Greek lessons for Scotland
Here’s an example of exactly the risks I was talking about in last week’s piece for the Scotsman:
Greece… has no real independence when it comes to fiscal policy any more, and if everything goes according to plan, it’s not going to have any independence for many, many years to come.
Greece has been politically independent for 180 years. As part of today’s €130 billion bail-out inspectors from the International Monetary Fund will be installed in Athens to check whether the government is enacting the necessary cuts. It will have to set up a separate account that must always contain enough money to service its debts for the next three months. Papademos (or whoever replaces him when voters revolt again) will be obliged to privatise more state companies than already promised.
The price of staying in the euro, which is vastly overvalued for Greece, is long-lasting deflation in an economy that’s already been in recession for half a decade. If the plan works, which I doubt, in effect the government won’t really be governing. It’ll be the technical supervisor over a plunge in pay and a massive diminution of the state.
Scotland’s not Greece. It’s got an estimated public debt:GDP ratio of 70-80%, much lower than the 120% target Greece is supposed to hit in 2020. The trade deficit has been estimated at 4% for the past eight years, compared with Greece’s 10%. Hopefully, the Scottish government is more credible and the country’s a better place to do business.
But the euro’s clearly not a very liberating place for the smaller, peripheral countries. As so many people have noted, the eurozone isn’t an optimal currency area. One interest rate doesn’t fit all countries and the European Central Bank is paranoid about inflation. There’s no way of performing fiscal transfers or limiting spending.
Portugal’s probably next in the firing line, and then maybe Spain, and Italy and Ireland. The euro blueprint was dodgy from the start — and I doubt the currency can ever be made to work properly. It’s wrong to blame the peripheral governments entirely for their travails. When a fisherman catches too many tiddlers in his net, he doesn’t blame the holes for being too small. He gets a new net.
The lessons for Scotland should be clear. Abandoning the pound for the euro would be folly. A new currency would be a step into the unknown. In the event of independence, even keeping the pound would expose Edinburgh to the icy stare of the international debt markets. Paradoxically, Scotland may have more independence on tax and spending now than it’d have in the event of political separation.
UPDATE: Jeffrey Sachs, never an economist i’ve had much time for, says that the European Central Bank’s liquidity injections “…changed the perspective from what was unmitigated disaster and a self- fulfilling crisis over the cliff, to a very painful period for Greece but not a catastrophe, even for the other countries of Southern Europe… The mood is brighter.”
Not a catastrophe? I can’t see how much worse things could be for Greece. Brighter for whom? Certainly not the fifth of the Greek workforce that’s unemployed or the many millions who’ll suffer a collapse in wages in the decade ahead.
Unfortunately, in their efforts to reject Keynesianism, economists like Sachs and Edmund Phelps (also quoted in the article) don’t even realise they are supporting the sort of remedy that Keynes himself would have promoted. He wrote extensive about management of the money supply and believed that monetary and fiscal policies were both weapons to help boost demand.
Liquidity injections won’t themselves solve the Greek problem, though, because the economy has been subjected to swingeing cuts at a time when it needs expansion. The economy won’t be able to generate the government revenues needed to pay back creditors. Fiscal policy must play a part in restarting the growth engine.
Scotland’s currency paradox
SHOULD Scotland win independence, the question of currency must be addressed, but keeping the pound would be in the country’s best interests, writes Daniel Gay
Ditching the pound would narrow Scotland’s economic options, not enlarge them. Even if Holyrood keeps sterling, the eurozone crisis shows that independence risks throwing away some hard-won freedoms.
A healthy currency is a golden prize, as Europe is discovering. In a classic 1961 article Nobel prize-winner Robert Mundell theorised that a currency zone was only optimal if capital and labour could flow easily from one area to another. A bit like the way that pouring water into one corner of an ice cube tray fills the other sections evenly, workers and capital would move to fill in any economic gaps. Mundell argued that to make up for remaining unevenness and differences in economic cycles, a central authority would need the mandate to tax the prosperous parts and spend more on the laggards.
Half a century later the Eurocrats would do well to reread Mundell’s paper. Optimal the eurozone is not: the result of naïve optimism and bad design.
