Club Troppo

Public debts in Southern Europe only grew in 2011, and they were already unsustainable in 2010. Worse, the interest rates these countries have to pay on their debts has grown as all the long-term rolled-over debt held by these countries now carries a 7% upwards interest rate.

Greece is the worst affected, with a government debt to GDP ratio of about 160% and getting worse. It is clearly now on the other part of the Laffer curve and further tax increases will not lead to more tax revenue, but less tax revenue. Whilst for other countries, an ECB bailout is the most likely scenario, Greece is on a collision course with an official default that it can no longer turn away from. No one seriously believes the Greeks are going to pay their loans back. Greece is drifting irrevocably into the situation whereby it will officially default and simply not be able to pay the wages of its civil servants, the pensions of its elderly, and have Greek banks collapsing around them as well, unless the ECB bails them out completely, which now seems unlikely. Re-introducing a Greek currency would mainly add huge capital flight to the woes and solve nothing in the short run. It really is looking rather bleak for Greece at the moment, whether it manages to trick the rest of Europe into another stay of execution or not.

Here, I want to point to particularly interesting political processes that have locked Greece into a default death spiral: political paralysis, civil service paralysis, and population paralysis. And at the heart of them are the special interest groups that dominate Greece.

What do I mean by special interest groups and their hold on Greek society? Iannis Carras wrote a hilarious and informative piece on how it works in Greece. Iannis relates the story of how a particular set of rent-seekers conspired to divert water from Western Greece to Thessaly by means of large construction projects. Diverting this water via large dams and reservoirs was done against the wishes of local residents, against EU planning rules, and against the ruling of the Greek high court judging it to be illegal. How did the rent-seekers get round this? They nominally broke the project of water diversion from one region to another into several smaller ones and simply kept going. And what drove this project? European cotton subsidies! Cotton is very thirsty and so water was diverted to the area more suited for cotton. Who drove it? Construction companies, Thessaly major farmers, and Greek politicians, all happily flaunting Greek law. Worse, it turned many a Greek politician and former farmer into a pure rent-seeker. And once they got into that game, they kept going. A favourite means of extorting money out of their own government is now for Greek farmers to simply block the roads until someone gives them money!

Other examples abound. Greece is now full of museums, ports, and roads which no-one uses, paid by the European Union and spawning groups of entrepreneurs everywhere whose main income in life comes from lobbying either the EU or any other major institution. Indeed, in a quite cruel illustration of the increased power of vested interests in these times, Carras notes that the only real reforms being implemented in Greece are all in favour of the construction industry. The most recent such example is the removal of environmental obstacles to build houses, effectively allowing large-scale theft of government natural reserve land by private companies,  which in turn makes a mockery of the intended sale of that same government land. A sale which was hoped to reduce the government deficit!

Iannis Carras’s sobering conclusion is that ‘EU aid has strengthened the position of intermediaries and rent-seeking elements in the Greek economy.’

Then the issue of paralysis, whereby the main thing to say at the outset is that paralysis mattered because it prevented structural reforms from happening.

Importantly, structural reforms could have tilted the balance of whether default was inevitable, but it has turned out to be impossible to legislate and enact structural reforms. By structural reforms, I mean tackling tax evasion, opening the economy up by means of labour market reform, and dismantling the legal apparatus supporting strong special interest groups that paralyse the professional service sectors and the civil service. Such structural reform was needed to get economic growth going, has been advocated by virtually all intelligent observers inside and outside of Greece, and initially would have involved pretty simple off-the-shelf legislation. Yet, it has not been done and it now clearly wont be done, even though the consequence is a disaster for the country.

The first and probably most important lock-in process is the civil service: the need for quick spending cuts meant that the public sector had to reduce in size and freeze wages. What do you think happens inside the ministries when this occurs? That the lesser-paid remaining employees are going to do their utmost for their country by devising and enacting radical reform legislation, or that those who remain will be the weaker ones who couldn’t get decent jobs elsewhere and whose principle worry is not to rock the boat and retain their job? The right answer is the latter.

As a result of this paralysis of the civil service, the sheer capacity for structural reform has been strongly eroded, as was nicely illustrated in this excellent piece on the impossibility of reforms. Greece, and to some extent also Spain and Italy, is now less able to legislate and support structural reform than 2 years ago. All that remains is austerity packages, which are technically easy: bit less money here, slight increase in tax rate there. Nothing new has to be set up or thought through.

(Continued)

Next month I’m doing a gig for Rotary where I’m going to be on a panel with a demographer and a climatologist and they’re going to ask us to say what will happen in the next 20 years.

