were glaring. Demonstrations in Cairo and Tunis had a clear objective: to end dictatorships and allow for a meangful universal suffrage, multiparty system, and freedom of speech and association. These were clear and simple demands. The protesters knew what they wanted, and eventually won in both Egypt and Tunisia. But the demonstrators in Madrid were not able to clearly say what they wanted: indeed, they desire a better democracy, but what exactly does it mean? Of course, they also want a less corrupt “system" but this is what we all want. How to achieve it is a problem, and they offered no solution. When los indignados finally formulated their 8 theses, all of them except perhaps two (on changing the electoral system and the financing of political parties) were so general in nature, lacked any clear "addressee" responsible for them, or indication of the way in which things need to be improved, that they were made in fact irrelevant. Anyone would sign on these demands any time, and nobody could do anything with them.

And since real democracy took place on the election day and the right won overwhelmingly, while the demands of protesters appeared so general and vague, the demonstration turned into a fiesta, young people having good time in the central city squares, discussing, chatting, drinking beer, smoking marijuana, listening to jazz and rock music for most of the day and night. At 3 a.m., La Puerta del Sol was full of young men and women who enjoyed themselves the way they enjoy themselves at any music festival. Love blossomed—which is indeed excellent, except that it had nothing to do with politics.

And while some youngsters were speaking passionately about the evils of the "system", at the edges of the square, real poor people slowly emerged trying to sell beer or cigarettes, and to make some extra euro. And so it turns out that the older generation, gathered at the "El Pais" party, was indeed right - although when one looks at these young people, in a good mood, kind, pleasant and decent, and compares them to the well-situated, smug and self-congratulating democratic bourgeois, one is torn between sympathy and reason. But the twentieth century has taught us not to trust what our heart tells us.

Oh! Calcutta!

2011-05-25T11:46:00.002+02:00

The French magazine Le Point reported that Dominique Strauss-Kahn’s last words, before being hauled off the Air France AF023 flight to Paris by two New York Port Authority detectives, were addressed to one of the air hostesses “loudly and openly” and in front of witnesses: “Quel beau cul!”.

Admittedly this utterance sounds better in French than in English. Camille Clovis Trouille (1889-1975) - a minor part-time painter and decorator, Surrealist and anti-clerical – used a pun on that kind of French remark to name his painting of a naked woman’s buttocks: “Oh! Calcutta! Calcutta!”. And Kenneth Tynan used both that title and that painting in his 1969 Broadway show, featuring extensive scenes of total nudity, that at the time became the longest running and is said to be still today the sixth-longest running in Broadway’s history.

Nevertheless, the remark is not endearing or charming, but gross and aggressive. DSK is sub judice and the courts will decide whether he is guilty and of what. But there can be no doubt, regardless of the courts’ eventual ruling – especially if it is the case that his line of defence is the consensual nature of sexual acts with the Sofitel chambermaid - that he is “a man with a problem that may make him ill-equipped to lead an institution where women work under his command”. These are the words used by a colleague of his, with whom he had an affair, in a letter she addressed to the IMF Executive Board in 2008. A public external enquiry on that case cleared DSK because there had been “no harassment” but ruled that he had made “a serious error of judgment”. The Fund lacked - and still lacks - “clear and protected arrangements for reporting possible misconduct” and “clear disciplinary arrangements” to deal with it if it occurred.

Unfortunately, DSK’s latest little error of judgment has already had the most devastating consequences, not only for him and his family but for the IMF, which in the three and a half years of his tenure he had steered to a larger scale and to a greater role in global governance during the greatest world economic crisis since 1929; for the sovereign debt crisis in the Eurozone and the future of the euro; for the French presidential elections in which he had been a frontrunner who could have led the Socialists to their first victory since Mitterand’s 1988 re-election.

DSK is a Keynesian, like his Chief Economist Olivier Blanchard (from MIT). He persuaded IMF shareholders to raise $500bn additional capital thus trebling its resources. At the emergency summit of G-20 leaders on 15 November 2008 he proposed, and obtained, a large scale global fiscal stimulus of the order of 2% of global GDP, and encouraged a parallel monetary expansion. He opposed calls for an early exit strategy (for instance by the German Chancellor Angela Merkel and the ECB President Jean-Claude Trichet), which he viewed as premature, and above all a collective exit strategy considered by the G-8 of 8-10 July 2009 at L’Aquila, which would have been disastrous.

He junked the old “Washington Consensus” that had inspired IMF operations in the 1980s in Latin America and in the 1990s in the post-socialist transition economies. He was well aware of debt sustainability issues, but was also very conscious of the impact of fiscal austerity on poverty and distribution. Under his leadership there was concern for gradualism, and for client countries’ ownership of stabilization programmes. He aimed higher than he could reach, just to make progress; an instance would be his argument for a new role for the IMF as a global Lender of Last Resort, which was inappropriate, for which he never really developed a case and let drop.

His revolution was unfinished. He was acknowledged to be a very good diplomat, who listened to both North and South; was trusted by the Greeks, was the only non-German with an influence on Angela Merkel.

He is virtually irreplaceable. The problem with Christine Lagarde is not the Tapie affair, of which she is likely to be cleared on 10 June, but – as Martin Wolf puts it in the FT of 25 May – “her limited knowledge of economics”. DSK’s letter of resignation as IMF Managing Director ended, incongruously, with the words “Au revoir”. Sadly, he clearly meant “Adieu”.

Cuba’s Pre-Perestroika

2011-05-19T19:34:00.009+02:00

On 16-19 April 2011 the Cuban Communist Party PCC held its sixth Congress since the 1959 revolution, the first since 1997. The date is historic: on 16 April 1961 Fidel Castro proclaimed the socialist character of the revolution, the next day a contingent of Cuban exiles attacked the Bay of Pigs, two days later they were routed. The timing of this year’s Congress might be taken to suggest that Cuban socialism is in danger now as it was then; on Christmas’ Eve last year the party paper Grandma stated that «it [was] no longer the coming year but the coming country».

If so the frequency of Party Congresses leaves a great deal to be desired: one every almost-nine years, 14 years since the last one, in a period that saw the fastest and most complex changes on the planet, do not say much about the quality of democracy under Cuban socialism, even in its diluted form of «democratic centralism», prevailing on the island. Especially since the Cuban population is aware that Fidel Castro has transferred the Presidency of the country to his brother Raúl in 2008, but discovered only on 22 March 2011 that he had transferred to him also the direction of the Cuban Communist Party five years earlier (Renaud Lambert, «Ainsi vivent les Cubains», Le Monde Diplomatique, April 2011). A Party secret secretary seems bad form, to say the least.

Cuba today – mutatis mutandis - has reached the stage of economic and political development that the Soviet system had reached on the eve of Gorbachev coming to power in March 1985: a gerontocratic leadership, moreover transferring power within the family in North Korean style; an authoritarian political system; much talk of price liberalisation but continued generalised shortages of goods in excess demand at state prices, with rationing for the last 52 years; a dual currency, an unconvertible peso and a convertible one that replaced the dollar in 1994 (something that the Soviets thought of but fortunately refrained from doing); special economic zones to attract foreign investment; long-term leases of state assets in the tourism sector; leases of uncultivated land to landless farmers (about 140,000 leases in the last year); and endless talk about free private enterprises, still in practice restricted largely to self-employment (200,000 new licences since last October) and family firms in the service sector.

Inevitably, at the beginning of September 2010 even Fidel Castro recognised and stated, in an interview to the US monthly The Atlantic, that the Cuban model «does not work anymore». In mid-September the Cuban Workers Union CTC announced the suppression of 500 thousand public sector jobs by March 2011 (as already anticipated by Raúl on 1 August 2010). This was justified by «the need to raise production and the quality of services, to reduce the enormous social expenditures, to eliminate free benefits and excessive subsidies». The half a million are only 12% of public sector workers (who make up 80% of the active population, i.e. 4,400 thousand) one out of each four of them being regarded as redundant by Raoul, thus making total re-deployment from the public sector affect as much as 20% of active population (the figures are provided by Janette Habel, «Changement de cap a Cuba», Le Monde Diplomatique, October 2010; they add up only approximately. The FT of 24 April puts public employment at 85%, i.e. about 5 million). But bureaucratic impediments, lack of credit and of necessary material supplies, crippling turnover taxation, remain the main obstacles to the absorption of redundant workers through the growth of small scale private sector. The quality of education has suffered as a result of teachers leaving underpaid jobs; only 14% of the population uses Internet.

“We are convinced that the main enemy we face and will continue to face is our own shortcomings,” Raúl Castro said at the end of the Congress, echoing what Gorbachev might have said in 1985. The preliminary lineamientos (over 300 directives) of the Party Congress aimed at legalising what was already discrete current practice, such as price-fixing according to market principles (there has been a free peasant market for agricultural products since 1994, promoted by Raúl in spite of Fidel’s opposition), links between wages and productivity, greater autonomy for state enterprises. Above all there is a perceived urgency to open the economy, following the example of Vietnam and China. With the economic collapse of the Soviet economic and political system, Cubans lost their former benefactor and GDP fell by 35% during the «Special Period» of 1991-2000; today Venezuela’s subsidised oil in exchange for Cuban teachers and doctors is not enough to replace former Soviet support. Cubans now have to contend with the harsh reality of global markets, though they prefer to blame their aggravating economic backwardness not on globalisation but on their being denied access to it by the US trade embargo - perhaps the most myopic and counterproductive policy ever adopted by the United States towards a weak opponent.

There are bright spots. Since 1950, average life expectancy has risen from 58 to 77 years (as it did in Russia under Gorbachev). A recent issue of Foreign Affairs stressed that «Cuba is the only poor country in the world that can claim that health does not represent a fundamental problem for its population. Its success in this field is unrivalled». But tourism and nickel, the most dynamic sectors of the economy, were severely hit by the 2008 crisis; in the same year three successive hurricanes destroyed infrastructures worth $10 bn, equivalent to 20% of GDP. In 2009 agricultural production fell by 7.3%; the country imports 80% of its food, up from 50% in 2004, a growing vulnerability given the volatility of food prices over the last couple of years. Lending to Cuba by international financial institutions has been falling over the last four years, but total debt has been accumulating fast, from just over $16bn in 2006 to $20bn today, mostly towards China. (FT, 24 April 2011)

The ration card (tableta de abastacimiento) had some egalitarian merit in the distribution of basic goods, as an exceptional, temporary measure during short emergencies when established supply channels are suddenly disrupted by wars or natural calamities. Otherwise its continued persistent use since 1962, and the associated black/grey/multicoloured markets in which scarce goods are re-traded (whenever this is physically possible) at a premium, is a tragic misunderstanding of socialist values. Socialist planning ought to be capable of balancing supply and demand at stable prices, but if it fails it is much preferable to let prices do the rationing through price rises, at the same time subsidising the monetary incomes of the poorer groups of the population in order to support their real consumption levels. Yet the redistributive effects of market-clearing prices – in the absence of re-distributive, compensatory measures – are clearly undesirable. Urban poverty – i.e. inability to cover basic needs - is said to have risen from 6.3% in 1988 to 20% in 2000 (Mayra Espina, quoted by Jeanette Habel, «Cuba en quête d’un modèle socialiste renouvelé», Le Monde Diplomatique, January 2009).

Raúl recognises that the tableta is «irrational and unsustainable» but expresses vocal concern for the dangers of inequality, growth of the informal sector and the black market, themselves being generated in part by the rationing system: such concern should lead to generalised income subsidies rather than place a major drag on price-liberalisation. For without market-clearing prices you cannot imitate China and play with markets, with private entrepreneurship, hard budgets and export-led growth. A set up only too familiar from the last days of the Soviet régime.

o O o

In December 1969-January 1970 (the year of the 10 million tons of sugar) I visited Havana from Cambridge to lecture on investment planning at the Institute of Economics, following up on Richard Stone who had just been there to lecture on input-output models. In my course I tried to legitimise the use of an interest rate in investment selection, which was regarded then by Cuban economists as an exploitative bourgeois practice to be rejected. I pointed out that even Soviet Academician Stanislav Strumilin had advocated an interest rate within the Marxian Theory of Value, as the growth rate of labour productivity that reduced the labour value of future goods. I also argued that there was an implicit, shadow interest rate in investment choice in Soviet-type systems in the form of a minimum «recoupment period» within which additional investment costs had to be recovered by yearly savings in current operating costs.

I was curious to see what had been discussed in Cuban journals in the years immediately after 1959, and did some research in the Institute library. I was surprised to discover that the peak of the debate was a discussion between Che Guevara and Charles Bettelheim on whether or not the concept of value required a contradiction (sic). Bettelheim might as well have been sent to Cuba by the CIA, and perhaps he had been, to divert Cuban energies from the real tasks of building a socialist economy.

It was a memorable trip. Cubana Airlines from Madrid, stopover in Zander, Newfoundland, 17 hours on a propeller plane to Havana, stopover in the Canaries in the 17 hours on the way back to Madrid. Staying at the Hotel Nacional, together with large numbers of Russians and of the most gigantic multicoloured insects; lobster at every meal for a while, until I would have given anything for a sausage. Privileged access to free meals on a card and subsidised hotel shops, also for the spy-chaperon who was shadowing me all the time.

I visited Barradero beach (then deserted and to die for), Hemingway's house, a cigar factory, the most luxurious villa formerly belonging to the Rockefellers, with vast expanses of Carrara marble, beautiful succulents exotic flowers and colibri birds. I saw parts of the Cuban interior, including the Sierra, Santiago and its open sewers, sugar cane plantations where students and professors cut cane painfully and inefficiently at week-ends with dangerous looking machetes, a crocodile farm and the most over-built over-expensive cattle farm.

Empty shops everywhere, which two Italian town planners working there were planning to convert into cultural centres, and were horrified at my suggestion that it would be desirable to fill them with goods. Rationing for everything, not even tropical fruit was available for sale, though everything was available on the black market. An amazing display on the public roads of ancient-antique US cars, often cannibalised into the most curious hybrids. Buses (uauas) were driven around at terrifying speed, but I had a chauffeur-driven Alpha Romeo at my disposal, which Cuba had imported directly from Italy through a barter deal for nickel. I asked to be taken to the Bay of Pigs and, faced with vague promises, I went on strike i.e. refused to go on any other local trip until they did take me.

In Havana I met by chance an interesting young man, Carlos Vidali, a personal guest of Fidel’s being the son of Vittorio, the prominent Italian Communist who had traveled extensively in Cuba before and after the Revolution. Carlos arranged for me to meet the economy supremo Carlos Rafael Rodriguez, who firmly criticised my starry-eyed égalitarianism on pragmatic grounds. Only after my return to Europe did I learn that Carlos’ father was reputed – rightly or wrongly – to have had a role in organising Trotsky’s assassination.

According to Wikipedia Vittorio Vidali – also known as Enea Sormenti, Jacobo Hurwitz Zender, Carlos Contreras, "Comandante Carlos" – was a colourful figure, a founding member of the Italian CP, Comintern agent and finally Communist MP in the Italian Parliament. He «was definitely involved in the May 24, 1940 failed frontal assault on Trotsky's residence in Mexico City, along with [Iosif] Grigulevich and Mexican painter David Alfaro Siqueiros. Vidali is thought to have been involved with the insertion of assassin Ramón Mercader into Trotsky's inner circle – Mercader was to kill Trotsky later that year», though the Italian version claims that Vidali’s presence in Mexico at the time of Trotsky’s assassination may have been «a sheer coincidence».

o O o

The shocking thing is that in over forty years since my 1970 visit not much has changed in Cuba by all accounts; not much is different from the Soviet days just before and just after the beginning of Perestroika, and a self-selected self-perpetuating small group of dogmatic and decrepit old men have been repressing the development of an entire country and its people for over half a century without having the slightest idea of what they are doing and why, heading for total and unmitigated disaster not only for themselves but also for the people they have taken it upon themselves to rule.

Cucumber season

2011-05-13T19:43:00.011+02:00

The Silly Season, or Cucumber Season as it is called in several European languages – the diffusion of frivolous news to compensate for the mid-summer rarefaction of real events – has begun early this year. On 6 May Der Spiegel reported that “Greece Considers Exit from Euro Zone” with a view to re-introduce the Drachma, negotiating to that effect with EC and Eurozone authorities at “a secret crisis meeting in Luxembourg” that evening. The fact that the meeting was at first officially denied by Luxembourg Premier Jean-Claude Juncker, then admitted ("When it becomes serious, you have to lie"), lent credibility to the story. The euro lost 2 cents overnight with respect to the dollar.

No Exit

This non-scoop is utter nonsense, and not just because there is no provision for exiting the Eurozone other than by leaving the European Union – a drastic and traumatic step in nobody’s interest. Nor just because this would annihilate the Greek banking system (and heavily damage German and other European banks, including the ECB), or because Euros in the hands of the Greek public would continue to circulate – possibly curtailed by the amounts that the Greek public might be unable to recover from their banks (though they have already salted away €30bn abroad as a result of the crisis). Nor just because Greece would lose the financial support already committed by European institutions (half of €110bn, which have not yet been disbursed), and support lined up in the near future (there is current talk of another €60bn).

Greek exit from the euro is nonsense primarily because the re-introduction of the drachma would not allow Greece to reduce its debt denominated in euro through drachma inflation. The euro debt would rise in terms of drachma through drachma devaluation to compensate for drachma differential inflation with respect to the euro, and remain exactly the same as before the exit.

True, the possibility of drachma devaluation – beginning with the re-introduction of the national currency – might make Greece more competitive and make it prosper to the point of re-gaining solvency. But if a devaluation was 1) politically acceptable (unlikely, after 10 general strikes since the first austerity measures were introduced by the Socialist government) and 2) economically effective (in terms of import and export elasticities with respect to devaluation), the Greek government could replicate its effects via a Latvian-style domestic deflation without the additional costs and turmoil of leaving the Euro.

Which is why Greek exit from the euro is a non-starter, pace Der Spiegel’s news and Hans Werner-Sinn’s advocacy. The only other two possibilities are: a bail-out, or a default: Quartum non datur, to coin an expression.

No Bail-Out

When a debtor is solvent but illiquid, a bail-out involves temporary assistance, perhaps by European institutions on terms friendlier than those that might be offered otherwise by financial markets, with full later re-payment. But there is an increasing consensus that certainly Greece – at any rate, leaving aside the similar cases of Ireland and Portugal – is not illiquid but insolvent. The provision of additional loans to allow Greece to repay outstanding loans as they mature, at an interest rate higher than the likely growth rate of the country's GDP (taking both either in nominal or real terms) is a recipe for bankruptcy – unless there is a commitment, on the part of European institutions, to continue to provide non-repayable loans until Kingdom Come.

Paradoxically, this kind of approach appears to have a Keynesian connotation. In “Economic Possibilities for our Grandchildren” (1930) Maynard Keynes quotes approvingly a passage from a book by Lewis Carroll, 1889, [Ch. 10, The other Professor]:

“Let me remind you of the Professor in Sylvie and Bruno:”
[“Come in!”]
“Only the tailor, sir, with your little bill,” said a meek voce outside the door.
“Ah, well, I can soon settle his business,” the Professor said to the children, “if you’ll just wait a minute. How much is it, this year, my man?”
The tailor had come in while he was speaking.
“Well, it’s been a-doubling so many years, you see,” the tailor replied, a little grufy, “and I think I’d like the money now. It’s two thousand pound, it is!”
“Oh, that’s nothing!” the Professor carelessly remarked, feeling in his pocket, as if he always carried at least that amount about with him.
“But wouldn’t you like to wait just another year and make it four thousand? Just think how rich you’d be! Why, you might be a king, if you liked!”
“I don’t know as I’d care about being a king,” the man said thoughtfully. “But it dew sound a powerful sight o’ money! Well, I think I’ll wait-“
“Of course you will!” said the Professor. “There’s good sense in you, I see. Good-day to you, my man!”
“Will you ever have to pay him that four thousand pounds?” Sylvie asked as the door closed on the departing creditor.
“Never, my child!” the Professor replied emphatically. “He’ll go on doubling it till he dies. You see, it’s always worth while waiting another year to get twice as much money!”

