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

Germany is not a model for the euro area

Over the last few weeks, there has been a hot debate about the role of Germany in the light of the Greek debt crisis. Is it a model for the eurozone? The immediate answer would be no due to its obsession on monetary stability.
On Greece, the heads of government decided that 'as part of a package involving substantial international Monetary Fund financing and a majority of European financing, euroa rea member states are ready to contribute to co-ordinated bilateral loans"*. Then it continued ' Any disbursement would be decided by the euro member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank".
Germany, the most powerful euro area member country has imposed its views, but the final outcome was not shared by France, nor by the ECB which is contrary to any intervention of the IMF. But it is not clear whether this is a workable solution.
First, the fiscal consolidation of Greece looks unrealistic as it means reducing the deficit by 10 percentage points of GDP. Simulations made by several economists- including a french economist, Patrick Arthus- point out that a reduction of 1% in public spending causes a decrease in the budget deficit of only half point.
Second, Greece's problem is that it is paying too high interest rates and has a solvency problem. Even if loans will be provided at a 5 per cent rate, Greece should have access to financial markets.
We can understand the political argument that holders of Greek bonds will be reassured that the euro area will never let Greece fail. Why should Europeans accept default for Greece?
Last week's statement says that 'the current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the eurozone and enhance its capacity to act in times of crises. for the future, surveillance of economic and budgetary risks, and the instruments for their prevention, including the excessive deficit procedure, must be strengthened'.
The idea is that peripheral countries have a structurally weak fiscal position whihc reflects a lack of fiscal discipline (in the German sense). This is true of Greece and to a lesser extent of Portugal. But Ireland and Spain had strong fiscal positions, but weaknesses in private sector deficits due to the house bubble. That means that monitoring and surveillance should focus on the private sector, not only the public sector.
But in fact, the asset bubbles and credit expansion in the private sector in the periphery also reflects the absence of growth in the core. Honest economists must then acknowledge that the cause of the fiscal deficits is the result of the ECB monetary policy to accomadte the weak demand growth in the eurozone's core, and in particular in Germany.
German policymakers are not keen to discuss about weaknesses in global demand and other macroeconomic imbalances in the euro area. They wish to see a rapid reduction in fiscal deficits in euro area countries and this is why they insist on an 'improved economic co-ordination". the risk is that the eurozone might become de facto a big Germany with a structurally weak internal demand. Germany and other economies - like China- might find a way out through increased exports to emerging countries. For its structurally weaker partners - especially those burdened by uncompetitive production costs- the result would be years of stagnation or even deflation. Is this a model of economic 'stability'?
M.Wolf (FT March 30) argues that "the project of monetary union confronts a huge challenge. It has no easy way of resolving the Greek crisis. But the bigger issue is that the eurozone will not work as Germany wishes. As I have argued previously, the eurozone can become Germanic only by exporting huge excess supply or pushing large parts of the eurozone economy into prolonged slump, or, more likely, both. Germany could be Germany because others were not. If the eurozone itself became Germany, I cannot see how it would work. Evidently, Germany can get its way in the short run, but it cannot make the eurozone succeed in the way it desires. Huge fiscal deficits are a symptom of the crisis, not a cause".
As ancient Greeks said, we have the classical definition of tragedy: hubris (arrogance); ate (folly); nemesis (destruction).
* http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/113563.pdf

IMF will not resolve Greece's crisis

The Greek crisis has divided the 16 eurozone member countries on possible course of action. President Barroso has made efforts to find a compromise on a macro financial assistance instrument which would be coordinated by the EU. Ms Merkel has finally imposed the IMF solution for pure internal reasons and against EU general interest. Though, recent events on financial markets show that the measures decided by the last European Council were not sufficient to provide a durable solution to Greek problems and thereby ensure a more stable governance of the euro area. It is at best a short term compromise for crisis management.

However, IMF aid will not help to resolve Greek problems. A closer look at Greece's economic indicators suggest that we are dealing more with a solvency problem rather than a liquidity one. Greece's public debt to gross domestic product ratio is approaching 120 per cent, its budget deficit has risen to 12,75 per cent and the economy has lost around 30 percentage points in terms of international competitiveness over the past decade. As Latvia and Ireland's recent experience suggests, attempting to bring Greece's budget deficit down towards 3 per cent of GDP limit by savage expenditure cuts and without a recourse to currency devaluation could result in a cumulative contraction in Greece's GDP by 15-20 per cent over the next few years.

At the same time, attempting to correct Greece's large competitiveness loss through deflation will necessarily involve an eventual decline in Greek prices and wages of around 20 per cent.

In that scenario- with a decline of GDP and a sharp fall of prices and wages- the debt to GDP ratios would then overshoot instead of decreasing. If this is plausible, one would then think than it would be better to pursue debt restructuring rather than the IMF kicking Greece down the road.

This means that EU leaders will have to design new (not tougher) rules for economic governance such as burden sharing allowing for temporary solidarity mechanisms for countries running high deficits, especially in times of global crisis.

