Copenhagen is just the start of a process

Most analysts and press coverage talked about the failure about negotiations on climate change. Yet, the outcome of the Copenhagen summit was largely foreseen. It is true that too high expectations were placed on the talks. So what went wrong?

Climate change is too big an issue to be resolved at once. It is thus difficult to judge on the sole fact that the agreements were not binding- the Kyoto protocol was legally binding but had essentially no effect on the global emissions. We can also mention the (morally justified) protests of the third world countries. So let's be realistic.

This is an issue of balance of power in which the actions of 20 nations really matter. This is the first time in history that all leading economies had come together to take action on global warming. In its final declaration*, the Copenhagen summit did not reach an agreement on quantified targets on global emissions by 2020. However, it registered a number of key advances. The US administration (unlike the previous one) is now committed to curb gas emissions. There is some financing from rich to poor countries to help combat the consequences of global warming. Nations have also agreed on a deal on deforestation, which is a major source of carbon emissions.

The big developing nations - which will be responsible for future growth of gas emissions- have come close to acknowledge that there will be no solution without a contribution from them. We are not there yet- and there will no doubt be more fractious negotiations to come. The whole issue is about what model of development all nations want to pursue. China, India or Brazil cannot simply continue in their development path in a business as usual scenario- which is in fact not simply an imitation of the development model experienced by the most developed nations. We're also talking about meeting basic needs of the population such clean water, electricity (especially in rural areas) and other public utilities.

The time has also come to change direction. The major producers of carbon emissions - above all China and the US- should agree on introducing a carbon tax. This proposal has been dismissed as being politically impossible, but this seems to be the only way forward. China and India will never agree on binding quotas. That is fair as nobody can predict how much fossil fuel the rapidly growing economies will need by 2020. These economies should instead not grow on a business-as-usual path, but pursue their economic development while decreasing their carbon emissions.

Another key lesson from the summit is also the role of the UN. There has been a lot of criticism on its ability to solve the world's most pressing problems. Should key nations negotiate among themselves, and let others endorse (or not) as they wish? This would in my view be morally irresponsible: all countries should be part of the deal as problems should be addressed equitably. This is perhaps more difficult, as countries must, according to UN rules, reach a consensus before a binding decision is made. For a climate change agreement covering many complex areas, hundreds of negotiators had to meet in dozens of working groups to work on draft technical documents. But in the long run, the UN method will pay off and will prove its effectiveness in forging a treaty on climate change. This will depend on common will which should prevail against narrow and selfish interests of the single nations.

* http://unfccc.int/files/meetings/cop_15/application/pdf/cop15_cph_auv.pdf

The Food Drama is far from being over

During the world summit on food security (16-18 November), there are alarming news coming not only from underdeveloped countries with more than a billion people suffering hunger but also from the wealthiest nation. According to the US Agriculture department, around 49 million, say 14% of US families, do not have access to sufficient food and a further 11% has bad nutrition. The economic crisis has worsen the situation especially for large families : in 2007, 12 million children lived in families without any food, now the figure is 18%; more children are also in a serious state of malnutrition, rising from 700thousand to a million. these figures tell the human drama behind the recession which is far from being over.

What happened in this summit ? As Shakespeare said, much ado about nothing . The only strong message came from the Pope Benedict XVI, in his address to the summit: "Hunger is the most cruel and concrete sign of poverty. Opulence and waste are no longer acceptable when the tragedy of hunger is assuming ever greater proportions (...) the Catholic Church will always be concerned for efforts to defeat hunger; the Church is committed to support, by word and deed, the action taken in solidarity – planned, responsible and regulated – to which all members of the international community are called to contribute”. Moreover he lamented the weakness of current food security mechanisms, and urged better market access for poor countries.

The Summit formulated the objective of achieving food security for all through an ongoing effort to eradicate hunger in all countries, with an immediate view to reducing by half the number of

undernourished people by 2015. But once again, rich States did not show any concrete gesture to alleviate hunger in the most in-need countries. The final resolution sets a number of commitments, but no additional money. Where are the promises made at the G-8 in L'Aquila?

Concretely, the main message is the central role of agriculture in fighting climate change and ensuring food security. Agricultural production has to increase but at the same time the impact n the environment has to be mitigated. Specialists recommended governments to use bioenergy as a positive force for rural development. There are opportunities and risks for the environment and food security which need to be taken into account.

