Against Scroogenomics

Joel Waldfogel, Professor of Business and Public Policy at Wharton, Pennsylvania, makes a powerful case against buying Christmas presents: see his Scroogenomics – Why you should not buy presents for the holidays (Princeton University Press, 2009, review), and his earlier article "The Deadweight Loss of Christmas" (American Economic Review, December 1993, 83, 5, pp. 1328-1336).


Ebenezer Scrooge and Bob Cratchit

Waldfogel argues that “gifts may be mismatched with the recipients’ preferences”. We are worse at buying for other people than we are at buying for ourselves. As a result, a gift is likely to “leave the recipient worse off than if she had made her own consumption choice with an equal amount of cash. In short, gift-giving is a potential source of deadweight loss”. Waldfogel estimates, on the basis of a survey given to Yale undergraduates, gift-giving losses between 10 percent and a third of the value of gifts. The most efficient are gifts from friends and “significant others”; the most inefficient are those from members of the extended family, who therefore would be better advised to give cash. On average about 18 per cent of the value of gifts is estimated to be a deadweight loss. Waldfogel’s latest estimate of seasonal presents in the US is $85bn, i.e. which on his reckoning involves a net loss of over $15bn a year, which obviously could be better employed in alternative private or public pursuits.

Speaking as an economist, I am ready to acknowledge that economists are inclined to be spoilsports and miserable sods. Professor Waldfogel is no exception.

First, most gifts are either objects predictably coveted by the recipient or novelties not yet experienced by her but recognized as superior by the giver, and just as likely to surprise and please the recipient.

Second, gifts give rise to reciprocal exchange and a whole network of social relations (see Marcel Mauss, Essay sur le don, 1924). Reciprocity in gift-giving, including Christmas presents, instead of compounding inefficiency, has the added benefit of affirming and strengthening bonds of love and friendship. An exchange of gifts whose prices cannot be precisely guessed leaves an open-ended balance: it is as if both parties opened a credit account with one another, on which they could overdraw in the future.

Third, presents are statements about the consideration and the status enjoyed by the recipient, regardless of a mismatching of gift and preferences. Besides, even unwanted gifts can be, and mostly are, re-cycled: a gift multiplier is set in motion in which the disappointed recipient (who cannot be made worse off by the present) can realize the full value of the unwanted gift by passing it on, while the new recipient is made happier at no extra cost. The circulation of unwanted gifts is a kind of segmented barter system, where circulation stops if and when a sufficiently appreciative recipient is found.

The real pain of seasonal gift-giving is its concentration on one or two weeks in the year, inevitably leading to a frantic last-minute search for suitable objects, first in one’s mind and then around the shops. Although the first search could be eliminated by publicizing personal wish lists, the second by diluting purchases over time.

Everybody interested in receiving appropriate presents should keep a public wish-list – say, on one’s website – of coveted objects, roughly ranked according to their perceived ratio between satisfaction expected from those objects and their estimated price. Then a potential giver could go down the list until he finds an affordable single item – this would take care of indivisibilities, unless givers pooled their resources – and possibly go further down the list as far as he can afford. An object would be removed from the list as soon as someone made an irrevocable commitment to give it, so as to avoid duplication.

The problem with gifts, Waldfogel argues, is that the donor of an unwanted gift seldom gets a feedback from the recipient’s disappointment, and never learns; with a prior indication of individual preferences there would be no need for such a feedback. The incentive to keep a wish-list up-to-date is the resulting maximization of individual satisfaction from the total gifts received. Moreover, potential givers would be more generous than they would be otherwise, given the certainty of their gifts being well received.

Diluting purchases over time is perfectly possible, but hard for some people. A dear aunt of mine used to have a capacious and apparently inexhaustible “gift cupboard” always at hand, but I find it very hard to accumulate suitable gifts over time, since giving at once is an irresistible urge. One possible solution is to give presents throughout the year whenever an attractive and suitable object is found, instead of giving at Christmas, and to make oneself known for that particular habit.

Whatever you do, give widely and generously this Christmas, just as Ebenezer Scrooge did in the end. My token gift to you is a set of the collected posts from this Blog, “Transition – April-December 2009”, downloadable from my Website under Publications Miscellaneous.

A Very Happy Christmas to all my readers, and a Smooth Transition to a Super New Year.

European Bail-Outs: Unaffordable, Illegal, Conditional

The possibility of sovereign default within the Eurozone is still being contemplated uneasily by economic commentators. “Is the Greek crisis the beginning of a deeper sovereign debt crisis that could destabilise the Eurozone?” Paul de Grauwe (Leuven University) argues convincingly that “… with Eurozone government debt standing at 85% of GDP at the end of 2009, the Eurozone is miles away from a possible debt crisis. Things are different in some individual countries, in Greece in particular, a country with a weak political system that has been adding government debt at a much higher rate than the rest of the Eurozone and that in addition has a debt level exceeding 100% of GDP. So, while the Eurozone as a whole is no closer to a debt crisis than is the US, some of its member states have been moving closer to such a crisis.” Fair enough, especially considering that Greece has been cooking the books before and after joining the Eurozone, its government has just rejected any serious macroeconomic maneuvre, and is heading for a budget deficit/GDP ratio now officially set at 12.6% of GDP but more likely to reach 15%, and poised to exceed 130% government debt/GDP ratio.

Paul de Grauwe then asks: “Is it conceivable that a debt crisis in one member country of the Eurozone triggers a more general crisis involving other Eurozone countries? My answer is that yes, it is conceivable, but that it can easily be avoided.” His reassuring stance, unlike his optimism on sovereign default, is utterly unconvincing.

Paul is confident that a general crisis would be avoided because “A Eurozone bailout is likely”. “The other Eurozone governments are … very likely to bail out Greece out of pure self-interest. There are two reasons for this: First, a significant part of Greek bonds are held by financial institutions in Eurozone countries; these institutions are likely to pressure their governments to come to their rescue. Second, and more importantly, a failure to bail out Greece would trigger contagious effects in sovereign bond markets of the Eurozone. … The local sovereign debt crisis would trigger an avalanche of other sovereign debt crises. I conclude that the Eurozone governments are condemned to intervene and to rescue the government of a member country hit by a sovereign debt crisis.” This is arbitrarily selective pessimism, a worse case scenario for contagion – without the support of precedents – turns out to be a best case scenario for the likelihood of a bail-out. Paradoxically, Paul’s pessimism on contagion transforms itself into excessive optimism about a European bail-out.

What about the cost? Paul de Grauwe tells us that a bailout is affordable: in the unlikely event that Greece defaults on the full amount of its outstanding debt, “a bail-out by the other Eurozone governments would add about 3% to these governments’ debt – a small number compared to the amounts added to save the banks during the financial crisis.”

Would it be legal? Paul de Grauwe dismisses the no-bail-out clause of Art. 103 as “a misreading of the Treaty. The no-bail-out clause only says that the EU shall not be liable for the debt of governments, i.e. the governments of the Union cannot be forced to bail out a member state. But this does not exclude that the governments of the EU freely decide to provide financial assistance to one of the member states. In fact this is explicitly laid down in Article 100, section 2.” “Eurozone governments have the legal capacity to bail out other governments, and in my opinion they are very likely to do so in the Eurozone if the need arises.”

Here are three strong objections, on the affordability, legality, and conditionality of a European bail-out.

The bail-out of a country like Greece is affordable – but only up to a point: we should consider that 3% of an average 85% of GDP is a non-neglibible average 2.55% of their GDP on top of their already excessive deficit/GDP ratio which most of them are already required to reduce by extant excess-deficit procedures decided by Ecofin. And an affordable bailout of a country like Greece could be followed or accompanied by the bailout of another country in Paul’s list of troubled economies, “Spain, Ireland, Portugal, Belgium” [not Italy, thanks Paul, but why not?], or even an EU member outside the Eurozone, like Latvia, for which a similar case for a bail-out could be made, and has been made repeatedly over the last year. Or - sooner or later on current trends - the UK.

Art. 103 is adamant: “The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State…”. The misreading is by Paul de Grauwe: Art. 103 states unambiguously that the Community not only shall not be liable, but shall not assume other Members' public liabilities – thus including necessarily any unilateral aid or support. It also rules both bail-out and unilateral “assumption” of the same obligations by Member States as well as by the Community.

True, a discretionary bail-out is allowed by Art. 100 – and, for that matter, by art. 119 even for non-Eurozone members – but not automatically. Such a discretionary bail-out requires three conditions: 1) a recommendation to that effect by the European Commission, 2) unspecified and therefore arbitrary “exceptional occurrences” – suggesting more of a swine flu pandemics than financial pandemics; and 3) a qualified majority vote by the Council. Paul de Grauwe fails to mention such conditions.

Finally, presumably the “assumption” by EU authorities or Member States of responsibility for a bailout would have to be accompanied by the EU and or Member States' ability to impose conditions on economic policy and especially on the fiscal policy of the bailees. Angela Merkel effectively expressed this requirement by proposing “a huge transfer of sovereignty to the centre, when she said that the EU should have a right to intervene in a situation like [the current Greek situation] (presumably in exchange for a bailout guarantee)”, see Wolfgang Munchau, FT 14 December. Writing in Handesblatt yesterday, Sebastian Dullien and Daniela Schwarzer “make the case that a clear rule should be established on the conditionality of support. The rule should forsee that the country temporarily loses sovereignty over fiscal policy to the European Commission or the Eurogroup, which should be given a veto power over national budget for a specified post-crisis period.” (Eurointelligence.com, 16 December).

