Sunday, December 20, 2009

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.

Wednesday, December 16, 2009

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.” (, 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”.

Sunday, December 6, 2009

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?