Eurobonds: Just because you want to ignore economics does not mean that economics will ignore you
The game now is that everyone sits round the table, staring at Germany until it blinks. Eurozone leaders figure the only way to save the euro is for all 17 member nations to get together and issue 'eurobonds'. There are some big hitters among those who think this is a really good idea – people like the new President of France, Francois Holland, the Italian Prime Minister Mario Monti, and the European Commission President Jose Manuel Barroso.
Right now, when eurozone countries want to borrow money, they issue their own bonds, selling them to investors for cash and the promise of a return – a rate of interest paid each year over a specified period, say ten years. Sadly, it has become nigh impossible for the government of Greece to finance its spending this way, because investors figure that its promises to repay are so shaky they demand double-digit rates of interest – which is cripplingly difficult for Greek taxpayers to fund, making it even harder for the country to stay afloat. And there are precious few people prepared to take the risk that Greece will actually be able to repay them in anything like ten years from now.
So the plan is that the eurozone as a whole should step in and issue its own eurobonds. The promise to pay lenders interest and indeed to repay their principal at the end of the term would be collectively guaranteed by all 17 nations. So eurozone countries, including those in trouble such as Greece, Ireland and Portugal (and those who are likely to be in trouble soon, like Spain and Italy) could borrow at realistic rates of interest, without crippling themselves.
That is good news for the troubled countries, because it means that all countries in the eurozone would actually be able to borrow at the same interest rate.The snag is that any such country cannot actually pay its share of the interest and principal payments when they become due, the other countries would have to help them out. And the stronger countries are not exactly thrilled at this prospect.
Nor should they be. In the first place, the eurobond idea distorts the price mechanism. If you are lending to someone, the interest you get in return should reward not only your forbearance but the risk you run of not being repaid when you want your money back. Lumping risky and non-risky (well, less risky) countries together means that prices no longer reflect that risk. The risk is pooled. Specifically, the stronger countries are subsidising the risks that are being run by the weaker ones. And when you subsidise something, you generally get more of it. But who wants weak countries to live beyond their means and take a bigger risk of running out of money than they already have done? We had enough of that from the banks, thank you very much.
But the system builds in moral hazard for the over-spent, over-borrowed countries to do exactly that. Live beyond your means, and your richer cousins will underwrite your profligacy and pay people to keep lending to you. Act prudently, and you get hit for a bill from the imprudent nations.
When it comes down to it, of course, Germany has the broadest shoulders. France might think itself in the same league, but actually investors reckon that is a pretty bad bet too – all the more so now that it has a socialist president who figures that balancing the books is for the birds. The German public certainly can't see why they should pay for other people's profligacy. Germany and the other stronger countries would in fact find it more expensive to borrow themselves, because they would be sharing the cost of the weaker countries' borrowing too.
Will it happen, though? Yes, quite probably. The alternative is to let Greece slide out of the euro, followed probably by a number of others that just can't make the grade. That would be messy, and it would cost European banks a lot of money – urged on by regulators, the banks hold a lot of government bonds, which were always reckoned to be safe investments. Though now, patently, they are not. That purely financial concern is what is in George Osborne's mind. But the real concern of pretty much everyone else is a political concern: that the exit of any country marks a retreat from the EU idea of deeper and closer integration, the fear that the European Project would find itself on a falling tide. And that they find deeply shocking.
The euro was always a political rather than an economic venture. But, as my economist friend Richard Jeffrey of Cazenove Capital puts it: "Just because you want to ignore economics does not mean that economics will ignore you." It's painfully clear what the end will be. The only question is how long it will be postponed, and at what cost.
Austerity or bust
The austerity vs stimulus debate is the focal point of attention once more, as the recent results of Greek and French elections show an increasing opposition against Europe’s unique type of redistributive austerity. But few understand what austerity really means. They refer to it as “painful cuts that are hurting growth”. Even by phrasing the choice as 'austerity vs growth', it is obvious that people don't really understand what austerity is, and even less what their governments are doing.
Recent posts from the Mercatus Center, Cato Institute, Tyler Cowen and many others shed some light on this, and have pointed to the inconvenient fact that there is no real austerity in Europe, at least not the type that could theoretically help these economies recover. In fact, Tyler Cowen asks what austerity is, 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:
"In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided."
"A state of reduced spending and increased frugality in the financial sector. Austerity measures generally refer to the measures taken by governments to reduce expenditures in an attempt to shrink their growing budget deficits."
Defining the term is particularly important for policy reasons. As you can see, there is no mention of tax increases in any of the two definitions. However, governments do often tend to use tax hikes to lower the deficit. But the very definition of austerity implies cutting spending and cutting entitlements in order to create more scope for the private sector to grow on its own. In other words, to remove the dependency mentality from people and from businesses.
