Six years on
In August 2006 the Adam Smith Institute produced its own (and only) wristbands. People were being urged at the time to "Make Poverty History." While it would be nice if it happened, the slogan was largely empty in that it did not involve actually doing anything.
Our case was that no country has ever emerged from poverty through development aid, and no country has ever done it without trade. To us that seemed to suggest that opening our markets to their goods might help them more than sloganeering would.
Trade creates wealth. Full stop. The rich countries did not become so by stealing wealth from others; they did it by creating wealth through trade. When people exchange, each gains something they value more in return for something they value less, and both become richer.
Our wristbands said "I buy goods from poorer countries," expressing something people actually do about relieving poverty, as opposed to sloganeering. The wristbands were made, of course, in poorer countries, and we produced thousands of them. We sent one free to anyone who gave us a mailing address, and they went all over the world. We had a second batch made, then a third, then we stopped. We still have requests come in, years later, but the stock is long gone.
The arguments against free trade have not gone, however. We said then:
"The trade which can lift peoples out of poverty is assailed from many directions. A motley assortment of protectionists and anti-capitalists use every argument they can lay their hands on to protect their interests. From the CAP to ‘food miles,’ the effect is to deny poorer people the chance to gain wealth by selling us what they produce."
Alas this is still true. In straitened times we are urged to buy local, and protectionism is urged to protect domestic industries. This is just a concealed tax, in which we become poorer by paying more for goods and services that free trade would have given us more cheaply. We become poorer through protectionism, while poorer countries are denied the chance to become richer. This is as bad a deal now as it was then, and as it always will be.
New at AdamSmith.org: Why Nations Fail, reviewed
What makes countries end up in persistent and permanent poverty? Why is Mexico much poorer than the United States? Why is Latin America so fundamentally different to North America? How is it possible that an average American is 40 times richer than an average Sierra Leonean? Is it climate, geography, culture, or could it be the ignorance of domestic leaders? Acemoglu and Robinson suggest it’s none of these – rather, the real reason behind the poverty trap and significant between-nation differences lies in the role of political and economic institutions.
Politics and the formation of political institutions take centre stage in their book, which formulates the thesis that only within an inclusive political system is it possible for nations to achieve prosperity. The opposite scenario will occur under extractive political institutions where wealth will be accumulated within a narrow ruling elite which will aim to preserve its power thus sentencing a nation to persistent poverty.
In the very beginning of the book the authors hint to the reader how it will be organized – through a series of historical case studies upon which they illustrate their theory of institutional change and the consequential success or failure of nations. It starts with the example of Nogales, a city on the US-Mexican border, which is split in half by a fence. One city, in the same geographical position, characterized by the same cultural upbringings, same population, same diseases, but one part three times richer, much healthier, safer, and with higher living standards. The crucial difference is the very border separating the two parts of the city depicting the different institutional settings within them.
Adam Smith on US independence
Good predictions are hard to find. Economics in particular has seen more than its fair share of bad predictions. Not to go too deep in history and examine the predictions on the demise of the Soviet Union and communism in general (here's what Paul Samuelson had to say), just recall how many pundits claimed in November 2011 that the Eurozone would break up by the New Year? [I admit it, I fell for that one — ed.]
And yet it still stands, not out of the gutter quite yet, but still determined to remain and reform. Or how many made the case for the euro and how it will increase convergence in Europe, particularly in the area of competitiveness? Or how many out there though that the housing prices never fall which is why it could be a good idea to package mortgage loans into securities? (this type of mentality was best explained in Reinhart and Rogoff’s book This Time is Different). This just means that not even the most notable forecasters out there are necessarily always correct.
However, EconLog's David Henderson pointed out yesterday (the 4th of July) how Adam Smith goes did make some strikingly precise predictions. In his 1776 The Wealth of Nations he had this to say on the outcomes of the 13 colonies' independence war, Britain's possible and likely reactions and, most impressively, the further development path of the newly founded nation:
"To propose that Great Britain should voluntarily give up all authority over her colonies, and leave them to elect their own magistrates, to enact their own laws, and to make peace and war as they might think proper, would be to propose such a measure as never was, and never will be adopted, by any nation in the world. No nation ever voluntarily gave up the dominion of any province, how troublesome soever it might be to govern it, and how small soever the revenue which it afforded might be in proportion to the expence which it occasioned. Such sacrifices, though they might frequently be agreeable to the interest, are always mortifying to the pride of every nation, and what is perhaps of still greater consequence, they are always contrary to the private interest of the governing part of it, who would thereby be deprived of the disposal of many places of trust and profit, of many opportunities of acquiring wealth and distinction, which the possession of the most turbulent, and, to the great body of the people, the most unprofitable province seldom fails to afford. The most visionary enthusiast would scarce be capable of proposing such a measure with any serious hopes at least of its ever being adopted.
