Wednesday, December 28, 2011

The game's up

John Quiggin at Crooked Timber declares a neat little victory over Stephen Williamson, who had trashed his Zombie Economic books on his blog, and later for the Journal of Economic Literature. Quiggin points out that one of Williamson's rhetorical tools - the claim that some of the theories Quiggin critiques are actually tautological - implies that those theories are entirely pointless, and scientifically worthless.

While this was just a petty aside in a blog post, it could be safely ignored. But now the same points have been made in the august JEL, a house journal of the American Economic Association, they acquire a cachet which means they can't be so easily dismissed as Aunt Sallies.

I'm pleased to see this problem get a bit more attention because I've always been frustrated at how economists and rational choice theorists in general play bait-and-switch with the rationality assumption. Obviously if anything can be rational, then rational choice cannot make substantive predictions. But at the same time, the claims that are usually made in the name of rationality are far tougher - ie that people are self-interested, rational and capable of complex calculations about their material interests. The tautological rationality assumption is only wheeled out when the latter claims run into trouble (which they generally do when we try to explain non-trivial problems).

So, as Quiggin says, whenever we want to make this kind of point, we can just cite Williamson 2011 in the JEL.

As a footnote, I love Williamson's introductory paragraph, which states that 'in economics, the 2008-9 financial crisis has resulted in renewed appreciation of advances made in information economics, the theory of financial intermediation and monetary economics'. Which is like saying that collapse of the Berlin Wall brought renewed appreciation of advances in our understanding of Soviet communism through the 1980s, or that 9/11 alerted us to our most cutting-edge findings in the study of international terrorism.

Saturday, December 24, 2011

Thursday, December 22, 2011

Gis' a job!

Nice one. Via Brad DeLong, Jim Henley explains the otherwise inexplicable: the Lib Dems remaining in this Conservative government.

It all makes sense if you start to think about what Nick Clegg plans to do when his political career is over (circa 2015) - get a well paid job in the corporate sector. And how do you get offered a well paid job in the corporate sector? Well, not by reforming the banks, penal tax rates on bonuses, and help for the poor, that's for sure.

This raises a broader question: How much is the general shift towards pro-rich policy over the past decades explained by the failure to generate a political elite that actually responds in any serious way to popular demands? This angle certainly sounds more plausible than the alternative - that somehow median voters became convinced of the need to line the pockets of the 1%.

Martin Wolf on inequality

Martin Wolf takes on inequality in today's FT. He points out that a lot of the increase in inequality in the UK is down to an increase in the dispersion of male earnings, and that

some – perhaps a great deal – of the ultra-high incomes at the top are almost certainly the fruit of rent extraction facilitated by a breakdown in the control exercised by principals – outside investors – over their agents – corporate executives and financiers. Huge rewards then are both unjust and inefficient.

This is the key point - any pretence that inequality might be the price to be paid for economic dynamism cannot survive the events of the past three years. Hopefully this realization can spread beyond the pages of the FT fast.

Print and be damned

It looks that the ECB is finally, by a circuitous route, doing what needs to be done. It remains to be seen whether it will do enough, but the combination of nearly half a trillion euros - in one day - in cheap loans to banks, with the acceptance of troubled sovereign debt as collateral, is a step in the right direction. The direction, that is, of acting as a lender of last resort, despite German protestations.

This is a smart move by Mario Draghi, who talked tough on bail-outs, then effectively ate his words, but did so in such a way as to leave most German voters unsure as to what has really happened.

Anyway, this is just a start. The austerity medicine will still depress Southern European economies, and monetizing slices of their debt just as we approach the abyss is not exactly going to resolve the problem.

Wednesday, December 21, 2011

Is there such a thing as moral hazard for nations?

Just in case you needed any more reasons to oppose austerity, here's another, outlined in this neat and evocative Guardian piece ('Europeans migrate south as continent drifts deeper into crisis): emigration.

Yes, in a development that has probably never occurred to Europe's blinkered political leaders but is blindingly obvious to anyone residing in the real world, young, ambitious and dynamic European citizens are escaping from the misery of austerity and seeking a new life elsewhere, often outside the EU. It is hardly worth pointing out the obvious implication - that austerity is even less likely to work if the most productive sections of society are bailing out and leaving the pain behind.

This is neat in all sorts of ways, but what I find intriguing about it is the stark distinction it draws between the collective responsibility of debtor nations and the individual responsibilities of their citizens. So Greece must suffer for its mistakes, otherwise moral hazard will encourage it to behave badly in the future; but of course there is nothing stopping individual Greeks leaving the sinking ship and evading the punishment.

This reminds me of a neat piece of prose on the crisis by John Lanchester, who has made more sense out of this mess than many economists. In a piece published in the London Review of Books last summer, he noted the following:

From the worm’s-eye perspective which most of us inhabit, the general feeling about this new turn in the economic crisis is one of bewilderment. I’ve encountered this in Iceland and in Ireland and in the UK: a sense of alienation and incomprehension and done-unto-ness. People feel they have very little economic or political agency, very little control over their own lives; during the boom times, nobody told them this was an unsustainable bubble until it was already too late.

In consequence, people don't feel that the crisis was in any real sense caused by them:

The austerity is supposed to be a consequence of us all having had it a little bit too easy (this is an attitude which is only very gently implied in public, but it’s there, and in private it is sometimes spelled out). But the thing is, most of us don’t feel we did have it particularly easy. When you combine that with the fact that we have so little real agency in our economic lives, we tend to feel we don’t deserve much of the blame. 

It's difficult to argue with this. But irrespective of whatever moral responsibility an individual Greek may bear, there is no law whatsoever against him or her leaving the country and starting afresh, washing their hands of the whole mess.

A kind of citizen's default. So much for moral hazard.

Sunday, December 18, 2011

It's all covered by Road Tax

Stat of the week from the blog Man's Greatest Mistake: the total cost of all motor vehicle accidents in the UK for a year is: (drum roll) £18 billion. That's about 1% of GDP, or, put another way, about 15% of the government deficit.

So not a trivial amount of money.

I've been thinking for a while that actually, reducing car use is one of the best ways of increasing living standards. After all, many families on middle to low incomes have one or sometimes two cars, and the associated costs are enormous. Providing people with alternatives, through more public transport investment and traffic calming to make cycling more attractive, would basically make people richer. And that's before we start to consider the environmental benefits.

It's a no-brainer, but of course a very radical change to get people used to. But on the other hand we're going to have to do it one day, so why not start now when we have a bunch of other good reasons to do it, like avoiding a second great depression?

Friday, December 16, 2011

Joseph Stiglitz explains the depressions

Fascinating piece in Vanity Fair by Stiglitz. He argues that the implosion of financial sector was a symptom of broader structural dysfunctions in the economy, involving the transformation from an industrial to service-based economy. He develops the argument but comparing with the 1930s, where the collapse of the financial system was in large part an effect of the difficult structural change from an agriculture-based to an industrial economy.

This is important stuff. It carries two broad implications. First, fixing finance alone won't solve the problem. It is an essential pre-requisite of exiting the crisis, but there also needs to be a fundamental shift towards a services-based economy, achieved through state intervention to retrain workers and make the investments needed to hasten the transformation. The private sector won't do it alone, and currently policy, by depressing demand, simply locks us into a downward spiral.

Wednesday, December 14, 2011

How to increase your debts by saving more

When it comes to understanding the crisis, it's still hard to beat Krugman. By explaining IS-LM to a popular audience (including me) he's doing a great service, and I read today's blog post after seeing this chart (courtesy of Richard Koo), which shows that the UK government deficit is paralleled by a big increase in private saving.


According to IS-LM deficit reduction, unless it is counteracted by a dramatic increase in private borrowing (in a credit crunch?) will simply shrink GDP, because this is the way that desired savings get to match desired investment.

So if we really save hard enough, our incomes will shrink enough to make our savings as small as the paltry levels of investment we're currently suffering.

Look at the IS-LM graph long enough and a smaller deficit looks less appealing.