Deutschland Über Alles

Now that the European Monetary Fund has been ruled out as it would require a new treaty and the agreement of all member states, there are not so many options left for EU action. We should however take the proposals put forward by W. Schäuble, the German Finance Minister seriously. His proposals are the following: any emergency aid for countries with excessive fiscal deficits should be combined with sanctions; suspending voting rights of badly behaving members within the eurogroup; and allowing a member to exit the monetary union, while remaining inside the European Union.

After weeks of discussions on various possible options, Germany has expressed once again an orthodox view on economic policy in the Euro area. There is no other option than reduce fiscal deficits, no matter what this would imply.

M.Wolf (FT 18/03) has provided a thorough analysis of the economic implications for the global economy. He developed three arguments: " first, it will have an overwhelmingly deflationary impact; second, it is unworkable; and, third, it might pave the way for Germany’s exit from the eurozone."I agree with the first two arguments, not the last one.

If weaker countries are forced to reduce sharply their fiscal deficits, this will weaken the entire euro area. But the result would also be fiscal deterioration in Germany and France because of the high degree of economic integration in Europe. France already has a deficit forecast close to 9 per cent of gross domestic product this year. Does Mr Schäuble imagine France could be fined? Surely not. Yet it is not Greek public finances that threaten the stability of the eurozone. The threat is the public finances of big countries. But Germany could not force such countries to reduce their deficits and has no chance of expelling any member it disapproves of from the eurozone. Will the Germany leave the euro area? This is very unlikely: Germany belongs to a currency area with some of its main trade partners.

A disruption of the euro area would indeed be very bad for German manufacturing, and eventually would weaken the German position in the world economy. Perhaps, it is still time to look for other cooperative solutions within the euro area. Greece has threatened to use the IMF as a means of putting pressure on euro area governments -as the Finance ministers agreed on 15 March on the possibility that individual governments would supply Greece with direct, bilateral loans if necessary. European governments are divided on the IMF and on its forms of intervention, but they should, however, show courage and wisdom in proposing genuine European solutions.

Why are American jobless?

A dear friend has sent me a message circulating on the Internet. It is presented as a joke, but it might have some truth in it.

"John Smith started the day early having set his alarm clock (MADE IN JAPAN ) for 6 a.m.

While his coffeepot (MADE IN CHINA ) was perking, he shaved with his electric razor (MADE IN PHILIPPINES ) . He put on a dress shirt (MADE IN SRI LANKA ), designer jeans (MADE IN SINGAPORE ) and tennis shoes (MADE IN VIETNAM). After cooking his breakfast in his new electric skillet (MADE IN INDIA ), then he sat down with his calculator (MADE IN MEXICO ) to see how much he could spend today.
After setting his watch (MADE IN TAIWAN ) to the radio (MADE IN INDIA ), he got in his car (MADE IN GERMANY ) filled it with GAS (from Saudi Arabia ) and continued his search for a good paying AMERICAN JOB.
At the end of yet another discouraging and fruitless day checking his computer (MADE IN MALAYSIA ), John decided to relax for a while. He put on his sandals (MADE IN BRAZIL ) poured himself a glass of wine (MADE IN FRANCE ) and turned on his TV (MADE IN KOREA ), and then wondered why he can't find a good paying job in AMERICA .
AND NOW HE'S HOPING HE CAN GET HELP FROM HIS PRESIDENT (MADE IN KENYA )"

If we just skip the last sentence, the message is that the average American consumer is a global one. Globalization has brought some benefits in terms of cheaper products for low-middle income Americans, but on the other hand it has de-structured the US productive system as many jobs have been displaced to exporting countries. This is mainly true for consumer goods, including cars, TVs and also computers, but the US has strengthened at the same time its leadership in high-tech industries. So where are the jobs? They are in the so-called 'knowledge economy' and require higher education and skills than in traditional industries. Investing in education and research is the key to the future as we need to prepare future generations to the next technologies and build the cutting edge industries which will create jobs tomorrow.

An exit strategy for the euro crisis

The Italian Finance minister (Corriere Sera 6 March) is right to say that there is no exit strategy at the moment, but only a crisis management. The Greek debt crisis has highlighted the limits of the eurozone governance and the need for a durable solution to the euro crisis. The measures taken by certain governments like Latvia, Portugal, Spain and Greece to cut wages to restore fiscal consolidation are unpopular and may also have some deflationary consequences. Soaring budgets deficits in almost all European countries are not the cause, but the consequence of the crisis. The situation might also be different in other more developed countries: for example in the United Kingdom, the government has increased public investment because private investment has declined. The experience of Japan deflation in the 90s confirms that if private sector is de-leveraging- reducing spending to reduce its debts- then public sector cutting its deficit will deepen, not lighten recession. This is what Keynes called the 'paradox of thrift'.

The debate between 'laxist' countries (the so-called 'Pigs') and those defending financial rigor is a sterile one. It is evident that the Greek issue has become an European one, but this is also the case for the other countries at risk such as Spain or Portugal. French and German banks hold more than 60% of debts in those countries, but why creditors are pushing them in the hands of speculation and eventually to a 'default' situation?

