Tuesday, March 24, 2009

Andate a lavorare!

Italian Prime Minister Berlusconi opened the high speed rail link between Bologna and Florence today (see picture). The original project dates back to 1973 - 21 years before he entered politics - so Silvio's claim of paternity for this useful bit of infrastructure is open to doubt. He did, however, offer words of encouragement to Italians seeking a way out of the recession: 'work harder'! (Maybe someone should tell him about 'aggregate demand').

Anyway, that set me thinking about the puzzle Berlusconi poses to political science. On the face of it, his involvement in politics does not seem to have brought good times to Italy - growth has been sluggish, promised institutional and administrative reforms have failed to materialize, corruption and misuse of public office seem as bad as ever (as documented by La Casta, a recent journalistic exposé of politicians' high living). His outrageous behaviour on the international stage (for example, his joke about concentration camps to the European Parliament) has heaped ridicule on his country and irritated powerful opinion makers (most notably the Economist - well, maybe he's not all bad).

Even worse than this, Berlusconi himself has gained very obvious private advantages out of his political adventure: laws have been passed to prevent him being convicted of various offences, his media empire has gone from strength to strength thanks to carefully designed laws and manipulation of the state television company (his only real competitor) by his government ministers. His sole response to Great Depression #2 has been to propose a deregulation of house building in Italy, an area in which he and his allies have big financial stakes. In short, he is doing well without doing much good.

Yet he remains stubbornly popular amongst a majority of Italians. Why? Isn't the electoral process, if nothing else, a neat mechanism for 'voting the rascals out'? How can a politician who is clearly extracting private rents from his control of the institutions, and shows no signs of having any solutions to the country's problems, keep getting elected?

One popular view, especially on the left, is that Berlusconi's control of the media allows him to brainwash the Italian public with propaganda, creating a false consciousness that lulls lower class voters into betraying their class interest.

There is some evidence for this: those who tune into Berlusconi's channels are disproportionately likely to vote for him. But there is, of course, an endogeneity problem there. And in any case, it takes more than the perma-tanned Emilio Fede to convince Italians that there has been any real economic or political progress in the last 15 years - you can fool some of the people some of the time.... Moreover, the mainstream press is rather less enthusiastic, so it's not as if there are no sources of critical news coverage.

Instead, we must reluctantly conclude that Berlusconi is giving a large chunk of the Italian electorate what they want: conservative economics (with a very small 'c'), lip service to Catholic values (of the kind only a hyper-rich divorcee with legal issues can offer), and enough money to convince the other right-wing parties - the Northern League and (now dissolved, in theory) National Alliance - to support him in parliament.

But hang on a minute: 'conservative' economics is one thing, but how do you get the votes of middle class Italians when the economy is stagnating?

By 'conservative' I mean precisely that - conserving the privileged positions enjoyed by a myriad of economic interests in Italy: taxi drivers keen to avoid an expansion of licences, small shopkeepers wanting to avert retail liberalization (small bookshops and media outlets excluded since Berlusconi owns the Mondadori chain), small businesses and self-employed professionals hoping for a light touch from the tax inspectors, banks seeking protection from foreign buyouts, property speculators anxious their corrupt deals will not be disturbed by the judiciary... and so on. Berlusconi protects these people from change, and ensures that the real costs of stagnation are heaped onto the salaried working and clerical class. Indeed, in a sense the stagnation is precisely a symptom of how successfully he has defended these groups (Olson's 'Rise and Decline of Nations' dixit)

So, Berlusconi defends broad social interests, like any other democratic politician. But just one part of the puzzle remains: why do these social interests tolerate Berlusconi's self-dealing, which has costs for everyone?

Because these costs are diffuse, rather than concentrated. All Italians have to put up with the poor quality and endless advertising breaks of Italian TV, but these costs are easy to bear (at least if you've never watched the BBC). And in the judicial sphere, Berlusconi has been pursued for largely 'victimless' crimes: again the costs of loosening the penal consequences of accounting fraud and tax evasion are mostly diffuse, whilst the benefits accrue to Berlusconi and his electorate in a fairly concentrated fashion.

In short, Berlusconi sells a product - the defence of conservative interests - at a price most conservative Italians think they can afford - a few favours for Berlusconi and his friends and family.

So the real puzzle is: why isn't politics like that everywhere? I'll save that one for another post...

Sunday, March 22, 2009

Becker's law: government sucks

Nobel prize winner Gary Becker has made an interesting contribution to the Financial Times' 'Future of Capitalism' series here.

His argument is basically as follows: OK, the financial crisis is serious, but even if we accept that free market capitalism is a cause of the crisis and subsequent recession, the gains from free market reforms over the past 30 years leave us still better off than we would have been. Moreover, we should beware of stimulus plans and regulatory responses that will threaten these gains. The basic principle should be 'first do no harm': for Becker, government interventions will tend to do more harm than good.

