Friday, December 31, 2010

The decline of work

Our civilization is facing one of its most acute crises as it has financial, economic, social and moral implications.  Beyond the financial meltdown, work is at the heart of the decline of western values. Middle class has impoverished over the last two decades; part of the young generation do not even know what work is. But the decline of work is not only expressed in economic terms, it has above all a moral and social aspect.

What is happening in our western world? In past 25 years, globalization has opened up the boundaries in which national states could intervene to regulate the economic activity. Now, the most negative feature is that it creates a downward pressure on wages: a billion and a half workers in developing countries with low wages and almost no rights are competing with half a billion of workers better paid and socially protected. In western countries, there has been an overall reduction of the workforce, in particular blue collars and middle class employees which guaranteed average incomes to buy goods and services produced for them and these jobs are now being destroyed; conversely, lower paid jobs with hardly any social protection have expanded in all sectors. The consequence is that the share of annual output to workers was reduced and the one which went to capitalists increased dramatically. We have a direct experience of this structural change: entire categories of workers had their (real) incomes gradually reduced and their social status as well, whilst we are surrounded by highly qualified people who accept to work with low remunerations and low protection. This is what impoverishment of work actually means.

Technological change affects work in many ways. It reduces, first of all, the number of workers needed to produce he goods and services needed by the global population. It also changes work organization, allowing people to work more autonomously and to relate with others much faster. But all these changes do not mean necessarily the 'end of work' (J.Rifkin), nor a negative impact on human beings ('labor' in Latin means suffering!). Productivity and autonomy can be reconciled with more jobs created elsewhere and better quality of life.   

As explained by classical economists, the economic value of work and its social value are indissociable. Between the 50s and the 80s, it was a sort of 'golden age':  industrialized economies grew steadily and workers could get more income and social rights. Work was the only means to realize people's aspirations for better living, come into their own in society and create a better future for them and their children. Then  started a slow but steady decline. If work loses economic value, it also becomes less relevant in social, cultural and political terms giving rise to an individualistic and fragmented vision of society.  This was the project which was inherent to neo-liberalism which pervaded western societies in the 80s and 90s. 

Yet, this is not what young generations want. Overwhelmingly, they desire a job to be independent, start a family life, build or buy a house, all things which were possible for their parents. But what social research tells us is that, most of them  don't have realistic expectations that this may happen one day. 

We must give value to work as it is the foundation of any society as laid down in many Constitutions of democratic countries. It is not just a matter of industrial relations and the role of trade-unions. It is a more fundamental issue as it has profound societal implications. The challenge for the next millennium is to create better jobs, with higher intrinsic value and to train people being able to make them. If work gets an increasing economic force, it may drag all the rest of the economy while ensuring a more balanced society, a stronger democracy and a more sustainable economy. The decline of work values has conversely increased inequalities and made democracy more fragile and vulnerable to any form of extremism. Restoring the value of work is the only antidote to the decline and perhaps the fall of our western societies.   

Sunday, December 26, 2010

Conspiracy over the euro

Conspiracies theories are always viewed with skepticism by scholars and public thinkers. But sometimes, it may help to understand the essence of phenomena and to go beyond conventional wisdom. It is not just a matter of belief but a hypothesis to understand the sequence of historical events as well as the motives and actions of secretive coalitions of interests.

The euro has been strongly attacked since 2009 and its evolution is subject to wide fluctuations. The euro crisis is not just the result of 'irrational exuberance' (as Alan Greenspan called it) of markets. Behind it, there are great economic powers which tend to influence economic decisions in weaker economies. Markets are not abstract entities; we are talking about powerful banks which influence -rather than anticipating- economic policy decisions, for instance on sovereign debt service. The core of speculative attacks stems from 'hedge funds' those funds which can bring high returns in times of low interest rates. But the brain is the international banking system which operates permanently on all financial markets, from New York to Shanghai.

The New York Times has explained recently how this 'brain' works and has indicated the banks at the core of the system - among which  J. P. Morgan, Bank of America, Goldman Sachs, Ubs, Crédit Suisse, Barclays, Citigroup and others. Each of them has a network of links and shares all over the world as well as a huge mass of capital at their disposal. Every week, senior executives from these banks meet to examine carefully the economic outlook in terms of employment, manufacturing output, exchange rates, mortgages, spreads on sovereign debts, commodities, and sometimes  political instability and decide on whether act or wait. Whilst the business community and right wing governments discuss about liberalization of markets, free competition and other dogmas of economic liberalism, free markets are in fact guided by a small cartel with unlimited resources and huge economic and political power. Remember, Karl Marx referred to a global banking cartel in the second half of the nineteenth century !

But international speculation is not directed at the exchange rate of the euro, but sovereign debts and spreads  on interest rates. It aims to increase the differential rates between weak European countries- with high public debt- and German 'Bunds'. The only institution which can challenge this is the European Central Bank, which, although it is not enshrined in its Statute, has to reduce the 'spreads' among the euro area members. Differentials in interest rates have some underlying causes, such as a crisis of public finance or the banking system, or both. Speculators are attentive to these realities and influence them to decide the right moment to attack. Then, they retire when the European Central Bank comes into play and bring back home huge profits that will constitute the weapons to restart the game. The final objective is to split the euro area in two: on the one hand, a strong area with Germany at the centre and with the euro (or a D-Mark?) as a common currency  and on the other hand, a weak area with peripheral countries and a currency which might fluctuate around the euro.

If such a project materializes, it will open for international speculators a wider field of action which will bring huge profits. This will not inevitably happen as the euro area has strengthened its governance rules and will try to survive. The speculation will, however, continue its war and yield profits as long as sovereign debts will not be reduced and more importantly wide inequalities in economic development persist among member countries. 

The European Council of 16-17 December has decided to set up a permanent crisis resolution mechanism after 2013 and agreed to revise the Treaty accordingly to enforce it. This has been widely discussed and analysed during last months after the Greek debt crisis and the subsequent Irish crisis has accelerated this decision.