In five minutes.

That’s five minutes each – so there’s plenty of time. I get to talk about the economy.

I already know that I won’t be playing the clairvoyant but will suggest that the best questions about the future are what things we can do to make it better. It will look much like today, though we’ll be richer, mining will (presumably) be a lot bigger and other traded sectors commensurately smaller. Anyway, if I were to think about the biggest challenge it’s inequality. It’s hard not to see rewards to the stars getting higher. And trade and technology will continue to undermine the wages of the unskilled.

I thought I might quote the work of Mike Norton who was written up by Dan Ariely in one of those ‘smarties for 2012′ columns as follows;

There’s a significant amount of literature on the theory that, as people become richer, they don’t necessarily become happier. Norton asked instead whether people know how to use money to buy happiness. [Mike] asked: if you give money to people, what do they do with it? The answer was that they spend it on themselves. He then posited: what if we ask people to spend money on other people? His research revealed that those people are actually happier as a consequence. This worked with individuals, and also with groups — when people spent money on people they worked with, the team became more productive. He and I have been working together to try to figure out what level of wealth inequality people in developed countries are willing to tolerate. What we found is that people want to live in societies that are much more equal and much fairer than currently. So why are we willing to tolerate the current level of inequality? We don’t have the answer for this yet.

So I might run that by them. I’ll be interested to hear what they think. When I think of this it rings true. I think there’s a deep dissonance in people’s attitudes to inequaliy – especially in Australia. They don’t like inequality. They really don’t. But it’s not just that they don’t like it in principle, but then reject the measures in practice.  I think there’s an additional step. If you want to tackle inequality effectively explaining what you’ll do will require abstract thought. You’ll explain that you’ll need capital gains taxes, and high taxes on top marginal incomes. And rent taxes – including green taxes. If you had an hour with everyone in the country you might be able to bring them round, at least those who would be made better off by what you have in mind – which is a large majority.

But that’s not how people make up their mind on these things.  They see that a politician is putting up some tax somewhere (even if it won’t do them a skerrick of harm like the mining tax) and they can easily be made to think “There’s that sneaky politician trying to slip their hand into our pockets”. The fact that it’s proposed by Ken Henry who has no axe to grind and is opposed by self-interested billionaires doesn’t seem to change the dynamic.

Anyway, what do you think I should I talk about?

What a load of old sensationalist nonsense. I’m seriously starting to worry about Giz. If I want to search anonymously there is a thing called an anonymous tab. And I don’t log into my Google account outside work because why would I? – My phone is logged in.

That’s how the first commenter responded to this piece in Gizmodo accusing Google of being evil because it – wait for it – shares identity information between functions. That’s right, Gmail can now share information with Google search with Google + and on it goes.

This is supposed to be some attack on our privacy. Well there are very nasty things Google can do to harm my privacy. Those things would be telling other people things it knows about me that it could reasonably expect that I might not want them to tell them.

But it doesn’t do that. It is just using all the data it has to further improve improve the adds and other services it provides me. WTNTLAT? *

My point is, as I said here, privacy law, and privacy activism should be focused wherever practicable on stopping conduct that actually threatens privacy – ie where that information is provided to agents other than the one that has the information in the first place. It always pissses me off when I have to wait to be read some stupid thing which tells me my voice is going to be recorded “for quality purposes”. If it’s for training purposes they can protect my privacy by making sure the recordings don’t get leaked and by destroying them after the couple of weeks it was necessary to hold them to use them for the entirely benign purposes of quality control.

And remember, although Google is probably mostly thinking of optimising advertising here . . .

1. making advertising relevant is a source of considerable value to the world and
2. there are lots of other ways that the data might be able to be used to simply provide improved services to people – such as search, prompting connections with others, or with information of relevance to users, task management and all the other things that I can’t think of.

So broadly speaking, and with the caveat that I’ve not researched all this in great depth, I submit these views to you O Troppodores and Troppodillians.

* “Define: WTNTLAT” doesn’t generate any answers in Google, so we’re on the ground floor here Troppodores. This could be Troppo’s big break – our own little footnote in the English language, our own corner of the universe.

Quite funny

About 8 months ago, I had a look at what was then happening in the Arab world and made predictions about what was going to happen next. Time to see what really happened and update the forecast.

A minor prediction I was making was that Libya would again succumb to the resource course, making democracy impossible there, an article taken over by the Congressional Quarterly in the US (December edition). So far I am looking good for that prediction, with individual cities maintaining their own prisons and militias, as well as open fights about the division of the oil spoils.