This means that European solidarity is inevitable to avoid a possible disaster and new forms of economic governance need to be invented. There has been a lot of hesitation about the idea of an European loan of 25 billion euro to provide liquidity to the Greek economy, but now the IMF seems in pole position to act as a last resort lender, undermining the foundations of the Economic and Monetary Union.

The Greek debt crisis is a serious one and the government has to act in a responsible way to restore its credibility. But what happens in Greece is in fact a massive speculative attack which might extend to the whole European continent. This is largely caused by the absence of measures to regulate financial markets after the financial crisis of August 2007 and the solvability crisis of September 2008 (with the collapse of Lehman Brothers). EU leaders cannot simply impose new austerity measures to the Greek government without any help. While the EU has helped non-eurozone states (Hungary, Latvia and Romania) struggling with balance of payments difficulties, it has no power to intervene when it comes to helping one of its 16 members. This means that Greece is less protected against speculation than a non member of the eurozone.

The Greek people cannot accept further sacrifice, while Goldman Sachs continues to sell CDS (Credit default swaps) without any transparency and scrutiny. This requires immediate action: the future EU authority in charge of financial regulation should bring this to an end and call for further investigations on conflict of interest of Goldman Sachs. The European Commission, the watchdog for competition matters, has the power to act against such illegal practices.

In terms of economic governance, the Lisbon treaty (art.122) provides the opportunity to set up a financial stability mechanism managed by the European Investment Bank 'EIB) in order to help member States victims of speculative attacks. The proposal put forward by the European socialists of the European Parliament is a step toward the construction of a European market of sovereign debt. Other recent proposals include the creation of an European debt Agency (Belgian PM), the emission of euro-obligations (Tremonti) and even a European Monetary Fund.

It is a time for radical reforms to regulate finance, so that 'creative finance' is brought to an end and does not generate transfers to those who gamble with the nations'resources. It is also a time to design an exit strategy that allows the public sector to serve the fundamental needs of the economy. We cannot return to the status quo ante.

'Pigs' need support from Europe

Lately, the Greek crisis has captured the attention of many analysts, who tend to focus almost exclusively on European deficits and debts on the European periphery. This 'ideological' campaign on the so-called Pigs (Portugal, Italy, Greece, Spain)- or Piigs (if we include Ireland)- conveys a negative message that those governments are irresponsible and that they should cut spending regardless of any deflationary consequences on economic activity.

There is some confusion about the causes and effects of the crisis. Krugman (Nyt Feb.15) is right to assert that the lack of fiscal discipline is not the source - and probably not the main factor- of Europe's problems. Most southern European countries have lost competitiveness over the past decade with rising costs in the manufacturing sector and growth was largely fueled by the construction sector which caused the house bubble.

P. Krugman, like many American economists, do not have much sympathy for the euro. The economic arguments are well known: lack for labour mobility, no optimum currency area and no federal budget to absorb external shocks. But the euro is also a political project to strengthen European integration after the collapse of the Soviet Union and the disintegration of the Eastern bloc.

As N. Roubini and A. Das (FT Feb.3) put it, Greece highlights 'an uncomfortable truth, that no currency union has survived without a fiscal and political union'. Unlike the United States, Europe lacks burden sharing mechanisms to provide assistance to its member States when they are faced with critical budgetary situations.

All southern countries (Pigs) will need to change their growth model based on residential construction driven by a boom in house prices. Spain like Ireland have a fragile banking sector due to massive mortgage debt, which is a key source of financial contagion. . Spain has to engage in fiscal consolidation to restore debt sustainability and to achieve higher growth to face mass unemployment. Ireland has made deep budget cuts; Portugal is struggling with a painful deflation; Italy has also introduced fiscal austerity but has still to restore its external competitiveness. In comparison, Greece has a high debt (but lower than Italy), a high budget deficit ( comparable to many countries and has lost structural competitiveness (but less than Spain). The main concern is that Greece has huge liquidity problems as it will have to find around 30 billion to refinance its public debt, but this is something that the IMF can deal with (but this is now ruled out) or eventually by a consortium of banks or non traditional creditors like China.

In fact, Greece has become the front line of a wider battle between the federalists, who seek further political integration and the eurosceptics - which in fact include the US and countries which did not join the euro area for domestic reasons as well as the Czech republic for ideological reasons. The latter expect a failure of the euro area to advance their pro-free market agenda and undermine the whole European integration process. In this regard, they expect that Greece would leave the euro area in order to devalue and re-denominate its liabilities into a 'new dracma' like in Argentina. But no serious economist can defend such a position as this would trigger, as B. Eichengreen puts it, the 'mother of all financial crises'.

Making the euro work needs a political union, but this is probably a long term endeavor as many countries will oppose it. For the time being, the question is whether Europe will intervene or if it will leave the case in the hands of the IMF. If Europe decides to act, there will be a need to design formal rules for fiscal burden sharing such as debt restructuring mechanisms for eurozone sovereigns to restore the credibility of the euro. But there is a more fundamental question: which Europe do we want, a cohesive or a fragmented one? Without any doubt we should opt for the first model albeit it entails high social costs but in the long term appears to be more sustainable both on efficiency and equity grounds. This means reinvigorating EU solidarity with countries most in-need. Pigs unite !