Sunday, September 18, 2011

Balanced Budget

Balanced budget is a consistent topic of debate among economists. Mainstream economics advocates that budget deficits are always harmful and provides a series of arguments such as forward looking expectations of economic agents, crowding out effects and other pseudo-scientific ideas . On the other hand, alternative theories of heterodox economics (especially Keynes and post-Keynesian economists) argue that budget deficits may be useful, and even necessary in times of crisis as they provide fiscal stimulus to sustain aggregate demand. A common view is that budgets did not need to be balanced year on year, but over the economic cycle,  that is with a surplus in booming years and a deficit in recession years, which result over the period in a balanced budget. This view was seen as a synthesis between the two schools of thought but it is now being widely contested by the more radical right wing economists.

The Chicago school of economics - which advocates minimum government intervention and self regulated markets - came under attack in the wake of the financial crisis of 2007-08 . In fact, their economic theory was regarded at that time as an intellectual failure with serious economic consequences. Their belief in rational behaviour and self regulation of markets has contributed to the formation of financial bubbles and therefore to the growing income inequality. Many economists from that school argue that fiscal stimulus plans just create debt-financed government spending which crowds out an private investment - in thes sense that debt absorbs the savings that would normally go to private investment-, even if the economy is depressed , and therefore, they don't contribute to economic growth. P.Krugman is right to say that their ideas about the financial crisis were simply a product of  the 'Dark Age of Macroeconomics ! If public funds are used effectively, i.e. they are geared to finance growth enhancing  investments, they can generate high social returns in the medium to long term. In simple words, public spending does not reduce total investment (in the same proportion), but increases GDP which leads to more savings and tax revenues, and therefore reduces the budget deficit.
The economic debate did not, however, turn into a clear and honest political debate. Fiscal conservatism claims that a budget balance is a primary goal for a society, which means in substance less State intervention and eventually less public services provision, especially to the less favoured groups. This ideology is on the rise  in the US (especially the right wing Republicans) and in Europe (especially Germany and its allies) and its motto is 'no budget deficit', whatever that means. In fact, deficits are not all the same and policy measures to reduce it may vary according to different objectives. But the main point of issue is that austerity alone risks to cause a disaster, as acknowledged by many contemporary analysts (see Martin Wolf in FT 28/06).  

In Europe, wise men say with great conviction that the euro crisis was caused by failure to enforce the stability pact, that is to control limits on deficits and debts. The account balance (i.e. the difference between governments revenues and public expenditure) has worsened in almost all countries, but this is not the cause of the crisis, rather its consequence. Ireland and Spain were considered as the best examples of budget discipline, having budget surplus and low debt level. At the same time, France and Germany, the advocates of financial rigour had high budget deficits and breached the Stability Pact rules during several years for which they never got any sanction and even managed to relax the EU budgetary rules in 2005. Conversely, Spain has exceeded the 3% deficit limit only in 1998 and in the last three years its deficit reached 10%.

Now, the strengthening of the so-called 'economic governance' rules - with sanctions to countries which fail to comply with balanced budget rules - calls for stricter austerity measures which will lead to social turmoil and further economic depression. German and French political leaders urge all the euro area countries to adopt the 'golden rule' - meaning the ban on deficits and debt - and to reform their Constitution in due course. Only Spain has managed to do so, with a bipartisan reform due to internal political reasons. But,  the failure of political leaders to explain the austerity measures in their respective countries  further contributes to the economic mess and makes it even more difficult to solve the current crisis.

Budget deficits are not an economic sin per se.  The idea of a (strictly) balanced budget in times of crisis is not economic wisdom,  but rather a heresy , which in its proper Greek sense,  means 'choice'.

Thursday, September 15, 2011

The Unbearable Lightness of Poverty

Rising poverty is an interesting indicator of the depth of the Great recession .  We have a two-speed process which hits most severely the poor whilst the richest seem to have escaped the worst of the recession's impact. Let's take the US situation for which data were published yesterday.

Over the past two decades, poverty has risen dramatically as a result of the financial crisis. More Americans are living in poverty than at any time in US history. According to the US census bureau, in 2010, 46,2 m people fell below the poverty line, calculated as an annual income of $ 22,134 for a family of four and $11,139 for an individual. So, nearly a quarter of Americans !

Nearly a quarter of American children are now living in poverty. Their number increased for the fourth year in a row to 22 per cent, the highest since 1993. Child poverty was the fourth highest in 2010 since the mid-1960s, when the federal “War on Poverty”  programme was launched by Lyndon Johnson.

The median household income of Americans dropped significantly since 2000 and by 2.3 per cent in 2010 from the previous year, due to increasing long-term unemployment, which has depressed wages and left many without income.