But, let's be clear, it is not about technology. The Brazilian experience has been successful, despite many difficulties, in achieving ahead of schedule the Millennium Development Goal to halve poverty and hunger by 2015, including through political will and social programmes for smallholder farms and women. So why not follow this example?

Is Free Market Ethical?

I read recently an article from Philip Booth ('Ethics alone will not prevent financial crises' in FT 15 Nov.) from the Institute of Economic affairs*, a British right wing think tank which supports the revival of free market ideas on 'ethical' grounds. Basically, he argues that free market as such is not against catholic social teaching as laid down in recent encyclicals of the Church. But his main argument is also to fight against the idea that the crisis has deep ethical causes such as bribery, greed and other immoral sentiments.

He writes: "governments and regulators have distorted incentives and, as a result, the self-interest of bankers has not been in harmony with the interests of society and disaster has followed". In other words, if the economy was ruled solely by free market ideas, the crisis would have never happened. This is an 'immoral' argument which owes more to Hayek and Friedman than to the Church social doctrine.

I agree that the crisis does not have as such an ethical root, although it is clear that immoral behaviour has contributed to aggravate the crisis leading to the financial meltdown in 2007. Speculative bubbles are the fruit of greed and lust for money, not the result of rational economic behaviour.

However, the topic raises more profound philosophical issues which underpin the whole debate about ethics and economics. Adam Smith referred to the 'invisible hand' to describe the apparent benefits to society of individuals behaving in their own interests. He writes in his 'Theory of Moral Sentiments' (1759): "... In spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose ... be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society". In other words, Smith explains that man pursues his self interest while commanding himself based on the principles of natural law.

A. Hirschman departs from Smith's moral philosophy and develops a powerful reconstruction on the 'ideological' origins of capitalism. His main argument is that the rise of capitalism depended on the activity of merchants and bankers, which was originally considered sinful. So, what changed? How could an immoral enterprise become ethically acceptable? The answer lies in the moral justification of the interest as opposed to the passion - which by essence is unpredictable and irrational. Following his thinking, it is not an argument in defence of capitalism, but rather a cause of its birth and rise over more than two centuries. But, while acknowledging some virtues of capitalism, Hirschman also admits that interest driven behaviours might be dangerous, and therefore might need to be contained. His arguments have gained some validity in the context of the crisis as self interested economic behaviour, e.g. in the financial sector, will require more stringent and transparent rules.

When the Pope suggests that self-interest should be put in harmony with collective interest, he expresses a moral view. But, what is the dominant conception of economic virtue today? Isn't market competition extended to many segments of the economic and social sphere, including education and health?

In fact, Ethics matter as much as Economics. It is hardly impossible to draw a dividing line between the two. We must understand that Economics is a moral science which pursues the achievement of common good. But as every (honest) economist knows, it is more difficult to translate those principles into practice.

* http://www.iea.org.uk/
** The Passions and the Interests:Political Arguments for Capitalism before Its Triumph, Princeton University Press 1997

Climate change, poverty: two defining challenges

Climate change and poverty are the two defining challenges of the 21st century and they must be tackled together. It means that if we fail one, we fail the other. The aim is to meet the environment's carbon constraints while creating the growth necessary to raise living standards for the poor.

It is true that climate change affects gravely the poorest in many parts of the world. Natural disasters have a devastating impact on human lives and also on means of subsistance.

There is no alternative to a low carbon economy. Current growth patterns are characterized by high prices for fossil fuels and undermined by a hostile physical environment that climate change is already creating. If risks are not addressed, the eventual consequences will be worse.

Climate change poses a profound threat to our economic future and to the economic possibilities of our grand children (to quote a famous essay by Keynes), while low carbon growth promises decades of sustainable prosperity.

The Stern report* concluded that "the benefits of strong, early action on climate change considerably outweigh the costs". It proposes that one percent of global GDP per annum is required to be invested in order to avoid the worst effects of climate change, and points out that failure to do so could risk global GDP being up to twenty percent lower than it otherwise might be.

However, there is a continuing rich-poor divide on sharing the burden of curbs on greenhouse gas emissions in a drive to avert droughts, wildfires, species extinctions and rising seas. At the G-20 on 7 November, Britain pushed to reach a $100bn deal to meet the costs of climate change by 2020 but developing nations held firm they would not accept.

The forthcoming UN summit in Copenhagen will probably not lead to an agreement on the costs of climate change. Economic interests from rich and emerging countries seem difficult to reconcile. But rich countries should also endeavor on helping the poor to adapt to climate change, sharing technology and cutting emissions from deforestation. The selfishness of the rich countries is in fact the main source of division.