The trouble is that this approach can hold only in Lewis Carroll’s Wonderlands, for in the real economy there simply may not exist an interest rate such as to make a creditor, or the financial market as a whole, willing to renew a mature loan in its entirety for another period – let alone another and another. The creditor is more likely to want to cash in at least some of his credit and of the accrued interest, and re-lend only the rest. Clearly Maynard Keynes was not being serious, he was only amusing himself with literary references, as he might have done in conversation with fellows and guests at High Table dinner or over Wine Room drinks.

Bail-outs as Ponzi Schemes

The nature of European bail-outs has been well understood and demonstrated in an article in the Financial Times of 5 May by Mario Blejer – former Governor of Argentina’s Central Bank and director of the Centre for Central Banking Studies at the Bank of England. Blejer likens financial support for Greece, Ireland and Portugal to a giant “pyramid or a Ponzi Scheme”. Ponzi paid insustainably high interest rates out of new deposits, before running away with the residual loot. European bail-outs involve the accumulation of non-sustainable interest rates without the possibility of their ever being paid together with the original loans. The principle is the same.

The bail-outs raise total debt and its share of GDP. “A case in point is the €78bn ($116bn) loan to Portugal. It is equivalent to more than 47 per cent of its gross domestic product in 2010, possibly increasing Portugal’s public debt to about 120 per cent of GDP.”

“It could be claimed that this mechanism is helping the countries involved since the official loans, although onerous, carry better conditions than the ones that need to be serviced. But the countries’ debts will increase (as a percentage of GDP the debts of Greece, Ireland, Portugal and Spain are expected to be higher by the end of 2012 than at the start of the crisis). The share of debt owed to the official sector will also increase (in addition to the bond purchases by the European Central Bank, which reportedly owns 17 per cent of these countries’ bonds with a much higher percentage held as collateral).”

“Some of the original bondholders are being paid with the official loans that also finance the remaining primary deficits. When it turns out that countries cannot meet the austerity and structural conditions imposed on them, and therefore cannot return to the voluntary market, these loans will eventually be rolled over and enhanced by eurozone members and international organisations. … “… this “public sector Ponzi scheme” is more flexible than a private one. In a private scheme, the pyramid collapses when you cannot find enough new investors willing to hand over their money so old investors can be paid. But in a public scheme such as this, the Ponzi scheme could, in theory, go on for ever. As long as it is financed with public money, the peripheral countries’ debt could continue to grow without a hypothetical limit.”

Except that there is a political limit to solvent countries’ willingness to take on the debt of those insolvent: “We are starting to observe public opposition to financing this Ponzi scheme in its current form, but it could still have quite a way to go. It is apparent that, if not forced sooner by politics, the inevitable default will only be allowed to take place when the vast part of the European distressed debt is transferred from the private to the official sector. As in a pyramid scheme, it will be the last holder of the “asset” that takes the full loss. In this case, it will be the taxpayer that foots the bill, rather than the original bondholders that made the wrong investment decisions.”

Blejer points out that the desirability of this approach depends entirely “on how one assesses the value of the time gained. Would a bank crisis now be more damaging to the European economy than a future debt write-off? Or, alternatively, is recognising reality and accepting a debt restructuring now preferable to increasing the burden on future taxpayers? At the end, it is a political decision, but it would be refreshing if things are called by their name. Euphemisms may be useful in the short run, but one finally recognises a Ponzi scheme when it persists.”

No Default?

The undesirability and ineffectiveness of exit from the Eurozone, and the Ponzi-like nature of continued assistance to insolvent sovereign debtors, leaves only one option: default – preferably consensual, negotiated with creditors rather than unilaterally declared and abrupt; in the form of lengthening debt maturity, interest rate haircuts, as well as debt reduction, but default nevertheless. There is no way “No Exit, no Bail-Outs, no Default”, or immovable objects and irresistible forces, can co-exist other than in a Wonderland.

Richard Portes (who was involved in Poland’s 1981 default) makes a powerful case for the restructuring of Ireland’s debt: “A reasonable target would be a debt reduction of €40-50 billion, in present value. That is on the order of 30% of GDP and would bring the debt ratio down to a sustainable 80% or so. The required haircuts would be in line with current market valuations of Irish sovereign debt.”… “Of course, there is a way for Ireland to escape responsibility. Just wait for Greece to restructure its debt, at which point there will be general confusion and the markets will shun Ireland anyway. Then restructure, when it will be widely accepted as unavoidable. Maybe that is the unspoken strategy. If so, there may not be long to wait.”

Martin Wolf (in his FT Column of 11 May) works out that with a debt/GDP ratio of 160%, and with very optimistic assumptions of a 6% interest rate (less than half of the current 15%, or the 25% on two-year bonds), and a 4% nominal growth rate, even to stabilize debt Greece would need to run a primary surplus (before interest payments) of 3.2%; and a 6% primary surplus would be necessary to reduce the debt/GDP ratio down to the Maastricht Treaty ceiling of 60% by 2040. “Every year, then, the Greek people would need to be cajoled and coerced into paying far more in taxes than they receive in government spending.” “What might persuade investors that this is sufficiently likely to justify funding Greece? Nothing I can imagine. But remember that 6 per cent would be a spread of less than 3 percentage points over German bunds. The default risk does not need to be very high to make this extremely unappealing.”

Wolf recommends “a pre-emptive restructuring of the debt, perhaps next year. Since market prices tell us that this is what investors expect, it should not come as a shock to them. A restructuring ought to raise the country’s creditworthiness and increase the incentives to sustain a programme of stabilisation and reform. Moreover, with a planned, pre-emptive restructuring the authorities could also prepare the needed support for banks, both inside Greece and outside it.” “Overindebted countries with their own currencies inflate. But countries that borrow in foreign currencies default. By joining the eurozone, members have moved from the former state to the latter. If restructuring is ruled out, members must both finance and police one another. More precisely, the bigger and the stronger will finance and police the smaller and the weaker.”

What used to be isolated voices contemplating default are turning into an increasing chorus. “A Reuters poll finds that investors and economists believe Greece will have to restructure its sovereign debt, with 14 out of 15 fund managers and 26 out of 28 economists polled. Opinions are more divided when it comes to the timing. Half of these economists and a third of the fund managers believe it will happen after April 2012. From those 11 economists and 8 fund managers believe restructuring will happen through haircuts, while a majority believes it will happen through extending maturity and lowering interest rates.” (Eurointelligence.com, 13 May). “FT Alphaville picked up on a paper by Barclays Capital, which looked at the haircut needed by Greece to achieve a primary balance - which is 67% in 2012 – based on a primary balance of minus 2.5% this year. It goes into a great detail about recovery values to conclude that the situation is really messy.” (Ibidem).

The most vocal opposition to any talk of default comes from Lorenzo Bini Smaghi, at present a member of the ECB Executive Board. Bini Smaghi’s solution of the sovereign debt crisis is the issue of European sovereign bonds, that would compete with US Treasury Bonds, lowering interest rates and financing the bail-outs. It is immensely naïve to believe that a EU institution, backed by a tiny budget of just over 1% of EU GDP and a built-in zero primary surplus might successfully compete with the US Treasury, with a tax revenue of over 35% of GDP out of which it is conceivable that a primary surplus sooner or later might be sufficiently high to service its debt.

With Mario Draghi’s coming appointment as ECB President, after Angela Merkel’s endorsement, Bini Smaghi is expected to have to leave his ECB post to make room for a Frenchman, and was considered to be in a strong position for a bid to succeed Draghi as Governor of the Bank of Italy. But other frontrunners for the post, Vittorio Grilli (Director General of the Italian Treasury and the president of the EU’s economic and financial committee), Fabrizio Saccomanni (the Director General of the Bank of Italy) and Ignazio Visco (his deputy), are less committed to Bini Smaghi’s agenda. Certainly Draghi has already stated firmly that there can be no European sovereign bond ahead of Fiscal Union. Maybe he will also be more open to orderly but unmitigated defaults, before the sovereign debt crisis becomes unmanageable.

More on Hungarian Populism

2011-05-07T11:55:00.019+02:00

My friend the Hungarian economist Yudit Kiss (Geneva) contributes this comment:

Dear Mario,

You are very right about the parallels between Berlusconi and Orban – Viktor Orban is clearly inspired by Berlusconi but there are several points where he goes much further then any of the populist leaders today.

Since last April the Fidesz-MPP Party, that won a 2/3 majority of the Parliamentary seats in Hungary, started to dismantle systematically the democratic institutional system that was built during the last 20 years. The process started with the drastic curtailment of the powers of the Constitutional Court, then those of the Budget Council, the rights of the media, an attack on the independence of the National Bank, the introduction of a whole series of new laws and regulations, crowned with the hasty introduction of a new Constitution, all written to suit the values and interests of the governing party.

The new Constitution will be followed by the introduction of 39 "fundamental laws" (that need the approval of 2/3 of MPs) that regulate such basic dimensions of life as labour, voting rights, the pension system, party financing or the regional administrative system. These laws will be created within a year, probably by the same method as the Constitution and the other new laws that have been accepted by the completely docile Parliament since last April, i.e. with the exclusion of independent experts, social partners and the political opposition.

According to Fidesz, last April a Revolution took place at the ballot box and this gives them the right to change radically key dimensions of public and private life in Hungary – from the tax system to social welfare, from street names to education, from film-making to the right to vote. Since the new Constitution declared that Hungary is a Christian country and life is sacred since the moment of conception, the prohibition of abortion and the introduction of compulsory religious education might be just a question of time. Another measure with long-term consequences is the increased tenure of key public functions, so that even if it lost the next elections, Fidesz' interests would be represented at the highest levels under future governments. The new Constitution limits further the independence of judges (and abruptly lowers their retirement age, so that a large-scale renewal of the profession's staff and its leaders) making it even more difficult for everyday citizens to fight for their rights. The President of the Supreme Court was not consulted or informed about this measure previously; neither were the Director of the 1956 Institute or the Rector of the Corvinus University, who learnt about the end (the planned dissolution, in the case of the latter) of their institutions from the media.

With the signing of the Constitution by the President, who faithfully follows the governing party's directions, Hungary ceased to be a Republic and became “the country of the Hungarians". Fidesz claims to act on behalf of the "nation" and the nation includes Hungarians living abroad. One of Fidesz's first steps was that of offering citizenship to ethnic Hungarians living outside the country, promising them voting rights for the next elections. If the EU cannot prevent this, Fidesz will indeed reign for 20 years (as its leaders promised before the elections) and a very dangerous precedent would be created inside the Union.

According to the canon of the populist-nationalist rhetoric, Ministries and several public institutions became "National" and the government is in permanent fight against external and internal enemies. In the Prime minister's speeches Hungary is portrayed as an exceptional country that is not acknowledged by the world at its true value. The country's external enemies are international capital, the IMF and the World Bank, and according to Orban's speech pronounced at the 15th of March national holiday, Brussels that intends to "dictate Hungarians what to do from outside" but is doomed to fail. Internal enemies are the representatives of the previous governments, many of whom are subject to criminal charges, including former PM Ferenc Gyurcsany, or those who occupied leading positions under the previous government. (Corruption is undoubtedly a very grave and generalized problem of Hungarian society and there were some very corrupt Socialist politicians active during the last two cycles - together with corrupt politicians from other parties, including Fidesz – but the criminalization of the whole previous political leadership is more a political manoeuvre then an exercise in transparency.) The critics of the system, particularly if they raise their voice publicly abroad, are also labelled "enemies of the country", as shown by the current witch-hunt against the best of Hungarian philosophers.

Fidesz is on its way to build a genuine party-state – changing the management of state and public institutions and extending its control over spheres that enjoyed a considerable autonomy before, like regional or local governments or independent institutions, partially financed by the state. According to a decision taken in December, 35 prestigious independent public foundations, including the world-famous Institute Peto for handicapped children, several foundations defending minority rights or the 1956 Research Institute, have been dismantled. The directors of public media, theatres, academic institutions, schools, many public companies and institutions have been changed, when the institution itself is not closed down. Those who occupied leading positions under the former governments, including school headmasters, hospital directors or elected leaders of independent organizations have to reapply for their jobs and many of them are replaced. Party affiliation often overrules professional competence and, if arbitrary decisions are not accepted meekly, sometimes a whole professional team pays for it. In a recent, utterly Ubuesque episode the President of an intergovernmental committee in charge of deciding about geographical names was sacked, because he disagreed with the government's proposed new name for Budapest Airport that left out "Ferihegy", the traditional name that was used for decades. 20 out of 21 members of the professional committee had the same view, but the government's proposal went through and later the whole committee was dissolved.

In his first speech after the elections last year Mr Orban promised to put in order the economy, strengthen public order and then start work on a new Constitution. The economy was "put in order" in a way Janos Kornai describes in the NÉPSZABADSÁG article you quoted in a comment to your post on Populism. Many of the country's best economists criticise sharply the government's economic policy, including experts with such diverse backgrounds as Laszlo Csaba, Tamas Bauer, Gabor Oblath, Andras Inotai or Tamas Mellar. Public order was "restored" by a revision of the penal code and the introduction of severe punishments even for minor offences, like speeding, or smoking in certain public places, like bus stops. There are plans to lower the age of legal responsibility to 14.

Beyond the populist rhetoric, however, actual measures do not serve the interests of ordinary people. The new tax system favours the better-off sections of the population, welfare services are being and will be radically cut back, prices of public services are raised, while the new Constitution curtails seriously labour rights.

One of the first conflicts between the government and the Constitutional court broke out due to a new regulation that makes it possible to dismiss public employees without justification. In his pre-election speeches Orban promised 1 million new jobs in 10 years. According to the latest report of the Hungarian Statistical Office, in one year 13,000 new jobs were created, but at least 50,000 jobs were lost. Unemployment stagnated at 11.6%, but was 26.8% among first job seekers (between age 15-24) and reached 10.8% in the age group of 25-54. Average unemployment lasts 18 month, an increase of 1.8 month. The new regulations are also very harsh on the poor, jobless, homeless, marginalised, handicapped, including those on invalidity pensions. Some of these measures are utterly grotesque, but given the general context, one does not feel like laughing; homeless people can be fined for "using public spaces for living" and in some districts of Budapest those who are caught scavenging in the garbage bins also have to pay fines.

The new power's way of dealing with dissent is also very disturbing. After the first months' startled silence, public protests started with a small group of University students who took to the the streets in December with a slogan: "We are the first generation born in a state of law, we don’t want to be the last one." Demonstrations and meetings have multiplied since, including an approximately 30,000 strong gathering in defence of press freedom on the 15th of March national holiday, organized by a small team of civil society activists and a joint, Hungarian and international trade union protest that gathered about 50,000 participants in April. The government usually ignores these massive expressions of dissent, clearly stating that it does not consider necessary to follow a dialogue with its political adversaries, potential social partners or its people. If there is a dialogue it takes the form of choosing one privileged interlocutor – e.g. one particular trade union or one Roma organization – as the only legitimate representative of a certain constituency, with which the government carries out exclusive discussions. Another form is a practically ex-post and formal "popular consultation" that was used in the case of the Constitution; approximately 2 weeks before the final text was presented to Parliament, every citizen received a personal letter with 12 questions about the future text that did not touch any of the crucial points of the document. According to government sources approximately 920,000 persons responded, so the Constitution could be said to have been publicly and democratically discussed and accepted by the people.

In other cases, however, the government's reaction to criticism is harsher. Following recent demonstrations of public order organisations, including firemen, who protested against new measures that take away some of their social gains and worsen their working conditions, the changing rooms were searched and prosecutions were started against several participants, because they marched in their uniform that is not permitted by the current regulations. For this week-end's planned demonstration the firemen plan to borrow uniforms from their Austrian colleagues and hopefully no one will be persecuted. International solidarity helps…

In another, very telling case, the independent mayor of Esztergom, a city some 45 kms away from Budapest, revolted against the Fidesz majority city council that has been obstructing her work ever since her election in the municipal elections in last October. Following the mismanagement of the previous Fidesz leadership, the town is on the verge of bankruptcy and the new mayor wanted to put things into order. Backed by the inhabitants of the town, she asked for help from the government, but had no reply. Finally, she decided to walk to the Parliament, accompanied by a delegation from the city's civil society representatives and sympathizers all along the road. She was not received by any government representative and could only hand over her protest letter addressed to Viktor Orban to a MP at the gate of Parliament. In her absence the city council met, headed by a senior official and passed some new measures without consulting her.

The case of Hungary also demonstrates one of the most serious dangers of the recent breakthrough of the extreme-right; the adaptation of their language, arguments and objectives by mainstream political currents. The Hungarian extreme-right party Jobbik entered Parliament at the last elections. Jobbik is not a coalition partner and Fidesz and Jobbik often display their differences publicly; however, Jobbik's language has entered the public discourse, its arguments are taken up by mainstream politicians and it has been implementing its policy with increasing self-assurance and tacit support. One of the leit-motifs of Jobbik's political agenda is the "fight against Gypsie criminality" and this Spring they started to put into practice their agenda. Since early March Jobbik activists and uniformed members of the "Civil Guard Association for a Nicer Future" (successor of an outlawed, openly racist paramilitary organization, the Hungarian Guard) marched up and down in the village of Gyongyospata, "maintaining order", terrorizing, humiliating and harassing the entire Gypsy population, as a retaliation after a Roma youth was caught stealing wood in the nearby forest. The police stood by, having the order only to intervene if atrocities were committed on either side. Violence broke out in late April, after a stormy Easter weekend that most Roma families spent separately; women and children were evacuated to a youth camp near Budapest, because "Nicer Future" had scheduled a "training weekend" next to the Gypsy settlement. This led to a country-wide scandal (government officials stating that the Roma just left for a holiday and accusing the opposition of wipping up a scandal to discredit the country), and, finally the arrest of some of the leaders of the paramilitary organisation. When they were released a couple of days later and "shared their joy" with the embattled Gypsy community, a massive fight broke out (fortunately nobody was killed) and the government hastily took a measure to forbid "uniformed violence".

I could go on and on. There are some good sites that cover developments in English, see e.g. http://esbalogh.typepad.com/hungarianspectrum/,
http://hungarianwatch.wordpress.com/. A site summarising events in Gyongyospata http://gyongyospatasolidarity.wordpress.com/ .

You are also right about proposals for solutions. Unfortunately we live in a time of crisis, and the solutions that are being used to tackle this crisis are actually making it worse. People all over the world express their frustration with politics and the present state of affairs, but are not able to offer genuine solutions. New economic and social models are urgently needed!

The Spectre of Populism

2011-04-30T17:09:00.031+02:00

The spectre haunting Europe in the spring of 2011 is Populism. The search for political support, from votes in democratic elections to acceptance of policies between elections, through appealing to the self-interest of large and vocal groups by unscrupulous, even immoral means, has become a mainspring of political activity. Such means consist mostly of promises that are either: 1) impossible to deliver, or 2) temporarily feasible but non-sustainable on the proposed scale in the longer run, or 3) feasible and sustainable only at the very heavy cost of compromising an overriding public interest, including the rule of law. An example of the first is a manifesto commitment to stopping immigration altogether (by border controls or building walls), or making it illegal and repatriating immigrants; the second, an overambitious programme of large-scale public works, or a commitment to overgenerous welfare provisions and inter-regional transfers; the third encompasses criminality in government activities such as condoning and encouraging illegal buildings or tax evasion. It follows that, of necessity, a populist leader must be an inveterate and shameless liar, sometimes a rigid ideologue, often a criminal.

Paradoxically it is the nature of liberal democracy that generates populist politicians. The requirement to submit to the vote at regular, relatively short intervals makes for the need to try and fool all of the people at least some of the democratically critical time; or fool a majority of supporters for some of the time, until it becomes absolutely obvious to that majority that you cannot deliver at all, or can only do it for a short time, or that the costs of keeping promises are immense and make everybody worse-off. And when the opposition to populism is divided or gormless, populism can thrive even without commanding a majority.

