Wednesday, 30 May 2012

Good hunches

As opposed to Samuelson’s faulty predictions of the Soviet Union overcoming the US in the late 1990s, another economist with a popular introductory economics textbook provides much better and more precise predictions.

I recently read an article by Greg Mankiw from 2006, written as a prelude to Paulson replacing Snow as the US Treasury Secretary. Mankiw issues a lot of warnings on the sustainability of the US budget back then. 

He emphasizes the importance of consolidating the public finances in the long run as a key challenge for Paulson. Even in 2006, where everything was going so well, it was obvious to Mankiw (and many others) that the demographic pressure was placing a huge challenge on the Social Security, Medicare and Medicaid systems. But somehow there was no credible pledge on either sides of the political spectrum to address this concern. This is the problem with short-termist politicians: if things are going good, don’t try to implement potentially painful reforms that will endanger your chances of re-election. And this is exactly why I’m against short-term solutions like currency devaluation or large stimuli (both fiscal and monetary) that would restore growth temporarily and then allegedly make room for reforms. That’s nonsense and as I mentioned before, no such thing will happen in the foreseeable future for any nation facing fiscal problems of global proportions, since no politician will ever have the strength, power or the courage to do that. 

The article carries on to identify the main divergence between economists on which is the right way – more taxes to fund all the promises accompanied by a further expansion of entitlements, or on the other hand a reform of the entitlements system accompanied with closing of the fiscal gap with reduced spending and Pigou taxes (this is the approach Makniw strongly supports, today more than ever I think). 

In fact, he had this to say on raising taxes at the time: 
I think I read that last sentence about a thousand times in the past year. Also, this is probably why the tax raising part of the austerity agenda is failing so miserably. 

And finally, how’s this for a good hunch: 
If only Paulson had listened.

Monday, 28 May 2012

Graph of the week: Student loans

As the tuition fees are rising, student loans are skyrocketing. The following graph comes from last year's text in The Atlantic carrying a rather sensational title: "Student Loans Have Grown 511% Since 1999." 

Source: Indiviglio, D. "Student Loans Have Grown 511% Since 1999", The Atlantic, 18th Aug 2011

So which one was the bubble again?

Bear in mind that the growth in household debt (blue line) was the one responsible for the housing bubble leading up to the financial crisis of 2007 - 2009. But this time, absolute terms are actually more important. The total amount of household debt reached almost $10 trillion (making it systematically much more dangerous), while the student loans increased to around $550 billion, or roughly one twentieth of the size of total household debt. But its rapid, almost incredible growth is still worrying. 

What will happen to those students which cannot repay the loan? During the mortgage bubble burst, people lost their homes. Will students lose their lives with the bursting of the student loan bubble? 

One example particularly caught my attention. It was from a Harvard Business School graduate who found himself in a debt trap after graduating and getting a job. He soon realized that if he were to continue with the repayment of the loan over the 15 year period, his interest payments would equal almost half of his principal. So he started a quest (and a blog entitled "No More Harvard Debt") where his goal was to repay the entire debt within a year. He succeed in 7 months, and even managed to get some media coverage. (Btw, perhaps he could serve as a good example to Congress on how to curtail the national debt - just an idea.)

But not everyone is this prudent or even lucky enough to get a high-paying job that will equal his or her qualifications. I’m sure the return on investment has dropped significantly since more and more college graduates are forced to take lower paying jobs which puts significant financial constraint on them when attempting to repay the loan. 

High unemployment and less job opportunities are putting significant pressures on the current contingent of students as well. They chose part-time work or volunteering only to postpone graduation as much as possible. This biases the official unemployment figures downwards. It’s not true that unemployment is decreasing but that more and more people, due to high uncertainty, choose not to engage in the workforce (or walk out of it). 

A bleak picture is left for the new generations of graduates, and for those just enrolling in the University. The career choices they make now will be determined by the current economic climate, just like it was the case for those who took loans when things were going well. It is this sort of signalling that will influence the specialization patterns of the population in choosing their careers, and consequently the patterns of future economic growth. 