* http://www.hm-treasury.gov.uk/stern_review_report.htm

Tobin Tax is back?

At the G-20 in St Andrews on 7 November, the British PM Gordon Brown has proposed a levy on financial transactions to stabilize markets and raise new resources. This is nothing else than the so-called 'Tobin tax' ( proposed by the Nobel Price for Economics James Tobin in 1972) . Since then, that proposal was discussed in several occasions, but in particular after the two important financial crises which preceded the current one: in 1992 where the European Monetary System was under threat after the massive speculative attacks against the Sterling and the lira (which lost about 30% of its value) putting the Italian economy in a quasi default situation; the Asian crisis in 1997, which had devastating consequences for some Asian economies with riots and demonstrations for hunger.

The Tobin tax consists in a minimum levy on financial transactions , for instance 0,5% (as proposed by Prof. Tobin in an interview to Der Spiegel in 2001). In global finance, gains could be infinitesimal but the high frequency of operations and the large sums involved yield gigantic profits . So even a low tax could result in cancelling a large volume of transactions, which would not be profitable, although markets would gain in stability. Furthermore, tax revenues would be significant : at 0,5% it is estimated that they would represent more than 80 billion dollars a year, which according to many would be sufficient to eradicate extreme poverty in the world.

Such tax requires a large consensus among the most powerful governments and so far it has been opposed by all financial agents- which is not surprising- and also by many economists. According to opponents, speculation may be bad ethically speaking but has an important role in financial markets operation to guarantee financial liquidity. We can still think that the risks deriving from the Tobin tax might be deliberately overstated: even George Soros, who gave rise to the currency crisis in 1992, declared that the tax would have undermined his interests, but that it could have beneficial effects for the world economy.

It is not surprising that the proposal has been endorsed by all opponents of globalization, but Prof. Tobin himself argued that his idea was intended to make the world economy work better, although he also supported the idea to use it as a remedy to fight poverty. Created in 1998, an international organisation called Attac* supports the idea of introducing such tax to promote social justice.

Hitherto Europe was divided on the tax, with on the one hand France and Germany in favor and the United Kingdom against it. Gordon Brown's declaration in support of the tax is most welcome, although he made clear that the tax revenues would go into a fund for the State to intervene in bailouts. There is thus an important nuance: it would be reinvested in the country for emergence purposes not to redistribute resources to eradicate poverty. In any event, an agreement among European states will not suffice, and would need to be endorse by G-20. In the final declaration**, there is no mention of this tax but the discussion is far from being over.

* Attac (Association for the Taxation of Financial Transactions for the Aid of Citizens ) - http://www.attac.org/
¨** http://www.hm-treasury.gov.uk/d/2009_communique_standrews.pdf

Inequality and the economic crisis

Financial crises are considered being inherent to capitalism. As J. Stiglitz* put it, the roaring 90s of boom contained the seeds of self-destruction. Deregulation, excessive risks, creative accounting and tax cuts in favour of the wealthy led to the current disaster. But there is another factor which is often neglected in the analysis of the current crisis. Rising income inequality since the beginning of the 90s not only in the US but in almost all developed countries has been an important driving force in the global financial crisis.

The wealthiest - the top ten per cent - receiving a growing share of national income, directed huge financial resources into asset markets causing asset price bubbles. The middle class - say 60%- experienced a drop in real wages- especially in the anglo-saxon world and started borrowing massively as house prices rose, which helped postpone the problem of underconsumption or excess in production capacity. But eventually the gap between rising debts and less disposable income increased dramatically.

The same mechanism operated in the US during the 30s in the build up to the Great Depression. J.K. Galbraith* writes that the GNP (total production of the economy) was nearly less than a third in 1929. The overwhelming majority of tax payers had lower disposable income, while the top 1 per cent increased their revenues and corporate profits significantly. Speculation on a large scale went on during subsequent years : rising profits went into real estate and stock markets feeding the asset bubble. In the aftermath of the great crash, the majority of workers is confronted with less income and greater uncertainty about jobs.

What should be done to tackle income inequality? Huge fiscal stimulus programs were launched in the US, Japan, China and most European countries to sustain global demand. But the key to reduce inequality is to combine measures to sustain employment with income redistribution through the State. But other policy areas need careful attention. They include inter alia reforms of corporate governance as well as capping to bonuses for traders in order to put limits on maximising shareholder returns at the expense of wages.