In a representative democracy the purchase of the people’s representatives directly, and very cheaply with respect to the value of what you can obtain in exchange, including immunity from prosecution and blanket impunity, can be even cheaper than taking over a derelict but branded party or founding your own afresh (though this can also be a very profitable business). And once you have built temporary power, you do not even have to buy the people’s representatives out of your own pocket, for you can reward them at public expense. These long-standing techniques are greatly facilitated by the modern possibilities of building up monopolistic or quasi-monopolistic control of the media, in the absence of legislation against the conflicts of interest that are bound to arise.

United States pork barrel politics currently displays its populist public face in the Tea Party but while the Obama government is in power populism is held under some restraint. In Europe we already have the real thing. Clearly Italy with its inordinately disreputable and discredited Premier on trial for a remarkably broad array of criminal activities, backed by his populist ally and accomplice the Northern League, ideologically committed to undeliverable economic, fiscal and cultural policies (yet making fast progress beyond its current 8.3% of the seats), is what I had in mind in characterizing populism. But European populism, or populist-like policies, is widespread and gaining support elsewhere. The map reproduced below is from SPIEGEL ONLINE, 15 April 2011 (just before the Finnish elections, therefore putting True Finns at only 4% of the seats. Spiegel – quite rightly in the circumstances – uses indifferently “right wing”, “right wing populist” and “populist” tout court.)

In Finland, on 17 April half a million voters (19%) endorsed the racist, xenophobic and eurosceptic, anti-abortion “True Finns” party, catapulting it into third position, neck and neck with the first two parties. Its leader Timo Soini holds the balance of power in the formation of a new government. There may be dangerous repercussions on the measures to rescue the Euro agreed by the European Council on 24-25 March, including the additional billions for the euro bailout fund, the planned reform of the fund, and the rescue package for Portugal which is still to be finalized. True Finns are opposed to assisting "wasteful countries" (like Greece, Ireland and Portugal). "We were too soft on Europe," says Soini; Finland should not be made to "pay for the mistakes of others."

Recently right-wing populist parties have impacted government formation in Belgium, the Netherlands and, more recently, in Sweden. The SD (Sweridge Democraterna) cleared the minimum 4% threshold to enter the Riksdag where it obtained 5.7% of the seats, enough to deprive the incumbent center-right coalition of an absolute majority. Last year the anti-Islam anti-EU Dutch Freedom Party gained third position with 15.5% of the seats, making Premier Mark Rutte dependent on the goodwill of its populist leader Geert Wilders. In Belgium the Flemish Interest/Vlaams Belang obtained 7.8% of the seats. In Norway the so-called Progress Party holds 22.9% of the seats. In Denmark the anti-immigration, anti-Islamic Danish People's Party, that supported a center-right minority government for almost ten years, is now the third party in Parliament with 13.9% of the seats. In Switzerland the right-wing People’s Party (PV) is the largest group in the Federal Assembly with 31% of the seats. In Austria the Freedom Party (FPO), founded by Jorg Haider, and the Alliance for the Future of Austria hold 17.5% and 9.2% of the seats respectively. In Romania in the European elections of 2009 the Great Romania Party obtained 8.7% of the votes. Populist representation in Parliament is also present in Latvia (Fatherland and Freedom LNNK 5%), Lithuania (Order and Justice IT 12.7%), Slovakia (Slovak National Party, 5.4%), Bulgaria (Ataka 10.1%), Greece (Popular Orthodox Rally LAOS 5.6%). In France, the Front National of Marine Le Pen is not represented in Parliament but gained 15% of the vote in the first round of administrative elections, and 12% in the second round; the latest opinion polls give her the top position in the first round of the forthcoming presidential elections. The only other country in continental Europe without populist representation in Parliament is Germany.

These are depressing results for any progressive of left or right but insofar as they are expressions of voter-support for divergent, non-progressive policies, are still within the aegis of representative democracy; unlike what is happening in Italy, where the state itself is under assault from criminal and sectional interests, and is classically undefended by a fragmented and incompetent opposition.

It is Hungary, however, that can be defined as a laboratory for the new, national, populist Europe, with mounting aspirations to ethnic identity and zero tolerance of social diversity, with the Hungarian national-conservative Fidesz party rising to power last year behind populist calls for law, order and more police. (Soon after he was sworn in, Prime Minister Viktor Orbán promised a "noticeable increase in public security within two weeks.") Furthermore, “The ruling Fidesz party of Hungarian Prime Minister Viktor Orbán used its two-thirds majority to whip a new constitution through parliament on Monday [18 April 2011], and critics across Europe are in uproar. The move, they fear, will convert the party's conservative, nationalist ideology into a state doctrine, cement its power well beyond the end of its term and upset the democratic system of checks and balances” (SPIEGEL ONLINE, 19 April). The new Constitution reduces the powers of the constitutional court and broadens government powers over the magistrature, over budgetary and fiscal matters and over the media – extending it, through government nominees, beyond the current government tenure that is expected to end in 2014. The new authority controlling the media since the beginning of the year, Nmhh, already exercises censorship with orwellian efficiency. This is the very essence of Berlusconi’s project.

On the night the new Hungarian constitution was approved the German public TV network ARD commented: “The constitutional state has largely been abolished, future elections are effectively meaningless, the media are being whipped into line, as are theaters and museums and everything else that could shape the nation's culture." … "Barely a trace remains of pluralism, of variety, of the basic features of a free society. If you talk to people in Hungary about politics these days, you're confronted with fear, like in the days of East Germany. In this state, Hungary no longer belongs in the EU. It is a disgrace for Europe. But Europe is saying nothing."

The Süddeutsche Zeitung commented: "The constitution enshrines a spirit of ideological, ethnic intolerance, both externally and domestically. Some are being reminded of the fascist rhetoric in Europe between the world wars. Neighboring countries are getting unpleasant memories of the cultural arrogance and power of the Hungary of old, whose Magyarization programs they were subjected to. The new constitution claims that the state of Hungary represents all other Magyars, meaning the three million living in neighboring countries." (the quotes from both sources are taken from SPIEGEL ONLINE, 19 April).

In the 2010 Hungarian elections the extreme right party Jobbik also entered Parliament with 16.7% of the vote. In 2009 the Jobbik-backed para-military Hungarian Guard was banned, but new private militias have been re-created and have been harassing Roma villages over Easter, forcing the Roma population to evacuate, and have been involved in beatings and clashes (SPIEGEL ONLINE, 28 April; see also their Photo Gallery). “The police and the judiciary have lost control over the growing right-extremist citizen groups and paramilitary-style gangs. In recent months, extremists have repeatedly staged marches, primarily in eastern Hungary, against "Gypsy criminality." And police in the villages which have been targeted have shown a preference for standing aside.” The Hungarian state appears to have retreated from certain regions and left them to the right-wing vigilantes. So much for the promise of a noticeable increase in public security.

In Hungary the populist Executive has succeeded in identifying itself and its values with the state and has permanently altered what was a representative democracy, and by which it came to power, so that its populist policies cannot be removed by democratic vote. It is here, in the embodiment of populist values in place of democratic values within the modern state, rather than as policies on offer to the electorate in party manifestos, that the threat to the entire post-war social democratic settlement lies.

Voters are faced with: the global economic crisis, and the associated mass unemployment; enhanced international competition and protectionist temptations; rampant inequalities and the challenge of migrations, concentrated in a few areas and sectors; the euro crisis and the prospect of all having to share the cost of bailing out countries perceived as non-deserving; the exploitation and resulting demise of the welfare state. In short, they have strong objections both to re-distribution and to lack of re-distribution of income and wealth, i.e. ultimately to the re-distribution processes such as they are. In these conditions, voters will abandon nebulously felt democratic powers in return for equally nebulously-offered protection of their living standards and their way of life.

There is, too, a knock-on effect in other EU countries, including those up to now relatively unaffected by populism (whether as a result of their voting system or the maturity of their democratic values) but vulnerable to the wave of North African refugees connected with participation in the Libya mission, causing bickering and conflict, and leading to a waning of solidarity among these countries in their determination to rid Europe of a rogue state on its Mediterranean borders.

What can we do? Re-value political participation and activism. Never accept that "politics is dirty" or that "all politicians are corrupt", this is false. Fight indifference in all its forms. Forge political alliances by looking for common ground rather than indulging in unaffordable splits and unacceptable assaults upon people’s aspirations and self-sufficiency. Avoid dogmatism. Defend the democratic state and the rule of law. Speak up; those with access to media or academic outlets should use it to argue for representative democracy and refute the frightened selfishness of populist policies. And be counted. Never fail to vote whenever you have the opportunity.

Gaddafi’s Pseudo-Socialism

2011-03-30T22:02:00.004+02:00

On 1 September 1969 a group of Libyan army officers belonging to the Movement of Free Officers, Unionists, and Socialists led by Colonel Muammar Al-Gaddafi overthrew King Idris and proclaimed the Libyan Arab Republic (LAR). One of the main goals of the revolution was the building of a form of Islamic socialism to be achieved through "social justice, high levels of production, the elimination of all forms of exploitation and the equitable distribution of national wealth." In 1972 Gaddafi took the title of "Brotherly Leader and Guide of the First of September Great Revolution of the Socialist People's Libyan Arab Jamahiriya". At around that time the late Jozef Wilczynski, a prolific Polish specialist in comparative and socialist economics (then teaching at the Royal Military College, University of New South Wales, Canberra) invited me to join a research project lavishly funded by the Brotherly Leader for the development of the Libyan brand of socialism. I declined the invitation, thus missing my chance perhaps to influence the course of Libyan history but saving my soul – and I have never regretted it, least of all now.

In 1975-79 Gaddafi published in instalments his political-economic philosophy, The Green Book, a slim volume apparently styled after Mao’s Little Red Book and intended to be required reading for all Libyans. It was composed of three parts; Part One: The Solution of the Problem of Democracy - Power to the People; Part Two: The solution of the Economic Problem – Socialism; Part Three: The social Basis of the Third Universal Theory. This is also known as the Third International Theory, but should not be confused with the Third Socialist International or Comintern; it is a reference to a Third Way alternative to both capitalism and communism, aimed at solving the contradictions inherent in both, in order to promote a worldwide political, economic and social revolution, and liberate oppressed peoples everywhere.

There is however a connection with the Third Way of Tony Blair & Co. “Britain’s best known sociologist, Anthony Giddens, … [played] the part of intellectual emissary for the Third Way. Giddens is helping the Libyan dictator Gaddafi, whose son [Saif] studied at the LSE where Giddens is based, to be rehabilitated back into the orbit of Western acceptability”, see “Telling the Truth”, The 2006 Socialist Register Edited by Leo Panitch and Colin Leys. In 2006 Giddens went to Tripoli to interview Gaddafi for The New Statesman, where he wrote that Libya had been transformed: "Gaddafi's 'conversion' may have been driven partly by the wish to escape sanctions, but I get the strong sense it is authentic and there is a lot of motive power behind it. Saif Gaddafi is a driving force behind the rehabilitation and potential modernisation of Libya. Gaddafi Sr, however, is authorising these processes." Lord Giddens persisted in his visits in 2007. In 2003-2008 Saif al-Islam Gaddafi obtained from LSE an MSc and a PhD, supervised by Ed Miliband’s advisor and co-author Professor David Held and examined by Professor the Lord Meghnad Desai. The PhD dissertation is now alleged to be largely plagiarized (Lord Wolf is conducting an enquiry) and Meghnad Desai says no-one told him it had been copied so how was he to know? LSE’s Global Governance Unit founded in 1992 and formerly directed by Lord Desai, obtained from the Gaddafi International Charity and Development Foundation a £1.5 million grant, which forced an “embarrassed” LSE Director Sir Howard Davies to resign on 4 March 2011. The planned visit by Professor Mary Kaldor – Co-Director of the Centre – as a guest of the Gaddafi family this year may have had to be put off due to current events.

In the recent uprisings lots of copies of The Green Book have been burned by demonstrators, and monuments to it set in concrete have been pushed over and smashed to pieces by Libyans, often under our very eyes on TV screens. Andrew Roberts, in The Daily Beast of 2 March lists his best 10 quotes from the book, and claims that those demonstrators “are in fact not performing acts of vandalism so much as of perceptive literary criticism” – of a book that is “a mélange of banalities, non-sequiturs, nuttiness, Socialism, Islamicism and pseudo-intellectualism”. (Apart from the Islamicism much the same could be said of Giddens’ contributions to New Labour’s Third Way).

The theory of Gaddafi’s economic-political system is reminiscent of Josip Broz Tito’s Yugoslavia: a one-party system (ACC the Arab Socialist Union being the sole legal political organization in the country), an “associationist” structure of various levels of self-management institutions, workers’ participation in enterprise management and results, “social” appropriation of reinvested surplus, market institutions in domestic and international economic relations. Yugoslav reality suffered from more central planning than was apparent, mostly via monetary policy and direct controls, and from the inefficiencies of an ambiguous property-rights regime in which – as stated in the 1975 Yugoslav Constitution –“nobody was the owner”. Gaddafi’s system parroted Yugoslavia but politically was a military dictatorship and economically an oil-driven system, exceptionally healthy though vulnerable, where oil represented 90% of exports, while economic control and surplus appropriation were firmly established in the Gaddafi family.

The IMF – which Libya joined in 1958 – happened to conclude its 2010 routine yearly “Art. IV Consultations” just before the recent uprisings, and reported on 15 February “a strong macroeconomic performance”. In 2009 “solid growth” in non-hydrocarbon output at 9% had been matched by a decline of hydrocarbon output following OPEC policies and resulting in a GDP modest contraction of 1.6%. “Overall growth increased markedly by [they mean to, DMN] an estimated 10 percent in 2010 reflecting a sharp increase in oil production. Non-hydrocarbon growth also strengthened (to about 7 percent) as a result of large public expenditures. However, unemployment has remained high, particularly among the youth. Inflation is estimated to have picked up to about 4.5 percent in 2010 as higher oil revenue increased domestic liquidity and international commodity prices increased.” Per capita GDP peaked at 14.3 thousand US dollars, fell to 9.5 thousand in 2009 but recovered to 12.1 thousand in 2010. A budgetary surplus of “only” 7% in 2009 (due to the decline in oil revenue) rose again in 2010, when the external current account surplus also increased to an estimated 20% of GDP, from 16% in 2009. The exchange rate of the dinar, which is pegged to the Special Drawing Rights, remained stable and was judged to be “broadly aligned with fundamentals”. “Net foreign assets of the Central Bank of Libya (CBL) and the LIA [Libyan Investment Authority] are estimated to have reached $150 billion at end-2010 (the equivalent of almost 160 percent of GDP)”. And to counter the impact of higher global food prices, that unleashed the uprising in Egypt and Tunisia, the Libyan government abolished, on 16 January, taxes and custom duties on locally-produced and imported food products.

The Green Book, Part One rejects modern liberal democracy. “All political systems in the world today are a product of the struggle for power between alternative instruments of government. This struggle may be peaceful or armed, as is evidenced among classes, sects, tribes, parties or individuals. The outcome is always the victory of a particular governing structure - be it that of an individual, group, party or class - and the defeat of the people; the defeat of genuine democracy.” … “Parliaments are the backbone of that conventional democracy prevailing in the world today. … The mere existence of a parliament means the absence of the people. True democracy exists only through the direct participation of the people, and not through the activity of their representatives.” “The party is a contemporary form of dictatorship. It is the modern instrument of dictatorial government. The party is the rule of a part over the whole.” Plebiscites are “a fraud against democracy”. Democracy in Libya is based instead on direct democracy, in the form of various layers of popular conferences and people’s committees under which "management becomes popular, control becomes popular, and the old definition of democracy as 'control of people over the government' is replaced by its new definition as 'the people's control over itself'”.

The implementation of this project has been the object of a slow, gradual and troubled transition. In 2004 Gaddafi admitted that "popular participation in government was not complete". But reality is much worse: Gaddafi himself appoints a cabinet and departmental ministers, manipulates unelected revolutionary committees, draws an arbitrary line between state assets and his own (just like Saddam used to do) and runs a police state. Private ownership of the media is regarded as undemocratic, but in practice state ownership of all book publishers, newspapers, television and radio stations, silences any dissenting voice more effectively than a private near-monopoly like that of his ex-buddy Berlusconi. “Any ruling system must be made subservient to natural laws, not the reverse [i.e. to conventional laws]” – but Gaddafi’s will is law, period. This is candidly admitted at the very end of Book One: “Theoretically, this is genuine democracy but, realistically, the strong always rules, i.e., the stronger party in the society is the one that rules”, which is how Gaddafi and his ‘socialist’ élite of apparatchiks, spies and mercenaries ruled in GDR-style for the last 41 years over Libyan citizens, now criminally intimidated in Tripoli, and massacred in Misurata.

The Green Book, Part Two, outlines the desired economic system. Wage labour is abolished and forbidden; all employees must be "partners not wage-workers", and have a right to the products which they manufacture. “Wage-earners, however improved their wages may be, are a type of slave. They are temporary slaves, and their slavery lasts as long as they work for wages from employers, be they individuals or the state.”… “ The ultimate solution lies in abolishing the wage-system, emancipating people from its bondage and reverting to the natural laws which defined relationships before the emergence of classes, forms of governments and man-made laws. These natural rules are the only measures that ought to govern human relations.”

“These natural rules have produced natural socialism based on equality among the components of economic production…“. “The exploitation of man by man and the possession by some individuals of more of the general wealth than their needs required is a manifest departure from the natural rule and the beginning of distortion and corruption in the life of the human community. It heralds the start of the exploitative society.” In March 1977 the "Declaration of Sabha" transformed Libya into a Jamahiriya (a neo-logism meaning “the state of the masses”), more precisely the Socialist People's Libyan Arab Jamahiriya. Foreign capital had been taken over soon after the 1969 coup and still has a limited presence; large and medium industrial enterprises are owned by the state. “Exploitative” forms of private ownership were abolished, whereas private family businesses in the service sector were preserved.

However, the IMF report of last February indicates and endorses trends in the opposite direction to the implementation of the Green Book: “An ambitious program to privatize banks and develop the nascent financial sector is underway. Banks have been partially privatized, interest rates decontrolled, and competition encouraged. Ongoing efforts to restructure and modernize the CBL are underway with assistance from the Fund. Capital and financial markets, however, are still underdeveloped with a very limited role in the economy. There are no markets for government or private debt and the foreign exchange market is small.”

“Structural reforms in other areas have progressed. The passing in early 2010 of a number of far- reaching laws bodes well for fostering private sector development and attracting foreign direct investment. The success of the new laws, however, hinges on promoting inter-agency coordination and open consultation with the legal and business communities, and establishing permanent bodies to monitor, assess, and oversee implementation. A comprehensive civil service reform is needed to facilitate more effective wage and employment policies that would address the needs of a young and growing labor force.” [so wage employment is still there after all?].

According to the Green Book, Part Two, “Housing is an essential need for both the individual and the family and should not be owned by others. Living in another's house, whether paying rent or not, compromises freedom.” This principle was made law in 1978. Last January the government announced the creation of a large multi-billion dollar investment fund that will focus on providing housing for the growing population.

“Transportation is also a necessity both to the individual and to the family. It should not be owned by others. In a socialist society, no person or authority has the right to own a means of transportation for the purpose of renting it, for this also means controlling the needs of others.”

“Land is the private property of no-one. Rather, everyone has the right to beneficially utilize it by working, farming or pasturing as long as he and his heirs live on it - to satisfy their needs, but without employing others with or without a wage.”

“If economic activity is allowed to extend beyond the satisfaction of needs, some will acquire more than required for their needs while others will be deprived. The savings which are in excess of one's needs are another person's share of the wealth of society. Allowing private economic activity to amass wealth beyond the satisfaction of one's needs and employing others to satisfy one's needs or beyond, or to secure savings, is the very essence of exploitation.”

“Disparity in the wealth of individuals in the new socialist society is not tolerated, save for those rendering certain services to the society for which they are accorded an amount congruent with their services. Individual shares only differ relative to the amount of production or public service rendered in excess“. In other words, some people are more equal than others.

