Saturday, January 30, 2010

A Hayek vs. Keynes Rap Anthem

YouTube is offering a "Hayek vs. Keynes Rap Anthem: Fear the Boom and Bust "

Good stuff, though it comes with a warning by Dr M G Hayes, Secretary of the Post Keynesian Economics Study Group (, that the rap repeates "the standard claim that Keynes is all about sticky wages … the video bears witness that Keynes may be back in fashion temporarily, but only as the economics of depression."

Friday, January 29, 2010

Wonderful New Gadget from the World Bank

The World Bank has made available online - - the 2009 World Development indicators. This is a beautifully designed and presented form of data visualisation. The time pattern of any three out of 50 variables (from GDP to external debt, from trade to demography or military expenditure), for any number of 221 countries over the period 1960-2007, moves in colour smoothly and tellingly through your screen.

This is the luxury of a global research department at your fingertips. You ask the questions, you get the answers in real time. You can construct your own movie, with a happy ending (see the time trend of mortality of under-5 per thousand), an open ending (see the relentless generalised growth of globalisation measured by trade/GDP ratios – until 2007; you don’t see the de-globalisation of the last two years) or a worrying ending (the ballooning of debt). Thanks Mr Zoellick.


Monday, January 18, 2010

Forza Iceland!

On 7 October 2008 the global financial crisis spread to Iceland, when the Icelandic government put Landsbanki, the second largest bank by value, into receivership. On 8 October the government took control of Glitnir, the third largest bank, buying a 75 per cent stake for €600m; on 9 October it took control of Kaupthing, its biggest bank. These events triggered off a row between Iceland and the United Kingdom over the losses of UK depositors with the collapsed banks, especially in high interest accounts held with Icesave, an online arm of Landsbanki; Dutch depositors also lost out to a lesser degree. Icelandic funds for deposit guarantee were grossly insufficient to provide cover. The Brown-Labour UK regime actually used anti-terror legislation against a fellow NATO-member to freeze Landsbanki and other Icelandic assets held in the United Kingdom. The UK, and Dutch governments, reimbursed most of their depositors for their Icelandic losses, and claimed the money back from Iceland – UK depositors had lost something of the order of over €2.4 billion, the Dutch over €1.3 bn. This represented a per-capita burden of the order of €12,000 for each of the 317,000 Icelanders, or about €40,000 per household, or roughly 50% of Iceland’s GDP. On this, debt interest would be charged at 5.5% per year – a superb rate of return these days. According to the FT, “A year’s interest equals the running cost of the Icelandic healthcare system for six months.”

The deal was approved by the Icelandic Parliament on a narrow 33-30 vote, but over 60,000 people (some quarter of Iceland’s voting population) raised a petition against it, so that President Olafur Ragnar Grimsson refused to sign legislation and blocked the settlement – an implicit vote of no confidence in the Centre-Left Premier Johanna Sigurdardottir. A referendum will take place before 6 March. “The involvement of the whole nation in the final decision – said the President – is … the prerequisite for a successful solution, reconciliation and recovery.”

Two out of the three opinion polls taken since the president’s decision indicate that the legislation will be rejected in the referendum. Considerable pressure is being placed on Icelandic voters, under threat to lose a $10 billion loan package by the IMF, the EU and Nordic countries, and to see the rejection of Iceland's application to join the European Union, which was submitted last July.

The roots of the Icelandic crisis are in the unrestrained neo-liberal policies followed over the last ten years: the privatisation of the banks in question, their de-regulation, the policies pursued by a former Prime Minister of Iceland both in government and then as governor of the Central Bank, not to mention the responsibilities of British and Dutch regulators faced with inordinately fast growth in the foreign operations of the Icelandic banks. “Since the banks had turned Iceland into a hedge fund, with massive short-term foreign currency liabilities used to finance risky long-term assets, the economy was doomed.” (Martin Wolf, FT, 14 January 2010).

Deposit guarantees at the time of the Icelandic banks' collapse differed across Europe, with different national ceilings (only €22,000 in Iceland); what counts is the nationality of deposit-taking banks, not that of depositors. EU regulations require only that a deposit-guarantee system must be in place with “sufficient resources” to cover deposits, but leaves the central bank’s top up (up to 100% in the Netherlands) to bilateral treaties that neither the UK or the Netherlands have with Iceland. Moreover the Dutch Finance Minister Wouter Bos admitted that deposit guarantees are not designed to cover the case of systemic crises (see Sveder van Wijnbergen, NRC Handelsblad, 12 January 2010). And of course such guarantees are not a claim that can be instantly executed at the request of the depositor or his government, but a credit that can be challenged and tested in courts. It is not by chance that Alistair Darling still has not compensated foreign investors in Northern Rock.