The main problem with this argument is that it implies that global economic performance has been better since the dawn of the new liberal, globalizing age under Reagan and Thatcher, than in the post-war era of Keynesianism, Bretton Woods and government interventionism. A quick look at the data suggests otherwise. The OECD provides some historical data for world GDP here:

Dividing the post war period into two 1950-73, and 1973-98, we see that:

World GDP increased threefold (201%) in the first period, and slightly more than doubled in the second (growth of 110%).

Broken down by region:
US GDP grew 142% in the first period, 109% in the second.
Western Europe grew 195% in the first, 68% in the second
Asia (excluding Japan) 219% and 277%
Africa 171% and 96%
Latin America 229% and 110%.
The former Soviet bloc more than doubled in the first period, and suffered negative growth in the second.

Now these are crude numbers (1973 is the start of the oil crisis, so creates a bias for the first period over the second; the neoliberal age is truncated at 1998), but at the very least they suggest that not everything changed for the better in the last 30 years. In fact, not much really changed between the 'Keynesian' and the 'neoliberal' eras, as can also be seen by this chart published by Jayati Ghosh here:

Claims for the success of neoliberalism essentially rest on the US growing faster than Europe since the 1970s, and the rapid emergence of China and India. The US is more 'liberal' than Europe; China and India have both adopted liberalizing measures. But so have Latin America and Eastern Europe/Russia, with unimpressive results.
In short, this hardly seems a basis for arguing that government activism always makes things worse. But Becker doesn't need evidence for such a conclusion: it's enough to know that governments consist of self-interested rational individuals who have no incentive to do anything for the benefit of society. QED.

Wednesday, March 11, 2009

inequality is bad for your health

Interesting report on the relationship between inequality and mental illness in the Guardian:


The basic story in this research (by Lynne Friedli for the World Health Organization) seems to be that even in rich societies mental health problems result from inequality - because of stress caused by income insecurity and status problems, which will be higher in more unequal societies.

This is intuitively almost obvious: a poor American in some neglected urban ghetto still usually will have a high income by world standards, yet it would seem ridiculous to argue that someone at the bottom of the social heap in the US will be happier than someone with average income in a poorer society (and nearly all societies are considerably poorer than the United States).

The implications of these findings are important. Even if we accept that there is a trade-off between economic performance and equality - which I don't - the fact that inequality may make people ill even when they're rich suggests that we should do without extra economic growth that is likely to be achieved at the expense of fairness and equity.

Of course, the high inequalities of the era of financial deregulation don't seem for the moment to have worked out so well in economic terms either. But the WHO research shows that even while that model seemed to be working, it was probably not working for most people and was positively noxious for quite a few.

Monday, March 9, 2009

seeds of destruction

Brilliant piece by Martin Wolf in the Financial Times:

Seeds of Its Own Destruction

Hard to find a better pithy account of what's happened to global capitalism, from one of those who knows it best. Note also that Wolf is on the 'liberal' (ie pro-market) end of the political scale, so his criticisms of free market dogma as applied to finance have a particular potency.

Sunday, March 8, 2009

Partisan politics and the economy

The history of postwar British economic policy is in many ways a history of economic policy in advanced democracies, in microcosm. In the 1950s and 1960s, governments of both right and left were committed to full employment, collective wage bargaining, and some role for the state in planning the future use of resources. The dominant economic orthodoxy of that time held that governments could usefully intervene to manage the business cycle and enhance the productive capacity of the economy by making investments with public money and regulating markets. Clement Attlee did it, Winston Churchill did it. Even Republican Presidents of the US did it.

In the 1970s, things changed. The Philips curve - an inverse relationship between inflation and unemployment, which allowed governments to interpret and manipulate the business cycle - broke down. Attempts to stimulate demand failed to increase output, but increased prices: what was called stagflation at the time. Keynesian ideas about how to run the economy were discredited, the 'monetarist' doctrine of Milton Friedman - which held that governments could not control the business cycle - gained ground.

The election of Margaret Thatcher's Conservatives in 1979 saw the abandonment of demand management as a tool to secure full employment. In the recession of 1980-2, the government raised taxes and interest rates to push inflation down, successfully. But the Philips curve was not quite dead - unemployment leapt to well over 3 million. Economic planning was abandoned, the welfare state was curbed, government enterprises were privatized, the financial sector was liberalized and attempts were made to reduce government expenditure and taxation and contain budget deficits. Similar policies were followed in the US (without the 'containing budget deficits' bit).

By the 1990s, many of these ideas and policies had become widely shared, even on the left. Bill Clinton and Tony Blair did not reverse Reaganomics and Thatcherism, although they adopted some policies to alleviate the growing poverty and declining public sector which had emerged as a new focus of public concern. Finance was deregulated further, and only half-hearted attempts were made to address the growing inequality of incomes driven in part by astronomical earnings at the very top of the income scale.