“The antagonistic force of the trade unions in the capitalist world is capable of replacing capitalistic wage societies by a society of partnerships. The possibility of a socialist revolution starts by producers taking over their share of the production. Consequently, the aims of the producers' strikes will change from demanding increases in wages to controlling their share in production.”

“The Green Book thus defines the path of liberation to masses of wage-earners and domestic servants in order that human beings may achieve freedom”.

The Green Book, Part Three, is supposed to lay the foundations of the Libyan Third Way but is a collection of trite, often meaningless slogans, that do not deserve attention more than the samples given here for illustration: “The social factor, the national factor, is the dynamic force of human history. The social bond, which binds together human communities from the family through the tribe to the nation, is the basis for the movement of history.” “The national factor, the social bond, works automatically to impel a nation towards survival, in the same way that the gravity of an object works to keep it as one mass surrounding its centre.” “A tribe is a family which has grown as a result of procreation. It follows that a tribe is an enlarged family. Similarly, a nation is a tribe which has grown through procreation. The nation, then, is an enlarged tribe. The world is a nation which has been diversified into various nations. The world, then, is an enlarged nation. The relationship which binds the family also binds the tribe, the nation, and the world. … Since the tribe is a large family, it provides its members with much the same material benefits and social advantages that the family provides for its members, for the tribe is a secondary family… The tribe is a natural social "umbrella" for social security.” "The world will be ruled by the black people."

There is, however, a worthwhile, even an enlightening quote from the Green Book, Part One: “Society is composed of many individuals and entities. Therefore, if an individual is insane, that does not mean that the rest of society are mad, too.” And if the insane individual actually rules the country, in that case society would be mad not to throw him out at any cost.

The Banks are Made of Marble

2011-03-23T11:03:00.005+01:00

I've traveled round this country
From shore to shining shore
It really made me wonder
The things I heard and saw.

I saw the weary farmer
Plowing sod and loam
l heard the auction hammer
A knocking down his home

But the banks are made of marble
With a guard at every door
And the vaults are stuffed with silver
That the farmer sweated for

l saw the seaman standing
Idly by the shore
l heard the bosses saying
Got no work for you no more

But the banks are made of marble
With a guard at every door
And the vaults are stuffed with silver
That the seaman sweated for

I saw the weary miner
Scrubbing coal dust from his back
I heard his children cryin
Got no coal to heat the shack

But the banks are made of marble
With a guard at every door
And the vaults are stuffed with silver
That the miner sweated for

I've seen my brothers working
Throughout this mighty land
l prayed we'd get together
And together make a stand

Final Chorus
Then we'd own those banks of marble
With a guard at every door
And we'd share those vaults of silver
That we have sweated for

This song is taken from the Union Songs website. Banks of Marble sounds like a “depression song” from the 1930s but was composed around 1948-1949 by Les Rice, “a New York State apple farmer and one-time president of the Ulster County chapter of the Farmers Union. His songs have made him well-known to farmers throughout the northeast. … his most well-known composition … achieved great popularity among union members throughout the country and even in Canada”.

The website adds the comment “The song has gained new resonance since the 2008-2009 financial meltdown!”. What a terrible misunderstanding; the song today has lost whatever resonance may have had before 2008. For while banks are still of marble, with a guard at every door, their vaults are stuffed with toxic assets, not silver. Their depositors - when they have not been swindled by the banks themselves or other financial intermediaries - often have had to queue in the street to recover their own money, which they got back only to the extent that governments took on banks liabilities, including those towards bank bondholders and perhaps even shareholders. Over the last three years government rescue of banks and financial institutions has added to government debt and lowered bond prices raising their yield and the cost of rolling over debt. Ireland, for instance, spent about 20% of GDP in the rescue of a single bank, Anglo-Irish. The fall in value of the government bonds in their vaults, in turn, added to the problems of banks. The entire banking system of some countries, like Ireland, is regarded as largely insolvent.

In Europe, in 2010 banks' balance sheets were white-washed by perfunctory “stress tests” that gave a clean bill of health even to Anglo-Irish and the Bank of Ireland, that a few months later required €113bn public money for their rescue. The newly-born EBA European Banking Authority (1 January 2011, London) is about to subject European banks to another round of stress tests; their severity is still partly unknown but the danger of another white-washing exercise is not negligible. The discussion of tests is made opaque by technicalities involving capitalisation requirements dictated by Basel 2 versus Basel 3 (Bank of International Settlements, applicable from 2013), tier 1 versus core tier 1 primary assets, RWA (risk-weighted-assets), differential treatment for troubled government bonds marked to market or held to maturity in banking books at their face value. The bottom line is that the re-capitalisation needed by European banks, estimated to be of the order of €7.5bn in the 2010 round of stress tests, has now reached the order of magnitude of €100bn (on top of the re-capitalisation occurred in the meantime, like the €113bn mentioned above). The provision of this additional capital may well slow down economic recovery.

The chances of working brothers making a stand - and taking over those banks that are still worth owing thus making them their own - are zero, as they are made completely powerless by worldwide competition in the global labour market – through de-localisation, globalization of trade and investment, migrations – and the resulting mass unemployment. Their brotherhood is in question, and they have to contend with the overwhelming, almost complete dominance of conservative governments in Europe. Sad, and bad enough, but to pretend otherwise is outright tragic.

Inequality and the Global Crisis

2011-03-16T08:43:00.003+01:00

This is a Guest Post contributed by Branko Milanovic, a Lead economist in the World Bank's research department. Branko - at present a Visiting Fellow of All Souls College, Oxford - spent over a quarter century working on poverty and inequality and made original, pioneering contributions to this subject, including: Worlds Apart. Measuring International and Global Inequality, 2005, Princeton/Oxford; The Haves and the Have-Nots: A Short and Idiosyncratic History of Global Inequality, 2011, Basic Books (DMN)

The current financial crisis is generally blamed on feckless bankers, financial deregulation, crony capitalism and the like. While all of these elements may be true, this purely financial explanation of the crisis overlooks its fundamental reasons. They lie in the real sector, and more exactly in the distribution of income across individuals and social classes. Deregulation, by helping irresponsible behavior, just exacerbated the crisis; it did not create it.

To go to the origins of the crisis, one needs to go to rising income inequality within practically all countries in the world, and the United States in particular, over the last thirty years. In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s. That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark American income inequality over the last hundred years thus basically charted a gigantic U, going down from its 1929 peak all the way to the late 1970s, and then rising again for thirty years.

What did the increase mean? Such enormous wealth could not be used for consumption only. There is a limit to the number of Dom Pérignons and Armani suits one can drink or wear. And, of course, it was not reasonable either to “invest” solely in conspicuous consumption when wealth could be further increased by judicious investment. So, a huge pool of available financial capital—the product of increased income inequality—went in search of profitable opportunities into which to invest.

But the richest people and the hundreds of thousands somewhat less rich, could not invest the money themselves. They needed intermediaries, the financial sector. Overwhelmed with such an amount of funds, and short of good opportunities to invest the capital as well as enticed by large fees attending each transaction, the financial sector became more and more reckless, basically throwing money at anyone who would take it. While one cannot prove that investible resources eventually exceeded the number of safe and profitable investment opportunities (since nobody knows a priori how many and where there are good investment opportunities), this is strongly suggested by the increasing riskiness of investments that the financiers had to undertake.

But this is only one part of the equation: how and why large amounts of investable money went in a search of a return on that money. The second part of the equation explains who borrowed that money. There again we go back to the rising inequality. The increased wealth at the top was combined with an absence of real economic growth in the middle. Real median wage in the United States has been stagnant for twenty five years, despite an almost doubling of GDP per capita. About one-half of all real income gains between 1976 and 2006 accrued to the richest 5 percent of households. The new “gilded age” was understandably not very popular among the middle classes that saw their purchasing power not budge for years. Middle class income stagnation became a recurrent theme in the American political life, and an insoluble political problem for both Democrats and Republicans. Politicians obviously had an interest to make their constituents happy for otherwise they may not vote for them. Yet they could not just raise their wages. A way to make it seem that the middle class was earning more than it did was to increase its purchasing power through broader and more accessible credit. People began to live by accumulating ever rising debts on their credit cards, taking on more car debts or higher mortgages. President George W. Bush famously promised that every American family, implicitly regardless of its income, will be able to own a home. Thus was born the great American consumption binge which saw the household debt increase from 48 percent of GDP in the early 1980s to 100 percent of GDP before the crisis.

The interests of several large groups of people became closely aligned. High net-worth individuals and the financial sector were, as we have seen, keen to find new lending opportunities. Politicians were eager to “solve” the irritable problem of middle class income stagnation. The middle class and those poorer than them were happy to see their tight budget constraint removed as if by magic wand, consume all the fine things purchased by the rich, and partake in the longest US post World War II economic expansion. Suddenly, the middle class too felt like the winners.

This is what more than two centuries ago, the great French philosopher Montesquieu mocked when he described the mechanism used by the creators of paper money in France (an experiment that eventually crumbled with a thud): ‘People of Baetica”, wrote Montesquieu, “do you want to be rich? Imagine that I am very much so, and that you are very rich also; every morning tell yourself that your fortune has doubled during the night; and if you have creditors, go pay them with what you have imagined, and tell them to imagine it in their turn”.

The credit-fueled system was further helped by the ability of the US to run large current account deficits; that is, to have several percentage points of its consumption financed by foreigners. The consumption binge also took the edge off class conflict and maintained the American dream of a rising tide that lifts all the boats. But it was not sustainable. Once the middle class began defaulting on its debts, it collapsed.

We should not focus on the superficial aspects of the crisis, on the arcane of how “derivatives” work. If “derivatives” they were, they were the “derivatives” of the model of growth pursued over the last quarter a century. The root cause of the crisis is not to be found in hedge funds and bankers who simply behaved with the greed to which they are accustomed (and for which economists used to praise them). The real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably employed. The political problem of insufficient economic growth of the middle class was then “solved” by opening the floodgates of the cheap credit. And the opening of the credit floodgates, to placate the middle class, was needed because in a democratic system, an excessively unequal model of development cannot coexist with political stability.

Could it have worked out differently? Yes, without thirty years of rising inequality, and with the same overall national income, income of the middle class would have been greater. People with middling incomes have many more priority needs to satisfy before they become preoccupied with the best investment opportunities for their excess money. Thus, the structure of consumption would have been different: probably more money would have been spent on home-cooked meals than on restaurants, on near-home vacations than on exotic destinations, on kids’ clothes than on designer apparel. More equitable development would have removed the need for the politicians to look around in order to find palliatives with which to assuage the anger of the middle-class constituents. In other words, there would have been more equitable and stable development which would have spared the United States, and increasingly the world, an unnecessary crisis.

Euro-zone collapse? Most unlikely

2011-03-12T23:15:00.007+01:00

“It would be technically possible for a member state to leave the euro zone, but politically it is about as likely as a meteorite hitting the Eurotower in Frankfurt” – as Barry Eichengreen nicely put it.

Partly there are significant costs from monetary disintegration. These were massive in the post-socialist transition of the early 1990s, when COMECON and its transferable rouble disintegrated, the USSR and the rouble area split into 15 countries and currencies, Czech and Slovak members of the CSFR split together with the Czecho-Slovak crown and Yugoslavia splintered into more pieces and currencies than its former membership of five. A devastating deep and protracted recession followed, though in fairness this was due not only to such processes of economic and monetary disintegration but to the general move by these countries from planned trade transactions to their sudden exposure to market transactions at world prices and payment in foreign currencies.

Partly, the advantages from dividing the Euro-area would be highly questionable. The weaker countries leaving the Euro-zone and re-introducing a national currency would not lighten the burden of their national debt which would continue to be denominated and serviced in euro or other foreign currencies. They may or may not improve their trade competitiveness via devaluation of their re-introduced national currency – apart from the fact that competitiveness could be improved in many other ways if this is what a country wanted (“domestic devaluation” via wage restraint, investment in productivity increases, greater competition etcetera). Nor would there be any advantage for such stronger member countries as Germany.

In an article for the German Council on Foreign Relations Adam Posen argues that Germany has an intrinsic and direct interest in the prosperity of the eurozone. Germany benefits in terms of seigniorage, transaction cost savings, lower real interest rates available to its companies, a strengthened global influence, and improved shock absorption. These advantages increase with the size and the diversity of the Eurozone, and the German Chancellor Angela Merkel should not make a “competitiveness pact” for eurozone countries the condition for German continued support for the Euro.

All the same, over the last year, the prospect of Euro-area split has been a frequent though intermittent object of discussion. The title of a 2010 book by Hans-Olaf Henkel, formerly of IBM and ex-euro-enthusiast, expresses a widespread feeling in Germany today: Rettet Unser Geld! (Return our money!). Marshall Auerback also explores this possibility in a recent paper, “What happens if Germany exits the Euro?”, Levy Economics Institute of Bard College, 2011/1, though ending with a cautionary assessment not a recommendation.

“On the plus side, given Germany’s historic reputation for sound finances, the country would likely emerge with a strong Deutschmark, a global “safe haven” currency for currency speculators keen to find a true store of value.

But this would likely come at a huge cost: Germany would probably save its banking system at the expense of destroying its export base. The newly reconfigured DM would soar against the euro and become the ultimate safe-haven currency. This would mitigate the write-down impact of the inevitable haircuts on euro-denominated debt, because the euro (assuming it is retained by the remaining eurozone countries) would fall dramatically. Even if the euro itself vaporized, the Germans would simply pay back debt in the old currencies, likely at a fraction of their former value.

But Germany’s external sector would be wiped out. The resultant appreciation of the new Deutschmark, along with the inevitable banking crises in the periphery (which would exert significant deflationary pressures in those countries and therefore reduce consumer demand in the eurozone ex Germany), would engender a huge trade shock: Germany’s growth would slow dramatically, as exports compose such a large proportion of its GDP.

Another interesting byproduct: by accounting identity, a fall in Germany’s external surplus would mean an increase in its budget deficit (unless the private sector began to expand rapidly, which is doubtful under the scenario described above), so Germany would find itself experiencing much larger [public] deficits.”

This accounting identity is a centerpiece of Keynesian macroeconomics as popularized for instance by the late Wynne Godley, but it is or rather should be part of any macroeconomist’s education. Auerback divides the economy into three main sectors: domestic government, domestic non-government (or private), and the foreign sector. “By accounting identity, the deficits and surpluses across these three sectors must sum to zero; that is, one sector can run a deficit so long as at least one other sector runs a surplus.”

Looking at GDP accounting from the “sources” perspective, we get the identity:

(1) GDP = C + I + G + (X – M), i.e. national income must equal the sum of private consumption and investment, plus government expenditure plus net exports.

From the “uses” perspective, GDP must be taken up by private consumption plus savings plus taxation, i.e.:

(2) GDP = C + S + T. Therefore

(3) C + S + T = GDP = C + I + G + (X – M), or

(4) (I – S) + (G – T) + (X – M) = 0

As a simple matter of double-entry book-keeping, the three balances must add up to zero.

At present Germany is running a large positive external balance (X-M), matched by an even larger excess private savings over investment (S-I) minus a modest public deficit (G-T). If, as a result of the reintroduction of an overvalued DM, German external balance were to be substantially reduced or vanish, Germany would have to either contract private savings relatively to investment or run substantial public deficits or both. An abrupt change of gear, which is at odds with the wishes of the German people and leadership. Something for Chancellor Merkel to ponder.

(This is also, incidentally, why the size of a country’s government deficit does not lend itself to be targeted directly, independently of what else happens to the balance of private savings and investment as well as the external balance of the country).

189 German Economists

2011-03-03T21:19:00.009+01:00

Usually economists are inclined to differ among themselves. As Winston Churchill is reported to have said: “If you put two economists in a room, you get two opinions – unless one of them is Lord Keynes, in which case you get three opinions”.

Yet on 24 February 2011 no fewer than 189 German economists signed a letter, published in Frankfurter Allgemeine Zeitung, in which they expressed an exceptional degree of consensus. They “called on the German government to refuse any extension of the EFSF [European Financial Stability Facility], and to force highly indebted countries into an insolvency procedure. They include some of the best known German economists – Hans Werner Sinn, Jürgen von Hagen, Manfred Neumann, Michael Burda and Volker Wieland.” (Eurointelligence.com, 25 February). What is the collective noun for economists? A pride, or a flock, or a swarm? A basket, a case, a basket-case? Let’s call them an assumption of economists, to cover such an uncommon coincidence of views.

The unusually firm (single-handed) recommendation by the 189 German economists is based on the following six points:

“1. A permanent credit guarantee for insolvent countries would provide massive incentives to repeat the mistakes of the past. The reforms of the stability pact, and the newly discussed Pact for Competitiveness, are too weak to counteract this;

2. A long-term strategy against debt crises requires the possibility of a sovereign insolvency;

3. Credits to countries should be possible, but only after debt restructuring;

4. The fact of state insolvency should be determined not by the country itself, but by an international institution, such as the IMF;

5. The ECB must not provide unlimited support of insolvent countries through bond purchases;

6. Of the three solutions to a national debt crisis – debt reduction through growth, insolvency, and bailout – the latter would imply higher taxes, and/or higher inflation.”

“Holger Stelzner, the openly anti-European editorialist of Frankfurter Allgemeine Zeitung, writes that the eurozone is drowning in its debt, which has turned the ECB into a bad bank. The approach of policy makers everywhere is to solve a debt crisis through more debt. The increase in the ECB’s balance sheet from €900bn to €1800bn of mostly low quality debt was immensely risky. The ECB is no longer an independent institution, but an interested party.” (Eurointelligence.com, Ibidem).

Since its publication the letter has been criticized in the financial press, mostly for some inaccuracies – such as the failure to recognize that the lending capacity of the EFSF is much lower than its nominal €440 mn due to the need to over-collateralize its bonds in order to obtain an AAA credit rating in spite of the less-than-AAA-rating of several of its guarantors (Wolfgang Munchau in FT Deutschland, Eurointelligence.com, 2-3-2011, who also criticizes their failure to take into account the externalities associated with various alternative options, such as debt restructuring).

Nevertheless, it is exceedingly difficult to take issue with the substance of the arguments put forward by the 189, other than by conjuring up the unlikely and implausible prospects of Euro-area dis-integration, of a split into a Nordic strong-euro-area and a Southern weak-euro-area, or worse, the prospect of Greece going back to the drachma and Germany restoring the DM. The real question is the extent of collateral damage that a Euroarea-member’s default – in the form of debt restructuring – would cause, in view of the interdependence between banks and “sovereigns” both within countries at risk and across the entire area.

As it happens, a reasoned answer to this question has been provided recently by a Policy Brief (2011/02) of the Bruegel Think-tank, “A comprehensive approach to the euro-area debt crisis” by Zsolt Darvas, Jean Pisany-Ferry and André Sapir. They note the ineffectiveness of measures taken to date to tackle the euro crisis, seeing that sovereign debt spreads are higher today than they were in April 2010 in spite of EFSF, and the EU European Financial Stability Mechanism, the ECB debt purchase programme, on top of national austerity and structural reform programmes.

European policies have been insufficient, Darvas et al. say, because 1) they have failed to recognize the possibility of insolvency, treating crises as pure liquidity crises; 2) they have failed to address systemically the interdependence between sovereign and banking crises, and cross-country interdependence; 3) they have been re-active rather than proactive, squandering their credibility in partial, inadequate and belated responses. Their recommendations include a plan to restore banking-sector soundness; promoting budgetary consolidation and competitiveness through domestic reforms in peripheral countries; revising EU assistance facilities and – hear, hear – the restructuring of public debt where needed.

The Bruegel paper provides a detailed analysis of alternative scenarios in the “high-spread” countries (usually euphemistically labelled “peripheral”, or aggressively PIGS – where I stands for Ireland; Italy for once flies, or rather crawls, low enough not to appear on the radar screens). The starting point in Greece is a debt/GDP ratio scheduled to reach 150 % in 2011, mostly due to the mismanagement of public finances, and poised to continue rising in subsequent years. By contrast, in Spain and Ireland, “a major reason for solvency concerns arises from the public finance consequences of private-sector debt accumulation, not least because of the cost of rescuing insolvent banks. Furthermore, public debt levels in these two countries and in Portugal are more manageable (with levels in 2011 remaining below 70, 90 and 110 % of GDP”).

