Archive for January, 2012

So at what point does Greece just become a German colony?

A few days ago I was talking about the subtle, hidden ways in which sovereignty was being eroded during the European debt crisis, with the possibility of hedge funds taking Greece to the European Court of Human Rights. Today comes news that sovereignty is also being eroded in remarkably blunt, in-your-face ways, via FT reporting on Germany’s latest proposals for conditions on the Greek bailout. The German plan essentially calls for Greece to give up control of taxing and spending decisions, through the appointment (by the other Eurozone members) of an outside “budget commissioner” responsible for overseeing “all major blocks of expenditure” of the government.

This is obviously a pretty huge blow to sovereignty, and the German proposal is (rightly) being met with considerable shock. Control over the budgeting process is one of the key pillars of sovereignty and autonomy – it’s no coincidence that debates over how much autonomy “autonomous” regions within states should be granted generally come down to debates over who controls the purse strings. So will the Greeks sign on to this, or will the Germans back down? At this point neither seems all that likely (though the Germans backing down is probably the more likely of the two), which means the likelihood of a Greek default/euro exit just went up…

I think it’s particularly interesting to compare this episode to the last time we were face-to-face with a real likelihood of Greece’s Eurozone exit, then Greek-PM Papandreou’s call for a national referendum over proposed bailout terms in November 2011. This was also met with shock, and ultimately led to his resignation and the installation of current technocrat PM Papademos. At the time Papandreou’s move was widely seen as a mechanism to pave the way for a Greek default and possible euro exit since, as a general rule, publics don’t vote for wage cuts and endless austerity. Similarly, today it’s easy to view Germany’s stance as ultimately aimed more at speeding along a Greek default, as it’s difficult to imagine any state giving up control over taxing and spending to an outside commissioner. This isn’t necessarily a nefarious, cynical move; Germany is being clear about the severity of the situation and the trade-offs involved, and if of the available options default and euro exit is the least bad, then let’s hurry up and get to the end-game already.

But the contrast in the “non-default option” of these two episodes is striking. If the Greeks had voted in a referendum to accept austerity and endorse the bailout terms, then the government would have had popular legitimacy to go ahead and enact steep cuts, and some hope that these would actually be realized and carried through throughout the country. This isn’t to say there wouldn’t be any protests or anything, but a successful referendum would have empowered the government – and critically non-elected public servants – to push forward, and the population would be more likely to swallow the tough medicine they’d voted for.

Conversely, trying to get to austerity by completely stomping on sovereignty is not only a disaster for anyone who cares about democratic legitimacy, but perhaps more to the point probably isn’t even going to work that well. The thing is, austerity without political buy-in is extremely difficult. While an outside commissioner could force austerity-friendly legislation, getting the laws passed is but the first step; what happens next? Do the public servants actually follow through and enforce these laws, identifying spending cuts rather than just stonewalling? Will the public actually pay more in taxes, rather than just finding even more creative forms of tax evasion? No matter how much power is officially vested in the German budget commissioner, at the end of the day a lot will still depend on changes in the behaviour of individual taxpayers and government workers. And, of course, as the power of the foreign budget commissioner increases, these latter groups will be less and less inclined to go along with what s/he says. (Hat tip on this point to the excellent Megan Greene, who really should blog more often.)

I always thought Papandreou’s call for a referendum was something of a political masterstroke, even if it was likely to fail and accelerate Greece’s eurozone exit. The further we go down the current path – as it becomes increasingly obvious we need to get off this route yet each off-ramp looks worse than the one before – I predict many will come to see the referendum that wasn’t as a missed opportunity…

The Big Change in Sovereign Debt Politics No One’s Talking About…

So a few days ago there was an interesting story going around that hedge funds were going to try to sue Greece if the sovereign tried to force its creditors to take a loss. Now this was two or three news cycles ago and the story has since moved on (there was talk a deal was complete, then new talk that a deal was hung up on interest rates, then they were going to be kicking off a new round of negotiations, and I’ve since lost track…), but I want to go back to this hypothetical because it’s crazy for a number of reasons.