The main prediction I was making concerned Egypt where I predicted the regime would re-constitute itself, coopting deal makers in agricultural and slum areas. I predicted that the urban youth which was driving the protests would lose out.

This is indeed exactly what has now happened: the army has put the torture chambers on full throttle in order to intimidate the urban youth. The elections have clearly shown that the largely uneducated and agricultural population has no appetite for supporting intellectuals in cities, and has gone for what they know, which is the muslim brotherhood, more radical muslims, the army, or some regional politician. The muslim brotherhood, which over the years has become so infiltrated by the regime that it was amongst the first to condemn the original protests against Mubarak, has about 40% of the preliminary vote and the reform parties have merely 15%. The radical Islamists get 25% and more regional parties make up the rest. Given that the army has already decided to simply give itself some seats in parliament if it needs them, as well as several more months of systematic torture of any opposition before parliament is even convened, one is already seeing a grand bargain between the Muslim brotherhood and the regime: a further move towards religious austerity in exchange for no challenge to the economic parasitism of the army. Egypt will become a very dull place indeed.

(Continued)

Last month, I talked about the route that Mario Monti should take with Italy if he truly wanted to get it back to a higher-growth path. My advice was to take on the rent-seekers in blitz-reforms, whilst keeping the population in a state of great anxiety about the economy in order to reduce political opposition. Freeing the Italian economy from the many rent-seeking groups that stifle it was in my opinion needed to get long-term growth. I questioned whether Mario, the ultimate financial insider, was up to that kind of job.

How did he do?

Well, I would say he went one-third on the mapped route. As advised, he moved with lightning speed, bringing forward a set of reform packages by December 4^th, less than a month after taking power. Also, as advised, he went for some quick hits on existing vested interests. His increased tax on property and his taxing of funds owned up to after a tax-amnesty make up the majority of his tax increases and are visible forms of taxing the wealthy. He went for welfare reductions by removing the indexation of pensions for a few years (exempting the poorest) and a general tax increase via more GST.

In terms of long-term reforms, he went for pension age reform, which is a move that will not have major short-run fiscal benefits because in reality almost no-one works until the official pension age anyway and hence pension age reform should be seen as a long-term reform designed mainly for the civil service that retires early: it takes a long while for the various pension ages to adjust to the official one and for significant groups of people to go through the new system. Perhaps most important for the long term is that Monti is trying to reform the calculation of pensions such that they reflect total contributions rather than the wages of the last few years. Anyone who knows anything about pensions knows that that is a fairly revolutionary change and that it cant be done in the short run. It simply cannot be implemented retrospectively because of missing information about past wages. It is even hard to imagine that the whole stock of current employees close to retirement will be subject to this change, so I can only guess that the fine-print will say that it only applies to pensions from some far future date. It is a good example though of the kind of reform that economists have been calling for for decades (it is a key example in my own co-written econ textbook) but that you need the right moment for in order to push it through politically.

Yet, Mario didnt go for the truly debilitating special interest groups that would open up the economy in the short-run. No tackling of the laws on retrenchment, which is a real problem for hiring. No tackling of the professions (doctors, etc.), which debilitate much of the tertiary sector. He is even promising more unhelpful subsidies for business, like subsidies for eco-friendly building.

Hence, to be brutal, Mario went for the easier targets and didnt do much. Reduced welfare, an indexation freeze on pensions, indirect increases in income tax (i.e. via the states and not the central government), increases in GST, and a couple of obvious long-run reforms that will take decades to come into effect. No concerted effort to go after the tax avoiders and the fat-cats that dominate the political landscape in Italy. No major clashes with the unions either. Indeed, the size of the reform (20 billion Euro more taxation and 10 billion extra spending) is pretty paltry if you consider the problems that Italy faces (with about 2 trillion in debt). There is hence more of the appearance of decisive action, whilst the reality is that of a couple of helpful long-run changes whilst no major interest group has been offended in the short run. Indeed, all the reforms look pretty much off-the-shelf to me, which tells you there is little going on in the background in terms of policy development. Italy is not getting ready for real change.

What does this mean for Italy in the longer run? It most importantly means that there is now a much higher chance that Italy will default on its government debt: the reforms are simply not enough to either pay back the debt nor do they give confidence in medium-term future economic growth that would get rid of the debt.

Mario Monti undoubtedly knows this. So what game is he playing? Is he hoping for a miracle in the form of suddenly returning faith that Italy will always pay its debt and thus a return to 2% bond interest rates? I suspect he is not really hoping for a miracle but consciously has resigned himself to some form of default and meanwhile simply refuses to attempt the politically difficult, which is to take on the major interest groups that paralyse Italy and make it a place you prefer to visit rather than work in.

