Travelling

I'm off to the land of the free and home of the brave--no, not Scottland--for two weeks to indulge in some archival work. Limited or no posting for a while.

Rogoff & Reinhart

Via Paul Krugman I see that Steven Colbert is having fun with R&R. Looks like R&R are turning into the Cloward and Piven of the left. The difference is of course that C&P were never more than bogey men (women) for right wing conspiracy theorists while R&R's argument actually shaped policy and contributed substantially to prolonging the current crisis unnecessarily.

Beware of Americans bearing gifts

Apparently the US finance minister Jack Lew gave his German colleague Wolfgang Schäuble a copy of an Alexander Hamilton biography. As Schäuble will have discovered upon reading the book, one of Hamilton's main contributions was to have the federal government of the newly founded United States assume responsibility for debts run up by individual states. It's reassuring to see that Lew knows his history and understands that the USA as a federal state were not only founded on lofty ideals but also on the need to handle an imminent debt crisis. It's far less reassuring to see that German politicians are unwilling to learn from history (German, American or other) or even acknowledge its relevance. Apparently, Schäuble's come-back was a bland 'things are different today'.

Schoolboy error, not

The BBC has a great piece about how the Reinhart&Rogoff mistake was discovered by a student. Why is it that so many professional (professorial) economists are so bad at critically examining the case for austerity?

Stereotyping GIPSIs

I admire Paul Krugman as much as the next liberal bleeding-heart, but I disagree with him about the history of European debt. Recently he wrote on his blog:

'European officials remain in deep denial about the fundamentals of the situation. They continue to define the problem as one of fiscal profligacy, which is only part of the story even for Greece, and none of the story elsewhere.' 

Krugman is right to point out that many of the GIPSIs (Greece, Italy, Portugal, Spain, Ireland) had sound public finances until very recently. Spain, Ireland and Portugal were only thrown into financial turmoil when they had to bail out their banks. So no irresponsible spending by politicians there. But not all GIPSIs are the same. Greece and Italy are different. Their public debt is much older and has been accumulated over longer periods. Their debt is not the result of a single 'mishap' but reflect structural political problems.  I have written about this before: 

'In Italy, as in Greece, public debt has been run up over decades in the post war period. In Italy mainly since the early 70s. In this period, expenditure for the welfare state increased rapidly, but taxation did not keep up. This was in large part due to the political context. Italy was the only western country--together with Chile--in which an election victory of the communist party was a real possibility. Left wing terrorism added to the political pressure. However, while the christian democratic governments of the time were forced to expand welfare provisions, they were not willing to go against the interests of their constituents and tax businesses and higher incomes according to expenditure.'

The different histories of public debt in the GISPI countries have important implications for the possible solutions to the debt crisis. In Spain, Ireland and Portugal it is possible to fix the short term consequences of the financial crisis along the lines that Krugman suggests. But in Italy and Greece things are more complicated. Throughout their existence they have been politically highly instable and this has not changed now. While Spain and Ireland are governed (badly) by stable democratically elected governments despite the crisis, Italy and Greece have gone into full political meltdown. 

It will take more than ECB intervention, Eurobonds and stimulus in the European core to fix the problems of Greece and Italy. European politicians may be in denial about the causes of the debt crisis in some GIPSI but critics of austerity are not helping their cause by ignoring the heterogeneous histories of European debt. 

Reinhart-Rogoff and Asprine

There seem to be some very substantial problems with the data that underpins Reinhart's and Rogoff's thesis that countries with a debt/GDP ration above 90% tend to experience slower growth than others. A good summary of the problems with the data that have now emerged can be found here.

Other important doubts about the implications of the R&R data had been voiced earlier and are mentioned in the piece. Quite a part from the validity of the data, it is really important to ask what a correlation between high debt and low growth means (or rather would mean if it existed). Does this correlation really imply a causation and if so which way does it run? Most likely, people who take more Aspirine also have more headaches. But should we really conclude, that limiting your consumption of Aspirine will reduce your headaches?

