The European Central Bank should no longer be considered a central bank. Instead, it is a negotiating arm of Germany and (to a lesser extent) France. It is not surprising that the ECB does not act as normal central banks act. Instead of comparing the ECB to the Fed or any other central bank, we should compare it to the IMF.
The ECB is one arm of the Troika, along with the European Commission and the IMF. As such, it is involved in the negotiations during which bailout funds are extended to the European periphery in exchange for structural reforms. If the ECB eases monetary policy, then these structural reforms become less necessary in the short run. Indeed, this is what everyone who opposes current ECB policy is saying.
Given that, the ECB is not going to ease. It cannot, as to do so would be to cut out the leverage the European Commission has in forcing structural reforms. And the European Commission believes that without structural reforms the eurozone cannot last (absent perpetual transfers from the core to the periphery). The ECB is influenced disproportionately by the core euro countries, especially Germany. If the ECB does not keep Germany on its side, then its authority is likely gone.
So the ECB is not a central bank, and should not be considered as such. The ECB is a "lender of last resort" in the same way the IMF is, which is the way Bagehot intended: in a crisis, lend at a penalty rate. The penalty is structural reform. But the ECB is no longer tasked with stabilizing the European economy. That is no longer its remit, nor its goal.
- On Labor Power and Workers' Rights
- Regulation Is More Complicated Than You Think
- WTO Head Update
- Zombie Idea: Creditanstalt Did Not Cause the Depre...
- Poor Timing: Military Spending and the Business Cy...
- Understanding the Bangladesh Tragedy with Politica...
- Don't Abandon Materialist Conceptions of Politics ...
- People Should Care About This
- Some trade-related news
- The ECB Is Not a Central Bank
- Keynesian "Depression Economics" Does Not Apply to...
- ▼ April (11)
- ► 2012 (129)
- ► 2011 (365)
- ► 2010 (478)
- ► 2009 (521)
- ► 2008 (134)
- ► 2007 (142)
Saturday, April 6, 2013
The European Central Bank should no longer be considered a central bank. Instead, it is a negotiating arm of Germany and (to a lesser extent) France. It is not surprising that the ECB does not act as normal central banks act. Instead of comparing the ECB to the Fed or any other central bank, we should compare it to the IMF.
Monday, April 1, 2013
I'm swamped with real work, but I have more posts on austerity politics planned. Anyway, to keep the lights on around here I thought I'd ask a simple question with (I think) a simple answer. First the set-up, then a factual observation, then the question:
The standard Keynesian case appears to be that policy blunders around the world are the result of a mistaken belief in expansionary austerity. The eurozone crisis is often provided as the exemplary case, which it would have to be because the rest of the world economy is doing more or less okay. The Keynesian case against fiscal consolidation is that it is contractionary, not expansionary, when monetary policy is at the zero lower bound (meaning interest rates are zero). That's when you get the liquidity trap, paradox of thrift, and all the rest of it. If you're not at the zero lower bound then the whole case evaporates, and what drives macroeconomic outcomes is monetary policy, not fiscal policy. If you're not at the zero lower bound then fiscal consolidation is "appropriate" (neutral actually) since it can be offset by monetary policy, although there will be distributional consequences.
But the European Central Bank is not at the zero lower bound. In nominal terms it literally is not. Interest rates are not at zero. In fact, the ECB raised rates as the euro crisis worsened, and have since then held them steady. Quantitative easing programs have been "sterilized" by the ECB, which has taken pride in so doing. (I quote them on it in a forthcoming paper, about which more later.) All of the evidence which supports being in a liquidity trap -- sovereign yield at zero or even negative real rates, etc. -- at best only asymmetrically applies to the eurozone.
None of this is news, but so much eurozone commentary doesn't start from the position that the story is monetary rather than fiscal. So all this commentary ignores the fact that the entire Keynesian "depression economics" structure, which takes as a precondition the presence of a liquidity trap, does not apply to the eurozone crisis. Not one bit. The entire problem is monetary rather than fiscal, according to Keynesian economics. Belief or non-belief in expansionary austerity is a total non-issue.
So here's the question: why aren't we all talking about the distributional monetary politics within the eurozone rather than debating this or that fiscal policy?
Wednesday, March 27, 2013
The Mundell-Fleming "unholy trinity" is that a small open economy can choose two, but not all three, presumably desirable policies: capital account openness, a fixed exchange rate, and monetary independence. Quite a lot of political economy research goes into figuring out which two countries will choose.
But what do we call it when a country chooses none of them? Cyprus right now has a closed capital account, no monetary independence, and severe limitations on external exchange at any rate.
I nominate "The Devil's Trifecta" but I'm not great at titling things so perhaps readers can do better.
This is a nice way to think about just how screwed up the EU is right now: tasked with choosing one suboptimal policy, they choose three.
But non-economists can play too! Take Rodrik's trilemma, in which states can choose two of national sovereignty, democracy, and economic integration. In Cyprus, the last is gone and the former two are questionable: it looks like democracy might win the day but it was dicey there for a minute, while Cyprus's sovereignty is restricted by the EU and faces a possible threat from Russia. So let's score it a 1.5 with a negative outlook.
Tuesday, March 19, 2013
Andreas Assiotis is an acquaintance of mine. He also has a PhD in economics from the same American university where I did my undergraduate economics degree. At least at the undergrad level they were a New Keynesian bunch, not freshwater RBC. Now Andreas is on the faculty at the University of Cyprus in Nicosia. A few days ago he posted the following on Facebook (reprinted with his permission, although I have no idea if he agrees with any of my commentary which follows):
We had a party, and it's hangover time. From an economic perspective we did what we ought to do to save our country. An alternative would have included salary cuts, more layoffs, the already high unemployment rate skyrocketing, and extreme taxes that would have made this burden sharing even more unfair. There is a bright side: Starting from this moment we should all roll our sleeves and start planning for the future. Instead of demanding more money, higher salaries, and more goods we should demand more transparency, better institutions, law enforcement, better regulations... There is not a reset neither a boost button that any Xristofias or Anastasiades could hit...we, the populace, are the only entities that could change the future, OUR future...This is much closer to the Schumpeterian view of austerity than the Alesina view*. In fact, it sounds like nobody in Cyprus views this austerity as expansionary; hence today's rejection of the "bailout" plan, or whatever we're calling it. This was more like a old-school shakedown than anything in Alesina's model.