It is hard to know what Monti’s end game is, or even if he has one. Perhaps he thinks he can have another round of more serious reforms if this one gets through parliament. Perhaps he simply thinks this is the best he can do given the internal political realities of Italy. Perhaps he is trying to put Italy in the position where it could get by if it merely defaulted on the foreign part of the debt, not the domestic part, which in turn would strengthen its bargaining position in a bailout scenario. Whatever the end-game is, with these baby-reforms Monti has proven himself to be a conservative who will not upset the internal status quo. They chose well.

What is the road of least resistance scenario, and thereby the most likely scenario, for the Eurozone financial crisis? To solve this conundrum, we need to map the major elements of high resistance around which the road must navigate and the areas of low-resistance towards which the road will flow. These are:

1. (high resistance) It is actually politically very hard for any country to leave the Euro. If, say, Greece announces it leaves the Euro then one should expect a bank-run overnight with Greece deposit holders cashing in their savings and putting it in foreign Eurozone banks. Moreover, it might easily take a year before Greece could physically re-introduce its own currency, during which time the uncertainties and capital flight accumulate: money-machines have to be changed, accounts have to be converted, export contracts have to be re-written, and a system of converting anything valued originally in Euros into the new currency has to be negotiated. Apart from being a major hassle requiring expertise many countries do not have, it would give all the other countries an immediate excuse to stop paying that country any transfers. Young ambitious Greeks should be expected to shun a defaulting Greece. It is hence quite costly in the short run to step out of the Euro, as well as virtually guaranteeing a severe deepening of the recession overnight. This is equally true for any other country in the Eurozone: leaving the Euro is a bold and courageous step, unlikely to be witnessed any time soon. The road of least resistance therefore does not include any single country leaving the Euro.
2. (low resistance) The political costs to defaulting within the Euro are, when one reflects on it, surprisingly low. Greece has in effect been defaulting for several years now and has been handsomely rewarded with transfers and debt-write-offs. It was certainly the road of least resistance within Greece to steer straight into default. So too will the governments of Italy and Portugal be calculating that any default on their debts is a viable scenario and preferable to major internal upheavals that could be blamed on the government of the day. For what are other countries actually going to do when governments default on their debts? Not much. There is no mechanism via which they can kick countries outside of the Eurozone or the EU, so barring a whole set of richer countries deciding to set up a new EU and abandoning the rest, the Euro countries are stuck with each other. Countries cant kick each other out, nor can they really force any sanctions within the system. If, say, Italy decides to only pay back the government bond loans to its own banks in order to prevent them from going bankrupt but defaults on any loans held by foreigners, then the other countries have no other course of action than to protest and take the hit. They might retaliate by not honouring any loans to Italian banks but, again, apart from a wholesale break-up of the EU, they actually have surprisingly little means to punish any country. This incidentally is true even under the newly proposed stability pacts: if a country simply refuses to pay any fines then there is not much the other countries can do. Hence, defaulting is a low-cost option for individual countries.
3. (high resistance) The political costs for the rich countries to start a new EU of their own, the so-called rump-Europe scenario, is surprisingly high. Think firstly of how the richer countries benefit from the current union: because they suffer less from civil-service-demanded wage growth, their countries are more competitive precisely because they are in a currency-union with countries that do suffer more from civil-service driven wage inflation. This guarantees them higher levels of employment and exports, a brain drain of the less well-organised countries towards them, and very low interest rates at which to borrow, all advantages that would disappear if they cut the ties. Also, cutting the union would not in fact mean that their own banks would no longer be linked to the government bonds of other countries so cutting political ties does not actually stop the financial ties. Hence the economic benefits are neither immediate in the short-run, nor obvious in the long-run. Then think of the politics by thinking of the mechanism involved in breaking away: the countries would have to formally abandon the EU, would have to negotiate their relation with the Eurozone with those remaining in the EU (!!), then set up a new treaty for a new zone and introduce a new currency or convert the Euro into a Euro-plus that would hold for their region. Each step has to go through all the parliaments involved, virtually guaranteeing years of wrangling about the shape of a new treaty. Now, this scenario is certainly imaginable, but would take years to go into effect and hence cannot be sold by any politician as the solution to anything. Hence, a break-away by the rich countries would only be assured to lead to short-term economic loss (the countries being set loose would have to default almost immediately, with all the consequences associated to that) without clear long-term gain. It is therefore not a viable scenario. What rich countries can do is to ensure their own banks and economies are less exposed to those of the high-debt countries, but that is a slow process that takes years.
4. (low resistance) The European Central Bank’s determination not to become a printing press is, probably, brittle. Mario Draghi, the president of the ECB just last week reiterated how countries must help themselves. At the moment hence, the ECB is sticking to the line that it is there for price stability in the Eurozone and is refusing to write blank checks to over-spending governments.  It is quite openly gambling on the current crisis to force governments into tighter spending regulation, with, it might be said, some apparent success. Yet, if the going gets really tough and neither commercial banks nor governments have the cash to pay back their loans to each other and to outsiders, is the ECB really going to refuse to bail out governments and the financial sector by means of printing money? It would seem highly unlikely that the ECB would indeed keep up its refusal for massive capital injections if its back was against the wall because it really is the only institution that can do it. More probably, it would indeed take on the role of the American Fed and simply print money on a massive scale to prevent widespread bankrupcies of governments and banks.