Technically, it could be possible to stabilize financial markets with a large increase of the European Financial Stability facility - which was used to rescue Greece and Ireland- together with an increase of the ECB's purchase of government bonds. In practice, this would mean a bailout of bond holders. Yet we need a long term solution.for Europe's economic troubles and the key lies in the establishment of a European treasury and a federal budget as advocated recently by J.Attali, former EBRD president*. One of the most important contributions of optimum currency area theory is, indeed, that a monetary union, featuring a central bank without a Treasury is unthinkable. But this, we're afraid, would be a long term endeavour.

P.S: Last Friday, Tommaso Padoa Schioppa passed away. He was a convinced European federalist, an idealist with concrete ideas and he participated to the creation of the euro. His lessons should not be forgotten.

Saturday, November 27, 2010

Put People First

In the streets of Dublin, people demonstrate against severe cutbacks and tax increases with the slogan 'People before profits'. They are right to do so, as the austerity measures raise equity issues. The Irish government plans to cut minimum wage and slash 25.000 jobs in the public sector. But low tax rate for business is sacrosanct in Ireland.

Most of the 15 billion euro cuts will come from the welfare State and the working class. But these measures will not touch large businesses like Microsoft, Intel or Pfizer - which is true, they contribute to create hundreds of thousands of jobs and fuel exports. In fact, some multinationals which operate under Ireland's tax regime use complicated schemes to shift profits into and out of subsidiaries, allowing them to lower their effective tax rates.

The Irish government, which has lost popularity and support from citizens, will cut its deficit to less than 3% of its GDP by 2014 from 32% this year, that is a reduction of ten times (!). Ireland's total foreign debt, public and private is about 10 times its GDP. This situation is exploited by global investors to drive up borrowing costs, which are unaffordable under current growth scenarios. But, why should the middle class suffer from irresponsible behaviour of the Irish banks which will be saved in any event?

The question is whether there are credible alternatives which might alleviate the social costs of the crisis. Ireland - like Greece- should be allowed to restructure their debts - by extending their payments or reducing the principal (which means forcing banks to accept some debt write offs). If it is not the case, the Irish economy, which, from a poor peripheral country turned into one of the richest economies of Europe, will be condemned to stagnate over many years.

P.S: P.Krugman wrote on NYT a passionate article on the Irish crisis:
Yesterday, the EU Finance ministers agreed on an aid package of 85 billion € conditional upon an austerity plan. Borrowing costs will amount to 5,8%, higher than Greece (5.2%). The novelty is that debt restructuring might eventually be allowed as a last resort measure (A.M. 29/11). 

Sunday, November 21, 2010

The failure of the G-20

After Toronto which marked a turning point toward fiscal austerity, the G-20 in Seoul focused on the so-called war of currencies.  The 4-page communique stresses the importance of "re-balancing" the global economy, "coordinating" policies and refraining from "competitive devaluations". Not a single word about the reevaluation of the yuan nor on the recent moves of the FED to inject money in the US economy (which reduces interest rates and renders the US market less attractive for global investors thereby lowering the value of the dollar).

China  and the US are the two big players in the current war of currencies. Neither of them is ready to make concessions. Other nations try to reduce the value of their currencies to stimulate exports and therefore create jobs. So the real problem is not just about global imbalances; it is mainly about imbalances between the US and China. In the US, income inequalities are rising dramatically, with more income concentrating at the top 10% and this reduces the relative income of the American middle class. This means more pressure on exports to fill the gap.

In China, an increasing share of income goes to the productive sector rather to Chinese consumers - just like Germany. this reduces the relative income (in terms of purchasing power) of the Chinese relative to scale of domestic output produced by the Chinese economy. This also means more pressure on exports to fill the gap.

Targeting currencies is not effective to stop trade imbalances. A reevaluation of the remimbi will have an effect on trade balance if China responds by reducing real interest rates or expanding credit - which in fact it did after the reevaluation of the remimbi in 2005 and which japan did after the Plaza accord. The expansion of cheap credit offset the impact of the appreciation of the currency and the trade surplus continued to grow. It would be much more effective to target current account imbalances to re-balance the global economy.

The broad agreement on global recovery is meaningless. The truth is that more needs to be done to ease tensions that are moving the global economy closer to the edge of irresponsible protectionism. The key responsibility rests with China and the US, and any move towards a new monetary order will depend on their respective economic policies.

Sunday, November 7, 2010

We should save the euro

Economic pessimism is spreading among the ideas of opinion leaders. In a recent article, N.Roubini* (called Mr Doom) predicts the collapse of the eurozone. He argues that the fundamentals problems of the euro - high deficits and stocks of debt, loss of competitiveness- are still unresolved, especially in the periphery with the possible default of Greece. He concludes: 

"So a eurozone that needs fiscal austerity, structural reforms, and appropriate macroeconomic and financial policies is weakened politically at both the EU and national levels. That is why my best-case scenario is that the eurozone somehow muddles through in the next few years; at worst (and with a probability of more than one-third), the eurozone will break up, owing to a combination of sovereign debt restructurings and exits by some weaker economies".'

Another influential economist, J. Stiglitz** asks whether the euro can be saved looking at the economic situation from a global perspective and warns on the dangers of fiscal austerity.

"For the EU’s smaller countries, the lesson is clear: if they do not reduce their budget deficits, there is a high risk of a speculative attack, with little hope for adequate assistance from their neighbors, at least not without painful and counterproductive pro-cyclical budgetary restraints. As European countries take these measures, their economies are likely to weaken – with unhappy consequences for the global recovery" (...)  The social and economic consequences of the current arrangements should be unacceptable. Those countries whose deficits have soared as a result of the global recession should not be forced into a death spiral – as Argentina was a decade ago"

Both are right in their analysis, but they don't have much to offer in terms of proposals to save the euro. The traditional measures such as competitive devaluations or appreciation of the euro are not achievable in current circumstances.  In fact, the European economy  is basically a market social economy ruled by strong supra-national institutions, including the ECB, cohesion transfers and an  internal market which needs to be reinvigorated along the lines of the Monti report. 