This is why I think we need to be careful about how we use the language of "austerity". If I understand him correctly, Blyth's main thesis has absolutely nothing to say about the Cypriot case. And probably not the Greek case or the Portugese case or the Irish case. More traditional models of political economy have plenty to say about these things. So why are we insisting that very different things be described in the same way? Why not have distinct terms for distinct concepts?
What's happening to Cyprus, Greece, Portugal, Spain, and Ireland is austerity. Not expansionary austerity. Contractionary austerity. And they know it. It's a grinding political battle over who bears the burden of debt. There's no hood-winking going on, no zombies ideas or confidence fairies or animal spirits or any other mythical beasts which need conjuring. Just old-fashioned materialist politics.
*Also, this has nothing to do with Alesina's model and in fact basically none of the EU austerity plans have. Nor the U.S./U.K. plans. More about that in another day or several.
Friday, March 15, 2013
Henry Farrell has reviewed Mark Blyth's new book, Austerity: The History of a Dangerous Idea, which has not yet been released commercially. (I've written about Blyth's research program before. See here and more if you scroll down here.) As I've previously said, the book looks very interesting and I welcome the chance to read it. I love intellectual histories, and this looks like a good one. But Farrell's review increases my level of skepticism of Blyth's core argument regarding present circumstances, which had already been growing in me.
Here's the gist of my concern: Blyth wants to advance an argument that the practice of austerity as a crisis response has ideational causes. That's why the subtitle of the book refers to an "idea". If true, this would call us to reconsider a good bit of the political economy literature, which has focused on materialist politics as filtered through various institutional structures as the most important factor in crisis policymaking. It's a provocative claim, and in making it Blyth does the dirty work of actually reading all those old political economists -- from Locke to Hayek and beyond -- who concerned themselves with the relationship between (sovereign) debt and growth.
The problem I have arises from Blyth's definition of austerity as an idea distinct from materialist interest. I don't think he's totally wrong about any of the main causes of the current crisis, and in fact he is very convincing on some points which I hadn't previously considered. I'm less sure about his explanation of the political response to the crisis in Europe as being primarily ideational. This impression comes not only from Farrell's review, but also from Blyth's hour-long lecture from the book, a version of which is on YouTube, in which he defines "austerity" (in the Q&A) as "a claim that if you cut public debt you will grow". I.e., expansionary austerity, via the work of Alberto Alesina. He specifically says that in his view not all spending cuts constitute austerity, only those intended to facilitate growth. His argument is that European policymakers have fully bought into this belief. His evidence is that Alesina gave a talk at an Econfin meeting, and was referenced in several reports from the ECB. Farrell's review doesn't dwell on this point of definition, but it is quite important. (More on Farrell in a bit.)
Historically, "austerity" generally referred to a set of policy measures designed to facilitate structural macroeconomic adjustment through internal devaluation of wages and prices rather than external devaluation of the exchange rate (which was often a metal standard originally, and a pegged exchange rate or currency board more recently). Most often, these were necessary because external liabilities -- public or private debt owed to foreigners -- had grown past the point at which service was feasible, and the highest policy priority was some sort of fixed exchange rate which made external devaluation undesirable. Austerity policies generally included cutting social spending, raising taxes, increasing interest rates to defend the exchange rate, and trying to boost exports (i.e. production) over imports (i.e. consumption). In other words, austerity was designed to reduce society's standard of living -- on purpose, but in a temporary fashion -- in order to get out from under the debt while maintaining the exchange rate. So the basic logic has nothing to do with spurring a short-run expansion; it has to do with avoiding a long-run collapse*.
That doesn't mean it's good policy. But it does put things into perspective: governments who enforce austerity generally have no good options. Either they devalue their currency, which makes consumption more expensive; or they default on the debt, which makes immediately eliminating any external deficits (via tax increases and spending cuts) mandatory; or they raise taxes and cut spending and try to pay down the debt. All are forms of austerity. The choice between them is political, and is primarily a function of distributional politics (in my view, anyway). The underlying problem is the debt, and the debt is something more than an idea. So far I think Blyth and I are more or less in agreement.
Back to Farrell's review, in which he applies something like the above description to some countries in crisis, such as Greece today: unless the Germans give them a bunch of money in some form or another, they face austerity (in some form or another). Blyth goes a bit further in the lecture (and presumably the book): even the "unless" here is wrong. If Germany gives Greece a bunch of money then Greece may suffer less but Germany will suffer more. The "austerity" hasn't gone away... it's only been redistributed. The idea of austerity is hardly the reason why Germany won't give Greece a blank check; the materialist reality is the reason for that. And in this case, the eurozone crisis is too big for Germany to manage. Heavily-indebted European countries, and their banks, are "too big to bail".
Farrell suggests that countries such as the U.K. need not bother with austerity, but do so anyway, so this is where Blyth's book really does its work: these ideas are so powerful that they compel states to do disastrous things which are not in anyone's material interest. This is where either I misunderstand Blyth or Farrell does. Since Farrell's read the book and I haven't, I'll presume it's me. But I don't think the U.K. really fits the story. If austerity programs are bad then you shouldn't do them unless you really have to do them, in which case you are Greece and not the U.K. But, according to Farrell, the U.K. is engaged in austerity. This argument rests on a core empirical claim: that countries sometimes (frequently?) practice austerity when they don't have to do so.