Saturday, December 10, 2011

Britain's loss, Europe's gain?

Fascinating piece in The Economist about the Euro summit and Cameron's 'walk out'. The interesting thing is that the article discusses the whole issue from the point of view of the kind of pro-free market Anglo-focused angle typical of the Economist.

It finds, with impeccable logic, that Cameron, and the British right, have been roundly defeated. After all, what does a 'walk out' mean? Either that we stay in the single market but with no real influence on how it's regulated, or we leave the single market and see investors take a detour around us as they seek access to a market of over 400 million people. Even the City, which Cameron purports to defend, could well ditch us and head to Frankfurt (after all, the City is basically an offshore arena for American banks, and stopped representing indigenous capital sometime in the 1960s).

Doesn't look good. Unless of course you want to take Britain back to the 1950s, which is precisely what most Conservatives really aspire to.

One step from disaster

A pretty good assessment of yesterday's summit outcome from Tim Duy's Fed Watch (via Mark Thoma).

In the end, this mess is entirely a political one. Not that economists aren't in large part to blame, but the key point is that some economists have figured out what the answer is, but too many politicians find it convenient to stick to the line that made some kind of sense until 3 years ago, but makes no sense at all now.

So what we need is a theory of economic policy lunacy.

Thursday, December 8, 2011

Weber's revenge


Markets have faith in Protestants (% of Protestants in population, by logged 5 year CDS price today).
The Rsq without Greece is .45, meaning that Protestantism predicts almost half the variation in the log of CDS prices.

Quite why Protestantism is related to the perception of fiscal responsibility is one for another post.

Tuesday, December 6, 2011

Monday, December 5, 2011

When will Germany start living beyond its means?

In most of my posts on the southern Europe debt crisis I've focused on the contractionary nature of fiscal retrenchment, and the 'paradox of thrift' it engenders - that by retrenching, Southern Europe risks shrinking its GDP, thus cancelling out any putative gains from austerity.

Paul Krugman, in response to Ezra Klein, reminds us that there is another big obstacle to this strategy: that Southern Europe cannot recover without unwinding its trade deficit, and its trade deficit is the counterparty to the German trade surplus.

In other words, are the Germans willing to run a trade deficit to make this happen? Because if they are not, it's not going to work. And nothing I've heard out of Berlin recently sounds like coming close to recognizing this.

Elementary, Signor Monti

Fascinating stuff - yields on Italian debt dropped sharply today (FT Alphaville » Signor Monti, sensazionale). Monti's €27 billion of contractionary budget cuts and tax rises really did the trick...

The fact that Spain's yields did much the same suggests a momentum behind the Euro crisis management strategy of Merkel and Sarkozy. It also suggests that should this week's summit fail, we could pretty quickly be back to where we started last week.

All of this goes to show that policy's real effects seem to matter less than their effects on expectations, and that countries like Italy and Spain are only at risk of default if markets think they are at risk of default. There is nothing remotely rational about our current financial arrangements.

'via Blog this'

Munchau is depressed

Reading Wolfgang Munchau is not a lot of fun at the moment. His doom-laden pronouncements are all the more depressing for the fact that he is almost certainly right to predict that France and Germany look set to fudge it yet again.

In any case, at least the scenario is becoming clearer. The ECB will probably act if given the political backing, as Draghi suggested the other day. But Merkel only seems to want ECB action if the Southern Europeans commit to open-ended austerity. This is politically implausible, as well as being almost certainly economically counter-productive.

So here we are. If we were a game theorist, I could probably write a nice paper about this. It's basically a Prisoner's Dilemma game, but I fear it's an unbalanced one, because I'm not sure the Germans even understand what the cooperative outcome would be. So they dig in their heels.

Let's just hope they blink, because they're going to be dragged down by this as much as anyone else. What price those years of 'sacrifice' for competitiveness if they end up with a Swiss exchange rate and an insolvent banking system?

Sunday, December 4, 2011

George Osborne's U-turn

George Osborne has turned Keynesian:

"We need to put to work the many billions of pounds that British people save in British pension funds, and get those savings invested in British projects. You could call it British savings for British jobs," he said in the autumn statement, adding that the government was exploring guarantees and ways of letting city mayors borrow against future tax receipts in an echo of the vast municipally funded works that built Britain's water, sewerage and road network in the Victorian era, as well as hospitals and schools"

Exactly how is that different to the deficit spending that the government refuses to contemplate?

The Monti treatment

Contractionary measures for contractionary times (Monti outlines tough measures for Italy). €27 billion taken out of a stressed economy, which is also suffering financial uncertainty on a colossal scale.

Can any of this work? Yes, but only as an offer to the Gods of austerity, giving them the political offer to authorize a monetary bailout through the ECB.

Peculiar how entirely irrational policies can become rational, if they are designed to encourage irrational leaders to do rational things.

Wednesday, November 30, 2011

Feldstein on Italy

Martin Feldstein weighs in on the Euro crisis (Italy can save itself and the euro), and makes some interesting points.

First, as Feldstein notes, Italy has a huge stock of debt, but it's flow situation is not that bad - it has been running a large primary surplus for years, unlike Greece. It could reduce its deficit and enhance market confidence with realistic adjustments to taxation and spending. This is an important point, since the measures asked of Greece are truly impossible to successfully implement.

Feldstein also makes another good point - that with public spending running at half of GDP, there must be savings that Italy can make somewhere. This is clearly true: Italy has a public sector that wastes resources on a truly awesome scale. However, it is also true that any major cuts will be contractionary in the current climate, and could reduce what little growth Italy has in store.

And that brings us to another point. As Feldstein shows, that required fiscal adjustment, with measures taken to increase growth, could quickly rebalance the situation. But if the reforms needed were so easy to achieve, maybe they would have been implemented already, given Italy's poor economic performance over the past two decades. Clearly, the time for such reforms was in the more buoyant climate of the late 1990s and early 2000s - now they will probably have contractionary effects.

That all said, there is a lot of low-hanging fruit when it comes to possible reforms. More women could be encouraged in the labour force very easily (see the weird but interesting proposal by Alesina and Inchino to reduce employment taxes for women), competition could be usefully introduced into some closed markets (the 'professions', local transport, retail). A bonfire of pointless regulations could save a lot of time and energy for businesses and citizens and allow resources to be deployed more productively.

The trouble is, there is at present no political constituency for these measures. The majority position in Italy is economic and cultural conservatism, with occasional bursts of intolerance towards groups such as immigrants that are key to the country's future. Berlusconismo has to be defeated before anything good can happen.

Monday, November 28, 2011

The Euro elite

Reuters reports that Germany is planning 'elite' bonds with 5 nations. So this is still all about saving Germany's skin? The only reason to be hopeful about a development like this would be if it was a preliminary step to a bailout of the periphery. But that bailout needs ECB intervention, and I can't see how a 'hard' Eurobond makes any difference to that.

Saturday, November 26, 2011

The German burden

Paul Krugman once again puts the boot in (Mysterious Europe). What occurs to me reading this post is that ultimately all that the Germans would be required to do to resolve the problem is allow the ECB to backstop Southern European debt, and in the meantime spend some (preferably all) of their surplus on Southern European products.

So, we are inviting the Germans to spend some nice holidays in Greece and Spain, preferably eating lots of good local food, and buy a bunch of Gucci handbags and the odd Ferrari.

Is that really so much of a sacrifice?

'via Blog this'

Thursday, November 24, 2011

Understanding the Euromess

Great lecture from Barry Eichengreen - Europe's Never Ending Crisis (link courtesy of Mark Thoma). All you need to understand the basics of what is going on in Europe.

Wednesday, November 23, 2011

Chart of the week

Here's great chart courtesy of Nick Andrews. It shows the bond yields for Eurozone countries from the early 1990s to the present:



Yet further proof of the efficient markets hypothesis, if you ask me.

Reform, reform, reform!

The technocratic turn in the Euro crisis has brought us yet more talk of 'reform'. German central bankers grimly warn that there can be no quick fixes and that debtor countries must 'reform' in order to save the euro. But what do they mean by reform?