Grease that rusty guillotine

Dominique Moïsi compares François Hollande with Louis XVI and warns that if he (Hollande) does not learn his history lessons he will have to face the consequences. That's great. By that I don't mean the apparently imminent execution of Hollande but the fact that this is finally a historical comparison that does not involve Heinrich Brüning or the rise of fascism in the 30s. But there are some points that remain unclear in Moïsi's argument. I have done some comparisons of 18th history with the present myself. That kind of long term comparison is often tempting, sometimes illuminating, but always tricky because of huge differences in the historical context.

Moïsi's main point is that the 'Ancien regime ... fell ... when the privileges of the aristocracy were no longer perceived as the counterpart to services rendered to society' and that we are seeing a similar situation today. This, he thinks, is the sign of deep crisis of the political system. 

The first question that I would like to ask Moïsi is how deep he thinks the political crisis is today in comparison to the late 18th century. My impression is that if growth rates were to pick up again from tomorrow we would see the talk about a political crisis in France disappear rather quickly. Before the French Revolution there were a few bad harvests, but most historians would agree that even with extraordinary harvests the Ancien Régime would not have survived because its structural problems were to big. 

This leads to the question of whether there are any structural problems today that are comparable to those under the Ancien Régime. Moïsi seems to think so, but does not really spell out what he means. So let me give this a shot:

The main obstacle to resolving the debt crisis of the French state were the fiscal priviliges of the aristocracy and the church. Their near complete exemption from taxation meant that a substantial part of revenues could not be taxed. Taxation on the revenues that could be taxed therefore became oppressive. In the words of Michael Kwass the Ancien Régime was a 'welfare state for the rich'. But government revenue still remained too low to provide for the increasing expenses, mainly for warfare. This was clear to most contemporaries but the political structure of the Ancien Regime meant that this could not be changed. Those who were unhappy with the status quo had not political power and those who had political power were quite happy to leave things as they were. Political elites used their political power to protect their economic privileges, thereby undermining the stability of the whole system. Of course the collapse of the Ancien Régime was not only a fiscal matter, but it was one of the central problem. 

What about today? Are there similar structural problems that prevent a solution of the current debt crisis? I would say yes but in a roundabout way. In most industrialised countries, the policies of the last decades have led to shift of the tax burden from the rich to the poor. At the same time, wealth and incomes have been redistributed from in the opposite direction. There may be some effect of this shift on overall government revenue. This may be a similarity to the Ancien Régiem. But I would argue that this development resulted mainly in a shift of the tax burden that left overall government revenues intact. The real problem lies in an other effect of growing inequality: domestic demand is depressed and growth remains sluggish. Over the last decades the solution in many economies was increasing private debt but this creates problems of its own of which we are now well aware. So, I would agree that the fiscal policies put into place by today's political elites in the interest of economic elites let to the current crisis. But the mechanism is more complex than in the 18th century. 

However, as perceptive readers will have spotted, there's a missing link in this argument. In the 18th century economic and political elites were to a large degree congruent. It's easy to see why the Duke of Orleans would and could oppose fiscal reform. He was both an extremely wealthy man and the brother of the king. But today's political elite is--which a few notable exceptions--not part of the economic elite. It is therefore much more difficult to explain why policies that benefit the economic elite are put in place. Is it because politicians are slaves to the ideas of defunct economists? Hayek and Friedman in this case? But this merely begs the question of why they're not slaves to defunct economists with different views. Or do party donations play a role in shifting political power from the masses the elite? More questions than I can answer in one blog post. But worthwhile thinking about. 

Thatcher's legacy

"Margaret Thatcher once said that her greatest political achievement was New Labour. Tony Blair said today she was a ‘towering figure’..." More here in the LRB and here in the Guardian. 