In Europe, all political leaders agree that the euro should be saved although they might differ on the solutions. The EU has taken steps for a permanent crisis resolution mechanism to rescue countries in great financial difficulties and will apply sanctions for countries with excessive  budget deficits. What is missing, in fact,  is a fiscal framework giving to the EU - now that it has stronger institutions with the entry into force of the Lisbon Treaty- the power to relaunch the European economy by means of a large infrastructure program which eventually will produce lasting impacts on growth and employment. The issue is again where to find the necessary resources without increasing the stock of public debt. Why isn't possible to create a special Fund with resources from international financial institutions, in particular the European Investment Bank, whose scope is  to contribute to the achievement of EU objectives?

The EU economic model is not flawed, as argued by many economists from the other side of the Atlantic. But it needs a much greater ambition to avoid a high price to pay in terms of jobs and human suffering. 

Monday, November 1, 2010

Italy has no future

Unemployment is a serious concern everywhere, especially among young people. In Italy, it affects over a quarter of the entire population, six percentage points above the European average. However, this has not led to any significant reaction of the society. In France, the pension reform - rising the retirement age from 60 to 62- caused a cycle of demonstrations which blocked the country during several weeks. This massive movement involved workers from all sectors but also young students  who expressed their concern not about pension reform but about their future. The French pension reform is particularly unjfair as it penalises particularly people who started working very early.

In France like in Italy, younbg people have no bright prospects . Social mobility does not work any longer: young generations are not getting a better situation relative to previous generations. But they don't protest, neither do their parents. They express distrust of the institutions, including the Church, and in past years hundeds of thousands left their country in search of a job in other European countries.

So what makes Italy so different from France? Italians are traditionally tied up with their families; this has become more evident with the crisis, where the family is a 'natural' safety net, in the absence of  a Welfare State protecting those who lost their jobs. For their future , the young count increasingly on the assistance of their families. They stay longer living with their families, even beyond 30 or 35, or when their leave their homes, they tend to rent a house close to their parents. Ties become even closer, because of reciprocal need and dependence. In so doing, the family has a 'conservative' influence on society as it protects its children in all areas, studies as well as professional activity.

Politicians have understood this phenomenon and use the family as a flagship for their political campaign. But just in a rethoric way, because in fact, little has been done, especially on social services for women having a job, or tax benefits for families with children. Families are increasingly under stress, as an inefficient State has now to struggle with debt reduction. Social cohesion is a matter of concern, and it might be in peril.

Saturday, October 9, 2010

After mass reaction, we need social dialogue

It was largely predictable that austerity measures would cause a mass reaction among those who are most affected by them, that is middle class workers with lower income. It started in Greece after the government decided to cut wages in the public sector and to increase taxes; now, demonstrations are taking place in several European countries, and not the least in Brussels, in the heart of Europe. Trade unions led those strikes in a responsible manner. One can expect that social dialogue takes place as it should in any democracy.
The question is whether governments confronted with huge deficits have an alternative to austerity. It is also interesting to note that most demonstrations took place in countries governed by socialist parties which belong to the so-called European periphery . It might not be a coincidence, but this is revealing of the social climate there.
We should not forget that tax payers had to bear the burden of the financial crisis to rescue the banks heavily affected by toxic assets, especially in the US, UK and Ireland, whilst many banks continued to give substantial bonuses to their managers. In all countries, tax payers are paying the price of the greed and stupidity of those bankers, because systemic risks have triggered a much wider crisis in the real economy, with devastating effects on businesses and workers. And now governments have decided savage public spending cuts  to reduce budget deficits. It is odd that the Uk government - which was elected on the issue of a fairer society- has now abolished children benefits for more than a million families, with savings of a billion a year. Instead of welfare cuts, it would have been fairer to ask bankers to pay for the crisis more than they actually do.
Welfare accounts for 30-50% of public spending in European countries, even more in Sweden. But, many governments are taking regressive measures rather than tackling effectively income inequality through changes in taxes and spending. The problem is not so much tight public finances, but the way they are utilized to sustain the economy. It is true, that, despite some redistributive measures in favour of poorer families and pensioners, income distribution in the United Kingdom was more unequal at the end of the Labour term that at the beginning.But this has more to do with the financial system than the budget priorities.
Unfair austerity measures will aggravate poverty and joblessness. We need a genuine social dialogue to ensure that budgetary measures are promoted with a sense of equity and social justice and do not affect once more the poor. If governments are scared about default, they should also care about uncontrolled mass reaction.

Saturday, September 18, 2010

Poverty rises in times of crisis

The US Census Bureau* has published last Thursday (16 Sept.) a report on the impact of the recession on poverty. The economic crisis has brought four additional million of Americans in poverty in 2009, reaching in total 44 million, or one in seven citizens. The poverty rate climbed to 14,3%, the highest level since 1994. For a single adult, the poverty line was $10,830 in income (before tax) and for a family of four, $ 22,050.

Given the depth of the recession, some economists had expected an even larger rise in poverty. It has hold down because of unemployment insurance or other assistance. But millions of Americans are still struggling with poverty, in sharing homes with parents and even non-relatives. The Census report found a dramatic increase in the number of such multi-family households over the last two years. Another sign of the crisis is the rise in food stamp recipients, which affects nearly one in seven adults.

According to Lawrence Katz, a Harvard economist, if the two recession years are considered, the decline was 4,2 percent and median family incomes in 2009 were 5 percent lower than in 1999. This means basically no gains achieved for the average American household on an entire decade.

The number of US residents without heath insurance climbed to 51 million in 2009 from 46 million in 2008, although it is expected that these numbers will shrink as a result of the healthcare reform which begins to take effect.