At the end of the 2000s, the world financial system collapsed. Vast amounts of public money were poured into a bankrupt banking system in the US by a Republican administration, a Democratic administration, and in the UK by a Labour government. Banks - the frontline of free market capitalism - came under effective government control.

What does this fable tell us?

Well, although there is nothing that surprising about a Labour government nationalizing the coal industry in the 1940s, and a Conservative government privatizing it in the 1980s, a lot of the time governments of both sides follow whatever policies are consistent with the economic fashions of the moment. So, Conservative governments in the 1950s did not reverse Labour's nationalizations, and Blair and Brown have not (except when forced into it) reversed Conservative privatizations. Moreover, however much the current Conservative leadership may protest, it is not obvious whether they would handle the current crisis in any fundamentally different way.

So does this mean elections change nothing? Not quite. Thatcher may have been doing similar things to Reagan in the 1980s, but France under Mitterrand and Spain under Gonzalez - both Socialists - did not follow the same path as the Anglo-Saxon countries. All western countries faced similar pressures in the past 2-3 decades - globalization, deindustrialization, slower growth, changing patterns of family life - but not all of them have seen inequality and poverty rise quite as fast as in Britain and the United States. Similarly, economic performance under these constraints also varies.

In short, the changes in British economic policy since WWII have been political choices made by elected politicians. Although not, of course, in circumstances of their own choosing, to coin a phrase. Not only are politicians constrained by events and global trends, they are constrained by available knowledge about how the economy works, and - probably more so - intellectual fashion. Until a year or so ago politicians could confidently dismiss the notion that more regulation was necessary to safeguard the financial system. That view is not heard quite so often now.

But in a democracy, intellectual fashion doesn't necessarily win elections. So the question to ask is not just why did British Conservatives get interested in the ideas of Milton Friedman in the 1970s. We also need to understand how they managed to convince British voters - including some who had little obvious reason to embrace these ideas - that inflation was more important than unemployment, and that free markets would make most people better off.

Friday, March 6, 2009

Printing money

In the this morning's GV101 lecture I mentioned that the Bank of England had decided to start injecting new money into the economy through quantitative easing.

Anyone interested in a basic explanation of what that means can find one, courtesy of the Financial Times, here.

Sunday, March 1, 2009

Chelsea pensioner

This week the British government finally got tough on banking's 'Fat Cats'. By inviting Sir Fred Goodwin, former head of the bankrupt RBS group, to voluntarily forego part of his £16 million pension package. I'm sure Sir Fred is giving the matter his full consideration.

One irony of this situation is that the recent neoliberal orthodoxy has held that our publicly funded pensions systems are unsustainable. Pay-as-you-go schemes in which workers paid contributions to finance current retiree pensions, and thus built up entitlements to their own future pensions, are a luxury we cannot afford. The aging population means that the delicate balance of working-age to retired citizens has shifted, and there will not be enough future workers making contributions for future pensions to be paid. The alternative is that individuals should make their own private provision, investing in pension funds which will pay out once they have stopped working.

The crux of the problem is that we are just too healthy these days. Even in the UK, which does not have a particular longevity 'problem' compared with healthier societies such as Japan or Italy, life expectancy at age 65 has shot up to 81 for men and 84 for women. This means than the average pensioner has to be maintained by P-A-Y-G contributors for 15-20 years. Can this be done?

Well, it can, provided we don't follow Fred Goodwin's example. He has retired, aged 50, with a pension worth £650,000 per year. This means a total payout in today's money (simple arithmetic with nominal figures) of £20,150,000 if he lives to 81 (I sincerely hope he does). That amount of money would pay for 4,272 British pensioners for a whole year at the basic state pension of £90.70 per week.

As a society, we have to come to terms with the fact that early retirement on generous pensions is simply a redistribution from this generation of the young to this generation of the old. This is the case whether the pensions are state funded, or privately funded - they still require transfers of consumption from the working age population to retirees either way.

Sir Fred's deal has made the case both for sensible and socially equitable retirement ages and for state provision. After all, the main alternative to public PAYG pension provision is private investment, and the collapse of the stock market resulting from irresponsible banking has destroyed the value of the pension funds on which the private option rests. Some desperately unlucky 65 year olds have financed bankers' generous pensions through the high management fees charged on their pension funds, and have ended up with under-funded pensions as a result of the banks' inability to manage our money properly. Privatized pensions look great when the stock market is booming, but... the prices of shares can go both up and down.

So maybe we should be grateful for Sir Fred. His remarkable performance as scapegoat for a discredited profession has made public provision of pensions look like a great idea again.