The first is simply the usual hypocrisy you hear whenever a creditor who has been earning outsized returns because they were taking on risk turn around and, ex post after the risk has been realized, are completely outraged about losing out on their investment. Look, the reason Greek debt always paid higher returns than risk-free German or US debt (side note: is there any risk-free asset in the world today?) is because Greek debt was never risk free. This is a pretty basic “there’s no free lunch” principle of investing, but it always surprises me how rarely it comes up in these kinds of discussions. Everyone is shocked, just shocked when someone who had a pretty good chance of defaulting actually defaults – it’s ridiculous.

There’s something extra interesting about this case though, which first requires a bit of background on international relations theory. Unlike at the national level, at the international level there is no supreme authority to enforce rules, ie the global system is ruled by anarchy. For sovereign debt, what this means is that if a country is considering defaulting on its debt to foreign creditors, there isn’t any authority that can force it not to. So why don’t countries default all the time? Because if they did they’d develop a reputation as defaulters (*cough, Argentina, cough*) and the next time they wanted to borrow money they’d find it extremely expensive, if not altogether impossible. So a rational state, knowing that it will want to borrow money in the future at reasonable rates, has an incentive to not anger creditors today, which serves as an enforcement mechanism for repaying sovereign debt.

But note that this mechanism depends on the negative reputation effects of not honouring a debt contract. If a claim on a country is viewed as widely illegitimate or unfair – say, for example, when greedy hedge funds buy up cheap distressed debt and then demand full payment – it seems reasonable that future creditors won’t judge this as harshly as if, say, tomorrow Germany announced it wasn’t going to pay back any of its debts. So when a state is internally debating whether or not to pay back debt, it weighs the legitimacy (in the sense of whether other market actors think the debt should be paid back) of the outstanding debt; as legitimacy falls, the marginal effect of defaulting on the debt on future borrowing ability falls, and so the inclination to default increases.

Now to the interesting part in this case: the hedge funds are essentially trying to get around this anarchy problem by threatening to take Greece to the European Court of Human Rights. Specifically, they’re claiming that changing the terms of Greek bonds would be a property rights violation, and according to European law property rights are human rights. Somewhat remarkably to me, the NYT article suggests this actually could be a successful legal strategy. I don’t know enough (read: anything) about European law to fully understand what kind of power this court holds over Greece; presumably this can’t fully get over the anarchy problem as I doubt the court can deploy soldiers to Greece and/or throw the government in jail, but I assume they have some sort of power to impose costs of some kind, rather than just making proclamations. So if the hedge funds won at court, Greece would have to choose between paying them or suffering the costs of being in violation of the court, a fact which should alter the government’s current calculation of whether to default. Which is a pretty big qualitative change in the international relations of sovereign debt. Did European states know this was what they were signing up for in creating the EU? (I don’t mean that in a rhetorical way to suggest it was a mistake, it’s an honest question – I don’t think the full ramifications of semi-sovereignty have yet been fully realized…)

A final funny point to consider is that everyone knows the hedge funds would happily accept a deal where they get paid 60 or 70 cents on the dollar of the debt they currently hold (the last figure being debated was 50 cents, with the Greeks (read: Germans and IMF) wanting to push it lower.) But, again with the caveat that I have no legal background, it seems to me like it’d be pretty hard to make the case that a cut of 30 cents on the dollar is legal but a cut of 60 cents on the dollar is illegal. Presumably the legal argument has to be built around sticking to the exact letter of the bonds, even though this is something that no investor/policymaker currently takes at face value…

The Graph of the Millennium

I’ve been belatedly reading through a number of “the year in graphs” collections that came out toward the end of the year. As a push back to the rather overwhelming pessimism that comes through from these graphs selected by top economists, I want to offer up what I think is the single graph that best captures the millennium to date, and it’s an unambiguously positive story:


Source (PDF).

The graph shows real growth for advanced and developing economies from 1980-2015. While the crisis obviously shows up here, what’s really striking is the structural break in developing country growth; after bouncing along at around 3 percent for the 1980s and 1990s, a rate too slow to close in on advanced economies, in the new millennium developing country growth is now up around 7 percent.