There is a deep irony in all of this. Germany spent close to two decades being lectured by the Anglo-Saxons about 'reform' - the German social market economy, based on social partnership, long-term investment, strong social protection and a heavily regulated service sector, were singled out by neoliberals as the reason for Germany's weak economic performance after reunification. And Germany did reform - the Hartz measures moved the German social model in a more liberal direction, permitting the creation of more low skilled and low paid jobs and reducing welfare entitlements, at least for some workers. And lo and behold, Germany quickly shed its reputation as the sick man of Europe and is once again calling the shots in Europe.

How much of this is down to 'reform', rather than Germany's rather conservative consumer culture, is a difficult question to answer. However, one simple point that can be made is that Germany is not the only country in Europe that has 'reformed'. Italy and Spain have both had waves of labour market reform and important institutional changes in financial markets. The obvious implication is that reform is not necessarily a solution to anything, and that we need to be a bit more specific about what reform means.

One good example of this is that the dominant orthodoxy of the last couple of decades has been the deregulated capital markets were good for both stability and growth. Ahem. Germany actually resisted reform in this area (the famous Mannesman takeover by Vodafone led to a more restrictive law), much to the disgust of Anglo-Saxon observers. Meanwhile Spain embraced contemporary financial practice much more enthusiastically, resulting in an unsustainable housing boom which has left the country deeply exposed in the current crisis.

The Euro crisis is bad for everyone, but the pain does not seem to correspond in any consistent way with the extent of reform in the various European countries. It is not easy to see how more of this ill-defined reform is going to solve the problem.

Tuesday, November 22, 2011

The myth of technocracy

Paul Krugman has written a great Op-ed (Cruel Euro Romantics) which, as usual, nails it.

The arrival of technocrats at the helm of two of Europe's most stressed governments has been largely welcomed by people who should know better. And indeed, no genuine democrat can really regret the demise of Silvio Berlusconi. But what exactly can technocracy offer us in the middle of this terrible crisis?

Well, they don't have a magic wand, for sure. Times remain tough, and Italy's bond spreads have merely stabilized at the unsustainable levels they reached under Berlusconi. But, as Krugman argues, the problem with technocracy goes further - that in fact, these technocrats are the ones who got us in this mess in the first place, with their fantasy world of a diverse Eurozone gliding seamlessly towards convergence under monetary union. Why on earth should anyone have expected this to happen?

So these technocrats are really 'romantics' - rather than robotically applying the findings of the best economists, they chose instead to invent for themselves an imaginary world in which the Euro would succeed where other monetary experiments had failed. Krugman, of course, argues that the failure of technocracy is their choice to use the wrong kind of economics, and that the right kind - his kind - would allow us to solve the problem, or least avoid catastrophe. I'm inclined to agree. But there is something else here that Krugman misses.

The other problem with technocracy, is that it does not engage the people. In fact, this is the very point of it. Technocrats have the theories and facts to make the right decisions, so they should be left to do it, free of the daily noise and fury of politics. But even if they had the right policies, they still have to convince the people that their policies will deliver some approximation of the collective good, otherwise the compliance with rules and norms any society rests on will break down.

This is the colossal failure of the European Union. It is bad enough that they designed institutions that have left us on the brink of disaster. But worse, they did so without ever bothering to explain what the benefits, costs, and likely risks of the project were. Now, again, the European policy elite wants us to write another blank cheque to the same people who have already let us down. It can't work.

Published thoughts on Italy

Piece for Foreign Affairs: How Italy's Democracy Leads to Financial Crisis.

Blurb: Monti’s appointment fits an established Italian pattern: fiscal laxity under populist center-right governments followed by brief emergency periods of technocratic austerity under the center-left and EU. To make fiscal responsibility stick this time, Brussels should back Monti as he builds up a popular mandate for gradual reform.

Friday, November 18, 2011

Time for Germany to show leadership

Great piece by (interest declared) my friends Matthias Matthijs and Mark Blyth in Foreign Affairs: Why Only Germany Can Fix the Euro. They argue that Germany is copping out of its responsibilities: 'As the eurozone's biggest economy, it was Germany's job to stabilize the system when the first signs of financial trouble appeared. Instead, it did precisely the opposite. Whether the euro survives depends on Frankfurt finally assuming its role as leader.'

The argument is similar to Wolf's but punchier. And there are some valuable home truths thrown in. That Germany's virtue is the mirror image of Southern Europe's supposed vices, that Germany can only be like Germany if others are like Greece, that deflation can only end in disaster, and that the answer lies with the ECB acting as a lender of last resort. Some great data snippets in there too: the Euro engineered the colossal current account imbalances within Europe that have created the problem. So

Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion.

Basically, the Euro locked Southern Europe into acting as the borrower of first resort for German savers. Then when the music stopped, they asked for it back, all at once. Too late.

Martin Wolf on Italy

A characteristically clear and articulate analysis from the FT's Martin Wolf: Europe must not allow Rome to burn. Wolf argues that Italy can survive the crisis, but only with strong support from outside, and that means Germany authorizing the ECB to backstop Italian debt.

Given Guido Westerwelle's obtuse offerings in the same newspaper yesterday, the chances of this happening don't look good.

Thursday, November 17, 2011

Important news just in

You turn if you want to

Like the markets, I'm oscillating between fear and terror on the future of the euro. On a good day, I'm simply deeply worried. On a bad day, I stick my head under a blanket. This article by Guido Westerwelle (Germany is not for turning on how to save the euro) is actually the kind of thing that keeps me under the duvet.

As well as the ritual commitment to standing firm and avoiding easy get-outs (we prefer to do things the difficult way), Westerwelle shows a touching faith in 'reforms'. So, he states, the way to tackle the immediate crisis is for 'Greece’s government (to) without further delay adopt and implement the necessary reforms'.

Right. Presumably in a minute he'll tell us what the reforms are. Yes, here goes: 'Only when states regain trust by immediate and thorough reforms, can the crisis be overcome.'

Yes, couldn't agree more. So, these reforms are....? Well, he doesn't say, but he does mention that 'Putting the European Central Bank’s printing presses to work... would have dire consequences, both raising inflation and dissipating vitally important incentives for reform'.

So reform is the key. The thing is, there are reforms and reforms. Germany spent most of the last two decades resisting reforms that Brits and Americans insisted were necessary to drag it out of the post-unification torpor. It did make major changes to labour markets and the welfare state, but avoided reforms in a host of other areas. So not all reforms are good reforms, at least for Germany.

Southern European countries have also adopted reforms. Labour markets have been liberalized, financial markets opened, public spending cut, pension ages increased. Not just now, but well before the crisis. Some of these reforms were beneficial, maybe some didn't go far enough. But the notion that reform will solve everything assumes that we know what reforms will restore growth, competitiveness and fiscal stability. And we don't.

Hanging the fate of the Euro on a vague and untested programme of 'reform' is wishful thinking at its most dangerous. It won't work politically, and it probably won't work economically. And it certainly won't deal with Germany's €182 billion trade surplus, which it lent out to the rest of the Eurozone thus creating the debts that we're all worrying about.

Wednesday, November 16, 2011

Monday, November 14, 2011

Bunga bunga economics

Only just noticed this great op-ed by Paul Krugman.

Apart from the great opening line 'this is the way the euro ends — not with a bang but with bunga bunga', the really interesting point is this:

"Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. "

I've long believed that Europe was the main reason Italy had not ended up like Argentina. Maybe I was over-optimistic.

Economists at work

Research by Mark Hallerberg and my LSE colleague Joachim Wehner finds that Economically-troubled countries are more likely to be led by those with economics training.

Although my colleagues suggest the causal chain runs the other way, it doesn't look good for Papademos and Monti... More seriously, placing faith in technocrats might make more sense if they hadn't been such enthusiastic promoters of the particular model of monetary union that has created this mess.

The Monti effect

Sunday, November 13, 2011

Depression or Inflation?