Soros's sorrows

Germany needs to make up its mind: agree to Eurobonds or leave the Euro. Here's George Soros's argument and here's a broadly positive comment by Wolfgang Münchau (in German). I broadly agree that Eurobonds would go a long way to solve the current debt crisis of European periphery countries but I see two problems in the longer-term: one economic and one political.

First, let's assume the debt crisis is solved through Eurobonds. But after that we are still faced with very substantial imbalances in the Eurozone that are mainly due to German export surpluses. At the moment most politicians seem to think that this problem should be solved by lowering costs in the periphery. Hence austerity. Critics say that this should be addressed either by countries leaving the Euro and devaluating their currency or by inflating costs in Germany and other core countries. However, both arguments assume that German exports are price elastic, that is will fall if their prices increase. However, German exports are strong even to countries with very low costs of production such as China. It might well be that the strong international demand for a range of German products is not mainly due to their competitive price but to the fact that there is are no equivalent substitutes available. This share of exports that is driven by qualities of the produce and not its price may be substantial.

This would mean that tinkering with exchange rates and internal inflation or deflation would not do much to address trade imbalances. What would then be needed are development and industrialisation programmes for the European periphery. Such programmes might be very successful but they also require a level of political integration that seem utopian at the moment.

Second, once Eurobonds have solved the debt crisis what would make sure that periphery countries address their structural economic problems? This is one of main concerns of German politicians at the moment and while it seems overblown in the case of most periphery countries it should be a real concern in the case of Italy and Greece. Unlike Spain or Ireland, these countries were not dragged into this crisis because they had to bail out their banks. The debt crisis in Italy and Greece reflects their political instability. It is not a coincidence that both countries now have unelected governments of experts. Spain and Ireland may not have good governments but their political system continues to function even under great strain. These political problems of Greece and Italy will not go away if Eurobonds are adopted and they may be solved by greater European integration. But until the decadent political institutions of Greece and Italy are substituted by European structures there is still plenty of time for plenty of things to go wrong.

Thatcher

The death of Margarete Thatcher has given rise to a debate about her achievements. Ostensibly this is about the past, but inevitably it's also about the present. Members of the current British government apparently referred to themselves as 'sons of Thatcher' in the past and the similarities between current economic policies and Thatcher's are too similar to allow for a purely historical debate. And quite rightly so. If Thatcher's policies got the UK out of the last economic crisis, why not try them again? Here are some thought's on Thatcher's legacy:

(1) There can be no question that Thatcher's budget cuts and tight monetary policy led to a worsening of the economic crisis in the late 70s and early 80s, it remains much more doubtful how much credit she can take for the strong economic growth in the 90s and 00s. First of all there is the problem of the delay: Paul Krugman points to the fact that the economic renaissance of the UK happened only in the mid-90s. That's almost a decade and a half after Thatcher's reforms. 15 years is a long time in economics and one might wonder how much credit she and her policies can take for the recovery.

(2) Even if we accept that Thatcher should share some of the credit for the recovery are not a decade and a half simply too long a period for any economic cure to produce results if we are to take it seriously. As Keynes famously remarked, the long run is a bad guide to current affairs. By the time that recovery set in the lives of many individuals and whole regions of the UK had been ruined. If we agree with Thatcher that there was no alternative to her policies then this was an inevitable sacrifice. But one might wonder wether there were no faster and less punishing ways out of the crisis.

(3) How good was that recovery anyway? Many developments that occurred as a result of Thatcher's policies are today blamed for the present crisis: growing inequality, increasing private debt, housing bubble and financial deregulation. It seems that her interventions may have contributed to end a medium sized crisis only to lay the foundations for a gigantic one. Or in the words of Martin Wolf in today's FT: 'Today, alas, the post-Thatcher renaissance looks as much illusion as reality.'

Silence is golden

But not when you're writing a blog. Apologies for the prolonged silence. First there was not much to comment on, then Easter and then some other things to take care of.