Here is where limiting the definition of austerity to Alesina's "expansionary austerity" truly matters. Look at the U.K.'s budget (from HM Treasury's most recent budget document):
Over the past 15 years, the UK's budget as a percentage of GDP has averaged below 40%. As the crisis began, it was about 41%. In response to the crisis, it spiked to about 48%, an increase in government spending of about 17%. That is the opposite of what Alesina recommends, which is a massive, immediate cut in spending. Since 2010, British fiscal expenditure has gradually declined about four percentage points (not massive or immediate) from an exceedingly-high baseline, so that it remains above its pre-crisis level. Tax receipts have stabilized and practically normalized, but the deficit remains well above the historical norm at 7-8% of GDP per year. I.e., the U.K. is accruing more debt rather than paying it down. The U.K.'s sovereign debt level is now the highest its been since the end of WWII.
The U.K. is closer to the "soft Keynesian" playbook than Alesina's, in other words. So either I am conflating Blyth's argument or Farrell is. (Krugman also calls the U.K. policy mix "austerity", and notes that U.K. growth has lagged U.S. growth since the crisis. But whether a moderate increase in fiscal expenditure is austerity depends on the definition of "austerity". According to Blyth's definition I'm not sure it does.)
The U.K. is still hurting -- its economy was heavily dependent on the health of the financial sector, and its exports have suffered tremendously from economic weakness on the Continent -- but it is doing far better than most European economies. And the worst is probably over for the U.K. Full recovery may be excruciatingly slow but the situation does not appear to be deteriorating further (Blyth's hallmark of austerity). Meanwhile, any new debt accrued will need to be repaid, with interest. Bond rates are low now, but they will rise once the economy fully recovers, so even if taking on debt is cheap today it will be expensive to service tomorrow. The Conservative government has decided it would rather trim a bit now rather than push the whole bill back.
The prudence of that policy is certainly debatable. What is not debatable is that this is in any way analogous to Greece's situation. Yet the U.K. policy mix is frequently referred to as "austerity" in the same breath as Greece, including by Farrell in his review of Blyth. I think this is mostly Blyth's fault: he's used a common word in an uncommon way -- again, in the lecture; we'll see about the book -- so when people see it they think he's referring to something more general: contractionary austerity, of the sort written about by Schumpeter, or maybe neutral fiscal consolidation (the Treasury View) rather than Alesina's narrow conception of expansionary austerity. I initially made this mistake as well. I wrote a draft of this entire post complaining that Blyth was guilty of conceptual confusion. He's not. But because he's taken the word "austerity" to mean something different from the general/historical understanding, he's given us a fairly difficult task to overcome before we can understand what he's really talking about.
In his review, Farrell describes the U.K. situation thusly:
After enduring two recessions in the last four years, Britain is now well on its way into a third. The pain has been compounded by a succession of austerity budgets, in which Britain’s Conservative-led government has tried to hack away at spending. Repeated rounds of cuts have battered the British economy. However, Britain’s chief economic policymaker, Chancellor of the Exchequer George Osborne, wants still more pain. He is pushing the government to identify £10 billion more in cuts this year.
I think Farrell's right on the substance: to the extent that Britain has restrained the growth of fiscal deficits that has had a negative impact on the economy. But they are far from a primary surplus and don't even (optimistically) plan on running one for another 6-7 years. They're not paying back externally-held debt. The most you could say of this is that the deficit spending isn't expansionary enough. There's certainly a case to be made there. It's my own personal view, in fact. But that political decision is best explained by materialist, not ideational, politics: the Conservative government and their wealthy constituents understand that when the bill does come due, they'll be the ones to pay for it, while the benefits from increased fiscal expenditure are unlikely to benefit them much. Cameron has courted the U.K.'s business community using naked language to this effect, and prominent business leaders have supported the cutting programs. They'd rather keep the future bill low, if possible, all things considered. Hence, the attempts to "hack away at spending". Hence the tax cuts for the rich and tax increases for pensioners in the most recent budget, which were praised by business and The Economist. All very materialist.
So what does an ideational explanation (note: not necessarily Blyth's argument) bring to the table? Only that Cameron government thought this would be expansionary. But it didn't. Treasury reports under Chancellor Osborne revealed that they expected 1.3 million jobs lost.
How about monetary policy? The U.K. is not defending a fixed exchange rate or commodity standard. Its interest rates have been near zero for years, and it has engaged in quantitative easing programs. The U.K. has recently hired one of the most expansionary central bankers in the world to try to spur on the economy, and are considering changing the Bank of England's legal mandate to give him more flexibility to do so. This central banker, Mark Carney, has said that he will pursue "radical" monetary policies in an attempt to generate growth, with no apparent concern for the value of the pound sterling.
This is certainly something qualitatively different from what Greece is doing: devaluing internally in order to maintain a fixed exchange rate. It's the opposite policy. And so Blyth says in his lecture that the U.K. policies do not constitute the sort of austerity he's concerned with. He clearly distinguishes between the U.K. Conservatives' policies and the continental European policies; the implication is that the latter is "austerity" while the former is just normal distributional politics.
But, as I mentioned before, that is not what "austerity" has meant throughout history (even Blyth's own intellectual history), where "history" is as recent as the Washington Consensus responses from 1980-2000 to crises in East Asia, Latin America, and elsewhere. And, arguably, the ongoing eurozone crisis, where the roles of Thailand, Indonesia, South Korea, and Malaysia are being played by Greece, Spain, Ireland, and Portugal; and the role of the IMF is being played by the Troika. It's not what folks like Krugman and Farrell mean when they talk about austerity now. And, frankly, I don't think Blyth's restriction on that definition is helpful. I guess it's possible that the German finance ministry actually believes that Greece's economy will grow following massive public sector cuts, but it is not necessary to believe that in order to explain Germany's actions.
I look around the world and I see two kinds of (industrialized) countries facing crisis: those which have no choice but to engage in austerity, and so do, and those which do have a choice, and so do not. The former are the beleaguered eurozone states. The latter are large industrial economies which have responded to economic slowdowns with, shall we say, half-measures that fall somewhere in between the Keynesian ideal and the Treasury View*. A sort of "soft Keynesianism" which meets the partisan predilections of elected governments. The former Blyth characterizes as having been victims of "the greatest bait-and-switch in human history". Perhaps so (perhaps not, and Farrell questions this claim as well), but how they got into crisis ex ante has little to do with what is done about it ex post, and what is done about it ex post has little need for an explanation which is distinctly ideational rather than materialist.