Nice post by Simon Johnson at The Baseline Scenario: Johnson lays out neatly and concisely the choice facing Europe, and the world, at this juncture: monetization or depression.

The logic is that, as many others have been pointing out for a good while now, there is no feasible readjustment or recovery under the existing regime. Sovereigns will default unless bailed out, and Italy is too big to bail out unless this is achieved through the ECB printing money to buy up Italian bonds. And sovereign default would drag Germany down with the rest of us.

Johnson argues that there is a huge moral hazard problem here, but at this point we're just going to have to deal with that later. After all, what's the point of averting moral hazard by destroying the world economy?

'via Blog this'

Saturday, November 12, 2011

The worst politician in democratic history?

Well, he's actually gone and resigned (Silvio Berlusconi si รจ dimesso la piazza in festa grida: "Buffone").

He leaves behind a country on its knees, and still in denial for the most part about what is happening. Maybe Monti can start by telling people the truth - will Italy be able to face it?

Friday, November 11, 2011

Nouriel Roubini's prophetic words on Tremonti, Italy and EMU

Paul Krugman reminds us of an incident in 2006 where Nouriel Roubini told Giulio Tremonti a few home truths, much to the Italian Finance Minister's disgust:
Italy’s Tremonti’s Temper Tantrums on EMU in Davos…a Sad Embarrassing Episode for Italy…

Pity Italians didn't pay more attention - it could have spared them a lot of trouble.

Tuesday, November 8, 2011

The Berlusconi effect



(spread with German bonds, Bloomberg)
Today is a big day. Berlusconi could survive today's vote, in part because the opposition may well abstain to avoid the technical difficulties resulting from the failure to approve last year's government accounts. But even the Northern League is now calling for him to resign. It may take a few days yet, but I'll be putting some champagne in the fridge (or maybe Prosecco).

Monday, November 7, 2011

Gavyn Davies on the Euromess

Seeing Berlusconi finally on the verge of political oblivion produces mixed feelings, because in fact he has not been defeated by his own mistakes or political weaknesses. Instead, like the fall of Papandreou and Zapatero, it is a result of the fundamentally unsustainable nature of monetary union.

As Gavyn Davies points out in the FT, the German current account surplus more or less exactly corresponds to the current account deficit of Spain, Greece, Italy and Portugal. The stark implication of this is that

Viewed in this light, it is clear that there needs to be a capital account transfer each year amounting to about 5 per cent of German GDP from the core to the periphery. Without that, the euro will break up.

I wonder how many Germans have understood this. In any case, as Davies points out, there is not way this can happen under current arrangements (austerity, deflation and limited ECB intervention). And so the end game continues until the Southerners have had enough and opt for the Argentine route.

Berlusconi, Papandreou and the various corrupt networks they represented should not be exonerated, but ultimately the collapse of this phase of monetary union is not actually their fault. Ireland, with a very difficult social structure, economic regulation and political system (although corrupt enough in its own way) is in a similar mess. More enlightened politicians would probably not have averted disaster. The proof of this is that Spain, the star pupil of economic reform in Southern Europe, is barely better placed than Italy and Greece.

The sad thing is that Northern Europeans may happily blame corruption for the South's plight, but Southern citizens are not in the mood to listen to the sermon. Ironically, the humiliation of the bailout arrangements could end up stirring national pride and generating an alternative (and equally implausible) narrative: blame the Germans.

Berlusconi finally meets his match


Yes, Berlusconi has dealt with pretty much anything that Italian politics has been able to throw at him over the years, but in the end the power of the bond markets is going to get him ("Va via": borsa su. "Resta": crollo I mercati e il destino del premier).

Brings to mind the famous phrase of James Carville, about the bond markets being far more powerful than a president, a pope, or a .400 baseball hitter.

Anyway, I think Silvio may well go tomorrow, if the vote in parliament on the government accounts doesn't produce a majority. If not, with bond yields hitting their Euro-era record today, it can't be much longer.



Sunday, November 6, 2011

Happy birthday, my blog

Yes, Unpublishable Thoughts has reached its third birthday. Despite the difficulties in posting regularly (I often don't) and coming up with insightful posts that add something to the crowded blogosphere (ahem, as I was saying...), it's still here.

Unfortunately, the main reason I started blogging - the financial crisis and the resulting recession/depression - is also still here. Three years on, things look increasingly desperate, and we're still a long way from the kind of political transformation that I fondly imagined would take place once the failures of free market idolatry were revealed to all.

By the way, my first post was a celebration of Obama's election victory, and shortly after I mused on the consequences of Britain's decision to stay out of the euro.

Roubini and Depression

Krugman cites Roubini On Internal Devaluation characteristically predicting gloom and doom in Europe. I was optimistic about European leaders responding to the obvious disfunctions in the Eurozone institutions by enhancing the EU's capacity to do the kind of things states do when faced with asymmetric shocks. Now I'm not so sure. The failures of the past two weeks make it more and more likely another Lehman-style collapse will force their hand. By that stage, the distrust between member states and the increasing costs of resolving the problem will make it harder to cut the kind of deal that is needed.

In short, I'm depressed. Thanks, Nouriel.


Friday, November 4, 2011

Rogoff and Eurojunk

Kenneth Rogoff weighs in to the debate surrounding the G20 (The eurozone does not need IMF help) in the FT today.

As well as rehearsing a few well known arguments about the inadequacy of the Eurozone's governance arrangements, he tellingly suggests that

it is hard to see much benefit in (the IMF's) involvement, aside from providing a fig leaf for large-scale European Central Bank purchases of euro sovereign junk bonds

And this gets to the nub of the matter. The only plausible way of keeping the Eurozone together is for the ECB to do what any national central bank would do when faced with a sovereign debt crisis - print money to buy the debt. This is off the table, for political reasons. But it is the only way out, and we will have to get there at some point. So how?

One way is the IMF route suggested by Rogoff, another messier, but more likely, route is that the money will be printed to bail out European banks when the default actually happens. Strangely, in the weltanschauung of the current global leadership, it makes more sense to bail out banks than states. The logic is the same, but of course the damage (political as well as economic) is greater.

There is a pattern in this whole saga. The policies that might work economically don't work politically, and viceversa (the now famous Eurovenn). But when the politically palatable policies fail, we edge towards the economically viable ones, albeit having raised their costs and created a lot of damage along the way.

A set of arrangements designed to have as little democratic legitimacy and executive efficacy as possible is proving catastrophic when faced with a serious crisis. The EU has to become something radically different, or jump back to the 1970s.



Wednesday, October 26, 2011

Berlusconi's Diplomatic Skills

I wonder why the Germans are so nervous about Berlusconi's commitments to economic reform in exchange for financial aid?

What economists lack - Paul Krugman

Paul Krugman's presidential address to the Eastern Economic Association (The Profession and the Crisis) identifies three failures of the economics profession in the present crisis: a failure to see the crisis coming, a failure to imagine such a crisis being possible, and a failure to draw on the insights of Keynesian economics to deal with it. For Krugman, the latter is the most serious failing, and it's hard to disagree - up to know we have had a series of fanciful invocations of austerity to deal with what looks for all the world as a kind of depression. After that approach did so well in the 1930s.

Meanwhile Joe Stiglitz is equally damning about this policy direction in his presentation of the report by the UN Economic and Social Committee. Two Nobel prize winners at odds with most of their profession: looks like time for a paradigm shift to me.


Monday, October 24, 2011

Mark Thoma makes a bold claim: Raise Taxes on the Wealthy

It's pretty amazing how what used to be a platitude has become a taboo (at least in the US). The ever-reasonable Mark Thoma makes a restrained case for progressive taxation and gets disheartened by the aggressive bile he receives from online commenters.

Thoma points out that the US economy hasn't, by any serious measure, prospered as a result of the declining fiscal burden faced by the super-rich. But his argument also receives strong support from comparative analysis. A quick look around the advanced world shows that the most unequal societies are also the worst performers in the post-crisis scenario. In Europe, egalitarian Sweden, Holland and Germany are the strongest performers, whilst less progressive economies such as Ireland, Greece and Italy suffer (not to mention the UK). In North America, Canada is in much better shape than the US.