There are, however, strong signs, that high poverty will continue to rise as unemployment remains stable and recovery weakens. the decline in incomes in 2008 had been greater than expected. Experts know that the poverty line is a flawed measure, and that poverty is a multi-dimensional phenomenon (as Sen called it in his works on poverty), but it remains a consistent measure of need for deprived populations and its variations reflect genuine trends.

Increase in poverty is intolerable in the richest country of the world, especially because it affects historically Black and Hispanic communities. This has a dramatic impact on the social life of the nation, its cohesiveness but also on the future of these young generations, who, for a large share of them, had never had a stable job and income.

Friday, August 27, 2010

We should care about Pakistan

The world neglects aid to Pakistan - if we compare it to Haiti- given the scale of the disaster. In his blog*, Robert Reich, an academic and former US secretary of Labor, explains why we should be concerned about it:

Flooding there has already stranded 20 million people, more than 10 percent of the population. A fifth of the nation is underwater. More than 3.5 million children are in imminent danger of contracting cholera and acute diarrhea; millions more are in danger of starving if they don’t get help soon. More than 1,500 have already been killed by the floods.

This is a human disaster. It’s also a frightening opening for the Taliban.

Wednesday, August 4, 2010

On Corruption

In recent times, there are worrying signs of increasing corruption in our most advanced democracies. This is not a new phenomenon, but what matters are the new forms that it is taking. According to many sources (Transparency International, World Bank, etc.) the level of corruption has reached in some countries, such as Italy and Greece, its highest level. In fact, the corruption index is based on surveys which capture the perception of the phenomenon by citizens, but it difficult to measure it accurately. In a survey carried out by Eurobarometre in 2009, most European citizens consider it a very serious problem, especially in Italy. Again, in this country, 17% of those interviewed declared to have experienced corruption in the last twelve months.
Economists have started dealing with this issue two decades ago. But the findings remain still controversial. For instance, the excess of bureaucracy is regarded as a major cause of corruption, but there is still an open debate on the issue of its relationship with economic development. Although most economists consider that corruption has a negative incidence on growth, there are still some views on an inverse causal relationship, that is low growth determines the level corruption. The channels of influence may differ insofar corruption allows inefficient businesses to survive and thus distorts competition, discourages new entrepreneurship and increases the price of good and services delivered by the public sector. Furthermore, it contributes to an inefficient allocation of ‘talents’ and skills: as D. North, a former Nobel price put it, a system which rewards pirates produces pirates not engineers. It is interesting to note that countries more prone to corruption are characterized by a plethora of lawyers- who make up a great deal of the unproductive class. If corruption in Italy would drop to, say, German levels, economic growth would improve by 0,8% per annum, using econometric coefficients derived from a recent study*.
In Italy, four decades of economic development – between the 50s and the 80s- were not conducive to similar institutional standards of the other founding members of the European countries. This means that the quality of institutions has not improved over time. It has been an era of growth without institutions for which the Italian economy is paying the price with a lower growth. The decline of institutions and the loss of control of corruption are, in fact, associated with recent evolutions in the political system, with Berlusconi’s aversion for the rule of law. There are also specific channels of transmission such as electoral rules and decentralization. In the current electoral system, candidates are chosen by political leaders irrespective of merit or competence, which creates opacity and a risk of corruption as compared to a system based on open lists based on the expression of preferences. Local governments are also more prone to corruption relative to central governments, especially if they are supported by very large majorities built around networks of ‘clientelism’ giving little space to a political opposition making a case for good governance.
Yet, we don't have a full understanding of the phenomenon of corruption, its causes and its effects on economic growth. But, it is clear that without it, policies would be fictive or not effective, and the gap between the political class and civil society will keep growing, economic growth will remain sluggish and we might end up with some kind of authoritarian State.
* T.S.Aidt, Corruption, Institutions and Economic Development, Oxford Review of Economic Policy, 2009

Sunday, July 25, 2010

Rising inequality in a declining country

Italy is no doubt a rich country. It is probably among the richest economies in the world, mostly concentrated in North America and the core Europe. But Italy is a country where exists a large part of the population living in poverty conditions, not only in the southern part as well as intolerable disparities in individual incomes and wealth.

The main feature is that there is no social mobility between the rich, upper classes and the poor, low income groups. The wealth produced by the economy is not redistributed, flows in the system and feeds the perverse logic of making the richest even richer. Over the last decade, the Gini coefficient - a measure of income inequality- rose from 0.29 in 1990 to 0.35 in 2005, following the rising trend in OECD countries. According to ISTAT, the national statistical office, relative poverty rose to 10,9% of the population in 2009 and absolute poverty to 4.7%; the respective figures for the Mezzogiorno- where more than two thirds of the poor live- are 22,7% and 7,7%. Furthermore, it notes a worsening of economic conditions among the blue collars and the elderly.

Fig.1: Growth of GDP in Italy 2000-2011

The main difference with other rich nations is that Italy has performed poorly over the last two decades (see Fig.1). Growth has remained sluggish from 2001 until now, with a dramatic drop in GDP in 2009 due to the global crisis. Yet, low growth does not allow any durable narrowing of income gaps, also given the magnitude of public debt.

Policies inspired by values of social justice should be pursued in order to dismantle the perverse logic of enriching the rich and to restore a virtuous circle in the distribution of income. The thrust is to act quickly through tax reforms which should benefit primarily the low and middle classes. But, it requires, above all, an effective partnership between the government and social parties as it was the case in 1993 under the Ciampi government.

Thursday, July 22, 2010

The false debate on austerity

The debate on austerity has brought a harsh confrontation between keynesians and anti-keynesians. This has been going on for sometime in the US with the 'deficit hawks' who claim that the US fiscal stimulus plans will lead to an unsustainable path of public finance . As Krugman argued, they just mess up with numbers; the US economy can cope with the federal debt burden- which is just above 60% of US GDP- which is exactly what the Maastricht criteria set as a limit for debt sustainability - thanks to low interest rates. Furthermore, it is rather obvious that ending the fiscal stimulus - or even tightening fiscal policy would just put the economy and jobs in peril.