Why am I concerned by this? Because restricting austerity to Alesina's model muddies the water, and insisting that eurozone leaders fully bought into it is a big claim which, if true, would jeopardize a lot of existing literature. Moreover, it's deceitful marketing. Describing this version as "discredited" (or as a "zombie", as John Quiggin does in a self-promoting blurb) begs the question: what is it, exactly, that has been discredited? Alesina's model hadn't been at the time it was supposedly being tried. I agree with Blyth's incredulity that anybody could have believed it in the first place -- although he's the one claiming that they did, not me -- but experiments are conducted because the outcome is not predetermined. If this was a new beast, then it wasn't an old zombie. So I guess Quiggin was fooled by the narrowness of Blyth's definition as well. That makes nearly all of us.
So the "history of a dangerous idea" is somewhat misleading: Alesina's theory wasn't formed in a vacuum, true, but it was a real break from past conceptualizations of "austerity". It was such a significant break that I don't think they really are the same concept. By referring to one subset of austerity theories -- expansionary austerity -- as if it was the only or even main one, Blyth appears to have made it tough on his audience. Maybe this is all resolved clearly in the book, and he simply elided that discussion in the lecture for reasons of brevity. I hope so, but if so that sense doesn't come out of Farrell's review. I'll read it either way, and I expect to enjoy it. I love intellectual histories like this, Blyth is a good writer, and many parts of his lecture are very good. I mean all that sincerely: I really enjoyed the lecture, and I anticipate getting a lot out of the book.
I'm just not sure about the thesis.
*The Treasury View is that fiscal stimulus will be neutral (multiplier of exactly one), so that version of austerity is a little less austere, but is still not expansionary. Most of the classics believed deficit spending would spur inflation, which is not expansionary in real terms. (Keynes' contribution was to point out that there would be no inflation if there were under-utilized productive capacity.) From what I can tell, none of the intellectual traditions Blyth covers in the lecture espouse expansionary austerity in a crisis except for Alesina.
Saturday, March 2, 2013
Some, like Krugman, have argued that the European crisis is a technocratic failure, the result of quasi-religious beliefs in mythical creatures ("the Confidence Fairy") held by Very Serious People in government and the commentariat. If only they would just abandon their heresies and follow the One True Keynesian path, everything would be fine. The optimal policy is obvious and Pareto-improving -- more monetary stimulus, possibly combined with debt rescheduling and the end of fiscal austerity -- so all that is required is the fortitude to implement it.
Others, like me, have argued that the European crisis is a political crisis, the result of a disjunction between the interests of the Eurocore (esp Germany) and the Europeriphery. Rather than postulate cognitive dissonance or willful ignorance (or something more sinister), I focus on distributional issues: either the Europeriphery's creditors are re-paid or they are not; either the Eurozone's macroeconomic imbalances are addressed by adjustment in Eurocore or by adjustment in the Europeriphery. Ultimately these are political questions, and political questions are generally decided by those with the most political power. In the case of the EZ crisis, any resolution must involve the European Central Bank, and the ECB has traditionally been influenced by Germany more than other member nations. There is no Pareto-improving policy -- what helps some countries hurts others -- so this is not a technocratic problem.
Look at this picture (via Niklas Blanchard) and tell me which view best explains the European Central Bank's policy calculus, and thus outcomes in Europe:
Germany is running above its nominal GDP trend; everyone else is below it. That means that further monetary stimulus will increase real GDP growth everywhere but Germany, which will instead experience higher inflation*. Germany does not want that to happen, because Germany does not like inflation. Germany has disproportionate control over the monetary authority of Europe. Therefore, the Europeriphery does not receive the monetary support which they want, because it would cause inflation in Germany.
No parsing of myths necessary; it works without them. Also no moral lesson. Just normal distributional politics.
UPDATE: Fixed some typos and poor wordings, which were both more common than usual (I think) and more egregious, and thus more likely to lead to misunderstanding.
*Added at the same time as typo-fixing: Arguably an increase in German inflation would not facilitate the sort of adjustment which is needed anyway. Higher German inflation would depreciate the real exchange rate of Germany vis-a-vis the other members of the eurozone, thus increasing Germany's competitiveness in export markets relative to, say, Spain. Movement in the opposite direction is needed. Because Spain cannot devalue externally through a fall in its currency, it will have to adjust to a rising real interest rate with an even larger internal devaluation. That means even lower wages, and probably more fiscal austerity.
If I'm right about that it's a potentially very interesting point which I've seen no one else mention.
Wednesday, January 23, 2013
In a previous post, Will discussed how a potential US-EU free trade agreement might effect widespread trade liberalization through inclusive institutions such as the UN. Indeed, many commentators are wary of the possible deal, believing it to signal the end of inclusive negotiations that characterize the WTO (though Will provides a nice counter to such alarmist claims).
A ratified US-EU FTA also has the capacity to change international investment law quite fundamentally. At stake is whether an agreement would have an investor-state dispute clause (ISD). Unlike traditional dispute settlement mechanisms, ISDs allow firms to sue states directly, usually within the context of an international arbital board such as the International Centre for the Settlement of Investment Disputes (ICSID). ISDs are controversial primarily because there is a widespread fear that MNC with deep pockets will engage in litigation wars of attrition. Furthermore, when investors can sue states directly, governments no longer have access to diplomatic tools to smooth over disputes. And, to the extent that the long term viability of open goods and capital markets requires some flexibility to deal with domestic push-back, the removal of states as arbiters of which investment disputes are worth pursuing and which are better left ignored could have lasting negative implications for the political viability of economic openness.
Unlike some other aspects of FTAs, ISDs can actually become salient issues. In South Korea there were a series of protests against the ISD provision of the recently ratified US-South Korea FTA. Other countries, including India, South Africa, and Australia, have recently decided to nullify portions of trade and investment treaties that include ISD provisions. Still, ISDs are widespread. The model US Bilateral Investment Treaty includes an ISD provision and ISD clauses are standard in US FTAs. However, the types of treaties that contain ISD clauses tend to be signed between states characterized by economic asymmetries.* BITs are a prime example - while over 2000 such treaties exist, there are no BITs between two advanced industrial economies.