Markets obviously do not believe there is going to be a European bail-out – or Greece would not have to pay a 250 points premium on its debt over the rate on German bonds. And if markets do not believe in a bail-out, why should investors who have received that premium because of such a disbelief benefit from a bailout? Let them take the full risks with the premium that has gone with it.

Having said all this, one can only agree with Paul de Grauwe’s bottom line, that “... the Eurozone governments should make clear where they stand on this issue. Not doing so implies that each time one member country gets into financial problems the future of the system is put into doubt.” Brussels transparent and clear rules should replace those - arbitrary, discretionary and unpredictable - that in our post of 30 November we called ”Moscow rules”.

A non-bail-out bail-out?

In our latest post (30 November) we discussed the possibility of a European bail-out in case of sovereign default by an EU member state, regardless of EMU membership. As it happens, The Economist of 3 December has a piece under Economic Focus on precisely “What would happen if a member of the euro area could no longer finance its debt?”.

The Economist recalls “That famous headline from the Daily News ran after President Gerald Ford refused to bail out New York City in October 1975, when the city was close to bankruptcy ... “: “Ford to City: Drop Dead.” “Within weeks Ford relented. Behind the belated rescue lay a fear that default by New York would hurt the credit of other cities and states, and perhaps of America.“

At present even high deficit and high debt countries like Greece, Ireland and Latvia can borrow at no more than 2-3 percentage points over the 3.1% rate on German bonds – hardly a danger signal yet – but this might not last forever, especially in view of their poor wage competitiveness.

The Economist acknowledges the ““no bail-out” clause that prohibits one country from assuming the debts of another [art. 103 of the Treaty establishing the European Community, see our earlier post]. That makes Greece’s public finances a matter between it and its creditors. Any promise, tacit or otherwise, of a bail-out by others would only encourage more profligacy (a view that mirrors Ford’s initial stance towards New York). In principle, a default by Greece or by any other euro-zone country would not threaten the euro any more than default by New York City in 1975, or California today, would mean the end of the dollar. Indeed, membership of the euro could help make debt-restructuring more orderly, since it would remove currency risk from the equation.”

But The Economist suggests an alternative, which is what actually happened to New York: “The non-bail-out bail-out”. Meaning: technical default, with some debt-holders not getting their money back, and a drastic fiscal squeeze. “The city had to cut public services, shed jobs, freeze pay, abandon capital projects and raise taxes to make sure it could pay back the federal loans. Such belt-tightening had proved necessary even in the months before the rescue. When it came, the president could claim that “New York has bailed itself out.”

“It is easy to imagine a similar kind of hard bail-out, should a euro-zone country ever run short of cash.” “It would be hard to sell [the bail-out] to voters in rescuing countries unless, as in New York’s case, the interest rates on bridging loans were punishingly high.” “A tough-love bail-out would still need someone with deep pockets to provide the cash. Given the state of public finances even in more stable countries, such as France, that cannot be taken for granted. Germany is better placed but would be unwilling to act alone.”

The Economist is confused and confusing. Would there or would there not be a bail-out? This is the question. Even unilateral aid from Germany would have to be authorized by the Council, for it not to be prohibited by art. 103 of the Treaties establishing the European Community (see our earlier post). That conditions for a bail-out, if any, would have to be tough, or be preceded by self-imposed austerity, is another matter. The defaulting country can always turn down financial assistance if it does not like the conditions, but they may still be preferable to no bail-out.

The Economist fails to provide an answer. The crux of the matter – as pointed out in last week’s post, is the absolutely discretionary nature of a bail-out, depending exclusively on a Council’s decision on “exceptional occurrences”, on a recommendation by the European Commission.

And, in view of their analysis, what for?

Sovereign Default: Absolutely No Bail-Out... Perhaps...

There is a general feeling, in IMF statements and among financial commentators, that there are increasing risks of sovereign default (Dubai World’s crisis is not strictly a case of sovereign default but strengthens this feeling). Willem Buiter talks of “the likely imminence of the start of the final leg of the journey from household default through bank default to sovereign default”.

Within the EU, for at least a year, Latvia has been permanently on the verge of default by virtue of its Argentina-like combination of: the commitment to a hyper-fixed exchange rate tied to a strengthening currency, managed by a Central Bank acting as a Currency Board; large scale twin deficits, fiscal and commercial; rising foreign indebtedness; decreasing external competitiveness; increasing interest rates; lower FDI and financial capital outflows.

During the same period from time to time other EU members have seen the lowering of their credit ratings and the rise of their interest premiums above the German benchmark – early warnings of possible default. At the beginning of 2009 eurozone bond spreads suddenly widened. At some point Ireland had its credit-rating downgraded by Fitch from AA+ to AA-, while the OECD and the European Commission demanded drastic budget cuts, and its GDP accelerated its decline. Greece is the most recent EU candidate for default since mid-November, after the discovery of a government deficit suddenly rising to 12.7% of GDP, instead of the expected 6%, and public debt-to-GDP ratio headed for 135%, amply overtaking that of Italy while nobody was watching (gross external debt, public and private, was 149.2% of GDP at the end of 2008; the real exchange rate has appreciated by 17% since 2006, losing competitiveness; see Munchau, FT 30 November).

Suppose an EU member state, whether or not a euro-zone member, experienced a serious financial crisis to the point of default. Would the European Union and its financial agencies, and/or the other Member States, come to its rescue?

Art. 103: No Bail-Out

The possibility of a bail-out is considered and specifically forbidden by Article 103, section 1, of the Treaty establishing the European Community (TEC; ex-Article 104, currently in force and directly applicable from 1 January 1994; see the latest consolidated version of the current treaties, Official Journal of the European Union (OJ) 29.12.2006 C 321 E/84).

“The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”

It should be stressed that Article 103 rules out not only any obligation to bail-out, but also any unilateral, voluntary and generous “assumption of the commitments of central governments, regional, local or other public authorities, etc.”, whether on the part of the Community or a Member States. No bail-out, period.

Nevertheless…

On 18 February 2009 the then German Finance Minister Peer Steinbrück speaking in Dusseldorf “signalled that [Germany] would support emergency action to protect the eurozone if one of its 16 member-states found itself in such serious difficulties that it could not refinance its debt.” (FT, “Germany ready to help eurozone members”, by Bertrand Benoit and Tony Barber). Mr Steinbrück noted that "We have a number of countries in the eurozone that are clearly getting into trouble on their payments", adding that "Ireland is in a very difficult situation". “The euro-region treaties don’t foresee any help for insolvent countries, but in reality the other states would have to rescue those running into difficulty” (EU Observer, 18 February 2009).

One might be inclined to say that Mr Steinbrück is no longer the German Finance Minister; and that in any case he had no authority to make that statement. And if the state of California can face the prospect of bankruptcy without any of the other federal states or the Fed or the US government turning a hair, why should an EMU country, especially if small, be bailed out in a considerably looser Union which is not even a Federation? Except that Steinbrück was not alone in his pronouncement, and there are two other clauses in the TEC that could plausibly be interpreted as providing for a bail-out, not only for EMU members but also for non-EMU member states. Not an automatic provision, but a possible course of action that could be taken on a majority decision.

Steinbrück’s statement was echoed shortly afterwards by Angela Merkel, speaking to foreign journalists in Berlin. Der Spiegel commented that “If Germany were to pay into a bailout based on its size relative to other eurozone countries, it would be forced to cover one-fourth of the entire tab. Peter Bofinger, a member of the German Council of Economic Advisors, actually quantified in €1.5bn a year the likely cost to the German taxpayer of a rescue operation within the eurozone. Then, in March 2009, Joaquín Almunia, then European Commissioner for Monetary Affairs and usually a tough custodian of fiscal and monetary rigour (the man who single-handed tried – though failed – to reduce the ERM-II band of exchange rate variation around the entry parity from 15% to 2.25%, just by his saying so), said: "If a crisis emerges in one eurozone country, there is a solution before visiting the IMF. Don't forget we are equipped to interact politically and economically to face the crisis, but these kinds of things should not be explained publicly." In March, the Irish Times reported that: "Unofficially, leading figures in Berlin admit that assistance for several EU members, including Ireland, is all but inevitable." In June 2009, Times columnist Anatole Kaletsky wrote: "Germany is at the heart of a huge plan to prop up crippled EU economies - not that the German people would ever know" (these quotations are taken from Openeurope.org, 17 July 2009).

Articles 100 and 119: discretionary bail-outs

How could the unambiguous No-Bail-Out provision of Art. 103 be circumvented? Almunia did not say, at first, invoking discretion. One way in which it could be done with impunity is via the EU or its member states giving credit guarantees rather than subsidies or credits. A guarantee costs nothing if it is not called upon, though in case of default it may cost up to 100% of the sums guaranteed; but in any case such a contingent, quasi-fiscal, future liability does not usually appear in the current budget. After all, this is how the EU supported eastern European transition economies beyond its budgetary constraints in the early 1990s.

But there no need for such an escamotage. There is always the possibility of the Council granting financial assistance to a member state experiencing exceptional difficulties (Eurointelligence, “Did you know that there is an explicit bailout clause in the Maastricht Treaty?” 18.02.2009). Art. 100, section 2, states that:

“Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision taken.” A similar provision for eurozone non-members is provided in Art. 119.