Friday, 25 May 2012

Achieving political stability – is it possible?

As an advocate of political stability as the crucial starting point which can address the radical dependency problems in Greece and most of Europe, I find it frightening how hard it is to achieve this stability, particularly when the political situation and the currently prevalent opinion among Europe’s citizens is turning more and more radical.

The latest article from an excellent political economist commentator Protesilaos Stavrou illustrates this point for the current political lock-down in Greece. The level of ideological heterogeneity that developed in the Greek society during the sovereign debt crisis is astonishing. From right-wing nationalists and neo-nazis, to radical socialists and communists - it seems that every option apart from a liberal one has entered parliament in the May elections. Naturally, the inability to form a government was the only possible outcome. Protesilaos describes the micro-political factors behind the inability to consolidate and points out to four probable scenarios that could happen as a consequence of this ideological outcome, none of which seems to offer much hope to the country. The move towards ideological radicalization is threatening to become too strong for any attempt of long-run institutional reform. Tired from all the pushing around it is no surprise that people are becoming more and more guided by emotions, instead of reason. Hatred towards the whole European project is reaching unprecedented levels. On the other hand, neither domestic or foreign politicians are doing anything to prevent this. On the contrary

Similar issues of radicalization and the feeling of hopelessness are emerging throughout Europe. I already warned of the threat of nationalism in Hungary under Orban, but it seems this threat has spread across much of the Eastern Europe. Not only is the economy in dire straits (again - see figure), but many states are faced with a political system close to collapse as well. 

Source: Financial Times, 18th May 2012. 

It is understandable why this is so. People are fed up with incompetency of current governments to deal with the crisis. On the other hand governments are unwilling to move forward any radical reforms that could address the systemic issues in Europe. This status quo situation is ruining confidence and increasing uncertainty. It is undermining political stability as well since the further this situation continues, the worse will be the reaction of the people and hence the final outcome. Greece is unfortunately a case in point.  

So in order to achieve political stability and prevent radicalization, the proper response has to be pan-European and arrive via an international agenda. An international agenda focused on institutional reforms based on a new underlying theoretical and analytic framework, much different from austerity measures focused only on deficit and debt reductions. Only an international agenda will possess a substantial amount of negotiating power that could encourage a change in  the dependency mentality. By this I don't mean that Germany et al should engineer the reforms, but rather a consensus to an approach based on scientific rigour that emphasizes the long-run importance of institutional reforms. 

Even if we imagine (for a second) that such a nation-wide consensus is possible, this approach will still be very hard to implement, since it requires a change in political culture and most of all, a change in mentality. No national politician will be willing to engage into this sort of reforms, nor will the voters be open to outside enforcement of new rules. As much as it is desperately needed, it is so much harder and delicate to implement. 

And so the quest continues. The currently attractive option are eurobonds, briliantly debunked today by ASIs Eamonn Butler, saying "Just because you want to ignore economics does not mean that economics will ignore you." But there are other options as well, fortunately none of them based on devaluation of currencies, large fiscal stimuli, inflation or similar ideas. Protesilaos has pointed me to the direction of two economists, Yanis Varoufakis and Stuart Holland who came up with a "Modest Proposal" to resolve the crisis. It focuses on three policies: creating a single banking authority and regulator, debt conversion via the ECB, but not requiring monetization of the debt thereby reducing the threat of inflation, and promoting an investment-led recovery afterwards. It's basically a call for federalism of the financial sector without sacrificing political goals. This week's issue of the Economist advocates a very similar approach. 

I’m sure there are many economists out there with even better and more innovative approaches on how to resolve this and, above all, how to achieve political stability that will have the necessary strength to engage into reforms. Unfortunately, their voices are unheard, primarily because of the dominance of those advocating quick fixes that are much more approachable and acceptable to politicians. Naturally, short-termists will always look good in the eyes of politicians and in the eyes of the media and their median reader. But the median reader, just like the median voter, will seldom realize the grave dangers in these kind of approaches. For example, no one could have foreseen at the time that having the Greek and German governments being able to borrow at the same costs, with two very different approaches to fiscal policy, was a terrible idea that would partially cause the contagion Europe is currently in. 