FT (14/09)  has reported on the data published by the Census Bureau :

According to Brookings, the poverty rate will continue to rise and hit 16 per cent in 2014. If that happens, nearly 10m American will have sunk into poverty since the recession began in December 2007.
In policy terms, poverty is considered by policy makers as a 'light' issue  as opposed to the 'hard' issue of debt and deficits. Neo-liberals will claim that poor always existed and that economic recovery will help them get out from that situation. But for this, they reckon austerity measures are an absolute necessity. At the same time,  the growing income gap is an issue for the US government  which is concerned about the effects on aggregate demand if wages continue to stagnate. Obama is right to launch a recovery plan, which will be funded in large part through the elimination of tax cuts for the richest Americans.

In Europe, the austerity measures have left aside the poverty issue, due to the shortsightedness of its political leaders. Ethically, poverty is unbearable for rich societies; economically, it is not sustainable as it further depresses demand and has a negative impact on median wages. We need 'hard' measures to combat poverty, not "light" or constrained policies.

Sunday, September 11, 2011

The Great Bank Robbery

Now we understand better what has happened over the last two decades. There has been an enormous bank robbery and the most surprising thing is that there is little discussion about it. We all know that banks have caused the mess we are in, they have been bailed out and now they are even benefiting from the crisis.

According to figures quoted by Nassim Nicholas Taleb ( the author of the best seller ' The Black Swan'), the robbery would amount up to 5 trillion dollars, so more than the amount that the Obama administration will have to cut in the federal budget. There is a clear explanation: banks have taken excessive risks with leveraging, which result in excessive profits and their losses are transferred to shareholders, tax payers and also retirees (for their pension funds). For many years, exposures were hidden and part of the profits continued to be given to investment managers as a remuneration of risk. This is a typical case of 'moral hazard'.

This massive robbery, as we can figure out, is not money invested in public goods such as infrastructure, schools or healthcare but transfers from the productive sector to the banks, which in fact, as Taleb rightly points out, represent a tax on workers and small businesses. The key point here is that a low interest monetary policy favors directly the banking sector as it reduces the rate of return from savings and   transfers the inflation risk to millions of  savers. So, in rescuing the banks, the State is just subsidizing profits to bank mangers and investors. This could explain why banks reimbursed the loans just after one year.

The scandal is the impunity of investment managers, whose remuneration is proportional to the level of risk. It is clear that this is a violation of elementary ethical rules. We should not be naive to believe that a well functioning market would have produced better outcomes and therefore there is no need for regulation and sound corporate responsibility.

The meaning of ethics among bankers and financiers is quite limited: concretely, it is about doing all kinds of financial investment, excluding  tobacco companies or corporations involved in former apartheid in South Africa, but obviously not hedge funds. Banks should do their normal business under strict supervision rules, ensuring that funds are invested in the productive sector and bonuses redirected to promote solidarity with the poor. The world would, indeed, look much different.

Sunday, September 4, 2011

Self-destructing Capitalism

Does capitalism have a future ? The question was raised by some economists and analysts who asked (quoting Marx) whether the capitalist system is not self-destructing. In a recent article, N.Roubini writes: "So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand".

In his powerful analysis of the contradictions of capitalism,  Marx maintains that capitalism eventually destroys itself as it exploits more and more people until the great majority of the population is converted into proletarians and thus creates the conditions for socialism. Basically, capital drives out labor, and so destroys its own market, as well as the source of wealth creation. Today, the capitalist system is confronted to a similar contradiction as in every one of its periodic crises. It continues to produce an ever-expanding volume of goods and services, which an impoverished population cannot afford to buy. So Marx was right, and of course we cannot blame the great man, who lived from 1818 until 1883 (the year when Keynes was born!) for the crimes committed decades after his death. 

However, the economic problems of modern capitalism differ greatly from those of the 19th century. There are two relevant features which can explain the current global crisis: the first one is the huge concentration of capital  and power of banks and financiers and the uncontrolled mass of money crossing national boundaries; the second one is the massive shift of wealth from labor to capital and the resulting inequalities in income as real wages decline.  

S.Brittan (Ft 26.08)  argues that 'even if the analysis is right the remedy is wrong. The justification for redistribution is ethical. if the only thing wrong with capitalism is insufficient mass purchasing power then surely the remedy is the helicopter drop of money envisaged by Milton Friedman. for this we need not s much a political as an intellectual revolution, namely the overthrow of the balanced budget fetish". 

Governments and central banks are breaking their heads about how to save capitalism.  The origin of the crisis is not an excess of debt, neither a mere problem of redistribution. The causes are much deeper and old remedies are useless. As Einstein said :"The significant problems we have cannot be solved at the same level of thinking with which we created them".