This provision was specifically referred to by Der Spiegel magazine in connection with the German Finance Minister’s statement. Angela Merkel also specifically referred to Art. 100 procedures. The possibilities were also mentioned of Germany issuing 'bilateral bonds' to raise money for struggling countries; or groups of several member states collectively floating a bond; Jean-Claude Juncker had proposed issuing a common euro zone bond for the 16 countries sharing the currency, a revolutionary idea that was supported by Almunia but met opposition from Germany. The source and therefore the scale of financial assistance would be affected, but clearly Art. 100 and 119 are sufficient to drive coach and horses through the No Bail-Out clause of Art 103 of the TEC.

Moscow rules

It is bad enough for EU member states to be subject to the fiscal straitjacket of the so-called Growth and Stability Pact, without those members that comply being subjected to the cost of bailing-out those who do not comply. It is bad enough for the ECB to provide emergency financial assistance to banks at its own discretion, without being subject to rules as a Lender of Last Resort; now the Council is to provide financial assistance to member states at its own discretion.

It used to be said that Soviet Law could be summarized by three basic rules: 1) Everything is forbidden. 2) Everything is allowed in special cases. 3) Special cases are decided by the Party. There is enough of that in Brussels already. Mutatis mutandis, this model is being replicated exactly by EU rules on financial assistance to member states: 1) Bail-outs are forbidden. 2) Bail-outs are allowed in special cases. 3) Special cases are defined by the Council.

Without rules, assistance may be provided not only on economic but on broadly political grounds: clearly the prospect of European assistance was used blatantly as an offer that Ireland could not refuse by failing for the second time to ratify the Lisbon Treaty. In March 2009, the German Ambassador to Ireland, Christian Pauls, warned that Ireland would "throw away its future" if it voted No to the Lisbon Treaty for a second time. He said, "A second No would have horrific consequences for Ireland and I am not the first to say it. I don't think there is anything particularly new in that." On 25 June, German MEP Jo Leinen said the Irish must vote "Yes" if they wish to continue to benefit from the "protective umbrella" the EU provides (Openeurope.org, cited). Political pressure now is also being exercised on Greece: it is presumed that Greece would not enjoy EU financial assistance unless it complied with EU demands for budgetary cuts (as in the no-longer-secret letter by Eurogroup President Junker reported today in the Greek press).

Unsettled State of Play

With Moscow rules, there can be no foregone conclusion.

German taxpayers expressed their opposition to using public money to bail out other countries that have got into financial difficulties: 70.9% were against “helping countries like Ireland or Greece”, 24.8% were in favour, 3.4% did not know (Open Europe in collaboration with the Institute for Free Enterprise, Berlin; published by Openeurope.com cited). One could argue that opposition to bailouts was also implicitly expressed in the German elections.

At present, EU borrowing is against the rules, but would be necessary to fund financial assistance to member states. Almunia recognizes that “a common bond” “is not politically viable today because some important member states said 'no'. This requires a political decision that is not in the hands of the Commission."

Doubts have been expressed about the possibility of intra-EU bailouts. The Former Chief Economist at the ECB, Otmar Issing, told the Frankfurter Allgemeine Zeitung that it would be a catastrophe to water down the 'no bailout' clause in the EU treaties, arguing that it would spell an end to "the political stability of the monetary union". He said that in order for financial discipline to prevail every member state must be responsible for its own debt and deficits: "without this there would be no end", he said (Openeurope.org, cited).

But the best comment on bailouts was by Karl Otto Pohl, former President of the Bundesbank. He said that if Germany decided to bail out other members of the eurozone it would open a Pandora's Box, adding "It would be like jumping in a swimming pool without water".

Humouring Gordon Brown

On 6-7 November 2009, at St. Andrews in Scotland, the G-20 finance ministers and central bankers, “representing around 90 percent of the world's wealth, 80 percent of world trade, and two-thirds of the world's population”, were told by British Premier Gordon Brown that “it was time to consider a global financial levy, such as a tax on transactions or an insurance fee, to build up a "resolution fund" as a buffer against future bailouts. Banks needed "a better economic and social contract" that reflected their responsibilities to society. Any measures must be implemented by all major financial centers, Brown noted” (IMF Survey Online, 23 October).

The IMF Survey Online goes on to say: “The IMF has been working on suggestions for such a levy and plans to have some initial ideas by its Spring Meetings in April, to be held in Washington.” Was Gordon Brown so eloquent and convincing, then, winning over the attention and consideration of IMF officials and World leaders, wearing his Saviour of the World hat?

Absolutely not. IMF Managing Director Dominique Strauss-Kahn told reporters the IMF was considering several options for the G-20 to look at. "We can't go on with a system where some individuals take risks that finally all taxpayers, like you and me, have to pay for.” But he added in the same breath: “The financial industry has made such big innovations that it is probably impossible to find a transaction tax that will not be avoidable by potential taxpayers. So it will be based not on transactions but on something else." “He made it clear that there was no consideration of a currency transactions tax.” Brown was engaging in a familiar behaviour pattern - pretending an activity was at his instigation, and displaying his trademark ineptness in mis-representing others' activity.

Of course. In 1972 James Tobin first suggested a tax on financial transactions, with the dual purpose of reducing their size and volatility, and raising funds to finance investment and growth in less developed countries. He originally envisaged a tax rate of 1% on all foreign exchange transactions, but later reduced it to 0.1% to 0.4% (still a tidy sum if it worked, considering that the volume of financial transaction is of the order of ten times world GDP). At that time it might have been possible to introduce it effectively in economies that were still relatively closed to financial flows. Then the UK still had even a dual exchange rate, one for current transactions, and one for investment carrying an investment premium; an individual or company based in the UK could only invest abroad by borrowing from the holders of investment sterling and paying them back in the same sterling.

Given the very high degree of financial globalization today, such a tax could only be global: it is sufficient for one country not to introduce the tax, for that country to attract the bulk if not all of the global financial turnover thus offering the entire world the opportunity to avoid it. The trouble is that there are no global governance institutions that could institute it or enforce it globally. And even if the tax was genuinely introduced as a global tax, it could be avoided by transactions taking place in cyberspace: the argument that a tax levied at a small rate would be preferred to a tax-free but less secure transaction no longer applies today: financial transactions in cyberspace are much more secure than they used to be, and any large transaction can be fragmented into a large number of small sequential transactions, each taking place after all the earlier fragments have been successfully executed, in such a way as to minimize any associated risk. Internet is another country. Moreover, the objective of reducing the size and volatility of financial transactions might require, in times of turbulence, much higher tax rates than a fraction of a percentage, higher than any conceivable insecurity premium of unofficial market channels, again leading to tax avoidance. It is no accident that James Tobin ended up practically disowning his tax.

Moreover, as Charles Goodhart argues: “most serious advocates of a Tobin tax admit that it would have the effect of raising both the volatility and the costs of financial markets in the long run.” [Goodhart has a better idea and recommends “a tiny tax imposed on every individual addressee in an internet message, payable by the sender, and collected by the server from the sender. ... First, it would kill spam. Second, it would make senders think who really needs to receive the message. Third, the internet, being so much cheaper than any other current message service, would remain the preferred channel of communication, so the tax base would be immobile. Fourth, and most important, it would be a significant source of revenue.” Eurointelligence, 26-11-2009].

Dominique Strauss-Kahn said there were two possibilities for a financial sector tax, including a "possible windfall tax for 2009, a one shot thing." The other would be a more long-term tax, at a rate which could be inversely proportional to the degree of bank regulation in each country. “We don’t want an extra-simplistic solution that will not be effective. I am very pragmatic: I would prefer a second best solution we can all implement."

So the Gordon Brown inspired tax will be a transaction tax which “will not be based on transactions but on something else”. Which is par for the course for a democratic leader who has not been elected as such democratically, and a Labour politician who has not based his policies on Labour values and electoral promises.

There are two very good reasons for Dominique Strauss-Kahn not to have rejected Brown’s "extra-simplistic solution that will not be effective" outright. First, in English it is considered “rude” to say No, a restatement of one’s different view is preferred. Second, contradicting a madman only encourages him.

The debacle of European social-democracy

In the elections to the European Parliament held on 4-7 June 2009 all parties of social-democratic inspiration obtained reduced support or were defeated outright everywhere – with the exception of Greece that confirms the general rule – in spite of the financial and real tsunami of 2008-2009 (extended at least to 2010 in terms of labour unemployment). What are the causes of the defeat of the European “Left”, at a time when they should have benefited from the crisis and harvested anti-cyclical electoral consensus?

In our previous post (The Fall and the Original Sin of Socialism, 9 November) we argued that Soviet-type socialism suffered from the original sin of Nikolai Ivanovich Bukharin and Rosa Luxemburg, i.e. their assertion that socialism marked the end of political economy as a science: neglect of economic laws was instrumental in eventually bringing down the entire system and the Wall that was built in 1961 to shelter it. The whole European social-democratic left was also tainted by the original sin of socialism, in believing that, somehow, economic laws could be suspended by socialists. And when, in the late 1990s, with the rise of the Third Way of New Labour and of the German Neue Mitte, social-democracy tried to mend its ways, in some respects it did not change radically enough, in most respects it went too far in embracing the hyper-liberal doctrine. Moreover, together with its old-fashioned economic dogmas, the new social-democracy jettisoned its best traditional political values. The global economic crisis of 2008-9 and the glaring failure of the hyper-liberal model caught the European “Left” on the wrong foot, unprepared to respond, split into litigious factions and voided of its political backbone. Hence its debacle and its abysmal prospects in the short and the long run.