Alternatives hypothesis are considered involving growth and interest rates, in order to evaluate fiscal sustainability in the four countries. In 2010 primary balances were -3.7% in Greece, -9.6% in Ireland (excluding bank support), -4.4% in Portugal and -7.3% in Spain. Their evolution to 2014 is taken from EU and IMF programmes and reports; on these assumptions the persistent primary balance needed from 2015 onwards is calculated, in order to (a) stabilise the debt/GDP ratio at its 2015 level, (b) reduce the debt/GDP ratio from its simulated 2014 level to 60 percent of GDP (the Maastricht criterion) by 2034. Consensus Economics forecasts of nominal GDP growth and an optimistic evolution of market interest rates (in the case of Greece, a reduction of spreads vis‐a‐vis Germany from 970 basis points today to 350 in 2014) provide the optimistic baseline, set against a more cautious alternative. (See Figure below; detailed calculations are provided in Zsolt Darvas, Christophe Gouardo, Jean Pisani-Ferry and André Sapir, “A Comprehensive Approach to the Euro-Area, Bruegel, forthcoming 2011).

The stabilised levels of debts in the case of the adjustment indicated by the blue part of the bars are: 160% in Greece, 123% in Ireland, 98% in Portugal and 84% in Spain. “The adjustment needs are of frightening magnitude, not only in Greece but also in Ireland. This is even truer under more cautious assumptions for growth and interest rates”.

“Even under the optimistic scenario, the primary surplus required to reduce the debt ratio to 60 per cent of GDP in twenty years would be 8.4 per cent of GDP. It would reach 14.5 per cent of GDP under the cautious scenario. This would imply devoting between one/fifth and one/third of tax revenues to interest payments on the public debt. Over the last 50 years, no country in the OECD (except Norway, thanks to oil surpluses) has ever sustained a primary surplus above 6 per cent of GDP. Even less ambitious targets would require politically unrealistic surpluses”.

The paper thus argues that Greece is insolvent, inevitably heading for default. “The various “soft options” (lowering of interest rate on EFSF, extension of maturity of EU/IMF loans, debt buybacks) might prove useful for other periphery countries, but are not enough for Greece.” They provide a simplified map of interdependence between banks and sovereigns in the periphery countries, and between periphery banks and those in the rest of the euro area. On that basis they can evaluate the spillover effects of debt restructuring, which in the case of Greece would be limited and manageable (the real threat coming from Irish and Spanish banks). Their conclusion is that a 30% haircut on Greek debt, in top of the “soft options” might prove a viable exit.

Markets have been expecting a “grand bargain” to be agreed and unveiled at the Eurozone March summit, resolving the sovereign debt crisis once and for all. The toughening of the German position now makes it unlikely. The hard facts of likely insolvency, if faced in earnest instead of denied against all evidence, might provide a springboard for a new approach. As Barry Eichengreen declared to Der Spiegel on 2 March, it is necessary “That at their summit in March, the member states face up to some unpleasant truths. Plan A has failed. Now they have to switch to Plan B. They must stop attempting to combat the crisis in Greece and Ireland by forcing these countries to pile more debt onto their existing debts by saddling them with overpriced loans.” … ”The present bailout attempts have never made sense. Essentially, all Germany and France want to achieve with these measures is to protect their own banks from collapsing. Now people are beginning to realize that there is no way around rescheduling Greece's debt - and that will also involve the banks. For this to happen, there is only one solution: Europe needs to strengthen its banks! Greece lived beyond its means, but in Ireland and Spain it is the banks that are the problem. The euro crisis is first and foremost a banking crisis.”

Eurobond, Public Deficit

2011-02-28T22:33:00.001+01:00

The following comments on the last three posts were e-mailed by Professor Michael Ellman, Chair of the Department of Business Studies, University of Amsterdam. They deserve wider circulation and are reproduced below with his permission.

Dear Mario,

I read your paper [merging the two recent posts on the Euro crisis] & blog [the post on Schuldenbremse] and am naturally in sympathy with both. I have a few comments:

(1) at the end of your paper you seem to suggest that a default by a EU member state would mean the end of the Euro or even of the EU itself. But why should it? The default of US municipalities or states has never threatened the dollar or the USA. If Greece defaults this will raise interest rates on bonds issued by other 'suspect' EU members and hit badly banks, insurance companies and pension funds that hold Greek debt. This may require the governments of the countries where these institutions are based to recapitalise them, which will worsen their fiscal position. The rise in interest rates for the other 'suspect' countries will worsen their fiscal position and possibly cause more defaults, which might lead to a change in the membership of the EMU. (As for Greece, if it stayed in the EMU it would have to balance its budget immediately since it could neither issue debt on the capital market nor borrow from the central bank, unless - like the UK in World War II - it forced its own banks and other financial institutions to buy national debt which would undermine their solvency and reduce credit to the private sector, as happens under wartime conditions). Of course, if retail depositors were happy to put their money in institutions mainly holding public debt - like the Soviet/Russian Sberbank or the Japanese postbank - then the situation could be stabilised.

(2) motivation for creating the EMU

It is generally considered that the creation of the EMU was a political bargain between Germany and France in which France agreed to German reunification in exchange for Germany giving up its DM. The point of that, from the French perspective, was to end Germany's dominance of European interest-rate policy. However, it now seems that an important result of the EMU will be to impose German ideas about fiscal policy on the EMU - a development which you and I think harmful. It is ironical that an institutional change designed to end German dominance in European monetary policy seems to be heading in the direction of creating a German dominance of fiscal policy.

(3) debt as a "burden"

Naturally John is right that debt interest is a transfer payment. But transfer payments require taxes to pay them. To say that rising debt payments are not a burden is analogous to saying that rising pension payments are not a burden. Rising interest payments on debt are only not a burden if they are of such a magnitude that they do not have negative economic effects (growth of informal sector, emigration, reduction of economic growth). The actual effects are likely to vary from country to country depending on growth rates, employment levels, economic institutions, tax levels, fiscal situation, etc. Try explaining that taxes have no economic effects to Irish ministers under pressure to increase their corporate tax rates.

(4) balanced budgets

There is another aspect to this - the demand for public debt. If states do not continuously issue new debt, where will financial institutions invest the "risk-free" tranche of their investments? To issue too little public debt is to risk a bubble in private sector assets.

(5) EU solidarity

You are quite right to stress that some much discussed possibilities are political non-starters because of a lack of EU solidarity. Here in the Netherlands (which was a gold bloc country in the 1930s) the main aim of economic policy is to bring down the deficit by expenditure cuts (and tax increases) and to bring back the debt level to the 60% level. Support for fiscal transfers to sinners is conspicuous by its absence. Support for EU integration, both among the public and the political elite, has declined markedly in recent years, partly for this reason. Despite everything the Dutch economy is doing reasonably well, with relatively low and declining unemployment. But this is entirely a result of external factors - growth in Germany and elsewhere in the world. Small foreign-trade dependent countries have their level of economic activity largely determined externally. Fiscal orthodoxy enables them to have relatively low interest rates with favourable economic effects.

Best wishes, Michael

Schuldenbremse [debt brake] by Constitutional Law? No, Thanks

2011-02-14T22:47:00.010+01:00

In 2009 the German Constitution was amended to introduce a balanced budget provision, or Schuldenbremse [debt brake]. Starting in 2016 the German federal government will be constrained to a deficit ceiling of 0.35% of GDP; from 2020 the Länder will not be permitted to run any deficit at all. An exception can be made for emergencies such as a natural disaster or economic crisis. All USA states except Vermont have a similar constitutional provision (Oregon is constitutionally bound to return to taxpayers any surplus in excess of 2%), though of course this does not stop them from incurring large debts. In any case States or Länder balanced budget commitments do not interfere with either a Federal macroeconomic stimulus or inter-state fiscal transfers, so that the restraint does not really matter all that much. There is a balanced budget provision is in the Swiss Constitution. Such a provision has been variously recommended also for the US Federal government but never achieved the support of two/thirds majority of states in both houses for it to be introduced.

Last year President Sarkozy proposed a return to balanced budget in France. On the eve of the Eurogroup meeting of 14 February 2011 the German Finance Minister, Wolfgang Schauble, leader of European Democratic Conservatives, proposed the introduction of a German-style constitutional ceiling in other EU countries. In the coming weeks the French Premier François Fillon is expected to present a Constitutional amendment committing France to a specified time-path of progressive reduction of the deficit from €150bn (2010) down to zero, to be approved by Parliament before the summer and to be monitored by the Constitutional Council.

Let us leave aside questions of the political feasibility of introducing such an amendment into a country’s constitution, and of the credibility of a government commitment to implement it. It is clear that current levels of sovereign debt are excessive and insustainable in most EU member states, and that deficits will have to be cut in order to stabilize and reduce them. The real question is about the effectiveness of government policies aimed at expenditure-cutting and tax raising. Such policies would reduce the deficit coeteris paribus , but at the same time are bound to reduce demand and therefore GDP and tax revenue to an even greater extent: their final outcome is indetermined.

Victoria Chick and Ann Pettifor (FT, 4 October 2010), using UK data from 1918 to 2009, show that a persistent expenditure cut is correlated with a rise in the debt/gross domestic product ratio; and expansions in expenditure with a fall in debt/GDP. They explain that “This result arises because government is not in a position to determine its own deficit/surplus. The size of the budgetary outcome depends on the plans of the entire economic system and its reactions to the government’s planned actions.”

“Since the deficit is not something that government can control, setting out to reduce the deficit is to look at the problem through the wrong end of a telescope: the way to reduce a deficit in a time of unemployment and feeble recovery is to spend (preferably wisely) to promote employment and permanent improvements to our infrastructure, including our “human capital””.

“Keynes looked through the telescope the right way round: “Look after the unemployment, and the budget will look after itself.” "(Chick and Pettifor, 2010).

What is worse, a simultaneous collective round of expenditure cuts and taxation increases is obviously going to have a greater impact on each country than its adoption by a single country – which is why the recessionary impact of deficit reduction is frequently under-estimated and neglected.

In any case, while a balanced budget might be a reasonable stance (possibly and conditionally) in an effort to stabilize public debt, surely this cannot be in a single year: not unnaturally, in 2003, approximately 90% of the members of the American Economic Association agreed with the statement, "If the federal budget is to be balanced, it should be done over the course of the business cycle, rather than yearly."

The case for a balanced budget is often construed as a way to prevent a burden on future generations: thus fiscal stimulus is regarded as “little more than an exercise in the redistribution of wealth from our grandchildren to today’s special interest groups” (Darrell Issa, "Obama's Keynesian failures must never be repeated“ , FT Comment, 8 February 2011)

John Eatwell commented that “If government borrowing were indeed a burden, then real per capita income of future citizens would be reduced.”

“But where there is borrowing there is lending, so that payments of interest and repayments of capital that may result from stimulus packages are from taxpayers to lenders – no loss of real income there, just a transfer payment.”

“The assertion must therefore rest either on the argument that government spending “crowds out” private investment, not very credible with the current output gap and interest rate policy, or that there is a behavioural link from current borrowing to present and/or future levels of investment and growth.”

“It is possible to build models and select empirical evidence that go either way. What is not possible is to make the unambiguous assertion of future “burden”.” (Burden on our grandchildren’ is ambiguous talk, FT Letters, 10 February).

The “crowding out” idea is indeed what lies behind advocacy of balanced budgets : public expenditure multipliers are deemed to be small, less than one, “close to zero” according to Barro. Individuals are believed to follow the principle of Ricardian equivalence: when government reduces expenditure today they expect lower taxes in the future and therefore they rush at once to work, earn and spend more . Thus fiscal consolidation is deemed to be expansionary, see the latest “Public finances in the EMU” report, or Rother, Schuknecht and Stark, “The benefits of fiscal consolidation in uncharted waters”, ECB, (2010).

However, recent empirical work (such as Christiano, Eichenbaum and Rebelo, “When is the government spending multiplier large?”, 2009 or Corsetti, Meier and Mueller, “What determines government spending multiplier?”, 2010) has shown that public expenditure multipliers “are likely to be much larger, between one and two, when monetary policy is at the zero lower bound, when exchange rates are fixed and when a large number of households are credit-constrained. This is more or less the case in the current situation: a number of countries are experiencing de-leveraging by households, the central bank’s interest rate are low, preventing an accommodation by the central bank of a budgetary contraction, and the Eurozone countries have, by definition, fixed exchange rates.” (Raphael Cottin, Public finances in 2011: happy austerity, Eurointelligence.com, 28.01.2011).

Cottin notes that the European Commission services implicitly recognize this: the latest “Public finances in the EMU” report mentions (Part III, section 6) that fiscal expansions are likely to be expansionary under the current conditions: “but the symmetrical argument, that fiscal consolidations are likely to be contractionary, is carefully avoided.”

The Italian writer Vittorio Alfieri (1749-1803) is famous, among other things, for having himself knotted tightly to his chair with rope, in order to discipline himself to hard work and uninterrupted study. This is traditionally taken as evidence of his strong will, as claimed in his celebrated statement "Volli, sempre volli, fortissimamente volli". Surely if Alfieri really had such a strong will he would not have needed to be tied so tightly to his chair. Sarkozy and Schauble may tie themselves and their own budget in knots but leave other member states alone to pursue a more rational and enlightened fiscal policy.

A single European sovereign bond? Pie in the sky, unless…

2011-02-06T13:54:00.010+01:00

Delors’ Union Bonds

Nearly 20 years ago, in 1993, Jacques Delors proposed the issue of “Union bonds", whose repayment would be guaranteed by the Community budget, in addition to EIB (European Investment Bank) loans to finance infrastructure investments in transport, energy and telecommunications (EC White Paper on Growth, competitiveness, and employment. The challenges and ways forward into the 21st century, (COM (93) 700 final). This was a pale reflection of a much more ambitious and radical plan suggested to Delors by one of his economic advisers, Stuart Holland, who envisaged the issue of Union bonds by a European Investment Fund as a vehicle for the transfer of a substantial share of Member States’ national debt to the Union. After such “tranche transfer” member states would continue to service their share of their debt, but at a lower interest rate (Stuart Holland, The European Imperative: Economic and Social Cohesion in the 1990s. Foreword by Jacques Delors, Nottingham: Spokesman Press, 1993). Stuart expected the bonds not to count as debt of the member states, by analogy with US Treasury bonds, but because member states would continue to service them that analogy does not hold. Neither did he contemplate any need for a Union guarantee: the EU having virtually no debt, Union bonds would be credible regardless. Union bonds remained a dead letter.

Eurobond redux

The recent euro crisis, correctly seen as a crisis of sovereign debt, resurrected the idea of a single Eurobond whose issue would gradually replace at least part of the member states’ sovereign debt. In 2009-2010 several proposals in this sense were voiced again, among others by Paul de Grauwe and Wim Moesen (Gains for All: A Proposal for a Common Euro Bond, in: Intereconomics, Vol. 44, No. 3, 2009, pp.132-135), Daniel Gros and Stefano Micossi (A bond-issuing EU stability fund could rescue Europe, 2009, Europe’s World, spring); Jacques Delpla and Jakob von Weizsäcker, The Blue Bond Proposal, Bruegel Policy Brief 2010/3, May); Erik Jones, (A Eurobond proposal to promote stability and liquidity while preventing moral hazard, ISPI Policy Brief, n.180, March 2010); and, of course, Stuard Holland again (Europe needs a Gestalt shift, 2010 and elsewhere).

One such scheme was authoritatively backed by Luxembourg Premier and Treasury Minister Jean-Claude Junker and the Italian Finance Minister Giulio Tremonti in the Financial Times of 5 December 2010 (E-bonds would end the crisis). Giuliano Amato also forcefully endorsed it (in IlSole-24Ore of 11 December 2010). But German Chancellor Merkel and French President Sarkozy rejected the idea, together with the alternative proposal of raising the size of the EFSF (European Financial Stabilisation Facility) set up in May 2010 to deal with Euro-zone sovereign default .

Lower interest rate

The scheme for a single Eurobond comes in different sizes and forms, but all proposals have an underlying consideration in common: a European bond would attract a lower interest rate than the average (weighted) interest rate at which nation states could borrow in international markets, because of the lower liquidity premium and the lower credit risk premium. The funds raised through issues of a single Eurobond could be channeled to Eurozone member states in various ways: by buying their new national bond issues, or by buying back old national bonds, or by lending to member states against the security of domestic bonds. If a tranche of member states’ debt could be “transferred” to the EU in this way, say something of the order of 60% of European GDP, in line with EU own-policy stated in the Maastricht Treaty and the Growth and Stability Pact, a Eurobond should not worry global financial markets. A stock of all-European bonds would give the Euro a wider appeal and promote its diffusion as a reserve currency. Eurozone debt as a percentage of GDP was 84% in 2010 (79% in 2009), 60% of it would be €5.5 trillion, large enough to compete with the US Treasury bonds and reap any conceivable benefits in terms of liquidity.

Responsibility for servicing these bonds could be envisaged as: several; several and collective; European.

Several responsibility

Every participating member state would be responsible for servicing these bonds in a pre-fixed proportion, say proportionally to the shares it holds in the European Central Bank (the kind of approach followed by De Grauwe and Moesen, 2009).

But an investor potentially interested in this type of bond could invest in it today, simply by purchasing a portfolio of bonds issued by all member states in the same proportions. Such composite instruments are not unusual: the Markit iTraxx SovX Western Europe Indez, for instance, is a basket of mostly Eurozone Credit Default Swaps. The yield on such composite bond would have to be exactly the same as that of a corresponding balanced portfolio. There would be no interest saving in issuing such a bond, for it would be a useless exercise. If the bond attracted a liquidity premium so should the composite portfolio, and financial intermediaries would profit from its introduction on an increasingly larger scale and, therefore, they would be bound to introduce it, without any official initiative or inducement.

Collective and several responsibility

Under this kind of scheme the bond could be covered by a "collective and several" guarantee, i.e. in case of default bond-holders could claim reimbursement from any participating member state of their choice (cf for instance, Jones 2010). A spokesman for President Sarkozy was reported as saying. "This proposal is not entirely new. It raises difficulties notably in terms of sharing costs and profits... " (Eurointelligence.com, 10 December 2010). Obviously the interest cost of borrowing through a single Eurobond, though lower than the average cost of borrowing individually by member states, would be higher than that applicable to “virtuous” states. However the lower interest rate due to the lower risk and enhanced liquidity could benefit all: all countries could be charged a rate lower than but proportional to their own market rate, all being better off, even leaving something left over for accumulating a reserve.

In the case of several and collective responsibility for the bonds, however, there would remain two distributive problems. A minor problem is how to cope with member states with a debt/GDP ratio lower than the tranche of national debt whose transfer to the EU is envisaged. Slovakia at 42% debt/GDP ratio in 2010, Slovenia at 34%, Luxembourg at 20%, or Estonia with with a paultry 8%, would have to be granted a scaled down maximum liability in case of default. A second, major, problem is that more “virtuous” countries like Germany would be more exposed than weaker members to the risk of having to bail-out defaulters; who could indulge moreover in “moral hazard” behaviour and deliberately take advantage of the cover from such collective responsibility (though moral hazard would be limited to the share of their debt covered by Eurobonds, since the rest of their debt would attract a higher marginal interest rate). Thus it is perfectly understandable that Germans and other “virtuous” member states would be irreducibly opposed to such a scheme (unless accompanied by the realization of objectives close to the hearts of the virtuous, e.g. fiscal conformity across EU member states). True, even as things are now these countries are exposed to the risk of having to bailout defaulters, so much so that interest rates on German 10-year bonds have also increased from under 2% to almost 3%. But as things are now their liability is not automatic, it can be accepted or refused according to German perceived interests (such as German banks exposure to default), and subjected to conditionality imposed on defaulters. Therefore such a solution of collective and several responsibility for the single Eurobond is almost certainly politically impossible.