More fundamentally, a new balance between capital and labour needs to be restored. Governments should act as a matter of urgency to tackle widening inequality as rightly pointed out by Matthew Slaughter (FT October 7). The steps taken by the Obama administration, particular on healthcare and taxation go in that direction but what about the European countries where only temporary measures are taken to prevent social explosion with unprecedent rise in unemployment?

¨* J.E.Stiglitz, The Roaring Nineties, Norton , New York, 2003

** J.K.Galbraith, The Great Crash 1929, published for the first time in US in 1954. This classic book is an illuminating essay on the causes of the Great Depression.

Misconceptions about the crisis

We must be worried that the crisis has not been fully understood despite all the energy put into it. GDP growth is turning positive, stock market prices rise again, banks make profits. Governments start preparing exit strategies hoping to turn back to normality.

In fact, the notion of 'exit strategy' does have a different meaning: it just refers to the state of economic affairs, not redesigning the global economic system. The accumulation of public debt and liquidity are creating fears of rising inflation. But this situation has been caused by the disfunctioning of markets. In a world without memory of the past, we tend to create a confusion between causes and effects.

Should we then take seriously this pledge for a return to normality? The danger is that economic agents ( for instance banks) continue to act as if nothing happened and then the actual conditions of the crisis will be reproduced. In effect, the origin of the crisis is not associated with public debt nor inflation; it is primarily a financial crisis, which reflects a huge disfunctioning of financial markets. Consequently, it is only partially attributable to myopic markets and predatory behaviour of financial agents. The bust of the financial system, has indeed, more profound causes.

In rich countries, the last quarter of century has in most cases been unfavourable to the working class. Inequality has risen everywhere; and it is not a coincidence that the crisis bursts at the heart of the capitalist system, in the United States where the increase of income inequality has been higher than elsewhere. The other countries have followed a similar path, but to a lesser extent due to social resistence. The consequence is that global demand weakens, due to the fact that most individuals with less purchasing power spend their whole income in consumption whilst a small minority will spend a lower fraction of their income. In that context, monetary policy is used to expand global demand: lower interest rates lead to wider access to credit and therefore an increase in private debt. The other side of the coin is that a tiny minority of individuals (probably less than 1% of the population) benefit from a susbtantial increase of their incomes and seek further opportunities for investing in financial markets. The result is the formation of asset bubbles through huge increases of asset prices. The system appears (although temporarily) to be in equilibrium since private debt corresponds more or less to the value of assets. Hence the impression that the net wealth of households has increased in value. However, when the market turned to a more realistic valuation of assets, then the system collapsed because debts could not be paid off.

Then comes the implacable mechanism of the crisis : the increase in inequality leads inevitably to a loose monetary policy, which in turns increases the systemic risks in unregulated financial markets as asset prices are set to increase continuously.

This is only part of the explanation of the current crisis. There are probably other causes which need to be taken into account, such as the accumulation of reserves (in dollars) by the emerging countries to protect themselves against macroeocnomic instability and which have further aggravated the crisis of demand.

The return to growth in GDP in most countries is certainly a good thing: it means essentially that the drop in global demand has been offset by the fiscal stimulus measures implemented through the States. However, world GDP is today at least 4-5 percentage points lower than its level before the crisis. Several years of continuous growth will be necessary to return to that level. In the meantime, unemployment - which is a key indicator of the 'end' of the crisis- will continue to grow.

In these circumstances, an 'exit strategy' might allow to turn back to economic conditions which prevailed before the crisis, but will not address the fundamental causes which led to the collapse of the capitalist system. The exacerbation of economic inequalities is not accidental, but it is the poisoned fruit of a particular conception of ' economic virtue' which puts at the heart of the model of society fiscal and social competition as the engine of growth.

The economic crisis is not a natural disaster, although many journalists and economic analysts present the financial turmoil as a 'tsunami'. All natural events occur in a limited timespan and cause damage and pain mainly to the weak categories of the population. It has to be seen on the contrary as a sign of profound disfunctioning of the capitalist system. Unorthodox economists, from Marx to Keynes and most post-keynesians like Harrod, Kalecki and Minsky have shown that this system is structurally unstable.

In his 'Theory of business cycles' (1939), Schumpeter wrote :"Cycles are not like tonsils, separable things that might be treated by themselves, but are like the beat of the heart, of the essence of the organism that display them".

We will not get out from the crisis if we fail to understand its underlying causes and if accordingly the right economic policies are not put in place in a coordinated way among States to tackle them.