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.

*http://robertreich.org/post/978427354/why-the-unfolding-disaster-in-pakistan-should-concern

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

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.

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.

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.

The high costs of austerity

As the economic crisis deepens, European economies are focusing on austerity measures to (supposedly) restore confidence for international investors and to continue borrowing on financial markets. It started two years ago with Ireland* which cut public spending and raised taxes. Then came the Greek debt crisis and other countries at risk of default. Consequently, governments of countries in crisis have taken drastic measures to reduce deficits.

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.

* See http://www.nytimes.com/2010/06/29/business/global/29austerity.html

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.

http://g20.gc.ca/toronto-summit/summit-documents/the-g-20-toronto-summit-declaration/