Impossible Demands

The pretence that economic laws can be ignored or suspended under socialism is a common feature of both the extreme left – with Potere Operaio in Italy promising a life as rentiers to all workers adopting their misguided strategy of “refusal to work”, or with the May 1968 Parisian slogan “Soyez réalistes, demandez l’impossible” – and of democratic socialism. For instance, at the time of the Labour Party Conference in Blackpool in 1949, Aneurin Bevan was declaring that "The language of priorities is the religion of socialism", thus confirming the muddled thinking and the neglect of a proper economic assessment of policy alternatives by social-democratic leaders. The notion of “priorities” is of course a contradiction in terms, since by definition there can only be one priority. What is being talked about is targets, not priorities, and the desirable trade-off between targets must be decided and specified. Old-style socialism, including the Soviet version, was generally committed to a plurality of mutually conflicting and often inconsistent “priorities” (see our post on Singular Priorities, 23 September 2009).






















For a long time – until New Labour came to power in the UK (1997) – rarely if ever did anybody in the social-democratic camp ask whether there might be feasibility limits to the welfare state – no matter how desirable; whether and how opportunistic behaviour (more pretentiously labelled “moral hazard” in economic theory) by welfare users should be taken into account; whether an economy characterized by dominant private ownership and enterprises might prosper and grow without profit margins sufficient to both finance and promote investment. Whether an economy open to trade and (both inward and outward) investment flows should not worry about its own international competitiveness. Whether there might be limits – though flexible, but therefore dangerously uncertain – to public expenditure, whether this was financed by rising public debt or by rising inflation. Whether public enterprises have a growth-promotion role not only in the production of energy and steel, but also in that of processed foods and textiles.

Trades Unions found themselves in a conflict of interest with the rest of the population that did not belong to them – representing mostly men and employed men at that – both in countries like the UK, where the Labour Party traditionally is the political arm of Trades Unions, and in countries like Italy where almost every party has its own Union. Not a conflict of interests as blatant and scandalous as that in which the Italian left unforgivably has permitted (especially in 1996-2001) a TV monopolist to rule the country, but a conflict of interests nevertheless. However, Trades Unions (including, indeed especially, Italian Trades Unions) have to some extent redeemed themselves from the original sin sooner than left-wing parties, recognizing that the wage rate is not a/the “independent variable” of the capitalist market economy, but on the contrary it depends on the internal and international factors indicated above, and therefore is subject to a “compatibility” test of Unions’ targets (for a survey of these discussions, in which in Italy Claudio Napoleoni played an important role, see Cavalieri 2006). Trades Unions everywhere are still leaning towards impossible claims, especially in demanding the preservation of jobs in non-viable, even bankrupt companies and industries in the current crisis, but at least they are aware of the economic implications of their negotiating stances.

The excess rebound after the Fall: Third Ways

The Fall of the Wall and the victory, that at the time seemed definitive, of hyper-liberalism, towards the end of the 1990s provoked a late and exaggerated conversion of European social-democracy to such hyper-liberalism, or at any rate to neo-conservatism, first in the transition countries of central eastern Europe by right and left governments alike, then in western Europe under the leadership of New Labour and its Third Way, replicated by the German Neue Mitte (see Blair 1998, Blair and Schroeder 1999, Giddens 1998). By the end of 1998 thirteen out of the then fifteen EU member countries (not Ireland and Spain) had social-democratic or left-wing coalition governments; social-democrats also held a dominant position in the European Parliament, which they promptly lost in 1999.

The new project of Tony Blair and Gerhard Schroeder was committed to traditional socialist values: “Fairness and social justice; liberty and equality of opportunity; solidarity and responsibility to others: these values are timeless. Social democracy will never sacrifice them” (Blair and Schroeder, 1999). However it differed from similar previous attempts in three major respects:

1) Acceptance of the primacy and desirability of markets, fully recognising their global nature in the modern world. “The market is part of the social organisation we desire, not just a necessary means which we reluctantly admit that we need, and need to master” (Karlsson 1999). Social-democratic policies were to be implemented using market instruments instead of direct controls and the management of state enterprises.

2) Rejection of public ownership and public enterprise, supporting private entrepreneurship and continued privatisation. The repeal of the fundamental Clause IV of the old Labour Party Constitution meant not just the removal of nationalization from the new agenda, but a commitment to continued privatization of state assets. “Government does all it can to support enterprise but never believes it is a substitute for enterprise… we want a society which celebrates successful entrepreneurs just as it does artists and footballers – and values creativity in all spheres of life” (Blair and Schroeder, 1999). And, above all,

3) Affordability, i.e. fiscal discipline and monetary restraint, rejecting Keynesian policies of public deficit and debt, and inflationary monetary expansion. “Sound public finance should be a badge of pride for social democrats”. “… deficit spending cannot be used to overcome structural weaknesses in the economy that are a barrier to faster growth and higher employment. Social democrats also must not tolerate excessive levels of public sector debt. Increased indebtedness represents an unfair burden on future generations. It could have unwelcome distributive effects. All the money spent on servicing high public sector debt is not available to be spent on other priorities [sic] including increased investment in education, training or the transport infrastructure”. (Blair and Schroeder 1999).

Undoubtedly these were moves in the right direction, for a socialist economy to become efficient and sustainable. Except that some social-democratic governments did not move fast or far enough in some respects, but by and large, most of them went much too far on the rebound (see Nuti 1999).

Under-shooting

Third Way leaders were still caught in the old ways: Blair and Schroeder do not talk of the costs and benefits of policy alternatives but of “priorities”, just like Aneurin Bevan. The pretence that socialism could suspend economic laws still permeates actual and proposed policies. For instance, Lionel Jospin and Fausto Bertinotti (while in Government) proposed the reduction of the working week to 35 hours by law – without proportionally lowering weekly wages below the level that they would have had without the reduction in hours. The consequent increase in unit labour costs in any open economy unfailingly would have led to a rise in unemployment.

Oskar Lafontaine, then German Minister of Finance, proposed to lower pensionable age from 65 to 60 years, which would have aggravated intolerably the already large and increasing burden of an aging population. An equally expensive proposal in Italy was the subsidised “scrapping” of employees over 50, as long as employers continued to pay social contributions to retiring age. This would have simply moved retiring workers into the black economy, and worsened income distribution by age among pensioners. Third Way policies failed to reckon with the black/informal economy as an effective, organised opposition to any government in general and to social-democratic governments in particular – an-economy-within-an-economy and a state-within-the-state.

Romano Prodi, while President of the EU Commission, proposed that excess reserves of the European Central Bank (ECB) should be mobilised to fund additional public investment. Central bank reserves can only be mobilised through additional monetary expansion, which if desired could be induced without reducing reserves and if undesired should not take place just because excess reserves are available. There was indeed a case for additional public investment concerted at the European level, but this was independent of excess ECB reserves, and was not promoted by the new approach.

The latest instance of the social-democratic belief that the laws of economics can be bent is Gordon Brown’s proposal, at the G-20 Finance Ministers’ meeting of 7 November 2009 in St Andrews, of a global tax on financial transactions. There are no global governance institutions that could introduce it and enforce it globally: it is sufficient for one country not to introduce the tax, for that country to provide the entire world with the opportunity to avoid it. And even if the tax was genuinely introduced as a global tax, it could be avoided by transactions in cyberspace, now much more secure than in 1972 when the tax was proposed by James Tobin. In today’s world, the proposal is a non starter, and it was treated as such by G-20 financial leaders and the world economic press.

Mostly, too much too late

In most other respects, the Third Way internalized and absorbed fully the entire theoretical apparatus of the hyper-liberal model.

Thus privatization found no limits, under-selling the family silver and dissipating state assets in all sectors, as well as mortgaging future state revenues through unrestrained securitization practices and other forms of creative finance. More state assets per year were privatised by Lionel Jospin in France in 1997-98 (25bn ECU in under two years) than by Margaret Thatcher (135bn ECU at 1998 prices in 17 years); large scale privatisations were implemented throughout social-democratic Europe. Public utilities, if not privatized outright, were entrusted to PPP – Public Private Partnerships – that reduce public investment requirements at the cost of guaranteeing attractive safe profits for private investors, and therefore higher prices for consumers, outside market control. Generalized de-regulation, especially in financial markets, instead of the desired competition generates monopolies, corrupts governance and facilitates the rise and diffusion of illegal practices.

New Labour set strict limits to its own fiscal policy, namely the “golden rule” that over the course of an economic cycle the government will borrow only to invest, and a self-imposed 40% ceiling on government debt (Blair 1998) – much stricter than those imposed by the Maastricht Treaty and by the so-called Growth and Stability Pact (a limit soon to be blatantly violated by Gordon Brown). Monetary discipline was sanctioned by Central Banks’ complete independence from government, rooted on the fragile foundations of the theory of rational expectations (that denies the existence of a long-term trade-off between inflation and unemployment thus leading to the delegation of inflation targets to Central Banks). The very first act of the New Labour government in 1997 was to grant independence to the Bank of England and to strip it of financial supervision – something which they regretted but did not seek to reverse in the 2008-9 crisis.