Now, Niall Ferguson, a British historian, claims that keynesians haven't learnt anything from the 30s (FT July 20) . It is true that the world has changed since the 30s; we are much wealthier than at that time, although that wealth has led to greater inequalities among people. It is therefore difficult to compare deficits in the 30s with the fiscal situation today. In 1930, governments did not use monetary and fiscal policy to offset the contraction of economic activity as they did in 2008-2009.

In replying to Ferguson's anti-keynesian argument, Lord Skidelsky, author of a voluminous biography of Keynes, points out that ... expansionary fiscal policy (in the UK and the US) was ruled out by adherence to the doctrine of balanced budget; in the US, a large part of the banking system was allowed to collapse. Public policy, that is, was not used to counteract the fall in private spending. In 2008-09 all the tools available to government were broght into play - bail-out of banks, open market operations, fiscal stimulus. the reason for the different response was the change of theory associated with the name of Keynes" (FT July 22).

Another point made by Skidelsky is on the economics which underpins the anti-keynesian argument. There is, in fact, some analogy with the supporters of the 'Treasury view' which keynes fought vigorously and which argue that 'bond financed government spending was bound to "crowd out" private sector spending". The other well known argument is that multipliers are quite small because of the openness of the economies and therefore the demand effect leaks out to other economies. Recently, the Congressional Budget Office estimated that each dollar spent to assist the unemployed brought about $1.90 dollars in additional economic output.

Fiscal conservatism is not the solution to reduce uncertainty and restore confidence among private investors. Governments have allowed banks to act as they wanted, being aware of the risks of a financial meltdown. As a result of the banking crisis, millions of people lost their homes and savings and were left without any protection.

The debate is less between austerity and fiscal stimulus; it is about a fundamental choice in favour of policies which create jobs and provide decent incomes for those most in need.

Sunday, July 18, 2010

Are Europeans going conservative?

The FT (12 July) reports the results of its survey* which indicates an overwhelming support - from citizens in the largest five EU countries and the US -for the spending cuts made by European governments led by conservative governments, with the exception of Spain. It also highlights that aid to developing countries and defence - adding unemployment benefits in the UK- should bear the bulk of the cuts, but on the other hand, there was barely no support for cutting public expenditure on police, healthcare and education.

This 'fiscal conservatism' is largely influenced by the debt crisis which resulted in a rescue plan for Greece and a resolution crisis mechanism for any other euro area countries in default. This also reflects a fear from middle class citizens- who already lost a fraction of their real incomes over the last decade- for any further taxes which might result from a rise in public deficits. This appears to be a natural reaction to protect their incomes and savings as the crisis deepens.

This survey is in fact biased as questions were not addressed to a representative sample of the population in those countries. It depends who are the respondents : if you ask public servants affected by wage cuts, the answer would not be the same. In fact, we don't know who are the citizens who answered to the survey. But, more importantly, it is difficult to draw a conclusion that there is support for a review of Europe's social model, except perhaps the UK . We know that the majority of the population in France and Germany are reluctant to any cuts in healthcare and pensions.

In its last issue (17 July) , the Economist is even more contemptuous: "the ideal of progress has been a myth for longer than Europeans may care to admit". The argument is that social progress in Europe was just an illusion and that European countries were living beyond their means by financing their welfare State with hefty debts. It continues: 'Europe has put its values before growth'' [...] the euro-zone crisis has exposed such hypocrisy". And it concludes: " "It may still take time before Europeans conclude that they must compromise their ideals in order to secure the growth needed to preserve what they can of their lifestyles".

The European social model is often associated with social reforms, especially in France, such as retirement at 60 and the 35 hour working week agreed under a socialist government. Why is this not a mark of progress? In most European countries, labour is heavily taxed compared to capital and land. The scandal is to rescue banks which have made gigantic profits with derivatives and other speculative instruments to the detriment of entrepreneurs and workers. The issue here is again about social justice. No government should restore a situation just to continue rewarding greed instead of protecting their citizens. This message should be understood by European citizens.

* The FT/Harris poll was conducted on line among 6.164 adults aged 16 to 64 in France, Germany, Spain, the UK and the US, and adults between 18 and 64 in Italy between June 22 and July 1.

Tuesday, June 29, 2010

The high costs of austerity

But rather than being rewarded for their actions, these countries are being penalised with a rise in bond yields. The economic downturn has been even sharper than if the governments would have spent on stimulus to keep people in their jobs. As a result, the economies of these countries shrunk dramatically ( more than 20% of GDP loss in Latvia and Lithuania) and remain in recession. Wages in the public sector have fallen by 20-30% in several countries. In the meantime, joblessness has risen to two digit reaching almost 20% in Spain!

Austerity prompts strikes and slowdowns which in turn shrink the domestic market, investment and tax revenues. As unemployment spreads and wages fall, mortgage arrears and defaults soar. Property prices have plunged in some countries. Some business owners are even escaping their debts and emigrate.

For States in crisis, austerity is not the only option. It has huge economic and social costs. It does not make countries more competitive: it uses unemployment to lower wages and imports and therefore depresses domestic demand. There is a second option for non euro-area countries which is currency devaluation but it is not pursued as it would delay their planned integration into the euro area as their currencies are pegged to the euro. It would also raise the price of energy and other essential imports, aggravating the trade deficit.

But there is another option which is worth being pursued and would yield better results. In some of these States in (fiscal) crisis, there is high taxation on labour and capital and land are under-taxed. Lowering taxes on wages would reduce the cost of unemployment and increase demand.

The main issue in European countries, notably in the eastern part, over the coming years will be whether economies can cope with heavily taxed wages and inflated housing prices while avoiding an overdose of needless austerity.