So, the question then is whether a US-EU FTA agreement will include an ISD clause. Generally, advanced industrial countries have shown they are more interested in promoting legal regimes that protect "their" MNEs while less willing to cede jurisdiction over investment disputes in which they might be a defendant. For instance, Australia has decided to drop ISD clauses from its BIT and FTA regime after it was sued by Philip Morris; Philip Morris used Australia's BIT with Hong Kong to establish ICSID jurisdiction. Given growing dissatisfaction with the costs of ISD, it will be interesting to see if such clauses would persist if the US and EU decide to not subject themselves to such extra-territorial juridical measures.
My quick, speculative take is that ISDs will be less widely used in the future. As advanced industrial economies begin to receive more FDI from emerging economies with which they have such dispute clauses, they will seek to extract themselves from such agreements. Moreover, a movement away from ISDs may be a good thing. First, ISDs tend to create duplicated layers of juridical authority that generate confusion. Second, as mentioned above, ISDs make it harder for governments to intercede in investor-state disputes in ways that allow for flexibility necessary to maintain broad coalitions of support for deep economic integration. Finally, there is some evidence that states with ISDs tend not to pursue meaningful domestic legal reforms, and thus ISDs can contribute to the persistence of partial economic reforms that ultimately impede broad-based growth.** Removing ISDs may help overcome some of these problems.
*An important semi-exception is that NAFTA includes ISD provisions. However, this clause remains quite controversial in Canada. Canada has not yet ratified the ICSID convention, reiterating the extent to which countries are quite resistant to ceding final arbital authority to an international tribunal. Additionally, the US-Australia FTA suggests, but does not require, dispute settlements between investors and states.
** A place to start reading about this: Ginsburg, Tom (2005) "International Substitutes for Domestic Institutions: Bilateral Investment Treaties and Governance" International Review of Law and Economics 25:107-123.
Tuesday, January 22, 2013
First, France: Gerard Depardieu has left the country to avoid paying the new top marginal tax rate of 75%. He's apparently moved to Belgium for now, but Putin has given him a Russian passport and an offer of citizenship just in case he develops a taste for little water.
Second, France again: Nicholas Sarkozy and Carla Bruni are considering doing the same thing, perhaps by moving to London. In a first-as-tragedy-then-as-farce moment, David Cameron is actively recruiting tax exiles. (Remember that in the not-so-distant past tax exiles were leaving Britain for France, among other locales. Here's a 1977 op-ed talking about the phenomenon among musicians. The Rolling Stones wrote and recorded Exile on Main Street as tax refugees. Others included Ringo Starr, Peter Sellers, Sean Connery, and many more. Here's a slideshow of some notable examples.)
Third, California: Phil Mickelson has said that he may leave the state as a result of significant income tax increases at the state and national levels. California's income tax rate is 13.3% for top earners; Texas and Florida don't have a state income tax at all. Mickelson makes upwards of $40mn/year, so moving from CA to FL could net him $5-6mn/year, if he could save the whole 13.3%. In total, Mickelson claims he'll be losing 62-63% of his income to various taxes.
Note that Piketty and Saez estimated the "optimal" top marginal tax rate -- where "optimal" in this case means maximizing public revenue while minimizing income inequality -- as something like 75-80%. (Although it should be noted that this conclusion is based on an assumption that is less likely to hold in Europe as it is in the U.S.) In other words, that's the approximate point where the slope of the Laffer Curve zeroes out and then turns negative. In this case, the anecdotes roughly correspond to the theory: the margin seems to lie at around a 65-75% top tax rate, which can be sustained before avoidance starts becoming widespread.
As a closing aside, in the U.S. state income taxes can be deducted from federal income taxes. As I understand it, there is no limit to the amount of these deductions. This raises an interesting political question: why don't states set their income taxes at exactly the same levels as federal income taxes? Their tax-paying citizens would be no worse off -- they'd pay the same amount of tax, deducting from their federal bill what they pay to their state -- while the state's finances would be significantly better off. The federal government's budget balance would take a hit, but why should state legislatures care about that? Obviously some complications would arise, e.g. everyone would need to itemize deductions, but it seems like these could be fairly easily managed.
Or maybe not. I'm no accountant or lawyer, so its possible that this is completely wrong. But if it isn't why hasn't anybody tried it?
Tuesday, June 19, 2012
The European Union is considering a dramatic revision of the current institutional arrangement concerning banking regulation and supervision. Currently, members of the EU must implement international capital standards -- the Basel accords -- but regulation of domestic financial sectors is left up to national governments. Some governments choose to have their central banks regulate, others give that authority to a separate agency; each is fine under current EU rules.
The leaders of France, Germany, Italy, Spain and Austria are willing to back a powerful supranational supervisor, and a decision to relinquish national control over cross-border banks is being prepared for next week’s EU summit, according to senior officials. One said the new-found political impetus was “astonishing”.The "astonishing" political impetus has come from the fact that the EU is currently experiencing a number of bank runs, capital flight from the periphery to the core, and a general lack of trust in the solvency of many of its financial institutions. To shore up confidence, many in the EU would like to create a "banking union" that would involve continent-wide deposit insurance for EU banks. In exchange for that guarantee, states would have to give up sovereignty to a higher body, which would presumably be heavily influenced by the core European countries (in this case, Britain, Germany, and France).
What would the effect of this be? It turns out that I've done some research on that question.* That work suggests that the answer is: it depends. Specifically, it depends on who the regulator would be. The top two choices appear to be the European Central Bank and the European Banking Authority. Why does it matter?
