Thursday, May 31, 2012

The Eurozone: an economy without a state

In today's FT Martin Wolf, as ever, nails it (The riddle of German self-interest - FT.com). One of the peculiar features of the crisis is that the Euro was created with the express purpose of facilitating financial and commercial integration, and yet at the first crisis the Eurozone institutions have refused to backstop the cross-border financial commitments that have been made, leading to a flight for safety which has created havoc. Didn't anyone think this could happen?

Certainly the history of financial globalization offered a few hints. Eric Helleiner's excellent book States and the Emergence of Global Finance details the myriad ways in which governments backstopped the increasing financial integration of the period after the 1970s, most notably by stepping in to halt financial crises with bailouts. These bailouts confirmed governments' commitments to the newly integrated financial order and gave investors the confidence to continue treating the global financial arena as a properly functioning market.

The saddest thing about this whole crisis is that it underlines the fatal lack of understanding on the part of policymakers, and the academics who advised them, of how markets actually work. They designed institutions which essentially, like in Alan Greenspan's 'flawed' model, relied on market participants behaving rationally (whatever that means). Rational behaviour is, of course, difficult to define and operationalize, but one thing that we know for sure is that piling money into indebted states with a history of reneging on commitments and overinflated real estate markets was obviously outside any meaningful theory of the self-regulating market. It's time to recognize that the theory was wrong, and that the Eurozone, like any other economy, needs a government.

Wednesday, May 30, 2012

Why Spain is bust and Italy is only broke (again)


Despite a bad auction today, Italy seems overall in better shape than the rest of Southern Europe as the FT recognized today (Are Italy and Spain decoupling? | Brussels blog). It has run a primary deficit ever since the early 1990s, something way beyond the abilities of the other periphery countries at the moment. The reason for this is, ironically, the fact that Italian public debt has been at crisis levels for a couple of decades - Italy faced a huge fiscal crisis back in the early 1990s, which was resolved thanks to fiscal reforms and spending adjustments pushed through by more or less technocratic governments headed by Giuliano Amato, Carlo Azeglio Ciampi and Romano Prodi. Italy would never have qualified for the Euro had it not made this herculean effort. And although Berlusconi failed to maintain this downward pressure on the debt, his governments continued to run primary surpluses up until the crisis of 2008.

Clearly Italy has intractable structural weaknesses and the future is far from rosy. But at least it didn't delude itself with a glorious decade of debt-fuelled growth, like its Mediterranean neighbours to the East and West. This made the reckoning a lot easier to cope with, particularly since Italian banks don't seem to have abandoned their traditional caution when it comes to home loans and consumer credit. Things are bad, but not as bad as they could be, and if Italy is dragged into default, it will largely be the result of Eurozone-wide contagion, rather than its own specific weaknesses.

Anyway, the point of this post is largely to crow about the fact that I made this point a couple of years ago.

Monday, May 28, 2012

Spain heading for bailout

It's hard to imagine anything more inevitable than Spain needing a bailout, and soon. The Rajoy government's latest trick - recapitalizing a bankrupt bank, Bankia, with bonds from a near-bankrupt state, Spain, is probably the final straw for investors who are paying attention. Bankia, in turn, has been suggesting that one way to return to profitability is to reduce its tax liability: in other words, to help the Spanish government get its money back, they will endeavour to pay less money to the Spanish government.

This is what hiring the likes of de Guindos achieves. After all, employees of institutions like Lehman Brothers are essentially trained to make money through tax avoidance/arbitrage and clever accounting, rather than generating real wealth through smart investment. The Spanish government is now in the hands of people whose ignorance and arrogance led the country into this mess, in both the political and the financial institutions. Rajoy turned a blind eye whilst corrupt regional leaders like Camps and Aguirre fuelled real estate booms which paid for their vote grabbing and created the conditions for today's tragic scenario.

Now it's all down to Europe. Will they blink, or will they bail? Almost certainly they will bail, just like in Greece, but in such a way as to make recovery impossible. If they let Greece go, who will buy into Spain? The endgame approaches.

Thursday, May 24, 2012

An explanation of moral hazard that even Angela Merkel can understand

So, Europe still doesn't want to face up to the Euro crisis. In simple terms, the contours of the problem are that a) there will be depression and potentially meltdown if the Southern European debt crisis isn't resolved and b) resolving the Southern European debt crisis would create moral hazard. So we will have a) because we don't want the outcome of b). This takes the superficial form of pretending that beating up on Greek politicians will improve their economy and solve the debt problem.