The crisis has laid bare the bankruptcy (figuratively and other) of the Anglo-American model of inequality-fuelled growth. Put another way, there is no equality/efficiency trade-off.

The world's population has doubled in my lifetime

The world population has reached 7 billion, apparently.

According to the Guardian's interactive tool How big was the world's population when you were born?, this is more than twice the world population at the beginning of my life (3,376,111,993).

This freaks me out slightly. Because I'm not that old, really.

Friday, October 21, 2011

It's too hot to work

Nice post by Kash Mansori at The Street LightWhere Exactly Are Those Lazy Southern Europeans, Anyway? Mansori points out that there is no evidence of lazy or feckless behaviour being any more prevalent in the South than in the North - working hours, overall employment, social spending and pensions are mostly close to the European average, although welfare coverage is on the whole less generous and working hours longer.

In fact, the prevalence of the grey economy should mean that Southern Europeans are working harder than the data suggests, although this is not an argument likely to impress Northern Europeans.

Of course, Southern Europe has its problems, and its history of corrupt leaders and authoritarianism have left legacies that continue to hold the region back. But the broad picture some Northern Europeans wish to believe in, of lazy Mediterraneans exploiting their virtuous neighbours, is based entirely on ignorance.

Tuesday, October 11, 2011

False Consciousness, Lesson 53

The Gawker reports on a Right-Wing Version of 'We Are the 99 Percent' - it's called 'we are the 53%', apparently the half of Americans who pay federal income tax and work their fingers to the bone so that long-haired pot-smoking drop-outs can protest against Wall Street.

It's hard to know if the people posting their pictures and hard-luck stories really exist, and it's certainly unlikely they are very representative. But still, it's an astonishing read: post after post describes what a miserable exploited existence these losers have had, and then goes on to express pride at never having complained about their lot or asked for any government help (or so they claim). The idea that 'occupy Wall Street' might be about them getting exploited a bit less is clearly difficult for them to grasp.

This type of reasoning is probably not that typical of today's America, and instead reveals a very high resistance to cognitive dissonance on the part of the '53%'. However, the claims that never having asked for help, even in the worst circumstances, is some kind of American virtue does seem to resonate in the US. It certainly would sound strange in Italian or Greek, or probably for that matter, in German.

In any case, I prefer this version of the hard luck story:




Note Marty Feldman's convincing Yorkshire accent.

Saturday, October 8, 2011

23 Things They Used to Tell You About Capitalism

Ha-Joon Chang has written a great little book called 23 Things They Don't Tell You About Capitalism. An engaging speaker, he recently presented the book at LSE - the podcast here is well worth a listen too.

Although it's important to make these arguments, and Chang does a great job of it, the dominant feeling I'm left with is dejection and frustration. Why? Because what Chang is arguing is almost self-evidently true, and should barely need saying. Indeed, 25-30 years ago much of what he argues in the book constituted the conventional wisdom. Yet the idea that markets are social constructs, that regulation is a politically loaded issue, that individual productivity is not really individual, have now become quite radical things to say.

Why? Well we know there has been a sustained assault on social democratic values over the past thirty years or so, and that has been largely successful in pushing back the frontiers of political intervention in favour of justice and fairness. But why hasn't the left fought back? Why instead have social democrats been forced onto the back foot, constantly conceding defeat and allowing the political centre to move ever-rightwards?

The reason is that the left has lost its anchor. The right can argue in favour of free markets, and can push for more 'freedom' in the knowledge that there is always a tax to be cut or a regulation to be abolished. The left, however, no longer has an objective to push towards. Instead it hangs on to what it has, and what it has is less and less as the right pushes the Overton window in its own direction.

The left has become the centre. The right, by pushing further in the direction of its most radical goals, is able to redefine continually what the centre means. The left, without its old anchor, is unable to resist being dragged reluctantly to ever more pro-market positions.

The answer has to be to find an anchor again. For me, that has to be equality. Policy has to deliver greater equality, or it's not worth pursuing. The time has come to put down some markers.

Greenspan meets Max Weber

So Alan Greenspan, perhaps the key architect of today's global economy (yes, that is not a compliment), has decided to weigh in on the Eurozone crisis and in particular on the North-South dimension of Europe's problems.

It's hard to know where to start, but here goes. The least interesting part of the nonsense Greenspan talks is that he rehearses the standard story about Mediterranean profligacy, of the Southern periphery living beyond its means as it hurtled to its inevitable reckoning with the harsh reality of the bond markets. This story is still popular, despite being debunked over and over, most recently by Mansori here. It is popular, of course, for the reason that it blames the victim, a common response on the part of the supporters of free market capitalism to the crises their prescriptions generate.

What more interesting is the apparently unselfconscious Orientalism of Greenspan's assessment of the Southern countries. Greenspan's analysis of the North-South divide in Europe goes as follows:

There remains the question of whether most, or all, of the south would ever voluntarily adopt northern prudence. The future of the euro beyond a select group of northern countries with a similar culture will depend on the ability of all eurozone nations to follow suit.


What would this 'similar culture', based on 'northern prudence', involve? Well, for a start it presumably doesn't involve the Anglo-Saxon recklessness exhibited by Northern European countries such as Britain, Ireland and Iceland. So we are talking about particular areas of the North whose prudence is expressed in  wage restraint and sound public finances: the countries generally referred to in the comparative political economy literature as 'social democracies'. So Alan comes out as an unexpected fan of large public sectors, high and progressive taxation, and strong trade unions. Who knew?

The counterpart of course is Southern fecklessness. Here we go back to a common refrain of blaming poor economic performance on climate. Greenspan cites approvingly the following words from Kieran Kelly:

if I lived in a country like this [Greece], I would find it hard to stir myself into a Germanic taxpaying life of capital accumulation and arduous labour. The surrounds just aren’t conducive.”

Never mind that the average yearly working hours of a Greek employee are the highest in Europe. It's just so hot, how can they ever do any work? A notion that nobody ever applies to Texas or Florida.

It's barely worth the effort of outlining all the ways in which Greenspan is wrong. But the fact that this kind of sub-racist nonsense can be given space in one of the best newspapers around is a sign of the times. The times are ugly, and what we thought was true wasn't. So why not just blame problems on those suffering them? It's a lot easier than trying to work out what went wrong, and admitting that powerful men like Greenspan didn't have the faintest clue what they were talking about.

Friday, October 7, 2011

The economy is a morality play

Today Krugman ('Notes On The Eurobubble') gives Alan Greenspan another well deserved kicking for blaming the Euro crisis on profligate Southern Europeans getting their just desserts. Krugman points out that huge capital flows from Northern European pushed up demand, output and employment in Spain and other countries, leaving them high and dry when the bubble burst. To blame the Southern Europeans for their plight is therefore misleading moralizing.

Krugman has been berating conservative economists for some time for the tendency to see the economy as a morality play. The trouble is, the political economy is a morality play. Economic behaviour is deeply embedded in social systems within which moral claims, as well as material desires, drive human behaviour. The Eurozone could well collapse entirely because Germans find it so hard to cope with the idea that their supposedly virtuous behaviour will not bring its own reward. Krugman is right in terms of the models, but the very real presence of moral reasoning in the politics of the crisis is precisely why economic modelling alone cannot give us the answers.

Tuesday, October 4, 2011

Political market failure

Thinking of Italy brings me naturally to thinking about the difficulty of making democracy work for the citizens. The inability of western governments to defend the basic economic interests of large segments of the population has become clear enough over the past 5 (or 20-30 if you were paying attention) years. Of course, no political scientist would make the ridiculous claims on behalf of democracy that some economists make on behalf of free markets. But still. What exactly do we except democracy to deliver?