My research, building off of some work by Copelovitch and Singer, argues that giving regulatory authority to central banks alters the policymaking incentives that central bankers face. Without getting too wonky, it incentives central banks to privilege the needs of the banking sector when choosing monetary policy, as financial instability could lead to the loss of their authority. This, in turn, incentivizes banks to behave more riskily, as they expect to receive preferential treatment from sympathetic central banks, so long as they stay above the statutory requirements. The cumulative result is a more bank-friendly monetary regime (the Copelovitch and Singer result) and a more risk-friendly banking sector (my result, supported by a ton of statistical tests). This may not be what the EU currently has in mind.
On the other hand, regulatory central banks may be better able to prevent financial instability in the first place by tailoring policy to the needs of the financial sector. I do not explicitly study this question, and I doubt it is strictly true, but central bankers have argued according to this logic in the past. Alternatively, unifying regulatory and monetary authority could reduce institutional competition and lead to better-coordinated policies. Of course, if that coordination is in a direction that rewards greater risk-taking by EU banks then that might not be the best thing.
*Currently under review so no link, but interested parties can e-mail me for a copy.
Friday, June 15, 2012
Layna Mosley, one of my professors at UNC, has a piece in Foreign Affairs on the European sovereign debt crisis. In a sense she's come back around to her dissertation work, in which she argued that international investors care much more about outcomes than the particular policies used to generate those outcomes, or things like the partisan composition of governments. Turns out that she was pretty much right about that, at least in the case of Europe.
She has two primary points. The first is that the composition of debt maturity matters quite a lot; a lot of short-term debt means a lot of servicing, which means a greater sensitivity to short-run developments. The second is that investors don't have nearly as much influence on government policies as most commentators ascribe to them. What influence they do have is, again, over outcomes rather than the particular decisions used to reach them. So yes, investors prefer lower debt levels, but they don't particularly care whether fiscal probity is achieved via spending reductions or taxation. Mosley previously referred to this relationship as giving governments "room to move": so long as they stay within certain parameters -- mostly relatively low/stable inflation and relatively low/stable debt levels -- governments have quite a lot of latitude to pursue other policies without being punished by investors.
It's a good piece with valuable lessons. Read it.
Tuesday, June 5, 2012
Its membership in the euro currency union hanging in the balance, Greece continues to receive billions of euros in emergency assistance from a so-called troika of lenders overseeing its bailout.
But almost none of the money is going to the Greek government to pay for vital public services. Instead, it is flowing directly back into the troika’s pockets. ...
If that seems to make little sense economically, it has a certain logic in the politics of euro-finance. After all, the money dispensed by the troika — the European Central Bank, the International Monetary Fund and the European Commission — comes from European taxpayers, many of whom are increasingly wary of the political disarray that has afflicted Athens and clouded the future of the euro zone.More here. I have said for awhile now that the story in the eurozone is that the north would keep the south liquid until the north's banks were sufficiently capitalized to handle a default, at which point the money would stop flowing. I thought that would be sometime in 2013 (I think I wrote a post saying that, but can't find it now), but now I think it could be this year.
Why should IPE folks like this story? Because this is the type of tale we tell all the time: "bailout" funds are used to bail out the donor, not the recipient. Just like "aid" funds to the developing world are often tied to certain types of disbursement and are thus a form of subsidy for corporations in the developed world.
There are parallels here (of course) to the Latin American debt crises of the 1980s, where much of the debt was owed to commercial banks in the U.S. The U.S. Treasury pushed for IMF intervention, mostly so U.S. banks could get their money back without the federal government having to officially bail them out. (The story is even more nuanced -- Congress understood what was happening and demanded new regulations of the banking sector, which led to the creation of the first Basel accord -- as Thomas argues here.)
Monday, June 4, 2012
Banks must raise their core tier one capital ratios to 9pc by the end of this month or face the risk of partial nationalisation. The global Basel III rules are also pressuring banks to retrench.
The International Monetary Fund said banks will have to slash their balance sheets by $2 trillion (£1.6 trillion) by the end of next year even in a "best-case scenario".That is only within the European Union, and it came about due to panic over Greece last month. Basically, this means that EU banks have to increase their capital cushions by over 200% by the end of this month. What does that mean?
The Bank for International Settlements (BIS) said cross-border loans fell by $799bn (£520bn) in the fourth quarter of 2011, led by a broad retreat from Italy, Spain and the eurozone periphery.Note that this just in Europe. But it made me wonder (on Twitter): why do this now? After all, it was Germany that insisted on a longer phase-in period for Basel III during negotiations, while the US/UK/Switzerland wanted that stricter capital requirements. Now the EU is doing a rapid phase-in and tougher capital limits years before they are required to by Basel. And they're doing it in the middle of a bank run during a continent-wide recession. What gives? A few things.
1. Banks do have to get to 9% tier 1 capital by the end of the month, but they don't have to come fully into compliance yet. That is, a lot of junk capital that is prohibited by Basel III -- but was allowed under Basels I and II -- will still be allowed. (ht to @Procyclicality for this point)
2. Nevertheless, this is still a big boost to minimum capital standards. So how will banks come into compliance? Two quick and easy ways are to:
a. Hold more cash.
b. Buy more sovereign debt.
The first of these is contractionary -- it's basically hoarding more cash rather than lending it out -- although the ECB can facilitate it if they want to pump eurozone banks full of cash. Non-euro EU central banks, such as the Bank of England, can do the same thing if they want and the US Federal Reserve has injected a bunch of liquidity into foreign banks when needed in the past as well. As a zero-risk instrument, cash has a zero risk weight, so adding more of it to your portfolio brings your overall capital ratio up.
The second of these is expansionary. OECD sovereign debt also carries a zero risk weight under Basel III, as it did under Basels I and II. This might seem bizarre at first, but remember who's making these rules: OECD governments. And OECD governments want to pay low interest on their debt. To do that, they rig the regulatory rules to make it more attractive for financial institutions to buy that debt. Hence, a zero risk weight in Basel.
So what does that mean? If banks need to boost their capital stock, there are two ways to do it: by raising more capital (e.g. by selling equity) or by shifting their risk portfolio. The
Was this the point of this policy? I don't know. Probably it was mostly a freak-out after runs started on Greece and then Spain. But I imagine it was part of the calculus, or at least has become so since. In practice this will likely be a transfer of private funding for public funding. Given that the ECB cannot provide liquidity directly to eurozone governments, but can accept sovereign debt as collateral when lending to banks, this could be part of a stealth bailout program that began when Mario Draghi took over as ECB chief from Jean-Claude Trichet last year. Call it "bailout by regulatory arbitrage".