With this contour map in mind, the road of least resistance is starting to come into view. (Continued)

I was in a conference in Tokyo last week on the topic of advancing the use of well-being indices throughout the world, hosted by the very generous, civil, and well-organised Japanese. One of the great things about such conferences is that you get to exchange views with smart people from other countries. A particularly memorable example was a conversation about what was really happening with climate change policies around the world, between myself, a Maldives scientist and an Indian senior civil servant. The key question was whether or not the Maldives should count on the rest of the world to save them from rising sea levels. Allowing for my imperfect memory, the conversation roughly went like this:

Maldives: so, when are you guys going to get serious about preventing my country from flooding?

Aus: you come from the Maldives, right? Haven’t you got any hills?

Maldives: no, our highest point is about 3 meters.

Aus: so low? Why aren’t you already flooded by the occasional hurricane or tsunami?

Maldives: we have a ring of coral around us sheltering us from the worst of the storms. So the real worry is the overall sea levels.

India: you have that prime minister who became all emotional at the last talkfest, dont you?

Maldives: yes, that is him. Our prime minister is very vocal at conferences.

Aus: so he should be. You guys are f*cked. We are just pretending to be interested in averting climate change. We dont actually care at all.

Maldives: do all Australians swear so much? You are joking though, right? Havent you guys just agreed to introduce the world’s highest carbon tax and promised a reduction in your emissions?

Aus: (snort) yeah, that fib was quite the media success. It even made the BBC. Dont be fooled though, we are not going to diddely squat. I challenged the climate scientists to an open bet on all the key promises saying that none of them were going to happen. No takers and plenty of endorsements. All the smart money in our country says we are not going to do anything of substance anytime soon. Neither is the rest of the world.

India: yeah, forget about asking us. You rich guys have had your turn. Now that it is our turn to zoom you shouldn’t ask us to worry about emissions.

Maldives: what do you mean you are going to do diddely squat? You have legally binding emission reductions, havent you?

(Aus and India both look with a mixture of incredulity and pity at Maldives)

(Continued)

Struggling Australians breathed a sign of relief today, when they read that the ‘relentless pressure‘ applied by Melbourne’s Herald Sun has forced a humiliating climb-down by the big banks and  delivered  the full interest rate reduction passed down from on high.

The paper reports that “Scrooge bank chiefs who had been silently sitting on the rate cut and gouging more than $4 million a day from their customers” faced a withering barrage of Twitter and Facebook incendiary bombs, eventually throwing up their hands and surrendering to the superior generalship of the editorial team at the Herald Sun, who generously gave the downtrodden a voice, and assured victory for the people.

Little Australian  kiddies, can now sleep soundly knowing that they will get the XBox 360 Kinect AND their own Hi-Def TV to play it on this Christmas, and their parents at least,  unlike our big  banks, will experience the joy of giving.

We’re not a religious lot we Australian’s, but this festive season, Australian’s will surely be whispering a little prayer. “Thank God for Melbourne’s  Herald Sun”.

Both Judith Sloan and Ian Harper argue that Newstart Allowance is too low, particularly for recipients who are long-term unemployed. In the late 1980s, the Social Security Review also argued for an increase in unemployment payments. The review’s authors wrote:

… immediate priority should be given to bringing rates of payment to pension levels. There is absolutely no justification which can be given for providing a lower rate of payment to single individuals, whether short-term or long-term unemployed, who must not only support themselves but engage in active job search and maintain the mobility and social contacts necessary to ensure against labour market marginality (p292).

(Continued)