Affordability and long-term sustainability, also labeled “pragmatism”, may and often do mean cutting welfare provisions, pensions, education and health. Of course this approach assumes that alternative opportunities for cutting expenditure (eg on weapons, agricultural subsidies, on the cost of government itself) or raising revenue (eg taxing wealth) have already been exhausted, or are otherwise unavailable. That you cannot have something for nothing is a corollary of affordable social-democracy; citizen rights also involve obligations, work-fare may have to accompany welfare.

Monetary and above all fiscal rigour led to the loss of popular support for the Left, although initially such policies were more widely supported than one might have expected, in the name of either the stabilization of public finances or the sacrifices required by the Maastricht Treaty for those countries that sought membership of the euro-zone.

Competition has been largely neglected by the Left, although greater competition in the market for goods and services would have certainly contributed to create additional employment much more effectively than any increase in labour market competition through the measures of labour mobility and wage flexibility accepted and implemented by the Left. New Labour introduced minimum wage legislation, and signed the Maastricht Treaty’s Social Chapter from which the Conservative John Major had opted out, but at the same time ended free university education, reduced benefits for single parents, raised tax rates on pensions. All these measure grossly reduced equality of opportunities in exchange for gaining trade union narrow goals available only to the employed, and to the detriment of the young, women and the old . The fight against tax evasion and fiscal paradises remained perfunctory and ineffective regardless of the left or right inclination of governments.

Corruption has tainted left wing national and local governments – whether displayed in the Italian traditional left strongholds or through the endemic overclaims of British MPs for expenses. The fact that corruption was cheap made it worse, not better. Unions-backed governments concentrated their efforts in the protection of organized employed workers, neglecting the unemployed, the precariously employed, the self-employed. Old age pensioners, in particular, have been victims of the privatisation and marketisation of pensions provision, through the needless and costly transformation of Pay As You Earn, re-distributive systems, to Fully Funded, capitalised systems whose resources have been decimated by the latest global crisis (See our post "First You Pay Then You Go", 13 June 2009, and the two subsequent posts). Educational and training support opportunities have been restricted - despite 'priorities' and goals - by depriving the poor of support as well as access.

Small and medium size enterprises have not enjoyed much favour with social-democratic governments, while co-operatives have been continuously attacked and, in many countries, often subjected to a perverse process of de-mutualisation that has privatized their social capital to privileged stakeholders. This is another doubtful New Labour’s first, leading to the transfer of over £70bn from social to private ownership in what can be described only as a self-appropriation process by insiders on a scale reminiscent of Russian privatizations in the 1990s.

At the end of the 1990s Germany’s Neue Mitte replicated New Labour’s policies of downgrading the role of the state, de-regulating the labour market, reducing the coverage of the welfare state, endorsing “structural reforms”. In 2003-2004 Gerhard Schroeder’s government promoted Agenda 2010, one of the most ambitious reformist programmes in Europe. It included the reduction of unemployment benefits to favour labour mobility; greater freedom to dismiss employed workers; drastic cuts in pensions and raising pensionable age to 67; a 25% reduction in the basic rate of income tax and other tax cuts; higher health charges. The measures were in line with the market liberal approach of the EU Lisbon Strategy and its 2010 deadline. Unemployment, poverty and inequality rose significantly as a result.

Populist temptations

At the same time, among other reasons, to compensate their electorate of institutional changes that had nothing to do with either social-democracy or modernization, and under the competition of centre-right governments, European social-democrats began to indulge in populist policies. Here “populism” is understood as the adoption of policies which are aimed at bribing selected groups of society for blunt electoral purposes, that are not sustainable other than for a short time and must later be reversed at a cost. Again, the UK leads under Gordon Brown in the promotion of one of most spectacular forms of populism, namely the encouragement of consumption expenditure by the population on credit, whether current consumption through credit cards and bank overdrafts, or the purchase of houses on mortgages, regardless of the borrowers’ capacity to repay. This is a damning responsibility of both the Bush and the Blair-Brown administrations in the genesis of the global crisis of 2008-2009.

Other governments not directly involved in this credit scam – also on the left – have effectively connived through the omission of controls and appropriate checks which were their responsibility but which they abdicated in the hyper-liberal euphoria. Another form of generalized populism – right and left – has been that of indulging in protectionist temptations – which in turn have reduced competition in goods and services and thus, if they have temporarily protected wages and jobs, have also raised labour migration pressures.

The loss of traditional political values

As if this were not enough, the liberal conversion of the left has certainly not encouraged new responsibilities or even the defense of their traditional values. Civil rights were sacrificed, particularly by New Labour, to increase civil management and control but under the pretext of fighting terrorism. The separation of powers, equality before the law, the laicity of the state (especially in a country like Italy) have suffered. Environmental protection and reclamation have been sacrificed to public expenditure savings and private profit; the degradation of urban centres and the cementification of the countryside have continued unabated. A non-negligible share of votes have been lost by the Left to one or more green parties, often available but unreliable as coalition partners.

Instead of promoting peace, New Labour and to some extent other European governments right and left have joined the USA in illegal imperialist wars for the conquest of major resources, particular oil, and to set in place institutional and physical surveillance structures, under the pretext of “exporting democracy”. Moreover Blair, co-responsible for launching the Iraq conflict under false claims, to add insult to injury was touted as a credible candidate for the first Presidency of the European Union, not only by New Labour but also by other left parties such as, to its utter shame, the centre-left Italian Partito Democratico.

International solidarity has paled into insignificance, both in the absolute terms of aid provision to less developed regions, and in comparison with the speed and the scale with which financial resources have been provided for the bail-out of financial institutions in the current crisis. This represents a diversion of welfare support from the population at large to capitalist investors. Inequality of both wealth and incomes has generally increased regardless of right or left governments. Equality of opportunities has been impaired by expenditure cuts and higher fees in higher education; research expenditure has suffered.

Liberty

The worst drawback of the new project was the neglect of traditional social-democratic political values. Dahrendorf (1999) notes that “one word appears almost never – and never in a central place – in all the these [Third Way] speeches and pamphlets and books, the word, liberty”. “This is no accident. The ‘third way’ is not about either open societies or liberty. There is indeed a curious authoritarian streak in it, and not just in practice”. For the UK, Dahrendorf cites the deconstruction of traditional democratic institutions actually advocated by Giddens (1998), with referendums and focus groups instead of parliaments, and the proliferation of agencies and quangos which evade civic control; we could add the creation of cabinets at local authority level which exclude elected representatives from much decision making and pay cabinet members more highly.

Other instances of this authoritarian design are: compulsory saving by workers for the reform of the welfare state, insistence on everyone working (including the disabled and single mothers), compulsory work under threat of loss of benefits. The danger, particularly for the UK, is what Dahrendorf calls “the Singapore syndrome”, whereby “the political class becomes a kind of nomenklatura which remains unchallenged because of the apathy of many, and when those who do not fit are silenced, nobody raises his or her voice”. There is a need to give back to freedom its rightful place in any social democratic design.

Slogans and Soundbites

The lack of a sound intellectual superstructure for the new Third Way was papered over by propounding new formulas and slogans of little content. The “stakeholder economy and society” was supposed to diffuse participation in decision-making and economic performance not only among stockholders but also among holders of other “stakes”, or legitimate interests, which individuals possess in their capacity as employees or consumers or simply as citizens. It was part of the pre-1997-election Labour agenda, but was quietly dropped after the elections – not a great loss, for it was an empty formula (see Nuti 1997).

Other formulas and sound-bites include: calls for modernisation, partnership, de-centralisation, community, technology, responsibility – mostly preceded by “new”; “free but compassionate markets”; Blair’s commitment to bridge “the false opposition … between rights and responsibilities, … between the public and private sectors, between an enterprise economy and the attack on poverty and exclusion” and so on. At least to some extent, these empty or suggestive propositions have been the deliberate product of party propaganda manipulating the electorate by means of the same advertising gimmicks as those used in promoting mass consumption. But as Giddens (1998) recognizes, “A precept of successful advertising … is that image alone isn’t enough. There must be something solid behind the hype, otherwise the public see through the façade pretty quickly” (p. 155). A lot more competence and, not least, imagination would have been needed to flesh out a positive and more appealing New Third Way.
After-thoughts?

An almost exclusive recent exception to the wholesale sell-out of social-democracy is José Luis Rodríguez Zapatero’s Spain, whose future political prospects however are just as grim as in the rest of Europe. Today there are some signs of after-thoughts, especially in Italy and Germany. In his electoral campaign for the leadership of the PD, the former, acting secretary Dario Franceschini apologised profusely to entrepreneurs of North-East Italy for having treated them as exploiters, potential tax evaders and capital exporters, instead of producers deserving attention and respect. The newly elected PD secretary, Pierluigi Bersani, made his victory address at a meeting with Prato artisans. Too little too late, and little credibility. In Germany Die Linke, the social democratic party of the Left founded by Oskar Lafontaine in 2007, in the October 2009 elections has recovered a million voters out of those lost by the SDP (which has has not learned anything from the debacle); the Greens have reached over 10% of the vote; altogether a feasible left wing coalition commands today 46% of the vote against 48% of the government coalition.