Will it work? I don't know.
Monday, May 28, 2012
In his op-ed, Tyler Cowen raises a concern about a euro-collapse that I haven't much seen previously:
We thus face the danger that the euro, the world’s No. 2 reserve currency, could implode. Such an event wouldn’t be just another depreciation or collapse of a currency peg; instead, it would mean that one of the world’s major economic units doesn’t work as currently constituted.There are a lot of claims -- some implicit -- in here. I'll take them in turn.
1. Does an exit of several peripheral countries from the eurozone constitue an implosion of a reserve currency? I don't think so. The status of the euro as a reserve currency does not depend on Greece's membership, it depends on Germany's management of it. If the alternatives are to jettison Greece -- or even several of the GIPSIs -- or to devalue the currency to keep them in, the euro's status as a reserve currency might actually be improved by a smaller membership of weak countries.
2. How important is the euro as a reserve currency? Roughly as important as the German mark was pre-euro, perhaps in combination with the the franc. The euro has not advanced much above the mark+franc status as a global reserve currency, if any at all, since its introduction in 1999. So the global economy as a whole does not appear to be very dependent on the euro; it is dependent on the US and, to a lesser extent, Germany, Britain, and Japan.
3. Would a euro-exit be more severe than a collapse of a currency peg? It conceivably could, but again: what matters most is Germany, and markets' belief in Germany's credibility to maintain a valuable currency. Germany's economy is not on the verge of collapse, nor does it depend on Greece, and German policymakers have repeatedly chosen to maintain policy credibility over possibly saving peripheral members. How much do markets care about Greece? I'll return to that below.
4. Would a euro-exit signal that one of the world's major economic units doesn't work? No. Greece is not one of the world's major economic units. A euro-exit would signal that one of the world's major political units doesn't work, but I'm not sure that this is new information nor am I sure that markets care all that much. The the extent that markets prefer stability over instability any resolution may be preferable to continued uncertainty.
Let's look at some data. Has the euro has significantly weakened as the crisis has grown more severe?
A bit. But if we zoom out and look at a longer time series we see that the euro is now trading at historical levels:
If Greece leaves will the value of the euro hold? Considering that Greece is by far its weakest link I would think so. Indeed, the fewer non-German members in the euro the more credibility it has! Germany does not need to devalue.
Anyway, just how important is the euro? At the end of last year global dollar holdings were nearly 250% higher than euro holdings. Or consider the exchange market. The introduction of the euro did nothing to reduce the world's reliance on the dollar, as I discuss (and graph) here. The euro is used in roughly the same percentage of the world's Forex as was the mark + franc. The global economy survived the end of those currencies.
There is only one truly important global currency -- the dollar.
Perhaps most distressingly, Cowen seemingly misunderstands the arguments of Kindleberger that he references in the paragraph immediately following the quoted one above:
We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences. For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States. (But when it comes to the euro zone, the United States is on the sidelines.)I said a bit about that in my post yesterday, and I'll say more about it in another post (this is plenty long already), but if the hegemon is most important than we should really only be concerned about the US (the global hegemon) and Germany (the regional hegemon), not Europe's southern periphery. And the role of the hegemon is to stabilize the system, not necessarily to guarantee good outcomes for every constituent within it.
Think about it this way: if Germany left the euro and re-issued the mark, do you think it would be stronger or weaker than the Germany-less euro? Do you think the new mark would be used more as a reserve currency than the euro or less?
So why should we think that a Greek exit would be much worse than "another depreciation or collapse of a currency peg"?
Thursday, May 24, 2012
Blogging has been non-existent the past few days because more pressing work has taken precedence. One such thing was an essay (with Thomas) for ForeignPolicy.com on why we should all be more blase about the Greek situation. It's very counter to the sort of convention wisdom that you can find here (other examples cited in our article).You can read it here. Our central claim:
Further economic and financial deterioration in Greece would certainly have negative impacts there and might adversely affect Greece's southern European neighbors, who are facing similar circumstances. But financial weakness in Greece is unlikely to spark a global crisis analogous to the one triggered by Lehman Brothers' collapse in September 2008 -- even if economic woes eventually force Greece to exit the monetary union. Instead, the global consequences of southern Europe's debt crisis are more likely to resemble the Latin American sovereign debt crises of the early 1980s, the East Asian crises of 1997-1998, and Argentina's crisis at the turn of the millennium. Each of these had significant local effects -- widespread bank failures, sharp increases in unemployment, large exchange-rate devaluations, deep recessions -- that were not transmitted globally. Indeed, in each of these cases the global economy continued to grow, major world equity markets held their value, and world trade expanded. None had the dramatic global consequences sparked by Lehman's collapse.We're already getting some pushback -- as we have from the underlying research that informed this piece -- such as this from Dan Drezner:
I think you understated the global impact of the 1997 East Asian crisis. I'd rather avoid another one of those.On the one hand, I agree: I'd rather avoid another one of those, although I don't know how that's possible. On the other, I don't think we understate the global impact of the E. Asia crisis. I think many people dramatically overstate it. The period during which the E. Asian crisis occurred -- the late 1990s -- is associated with one of the largest periods of global economic growth ever. These days we look back on it with nostalgia, and wonder how we can do it again. The E. Asian crisis was a crisis for E. Asia, but not so much for everyone else. I think it's likely that the S. European crisis will be the same. Actually, given the slow-motion nature of the thing, I think it's likely that the S. European crisis will be even less of an event.
We may soon see. I hope we don't.