The biasness and the persistent fallacies over what is the ‘right way’ – austerity or stimulus, austerity or growth, monetary action from the ECB etc. – have to be overcame by a theoretical and empirical framework that can be applicable to policy. The several ideas called upon in this article can provide a step closer to resolving this, but an international policy approach must be consistent with it. They've tried almost everything else – and have failed. Perhaps it's time to try something different, something real and something long-term oriented. 

Monday, 21 May 2012

The Argentine example isn’t helpful to Greece

Or to anyone else for that matter.

A lot of times during the past months I came across the idea that Greece should follow the Argentine 2001 example and devalue its currency. This would imply leaving the euro and returning to Drachma, followed by a series of bank runs and capital controls to prevent capital flight. But, crucially, the currency devaluation would cause a boom in Greek exports and sustain an investment-led growth.

I covered this fallacy in a text on currency devaluation earlier in November, claiming that no devaluation will help the Greek economy, as it won’t address the structural problems this country is facing. Here’s an excerpt of what I wrote back then:
"...there are many other indirect effects that are likely to completely crowd out any positive effects of currency devaluation...The Greek people and businesses were, just like the Greek government, running high debts and used them to fuel their consumption previous to the crisis. An increase of the exchange rate would imply higher interest payments in drachmas for all those with outstanding loans with the banks, leaving the households and businesses with less disposable income. As a response to this effect the labour unions may negotiate higher domestic wages in terms of foreign currency (the euro) which will crowd out the devaluation effect and yield an inflationary effect of roughly the same size as the devaluation, thereby undermining the increase in competitiveness. Besides, Greece needs to completely change and restructure its labour market and labour market conditions if it wants to make its workers more competitive on the international market. No currency devaluation will resolve the deep structural problems of the labour market, no matter how competitive they may seem to appear due to cheaper currency.

Concerning the export increase (due to lower export prices), if the labour unions do increase the wages and spur an inflationary effect over the economy, this will increase the prices of domestic goods further offsetting positive devaluation effects. Besides, currency depreciation can work only in countries which have high production levels and a huge industry such as Japan or China."
Nevertheless, many pundits claim (the latest one I noticed on the VoxEU portal) that devaluation is the only possible way to a full recovery, citing the evidence from Argentina’s rapid growth recovery in 2003 and 2004. Here’s what Kretzmer and Levy (2012) from Bank of America claim: 
However, they (and a lot of others stressing the benefits of devaluation) tend to overstate what really happened with the depreciation of the peso in Argentina and the real effects of the Argentine Corralito. For those who don’t know, the Corralito was the name for a series of measures initiated in Argentina in 2001 to prevent capital flight and bank runs. It allowed for small sums of cash to be withdrawn on a weekly basis, but only in pesos (all dollar denominated currency could only be withdrawn if converted into pesos). When the depreciation was made, the peso-dollar exchange rate dropped from 1:1 to 1:4. But, while the new exchange rate was in place the people could only exchange their dollars for pesos for an old exchange rate, meaning that in one go Argentina reduced the nation's savings by three quarters! Anyone with a $100 in savings all of a sudden found themselves with $25. Needless to say this helped debtors but at the expense of savers, private companies and taxpayers. It made a huge negative impact on the nation's wealth. 

Luckily the former Governors of the Bank of Mexico and Bank of Argentina, Mario Blejer and Guillermo Ortiz, recognized the devaluation threat and called for Greece to stay in the euro. They stress the same problem with the Argentine Corralito and claim that in Greece things could get even worse:
What Argentina needed then and what Greece needs now is a proper institutional reform based on, above all, achieving political stability. I’ve made this case repeatedly in a series of texts, including in the VoxEU, Institute of Economic Affairs, and my own blog. This will be excruciatingly hard to do, but in the case of Greece there are no easy short-term answers – only long term ones. 