Right-wing competition

Since its very beginning the new Third Way was wrong-footed by neo-liberalism – by adopting the private sector with open arms precisely at a time when former neo-liberals were moving towards more critical positions. At the heart of the new Third Way there was “profound pessimism”, an acceptance that: “The fundamental architecture inherited from the neo-liberal era cannot be disturbed; globalisation cannot be controlled or tamed; growing inequality can only be at best mollified. We are, in short, at the mercy of nature and the market” (Jacques 1998).

More recently, the social-democratic agenda has been subjected to unfair competition by center-right parties. Some of the traditional values of the left, such as employee participation in enterprise profits, and the upholding of tenured employment, have been hijacked (literally scippati) by the Italian centre-right government, that has appropriated them and therefore succeeded in broadening their own consensus. It is disconcerting to see the Economy Minister Giulio Tremonti to exalt the value of employment stability (“il posto”) with Silvio Berlusconi’s blessing, while CISL Trade Unionist Raffaele Bonanni has only just discovered the obvious principle that “precarious” (untenured) employment should be paid more and not less than stable employment; the fact that it is paid less is evidence of a perverse segmentation of the labour market. It is equally disconcerting to see employee profit-sharing schemes being proposed by Labour Minister Maurizio Sacconi with the opposition of the left wing Union CGIL.

In 2008-2009 the massive fiscal stimulus and monetary expansion agreed by the G-20 as a collective response to the global crisis, with the blessing of the IMF now endorsing Keynesian macroeconomic policies – makes the monetary and fiscal restraint advocated by New Labour and its rejection of Keynes positively retrograde. A total of $18 trillion were mobilized globally to bail out banks and other financial institutions since September 2008, while the amount of total development aid over the past 49 years was only $2 trillion, or just eleven percent of the money found for financial institutions in one year (United Nations, 24 June 2009).

A dismal future

Today the European left, including its Italian wing, is completely wrong-footed, isolated, fragmented in countless warring factions due to profound and widespread dissent on the relative weight to be given to militancy and to co-operation, without ideas or proposals, and therefore – barring the unlikely miracle of a large-based alliance eventually coalescing around a radical programme yet to come – the left is condemned to lose and lose over and over again, with a total certainty because of its deep conviction that it will lose. And it deserves to lose.

In order to understand how de-railed is the left today one has only to read what, even in October 2009, an authoritative socialist leader like Lionel Jospin – French Premier 1997-2002 – writes on the current capitalist crisis: “And now let us talk about socialists. Who are they, historically? They are the supporters of a form of social organization in which the general interest prevails over private [particuliers] interests and who, against the injustices perpetrated by capitalism, want to assure by means of reforms the most just distribution of wealth [richesses].”

Wrong, Lionel. No one can claim to know what is the general interest and nobody is willing to delegate to you its definition let alone its implementation. The political problem is precisely the confrontation and composition of individual interests in order to reach, collectively and democratically, after a good fight, the definition of a compromise that can represent a passable form of general interest. And the distribution of incomes and wealth – a distinction that probably escapes both Lionel Jospin and the French Group for the Re-Distribution of Wealth (that has just published a futile Report, see Oro 2009) – will have to take into account not only distributive justice but also the incentives and the efficiency associated with it. Up to a point – which in fairness has not yet been reached – both equality and growth can be enhanced pari passu, but sooner or later a disagreable trade-off between the two necessarily appears, Lionel, forcing unpleasant choices of which you do not seem to be aware. And there is an international dimension that seems to escape you completely.

A new, credible and attractive programme of European social-democracy needs to emphasize economic and political participation at all levels; genuinely restore co-operative and mutual values and institutions; assert a continued commitment to equality of opportunities, possibly by pursuing the notion of a basic income or citizens' income. We can and should debate these and as many as possible other new ingredients.


REFERENCES

Blair Tony (1998), The Third Way: New Politics for the New Century, Fabian Society Pamphlet 588, London.
Blair Tony and Gerhard Schroeder (1999), The Way Forward for Europe’s Social Democrats – A Proposal, The Labour Party, London, June.
Cavalieri Duccio (2006), Scienza economica e umanesimo positivo: Claudio Napoleoni e la critica della ragione economica, Biblioteca Storica degli Economisti Italiani, Franco Angeli.
Dahrendorf Ralph (1999), La Repubblica, giugno.
Giddens Anthony (1998), The Third Way – The Renewal of Social Democracy, Polity Press, Cambridge and Blackwells, Oxford.
Jacques Martin (1998), Good to be Back, Marxism Today, special single issue November/December.
Jospin Lionel (2009), Les socialistes face à la crise du capitalisme, Jean Jaurès Fondation, Paris, October.
Karlsson Mats (1999), Third way, Neue Mitte or Old Wine in New Bottles?, Conference on “Dilemmas of globalisation”, IPPR, Bellagio, 27-28 February.
Nuti D. Mario (1997), Democracy and Economy: What Role for Stakeholders?”, Business Strategy Review, pp. 14-20.
Nuti D. Mario (1999), “Making sense of the Third Way”, Business Strategy Review, Vol. 10, n. 3, Autumn 1999, pp. 57-67.
Oro Stéphanie et les members du groupe «Partage des richesses» (2009), Le partage des richesses et les moyens de corriger les inégalités, 9 October, Paris.

The Fall and the Original Sin of Socialism

The Fall of the Berlin Wall, whose twentieth anniversary is celebrated today, signified not just the Fall of the Iron Curtain and of the whole system developed behind its shelter, but also the “Fall” in a biblical sense: Man was driven away from what many hoped, though wrongly, might be a Garden of Eden. In this vein, then what has been the “original sin of socialism”, the sin leading to the Fall.

The Original Sinners

Without doubt the original sin of socialism was committed by Nikolai Ivanovich Bukharin (1888-1938) and Rosa Luxemburg (1871-1919). They are guilty of asserting, with unforgivable arrogance, that “socialism marks the end of political economy as a science”. They were followed, as is the way with original sin, by all of socialist mankind; by Rudolf Hilferding (1877-1941), as well as by the majority of Bolshevik economists (as we are reminded by, among others, Brus 1973; see the Appendix below for citations and sources). This sin is the origin of the decisionism and the voluntarism typical of economic management in the Soviet Union and in the countries that adopted its system, that eventually led to the Fall.

The uneconomic system

Remember? In the 1920s the “genetic” school of planning, that aimed at facilitating natural economic trends, was defeated by the so-called “teleological” (or “purposeful”) school, seeing the plan as an act of war, of aggression on the economy (for a survey see Charemza and Kiraly, 1990). Priority was given to investment over consumption, to investment in heavy industry over light industry, so as to produce steel that would produce more steel and ever more steel, regardless of the needs of the population. Many other targets were given priority, and as a result nothing at all had effective priority; the actual or opportunity costs of alternative targets were ignored or neglected. “There is no fortress that a Bolshevik cannot conquer”, Joseph Stalin loved to say. “2 + 2 = 5” was the planners’ arithmetic, and in fact the first five-year plan of 1929-32 was implemented in four years – and never mind the cost. When reality could not be forced to comply, change was faked: fake genetic miracles were claimed; just as economic plans were frequently the object of fake realizations.

The ratchet principle applied: if today we produce 100 it is imperative that tomorrow we should produce 110 - an effective incentive to conceal productive potential rather than mobilize it. There was a programme of innumerable campaigns, each centered on a single objective to be promoted regardless of cost. Stakhanovism concentrated on the exceptional performance of shock workers (with the assistance of countless, nameless helpers). Tight or taught planning had an essential role: it was believed that by aiming at impossible targets one would obtain more than by lowering the sights. This strategy occasionally might actually work, but it soon reaches the point where it defies the laws of physics and becomes a losing strategy: aiming at the Moon misses all desirable targets within closer reach. By the 1970s realised socialism in Poland was boasting that “Polak wszystko potrafi” (A Pole is capable of anything). We have seen and admired the results achieved by the Polish people: it was true, but certainly not in the sense meant at the time by Edward Gierek.

In its most spectacular and damaging form, the violation of economic laws in the socialist system consists in the adoption of the impossible target of maintaining low and stable prices, while goods are available in quantities lower than those necessary to validate such prices given their demand. Hence the inevitability of shortages, queues, black markets – as well as the absolute impossibility of introducing market elements into the traditional planning system: this is why all the numerous projects of economic reform in the direction of market socialism, in the 1960s-1980s throughout the socialist bloc, failed one after another, in one country after another.

All these are the implications of the pretense that socialism should not be subject to economic laws, both in general and in the specific Soviet-type model. In general, input-output type technical relations, and the optimization of production methods, must necessarily continue to hold in any economic system, no more no less than the laws of thermodynamics. And a fortiori economic laws of market equilibrium must hold in the specific Soviet-type system in which money was still used to pay wages and distribute consumption goods, even though prices were administered and supply was not affected by consumer sovereignty, so that Bukharin et al. could legitimately claim that the “law of value” no longer held.

Gorbachev’s responsibilities

For the persistence of this economic regime of shortages, queues and repressed inflation, Mikhail Sergieyevich Gorbachev bears a major responsibility. A great statesman, a generous, courageous and charismatic leader, Gorbachev was a lawyer: in economics he was an illiterate, surrounded by economically illiterate advisors. He believed that it was possible to maintain low prices and at the same time contain demand within the narrow, inadequate limits of production and imports. He believed that market imbalance was a necessary feature of his revolution, and bought expensive time by getting into debt with foreign lenders. Which is how the Soviet Union reached bankruptcy, economic collapse, literally famine conditions (agreed the famine was due more to the inefficient distribution system than to the lack of food, but the distribution system is also an integral part of any economic system).