Capital didn’t flit in a jiffy from Paris to Lisbon. How many Slovakians flew to Austria to find work, or Greeks to Belgium? Internal migration remains low because people are comfortable with their own cultures and languages.
Another design flaw is that no central agency has control over spending. When France and Germany broke the 3 per cent budget deficit target in 2003 Brussels could only watch. Contrary to prejudices about southern fecklessness, Franco-German rectitude is a myth.
A paper by Charles Wyplosz of the Graduate Institute in Geneva found that France flouted the rules in seven of the 12 years after the euro began and Germany five. Every country misbehaved, because nobody could punish them.
Compounding the difficulties, a single interest rate set in Brussels (by an inflation-paranoid European Central Bank) doesn’t fit all 17 members. The economic result: more black spots than an adolescent Dalmatian.
The United States is almost the perfect currency zone. Workers and capital move freely between states, helping equalise differences in wages, employment and financial returns.
Few barriers to investment exist between states; most people speak the same language (English, not Spanish); and cultural differences are minimal. At the drop of a Stetson, a Texan will relocate to New York to get a better job.
US states control their own budgets, so they can fine-tune spending. The 12 Federal Reserve banks each have a role in deciding interest rates. And even if the internal movement of capital and labour doesn’t smooth out economic differences, the Federal government can step in to bail out flagging states or issue a rap on the knuckles when a governor gets his wallet out once too often. These reasons are partly why the American economic recovery is outpacing Europe’s.
The UK currency area has outlasted any other. In 1603 the pound Scots was pegged to sterling at a rate of 12 to one. In 1707 under the new Parliament of Great Britain, sterling replaced the pound Scots as the legal currency.
Just like the dollar, the sterling area has all the right ingredients: Brits speak the same language; capital and workers can move easily from one area to another; the central bank sets an effective monetary policy for the whole country; and the government can spend more in one region when growth falters.
As Alex Salmond seems to be acknowledging, the euro’s toxicity burnishes the allure of the pound.
But a new article in the National Institute Economic Review by Angus Armstrong argues that: “It is noteworthy that at the same time that Scotland may [give up fiscal union], the Euro Area countries are looking… precisely to secure the fiscal union that Scotland may leave behind.”
Under the sterling zone, Westminster and Edinburgh share revenues and debts. Armstrong calculates that in the event of a split Scotland’s public debt would total about three-quarters of Gross Domestic Product depending on how oil revenues are shared.
The deficit – how much more the government spends than earns – would have been about 4 per cent of GDP over the past half-decade assuming Scots got their geographic share of oil.
That’s not too bad in today’s climate, but a hefty sum of investment comes from abroad. Despite Donald Trump’s grumbling, all those renewables projects from down South create a lot of jobs.
Firms based elsewhere in the UK account for a fifth of employment and turnover and almost half of registered medium and large companies, according to the Office for National Statistics. Companies from the rest of the world provide 16 per cent of employment and 36 per cent of turnover.
One of the big lessons from the euro crisis is that small countries relying on foreign investment must pay more to borrow.
Using the pound and issuing government debt in sterling, Scotland would lose the ultimate response of printing money to repay creditors. This risk would further hike interest rates on government debt.
As the Italians, Greeks, Spanish and Irish know only too well, being bullied by the bond markets is a harsh form of discipline; the kind of discipline that means less cash for schools and hospitals.
The Bank of England wouldn’t want to play central banker for Edinburgh without guarantees on Scottish spending, because otherwise it would effectively be writing blank cheques. Any Holyrood backstop would cost yet more money.
Having unravelled the union, Scotland would have even less control over official interest rates than it does now. The British central bank doesn’t currently pay much heed to events north of the Border, but in future it wouldn’t even have to bother pretending. An English boom at the same time as a Scottish slump could prove disastrous.
Scotland could cut out the Bank of England by issuing its own new legal tender. Jim Sillars has argued for a Scots dollar and the SNP is said to be keeping the option as a back-up.
But setting up a currency isn’t like opening a new Paypal account. Edinburgh would need its own central bank equipped with an arsenal of foreign exchange sufficient to fight off speculators – who would be queuing up to test the fortitude of a newly-minted currency in a resource-rich country.
Some small Asian countries learnt from their regional own economic crises in the late 1990s that they would need reserves of up to twice GDP. In Scotland, not all of the necessary scores of billions of pounds could be coaxed from the coffers of Threadneedle Street.