The clearest statement on political market efficiency I can think of is Donald Wittman's The Myth of Democratic Failure. The interesting bit about Wittman is that he makes two ambitious (to my view implausible) claims: that the rational actor model explains politics well, and that an effective and 'efficient' democracy can be explained in rational actor terms. The resulting text is an entertaining lesson in the usefulness of functionalist reasoning and ad hocery wheeled out in support of a notionally deductive theory resting on individual rational action.

But political science also makes less strong claims about democratic efficiency as a matter of course. The notion that governments could fleece the population systematically is rarely entertained. Yet at the moment this is what seems to be happening across the advanced world, with little in the way of organized reaction (as yet).

Which is the key - 'organized reaction'. Democracy requires organization - leaving political action to isolated individuals doesn't get us very far. And the difficulties of organization - the free rider dilemma, the danger of hierarchy, the asymmetric access to political influence - produce colossal inefficiencies in the political market. Political scientists need to start thinking about how these inefficiencies, coupled with economic disaster, could destabilize what we assume to be well entrenched democratic institutions.

Panem et circenses

Italy gets another downgrade, its Finance Minister blames it on his own government not calling early elections and instead hanging lifelessly onto power, yet most attention seems to be focused on Amanda Knox.

What was that about bread and circuses? Italy is currently suffering from a form of paralysis, apparently unaware that it is about to become an over-sized Greece.


Irrationality and morality

Paul Krugman has an interesting post pointing out the usefulness of economic modelling in times of uncertainty, where

'experience — the kind of experience business people gather over years in the market –ceases to be a helpful guide, whereas models and deep historical knowledge have at least a hope of getting at what’s really going on'

I think he's right, up to a point. The problem is though, that what he's trying to model is a world in which most people have no access to the kind of abstract reasoning and deep historical knowledge he can draw on. And that can end up vitiating the models.

I can see a kind of circularity to all this. The models tell us what we should be doing, but they only work if we do what we should be doing. If we introduce the diversity of agents, then we can get somewhere: so assume very bounded rationality for consumers, investors and voters, and more 'rational rationality' on the part of policy makers, and you may get a guide to policy. But policy itself is just as subject to the boundedness of rationality.

A further irony occurs to me. The boundedness of rationality comes across in the ideologically driven hyper-rational models of 'fresh water' economists, who desperately try to cling on their rational expectations models, for (often) moralistic reasons.

I've got a headache now.


Dimon may well be right, and Carlos Tevez is a reliable employee

Words fail me.

Oh, alright, here goes. Steven Rattner in the FT understands Jamie Dimon's bad mood, but gently reminds him that 'the rage of the citizenry demands tough new bank rules'. If only that were the problem.

Tough new bank rules are required because people like Jamie Dimon have enriched themselves beyond belief at the expense of the real economy, and will do it again given half the chance. I honestly don't want to live in the Mad Max world which would follow another round of hyper-leveraged madness from Dimon and his friends.

The striking thing about Rattner's tone - beyond the sycophancy - is the absurd expression of sympathy towards one of the most unaccountable and powerful individuals in the world. Rattner 'feels his pain' because JPMorgan 'conducted itself more responsibly than most of its peers.'

Sure, JP Morgan didn't go bust itself, but it would have done had governments allowed its counterparties to fold. And 'conducting yourself better' than other insolvent financial institutions is not a big ask. But above all, JPMorgan is one of the select bunch of too-big-to-fail institutions that would have to be bailed out if things went wrong. So how on earth can it be considered 'unfair' for Morgan to be subjected to the same rules facing the other major participants in the casino? He may have a point about shadow banking, but that point is better made if you at least are playing by the rules you demand for others.

Jamie Dimon's $16 million pay package (2010, sans bonus) is not the ideal pulpit for demanding a 'level playing field'. It is instead a measure of how the masters of the universe have entirely lost touch with the miserable reality facing the rest of us. Until some evidence of the social usefulness of Jamie Dimon can be found, I think we're entitled to view his opinion as a particularly tasteless case of chutzpah.

Monday, October 3, 2011

Munchau loses it

Wolfgang Munchau, in today's column Eurozone fix a con trick for the desperate, describes the latest solution for the Eurozone crisis as "the equivalent of putting explosives into a can, before kicking it down the road". The grounds for this are that the leverage involved in turning the European Financial Stability Facility into something powerful enough to hold back the markets turns it effectively into a CDO.

Munchau used to be a measured, cautious and conservative commentator. The fact that he is using such strong language these days totally freaks me out.

Sunday, October 2, 2011

How To Save Europe

The Baseline Scenario has a neat piece on the Eurozone crisis. The key passage is the following:

Greece and some other countries have serious budget difficulties. But most of the European periphery also faces a current account crisis – something has to be done to increase exports or reduce imports or both. If the exchange rate can’t depreciate, wages won’t be cut, and “fiscal devaluation” proves unworkable, activity in these economies will need to slow down a great deal in order to reduce imports and bring the current account closer to balance – unless you (or the Germans) are willing to extend them large amounts of unconditional credit for the indefinite future.

And as these economies slow down, their ability to pay their government debts will increasingly be called into question.


So, it's a colossal loan or the end of the Euro. Johnson identifies Italy in particular as a problem, since under low growth and high interest rates its debt could grow pretty quickly, and it's already at the upper limit of what's sustainable. But how happy will Germans be to bail out Italy under its current leadership?



Wednesday, September 28, 2011

Another crisis and choice for European social democracy

Just following on from What Ed should have said.... I've had some thoughts about what the crisis means for social democracy. OK, I'm not the only one, and probably none of this is strictly original, but hear me out while I try to make sense of it to myself.

Scharpf's argument was that Keynesianism in one country was dead. The response of mainstream social democracy was to adopt orthodox fiscal and monetary policies which, depending on the reading, would either secure full employment, or at least prevent the worst outcome - 70s style stagflation. The idea was that stability could be achieved by national governments in the context of globalization by following the right policies.

The crisis has blown that idea out of the water. Although Greece is the exception that proves the rule, governments in many countries - Ireland, Spain, even the UK at a stretch - were actually ticking all the boxes, and were still roundly screwed by the crisis. The reason for this was that mobile capital creates such a high degree of uncertainty and volatility that government policies, no matter how carefully designed and credible, cannot compensate for the shocks financial flows bring about.

The conclusions we can draw are, in my view, point in diametrically opposite directions. We can pessimistically take this as a given, and design even tighter and more credible fiscal and monetary institutions to lock in stability and stave off financial volatility. Might work for Germany, I guess, but in the end it's only a matter of time before those rules too would be torn apart by financial shocks.

Alternatively, we can bring back capital controls. Now the technicalities of how this would work are not my area of expertise, and I doubt it is straightforward. However the alternative (see above) is surely worse. If even hyper credible commitments and ultra rigorous decision-making rules don't protect you from shocks, than it's hard to see what else can be done, save all of us attempting to become little westernized Chinas with 40% savings rates (yes, exactly).

So, it's got to be back to some updated form of Bretton Woods. That, or a descent into chaos.

The Eurovenn

Every now and again it's useful to remind ourselves what political science is (should be) for:


The Euro crisis according to Martin Wolf, according to Paul Krugman.

What Ed should have said

In 1976, Jim Callaghan famously lectured the Labour conference thus:
"We used to think that you could spend your way out of a recession, and increase employ­ment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists"


20 years ago Fritz Scharpf developed this argument more systematically through a comparative study of four European economies, which concluded, like Callaghan, that Keynesianism was finished. The alternative, which Labour eventually developed under Blair and Brown, was to adopt strict fiscal and monetary policies to entrench macroeconomic stability and low inflation. The disastrous failure of this model makes 1976 look like the good old days.


So Ed could do with saying:
"We used to think that you could cut your way out of a recession, and increase employ­ment by reducing  Government spending. I tell you in all candour that that option no longer exists"


It's a tough sell, but to refuse the challenge condemns Labour, should it win, to the kind of centrist no man's land Obama finds himself in. The electorate have to be told what is going on, however counter-intuitive it is. There is nothing to gain by offering a softer version of Cameron's Hooverism.