The trouble is that a) also creates moral hazard, and b) doesn't necessarily exacerbate it. The former is shown by the experience of Lehman Brothers, which I blogged about at the time (yes, this blog is well into middle age in blog years). The catastrophic effect of the Lehman collapse more or less ensured that western governments would never let a major financial institution fold ever again. So the moral hazard effect was the opposite of what  we expected. If Greece is allowed to collapse, it will most likely create major upheavals in the financial system, and policymakers are very likely to decide, a la Lehman, that they don't want to go through that again. So Spain, Italy and the rest will feast on moral hazard.

The second point is that Greece being bailed out now would probably not have anything like the perverse moral hazard effects people like Merkel fear. After all, Greece has been in recession for 5 years, has living standards that are back to those of a decade ago, 25% unemployment, and a future of stagnation ahead. Do we really think Greeks will interpret a bailout as an invitation to spend like crazy and have to go through the whole experience again, just because in the end they were bailed out?

Of course, the real problem with the moral hazard argument is that we are not talking about a person, but a country. If Greek institutions suck, it's because Greece has not managed to create good institutions. Do individual Greeks need to be impoverished in order to encourage them to overcome all their collective action problems and build a Swedish/German style state? Do we really think it's that simple? Decades of political science literature still leaves us pretty uncertain about how you get good institutions. Although one thing we do know is that they are usually correlated with economic progress rather than collapse.

Tuesday, May 22, 2012

No democracy please, we're Europeans

So David Cameron wades in on the Greece crisis - sense of irony failure there I think.

Anyway, the Greeks are coming under pressure to vote for mainstream, pro-austerity parties, despite having voted for something else less than a month ago. This tells you everything you need to know about the role of democracy in the Eurozone.

In fact, the decline in democratic accountability is not an accident: it is the result in part of a certain demobilization of mass electorates in western countries, which has a variety of structural causes, but in part also of the determination of powerful interests to remove popular consent from a range of key economic decision making arenas. This, in turn, exacerbates the trend towards popular apathy, or at least resignation.

So currently, a set of institutions of 'governance' in the Eurozone have not only allowed a disaster to take place, but have also blocked any proper discussion of alternative ways out of the disaster. So the key actor in the management of the crisis is the ECB, an entirely unelected and unaccountable body with a tight connection to the world of finance, and largely impermeable to other interests. What makes you think that an institution like the ECB would ever be inclined to adopt policies in the interests of the non-rich majority of the Eurozone population?

The role of electorates, in the ECB/Merkel view, seems to be to elect governments that will follow policies the ECB, and by extension financial interests, want, even if this is going to lead to all of the burden of adjustment falling on the bottom 90-odd%. The Euro system was deliberately designed in this way to avoid politicians responding to popular demands for spending and low taxes. Clearly popular policies are not always in the long term interests of an economy, but surely it is the job of the democratic institutions to determine what those are?

What we have now is a technocratic approach to government which is not only democratic, it is very likely applying the wrong policies. If we have to have wrong policies, let's at least choose them through democratic means. And who knows, given the chance people might surprise the political class and the economics profession by choosing governments and policies that work in their interests.

Friday, May 18, 2012

The impossibility of austerity


One of the best pieces I've read on the Southern Europe debt crisis: EconoMonitor : EconoMonitor » Europe’s Depressing Prospects: Two Reasons Why Spain Will Leave the Euro

The following (a quote from Ambrose Evans-Pritchard) is particularly eloquent:


Berlin seems to think it can lock in a current account surplus with Club Med in perpetuity. Clearly, such as an arrangement is mathematically impossible within a currency union – unless Germany is willing to offset the surplus with flows of money for ever, either through fiscal transfers or loans or investment. These flows have been cut off.

So simple, and yet so difficult for many powerful people to grasp.

I still think Germany and the EU powers that be will blink first. But if they don't change course soon this will be a catastrophe.

The politics of crisis

So with the collapse of the Greek party system attention is turning to the politics of the crisis. About time. There's an interesting paper by Mian, Sufi and Trebbi about crisis provoking inequality and then political polarization, which in turn blocks reforms and makes exiting from crisis more difficult (Political constraints in the aftermath of financial crises | vox).  A couple of thoughts.