A European guarantee

Under this type of scheme the bond would be covered by a European guarantee extended by a hypothetical European Debt Agency that would have the task of “managing” a debt that has now become European. But “managing” debt involves manipulating the term structure of debt (funding and un-funding) and cover of exchange rate risk of bonds issued in foreign currency and the like, not the burden of debt service and repayment. It is crucial to consider that the European Union budget represents just over 1% of European GDP and, what is devastatingly worse, has a ZERO primary surplus, because the EU lacks the power of taxation and its scant revenues (primarily a share of VAT and the shrinking revenue from external common tariffs) can be supplemented by national contributions proportional to GDP only to balance the books and no more. Thus neither the EU Budget nor special Agencies obtaining resources from it can “manage” European debt, including its service, on the scale envisaged by the proposals (of the order of magnitude of over €5 trillion). Therefore such Eurobonds would get a rating lower than, say, that of Italy, who with tax revenues of 43% of GDP has at least the theoretical possibility of running a primary surplus and serving its debt.

Under a European guarantee the bonds in question would be among the junkiest of junk bonds, with a credit rating and an interest spread not lower but higher than the Eurozone average.

Junk bonds, unless…

Unless the Agency in charge of debt service were to be endowed from the start with an amount of resources adequate to credibly guarantee its Eurobond issues. But:

The EFSF could not act in that capacity because it can count only on participant states' national guarantees, not ready cash. Thus bond issues have to be over-collateralised in order to secure AAA rating since they are guaranteed by less-than-AAA rated countries, reducing the EFSF operational capacity from the trumpeted €440bn to about 230-240bn. And such funds would partly dissolve with any downgrading of guarantor member states, and would vanish proportionally to their share in the case of their default. So much is this so that a proposal has been discussed in Brussels "in finance ministry circles" whereby non-triple A nations such as Italy, Spain and Belgium should contribute cash payments to the EFSF rather than guarantees (Eurointelligence.com, 21 January 2011). And recently Eurostat ruled that “Member states will have to account for EFSF’s debt issues as gross debt, proportionate to their share in the EFSF” (Eurointelligence.com 28 January 2011).

Nor could the ECB act in the capacity of guarantor, for several reasons. First, even modest ECB purchases of the sovereign debt of the weaker states during the recent crisis (on a scale of just over $82bn since last February) raised concerns about the quantitative growth and above all the quality of ECB assets, which required a more than doubling of ECB capital from €5bn to €10.8bn at the end of 2010. Secondly, the ECB has announced last week that even those purchases have come to an end. Thirdly, such operations are bound to infringe ECB independence and the pursuit of its inflation target of close to 2% but no more than 2%. Alberto Quadrio Curzio (Corriere della Sera, 12 December 2010) has suggested the issue of €1000bn bonds guaranteed by the surplus gold holdings of Eurozone Central Banks; Germany’s 3,406 tonnes, plus Italy’s 2,451 tonnes and France’s 2,435 tonnes, together hold reserves higher than those of the Fed at 8,133 tonnes. This may not be the best option, for it would impinge on Central Banks independence and meet general legal obstacles (as well as special obstacles in a country like Italy where the Central Bank has the curious feature of still having dominant private shareholders); but at least Alberto has faced the issue squarely and suggested a possible solution.

Certainly the EIB could issue Eurobonds on a large scale – although if and only if its capital were raised to an extent commensurate with the scale of its envisaged operations, in the form of monies actually disbursed up-front or guaranteed by AAA-rating states and not, as Stuart Holland so implausibly argues, because it can finance national investments with loans that are alleged not to count as national debt (they still need to be serviced by borrowing member states, why should they not count as part of their debt and where in the treaties does it say that they do not?). The same could be said of a correspondingly capitalized European Debt Agency or similar ad hoc institution. But any such capital increase would have to be raised by the weaker (low rating, high spread) individual states first.

Would global financial markets really be sufficiently benevolent, enlightened and optimistic as to see such an increase in national debt as a move towards the reduction of European sovereign risk? Suppose the indebted individual members of a family incurred new debt to provide a family-guarantee on some of their debt; would creditors really regard this as offering them additional protection, or as an increased risk of default deriving from moral hazard encouraging higher profligacy by those family members?

Without a considerable and effective tightening up of fiscal constraints, as demanded by Germany, it is unlikely that Euro-zone creative accounting via the creation of a Special Debt Agency – a kind of Special Investment Vehicle à la Enron – would restore global investors’ confidence in Euro sovereign debt. The single European bond seems to require fiscal Union as its pre-condition, rather than being a substitute for fiscal Union. Not in our lifetime (i.e., over our dead bodies) comes the Eurosceptic, nation-staters’ cry.

Think Small: the solution

Fiscal Union is not a yes or no option: it comes piecemeal too, responding to the minimum stake that different member states can afford or stomach. All that is required is that at least some of the national tax revenue of member states – corresponding to a uniform, at least initially small percentage of national GDP – is specifically earmarked to servicing the single Eurobonds issued by a European institution. This is how it could begin; its effects would be cumulative over time. Of course it would not generate additional resources to service sovereign debt but, starting from the other end of the salami, so to speak, it would be an effective way of enforcing the fiscal constraints that are a precondition of both a European response to European sovereign debt and an ever-deeper Union. If not now, when?

And if not, is there European life after member-state sovereign default?

Monsieur Trichet Is In Denial

2011-01-29T23:59:00.012+01:00

On 27 January in Davos at the World Economic Forum the European Central Bank President, Monsieur Jean-Claude Trichet, stated boldly that “the euro is not in crisis”. He must have felt duty-bound to say that in an attempt to reassure international financial markets, regardless of what he really thought. If he actually believed what he said, then Monsieur Trichet is in denial, which is a poor foundation both for a fruitful discussion of the current crisis of the euro and for progressing towards its solution.

Of course, if one looked exclusively at the current exchange rate between the dollar and the euro and its recent trend, one would get the false impression that there is no crisis. On 29 January the euro stood at $1.37, a higher rate than before the Greek debt crisis erupted in February 2010 ($1.33), and much higher than the $1.18 rate to which it plunged in early May 2010 (and even that was 1cent higher than the initial exchange rate of 1.17 with which the euro started life in 1999). The euro recovery, however, was due primarily to the US Fed injecting $600bn liquidity over 8 months, compared with the comparatively restrictive policies of the ECB, and to US economic prospects being poorer than anticipated. After peaking at $1.42 last November, the euro fell again under $1.30 repeatedly (even a fortnight ago) with contagion spreading from Greece first to Ireland, then to Portugal, then threatening Spain.

Beside the exchange rate increased volatility, and the downgrading of credit ratings, a tangible and accurate measurement of the sovereign debt crisis of the euro is given by each country’s interest rate differential with respect to German bonds (usually taking 10-year bonds), the current yield on existing stock determining the rate at which the countries can borrow to rollover old debt or incur new debt. The spread over the German Bunds (whose yield has also risen as a result of the crisis, for fear of German exposure to baling out possible defaulters) has risen on average and significantly widened across countries over time, especially since the Greek crisis, and is now at record levels, higher than last May. Usually a 2% differential is regarded as the danger level; today Spain is just over, Italy just under that level; Portugal has almost 4% differential, Ireland over 6%, Greece 8 and a half per cent.

At interest rates higher than national growth rates (whether in nominal or real terms, as long as both are measured in the same way) national debt must increase relatively to GDP; debt is unsustainable and default looms. Even on the funds provided by the EFSF (the European Financial Stabilisation Facility set up last May) Greece and Ireland pay 5.8%, a rate lower than their market rates but higher than sustainable and signalling European lack of confidence in these countries’ ability to repay. Rescheduling of Irish and Greek debt – with lengthening of maturities and inflicting a haircut on investors – is now on the cards.

It is true that a recent bond issue by the EFSF was five times over-suscribed, but this was mostly “spurred by Basel III capital rules” set by the BIS, according to which AAA-rated sovereign bonds like those of EFSF “have a risk-weighting of 0%, which means that investors effectively don’t need to hold capital against it”. And that rating involves the EFSF over-collateralising its bonds reducing its operational capacity, and even EFSF bonds are subject to risk (for instance from the downgrading of one of the participating countries, which would require further capitalisation, see Klaus Regling, Eurointelligence.com 27 January).

The ultimate source of euro vulnerability is its premature birth. The single currency was supposed to be the crowning of the economic integration process, after political and fiscal union, after the unification of labour and social policies and, come to think of it, after a common foreign policy and a common army (though these could wait). Instead of which the single currency has been used to promote the so-called finalité politique, i.e. that political union that should have been the pre-condition of the euro. This is like a person buying clothes that are too tight and do not fit in the hope that this might facilitate slimming, by forcing one to diet: it does not work for me, it did not work for Europe. The fiscal constraints imposed by the Maastricht Treaty and the Growth and Stability Pact, 3% public deficit and 60% public debt, have not been observed by too many countries for too long (including Germany and France, who were first to violate the 3% ceiling), to be treated as substitutes for a fiscal union. Thus the initial fall and convergence of interest rates that occurred after the introduction of the euro have been reversed. The global crisis has lowered tax revenues and raised public expenditures, not least for rescuing financial institutions. Europe has reacted too slowly and inadequately to the sovereign debt crisis over the last year; European leaders have spoken with dissonant voices, often making perverse announcements, whether from ineptitude or malice.

Can the euro crisis be solved, or at least be significantly alleviated, by the issue of a single European bond covered by a European guarantee, to replace a sizeable tranche of national debts? This we will consider in one of the next posts.

Dr Marchionne’s Vietnam War

2011-01-11T21:17:00.006+01:00

[SEE POSTCRIPT/UPDATE, POSTED BELOW AS A COMMENT]

In 1968, at the height of the Tet offensive, I argued with US sociologist Edward Shils (1910-1995) at Cambridge about the uselessness, wickedness and immorality of the Vietnam war. Shils shut me up curtly by saying that the US were in Vietnam simply “because they can”, and there was nothing more to be said. And so they could, of course: the US had the troops, the military hardware, the financial resources to do it, and they could get away with it, wanting to get away with it (at the time). Which of course did not imply that the war was in the US' best interests, that it was justifiable, or that the US would win it in the end. Shils lived long enough to see the inglorious débacle of the US last exit by helicopter from the roof of the US Embassy in Saigon.

In 2010 FIAT's Sergio Marchionne adopted an antagonistic industrial relations strategy towards his employees, first at the Pomigliano d’Arco plant in Southern Italy and then at the Mirafiori plant in Turin. Either FIAT employees accepted greater internal flexibility, duration and intensity of work or FIAT would invest an alleged €20bn elsewhere, notably in Serbia and in Canada. At Pomigliano a workers' referendum endorsed the deal but the overwhelming majority of over 60% was judged insufficient by Marchionne. At the Turin Mirafiori plant on 29 December FIAT signed an agreementwith all unions (Fim, Uilm e Fimsic) except with the traditionally more militant FIOM metalworkers. Now a referendum has been called on 13-14 January, and FIOM has called a general strike for 28 January inviting not only metalworkers but all "social opposition forces" from students to movements opposing water privatisation.

Marchionne’s attitude is reminiscent of Shils’ views on the Vietnam War: FIAT is fighting the metalworkers’ Trade Union FIOM “because it can”. Globalisation has dramatically increased labour markets competition in the world: labour migrations and production de-localisation are the more spectacular forms of such intensified competition, but trade liberalisation is its most important quantitative manifestation. Even if existing factories stayed for ever where they are, new production would naturally follow the logic of global comparative advantage. This is what has reduced the average share of wages in GDP in advanced countries from 65% to 55% in 1980-2005 (IMF World Economic Outlook June 2007), a trend that has continued to date except for a small rise in wage shares in 2009 due to the temporary fall of profits in the recession. This is what allows FIAT to give such a blunt ultimatum to its workers: take it or leave it, don’t even think you can negotiate anything else.

The former communist leader Piero Fassino – now candidate as mayor of Turin, FIAT’s headquarters – has stated that were he a FIAT employee he would support the proposed deal and vote Yes in the coming referendum. Other Democratic Party politicians have dissented: Marchionne has already succeeded in splitting not only the Unions but also the main Opposition party. (See Antonio Lettieri, "La sinistra ai piedi di Marchionne", Il Manifesto, 8-01-2011).

One’s vote in such a referendum is not necessarily a reflection of one’s politics, but of family circumstances and wealth. Were I a FIAT employee, faced with the brutal alternative between unemployment and a worsening of my labour conditions I too might well vote Yes in the referendum. Which does not imply that the deal is in FIAT’s best interests, indeed that it is necessarily superior to other deals reachable after negotiation, or that its political/social implications are desirable, especially in the long run.

Some aspects of the proposed deal are very disquieting. The proposal has not been discussed beforehand, even within those Unions that have supported it. Such referendums, overriding union leadership, are unprecedented so that there are no set rules: at Pomigliano a yes vote of over 60% was regarded as insufficient for FIAT to go ahead with investment; at Mirafiori Marchionne demands only “over 51%”. An unintended consequence of existing Italian legislation involves FIOM members losing the right to union representation unless FIOM signs the deal. This could be rectified easily by either government decree or by an additional provision in the agreement with FIAT, before the referendum takes place, but neither Italy’s weak, absentee and corrupt government nor FIAT have taken the initiative, in spite of protestations by several unions and politicians and not just by FIOM. The threat of losing union representation poses additional and improper pressure on FIOM members. The deal marks the end of collective bargaining – which is, among other things, an integral part of the European Social Model – and marks the re-emergence of enterprise-level bargaining outside medium and small size firms. FIAT has had to leave the Confederation of Italian Industries in order to replace the standing collective contract, but metalworkers could also be moved to the new contract in other enterprises that followed FIAT’s example.

A major problem is that FIAT’s so-called “Fabbrica Italia” project does not really guarantee FIAT’s employees anything at all. The €20bn investment “envisaged” – with an unspecified time-horizon – exists only in the vaguest and most nebulous industrial plan not worth the paper on which it is not written. So far only €1,3bn have been “planned”, only another €700mn have been identified at the very outset.

The new contract would be signed with a New Company, a joint venture with Chrysler. As is always the case with multinational companies, including joint ventures, the distribution of profits between FIAT and Chrysler would depend on transfer prices of components between the two partners. The criteria for such distribution has not been remotely faced by the parties, or even raised by the Unions.

The greater flexibility, the acceleration and prolongation of worktime involved in the deal seem too minor to really impact FIAT’s global competitiveness but represents merely a net worsening of working conditions. They are 1) a shortening of 10 minutes per day in work pauses (three 10’ pauses instead of two 15’ and one 10’ pauses) compensated by €0.1877 per worked hour or roughly €45 per month; 2) the postponement of the 30 minutes meal break to the end of the shift; 3) loss of illness allowance for period of “anomalous absenteeism” to be assessed case by case by a joint committee; 4) up to 18 8-hour shifts over six working days; 5) up to 120 hours overtime work without having to negotiate with the Unions, plus another 80 hours with union agreement; 6) in case of strikes or other breaches of contract FIAT would not be liable to honour union permits and payments.

Would such greater internal flexibility, prolongation and intensification of work solve FIAT’s problems and miraculously restore competitiveness in a sector affected by world-wide supply over-capacity and demand recession? (see a letter endorsed by 146 Italian economists on the subject, on the Sbilanciamoci website. )

Fact 1. In 2009 FIAT produced 650 thousand cars in Italy, barely a third of those produced in 1990, compared to a planned 2mn and to the stability and growth of quantities produced in the major European countries. The stated intention of more than doubling output seems over-optimistic.

Fact 2. FIAT spends on productive investments, and on Research & Development, shares of turnover significantly lower than those of its main European competitors, and it is not active in the development of low environmental impact alternatives. European competitors of FIAT, like Volkswagen, have responded to crisis by reducing working hours while protecting wages and employment.

Fact 3. While in 2004-2008 FIAT recovered from a very serious crisis and developed a few models, in the last two years FIAT has not introduced any new models; its market share in Europe has fallen to 6.7%, the largest drop in car output shares in Europe in 2010.

Fact 4. In 2010 Fiat shares rose 90%, beating all competitors, also following the recent split of Fiat Industrial from the rest of the company involved in car production. In the third quarter of 2010 FIAT was first in the Italian stock exchange in terms of shareholder value, with a 33% return on capital.

Fact 5. In spite of the rhetoric of FIAT depicted as an enterprise “capable to walk in the market on its own legs”, from the end of the 1980s and the early 2000s FIAT has enjoyed public subsidies of the order of €500mn per year. Perhaps FIAT should have been given subsidies to deal with the crisis by the Italian government, or at least Marchionne should have asked.

Fact 6. Over the last ten years FIAT global employment in car production has fallen from 74 thousand to 54 thousand units, of which only 22,000 are in Italian factories. Employees have average skill levels lower than those of FIAT’s competitors, and among the lowest wages in the sector in Europe.

Fact 7. In 2004-2009 Dr Marchionne earned €36.6mn euro, including the accumulation of his golden handshake, i.e. €6.3mn a year. Plus 4million free shares, worth 69.8mn on 7 January 2011, which will have appreciated further already since then. This brings his yearly income to €38.8 mn a year (See Massimo Mucchetti, "Marchionne e lo stipendio del dipendente FIAT", Corriere della Sera, 9 January 2011), which corresponds to 1,037 times the average yearly cost of Italian metalworkers' labour over the same period. Not that this matters for the plausibility of FIAT’s industrial policy stance but certainly not an irrelevant consideration in providing a perspective for the average FIAT metalworker, whether or not she is a FIOM member.

[SEE POSTCRIPT/UPDATE POSTED BELOW AS A COMMENT]

A Very Happy (Digital) Christmas

2010-12-25T23:54:00.003+01:00

A Very Happy Christmas to all readers.

Normal Blogging will resume in the New Year.

Global Policy Forum, Yaroslavl 8-10 September

2010-09-03T18:13:00.005+02:00

Global economic integration, as measured by the ratio between world exports and world GDP, regressed slightly in 2009 only to resume its course immediately at an even faster rate. Globalisation, however, has not been matched at all - for better or worse - by the progress of global governance institutions. This is why the feeble and fragmented powers of international economic institutions - over 2,000 of them - are accompanied only by ad hoc arrangements from G-n groupings (from the G-1, i.e. the USA, to the G-24 of most advanced countries or the recently emerging G-20 including large less developed actors) to various Global Forums with the participation of some world politicians, businessmen and intellectuals. The Davos World Economic Forum was first and remains the foremost, but others have arisen in equally desirable locations. The millenary town of Yaroslavl - an ancient, former temporary capital of Russia - is hosting its second Global Policy Forum on 8-10 September, with prospective participants including the Russian President Dmitry Medvedev, the Spanish Premier José Luis Rodriguez Zapatero and the French Premier Francois Fillon. it is devoted to the general theme “The Modern State: Standards of Democracy and Criteria of Efficiency”.

Having accepted an invitation to join the Yaroslavl Forum, I was asked by the editor of the Conference website http://en.gpf-yaroslavl.ru/, Dr Dmitry Uzlaner, a number of interesting questions, listed below with my answers.

You are going to take part in the section 'The State as an Instrument of Technological Modernization'. What are your expectations about it? What problems seem to you most topical in this context?

Technological modernisation should not be understood as the introduction, at the fastest rate and on the largest possible scale, of the latest technique available, or the most productive in a physical sense. Modernisation is desirable only if

1) it introduces the best-practice technique, i.e. that which minimises total production costs calculated at the competitive market prices of all inputs, and

2) on the scale determined by total costs not exceeding the operating costs of production on already existing plant, whose historical capital cost is sunk and therefore irrelevant.

When input prices change, or some costs formerly neglected are included in production accounting, the best-practice technique also may change. The technique that is best for oil at $10 a barrel is not the same for oil at $150. The technique that is best when producers do not pay for the pollution generated in the production or consumption of their products is not that which is best when they do pay for it. A significant rise in the price of oil, or taking into account pollution costs previously unaccounted for, can require not only a technological change but possibly a “regression” to older and/or less productive techniques. This problem is well understood by economists and businessmen, but is all too often neglected by politicians and the general public.