To have any credibility the Scots unit would need to be pegged to the pound, a move which would constrain monetary and fiscal policy.
And the credit ratings agencies have in recent months hinted that Holyrood’s debt would receive a lower rating than the triple-A currently enjoyed by the UK. That could raise interest rates to more than double those currently paid by the British government, according to some estimates, and they would be even higher with a new currency than if Scotland broke with England but kept the quid.
Many of the 126 nations with smaller populations than Scotland will testify that control over education, health and defence can reap bigger rewards than the economic gains from staying glued to a union.
But even if Scotland sticks with sterling, in splitting with its neighbour it might abandon exactly what Europe covets. Freedom often comes in a strange guise.
How economists show their love
Economist in disagreement shock
Bloomberg has a funny diagram of Paul Krugman’s metaphorical punch-ups with other economists. I think this sort of conflict is a good thing, as it exposes economics as subjective rather than the social physics that many economists pretend it is. Social scientists should disagree, and one of the reasons why the discipline was so bad at foreseeing the crisis is that for many years there was an unhealthy agreement about many basic ideas.
Reasons to bash the banks
From Sunny Hundal at Liberal Conspiracy.
More problems with economics
I thought this article in Time magazine last week by the head of the Institute for New Economic Thinking was quite good. It’s nothing new but it summarises some of the methodological criticisms of economics over the last few years.
“Economists should resist overstating what they actually know”. A lot of mainstream economists bleat on like pub bores, pretending they know all the answers when really they’re just groping in the dark like the rest of us. Dressing things in fancy technical terms helps them hoodwink us.
Which brings us to the second point: “economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation.” A lot of maths is only there because it looks cool and makes economists feel sciencey (NB. I know that’s not a word). Much better to look at what’s actually going on in the world then write about it well.
Instead of devising universal laws that are supposed to work in all places at all times, “more research on economic history and evidence-based studies are needed”. Most journals operate in some sort of imaginary theoretical world, proposing ideas that have learnt nothing from history and which aren’t tested with practical research. If I learnt one thing from working abroad in traditional agrarian economies, it was that some of the theories we learnt in university weren’t relevant there.
The final point of the article is that politics and economics are unavoidably related. It’s virtually impossible to theorise in a vacuum; to imagine that research or policy prescriptions are valid unless you take into account political context. Just as the early thinkers like Smith and Ricardo talk of political economy, not economics, ”research teams would benefit from multidisciplinary interaction with politics, psychology, anthropology, sociology and history.” I’d add philosophy, as well.
Scotland shouldn’t join the euro
At a time when Alex Salmond is touting Scotland as a progressive model for the UK, we discover that Angela Merkel wants to automatically fine eurozone countries that spend too much, to make what she considers high debt illegal and to empower Euro-judges to rule on the budgets of the 17 euro members.
The treaty would enshrine the German model of fiscal and monetarist rigour as binding on the eurozone, in effect outlawing Keynesian economics.
Goodbye social spending, redistribution or counter-cyclical government policy. Signing up for the euro would be like swapping the influence of London for rule by Brussels.
Scotland’s not going to have much space for fiscal manoeuvre as Salmond pretends. Big tax increases would force businesses south. Hefty tax cuts wouldn’t be sustainable. But Scotland would still have more wiggle-room if it stayed outside the euro and avoided a life-sentence of Germanic austerity.
If Scotland does vote for independence it should keep using pounds (which it could do whatever Cameron says). It does more trade with England than with Europe. Plenty of countries piggy-back on strong currencies like the US dollar.
True, Scotland wouldn’t have a lender of last resort like the Bank of England, and Threadneedle Street wouldn’t want to play central banker for Edinburgh without guarantees on Scottish spending because otherwise it’d effectively be writing blank cheques. But better to negotiate a flexible arrangement with Westminster than submit to the fiscal diktats of Brussels.
Utterances of the c-word
During economic crises the c-word crops up with increasing frequency. In this video Terry Eagleton and my old lecturer Alex Callinicos point out that even conservatives have again started using the term capitalism, distinguishing it as a specific system rather than a natural state of affairs. Marxists, of course, like to set capitalism apart from prior modes of production because they see it being superseded by a new and better way of organising things, hence the old joke:
Q: How many Marxists does it take to change a lightbulb?