Saturday, June 26, 2010

The divisive Toronto Agenda

The G-8 and G-20 meetings in Toronto have a long agenda of complex issues on which rich and developing countries seek a common approach to set out new governance rules. Topics include banking levies, financial regulation, currency controls and many others.

From Toronto, bad news: there will not be at the G 20 an agreement on the levy on financial transactions. The reason is quite interesting: rich countries like US, UK, France and Germany want it but there is a strong resistance from the banking sector; other countries such as Canada, India and China, much less affected by excessive speculation- due to their relatively more traditional and stable banking sector, do not see any reason to penalise their own banks.

On financial reform, the US administration will pursue a 'unilateral' approach. Just before the meetings, the Senate approved a package of financial reform, including a tax on banks worth 19 billion $ to prevent future financial crisis. It includes a list measures including tougher powers for the Federal reserve to oversee 'too big to fail' banks, registration of hedge funds and the creation of a consumer agency to regulate mortgages.

The second issue of contention concerned fiscal policy opposing fiscal consolidation to reduce debt to GDP ratios and the pursuit of fiscal stimulus to sustain recovery. The final statement reflects this compromise: 'Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016' . But Obama - supported (only) by India- warned the eurozone and Germany in particular that early cuts to public spending might undermine the signs of recovery. It is also significant that the final statement stated that Germany and China should contribute to growth in global demand : 'Surplus economies will undertake reforms to reduce their reliance on external demand and focus more on domestic sources of growth'.

The Toronto meeting reflects in fact the strategic division on the response to the crisis between the European 'doctrine' (stability and budget deficit reduction) and the US conception based on maintaining fiscal stimulus plans to sustain the recovery of their economy. The feeling is that nations are concentrating on their own economies ignoring global welfare and aid to the most vulnerable countries. Unilateralism in areas such as financial regulation and trade is unproductive. Uncoordinated financial rules may be self-defeating because of the need for regulatory arbitrage. Does it make sense that the US will pass its new financial regulation law but no agreement on the Basel III rules on bank capital requirements has been reached.

In sum, the outcome of the G-2O meeting has been deplorable, but not for failing to co-ordinate fiscal policy. This is the least of its sins; it has failed on the main issues which are decisive for better global governance.

Saturday, June 19, 2010

The Spectre of the 30s

The lessons from the 30s seem to be forgotten. In 1937, when F.Roosevelt sought to balance the budget, the economy plunged again into a severe recession. And here in Germany, the financial orthodoxy pursued by the finance minister, Heinrich Brüning, from 1930 to 1932, led to the end of the Weimar Republic.
There are no sanctions for those- the experts who preach financial rigour and budget balance- who repeat the mistakes of the past. Since the 80s, the dominant economic view repeats the same discourse which led to the depression of the 30s. At that time, J.M. Keynes rejected vigorously what he called the 'Treasury view'. The main argument is that an economy with rising unemployment is badly managed and that mass unemployment should not be tolerated in any economy . The famous British economist made that point in the Mac Millan Committee*, putting forward a set of principles defining a full employment economy: full employment is the primary objective for economic policy; wage flexibility is not a remedy to unemployment; the currency in a country with high unemployment could not be strong unless depreciation of assets is compensated by high interest rates; the State can contribute to restore full employment via an active policy increasing public investment financed through a budget deficit; the Central Bank should help financing spending which will generate wealth in the future.

In recent times, President Barack Obama urged other G20 countries to boost domestic demand and increase exchange rate flexibility to encourage global growth and rebalance the world economy.He said in a letter : “I am concerned by weak private sector demand and continued heavy reliance on exports by some countries with already large external surpluses.”**

This warning seems to be largely ignored by the deficit hawks, which are now prevailing in Europe, Canada and other countries. The myth of 'sound finance' - which is related to a blind faith in free markets- is based on a 'classical' vision of capitalism driven by the search for more savings. As opposed to it, Keynes and other post-Keynesian economists such as Kalecki and Minsky demonstrated that the engine of capitalism is the debt which generates the 'quantum' of money necessary to finance investments.

As in the 30s, the danger of unemployment should deserve greater attention. Trade unions have understood it, not our political leaders.

* See P.Clarke, The Keynesian Revolution in the Making 1924-1936, Oxford University Press, 1988

Sunday, June 13, 2010

G-20: the return to economic orthodoxy

The 'hawks' are back and took over the G-20. The final declaration* of the 4-5 June meeting in Busan states: "Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions".

It seems that there has been a shifting attitude relative to the previous Washington communique issued on 23 April which insisted that demand stimulation policies" should be maintained until the recovery is firmly driven by the private sector and becomes more entrenched".

Historical experience in the 30s show that drastic cuts to public spending during a grave recession are not only ineffective in terms of reducing public deficits but also socially harmful. Restrictive fiscal policies - if not conducted wisely and gradually - may have opposite effects, as they might depress further the economy and reduce tax revenues, therefore further increasing public deficits.

So, what should be done? One possibility would be to wait that the economy recovers in order to allow central banks to use monetary policy to offset the contraction of economic activity resulting from budget austerity. But here again the 'hawks' ask for further budget cuts in the face of high unemployment and interest rates close to zero.

One might argue that the situation in Greece represents a serious warning against any further rise in public debt. But this cannot be taken as a general situation. Countries with high public debt are Spain and Greece (leaving aside the specific situation of Italian public debt being largely held by domestic financial institutions and households) ; they belong to the euro area and they have overvalued assets due to huge capital inflows in previous years. The risk is thus a prospect of deflation over coming years. However, for other countries, there is no objective reason to conduct immediately such policies. Ten year bonds in the UK yielded interests of 3,51%, in the US 3,21% and in Japan, 1,27%.