"If it was adopted, however, Great Britain would not only be immediately freed from the whole annual expence of the peace establishment of the colonies, but mightsettle with them such a treaty of commerce as would effectually secure to her a free trade, more advantageous to the great body of the people, though less so to the merchants, than the monopoly which she at present enjoys. By thus parting good friends, the natural affection of the colonies to the mother country which, perhaps, our late dissensions have well nigh extinguished, would quickly revive. It might dispose them not only to respect, for whole centuries together, that treaty of commerce which they had concluded with us at parting, but to favour us in war as well as in trade, and, instead of turbulent and factious subjects, to become our most faithful, affectionate, and generous allies..."
"They are very weak who flatter themselves that, in the state to which things have come, our colonies will be easily conquered by force alone. The persons who now govern the resolutions of what they call their continental congress, feel in themselves at this moment a degree of importance which, perhaps, the greatest subjects in Europe scarce feel. From shopkeepers, tradesmen, and attornies, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world."
How's that for a good prediction!
Beware of protectionism in regulation's clothing
Ed Milliband’s cheap soundbites on the banking crisis could prove very expensive for British taxpayers as wealth from London shifts to the US. Not only is the US the most litigious nation on earth but one has the impression that they see it as economic warfare. We cannot be sure but it is at least possible that US firms losing out in the competitive marketplace immediately, but confidentially, cry “foul”. We should be alert to the dangers of firms using regulation as a form of protectionism.
Of course bribing the Saudis to sell warplanes (British Aerospace) and US doctors to sell drugs (GlaxoSmithKlein) is wrong, but ask yourself why, in highly competitive markets, they should be indulging in those expensive practices if their (US) competitors are not. Is there a possibility that the US suppliers were simply out-bribed? Bear it mind that they have to be a lot more careful as their boards loaded with lawyers as ours are not.
Following the BP catastrophe in the Gulf of Mexico, President Obama stoked up the compensation claims by stressing the word British in BP. He apologised later but the damage was done. So the US taxpayer makes up on fining foreigners what they lose in the marketplace.
Law-breaking individuals should certainly be prosecuted and penalised. At the same time it is clear that Barclays and the other banks involved were not corrupt as corporations. Even if senior executives knew of malpractice, the Boards certainly did not, still less the vast majority of employees.
Three quarters of the fines already levied on Barclays were by US regulators. There is a tsunami of other fines and damages in the course of being claimed by US regulators, state and city governments, e.g. Baltimore, and private individuals.
Fining by UK regulators is one thing. There is less of an incentive for the government to collude with firms to keep out certain groups of competitors. Penalties and fines transferring to the US is quite another matter and it needs to be balanced. And where are the British lawsuits against US interests? Would we even be allowed to hold such suits in British law courts as Pax Americana has tended to be weighted in their direction? Should corporations foot the bill for what a tiny minority of employees have done? Should actions be limited to those employees?
Politicians should be careful what they wish for. Yes, justice should prevail but it should be speedy and well balanced. We do not need a judicial enquiry because the consequence could well be the handing over of the UK’s last successful sector, financial services, to the US and its lawyers, through protectionism under the guise of regulation.
New at AdamSmith.org: Shiny happy people? The madness of the Happy Planet Index
The New Economics Foundation’s Happy Planet Index has been inspiring bemusement and mirth since it first appeared in 2006. The third installment, released last week, continues to defy parody with its glorification of lawless, poverty-stricken countries in the name of environmental sustainability.
The index is made up of three elements—self-reported well-being, life expectancy and size of ecological footprint—but is so heavily weighted towards the latter that economic basket-cases, police states and peasant societies score highly at the expense of places in which you would actually want to live. Consequently, Luxembourg, where life expectancy is 80 years and the well-being score is 7.1, finds itself 30 places behind Rwanda, where life expectancy is 55.4 years and well-being is scored at 4.0.
If the good people of Luxembourg (ranked 138th) have not already bought a one-way ticket to more desirable destinations such as Malawi (72nd), Haiti (78th) or Afghanistan (109th), they can console themselves that they are still one place ahead of Sierra Leone (139th), although that could all change if the Sierra Leoneans buy a wind turbine.