What if...?

Suppose Gorbachev had recognized the continued validity of economic laws under socialism, would he have managed to modernize the Soviet system instead of sinking it? He would have had to give priority to economics over politics, and at best he could have followed the examples of those other economies that managed to combine public ownership and Communist Party political control with the mobilization of market forces domestically and internationally, like China, Vietnam, Belarus, Uzbekistan ( see Nuti, 2009). An authoritarian system is a very high price to pay for economic success, but this was still a possibility – except that once such an alternative is implemented it is extremely difficult to change course, because of its inertia and resistance to change.

Admittedly, in suffering the consequences of the original sin of socialism, Gorbachev was doubly unlucky in the very bad, if accidental, timing of his coming to power: his perestroika happened at a time of world recession and a low price of his oil, and coincided with the global victory of the hyper-liberalism of Ronald Reagan and Margareth Thatcher. Ten years earlier (in 1975) perestroika would have benefited from a higher oil price that would have provided the resources necessary to stabilize the economy and avoid Russia’s default. Twenty years later – i.e. today – the crisis of the hyper-liberal model and the global crisis of 2008-2009 would have allowed the Soviet Union or its component republics to implement a different economic model. A model, that is, with a greater role for the state and public ownership, the provision of larger amounts of resources by international economic institutions, subjected to lesser conditionality constraints – as it is happening today at the global level, with the IMF e the G-20 having taken on new and surprising functions approaching those of a Global Lender of Last Resort.

What about social-democracy?

At this point, what can we say about the failure that recently struck - with the exception of Greece that confirms the general rule - the whole of European social democracy, in spite of the financial and real tsunami of 2008-2009 (probably extended to 2010 at least in terms of labour unemployment). What are the causes of the defeat of the European “Left”, at a time when they should have benefited from the crisis and harvested anti-cyclical electoral consensus? This question deserves a post of its own but, in a nutshell: Social-democracy was also tainted by the original sin of Socialism, at least until the late 1990s and the Third Way of New Labour and the Neue Mitte that, unfortunately, overshot on the rebound.


Nikolai Ivanovich Bukharin (9 October 1888 – 15 March 1938)

and Róża Luksemburg (5 March 1871 – 15 January 1919)


APPENDIX: THE CLAIM OF THE END OF POLITICAL ECONOMY UNDER SOCIALISM

Brus (1973) notes that “In the course of the development of Marxist economics it was sometimes reckoned that political economy would come to an end at the same time as the capitalist system. Among those holding such views were those whose names are an integral part of the history of Marxism – Hilferding, Bukharin, Rosa Luxemburg”. Of political economy there would remain “… only technical problems, technical balance laws of production, a science of the rational organization of productive forces “.


Cohen (1980) talks of Bukharin’s conviction that “political economy and its traditional categories were not applicable to a post-capitalist society”. “As soon as we take an organized social economy, all the basic “problems” of political economy disappear: the problem of value, price, profit, and the like. Here “relations between people” are not expressed in “relations between things,” and social economy is regulated not by the blind forces of the market and competition, but consciously by a ... plan. Therefore here there can be a certain descriptive system on the one hand, a system of norms on the other. But there can be no place for a science studying “the blind laws of the market” since there will be no market. Thus the end of the capitalist commodity society will be the end of political economy”(from Bukharin 1979, cited by Cohen 1980, p. 93).


Rosa Luxemburg writes: “If political economy is a science that deals with the particular laws of the capitalist mode of production, then the reasons for its existence and its function are confined to the period of life of the latter, and the political economy will lose its basis as soon as that mode of production will have ceased to exist” (Luxemburg 1925, in Waters 1970 p. 244). “Consequently, the end of political economy as a science represents a historical world task“ (Luxemburg 1925, in Waters 1970, p. 248).

Rudolf Hilferding forcefully expressed the idea that “Centralized control of the economy on a national and eventually an international scale would allow for conscious social regulation of both production and distribution and create the objective conditions for a planned economy no longer subject to regulation by the law of value” (Mattick, 1983; see also Howard and King 2003).


Hilferding appears to believe that economic laws can be suspended even in the political struggle for socialism. According to Breit and Lange (1934) he “invented a theory of so-called political wages, arguing that, using its political strength in the democratic state, the working-class movement imposes on capitalism higher wages than those resulting from the capitalist laws of supply and demand. It turns out that this took no account of the nature of capitalist ownership. It is not possible to impose in a capitalist economy a distribution of income that is different from that determined by the automatic operation of the laws governing the capitalist economy, the laws of supply and demand and competition.”

Magdoff (1985) asks whether there exist economic laws under socialism. “The idea that objective economic laws are not present in a socialist economy was, in fact, orthodox doctrine in the Soviet Union up to the early 1950s.” It was Stalin, of all people, who maintained in his 1952 “Economic Problems in the USSR” that planning must respect economic laws. But these for him were not, say, the law of the Walrasian adjustment of price to excess demand, or the law of the Marshallian adjustment of production to the difference between price and marginal cost. Stalin’s “laws” were no more than slogans such as the "Economic law of planned proportional development” or the “Economic law of distribution according to labour”. Not to speak of the so-called “Economic Law of the ever fuller satisfaction of the constantly growing material and cultural requirements of all people through continued development and improvement of social production based on the highest technology”. In other words, pure propaganda/junk, on which even an orthodox communist like Harry Magdoff maintains evident reservations.

However Stalin recognizes that the so-called “Law of value”, otherwise known as the market, continues to hold under socialism to the extent that commodities continue to exist: this, heavily disguised, is the true and belated innovation of Stalin’s text, however contradicted and nullified by the endemic and permanent repressed inflation that blocked all market-oriented reforms attempted after his death, and therefore eventually led to The Fall.

REFERENCES


Brus Wlodzimierz (1973), Economics and Politics of Socialism: Collected Essays, Routledge and Kegan Paul, London.
Bukharin Nikolaj Ivanovich (1979), The Economics of the Transition Period, Routledge and Kegan Paul, London.
Breit Marek and Oskar Lange (1934), “The Way to the Socialist Planned Economy”, Translated by Jan Toporowski, History of Economics Review, http://hetsa.fec.anu.edu.au/review/ejournal/pdf/37-A-2.pdf
Charemza Wojciech and Julia Kiraly (1990), Plans and Exogeneity: The Genetic-Teleological Dispute Revisited, Oxford Economic paper, vol. 42, issue 3, 562-73.
Cohen Stephen F. (1980), Bukharin and the Bolshevik Revolution: a political biography 1888-1938, Oxford University Press.
Howard M.C. and J.E. King (2003), “Rudolf Hilferding”, in Warren J. Samuels (Ed.), “European Economists of the early 20th century”, vol. 2, Elgar, Cheltenham.
Magdoff Harry (1985), “Are there economic laws of socialism?”, Monthly Review, July-August.
Mattick Paul (1983), “Capitalism and Socialism”, Marxism: Last Refuge of the Bourgeoisie? http://us.geocities.com/collectiveact/pm_cas.htm
Nuti D.M., "A counter-factual alternative for Russia's post-socialist transition", in Grzegorz W. Kolodko and Jacek Tomkiewicz (Eds), 20 Lat Transformacji, Wydawnictwa Akademickie i Profesjonalne, Warsaw 2009.
Waters Mary-Alice, Ed., (1970), Rosa Luxemburg Speaks, Pathfinder Press, New York.

Last Rites

On 2 October the IMF General Director Dominique Strauss-Kahn, in Istanbul ahead of the 2009 Annual Meetings of the World Bank Group and IMF, gave a speech at the Central Bank of Turkey entitled “Making the Most of a Historic Opportunity”. “Countries are diverse, but civilization is one, and it is necessary to participate in this single civilization for the progress of the nation”, he said, quoting a magnificent but very ambiguous sentence uttered 75 years ago by Kemal Atatürk, the founder of the Republic of Turkey. One could argue that civilization's progress is the result of different countries and cultures sorting out their differences in peaceful dialogue, and that the best path for civilization can only be assessed afterwards by results.

In his speech, Strauss-Kahn takes – rightly – a positive view of the global macroeconomic policy response to the current crisis, and outlines “three principles that can frame our efforts to re-shape the post-crisis world…: First, international policy collaboration is essential. Second, financial stability demands better regulation and supervision. And third, the international monetary system must be more stable, and anchored by a global lender of last resort.” No question about the soundness of the first two principles. The third principle – which naturally envisages the IMF taking on the expanded role of “International Lender of Last Resort”, is so sketchy as not to mean very much at all.

Traditionally a National Central Bank acts as a Lender of Last resort by providing unlimited liquidity on demand, in the currency it manages, to banks within its currency area, at a penal rate against good quality financial assets. Thus for instance on Black Monday (19 October 1987) the Fed immediately announced its readiness to act in that capacity. Or, the Bank of England made the same announcement in July 1991 at the time of the BCCI (Bank of Credit and Commerce International) collapse. The statements alone were sufficient to calm down financial markets.