So where does this radical shift toward austerity stem from? the answer is that Finance ministers and governors of central banks of the G-20 are convinced that expenditure cuts would reassure investors. They just care about how world markets would react if the leading economies were not ready to make further sacrifices. But the idea that these sacrifices might be useful or even be harmful for large segments of the society does not count at all.

So the message is that if the leading economies will not pursue these virtuous policies along the lines of the G-20 and other organizations, it will undermine the fragile basis of economic recovery to satisfy hypothetical demands of investors for more austerity.

Sunday, May 30, 2010

Will Capitalism survive from immoral behaviour?

The OECD ministerial meeting (27-28 May) includes in its final declaration the following statement: 'The depth and breadth of the crisis has demonstrated the need to strengthen our commitment to fundamental principles of propriety, integrity and transparency. Our future growth and stability should be based on a commonly shared set of principles underpinning international economic and financial transactions'.

Launched as a concept by the Italian G8 Presidency in early 2009, the Global Standard aims to develop a set of common principles and standards for propriety, integrity and transparency in international business and finance.

In the G8 Declaration "
Responsible Leadership for a Sustainable Future" adopted at the L'Aquila Summit, G8 Leaders agreed on the objectives of a strategy to create such a comprehensive framework, the “Lecce Framework”, and to "make every effort to pursue maximum country participation and swift and resolute implementation".

The significance of this declaration is not only rhetoric. It is much more profound if we look from a historic perspective. Capitalism wants to build a moral society from immoral behavior. Political leaders are afraid of the consequences on the public opinion of the financial meltdown caused by the banks gambling with other people's money. In the US, part of the middle class has lost their houses as they could not pay back their mortgages.

In fact, some blame Wall Street for its greed, hubris, and stupidity. But free market economists will argue that this has always existed. Russell Roberts, a professor at George Mason university in Washington argues that " public policy decisions have perverted the incentives that naturally create stability in financial markets and the market for housing".
Free market supporters will support the idea that markets are always efficient and that new regulations are harmful. They prefer non binding rules such as the ones discussed in the OECD framework, with some exceptions such as the offshore places.

Capitalism is to blame because it is unstable and when crises occur, unemployment rises and inequalities tend to grow dramatically. This is Keynes' philosophical conclusion of his General Theory** in defining the foundations of an 'ethical' economy: "The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes" .

  *Chapter 24. Concluding Notes on the Social Philosophy towards which the General Theory might Lead

Saturday, May 15, 2010

Markets should become reasonable

Markets are not abstract entities. Behind the 'invisible hand', there are entrepreneurs as well as speculators who seek to invest to get a higher return. Long term investors promote the public interest whilst speculators will seek short term gains. We should therefore distinguish between markets which correspond to real economic activities, such as commodity markets, and 'fictional' markets, as derivatives, which are organised like a casino. Making money quickly gambling on fluctuations of the market is intolerable and immoral because it rewards greed, not economic risks.

Keynes wrote in his 'General Theory' *(p159): 'When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done'. ¨[...] It is usually agreed that casinos should, in the public interest, be inaccessible and expensive.

Today, the debt market has become a battlefield. It has turned into pure speculation: financial investors buy and sell sovereign debt bonds for their clients; they gamble on default risks of States on debts that they don't own. There are some good reasons to limit the operation of markets to the reality of goods and services. Ms Merkel has decided to ban short selling operations for public debt market. But this initiative will be effective if it is applied consistently by all countries, in particular by the United Kingdom, the largest financial haven in Europe. So it is likely that this will be vetoed by the new government which will want to protect their hedge funds and other instruments alike.

Furthermore, the European Union should ban financial speculation operated via sophisticated computer systems which are able to detect in some fractions of second market fluctuations worldwide. More than 40% of financial transactions are operated in that way, which bring huge and quick gains for the investors.

The US Senate has adopted recently a bill** for financial regulation to' protect consumers and investors from financial abuse' and pledges for enhanced international cooperation. The G-20 will have to agree on measures to increase transparency and regulation of financial markets.

But if we want to put an end to a casino economy, not simply because it is immoral or irrational but also because it is not economically viable nor socially desirable, we also need to set the right institutions to orient markets gradually towards the genuine aims of the economy. As Keynes put it (p 157): 'there is no clear evidence that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun'.

* J.M.Keynes (1936), The General Theory of Employment, Interest and Money, in The Collected writings of John Maynard Keynes, Vol.VII, Mac Millan - Cambridge University Press for the Royal Economic Society 1973


Thursday, May 6, 2010

The domino effect

The big issue today is whether the debt crisis will spread to other vulnerable countries such as Spain and Portugal. In the decade since the introduction of the euro, the economies on the continent have become increasingly interwoven. With cross-border banking and borrowing, many countries on the periphery of Europe owe vast sums to one another, as well as to richer neighbors like Germany and France.
This means that there is a domino effect. I quote here the New York Times (2 May) :

The first domino is Greece. It owes nearly $10 billion to Portuguese banks, and with Portugal already falling two notches in S. & P.’s ratings and facing higher borrowing costs, a default by Greece would be a staggering blow. Portugal, in turn, owes $86 billion to banks in Spain; Spain’s debt was downgraded one notch last week.
The numbers quickly mount. Ireland is heavily indebted to Germany and Britain. The exposure of German banks to Spanish debt totals $238 billion, according to the Bank for International Settlements, while French banks hold another $220 billion. And Italy, whose finances are perennially shaky, is owed $31 billion by Spain and owes France $511 billion, or nearly 20 percent of the French gross domestic product.'

The whole euro system is in danger. There are no simple solutions, but maybe we should think about a plan B on debt restructuring as suggested by N.Roubini (FT 30 April) if things go wrong. We can bail out Greece, but not all euro area countries.