Monday, September 26, 2011

A new stability pact

In view of the previous post, it should be clearer than ever that the talk of balanced budgets is entirely missing the point (even forgetting for a moment how stupid such rules are in practice). A real stability pact would call governments to account if their current account balances exceeded a certain share of GDP - hey, why not 3%? And by this I mean in either direction - creditor nations and debtor nations would both have to act.

This of course will not happen, because the prevailing ideology is still that financial markets are rational and not prone to the damaging bouts of euphoria and gloom which come close to destroying the Eurozone. The only certainty is that the current approach will fail. What happens after that is anyone's guess.

Friday, September 23, 2011

The Euro crisis is nothing to do with budgets

Krugman and Mansori on the Origins of the Euro Crisis: it's all about capital flows. The countries now in trouble were not all running fiscal deficits, but they were all running trade deficits, and that seems to be the best predictor of sovereign debt crisis.

So it turns out that the 'recklessness' that Southern Europe supposedly engaged in was allowing German and other Northern European savers to invest their money there. Doesn't quite have the same ring as the morality tale about budgets.

The political science of zombie economics

Reading Quiggin's wonderful Zombie Economics: How Dead Ideas Still Walk among Us, I'm left with a similar warm feeling of self-righteousness I get reading Krugman, but at the same time a sense of frustration. The frustration comes from the absence of any clear idea of the politics of all this: how, in a democracy, can such clearly disfunctional and regressive ideas still prosper, even when it is clear they are failing the vast majority of the electorate?

Obviously, it is hardly Quiggin's job to explain the politics: that should be down to us. What can political science offer? Well, for me the direction must be in reviving that old-fashioned approach to the study of politics that sees it as the study of collective action, of institutions, and which seeks to explain institutions in terms of genuinely political variables, rather than reducing them to aggregates of individual maximizing decisions. Here I can self-interestedly cite political parties as key intermediaries between social interests and political institutions. Why did political parties buy into the zombie ideas Quiggin dissects when there should have been obvious gains for any politician that could offer something better?

A couple of ideas occur to me. First, that democracy has been associated historically, in the classic modernization formulation, with the emergence of a large middle class and lower inequality (which sustains power-sharing, as in Boix's game theoretic account). On this reading, we could suggest that increased inequality also undermines democratic institutions in such a way as to reinforce the hierarchical and oppressive dimension of market capitalism. This would be a social-structural explanation for the success of regressive ideas.

Next, the parties literature documents a secular decline in the organizational strength and mobilization capacity of political parties. This limits the ability of elected politicians to mobilize resources to challenge free-wheeling capital. In this sense, there is a problem with the organizational infrastructure necessary to sustain economic interventionism, so that parties give up on non-zombie ideas. This is a modified resource mobilization theory.

Finally, social and cultural changes may affect the degree to which people can be convinced of policy ideas which are probably in their interests, but simply do not resonate (or maybe even dissonate). Individualization makes people reluctant to throw in their lot with others, and therefore resistant to social democratic ideas, even when all the evidence suggests that for most people these ideas are obviously in their interests. The metaphor that comes to mind is the angry driver in the traffic jam, railing against the other drivers rather than thinking of a collective solution that would get everyone to work on time at a fraction of the cost. This would be normative-culturalist (false consciousness?) explanation of the success of zombie ideas - they may be wrong, but they should be right.

As an after-thought, all of this offers a hint about the weird anti-science trends we're seeing these days, especially in the United States. Man-made global warming may be right, but to believe in it, for most people, is a leap of faith, involving trust in institutions (universities, the scientific professions, the government). If the patterns identified above are a problem for economic ideas, then why shouldn't they be a problem for other theories about how the world works? Bachmann's campaign against the HPV vaccine is probably no different in its essence than trickle-down economics or any of the other zombie ideas which are almost certainly wrong, yet politically enjoy the gift of eternal life.

Thursday, September 22, 2011

That sinking feeling

Global growth fears sink world stocks - FT.com:

Irony of ironies: this is probably our best bet for a policy change in the right direction. Ultimately, markets do want austerity, but in the Augustinian sense: they also want growth, and if growth requires printing money and running deficits, they want that too. Just not printing money and running deficits in currencies they're holding.

If investors show their lack of confidence in a policy that is designed purely to give them confidence, then policy change is the only response that makes any sense.

Greece to stay in the Eurozone by destroying its economy

Greece slashes more jobs and spending as it vows to stay in eurozone | Business | The Guardian:

That should do the trick... But seriously, exactly how does this help Greece stay in the Eurozone? The inevitable consequence of this policy is a deeper recession, and markets know this and will price Greek debt accordingly. Since austerity will neither reduce the deficit (because of its devasting effect on the denominator) nor reassure the markets, how does it help Greece stay in the Eurozone?

My suspicion is that the only 'positive' effect of this austerity to reassure German voters that Greece is truly suffering, and therefore not escaping its due punishment for fiscal misdeeds. If that is indeed the mechanism, then we have officially installed a penal system in place of a monetary union.

Wednesday, September 21, 2011

Sado-masochism, the cargo cult and the crisis

I share the despair of many of the smarter commentators (economists and non) out there who are lamenting the failure to adopt appropriate policies to deal with the slump. How can we explain the reluctance to drop the austerity nonsense and do something for growth, the only real way to deal with our debt problems? Well, here are some inchoate thoughts on this paradox.

First, I'm pretty sure the current arrangements challenge even the softest forms of rational choice theory. Whichever way you look at it, the choice for pain in the present for no certain benefit in the future has something self-defeating and masochistic about it, particularly since the pain doesn't even net out into clear benefits for any sub-group within the economy.

Second, it confirms the power of dominant ideas, and the difficulty of getting rid of these ideas when they have been proven wrong (see Quiggin's wonderful Zombie Economics). After all, you could hardly hope for a better disconfirmation of the policy mix (basically unquestioned in elite circles before 2008), based on financial deregulation, central bank independence and privatization, than what is happening now. Yet we still hang on to these failed ideas, in a way which is starting to look like the Polynesian cargo cult - policy-makers lay out the same prescriptions that seemed to work before 2008, and patiently wait for the crisis to end.

Finally, it illuminates the crucial role in all of this of political parties as intermediaries between policy and the public response. People are clearly hugely pissed at what is going on, yet there is no real policy alternative being presented by existing political parties, hence the lack of policy change. At some point, public anger will elicit some response from elected politicians, but in the meantime they continue to preside over an economic disaster, and in some cases have managed to mobilize popular discontent in favour of policies that are certain to fail miserably (see the entire Republican party in the US).

All this suggests we need to fundamentally rethink our models of democratic politics. I'll just throw that out there, because for now I have only the vaguest idea about how we are supposed to do this.

Saturday, September 17, 2011

Success

Another week has passed, the Euro is still standing. Let's just take it one day at a time.

Thursday, September 8, 2011

The endgame

Greece is now at the point where default is an inevitability - market prices suggest 91% probability of default within 5 years, at which point the game is over. I've no idea what Schauble and the others are thinking of doing, but the threat of contagion to Italy is even more terrifying, as one observer points out: "If Italy defaults, nearly every bank in Europe would feel the impact or go bust, either because they own debt or they are counterparties to debt".

Yet we're still involved in this silly game about deficits and fiscal targets. That way lies madness. Money has to be brought under political control here, or the whole financial system will collapse. Moreover, that political control cannot be the creditor nations bossing the others around - they're are as much to blame as anyone else.

Europe's Shotgun Wedding

Here's a longer than usual post on Europe:


Europe’s Shotgun Wedding

It is difficult to deny the parlous state of the European project. The sovereign debt crisis in the Eurozone periphery is placing enormous strain on the institutions of the European Union and on the relationships between member states. The powerlessness of the EU’s executive and legislative institutions has been set in stark relief by the activism of the barely accountable European Central Bank, which is reaching way beyond its mandate to keep European banks and sovereigns afloat. Meanwhile the hostility of Germans and Finns to the bailouts of the peripheral countries is matched by the resentment felt by those suffering the spending cuts demanded in return. The European project appears to be falling apart.