A: You can’t change the lightbulb, you’ve got to change the system.
My other favourite is the one about the Trot caught bashing up his bog. “I said smash the system”.
The Financial Times has just run its second series on capitalism in three years. In 2009 it analysed “the future of capitalism“. The future turned out bleak: it’s just proclaimed that capitalism is in crisis.
The FT’s chief economics writer Martin Wolf hails from a very different corner of politics to Callinicos and Eagleton, so it’s entertaining to read his remedies. First, he recommends managing instability. He agrees with leftists that capitalism is inherently wobbly. The mainstream of economics had come to believe that it could tame the tiger through a competitive economy and a trustworthy central bank which convinced everyone that inflation was under control. That view turned out to be wrong, and like most economists nowadays Wolf is a late convert to Hyman Minsky, who decades ago foresaw that the very upturn which appeared to be creating newfound prosperity would itself create unsustainable levels of debt, in turn bringing the whole edifice crashing down. Wolf thinks that regulation, better government supervision and enhanced central banking can stop similar crises from happening again. I’m not so sure about the latter, given the almost unanimous deification of central bankers and their cohort in the last decade or so, and their abject failure. As I wrote to Time magazine 13 years ago, Greenspan and his friends at the US Treasury weren’t the “Three Musketeers”; they were men in suits, and they’d turned the stock market into a cult.
“Protecting the economy from finance” is strong stuff, given that a few years ago politicians and economists couldn’t wait to bow before the Goldman dollar. But shielding poor old corporate capitalism is what Wolf thinks we should do. He thinks the main banks shouldn’t be allowed leverage of more than 10 to one. Investment banking must be separated from ordinary deposit-taking and lending. People need protection from predatory mortgage sellers. I was struck by the way in which US capitalism unwound because it had preyed on the poor. Parts of Wall Street purposefully sought out vulnerable borrowers so that they could foreclose on their properties when they failed to keep up repayments.
Wolf also advocates redistribution. This is something that probably only plays to a UK rather than an American audience, but it’s vital. Propping up the poor is not only moral; it’s essential to sustaining demand during crises. Inequality is also bad for the rich in the form of increased insecurity and a fractured society. Making sure that rich people pay their taxes would go a long way, but as Wolf acknowledges, closing international loopholes is a tricky task, and one that requires international cooperation.
Wolf’s probably a bit more of a fan of the corporation than I am, but he points out that it’s central to capitalism’s success. He thinks that it’d be tricky to hold companies to account, given that it’s the freedom of their environment that’s partly the source of their dynamism. But he does recommend making pay structures transparent and he believes that boards should be diverse and well-informed. I suspect this sort of talk would invoke snorts of derision from the likes of Eagleton. For Marx, companies were both the origin of dynamism and the locus of exploitation. Hoping that they will somehow mend their ways is akin to wishing that X-Factor would become a bit more intellectual.
Probably the best insight is that: “Protecting democratic politics from plutocracy is among the biggest challenge to the health of democracies.” One of the reasons the bankers were so readily bailed out is that they bought the West’s politicians; probably more so in the States than here. Wolf is right that parties should be funded publicly. I’d say that private contributions should be severely limited if not curtailed.
Lastly, Wolf says that “open markets, monetary and financial stability, security and, above all, protection of the environment” are all global public goods and that they need to be regulated internationally — something that’ll be very unlikely in the near future. He still thinks we should strive to make capitalism better rather than accepting it for what it is.
Despite their differences, ironically much of Wolf’s analysis could have come from Marx: the acknowledgement of instability; the globalisation of capital; the injustice of inequality and the influence of business on government. Maybe Wolf isn’t so far removed from Callinicos and Eagleton after all. Yet despite admiring the unfashionable consistency of Marxists, I find Wolf more interesting. Yes, Marxists aren’t afraid of using the c-word and they know the next calamity is around the corner. But their obsession with the system means they don’t always bother with nuanced policy prescriptions. Persistent bearishness is a bore, and it’s too easy.