Now I don’t want to oversell it, but I honestly believe this is pretty much the best thing to happen to humanity in the aggregate since the Enlightenment and the Industrial Revolution… Today more people in the world live in economies that are experiencing the transformative effect of rapid, sustained catch-up growth than ever before. Throughout history most people in the world have been poor. Soon, for the first time ever, most people in the world will be middle class, allowing them significantly increased opportunities to build better lives for themselves and their children. While there’s a lot of (mostly bland) talk out there about the rise of the BRICs, etc etc, I don’t think this fact – and the remarkable success/progress it entails – has yet been fully appreciated.

Of course things could still go off the rails. But for the most part the sources of success in developing economies today run pretty deep – good demographics, the spread of capitalism, and improved governance, all of which serve to turn potential convergence into realized convergence – so I’m pretty optimistic. And of course this success will bring its own challenges, particularly climate change and other resource pressures, which are politically difficult – through importantly by no means economically impossible – to tackle. (And whatever solution you happen to favor for these challenges, it’s pretty difficult to argue that “keeping poor people poor” should be a part of it.)

So if the daily news coverage of the economy (like today’s rumors of further downgrades in Europe) is getting you down, just remind yourself: from a longer perspective, for the world economy as a whole, these really are the best of times.

(As a side note, I’m in the process of co-authoring a book on these themes, of which my half is mostly done while colleagues drag their feet. But look out for it hopefully later this year…)

Were Japan’s Lost Decades Worth It?

Just a quick follow-up to the earlier discussion on Japan. The main reason I first became interested at all in the Japanese economy was to repeatedly refute the common China/Japan comparison, where lots of people who seem to be confused about the dynamics of long-run catch-up growth think China’s growth will fall off a cliff just like Japan’s did, because, well, that’s what Asian economies do when they start to get big and scary. The very simple point is that if anything China today looks more like Japan circa 1960, when the country was still poor and in the early years of its rapid ascent, than Japan circa 1990, when the country was rich and entering its years of stagnation. So the Japanese experience is relevant to China’s path, but less as the cautionary tale everyone thinks of, and more as an inspiring example of how dramatically an economy can be transformed by sustained high growth.

And I still stand by that. But after giving a little more thought to the lost decade(s), I think it’s interesting to consider what lessons Japan’s entire post-war economic experience might hold for China (or other countries for that matter).

Japan was one of the first countries to experience dramatic convergence growth, and has been one of the most underperforming economies of the last 20 years. I don’t pretend to be an expert on the Japanese economy or the causes of its recent stagnation (one of the nice things about a blog is you can throw out speculative ideas for which you’re unwilling to do the leg work on and actually research), but it seems plausible that decades of a (successful) growth strategy centered on very high investment/industrialization increased the probability of entering a sustained period of overcapacity and the need to unwind lots of non-performing loans. I certainly wouldn’t say that the lost decade deterministically followed the boom years, or that there weren’t policy mistakes along the way (like too tight money), but I would guess that Japan’s recent troubles are in some senses a “natural” outgrowth of its earlier advances.

So the question is, if we take the whole post-war experience together, the good and the bad, should Japan be considered an economic success? If the later stagnation was the price to be paid for the earlier convergence, was it worth it?

I would say rather definitively yes. I think one key takeaway from Eammon Fingleton’s “the lost decades weren’t so bad” argument is that it’s possible for a rich country to endure a period of stagnation and still have its people do pretty well. Two decades of effectively zero growth for a poor country is a moral tragedy. For a rich country, it’s far from ideal, but it’s manageable (which isn’t to say that it always will be well-managed).

To bring this back to contemporary China, today there are a lot of complaints about how the Chinese economy is so unbalanced, that consumption is too low, that it can’t keep exporting cheap goods and under-pricing capital forever, etc etc. My problem isn’t particularly that I don’t think that these things are true, or that the Chinese shouldn’t try to correct some of these issues. It’s just that, relative to high sustained growth, they don’t seem all that important. The lesson from Japan: get rich quick, then figure out the rest.

Time for a rethink on central bank independence?

There’s some very interesting stuff going down in Hungary right now. The politics of it are complicated and I won’t pretend to completely understand all of it (see Edward Hugh here for a nice recap), but in brief at the end of the year the Hungarian government, in defiance of the EU, passed a law that limited the independence of the central bank, subsequently suffered a credit downgrade and a spike in borrowing costs, and now looks to be in need of IMF support. The IMF (backed by Brussels) is likely to make repeal/adjustment of the law a prerequisite of any such support, and so the Hungarian government seems to be preparing to backtrack out of necessity.