The UK and the Dutch are at liberty to cover their nationals’ deposits with Icelandic banks but – until an agreement with Iceland not only has been signed but has also cleared all the protective hurdles put in place by the Icelandic constitution – they cannot unilaterally and automatically execute their resulting credits towards Iceland. The use of anti-terrorist legislation by Gordon Brown to seize Icelandic assets in Britain undoubtedly damaged Iceland’s credit rating and credibility; it was an outrageous, illegitimate insofar as it had nothing to do with terrorism, crass and aggressive move that backfired, notably the referendum initiative was taken by an Association that called themselves “Icelanders are not terrorists”. If Iceland needed a pretext to have second thoughts about the deal, which it does not, redoubtable Gordon Brown’s use of anachronistic gunboat diplomacy is more than enough.

Iceland is already over-indebted. Its stock exchange fell by 90% in the crisis, the krona has lost more than half its value against the euro since July 2007, and even the IMF reckons that “further depreciation of the currency would not be feasible, as it would raise the debt-to-GDP ratio to 240%. The Icesave deal would have done the same. The country’s ability to pay foreign debts – out of net exports – is limited” (Michael Hudson, FT 13 January 2010). According to an OECD economic survey (September 2009) between 2007 and 2010 Iceland's real consumption will have fallen by almost a quarter and domestic final demand by almost 30 per cent. Iceland can invoke customary provisions for "onerous debt". A renegotiation of the original settlement with the UK and the Netherlands would be in the interest of creditors as well: claiming the impossible is bound to result in obtaining less than if a more modest but feasible claim was put forward.

The same bullying tactics – not to say blackmail – that pushed Ireland into ratifying the Lisbon Treaty in last year’s referendum under threat of losing all kind of EU subsidies, are now being used to bully Iceland. Wouter Bos threatened an EU boycott and International Monetary Fund blockade, and a Dutch director of the IMF, Age Bakker, announced that all aid already committed to Iceland would be delayed – a decision that is not his to take but for the IMF Board of Directors, within which he would have to abstain on this issue because of his evident conflict of interest. This is a further disgrace, for neither the interests of Ireland nor those of the EU, or the interests of global financial stability, are changed by a jot with the settlement of a relatively small claim (by EU and IMF standards) with or without a dispute – a settlement which will have to be negotiated, or ruled upon in the European Court of Justice, but either way will be resolved in due course. There is no legal or moral case, and – more to the point – it is not in anybody’s economic interest, to imprison Icelanders in their own country for debt.

'Lord' Myners, the UK Financial Services Secretary, has said that if the deal with the UK and the Netherlands is rejected in the referendum, voters would “effectively be saying that Iceland does not want to be part of the international financial system” (Martin Wolf, cited). It is true that after the President’s decision Fitch has already downgraded Iceland debt to junk status (though not other rating agencies, who have refused to aid the pressure), but it is up to the Icelanders to decide at what price they want Europe and access to international finance. Not unnaturally Icelandic support for joining Europe has decreased significantly since the dispute: by last September a Gallup poll showed that 48.5 per cent now were opposed and only 34.7 per cent in favour. Support cannot have improved since then. The threat of not joining the EU might be treated by Icelanders as a welcome promise.

There are only two redeeming features of this particular Icelandic saga. One is Iceland’s small size. Small is not only beautiful, it is also economically manageable and digestible. €3.8 billion is chump change these days. Which offers the main, probably only ground left for hope in Latvia.

The other piece of good news is that, at the end of last October, McDonalds announced the closure of its three outlets in Iceland and said that it had no plans to return. This was due to the “very challenging economic climate” and the “unique complexity” of its operations (i.e. importing most ingredients from Germany at rising costs, with the Economist’s Big Mac Index still making the krona very much over-valued). Such a privilege for Iceland is shared with only Albania, Armenia and Bosnia and Herzegovina in Europe. A high price to pay for exclusivity, but a privilege nevertheless.

Saturday, January 2, 2010

The Year of the Tiger: Paul Krugman’s spurious case for protectionism

Free trade – domestic, international, global – is certainly efficient, provided that a large number of usually unspoken but well known conditions are satisfied concerning, broadly, the nature of technology, competition in the markets for goods and factors, and government policy instruments. Efficiency – in the Pareto sense of cost minimization or output maximization under constraint – is not a foregone implication of free trade, but it can reasonably be presumed until it is specifically disproven for a given time and given trade partners: the burden of proof rests with protectionists.