Tomorrow never comes
So that's sorted, then. Greece has given the pro-bailout parties a narrow majority (thanks to a quirk of the Greek electoral system that gifts fifty extra seats to the party that wins the most votes). Greece will take another bailout; the markets can stop panicking; the crisis is averted; the euro is saved.
Well, not quite. Had the anti-bailout far-left SYRIZA coalition won, the situation would be moving a lot more quickly towards a Greek exit from the Eurozone and, in all likelihood, a rapid acceleration in the Eurozone crisis. That Greece will probably take a bailout will soothe bond market traders' anxieties for a while. But look at how short-lived that period of calm following a bailout has become — Spain's sovereign debt yields fell for just a few hours after its bailout last weekend, and then quickly returned to historical highs.
In all likelihood, it seems that the next Greek bailout will be no more final than the last two were. Spain is rumoured to be seeking another, governmental bailout (as opposed to last weekend's one, aimed at bailout out Spanish banks).
The upshot of the last few weeks' developments in the Eurozone is that bailouts of banks and countries have become institutionalized. The lack of any real objection to the Spanish bank bailouts underline the reality that there is no European bank whose losses, if great enough, will not be moved to taxpayers in that country. Ireland's landslide "Yes" vote for the Fiscal Compact Treaty means that the European Stability Mechanism bailout fund is now a feature of EU law. The settlement is now more-or-less official: If banks are irresponsible, taxpayers will bail them out; if states are irresponsible, taxpayers will bail them out.
The political economy of this settlement should not be a surprise. Clients of the state — the various interest groups comprising interconnected banks, public sector workers, pensioners, subsidized and otherwise-protected businesses, and others — appear to be so embedded in the political fabric of the Eurozone states that policies for the good of the country, such as orderly bank defaults or radical competitiveness reforms, are impossible. Ireland's "Croke Park Agreement" that protects public sector workers from layoffs is just one example.
Mancur Olson, in his masterpiece The Rise and Decline of Nations, argued that this is a pattern of history. Olson argued that states may flourish when their leaders aim to act in the general interest, but over time special interest groups will accumulate, eventually causing politicians to become hostage to them over the interests of the numerous, but voiceless, citizens.
In Olson's words, states become victims of "institutional sclerosis" as groups who will lose from any reform establish themselves, making political change impossible. He used the post-1945 success of Germany, Japan and Italy as examples of countries whose client groups were obliterated, allowing their governments to carry out generally beneficient reforms without significant opposition. (I wonder if post-reunification Germany's labour market reforms are another example of this. I don't know.)
European leaders have, it seems, learned that voters will choose a known decline into destititute service to reckless banks and clients of the state over an unknown economic disorder that contains much destructiveness, even if it may prove to be creative. I doubt Greece will manage to stay in the Eurozone and avoid sovereign default. (It has already defaulted once during the crisis, despite the euphemistic language used to avoid calling it that.) But I am much less certain that the Euro crisis will ever come to the head that constantly appears to be on the horizon.
A quick Eurozone geography recap
This just landed in my inbox and seems to be doing the rounds:
1. “Spain is not Greece.”
Elena Salgado, Spanish Finance minister, Feb. 2010
2. “Portugal is not Greece.”
The Economist, 22nd April 2010.
3. “Ireland is not in ‘Greek Territory.’”
Irish Finance Minister Brian Lenihan.
4. “Greece is not Ireland.”
George Papaconstantinou, Greek Finance minister, 8th November, 2010.
5. “Spain is neither Ireland nor Portugal.”
Elena Salgado, Spanish Finance minister, 16 November 2010.
6. “Neither Spain nor Portugal is Ireland.”
Angel Gurria, Secretary-general OECD, 18th November, 2010.
7. "Spain is not Uganda"
Rajoy to Guindos... Last weekend!
8. "Italy is not Spain"
Ed Parker, Fitch MD, 12 June 2012
Well, that's clear then.
Cold comfort
Oliver Blanchard, Chief Economist at the International Monetary Fund, blogged on Latvia's economic miracle this week. Latvia has begun to recover from a deep recession of about 10% in 2008, despite or because of a deep austerity plan and little monetary stimulus (in order to maintain a peg with the Euro). With 5.5% growth in 2011 and an estimated 3.5% growth in 2012, Latvia now has "one of the highest growth rates in Europe, the peg has held, and the fiscal and current accounts are close to balance."