This isn’t the only case of central bank encroachment of late. Cristina Kirchner took on the Argentine central bank in 2010 over whether or not to use reserves to pay off debt (and largely came out the victor), while in the US Ron Paul and the “End the Fed” crowd (as well as the milder “Audit the Fed” crowd) have never been so popular.

Central bank independence is about as sacred a tenet as you can get in economics, but – while I don’t necessarily want to associate myself with the above characters – I do think now is a particularly valuable time to revisit this issue. In a Washington Consensus world where it seemed obvious that central banks should be targeting 2% inflation, central bank independence had a lot going for it. But things are a little more complicated today. For one thing, there’s a strong case to be made that some above average inflation is the best (only?) policy prescription available today for helping lift us out of the downturn, and could particularly be a boon in trying to get production costs under control in Greece and Spain. And even when we look out at the longer term, the 2% inflation target seems to be losing some of its appeal – none other than Olivier Blanchard openly discussed the idea of a 4% target a little while back. Critically, these aren’t just issues of pareto efficiency; they’re very normative issues which impact distribution, pitting savers vs. borrowers (not to mention Germans vs. Greeks), and can considerably tilt the field towards or against various economic actors and industries. In other words, picking an inflation target is an inherently political decision, producing winners and losers. Moreover, as the mission creep of central banks expands into financial regulation (and beyond?) the normative, political questions only get thornier.

Central bank independence, while it brings many benefits, tends to obscure this fact. When central banking is widely viewed as a purely technical domain, those who exert influence over central banks (more often than not the financial class) can silently shape these political decisions to their own benefit. Maybe this is a price worth paying to keep politicians from turning on the spigots before an election; but maybe not. In any case, now seems like a good time for this discussion.

Occupy Wall Street is still looking for an issue to rally around: how about calling for a serious political debate over what the inflation target should be?

Japan’s Secret Success

So in my last (embarrassingly dated) post I was talking about the secret success in global poverty reduction, and today I want to highlight (via a Eammon Fingleton story in this week’s NYT Sunday Review) another hidden success story: the Japanese economy. Well, “success story” is perhaps a bit strong, but Fingleton’s article nicely pulls together a lot of points I’ve been thinking around but hadn’t fully articulated around the idea of Japan’s demise being greatly oversold. (See earlier posts here and here for hints of this thinking.)

The simple point is that the widely accepted narrative of two decades of decline/stagnation just doesn’t seem to jive with evidence of life as it is lived in Japan, which seems to have improved about as much as it has in the US and Europe over the last 20 years. Part of this is about the distinction between economic measurements and happiness/quality of life measures, but even in rather pure economic terms there’s plenty of evidence that Japan is doing okay. As is widely known, Japan has low unemployment, a trade surplus, and a strong currency. But even more interesting are a number of other sub-indicators which seem to suggest economic life in Japan isn’t really so bad: Fingleton notes that internet infrastructure (and indeed infrastructure more broadly) has expanded dramatically, skyscrapers continue to go up across Tokyo, electricity output is growing, and the Japanese have the coolest new cell phones, drive the flashiest cars, pamper their pets the most, and eat at the best restaurants. Does this sound like a population that is suffering from decades of economic malaise?

Given the disappointing GDP record (specifically in comparison to the US and Europe), the obvious question is whether a) there are technical deficiencies in measuring GDP that can explain the difference or b) GDP just isn’t that closely correlated with these other things. There’s probably some truth to both, but my guess is b) is the more important factor.

As a final note, as I’ve never actually been to Japan, in some sense the most contact I’ve had with Japanese people is via the tourist buses that clog the streets of the various tourist-friendly cities I’ve lived in (Ottawa, Paris, DC, and now Oxford). As a snotty local elitist I of course always found this to be a nuisance, but of late my thinking has (somewhat) evolved. Because when you think about it, a society where almost everyone has a job, the latest technologies are widely employed to make life easier and more enjoyable, and people choose to use their time and resources to travel the world and take in new cultural experiences (rather than, say, buying lots of crap at Wal-Mart) is actually pretty close to how I’d envision an ideal 21st century advanced economy.



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