Then comes the following graph from Veronique de Rugy of the Mercatus Center:
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 a 50-year historical high (46% of GDP). 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 industrial winners, guide investment projects, subsidize housing, subsidize unemployed young people, and even control the amount and prices of loans in the economy. How do any of these address systemic dependency and how do any of these fit in the aforementioned austerity definition?
In France, the painful burden of redistributive austerity was one of the causes of Sarkozy's electoral defeat. The French were apparently fed up with it. Still, I'm struggling to see the actual austerity in France. I may be wrong, but 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, private sector growth is unlikely, banks are in an uncertain position and refusing to lend. In France, as a result, people are 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 vs 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 after what the world economy is going through at the moment.
We should expect austerity to be an unpopular policy. Its 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 has no chance of achieving growth any time soon, is constraining the population from spending (through tax hikes) and the businesses from investing (by causing uncertainty, sending bad signals, and offering no institutional support), and will result in a double loss — of 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.
The glory of this neoliberal globalisation thing
We do all, at least occasionally, need to poke our heads up from the readings of our own dogmas and do a little reality check. Have a look at the real world and make sure that the effects are indeed as we would have theory predict. That neoliberal globalisation thing then, perhaps that application of the Washington Consensus to the abject poverty of Africa, how's that working out then? We saw last week that increased openness to trade leads to economic growth: but as we know, economic growth does not necessarily leads to an improvement in the lives of the poorest. Perhaps we should, as so many NGOs advise us, change our tactics?
That is the annual change in child mortality in those selected countries. No country, no group of countries, has ever seen anything like this, it simply has not happened so quickly anywhere else at all. Something, blessedly, is going very right indeed in this world. My suggestion is that we keep doing exactly what it is that we are currently doing: we might call it globalisation, foreign direct investment, openness to trade or as Madsen puts it, buying things made by poor people in poor countries. But it's working, isn't it?
Licensing creep
The Institute for Justice, an American libertarian think tank that focuses on legal issues, has just released a superb report on occupational licensure. Charting how many occupations require state permission in each state, the most striking result is how regulated low-skilled parts of the market are, and how high the barriers are.
On average among the 102 professions surveyed, government licenses require applicants to "spend nine months in education or training, pass one exam and pay more than $200 in fees. One third of the licenses take more than one year to earn. At least one exam is required for 79 of the occupations."
The most likely explanation is that licensed professions have successfully lobbied the government to restrict access to the market to inhibit competition. It might inititally seem more outrageous that manicurists are more heavily regulated than pre-school teachers, but this might be a blessing in disguise.
As David Friedman has written, the likely outcome of licensing professions is lower quality and higher prices. To paraphrase Friedman: Regulate manicurists, and we'll presumably have longer nails. Regulate pre-school teachers, and we'll presumably have more ignorant children.
Paul Krugman's junk statistics
Paul Krugman posted the graph above on his New York Times blog the other day. It charts change in GDP against austerity as % of GDP in European countries. Krugman claims that this proves that austerity is directly related to GDP contractions, making the basis error of confusing a correlation for a causation.
The big problem is that Krugman assumes that spending cuts have taken place independent of lower or negative GDP growth, and then tries to prove that austerity has caused lower GDP growth by showing a correlation between more austerity and less growth. But, obviously, you could make the reverse claim – the countries (like Greece and Ireland) implementing the harshest austerity packages are doing so precisely because they have had shrinking economies. Greece is cutting back expenditure more quickly and deeply than Germany is. Greece has to, Germany doesn't.
There is a relationship between GDP contraction and austerity, but it could run either or both ways. It would be interesting to see some time series that tried to see whether austerity has followed or lead economic recessions. That might tell us something interesting, but this doesn't. I don't know whether to assume Krugman's being silly or deceptive by pretending this graph is "proof" of anything significant at all.
Europe's nightmare has just begun
The chart above comes from Veronique de Rugy of the Mercatus Centre. It tells a different story to the popular narrative that European voters have tried and rejected austerity. In fact, they have hardly tried it at all, returning generally to 2008 levels of government spending. France has not cut at all, yet it has just elected the patron saint of mediocrity, Francois Hollande. Not that Sarkozy was much better. De Rugy comments:
First, I wish we would stop being surprised by what’s happening in Europe right now. Second, I wish anti-austerity critics would start acknowledging that taxes have gone up too–in most cases more than the spending has been cut. third, I wish that we would stop assuming that gigantic “savage” cuts are the source of the EU’s problems. Some spending cuts have been implemented in a few countries. Also, if this data were adjusted for inflation (which I would prefer but the data isn’t available) it would possibly show a slight decrease and certainly a flatter line for all countries. However, the overwhelming take away from the European experience is that a majority of governments haven’t really implemented spending cuts, large or small, and some have even continued to grow.