Finally, back in 2004, The Economist did an analysis of Argentina’s recovery and what steps are needed further to continue on the positive momentum created. They concluded their article with the following:
"If Argentina is to make the most of its opportunity, Mr Kirchner will have to take swift, perhaps unpopular, action to clear up the unfinished business left over from the collapse. But above all he will need to draw the right lessons from its travails. A good place to start is the rule of law."
Exactly my point.

Note: This post was also published at the Institute of Economic Affairs blog, on 18th June 2012. For all my other IEA articles, see here

Friday, 18 May 2012

Graph of the week - Remittances

From the Economist comes the following figure on remittances:

Source: The Economist, 28th April 2012






Tuesday, 15 May 2012

More on austerity

Note: This post was also published on the Adam Smith Institute blog on Thursday 24th May, titled "Austerity or bust". For all my other ASI writings see here.

The debate on austerity v stimulus is again the main focus of attention. Particularly due to the recent results of the Greek and French elections where opposition to European "redistributive austerity" is gaining strength. Even though they don't refer to it as redistributive austerity, but as "painful cuts that are hurting growth". Even in the very phrasing of the debate as 'austerity v growth', it is obvious that people don't really understand what austerity is, and even less what their governments are doing. 

The recent texts from the Mercatus Center, Cato institute, Tyler Cowen and many others shed some light on this and have pointed out to a controversial yet very true fact that there is no real austerity in Europe, at least not the type that could theoretically help the economies recover. In fact, just yesterday Tyler Cowen asks what is austerity, trying to come up with a precise definition in order to overcome the biases behind the term and its policy effects. Looking at Wikipedia and Investopedia he finds the following:
Defining the term is particularly important for the policy implications. As you can see there is no mention of tax increases in any of the two definitions. However, governments sometimes do tend to use tax hikes to lower the deficit. But essentially the very definition of austerity primarily implies cutting spending and cutting entitlements in order to create more scope for the private sector to grow on its own, i.e. to remove the dependency mentality from people and from businesses. 

Then comes the following graph from Veronique de Rugy of the Mercatus Center
Source: Mercatus Center, de Rugy: "Fiscal Austerity in Europe
Doesn't Mean Large Spending Cuts"
 (May 7th 2012)
Where is the austerity here? Where are the significant cuts in spending necessary to address public and private sector dependency on the government and to reform the labour market? Particularly interesting examples are UK and France, where no signs of decreasing spending can be seen. In the UK, public spending to GDP has reached its 50-year historical high point (46% of GDP, see figure). Some cuts have been made, but everything that was saved up was again used to steer the economy. And so Britain saw schemes that want to pick industry winners, guide investment projects, subsidize housing, subsidize young people, and even control the amount and prices of loans in the economy. How does any of these address systemic dependency and how does any of these fit in the aforementioned austerity definition?

In France, the painful burden of austerity was one of the causes of Sarkozy's electoral defeat. The French were apparently fed up with it. Even though I'm struggling to see the actual austerity in France. However, I don't live there, so maybe I'm wrong. Maybe what's bothering the people in France is the same thing bothering people in the UK - taxes are going up, people are left with less and less disposable income, nothing is done to address the endemic dependency of the people or businesses to the state - which means that private sector growth is highly unlikely to follow, banks are uncertain and they refuse to lend no matter what the ECB does (or the BoE in the UK case), and finally, as a result people resort to radicalism, which was evident on both French and Greek elections where ultra-right and ultra-left parties won seats in parliament and got a dangerously significant portion of the votes. 

The very idea of depicting the debate as austerity v growth is wrong. This implies that the solution is the opposite of austerity - a monetary or fiscal stimulus to close down the nominal GDP gap. Even if a short-term fiscal or monetary stimulus can temporarily boost growth, that isn't the way towards a proper restructuring of the economy. I know the logic behind these views - "let's just get the economy going and all will be better afterwards". The idea that it's much easier to do structural reforms after things are going well is a wrong approach, since no politician will have the power, strength or the courage to engage into painful but necessary reforms, especially after what the world economy is going through at the moment.