First, I'm not sure inequality provokes political polarization, at least at the level of the party system. The US, everyone's favourite case, seems to back this theory, until you consider that the Democrats have actually been moving rightwards over the past quarter-century - they just haven't been moving quick enough to keep up with the Republicans, who are dropping off the edge of the democratic spectrum. Sure, there is a lot of potential for inequality to result in polarization, but when an institutionalized party system fails to pick up on this potential, it won't emerge.

Second, although there is plenty of evidence of political parties actually forming a pro-liberalization cartel, rather than polarizing, whilst inequality rises, this can't necessarily hold forever. In Greece, we have seen what happens when the crisis hits extreme levels - people reject existing parties and vote for minor, usually more radical, political forces. So the effects of crisis could well produce polarization, but first the existing party system - which have so far tended to cartelize around austerity and further liberalization - has to collapse. I don't think Greece will be the only case, but so far the cartel is holding in Spain, Italy and Portugal (and in Ireland to a lesser degree). So far elections in western countries have almost always overthrown the incumbent, but have also almost always returned the established opposition. In Greece, it took a third post-crisis election to usher in the crazies. We'll see if that happens elsewhere - Italy 2013 is a good candidate.

Finally, it's not surprising that political parties are struggling to impose 'reforms'. First, these reforms won't necessarily produce much growth - their impact is likely to be marginal in the short run. The fact that liberalization measures are associated with the ideas and institutions that brought us casino capitalism and unsustainable housing bubbles doesn't help. But the second point is that even if the reforms were a good idea, political parties in western democracies no longer have the legitimacy and authority to impose them against the predictable opposition of affected groups. The last 30 years in the west have seen not only liberalization, but also party decline, with party membership, voter partisan identification and voter participation all falling across western countries. Parties are not what they once were, as Philippe Schmitter put it a few years back. We are facing a situation of unprecedented economic stress with not only indebted governments, but tired and fragile political institutions. Not good.

Fox: fair and balanced

Not much blogging recently - there is too much to blog about...
But I did have time to pen a letter to the FT responding to Liam Fox's ridiculous piece about German economic strength: here it is.

Friday, May 4, 2012

Can Trade Unions be 'extractive elites'?

Acemoglu and Robinson's latest epic is sitting on my desk. They've helpfully set up a blog about the book, with comments and responses to reactions, including Francis Fukuyama's surprisingly powerful hatchet job. Anyway, their latest post comments on a review by the Economist's Buttonwood column, which suggests that present-day examples of 'extractive elites' - the key concept in Why Nations Fail - are bankers and public sector trade unionists.

Like the first one. The second one, not so much.

A & R are receptive to the first idea, on grounds that most informed opinion seems to accept by now - that super-rich bankers that brought the world economy to its knees through reckless gambling may be a good example of an extractive elite, ie one that 'extracts resources from the many for the few'. I think that is a pretty hard case to rebut, given recent experience.

What I don't get at all is how public sector unions can fall into the same category. After all, even in countries with a small public sector, we are still talking about 'many' people here. The more people that have to extract resources, the less people are left to extract resources from. Put another way, the bigger the group is, the more the group has to 'internalize' the consequences of its extractive behaviour. This is the reason why successful extractive elites have to be - well - elites.

The second point that needs making is that unions, battered by the negative press of the last 30 years or so, are ripe for a rebranding. A & R reasonably enough state that they 'don't know the answer' to the question of what role unions can play in dealing with the current problems of inequality and stagnation. Respectfully, I suggest that we in fact know quite a lot about unions. We know that the countries that have the highest union density have emerged the healthiest from the financial crisis (Germany and small Northern European states such as Sweden), whilst countries with weak unions are in a terrible mess (the UK and the Southern European countries all have small and declining union membership). We also know that union density is highly correlated with higher median earnings:




(courtesy of Think Progress)

All the evidence is that having strong unions is a big advantage in the recent period, both for equality and for overall economic performance. Of course, there could be all kinds of endogeneity problems here (eg, unions decline where they become disfunctional), but on balance higher union membership has to be a good thing, because 'encompassing' unions internalize the costs of their behaviour, incentivizing pro-growth policies.

In short, unions are the opposite of extractive elites. Even in the worst case, they can't extract that much without damaging themselves in the process. Strange that the Economist can't see the difference between unions and bankers.