What European voters have rejected is the idea of austerity. The very suggestion that their governments should live within their means is, apparently, unacceptable to the majority of voters in France, Greece and, as seems likely, the Netherlands. Hollande may be a nonentity, but the National Front candidate, Marine Le Pen, polled 18%, and the far-left Jean-Luc Melenchon 11%. Both seem likely to do well in next month's parliamentary elections. Golden Dawn, Greece's Nazi Party, has just polled 7%, the Communists 8.5%.
This is worrying stuff. No doubt an element of this is anti-bailout sentiment which, shamefully, has not been given a legitimate political voice in most European countries. But much of it must be down to the threat of austerity, as we're told. If these voters had been through years of hard cuts and belt-tightening, a backlash would be understandable. But these voters haven't lived through that yet. The worst economic misery is yet to come, sooner or (as people like Hollande would have it) later. If this is what things have come to before the austerity, what's coming after?
The idiocy of the protectionist growth argument
You don't have to go far into NGO land to find people arguing that poor countries need to protect their baby industries from the big bad wolves of international capitalism. That trade barriers are a good idea, that infant industries need to be nurtured and, as is the way of these things, the Washington Consensus is the imposition of the poverty that the poor suffer from.
That this is entire nonsense does not stop those idiots wearing ideological blinkers from repeating it. Which is something of a pity as it really is trade, openness to it, which drives economic growth:
In recent years, sub-Saharan African countries have grown remarkably. According to data from the Penn World Table 7.0 (Heston et al. 2011), average annual real GDP per capita growth from 2005-9 has been over 2.5% (3.5% when excluding 2008 and 2009). This recent growth performance is remarkable given that, for over four decades since 1960, real GDP per capita growth in sub-Saharan Africa was dismal, averaging less than 0.5% per annum.
We are, as we know, talking about the poorest of the poor and any uptick in their fortunes has been both extremely difficult to find and extremely welcome when it is.
One thing that might be remembered is that, post-colonialism, most sub-Saharan countries did in fact follow the policies of infant industry protection behind tariff and licencing barriers. It was the falling apart of this in the 80s and then the gradual adoption of good old neoliberalism in the mid to late 90s which has turned the numbers around.
By casual empiricism, it is interesting to note that the average sub-Saharan African country is today over 30% more open to international trade than in1960 (as measured by the ratio of exports plus imports over GDP). The big question is, of course, whether this increase in trade openness is a cause or a consequence of the increase in economic growth.
So, we have a correlation: what is the causation?
We find that openness to international trade increases economic growth in sub-Saharan Africa. The instrumental-variable estimates suggest that, on average, a one percentage point increase in trade openness is associated with a short-run increase in GDP per capita growth of about 0.5% per year. The long-run effect is larger, reaching about 0.8% after ten years.
It is that trade openness precedes the growth.
Thuys we have an interesting piece of objectivity in economics. It is certainly possible to make subjective arguments either way about trade and growth. That everyone else had protectionism when they grew so therefore this is a necessary part of growth, just to give one currently fashionable argument.
However, such theorising does need to be calibrated against reality which is what this paper has done. And the answer is, no, protectionism is a complete crock at reducing poverty through economic growth. It is that trade that does it: we neoliberals are right again!
Blue Sky Thinking
Long queues are a clear indication of supply failing to meet demand. In the Soviet Union, you queued for bread and butter. In the UK not too long ago, you queued for the GPO to install a telephone. The mismatch was usually due to some government agency mucking things up.
So it is now with Britain’s airports where arriving passengers have faced queues of up to two hours due to an inefficient UK Border Force. The solution is obvious – privatise the UK Border Force. Let the airports, airlines and passengers sort out amongst themselves how to deliver an efficient immigration service. Let them decide how much to spend and how much to charge and when and where to staff.
In the government’s defence, they’ve been forced to slim staff numbers as part of its overall priority to get a grip on the nation’s finances, but that’s why more imaginative thinking is required. That process may have started amid reports of talks to increase charges on airlines to hire more Border staff. That makes eminent sense – users and beneficiaries should pay.
Willie Walsh, head of the company that owns British Airways, has said that airlines would be prepared to pay for the right service but then hit the nail right on the head with his comment that this willingness disappears if the government was wasting money. Indeed, as Labour proved with health and education, you can’t just pour endless cash into a government agency without accompanying structural reforms.