Austerity should be an unpopular policy. It's primary goal is to cut the dependency to the government. This does not come easily and will cost votes. But doing what the European politicians are doing currently, first of all has no chance of achieving growth any time soon, second it's constraining the population from spending (via tax hikes) and the businesses from investing (uncertainty, bad signals, no institutional support), and finally will result in a double loss - elections and the recovery. As Margaret Thatcher once said: "If you want to cut your own throat, don't come to me for a bandage". This precisely sums up what Europe's allegedly austere governments are doing - cutting their own throats and hoping they stay alive. Not likely. 

Sunday, 13 May 2012

Brace yourselves, there’s another bank holiday coming

Note: This post was also published on the Adam Smith Institute blog, on Wednesday, 16th May 2012. 

Last year in the UK there was a lot of fuss about the Royal Wedding in economic and political circles.

It was led to believe that because of an extra bank holiday for the Royal Wedding last year, and for the Diamond Jubilee this year, the economy slipped back into a recession. An extra bank holiday was apparently the reason why the second quarter of 2011 had negative growth (-0.1%, see graph below). And it will probably be why the UK will have a negative growth in Q2 2012 too, making it three consecutive negative quarters.

Things were just starting to look better, didn’t they? The impressive 
growth of 0.2% in Q1 2011 was totally offset by the Royal Wedding. 
Btw, the UK didn’t slip back into a recession – it never actually got 
out of one.  Source: Trading economics

If only the British were working on those days, everything would have been different. Instead of a -0.3% drop, the UK could have grown by, say 3% that quarter. What a missed opportunity. Note: the 3% was an estimate based on no data at all, just my personal opinion, which makes it as imprecise as any forecast you could see that blames things like the Royal Wedding for a re-occurring recession.

I’m waiting for the next logical step from UK policymakers – to make the people work on Saturdays and Sundays in order to mitigate the effects of the Royal events. That ought to make the economy grow. 

In fact, I have an even better proposal; since we’re in a recession why not make every week a 7-day working week for everyone! First, it would ease the inequality pressure a bit, and second it would spur growth well over the previously estimated 3%. If you want a Chinese-style bounce back of a 9% growth, than working weekends is the way to go. 

But seriously, when forecasters of economic activity design their models they never stop to think beyond the one-non-working-day parameter. Didn't anyone consider the amount of tourists that came to London for the Royal Wedding, and that will arrive for the Diamond Jubilee? People have stayed in London for more than a week in those days. The hotels were full and made a bundle. The airline companies made money, Transport for London made money (the tourists did need to buy tickets amid the congestion they’ve temporarily caused), shops sold more stuff, tourist attractions sold more tickets, and some money even went to the non-taxpaying parts of the economy. A lot of money was left in the country and will be left during the next couple of months. 

This isn’t an explanation of the recessionary quarter(s) and anyone in power claiming that it was is simply hiding his or her own incompetence for being unable to achieve a recovery. 

In the end, it’s not how many days in a week people work, it’s how much value an economy can create. This is where the UK is lagging behind. And it won’t fix it with giving businesses extra money but by giving them an equal, unconstrained opportunity to compete and succeed. And it certainly won’t fix it by abolishing Royal events that can actually attract people to come and spend their money in this country. 

As soon as you know it, the Olympics could be called off because it could cause massive delays to people coming in and out of work. What a tragedy for the economy. I’m guessing it will cause a massive amount of stress making the people perform sub-par throughout those 8 weeks. It’s no telling what this could do to the economy. Brace yourselves, not because of the Eurozone collapsing, rising energy prices or a hidden threat of inflation – no – brace yourselves because there’s a Diamond Jubilee coming.

Wednesday, 9 May 2012

VoxEU debate on austerity: "Time to reform institutions"

The famous CEPR economic research policy portal started a debate last month on austerity, entitled "Has austerity gone too far?", with a leading comment from the moderator Giancarlo Corsetti, from the University of Cambridge. This was followed by an article from Alesina and Giavazzi (Harvard and Bocconi), making the case in favor of austerity measures, and a counter-argument from Brad DeLong (Berkeley). The debate has since featured many prominent economists (from the IMF, EC, German Bundesbank, LSE, Chicago, NIESR etc.) and I am grateful and honored to be among them. 