The role of the State is paramount in: funding fundamental research and general technical education; enforcing market competition (for imperfect competition will distort the incentives to modernize and adversely affect the scale though not necessarily the occurrence of modernization; generally creating an economic environment favourable to modernization, for instance striking a balance between the production of new technology via patents protection, and the diffusion of technology. But there is no case for the State to have a direct hand in the choice of particular techniques in particular sectors let alone enterprises.

Which economic systems are doing better in the modern world? What factors determine success and failure of the system?

The collapse of the Soviet-type system in 1990-91 has led to a widespread conviction of the superiority of the capitalist system: the combination of market efficiency and the private appropriation of efficiency gains is a major stimulus to technical progress and innovation. For instance, Janos Kornai (Innovation and Dynamism, WIDER Working Paper No. 2010/33) argues that capitalism provides a strong incentive to dynamism, enterprise and the innovation process, and that every revolutionary new product for civilian use - such as information technology, the computer, the mobile phone and internet - has been brought about by the capitalist system. However, we should take into account the role of state-initiated and state-funded research, in this case space research, and its impact on such technical developments. It is true that Silicon Valley could not have developed in a centrally planned economy, but what seems indispensable is not necessarily a capitalist system, but a competitive market environment. Managers of private enterprises are already more motivated by profits than their shareholders, and equivalent incentives can be replicated in state-owned enterprises. China today, for instance, displays more dynamism, enterprise and innovation - and more resilience to economic crisis - than the traditional capitalist system, though this has far reaching implications for democracy.

Today Russia strives for the creation of modern high-tech infrastructure and technological renovation of the entire production sector. What to your mind are the best development strategies for countries like Russia? Which post-communist states were most successful in economic and political modernization? What factors determined their success?

In its current situation Russia, having suffered from decades of central planning inefficiencies, cannot go wrong by upgrading infrastructure and production; the question really is at which point such policy should be subjected to a strict analysis of economic efficiency. Russia has been blessed by an abundance of natural resources, notably oil and gas, which is an opportunity to be exploited. But the development of a diversified industrial basis is essential in the medium-to-long run.

Among post-communist states, economic success has not always gone hand in hand with democratic progress (from Poland to Belarus and to some extent Russia itself), but democracy must be regarded as a necessary pre-condition of long-term sustainable economic development.

What trends in modern economic theory you find most interesting and percective?

The global financial crisis of 2007-2010 has led to a considerable re-assessment and down-grading of the hyper-liberal economic theories of the 1990s and most of the 2000s. Markets are often non-competitive; in any case they are incomplete, given the lack of inter-temporal and contingent markets, leading agents to act on the basis not only of current prices and quantities of today’s goods, but also of their expectations of future prices and quantities. This is why higher savings might lead to a depression, and a global lowering of wages might increase unemployment. We live in a Keynesian world. Not only are markets somewhat inefficient and unstable, they are also patently unfair as demonstrated by rising national and global inequality.

Having said that, we must recognize that markets - with strong qualifications for at least some financial markets like derivatives - are absolutely indispensable in any economic system, for they provide automatic mechanisms of economic adjustment: of enterprise production to prices, of prices to excess or deficit demand, of actual to desired capital through capital stock adjustment via investment, of inputs supplies to actual outputs. We cannot live without markets.

What, to your mind, are the main problems of interaction between the intellectual community and policy makers? What form of communication is urgently needed? Is it just financing of intellectual think-tanks by some governmental bodies, or a kind of intellectual intercourse like forums in Davos, St. Petersburg, or Yaroslavl, etc.?

The decisions taken by policy-makers reflect mostly their own interests and values and those of their clients, and are rarely purely technical decisions that might be influenced by arguments developed by the intellectual community which, moreover, itself might not be representative of the people. Therefore problems of communication and interaction arise only in the narrow range of decisions open to a technical/intellectual argument; such is the natural limited area of operation of both think-tanks and forums. The real problem is that of democratic formulation and implementation of the public interest, and in a global dimension - though think-tanks and forums such as that of Yaroslavl can indeed have positive effects.

Vladimir Popov replies on China

2010-07-19T10:39:00.011+02:00

[A Guest Post by Vladimir Popov, New Economic School, Moscow, vpopov@NES.RU, http://www.nes.ru/~vpopov]

I am very grateful to everyone who commented on my post of 24 May on the Uniqueness of Chinese Capitalism. Here are some brief replies that I hope might promote further debate.

Mario stresses the prohibition of trades unions and strikes in today’s China. Well, trade unions formally exist, but the right to strike is really not guaranteed by Deng’s constitution, although it was guaranteed by Mao’s constitution. (By the way, the relative popularity of Mao and Deng in China today could be measured by observing the numbers at the memorial site where people can go and put virtual flowers to personalities they like: http://jidian.china.com Since 2009 and until July 8, 2010, Mao got over 2 million bouquets of flowers, Deng – only 33,000, less than Zhou Enlai (nearly 200,000) and Norman Bethume, a Canadian doctor helping Republicans in Spain in 1936-39 and Communists in China during the Anti-Japanese and Civil Wars (over 37,000)).

Mario questions my statement that all developed countries had authoritarian regimes in the past. “Including England, Sweden, Denmark, Switzerland, the United States? If you said "many developed countries had before" nobody could argue, but all? You might say more about this presumably universal authoritarianism”. Well, I would stick to what I said – there was life before democracy, which emerged at a very late stage of human history. In ancient Greece neither women nor slaves had voting rights. In France in 1815-30 voters amounted to only 0.25-0.3 per cent of the population, and about 0.6 per cent in 1830-48. In England suffrage was extended by the Reform Act of 1832. Nevertheless, voting rights were received by 14-18 per cent of men only. Universal male suffrage was introduced only in 1928. In Germany, Italy, Belgium women were not given voting rights until after the Second World War. Rich countries were generally late in introduction of universal suffrage: it was granted in 1965 in the USA, in 1970 - in Canada, in 1971 - in Switzerland. (Polterovich, Popov, 2007).

Mario writes: “Mao's contribution to filling state coffers is fine, but did he really contribute to building state institutions? I thought Maoism had been fairly destructive rather than constructive in this respect?”

I referred to the fact that Mao created the “vertical of power” that not only Putin, but Qin Shihuangdi (the first emperor that unified China in 3rd century B.C.) could not have dreamt of. I gave the data on shadow economy and murders. I said that party cells were created in every village, so for the first time in China’s history the central government in Beijing could enforce decisions taken in the capital all across the country. And I explained that government for the first time in Chinese history started to collect reasonable revenues (always a problem in developing countries).

A couple of examples can be enlightening. In Mao’s days policemen used to be unarmed like most British Bobbies. Bank officials collected cash from retail shops at the end of the business day and carried it back to the bank on a bike or via public transport (and unarmed, of course). Today, the same procedure is different – armoured vehicles, bullet proof jackets, helmets, machine guns…

Another good indicator of the ability to maintain social order and the magnitude of non-compliance with existing regulations is the incarceration rate – the number of inmates per capita. It is 120 per 100,000 against 751 people in prison or jail for every 100,000 population in the US and 151 in the UK. Which is the “land of freedom” and which is the “prison state”?

Anonymous comments that the lower Chinese murder rate does not account for “capital punishment and the silent massacre of female babies along with the number of suicides directly or indirectly induced by Chinese state repression and rule of force”. It does account for capital punishment; Amnesty International estimates that “Legal murders” – executions (1000-2000 a year) account for about 5% of total murders.

“The silent massacre of female babies” is probably a reference to Berlusconi statement that “under Mao's China they didn't eat babies, but they boiled them to fertilise the fields” (Berlusconi, 2006). There is a debate, whether China has sex-selective abortions (although it is illegal for doctors in China to reveal the gender of the foetus) because China has one of the highest gender imbalances for the newborns. But “silent massacre of female babies” is as probable as “boiling them to fertilize the fields”.

And on “suicides directly or indirectly induced by Chinese state repression and rule of force”: the total number of suicides in China is 21 per 100,000, quite high by international standards, but less than in Japan and Finland, and way less than in Estonia and Hungary.

Alberto’s comment that “authoritarian types of mixed capitalist economy with an important steering role for the state have thrived in South-East Asia, from Japan to Singapore, to South Korea and Taiwan, without any communist connotations, leading those countries to development and prosperity” is missing the point. All the countries mentioned were supported by the US during the Cold War as counterweights to global communism, some even call this “development by invitation”. Not only did they receive Western assistance, but also, and most important, got access to US markets. In addition in Japan and Korea the agricultural reform was carried by the US occupation authorities and in Taiwan it took place under pressure from the US.

In a sense, Alberto writes, “over the long haul Chiang Kai-shek has triumphed over Mao. (An analogous consideration could be made with respect to Vietnam, where after a long bloody civil war the vanquished appear to have triumphed over the victors.)”. I would dispute that. Chiang Kai-shek, as the puppet South Vietnamese government, had the time to carry reforms and produce an economic miracle but failed to do so. There was no growth and no peace in China in 1928-48, when Chiang Kai-shek was the leader. When Chiang Kai-shek fled to Taiwan (even after the so called “golden decade of the 1930s”), he left China with GDP per capita of $500 (Maddison, 2008), same as in 1500, and a life expectancy of 35 years.

To put it differently, to produce an economic miracle in Taiwan Chang Kai-shek had to be defeated and learn from his defeat and from the communists (and to carry out agrarian reform on the island that he never carried out in China) and to get a support from the US (access to the US market).

“…Maoism left the Chinese economy and society in such a bad shape that simply the demolition of Maoism produced the economic miracle”, says Alberto. This is wrong again. The catch-up development of China since 1949 was extremely impressive: not only were growth rates in China higher than elsewhere after the reforms (1979 onward), but even before the reforms (1949-79), despite temporary declines during the Great Leap Forward and the Cultural Revolution, Chinese development was quite successful. According to Maddison (2008), Chinese per-capita GDP was about 70 percent of India’s in 1950, rose to about 100 percent by 1958-59, fell during the Great Leap Forward, rose again to 100 percent of the Indian level by 1966, fell during the first years of the Cultural Revolution, and rose again to 100 percent by 1978. By 2006, it was more than twice the Indian per capita GDP. World Bank estimates, however, suggest that since 1960, Chinese growth rates (five-year moving averages) were always higher than Indian growth rates. Life expectancy in China in 1950 was only 35 years but by the end of the 1970s rose to 65 years—thirteen years higher than in India. Today, it is seventy-three years—seven years higher than in Russia and India. Some charts below (from Popov, 2009).

Berlusconi (2006). Communists boiled babies: Berlusconi. “Herald Sun”, 27 March 2006
http://www.freerepublic.com/focus/f-news/1603618/posts

Maddison, A. (2008). Statistics on World Population, GDP and Per Capita GDP, 1-2006 AD (http://www.ggdc.net/maddison/Historical_Statistics/horizontal-file_09-2008.xls)

Polterovich, V. Popov, V (2007). Democratization, Quality of Institutions and Economic Growth.
-TIGER Working paper No. 102, Warsaw, July 2007.

Popov, V. (2009). Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

Is The Chinese Variety of Capitalism Really Unique?

2010-05-24T15:44:00.020+02:00

A Guest Post by Vladimir Popov [1]

Because the Chinese economy did much better in the recent recession of 2008-09, there is no shortage of articles suggesting that the Chinese model is more viable and that the West should learn from China.

“We in the West have a choice - writes Anatole Kaletsky in The Times -. Either we concede the argument that China, in the 5,000 years of recorded human history, has been a much more successful and durable culture than America or Western Europe and is now reclaiming its natural position of global leadership. Or we stop denying the rivalry between the Chinese and Western models and start thinking seriously about how Western capitalism can be reformed to have a better chance of winning” [2].

“East is East, and West is West, and never the twain shall meet”? Rudyard Kipling's oft quoted words prompt a more modest question: does the Chinese economic model today differ radically from the Western model; does it really have magic properties that allow growth amidst the world-wide recession or has growth been just a stroke of luck?

Certainly the Chinese economy is no longer either centrally planned or state-owned. On the similarities with the West side we have the:

- Dominant role of the private sector - 75% of GDP is produced by non-state enterprises, including joint stock companies and individual private businesses, which are not that different from their Western counterparts;

- Relatively small share of government spending in GDP (about 20%) – lower than in all Western countries and often lower than in developing countries with similar per capita GDP;

- No longer free education and health care, and relatively high income and wealth inequalities (Gini coefficient of 45% and 64 billionaires on the mainland alone, according to the March 2010 “Forbes’ account, second in the world after the US with 403, but ahead of Russia's 62).

Differences with the Western economic model also do not seem to be all that significant:

- China has a strong, export-oriented industrial policy – mostly caused by undervaluation of the yuan leading to the accumulation of vast foreign exchange reserves. This is not without a precedent, however, since this practice was used by Hong Kong, Japan, Korea, Taiwan and Singapore at earlier stages of development);

- Land is still not private property in China and is not traded, but private, long-term transferable private leases are widespread; besides, public ownership of land is not uncommon in other countries, albeit in smaller proportions;

- China exercises controls over its capital account but, again, this practice is used by many developing countries now and was still being used by European countries just half a century ago, until well after the end of the Second World War;

- China has an authoritarian regime (which, of course, all developed countries had in the past; some of them, like Spain, Portugal, Taiwan, South Korea, as recently as three-four decades ago).

A real difference is the institutional capacity of the state.

Many formal comparisons of the similarities and differences of Chinese and Western economic models misses the most important point. The uniqueness of China is that while it looks very much like a developed country today in terms of the institutional capacity of the state, it is a developing country according to GDP per capita. Instead China should be compared with developing countries today or developed countries a hundred years ago, when their GDP was at the current Chinese level; this comparison is very much in China favour.

The institutional capacity of the state, narrowly defined, is the ability of a government to enforce laws and regulations. While there are a lot of subjective indices (corruption, rule of law, government effectiveness, etc.) that supposedly measure state institutional capacity, many researchers do not think they help to explain economic performance and consider them biased[3]. The natural objective measures of state institutional capacity are the murder rate – non-compliance with the state’s monopoly on violence[4], and the shadow economy – non compliance with the economic regulations. China is unique in having some of the lowest scores for both indicators in the developing world, comparable to those of developed countries (see chart 1).

Chart 1. Murder rate per 100,000 inhabitants and government effectiveness index (ranges from -2.5 to +2.5) in 2002

Upper chart - countries with a high (15-75) murder rate; Lower chart – countries with a low rate (0-3). Source: WHO, World Bank.

With less than 3 murders in 2002 per 100,000 inhabitants against 1-2 in Europe and Japan and over 5 in the US) China looks like a developed country. Only a few developing countries, mostly in the Middle East and North Africa (MENA), have such low murder rates, normally they are considerably higher, as in Latin America, Sub Saharan Africa, and many Former Soviet states. By way of comparison, it took Western Europe 300 years to move from a murder rate of over 40 per 100, 000 inhabitants in the sixteenth century to current levels of 1-2 murders per 100, 000 inhabitants in the nineteenth century beyond [5].

The same is true of the shadow economy: it is less than 17% of the Chinese GDP, lower than in Belgium, Portugal, Spain, whereas in developing countries it is typically around 40%, sometimes even over 60%. Only few developing countries have such low share of shadow economy, in particular, Vietnam and some MENA countries (Iran, Jordan, Saudi Arabia, Syria).

Chart 2. Share of the shadow economy in GDP in 2005, %, and government effectiveness index in 2002 .

Source: World Bank. Data on shadow economy are from: Friedrich Schneider. Shadow Economies and Corruption All Over the World: New Estimates for 145 Countries. – Economics. Open Access, Open Assessment E-Journal, No. 2007-9 July 24, 2007 (measures of the shadow economy are derived from divergence between output dynamics and electricity consumption, demand for real cash balances, etc.).

Where does the strength of the Chinese institutions come from?

The pre-conditions for the Chinese success of the last thirty years were created mostly in the preceding period 1949-76. It would be no exaggeration at all to claim that without the policies implemented by Mao’s regime, the market-type reforms of 1979 and beyond would never have produced the impressive results that they did. In this sense, economic liberalization in 1979 and beyond was only the icing on the cake. The other ingredients, most importantly strong institutions and human capital, had already been provided by the previous regime. Without these other ingredients, liberalization alone in different periods and in different countries was never successful and sometimes was counterproductive, as in sub-Saharan Africa in the 1980s.

Market-type reforms in China in 1979 and beyond brought about such an acceleration in economic growth because China already had an efficient government, created by the Chinese Communist Party after the Liberation, which the country had not had in centuries - not least because of its deliberate destruction by various colonial, European aggressors. Through the party cells in every village, the communist government in Beijing was able to enforce its rules and regulations throughout the country more efficiently than Qing Shi Huang Di or any subsequent emperor, not to mention the Kuomintang regime (1912-49). While, in the late nineteenth century, the central government had revenues equivalent to only 3 percent of GDP (against 12 percent in Japan right after the Meiji Restoration) and, under the Kuomintang government, they increased to only 5 percent of GDP, Mao’s government left the state coffers to Deng’s reform team with revenues equivalent to 20 percent of GDP [6].

The Chinese crime rate in the 1970s was among the lowest in the world, A Chinese shadow economy was virtually non-existent, and corruption was estimated by Transparency International even in 1985 to be the lowest in the developing world (China, together with the USSR, was in the middle of the list of 54 countries – below Western countries, but ahead of most developing countries and even ahead of South Korea, Greece, Italy, and Portugal [7]). In the same period, during “clearly the greatest experiment in the mass education in the history of the world”, literacy rates in China increased from 28 percent in 1949 to 65 percent by the end of the 1970s (41 percent in India, for comparison)[8].

By the end of the 1970s, China had virtually everything needed for growth except some liberalization of markets — a much easier ingredient to introduce than human capital or institutional capacity. The foundations for the truly exceptional success of the post-reform period had been laid purposefully in 1949-76. [9]

But even this seemingly simple task of economic liberalization required careful management. The USSR was in a similar position in the late 1980s. True, the Soviet system lost its economic and social dynamism, growth rates in the 1960s-80s were falling, life expectancy was not rising, and crime rates were slowly growing, but institutions were generally strong and human capital was large, which provided good starting conditions for reform. Nevertheless, economic liberalization in China (since 1979) and in the USSR and later in Russia (since 1989) produced markedly different outcomes.[10]

[Russia was assaulted for decades by the West and suffered massive human and material losses in the Second WW. China may have been having objectively hard and troubled times but it was not under attack in the same way, and having itself constantly diverted from its course of action by the Americans].

Fast economic growth can materialize only if several necessary conditions are met simultaneously. Specifically rapid growth requires: infrastructure, human capital, in agrarian countries even land re-distribution, strong state institutions, and economic stimuli, among other things. Rodrik, Hausmann, and Velasco talk about “binding constraints” that hold back economic growth; finding these constraints is a task in “growth diagnostics”[11]

Why did economic liberalization work in central Europe but not in sub-Saharan Africa and Latin America? The answer, according to the outlined approach, would be that in central Europe the missing ingredient was economic liberalization, whereas in Sub-Saharan Africa and Latin America there was a lack of state capacity, not a lack of market liberalization. Why did liberalization work in China and central Europe but did not work in the Commonwealth of Independent States? It is because in the CIS it was carried out in such a way as to undermine state capacity — the one useful heritage of the socialist past ― whereas in central Europe and even more so in China , state capacity did not decline substantially during transition?

Unlike Russia after 1991, so far it seems that China in 1979-2009 managed to preserve its strong state institutions better — the murder rate, a reliable measure of state capacity as noted above, in China is still below 3 per 100,000 inhabitants compared to about 30 in Russia in 2002 and about 20 in 2009. In the 1970s, under the Maoist regime, the murder rate in Shandong Province was even less than 1 [12], and in 1987 it was estimated to be 1.5 for the whole of China [13]. The threefold increase in the murder rate during the market reforms is comparable with the Russian increase, but Chinese levels are nowhere near the Russian levels.