Unsurprisingly, Ryanair’s Michael O’Leary weighd in with his claim that “The big problem with the queues at Heathrow and at Stansted is they are treating EU citizens like potential bloddy terrorists and they are not.” He claimed it wasn’t short-staffing as a result of budget cuts but rather a work-to-rule mentality.
So don’t offer the government more money to carry on as is; privatise the whole process.
In the spirit of airline pricing, there could be first, business and economy immigration lanes or the equivalents of easyJet’s Speedy Boarding and Ryanair’s Priority Queues. A really clever company would roll out trolleys with refreshments when queues do build up or maybe offer up work experience students to hold your place in any queue while you take a toilet break. How about immigration hall buskers?
Private companies have a much better record in chopping and changing to altered circumstances and in adopting and adapting modern technology. Let them get on with it.
Oh, the vested interests will squawk that national security is too important to be left to the private sector, just like teachers claim that children cannot be entrusted to anyone but their own guarded priesthood. However, assorted government agencies over the years don’t have a spotless record when it comes to keeping out undesireables.
Isn't it great that Apple makes everything in China?
Via The Guardian I find a paper doing the usual bleating about how it's simply just terrible that Apple works the way it does, gets all that grubby manufacturing work done in China. True, this paper is a little more sophisticated than the usual we're all exploiting the Chinee stuff. But then again they do use "Foucaldian" and not as a term of derision so they're not that good.
However, in there I found one quite remarkable set of numbers. So I shall remark.
In 2002 the average Chinese manufacturing wage was US$ 0.72 an hour.
In 2008 the average Chinese manufacturing wage was US$ 1.57 an hour
There are other interesting numbers in there, like the Chinese manufacturing labour force peaked in 2005 and had declined fully 10 million people by 2008 (that's a larger percentage cull than we've ever had in such a short time period, yes, including Maggie).
But isn't that simply wonderful? Over 100 million people have doubled their real incomes, doubled their lifestyle, in only 7 years? Isn't this, as the good little liberals that we are, what we're all striving for? That the poor become rich?
And it is all happening simply because of trade, simply because we, the rich of the world, are buying things made by poor people in poor countries.
Howzabout that for a bit of voluntary cooperation, a bit of spontaneous order then?
And can anyone think of any government, bureaucratic or State planned action that has managed this feat, of doubling the real incomes of 100 million people in so short a time? Maybe this global neoliberal stuff really works then? As, you know, we've been saying for decades?
Thank you, Argentina
You can always count on Argentina for abject lessons on how not to run a country. That’s always been painful for its citizens but useful for the rest of us to see how hair-brained, populist schemes just don’t work.
This week, President Cristina Fernandez de Kirchner announced the seizure of Spanish oil company Repsol’s stake in Argentine oil company YPF to give the government 51% control. Spain is outraged and has recalled its ambassador. The Argentine navy has been diverted from the Falklands and is now steaming towards the Canary Islands.
Ms Fernandez justified her move on the grounds that YPF has failed to invest sufficiently to prevent Argentina from importing ever greater quantities of fuel. The fact that Argentine oil reserves have been dwindling means the sector needs greater and increasingly sophisticated investment to reach more complex structures, just like in the North Sea. Expropriation isn’t going to attract that kind of high-risk investment.
Once in state hands, odds are high that YPF will be used by the government for other purposes, just like Venezuela’s PDVSA. It was no surprise that Hugo Chavez cheered the news from Ms Fernandez. Perhaps he hopes she can show PDVSA how to increase daily oil production which has fallen by 7% in the past five years.
The YPF seizure continues Argentina’s cavalier attitude towards other people’s money shown back in 2008 when Ms Fernandez grabbed some $24 billion of private pension funds and used central bank reserves to meet debt payments. More recently, the country has been in a spat with the IMF over the quality of its statistics. Argentina claims inflation is running at somewhere between 5% and 11% but private independent estimates put the number at somewhere around 25%. The Economist is refusing to publish official Argentine inflation data.
Disrespect for the law and wilful distortion of the facts are no way to manage an economy. Productive investment requires assurance that monies invested will be paid back and that investment decisions are based on reliable data.
Like many floundering politicians, Ms Fernandez confuses ownership with productivity. This is especially so when it comes to natural resources as if the mere existence of oil within a set of borders is wealth in itself. But wealth comes from finding, extracting, processing, shipping and selling the commodity, just like any other product. America, Canada, Britain, Australia and others benefit from the exploitation of their natural resources by private companies operating within clearly understood legal arrangements, not from state ownership of the entire production process and certainly not from expropriation.
With her latest move, Ms Fernandez continues the long, sad tradition of Argentina failing to live up to its potential. At least the rest of us get real-world case studies of bad policy-making.