More recently the Governor of the Bank of England, Mervyn King, in his letter to the Treasury Committee on 12 September 2007, discussed the rescue of Northern Rock in these terms:

“Central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate. Such operations in this country are covered by the tripartite arrangements set out in the MOU [Memorandum of Understanding] between the Treasury, Financial Services Authority and the Bank of England. Because they are made to individual institutions, they are flexible with respect to type of collateral and term of the facility. LOLR operations remain in the armoury of all central banks.”

It should be immediately clear that “Lender of Last Resort” is an inappropriate label for any role that the IMF might take in providing global liquidity in a crisis. Presumably it would provide finance denominated in the currency basket known as Special Drawing Rights. But to whom? To commercial banks throughout the world (as the label suggests), including investment banks, and hedge funds, or only Central Banks, and/or governments? And against what? Government paper, illiquid but marketable assets, toxic assets, or in the form of an unsecured loan? If against nothing, on what scale? At what interest rates and, above all, subject to what conditionality? Clearly before even beginning to talk about an international lender of last resort there is a very great deal of detail that need to be considered and settled. As we all know “The devil is in the detail.”

Transition economies: a worse nosedive than anticipated

“At the start of this year, the global economic crisis was hitting central and eastern Europe with unimaginable force. Any illusion that this region was somehow immune from the “western” credit crunch and the subsequent financial squeeze was definitively quashed. Output was declining at startling rates that would only become apparent much later in the Spring.”
“But the danger signs were everywhere. There was real risk of a genuine emerging market crisis – that financial systems in a number of countries would collapse entirely, that currencies would run out of control, that there could be sovereign defaults.” (Anthony Williams, EBRD Head of Media Relations, The road to a fragile recovery, 16 October 2009)

Now they tell us

I don’t remember the EBRD ever signaling any such danger. Slowdown, yes, in their forecasts for 2009 and 2010, that from optimistic growth expected in May 2008 got progressively worse to insignificant growth in January 2009 and an average 5.2% contraction for the 29 countries of EBRD operation in May 2009. I suppose it is part of the institutional duties of the EBRD not to encourage pessimistic expectations that may become self-fulfilling, but then we should note this for future reference and remember that, when the EBRD forecasts a significant slowdown, what they really mean is an impending disaster.

How was the disaster averted? “That this horror scenario didn’t happen – Anthony Williams continues – was a result partly of unprecedented international support, with the EU and organizations like the IMF providing huge macroeconomic packages that were flexible and tailored to specific country needs [to Latvia, as well as Hungary, Ukraine, Romania and other CEE]. Other IFIs, including the EBRD, stepped in to provide micro support to banking groups and corporates with little or no access to liquidity. Crucially western banks, a dominant force in financial sectors in many countries in central and eastern Europe, did not retrench as feared. The authorities in eastern Europe responded with policies aimed at dealing promptly and effectively with the crisis, even though those responses were in some cases immensely painful and politically unpopular.”

At least in Latvia, it is not at all clear that a systemic crisis has been averted. And evidence that western banks “did not retrench as feared” has not been provided by the EBRD; perhaps they will in due course, in their Transition Report 2009 due in November 2009 or elsewhere. Did western banks really not retrench at all, or on average? Did they retrench less than feared, and how much were they feared to retrench and by whom? Certainly not by the EBRD. And recently Swedbank, the largest Swedish lender in the Baltic region, “has threatened to scale back its presence in crisis-hit Latvia if the country goes ahead with controversial plans to limit the amount lenders can collect from mortgage-holders” (Stefan Wagstyl, 28 September 2009).

Otherwise, is everything fine now in transition economies? It might be in the Czech economy, which has been taken off the list of EBRD countries of operation because it no longer needs its credit – the first to deserve this upgrade – and, most annoyingly, off EBRD statistics. Not fine at all in the 28 EBRD remaining client countries (including Turkey since last year), where the average nosedive now expected for 2009 turns out to be more pronounced than the Bank anticipated in May 2009: a contraction of 6.3% instead of 5.2%, with Estonia, Latvia, Lithuania, Armenia and Ukraine expected to decline by well over 10%.

“Signs of positive growth in the third quarter of 2009 suggest that the recession is now bottoming out in many countries of the EBRD region. However, any upturn in 2010 is likely to be fragile and patchy.” (EBRD press report, 15 October 2009) For 2010 the EBRD now forecasts an average growth for the region of about 2.5%, which is 1% higher than it forecast in May 2009, but since it starts from a level which is now 1.1% lower than it was expected then, the higher growth forecast for 2010 actually masks a lower absolute level of GDP than previously anticipated. And “There are likely to be significant cross-country differences in output growth in 2010”, with Latvia, Lithuania, Hungary and Bulgaria expected to continue to contract until 2011. “It is also clear that the social costs of the global economic crisis are only likely to be felt in earnest next year, when corporate bankruptcies and unemployment will continue to rise”, said EBRD Chief Economist Erik Berglof (Ibidem)
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The same factors that transmitted the global crisis to transition economies – the contraction in world trade and tight credit conditions – are now causing its continuation. “The Institute for International Finance, a bankers’ group, estimates that in 2007 $382bn – more than 40 per cent of the financial flows into all emerging markets – went into CEE. The IIF forecast in June that even with all the extra support the IMF, the EU and the EBRD are putting into the region, this year’s figure would be about zero” (Stefan Wagstyl, FT, 28 September 2009).

Heterogeneity

Transition countries with a fixed exchange rate regime – excluding euro-zone members but including Bulgaria, Latvia or Lithuania – are facing a slower and more painful adjustment, the burden of which falls on wages and prices and therefore ultimately demand and employment. Other factors explaining country heterogeneity are the differences in their fiscal positions, the weakness of banking systems, and dependence on commodity exports. The full set of the EBRD October forecasts is reproduced below, or can be downloaded from the EBRD website ).

“Russia’s economy is expected to shrink by 8.5 per cent on a year-on-year basis in 2009, followed by a rebound in late 2009 and growth of about 3 per cent in 2010 year-on-year. Kazakhstan will suffer a much milder output decline this year (of about 1.5 per cent) but the recovery is expected to be weak, in the order of +1.5 per cent.”

“Relatively faster 2010 growth, in the order of between about 2 and 5 per cent is expected in some internationally competitive countries with relatively sound pre-crisis banking systems, such as Albania, Poland, Slovakia, and Slovenia.”

“Some commodity rich countries including Azerbaijan, Mongolia, Turkmenistan, and Uzbekistan, whose financial systems were smaller and less affected by the crisis, and whose growth is mostly driven by commodities, are also expected to grow faster in 2010, in the order of 5 per cent or more.”

“In Hungary, which was hit particularly hard at the start of the crisis, the crisis has been contained thanks to strong international support as well as sound domestic policies. However, its growth is expected to remain slow in 2010 due to necessary fiscal adjustment and a continued credit crunch. It is expected to show slightly negative growth next year, driven by a weak economy in late 2009 and early 2010” (EBRD press report, 15 October 2009, cited above).

Divergence?

The crisis spells – at least temporarily – a reversal in the convergence process that had accompanied EU enlargement. In 1999-2008 income per head in the EU (15) grew at an average yearly rate of 1.41%, and in the Euro-zone at 1.47%, while in the new member states it grew at 2.00% (Poland) or more (from 2.29% in Hungary to 4.17 in Romania). “Growth over the medium term in the EBRD region is also likely to be below the trend experienced over the last decade” (Erik Berglof, quoted). The crisis is reinforcing the heterogeneity of national performances among transition economies and within the EU.

It is true that some of the factors making for vulnerability to external shocks – such as trade openness, economic and financial integration – are also factors that will reinforce recovery trends in an upturn. But there are other vulnerability factors – such as weak banking systems, fiscal over-stretching, or high private and public indebtedness made worse by mismatching of assets and liabilities – that need tackling before the global upturn can be expected to pull national economies out of recession or stagnation. And membership of a single currency area can make countries more resilient to a downturn but cannot be a cure after the event: a rush to a precipitous euro-zone enlargement today – necessarily preceded by a devaluation – apart from being against the Maastricht rules would not make any sense.

EBRD capital increase

Before the crisis the EBRD was confronted with demands from the US, its largest shareholder, to reduce the scale of its activities in transition economies. Now, as anticipated last May, the Bank is seeking a 50 per cent capital increase, an extra €10bn, from its shareholders – some 60 governments, including European Union members, the US and Japan – to compensate for the decline and reversal of capital inflows into the area. Thomas Mirow, the EBRD president, in a letter to shareholders warns that working with its current €20bn capital, the Bank would have to limit its annual lending to about €8bn in 2009-10 and reduce it to €6bn thereafter. “Activity would shrink while the recovery is still precarious,” while “raising the capital by €10bn to allow the bank [would] commit €9bn-€10bn annually, or €20bn in total extra funding in 2010-15. By mobilizing extra capital from private investors, the total additional funds raised could reach €60bn” (Stefan Wagstyl, FT, 28 September 2009). A final decision will be taken at the EBRD’s next annual meeting in Zagreb, in May 2010.

Mr Mirow states that “The region will need to change its growth model – away from reliance on easy finance and commodities, and towards the development of domestic financial markets, strong institutions and a diversified production base.” If conditions improve “further and faster than is currently expected”, the extra capital might not be needed and could be returned after a review in 2015. Not a chance, regardless.