Here is an excerpt from my contribution to the debate, entitled "Time to reform institutions":

"Europe needs to move on beyond austerity and stimulus, and focus on reforming its institutional system that will address the misplaced incentives and the dependency mentality, and restore proper market signalization that will enable new patterns of specialization and increase productivity.  
There has been too much backlash between proponents of austerity and proponents of a fiscal stimulus. In a wide array of evidence from either sides of the debate (Alesina and Giavazzi leading the argument on one side and DeLong on the other in the VoxEU debate), they all certainly have merit, but they seem to miss an important point. 
The debate needs an approach from another side of the political economy spectrum – the new institutional and free-market perspective calling for institutional reforms. Reforms that will address misplaced incentives in the labour market, the dependency mentality, and the non-functioning of basic state institutions. By doing so they could be able to restore proper market signalization that will enable new patterns of specialization and increase productivity. 
Structural reforms are being called for by both sides of the argument, but no one really puts too much emphasis on them. They are pictured as a natural outcome of the respective policy in place, whether austerity or expansion. Alesina, for example, calls for “spending-based consolidation accompanied by the right policies”. These right policies include “easy money policy, liberalization of goods and labour markets, and other structural reforms”. On the other hand, DeLong emphasises the importance of “credible plans for long-run fiscal balance, structural reforms to free-up enterprise and increase opportunity, along with reforms of the social-insurance state”, all to come as a consequence of consolidation after the economy gets injected with more funds and the state supports its growth. 
But so far, no one has been precise in how to achieve these structural reforms. They won’t follow automatically after austerity or fiscal expansion; they must be initiated by “market-augmenting governments” (Olson, 2000).

Where to start from? Political stability."
 Read the whole thing here.

Saturday, 5 May 2012

Graph of the week: Big Mac Wages



The Big Mac Wage Index is a bit different.

Source of graph: WSJ blog





Wednesday, 2 May 2012

Persistent fallacies

Note: This post was also published at the Adam Smith Institute blog, on 12th June. For all my Adam Smith Institute texts, click here

Whilst reading Acemoglu and Robinson's insightful and exhilarating book, I ran across a stunning fact. In the Chapter 5 of the book, entitled "I've Seen the Future and It Works" they talk about why economic growth cannot be sustainable under a set of extractive political institutions. They mention the case of Soviet Russia and emphasize how their rapid growth during the 50-ies and the 60-ies was unsustainable since it wasn't supported by economic dynamism or innovation, i.e. there were no forces of creative destruction. They managed to achieve growth simply by reallocating a huge number of people from under-productive agriculture into industry. It was only natural that rapid growth would follow since productive resources (labour and capital) could now be used in a much more efficient way, and close to full capacity. However, when this reallocation ran out of steam (70-ies and 80-ies), a collapse was imminent. 

What was surprising was that a large group of academics, policymakers and intellectuals in the West were mesmerized by this astonishing growth. In fact, many people believed in the 60-ies that it was a matter of time before Russia would overcome the USA in its economic and global power. In fact, the argument was that not only do the Soviets grow faster, they manage to do that under full employment and a society based on altruism instead of individualism (and apparently better ethical values). 

Sound familiar? 

Now I've been aware of all of that, but this I didn't know:
Acemoglu, Robinson (2012) "Why Nations Fail", pp. 128. 
Needless to say, during the years Samuelson predicted the Soviet Union would overtake the US, Russia was bankrupt twice (!), and has returned to a system of extractive political institutions which were again able to produce some growth and better living standards based on rising oil and gas prices during the 2000s. But as the West again slowly begins to realize, this is unsustainable as soon as Russia starts experiencing a twin deficit and when its growth stops being driven by swings in energy prices. 

However, many pundits now share the same thoughts on China and its "miracle". But as the authors of the book clearly emphasize in their final chapter, China's growth now is as unsustainable as Russia's then. They are both based on extractive political systems which can only achieve temporary growth via reallocation of resources, not technological advancements or creative destruction. I just wonder how long will it take some leftist Western pundits to realize this?