Among the causes of Latvia's success, Blanchard names the following as being important:
3. Wages were flexible, at least relative to the generic European labor market. The initial adjustment came with a dramatic reduction in public sector wages, and thus a direct improvement in the fiscal position. Together with unemployment, lower public sector wages put pressure on private sector wages to adjust. A note of caution is needed here however: private sector wages, which are the wages which matter for competitiveness, have adjusted much less than public sector wages (by how much is a matter of some disagreement). Indeed, I worry that nominal wages have started to increase, while more adjustment still has to come to maintain current account balance as output recovers. One has to hope that increases in productivity will do the trick. This takes me to the next point.
4. There was—and, looking forward, there still is—substantial room for productivity increases. Latvia has income per capita of half the European Union average. Being far behind the technology frontier, it has a lot of room for catch up. [This is always important to remember when comparing economic growth across different countries: playing catch-up is a lot easier than leading the field.]
5. Latvia is a small, open economy—although less so than its Baltic neighbors. With exports around 50% of GDP, improvements in competitiveness can have large effects on both imports and exports, and in turn on GDP.
6. Public debt was very low to start, less than 10% of GDP. Even today, public debt remains around 40% of GDP. This more or less eliminated foreign investors’ worries about default on sovereign debt, and allowed for a quicker return of Latvia to international financial markets.
7.The Latvian financial system was largely composed of relatively friendly foreign banks—better than unfriendly foreign banks, or friendly but weak domestic banks.For the most part, the Swedish banks recapitalized their banks and maintained their credit lines to the Latvian subsidiaries, reducing the intensity of the sudden stop and of the credit squeeze.
Latvian policymakers would surely want me to add yet another reason—the strong front loading of fiscal consolidation: over the first two years of the program, the cyclically adjusted primary balance was increased by 11% of GDP. I am not sure.
Latvia's neighbours in Estonia have experienced an even greater reversal of fortune. Last year, Estonia grew by 8%, and that trend looks set to continue. Despite this, Paul Krugman used a rather misleading graph to suggest that Estonia cannot claim any "economic triumph", because output is still below its 2007 peak. (Which the Estonian president laid into Krugman over on Twitter.)
The problem with Krugman's graph is that it is context-free, and ignores the rapid (and clearly unsustainable) boom that Estonia experienced in the 2000s. It seems likely that much of Estonia's growth in the 2000s, like many Eurozone periphery countries, was malinvestment driven by credit expansions.
As such, recovery is not just a matter of boosting demand again, but liquidating those malinvestments and regearing the economy towards, as Arnold Kling called it in his paper for the ASI, "patterns of sustainable specialization and trade". This lumpy, disaggregated view of the economy is a surprisingly fringe one, but it's quite a lot more convincing to me than the focus on enormous aggregates that conceal the processes of change that take place in economies.
Rombama means more of the same
Following his victory in the Texas primary last week, Mitt Romney is now effectively the candidate for the Republican Party (putting aside the issue of unbound delegates). Therefore, we can all look forward to an Obama vs. Romney showdown this November. Unfortunately, both candidates appear to agree with each other on all issues of importance.
On foreign policy, neither are concerned about following the Constitution and getting a declaration of war from Congress. Meanwhile, neither are willing to rule out a war with Iran. So whatever the outcome of the November election, America's foreign policy will be unchanged until at least 2016.
On social issues it’s difficult to compare the two, because both are prone to changing their minds. Whilst Senator Obama appeared to be quite ‘progressive’ on the issue of drugs, President Obama has been all too willing to keep the same drug laws in place that would have led to his own incarceration had he been caught smoking marijuana or using ‘a little blow’ earlier in his life. Indeed he hasn’t even been willing to defend the rights of states to allow patients to use medical marijuana.
Meanwhile, Romney’s flip-flopping on the issue of abortion is well documented. Having been pro-choice in Massachusetts, he then became pro-life during the Republican primary. Who knows what he would actually do as President? I don’t think it’s likely that he would repeal Roe v. Wade, and if not, the differences in their rhetoric on abortion means very little.
Nor is there much disagreement when it comes to anti-terror legislation. Both support The ‘Patriot’ Act (or as Ron Paul calls it, the Repeal the Fourth Amendment Act). They also both support the National Defence Authorization Act, which effectively throws the presumption of innocence out of the window, as it allows suspects to be detained indefinitely without a trial.
