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 -

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


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.

Wednesday, September 7, 2011

Having a Laffer

So, whilst the deficit reduction strategy of the UK government runs into the not entirely unexpected collapse in economic growth, a fierce rearguard action is being organized to abolish the 50% tax rate for high earners introduced by Gordon Brown.

Perhaps the best comment on this is from Newsthump, the satirical web paper: '50% tax rate damages people who pay 50% tax rate, say people who pay 50% tax rate'. But beyond the obvious self-interest at play in these demands, it's worth examining just what is so bad about the 50% tax rate.

First, there is a bunch of evidence that the tax take has gone up as a result of this (estimates suggest it will raise £12.5 billion more over five years). £12.5 billion does not eliminate the deficit on its own, but it's not small change.

Second, are we sure that we really don't want high earners to leave? The damaging effects on the economy would stem from disinvestment, or the providers of valuable services no longer providing them here. But so much of this money is rent-seeking that I'm not that sure these effects would be so terrible.

Third, if we accept that the highest paid will leave the moment we tax them a little more, then we may as well give up on the idea of a cohesive society - so much income is now concentrated in few hands that failure to tax that income properly leads to extremely disruptive social divisions. We've seen a bit of that recently.

In any case, what's striking here is that various western countries have recently seen their highest paid citizens arguing that they should pay  more  tax. Britain's wealthy, it seems, are entirely free of this kind of social responsibility.