Saturday, May 1, 2010

The Euro will be saved only by true EU cohesion

    A recent note from Citigroup to its clients warned that the Euro area risked falling apart if the EU member states did not unite at a financial and political level. The biggest financial services company in the world informed its investors that the threats to the single currency will persist even after the crisis in Greece. According to Citigroup, the Euro area does not stand a chance of survival if the member States do not unite in respect to the economic and political measures. “The EU must take a stand and decide whether it wants to become “the United States of Europe” or a patched blanket of independent countries”, shows a note sent by the chief-analyst of Citigroup, Tom Fitzpatrick, quoted by Bloomberg.
    As negotiators are discussing a three year loan to Greece that could amount to as much as €120 billion in total - after euro area states and IMF agreeing earlier his month to provide up to €45 billion- the question arises about a risk of contagion to other countries. Portugal is seen as the country most likely to follow Greece; Ireland too is seen as vulnerable after its government published the euro area's largest budgetary deficit in 2009, at over 14 per cent of GDP; Spain became the latest euro area economy to suffer a credit rating downgrading. As contagion from the Greek debt crisis appeared to be spreading rapidly, markets have reacted strongly causing a rise in bond yields and a tumble in stock markets.
    Current talks are designed to create an 'ad hoc' support mechanism for Greece, despite difficulties in the other euro area countries. However, the European Commission will come forward with proposals in May, intended to set up a crisis resolution which tighter rules for fiscal discipline will be built inorder to prevent moral hazard. 
    The German debate is revealing about the lack of cohesion in Europe. Opponents to rescue Greece ask on the basis of legal arguments - the no bail out clause in EU Treaty- for Greece to exit temporarily the euro area . As W. Munchau pointed out (FT 25 April),' the argument is full of legal hypocrisy'. Greece cannot in fact exit the euro area without leaving the European Union. So, if Germany blocks the loan package, Greece will be in a default situation and will put several German, French and Swiss banks at risk due to the size of their holdings of Greek debt. 
    Euro area countries must prevent a fire from spreading to the entire European economy. If your neighbor's house is burning, you have a moral obligation to help him. Cohesion should prevail over the narrow interests of the euro area countries . If Europe acts as a united block, it can defeat market fundamentalism and save the euro.

Saturday, April 24, 2010

A free society means a fair one

Classical liberalism states that markets under perfect liberty will lead to perfect equality. Adam Smith observed, however, that the 'invisible hand ' would not warrant this end and should not be understood as a pure self-regulating mechanism. The metaphor was used in his Theory of Moral Sentiments, to explain the distribution of wealth (1759, p. 350) : 'The rich ... consume little more than the poor, and in spite of their natural selfishness ... 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 ... advance the interest of the society, and afford means to the multiplication of the species"
Contrary to common misconceptions, Smith did not assert that self interest necessarily brings benefits to the whole society, or that all public goods are produced through self-interested labour. His proposal is merely that in a free market, people usually tend to produce goods desired by their neighbours. The 'tragedy of the commons', applied for example to world natural resources,' is an example where self-interest tends to bring an unwanted result.

Moreover, a free market arguably provides numerous opportunities for maximizing one’s own profit at the expense (rather than for the benefit) of others. The tobacco industry is often cited as an example of this: the sale of cigarettes and other tobacco products certainly brings a very good revenue, but the industry’s critics deny that the social benefits (the pleasures associated with smoking, etc.) can possibly outbalance the social costs.

Adam Smith observed that throughout history we find "the vile maxim of the masters of mankind": "All for ourselves, and nothing for other People." He explains that the unproductive class prefers to devote part of the rent to luxury goods rather than provide 'subsistence to a thousand during a year'.

Free societies call for justice. A.Sen explained that freedom is not merely being left to our own device. It also requires that people have the necessary resources to live a decent life. In his recent book**, A.Sen develops a new idea of justice in opposition with the institutionalist vision of John Rawls, Kant and J.J. Rousseau who are engaged in a “long-range search for perfectly just institutions”, and a hunt for “spotless justice”. For Sen, these philosophies are ultimately regressive, because societies full of actual human beings will never agree on a final, perfect set of institutions and rules. More immediately, the search for a perfect set of arrangements for society can distract us from tackling real-life, immediate injustices such as poverty and malnutrition, access to education for women in the developing world or action on climate change. The perfect becomes the enemy of the good.

The competing vision of justice Sen prefers is a “comparative” one, which examines “what kind of lives people can actually lead". For him, as for Condorcet and Stuart Mill, abolishing slavery or giving women the vote would free people to lead lives of their own choosing, even without creating a perfectly just society. The keystone of judging the lives people can actually lead is an assessment of what Sen has labelled their “capabilities” — or, as he explains, “the power to do something”.

The book deserves careful consideration and analysis. The key question is, however, that liberty and fairness are mutually reinforcing and lead to a more egalitarian society. But, we should not overlook what A.Smith said about the masters of mankind, the "merchants and manufacturers," using their power to bring "dreadful misfortunes" and in our day the big transnational l corporations and financial institutions that dominate the world economy, that control today trade, investment and finance above the power of the nation-states. It is the arrogance of these 'masters of mankind' that has led us to the current crisis and its awful consequences for the poor in terms of job losses and wages cuts.

I would like to quote here the great poem by Percy Bysshe Shelley, Ozymandias, which is an ode against tiranny and the course of time:

I met a traveller from an antique land

Who said: ‘Two vast and trunkless legs of stone
Stand in the desert. Near them on the sand,
Half sunk, a shattered visage lies, whose frown
And wrinkled lip and sneer of cold command
Tell that its sculptor well those passions read
Which yet survive, stamped on these lifeless things,
The hand that mocked them and the heart that fed.
And on the pedestal these words appear:
‘My name is Ozymandias, King of Kings:
Look on my works, ye mighty, and despair!’
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare,
The lone and level sands stretch far away.

*An Inquiry into the Nature and Causes of the Wealth of Nations: A Selected Edition Adam Smith (Author), Kathryn Sutherland (Editor), 2008, Oxford Paperbacks, Oxford, UK

**The Idea of Justice by Amartya Sen
Allen Lane £25 pp496