If the Chinese model exists, is it replicable and sustainable, or even desirable?

The litmus test is a question on which economists sharply disagree: where will the next economic miracles occur, if at all.

Today, conventional wisdom suggests democratic countries that encourage individual freedoms and entrepreneurship, as Mexico and Brazil, Turkey and India, for future growth miracles, whereas rapidly-growing, currently authoritarian regimes, like China and Vietnam or Iran and Egypt, are thought to be doomed to experience a growth slowdown, if not a recession, in the near future. According to Jack Goldstone [14], “a country encouraging science and entrepreneurship will thrive regardless of inequality: hence India and Brazil, and perhaps Mexico, should become world leaders. But I say countries that retain hierarchical patronage systems and hostility to individualism and science-based entrepreneurship, will fall behind, such as Egypt and Iran ”. Many believe that rapid growth could be achieved under authoritarian regimes only at the catch-up stage, not at the innovative stage: once a country approaches the technological frontier and it becomes impossible to grow just by copying innovations of the others, it can continue to advance only with free entrepreneurship, guaranteed individual freedoms and a democratic political regime [15].

We still do not have enough evidence for innovation-based growth. For one thing, on all measures of patent activity, Japan , South Korea and China are already ahead or rapidly catching up with the US. The patent office of the United States of America, which had consistently issued the highest number of patents since 1998, was overtaken in 2007 by the patent office of Japan . The patent office of China replaced the European Patent Office as the fourth largest office in terms of issuing grants (the five largest patent offices - those of Japan, the USA, the Republic of Korea, China and the EPO accounted for 74.4% of total patent grants). The number of resident patent filings per $1 of GDP and $1 of R&D spending is already higher, sometimes considerably higher, in Japan, Korea and China than in the US [16].

And the evidence for catch-up growth is controversial to say the least. Imagine, for instance, that the debate about future economic miracles were happening in 1960: some would be betting on more free, democratic and entrepreneurial India and Latin America, whereas others would predict the success of authoritarian (even sometimes communist), centralized and heavy handed government interventionist East Asia. What is unknown, however, is whether the gradual weakening in the reform period capacity of the Chinese state will continue to weaken further, which will convert China into a “normal” developing country. In this case Chinese rapid growth would come to an end and there wouldn’t be any more a question of what is so special about the Chinese economic model.

POSTSCRIPT by DMN: The 27 May issue of the Russian magazine "Russkiy Reporter" lists Vladimir Popov among the "10 best [Russian] economists and sociologists in 2000-2010". Vladimir is sketched on the right-hand top corner of the magazine's cover.
Warmest congratulations, Vladimir!

[1] New Economic School, Moscow. vpopov@NES.RU, http://www.nes.ru/~vpopov.

[2] Anatole Kaletsky. “We need a new capitalism to take on China . If the West isn’t to slide into irrelevance, governments must be much more active in taking control of the economy”. “The Times”. February 4, 2010, http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article7014090.ece.

[3] Mushtaq H. Khan. Governance, Economic Growth and Development since the 1960s. DESA Working Paper No. 54, August 2007.
http://www.un.org/esa/desa/papers/2007/wp54_2007.pdf

[4] Crimes are registered differently in different countries—higher crime rates in developed countries seem to be the result of a better registration of crimes. But serious crimes, like murders, appear to be registered quite accurately even in developing countries, so an international comparison of murder rates is well warranted.

[5] Eisner, Manuel. Long-Term Historical Trends in Violent Crime. – Crime and Justice, Vol. 30 (2003), pp 83-142.

[6] Lu, Aiguo. China and the Global Economy since 1840. New York , St. Martins Press, 1999.

[7] Internet Center for Corruption Research, Historical comparisons. Http://www.icgg.org/corruption.cpi_olderindices_historical.html

[8] Peterson Glen. State Literacy Ideologies and the Transformation of Rural China. The Australian Journal of Chinese Affairs, No. 32 (Jul., 1994.

[9] To a lesser extent, this is true for India : market-type reforms in the 1990s produced good results because they were based on the previous achievements of the import substitution period. Fast Indian growth is sometimes attributed to the deregulation reforms of the 1990s, but it was shown that fast growth actually started in the early 1980s, well before the deregulation reforms were launched (Ghosh, Jayati. Macroeconomic and Growth Policies. Background Note. UN DESA, 2007). Like Chinese growth, Indian growth was based on the achievements of the 1950s-70s period of ISI and mobilization of domestic savings: the savings rate (as a percentage of GDP) doubled in the last fifty years, going up from 12-15% in the 1960s, to 16-20% in the 1970s, 15-23% in the 1980s, 23-25% in the 1990s, and to 24-35% in 2000-08.

[10] Popov, V. Shock Therapy versus Gradualism Reconsidered: Lessons from Transition Economies after 15 Years of Reforms. – Comparative Economic Studies, Vol. 49, Issue 1, March 2007, pp. 1-31
(http://www.nes.ru/~vpopov/documents/Shock%20vs%20grad%20reconsidered%20-15%20years%20after%20-article.pdf); Popov, V. Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

[11] Rodrik, Dani, R. Hausmann, A. Velasco. Growth Diagnostics. 2005. Http://ksghome.harvard.edu/~drodrik/barcelonafinalmarch2005.pdf

[12] Shandong Province database [ Shandong sheng shengqing ziliaoku].
http://www.infobase.gov.cn/bin/mse.exe?seachword=&K=a&A=16&rec=42&run=13.%20%20Chinese%20PPP%20GDP%20per%20capita%20in%20the%201970s%20was%20about%201000Chinese PPP GDP per capita in the 1970s was about $1000 – at the same level as in Western Europe in the seventeenth century, when the murder rate was about 10 per 100, 000 inhabitants (Eisner, op.cit; Maddison, Angus. Statistics on World Population, GDP and Per Capita GDP, 1-2008 AD (http://www.ggdc.net/maddison/).

[13] WHO Health for All Database, 2004.

[14] Goldstone, J. Unpublished comments on Popov, V. Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

[15] Ronald Inglehart and Christian Welzel. Modernization, Cultural Change, and Democracy: The Human Development Sequence. Cambridge University Press, 2005.

[16] World Intellectual Property Indicators. WIPO, Geneva , 2009.

How to turn a minor crisis into a Greek tragedy

2010-05-09T13:53:00.006+02:00

In the last four months the Greek economy has escalated from a minor national crisis to a near-catastrophe spreading to the whole of Europe, due to a combination of:

genuinely worrying Greek macroeconomic trends - in terms of government deficit, public and private debt and its maturity structure, trade competitiveness, current account imbalances - made worse by a recent and past record of national accounts falsification and cosmetic manipulations (both the responsibility of past right wing governments);

plus European chauvinism in wanting to keep the IMF out of it in spite of the fact that only the IMF Board can mobilise substantial resources more cheaply and quickly (in half an hour or so) and smoothly than anybody else, and Greece is actually entitled to those funds. The very proposal of setting up a European Monetary Fund was unnecessary (why have a regional agency when there is a global one, should we also have a European Trade Organisation, a European Health Organisation, a Bank for European Settlements?). It was also a waste of time or, worse, a costly dilatory tactic;

plus German populism in delaying and opposing EMU assistance against the interests of the German governent and public (German banks have at least €32bn exposure to a Greek default, higher than the current German cost of a rescue package over three years, of €22.2bn), just to please the North-Rhine Westphalia electors voting today; Angela Merkel deserves to be duly punished for that;

plus the EU'S unbelievable vagueness about the scale, form and terms of a bail-out: "the EU will provide as much as it will be needed if and when it will be needed" does not tell investors what they want to know: how much, whether they will be guarantees or loans, by the Union or bilaterally by member states, EU or EMU. And there is still uncertainty about the very legality of a bail-out, with the German constitutional court examining various appeals against the rescue package. Jean-Claude Trichet and Angela Merkel insisted on "no subsidy" on interest to be charged to Greece, thus effectively casting serious doubts about the effectiveness and success of their own package. The compromise 5% interest eventually charged on EU states' bilateral loans is higher than both the interest charged by the IMF (just over 3%) and the cost of borrowing by the German government;

plus the adverse effects of silly pronouncements by a number of EU high officials and economic commentators, i.e. talks of possible expulsion of Greece from the eurozone (for which there is no legal instrument), or voluntary withdrawal by Greece returning to the drachma (this would require its withdrawal from the EU, which is not in anybody's interest, and just imagine the level to which drachma interest rates would rise) or the introduction of a currency parallel with the euro; or German withdrawal from the Eurozone for the reverse of those reasons, or a two-euro zone, one Southern and weak and the other strong and Nordic ...

plus Greek failure to apply in good time for even the little finance they had secured in April (€45bn), allegedly not to signal distress, yet thus precipitating a much greater distress.

plus delays and quarrels leading to interest spreads over Bundes and to CDS prices rising to the point that Greece could no longer afford to access international financial markets, for at such high market rates Greek debt would have been unsustainable and demonstrably ended in default in the near future.

At that point the scale of the package required rose to €110bn (€80bn from EMU member states, €30 from the IMF) but, by the time this was granted, "markets" wanted even more.

And the burden of adjustment will fall on Greek public sector employees and on pensioners. Some of them benefited from large public deficits, for instance through the hiring by the previous rightwing government of thousands of their supporters, and through an earlier retirement age than most (including Germans). But they were not the main beneficiaries of rising public debt, or of rising inequality at large. When Romano Prodi squeezed Italians hard in order to meet the Maastricht conditions to join the euro, at least he made some symbolic gestures of taxing interest revenues and putting some extra tax on real estate. The people on whom the burden of Greek adjustment unfairly falls today have every reason to show their dissent on the streets of Athens - especially since the party now in opposition, responsible for the debacle, will not face up to their responsibilities. Popular protest, of course, objectively strengthens the expectation and the likelihood of default. In 1988 Ceaucescu implemented a brutal deflation in order to pay off all of Romania's foreign debt at a stroke, but fortunately Greece 2010 is not Romania 1988: creditors, bailers-out and the Greek government should recognise that there are limits to the political feasibility even of otherwise sound economic policies.

The coup de grace to Greece and perhaps to the euro was given by rating agencies unreasonably downgrading government bonds in the Eurozone even after the large scale rescue package had been approved. The "three sisters" should have been utterly discredited by their past failures in predicting performance, from Enron to Lehman Brothers, and by their past record of frequent conflicts of interest, yet they still mould and guide expectations, and are taken seriously even by the ECB (until Trichet fortunately decided to keep accepting Greek bonds as collateral regardless of their credit rating, and initiated a long-required re-assessment of the rating agencies' status. Nevertheless, talk of setting up a European (public?) "independent" rating agency is laughable, for nobody would take seriously its ratings of European bonds.

The attack on the euro must have been - at least partly - encouraged by the Americans and the British in order to deflect public attention away from their own economic and political troubles. Not necessarily through a conspiracy, as it has been suggested by some commentators, more by following a natural and self-serving inclination. In the end - during the night of Friday 7 May - Europe delivered, but delivered so much later than they should have that the tragedy is not over by any stretch of the imagination. And the deal made even the usually clownesque Berlusconi - compared to Trichet and Merkel and Sarkozy - look like a born statesman.

I'll Not Vote Brown's Labour

2010-04-14T14:30:00.005+02:00

Remember Christopher Logue's poem "I shall vote Labour" (1966)? I remember reading his verses in The New Statesman at the time:

I shall vote Labour because
God votes Labour.
I shall vote Labour to protect
the sacred institution of The Family.
I shall vote Labour because
I am a dog.
I shall vote Labour because
upper-class hoorays annoy me in expensive restaurants.
I shall vote Labour because
I am on a diet.
I shall vote Labour because if I don't
somebody else will:
AND
I shall vote Labour because if one person
does it
everybody will be wanting to do it.
I shall vote Labour because if I do not vote Labour
my balls will drop off.
I shall vote Labour because
there are too few cars on the road.
I shall vote Labour because I am
a hopeless drug addict.
I shall vote Labour because
I failed to be a dollar millionaire aged three.
I shall vote Labour because Labour will build
more maximum security prisons.
I shall vote Labour because I want to shop
in an all-weather precinct stretching from Yeovil to Glasgow.
I shall vote Labour because
the Queen's stamp collection is the best
in the world.
I shall vote Labour because
deep in my heart
I am a Conservative.

[ 'I Shall Vote Labour' from Selected Poems by Christopher Logue published by Faber & Faber.]

Contrast and compare with the following excerpt from Tony Wood's Editorial in the latest issue of The New Left Review, "Good riddance to New Labour":

"... is there any reason to find Labour preferable? Arguments for them as the lesser evil rest on a number of false assumptions.

First, the notion that there is any principled social or political basis for loyalty to Labour: whatever such attachments used to mean, the party’s own self-transformation in pursuit of power has emptied them of any real content, turning them into little more than sub-political badges of identity. There is no reason why voters should be any more sentimental about the Labour Party than it has been about them.

Second, the idea that rejection of New Labour necessarily means voting for the Tories: abstention, a spoilt ballot, or a vote for one of the minority parties denied representation by the British parliamentary system are perfectly honourable options. Within the present morass of British parliamentarism, any consistent left should not restrict itself to one enemy, but should rather engage in combating the entire putrid edifice, the better to carve out an exit from it.

Third, those who advocate yet another term for New Labour ignore the fact that, in a system where actual political differences are minimal, no government should be allowed to continue in power indefinitely, lest its corruption go unchecked. The notion that a spell in opposition might actually do a ruling party some good, though widespread in previous decades, is rarely voiced today—itself an indication of the system’s degeneration.

But surely the clinching argument against New Labour is one of simple democratic principle. Any government with a record as appalling as this one’s deserves to be punished at the polls, if accountability to the voting public is to have any meaning. The specifics of New Labour’s record—one murderous war after another; slavish devotion to finance; promotion of rampant inequality; repeated assaults on civil liberties; fragmentation and privatization of public services; outrageous corruption—make plain that they have fully merited being turfed out of office. Good riddance; this execrable government deserves to go."

I'll not vote Brown's Labour
because my balls would drop off
if I did and, above all, because
deep in my heart
I am a Socialist.

P.S. In fairness, I will vote Labour in my local elections, where clever and competent candidates committed to improving the life of their community innocently stand, unfairly handicapped by Gordo. They might have called for his demise before the elections, but nobody should be put in a position of having to be a hero.

Inflation: Up or Down?

2010-04-12T19:05:00.003+02:00

On 12 February the IMF published a paper by Olivier Blanchard (the IMF Chief Economist from MIT), Giovanni Dell’Ariccia and Paolo Mauro, on “Rethinking Macroeconomic Policy.” The paper re-examines the traditional macroeconomic and financial policy framework in the wake of the recent devastating crisis. It reviews the main elements of the pre-crisis consensus about macroeconomic policy, evaluates what was wrong and what still holds of that consensus and makes a first attempt at re-drawing the contours of a new macroeconomic policy framework. It makes compulsory and compelling reading. Among other points the authors note how, traditionally, central banks have adopted low inflation rates of around 2 percent (like the ECB, just to name names); they argue that such a target should be raised. Interviewed by the IMF Survey Online, on this point Olivier Blanchard explains:

“The crisis has shown that interest rates can actually hit the zero level, and when this happens it is a severe constraint on monetary policy that ties your hands during times of trouble.

As a matter of logic, higher average inflation and thus higher average nominal interest rates before the crisis would have given more room for monetary policy to be eased during the crisis and would have resulted in less deterioration of fiscal positions. What we need to think about now is whether this could justify setting a higher inflation target in the future.”

Such an enlightened argument is not universally accepted. Frankfurt Rundschau reported that a Bundesbank internal paper, on the strength of this policy recommendation by Blanchard et al., launched a devastating attack on the IMF and referred to it as the Inflation Maximising Fund (Eurointelligence.com of 9 April).

The Wall Street Journal of 9 April reports:

Trichet: Some Euro Zone Countries May Need to Accept Deflation (by Brian Blackstone)

“European Central Bank President Jean-Claude Trichet says some countries in the euro zone might have to accept a period of deflation to restore long-term economic growth prospects.

“Some countries, to regain competitiveness, will have to keep inflation below the EU average,” Mr. Trichet told the Italian paper Il Sole 24 in an interview published Friday.

Asked by the paper whether this means “even accepting a period of deflation, with all the possible social consequences this might have?” Mr. Trichet replied: “Yes.”

“It is normal that some regions, after growing above the EMU average for some time, and after having accumulated high national inflation, experience a correction and therefore a period of negative inflation, as it is currently happening in Ireland,” Mr. Trichet said.

The ECB contends that it has avoided deflation for the euro zone as a whole, which is supported by recent data showing annual inflation in the region at about 1.5% in March, though that was probably pushed higher by energy and food prices.”

Let us rejoice that Monsieur Jean-Claude Trichet has not demanded that all the Euro-zone countries should have a rate of inflation lower than the average …

Wage Indexation

2010-04-04T22:58:00.007+02:00

Twentyfive years ago Ezio Tarantelli – a professor of Labour Economics in the University of Rome La Sapienza – was assassinated by the Red Brigades shortly after giving a lecture. A distinguished economist, he was a follower of Franco Modigliani with whom he had studied and taught at MIT, and an economic advisor to CISL (the Italian Confederation of Trade Unions). He was a strong supporter of an incomes policy negotiated within a Social Pact, not just for Italy but throughout Europe as a pre-condition of the single currency, which he also strongly supported long before it materialised. But his main interest was the advocacy of curtailing Italian wage indexation (the scala mobile) which he regarded as responsible for perpetuating and accelerating the wage-price spiral that follows any inflationary shock. He successfully advocated the adoption of a pre-determined inflation target, to be agreed among social partners and the government, in place of actual recorded inflation.

Ezio Tarantelli’s proposal for cooling inflation by indexing wages to a negotiated target instead of actual inflation faced two difficulties:

First, the alternative is never whether a given nominal wage level should or should not be indexed. For a given relative negotiating strength of Trades Unions and Employers' Unions, if wages are indexed there is less need to take into account subsequent expected inflation in wage-fixing. Indeed if indexation is full (i.e. of 100% of the nominal wage with unit elasticity of the wage with respect to prices and with a short enough lag) there is no need and no case for taking into account subsequent expected inflation at all. In times of rapid inflation, especially of accelerating inflation, wage indexation defuses inflationary expectations and allows the negotiation of a lower nominal wage than would have to be fixed if there was no protection from future inflation. This is precisely why, when wage indexation was first introduced in Italy in 1947, the President of Confindustria (the Confederation of Italian Industrialists) shipowner Angelo Costa actually greeted it as a major anti-inflationary measure. Wage indexation thus has an ambivalent impact: it prolongs an inflationary process but starting from a lower wage and price level than is achievable without indexation.

Second, nominal wages are not fixed forever but are normally re-negotiated periodically. Inflation-proofing through indexation, if triggered by a shock after negotiation, will exhaust its effects completely at the next wage settlement. The new nominal wage will be determined by the relative negotiating strength of employees and employers and other fundamentals prevailing at that later time, regardless of how much the nominal wage might have risen in the intervening period thanks to wage indexation. On average, with rounds of nominal wage negotiations taking place, say, at two-year intervals, the impact of wage indexation will last for only one year, for the new nominal wage will be fixed starting from scratch, from a tabula rasa. To be more precise, it will last for one year (half the period between negotiations) minus the lag between price and wage rises (say at least three months), since the last indexed wage rise during that year will coincide with and will be taken into account at the next round of wage re-negotiation.

In conclusion, wage indexation is neither a shield against inflation nor an inflation engine, it has a positive and a negative impact on inflation, respectively defusing inflationary expectations and prolonging the impact of a shock; but both effects - partially reduced though not eliminated by Tarantelli's proposal - are operational only for a very, very short time. In all, we are talking at best of nine months partial wage protection, though on balance the impact of wage indexation on inflation may actually be beneficial. (A paper of mine in Italian developing these points, Indicizzazione e scala mobile (1994), is available on my website).