It’s helpful to think of capitalism as a stage in history and as something separate from the actual everyday workings of society because we can then think of radical ways of fixing or superseding it. But we don’t live in a world that is functionally destined to fall about our ears with predictable regularity. Crises do catch us unawares, and they happen in slightly different forms. John Maynard Keynes taught us (or should have, until most economists forgot him) that things can be done to regain full employment. Sometimes it’s good not to be shackled to ideas about the system.
Businesspeople shouldn’t run countries
Paul Krugman asks:
…why does anyone believe that success in business qualified someone to make economic policy?
For the fact is that running a business is nothing at all like making macro policy. The key point about macroeconomics is the pervasiveness of feedback loops due to the fact that workers are also consumers. No business sells a large fraction of its output to its own workers; even very small countries sell around two-thirds of their output to themselves, because that much is non-tradable services.
This makes a huge difference. A businessman can slash his workforce in half, produce about the same as before, and be considered a big success; an economy that does the same plunges into depression, and ends up not being able to sell its goods. Nothing in business experience prepares one for the paradox of thrift, or even the inflationary impact of increases in the money supply (which is real when the economy isn’t in a liquidity trap.)
(The paradox of thrift says that during recessions if everyone tries to save more then demand will fall, reducing consumption and economic growth and in turn lowering savings. The liquidity trap is the situation we’re probably in now — where further reductions in interest rates won’t raise economic growth.)
OK, Krugman’s argument is more relevant to the United States Republican party nominations, which seem like an alternate universe in which candidates by the day spew forth increasingly slavish support of business and mounting hatred of tax and the poor. But it applies to other countries too, where politics is seen as a technical discipline in which we ‘employ’ ‘experts’ to sort our problems out. Mario Monti’s technocratic Italy is a good example. He’ll probably do a good job of slashing spending because he doesn’t have to bother about his constituency or mandate, but he might not be good for Italy over the long run, and nobody voted for him.
The technocratic view forgets that democratic politics is supposed to be about what people want — schools, sports, the arts, nice lives — it’s not just about further pumping up the economic behemoth. And anyway the apparent technocrats — who mostly seem to have a background in business — aren’t good for everyone. Democracy is a better way of running things over the long term. Politicians who cater to everyone tend to recognise the complexities of the economy and society; that consumers are also producers, or that the poor will revolt if they’re left in the gutter for too long. It might be relatively straightforward to do the sorts of things that help business in the short term, like getting rid of welfare and spending less on schools, but 10 years later you’re left with a shell of a state and a pissed-off population. The examples of democratic success are numerous. Amartya Sen famously argued that India never had a famine after it threw the Brits out. Dani Rodrik pointed out that in Argentina fiscal austerity prompted voters to reject the ruling party: “democracy shoved the golden straitjacket aside”.
I also like Krugman’s reference to feedback loops, the pervasiveness of which is one reason why social science is different to natural science. Society, which is what politicians have to deal with, is a self-relating system which is far more complex than a company. It is this reflexivity which requires not narrow expertise from a particular side of the productive system, but a more nuanced, broad-ranging set of views, mandated by the different human beings who participate in that system.
US government debt isn’t the problem newspapers think it is
This is from Dean Baker at the Centre for Economic and Policy Research
The Post Disagrees With Financial Markets
Friday, 23 December 2011 06:26 In an article discussing House Speaker John Boehner’s performance in his job, the Post referred to his negotiations last summer with President Obama over, “the federal government’s swelling debt problem.” Newspapers interested in maintaining the separation between the news and opinion pages would have simple referred to the debate over raising the debt ceiling, which is what was at issue.
The debt has risen rapidly because of the recession that followed in the wake of the collapse of the housing bubble. Financial markets do not see the debt as a problem, which we know since they are willing to lend the government huge amounts of money at very low interest rates. There was no reason to interject this sort of editorial comment in a news story.
… the notion that we’re facing some kind of imminent threat from deficits isn’t based either on what the market is saying or on received economic theory. It is, when you come down to it, based on nothing more than a gut feeling that deficits must be a Bad Thing; and the people whose guts apparently get taken seriously have been wrong every step of the way.
And yet this more or less made-up notion of a debt crisis, which is in the end a prejudice rather than a reasoned conclusion, is reported as a fact in what is allegedly a news story, not an opinion piece.