Paul Krugman, in his Chinese New Year (The New York Times, 31/12/2009) argues that China’s refusal to allow a revaluation of the yuan, on the strength of associated unilateral controls on capital inflows, justify the “very mild protectionism” that China is confronting at the moment. Should such an under-valuation persist, Krugman envisions and recommends the escalation of mild protectionism into “something much bigger”.

“China has become a major financial and trade power. But it doesn’t act like other big economies. Instead, it follows a mercantilist policy, keeping its trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory.”

“Here’s how it works: Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses.”
Yuan appreciation is prevented by Chinese restrictions on capital inflows and by its large scale purchases of dollars, leading to cumulative reserves of over $2 trillion. In the past Chinese dollar purchases contributed to keeping the US interest rate low (a mixed blessing, for it helped inflate a housing bubble). Today, “China’s bond purchases make little or no difference” to the US interest rate; instead, Krugman argues, “that trade surplus drains much-needed demand away from a depressed world economy. My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs”.

This is how Paul Krugman arrives at such a devastatingly high contribution to US unemployment. For 2010-2014 a Chinese current account surplus of 0.9 percent of gross world product has been projected (Blanchard and Milesi-Ferretti, two IMF top-officials, though speaking in a private capacity). This can be thought of as a negative trade shock to the rest of the world, actually slightly larger than China’s current account surplus because an identical shock would produce a lower surplus by depressing also Chinese trade. Ignoring this small correction, and assuming an average multiplier applying also to all other autonomous national expenditure items, of a plausible order of magnitude of, say 1.5, “we’re looking at a negative impact on gross world product of around 1.4 percent. Not huge — China isn’t the principal obstacle to recovery — but significant."

"And, if we think of the United States as bearing a proportionate share, and also use the rule of thumb that one point of GDP = 1 million jobs, we’re looking at 1.4 million U.S. jobs lost due to Chinese mercantilism.” (See Krugman’s post Macroeconomic Effects of Chinese Mercantilism, 31/12/09).

To buttress his argument, Paul Krugman quotes Paul Samuelson: ““With employment less than full ... all the debunked mercantilistic arguments” — that is [Krugman adds] claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He [Samuelson] then went on to argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.” (Krugman, The Chinese Year, cited).

Krugman’s argument is a Curate’s Egg: good, but only in parts. It is - up to a point - devastatingly right in his new-found support for protectionism, and it is irredeemably irrelevant with respect to yuan undervaluation.

If the economy is nowhere near full employment, as Krugman rightly notes to be the case, the domestic opportunity costs of both inputs and outputs are lower than their prices. This is, by itself, a sufficient case for government subsidies to lower prices down to opportunity costs, which for fixed production factors can be taken as close to zero, or for protection by means of a countervailing tariff. This regardless of whether there is an exchange rate mis-alignment. But what if the artificial undervaluation of an international competitor’s currency is so large that even bridging the domestic gap between prices and opportunity costs, or introducing equivalent import tariffs, domestic competitiveness cannot be restored? In that extreme case, there is simply no longer a case for protection, but only a case for wage restraint, or productivity promotion, or other competitiveness-enhancing measures.

What difference can it possibly make, from a competitor's economic viewpoint, whether a country is internationally super-competitive because of low wages – whether due to high unemployment, or low unionisation, strike prohibition or authoritarian rule – or high productivity, because of state subsidies or exchange rate undervaluation – whether due to direct controls or Central Bank market intervention? The prices at which China is willing to trade are what they are, the US can take them or leave them. If there is an advantage from US trade with China when China’s competitiveness is due to its low wages it will still be there when it is due to exchange rate undervaluation instead. Or not, as the case may be. Or won’t it?
Obviously when a country signs an international trade Treaty, or joins a Common Market, and a fortiori a Currency Union, concerns about fairness will induce all signatories to adopt general common rules enhancing competition, promoting institutional harmonization and economic convergence, preventing or limiting state subsidies, as well as tariff and non-tariff restrictions, while retaining the ability to introduce protectionist measures in cases of failure to comply with these rules. But Paul Krugman confuses the moral and legal right to implement a protectionist trade policy, in the face of unfair under-valuation, with the economic case for it.

The economic case for protectionism, or the lack of it, must be the same regardless of the ultimate source of a competitor’s super-competitiveness. And, by the way, I do not believe that Paul Samuelson might have referred to "nations ... effectively steal[ing] jobs from other countries" only in the case of under-valuation: any devaluation, if successful in improving the trade balance, exports unemployment regardless of whether it leads to an undervalued or an overvalued or an appropriate exchange rate.