Both Obama and Romney supported the TARP bailouts - the biggest single transfer of wealth from the poor to the wealthy in human history. Mitt Romney is also committed to stimulus packages and quantitative easing being used to boost economic growth and employment, which are the same policies that Obama has pursued (which have failed to create growth or employment). Neither are even paying lip service to the idea of sound money or reigning in the corrupt Federal Reserve system. In short: both are corporatists, not capitalists. This is obvious to anybody who has looked at the top contributors to both campaigns – the same investment banks and other corporate interests are funding them both. The winner of the 2012 election has already been decided: it’s Goldman Sachs. Sorry taxpayers, you lose either way.
Ireland should say No to "extend and pretend" treaty
Nothing summed up the farcical nature of Ireland’s referendum campaign on the European Fiscal Compact Treaty better than the Finance Minister Michael Noonan’s assurance that Ireland’s only contact with Greece was “feta cheese and holidays”.
Members of the Yes campaign have, absurdly, claimed that rejecting the treaty, as the UK and the Czech Republic have already done, would mean expulsion from the EU. The hard-left No campaign has been even worse, framing the vote as a false choice between austerity and growth. (Cutting back the state is the only way to achieve growth.) Both sides have tried to create fear and confusion among the Irish electorate.
Like many other Irish expatriates, I have watched this with frustration. Despite the ugliness of most of Ireland’s No campaign, there is a strong case for Ireland to reject the Treaty.
The Treaty will introduce a constitutional amendment banning ‘structural deficits’, and will give Ireland access to the European Stability Mechanism lending fund. In laying the foundations for automatic fiscal transfers between states, the Treaty is the first step towards true fiscal union between EU states.
Much of the Treaty may seem sensible. The ban on running a structural deficit is a welcome nod towards fiscal sanity – at least, it would be if it meant something. In fact, the Treaty does not define what a structural deficit actually is.
Like the Stability and Growth Pact, which required member states to keep budget deficits under 3%, most governments will ignore the deficit rule. Since the Stability and Growth Pact’s ratification in 1997, twenty-four of the twenty-seven signatories have since broken the terms of this pact.
The goalposts have been moved in the past. As the Irish fiscal analyst Cormac Lucey has noted, the IMF and EU both recorded the Irish government as running a structural surplus in 2007. These organizations’ methodology was later revised so that Ireland was found to be running a €15bn deficit in 2007.
States may find it politically easier to raise taxes than to cut spending, only doing more harm to their economies.
Banning structural deficits would not have avoided the Eurozone’s current problems. The welfare expenditures that have helped to bankrupt Eurozone periphery countries like Greece and Portugal are excluded from structural deficit calculations. Bank bailouts, which have been enormous in Ireland, are also excluded.
Apart from this measure, the key to the treaty is the access to the European Stability Mechanism (ESM), a €700bn fund to lend to Eurozone government at below-market rates.
It is a cheap line of credit that is being extended to ensure Ireland stays addicted to debt and bank bailouts. Its structure is almost the definition of ‘crony capitalism’: Article 32 of the ESM Treaty puts the ESM literally above the law, giving it “immunity from every form of judicial process”.
About half of Ireland’s national debt has come from its massive bank bailouts – €64bn, or 40% of GDP. As many of us argued at the time, Ireland should have let these banks fail.
Rescuing them was an exercise in crony capitalism, done to protect the rest of the European banking sector, not to spare Ireland any long-term economic misery. Ireland’s two million taxpayers now each face a €32,000 bill for these bailouts.
Access to the ESM would continue this cycle. Last Friday, Justice Kevin Feeney of Ireland’s Referendum Commission refused to rule out the possibility that ESM money would be used to bail out banks again in the future. The “low” rate provided by the ESM is like a heroin dealer giving a junkie a discount.
This cycle of bank bailouts paid for by more debt on the backs of taxpayers has to end. One of the few reasonable voices on the Irish No campaign, Declan Ganley, has argued that bailed-out banks should be required to repay the bailouts recently injected to them. Those that cannot do so should be put through insolvency purges with their assets sold to the highest bidder.
If Ireland does not access the ESM, global bond markets would still lend to Ireland, albeit at a more costly rates. That may force Ireland’s government to let bad banks fail instead of letting taxpayers foot the bill.
Ireland’s debt addiction cannot be cured with more cheap debt. The ‘extend and pretend’ strategy of taking on more and more debt to avoid making tough decisions will eventually lead to disaster. However Ireland votes, it will still have to meet tough but necessary fiscal targets set by the IMF and European Union.
Ireland can’t kick the can down the road forever. Rejecting the Fiscal Compact Treaty would, at a minimum, force Ireland’s political establishment to accept reality and pull back from the crony capitalist course on which it has set itself.