And yet, there are good reasons for believing that European integration could be about to accelerate. Not of course, because of any putative sense of European solidarity and togetherness on the part of voters or political elites: appeals to national self-interest have rarely been so popular. Further integration may not be desired by anyone, but it could be forced upon Europeans by the consequences of its decision two decades ago to adopt a common currency. Europe has often moved forward through an inexorable logic in which past decisions to pool sovereignty have consequences which necessitate further moves in an integrationist direction (the so-called ‘spillover effects’). Monetary union may prove yet another example of this. The decision to create a single currency has, in the space of just a decade, generated its own (catastrophic) spillover, and the logical, perhaps the only, response is to enhance the role of European institutions to resolve the second order effects of the creation of the Euro.

Critics of the EMU project argued back in the 1990s that the Eurozone was not an ‘optimal currency area’, and that monetary union without the development of supranational institutions to manage fiscal and redistributive policies would prove disastrous. Ignored at the time, this argument appears close to unanswerable in hindsight. Monetary union not only failed to bring about a convergence in inflation rates between Eurozone nations, it achieved the opposite effect, as destabilizing capital flows from surplus countries (chiefly Germany) led to an economic boom in Ireland, Greece and Spain. The resulting trade deficits run by periphery countries in the 2000s proved unsustainable, and the post-2007 credit crunch slammed their economies into reverse, wrecking their fiscal balances and spooking bond markets.

Although well understood by economists, the current account balances inside the Eurozone have been almost entirely ignored in the public debate, in favour of a simplistic narrative in which spendthrift Southern Europeans are entirely responsible for their current debt problems. In the case of Greece, this narrative clearly has some merit, with successive governments running structural deficits in good times while concealing the true state of public finances. But Spain ran a substantial budget surplus in the years preceding the crisis and had a debt to GDP ratio almost half that of Germany. There was no reason at all for Spain’s leaders to fear an abrupt descent into the fiscal abyss, and the markets took the same view, pricing Spanish bonos as barely any riskier than German debt. Even Italy, despite carrying the third largest public debt in the world, had in fact stabilized its public accounts before Euro entry and ran consistent primary surpluses right until the credit crunch. German and French breaches of the Stability and Growth Pact confirmed that the GIIPS (the four Southern European member states and Ireland) were, on the whole, no more inept at managing their public finances than the Northern Europeans.

The budget deficits facing the peripheral countries are largely a consequence of the crisis, not its cause. They are a reflection of the collapse in internal demand resulting from an unexpected correction in Eurozone current accounts. The unexpected end to the capital flows from Northern Europe which had financed large trade deficits in the first years of monetary union caused a dramatic collapse in investment and output, tearing a hole in tax revenues and forcing up government spending. Exhorting periphery states to embrace austerity is only likely to make deficits worse, because there is no alternative source of demand to drive economic activity.  Potential export markets are themselves depressed, and cutting wage levels in the periphery to regain competitiveness, in the absence of Eurozone inflation, would have brutal contractionary effects even if were at all politically feasible. Even without the complication of sovereign debt risk, the prospects for the periphery would have been a grim menu of deflation and a long wait for external demand to appear from somewhere. But doubts about government solvency in the periphery remove even that unattractive option.

So the recent attempts to repair the damage within the existing framework of monetary union, through limited bailouts from Northern taxpayers in exchange for austerity packages in the debtor countries, appear doomed. The costs of the bailout strategy have spiralled as more countries have been dragged into the self-fulfilling prophecy of sovereign default risk. Greece, Portugal and Ireland, amounting to only 7 % of Eurozone GDP, could perhaps have been rescued by decisive action, but the addition of Spain and the Italy to the danger list makes the bailout strategy entirely incredible, with predictable consequences in the bond markets. With the spreads of both of the larger GIIPS heading north, two much more radical scenarios, with entirely opposite implications, have emerged.

The first scenario is disintegration: the reversal of the process of ever greater European economic integration and cooperation.  In this scenario neither core nor periphery member states are prepared to meet the costs of staying together: German, Dutch and Finnish taxpayers refuse to sign up to the rescue of the profligate South, whilst in the periphery austerity packages founder on the rocks of collapsing output and/or political instability. The result is sovereign default in Greece, and some or all of the other periphery countries. But this would not in itself solve the crisis, since the competitiveness problems would remain, and periphery governments would still face the problem of financing budget shortfalls without the help of the private markets. If we add to this the resulting chaos in the Eurozone financial system, default could well lead to the exit of Greece and others from the Euro itself.

There are very strong reasons for believing that European leaders will avoid such an outcome at all costs, since it damages everyone. The periphery countries would benefit enormously from having their own currencies, since it would make the price and wage adjustment they require economically feasible and politically survivable. The example of the UK, which suffered a far worse financial crisis than any of the Eurozone states but avoided (so far) a run on its debt, is an appealing one. However the GIIPS cannot easily emulate the UK because they have to extract themselves from the Euro first, and doing so would likely cause such financial disruption as to outweigh the benefits of competitive devaluation. Perhaps more importantly, the creditor countries also have every incentive to avoid Euro exits. Germany is on the hook in two ways: first its trade surplus is almost entirely with the Eurozone, so Euro exits would undermine its main export markets. Second, German and French banks are exposed to periphery government debt to the tune of hundreds of billions of Euros. Default and or/exit would bring down the German banking system, requiring colossal bailouts at a time of declining growth prospects. In this respect, it is worth remembering that Germany’s own debt/GDP ratio is already a far from virtuous 81 %.

The incalculable risks of this first scenario mean that the alternatives, however unpalatable, will prove more appealing. A second scenario can be traced, in which further integration provides the Eurozone with the necessary policy instruments to address the imbalances and weaknesses revealed by the crisis. What exactly would this integration involve? The most immediate problem – the risk of sovereign default in the periphery – will inevitably require a degree of burden-sharing and risk-pooling, most likely through the emission of Eurobonds backed by the governments of the entire Eurozone. In this solution, demanded insistently by Italian Finance Minister Tremonti, peripheral government debt would be backstopped by German’s fiscal credibility, reducing debt servicing costs (whilst raising yields on German debt). Whatever form this pooled sovereign risk involves, EU institutions will have to be redesigned in order to manage it, enhancing supranational authority.

Simply staving off default will not end the crisis. The Eurozone also needs to resolve the imbalances which left the periphery so exposed after the credit crunch. The German economic model, based on high savings rates, wage moderation and fear of inflation, interacted fatally with a periphery lacking a sound basis for converting capital flows into productivity gains. The result was a brutal shock for the GIIPS when the money dried up, without the appropriate policy instruments (monetary policy, competitive devaluation) to allow for adjustment of relative wages. If Germany will not countenance the higher German and Eurozone inflation needed to accelerate the process of adjustment, then some way needs to be found to channel German surpluses to the periphery. Some kind of pooled fiscal sovereignty, on a far larger scale than anything so far attempted in the EU, would appear the most effective way of achieving this.

Why on earth should Germany accept an increase in debt servicing costs, an increase in domestic inflation, and tax increases to pay for economic recovery in the South? Because the alternative is worse. German virtue is the flip-side of the periphery’s vices: Germany’s trade surplus is the counterparty to the periphery’s trade deficits, and the excessive debt taken on by the GIIPS was loaned in large part by German banks. The collapse of the Eurozone would mean insolvency for German financial institutions accompanied by job losses in the manufacturing sector. European integration means that no member state can isolate itself entirely from problems in another. The more serious the problem, the more grief is shared amongst states whose economies are deeply inter-connected.

Of course, it is one thing to recognize the nature of the problem, another entirely to adopt the appropriate solutions, particularly when none of them are remotely appealing. Further integration has all the features of a shotgun wedding, the core and periphery tying the knot out of desperation rather than desire. For the wedding to go ahead, European leaders and voters need to be convinced that the alternative would be even worse. At the moment there is no evidence that we are close to this realization. European leaders, Mrs Merkel in primis, have an awful lot of explaining to do.