Monday, May 21, 2012
Henry Farrell re-ups his view of the eurozone as being a game of brinksmanship between Germany and Greece. I objected to this characterization back in February, and I still don't think it's the best. Take this:
If there weren’t any possible resolution, there wouldn’t be any incentive to engage in crisis bargaining. What we’re seeing suggests that the players on both sides think that there is a real chance of catastrophe, but also a real chance of a deal.Whether or not there is a possible resolution is most likely private information. (Or, more accurately, neither side knows the truth.) Let's look at this from Germany's perspective. Who are they negotiating with? For all intents and purposes Greece does not have a government that is capable of negotiating. Any future Greek government also has an inability to make a credible commitment to uphold any negotiated settlement in the future, which is why Germany had previously asked for all political parties in Greece -- whether in the government or not -- to approve of the previous bailout program. It is not clear right now who "Greece" is, much less what it is willing to accept.
Nor is it necessarily clear (to me) that Germany believes that there is a real chance of catastrophe for them if Greece exits. Perhaps there is, but it's probably not an economic catastrophe. At this point it might be cheaper to shore up the banks than to keep funding Greece indefinitely. Remember that Greece's creditors have already taken very large haircuts. Remember that European banks have had years to prepare for this, and European regulators have (presumably) been forcing them to do so. Euro governments, the ECB, and the EFSF would lose something on the order of €200bn from a full Greek default, of which €75bn would come from Germany. This is not nothing -- about 3% of Germany's GDP -- but it isn't enough to sink Germany either.
More likely Germany is worried about the political ramifications of a break-up of the eurozone, but in that case they should be interested in ensuring that they are not blamed when that happens. This implies that they will engage in negotiations right up until the end, and perhaps even after it, to demonstrate that they made a good faith effort to keep the monetary union intact even if they believe that there is no possible resolution that actually keeps the monetary union intact.
At a guess, Greece has considerably more bargaining leverage than it might seem to at first. One useful index of bargaining strength is relative levels of sensitivity to breakdown/catastrophe/failure to reach a deal. It’s plausible that Greece is relatively indifferent to breakdown at this point – years of grinding austerity inside EMU seem barely preferable to the costs of exiting the euro. In contrast, Germany could see the collapse of the euro (and consequent very serious economic costs) if a Greek exit leads to the collapse of confidence in Spanish, Irish, and worst of all, Italian banks. If I were to lay a bet on which side is likely to fold first, I’d be putting my money on the Germans.Again, it's not clear who "Greece" is or what their bargaining position is. As Daniel Davies says in comments on Farrell's post, there is no reason to think that Greece is indifferent between staying in or getting out. Something like 80% of Greeks say that they want to stay in. Even Tsipras has stated no intention to exit. The best case scenario of leaving -- probably Argentina -- is not very good, and I wouldn't be optimistic about the best case scenario obtaining in this case. So how much leverage does that really give Greek leadership? If their citizens want to stay in, and the costs of leaving are extreme, then Germany can demand quite a lot.
Nor is it clear that a Greek exit would lead to a collapse in Spain, much less Italy, or that such a thing could be avoided even if Greece stays in. The fundamentals are crap either way. It's not clear that a collapse in these countries would be devastating for Germany. They've maintained economic growth thus far, and capital flight from the GIPSIs would likely move into Germany, giving them further fiscal flexibility to deal with their banks and macroeconomy.
Right now the political dynamic in Europe is about who gets the blame for a Greek exit. If blame cannot be assigned in a politically satisfying way then they will continue to muddle through. However the greater the costs associated with keeping Greece in, the more likely the blame will shift away from Germany and the more likely that Germany will refuse to pay on any terms that are acceptable to Greek leaders.
Edward Hugh writes of the choices:
Right now there are two, and only two, options on the table: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn’t allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment – and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.The second of those is not palatable. It would wreck what remains of the political integrity of the Euro project, which has already been corrupted by the less-than-democratic approach to the bailout. Political integrity is not about keeping Greece in on whatever terms... moral hazard is a real risk and the original institutions designed to combat moral hazard (eg Stability and Growth Pact) have been obliterated as has the independence of the ECB. In other words, it's not clear what political integrity Germany would really be fighting for. The entire EU social contract has to be re-written anyway, at least implicitly.
Given that, Germany may wish to re-write it on more stable terms.
There is a very real chance that over a medium term time horizon Germany would be better off with Greece out of the eurozone. If that's the case then this isn't a brinksmanship game.
Sunday, May 6, 2012
A few months back I briefly commented on the ways in which different political science paradigms approached global issues differently, as illustrated by the TRIPs survey of academics:
IPE folks are the most convinced that at least one country will leave the euro. More than half of us. Meanwhile, only about 37% of IO folks and 30% of Europeanists think a country will exit the common currency. ...
I find this interesting for a lot of reasons, but mostly because I think provides a pretty stark reminder that political scientists think very differently about politics. This could break down along paradigmatic lines -- the authors of the report note that constructivists tend to be comparativists, while realists tend to be in IR. I still think that a materialist conception of politics carries me farthest down the road I wish to be on, so I think it is fairly likely that a country will drop the euro if things continue to deteriorate.Today comes two developments that are relevant to this discussion. First, and as recently expected, Nicholas Sarkozy lost the French presidency to Francois Hollande in an election that was widely viewed as a referendum on the EU's approach to the ongoing debt crisis, and in particular the Franco-German alliance to push Euro-wide austerity. Hollande has promised a new direction that focuses on growth, rather than austerity, and an unwillingness to let French economic policy be determined by Berlin. As such, the vote appears to be a rebuke of Sarkozy's cozy relationship with German Chancellor Angela Merkel, and a reinforcement of French sovereignty over European solidarity. (Ms. Merkel's party lost another local election, indicating that her citizens aren't especially thrilled with her policy course either.) The election was also notable for the fracture in France's right-wing parties, as the far-right nationalist National Front party received nearly one-fifth of all votes.
In Greece, meanwhile, things have taken a disturbing turn:
Greek voters appeared to radically redraw the political map on Sunday, bolstering the far left and neo-Nazi right in a wave of protest against the dominant political parties they blame for the country’s economic collapse.
The parliamentary elections were the first time that Greece’s foreign loan agreement had been put to a democratic test, and the outcome appeared clear: a rejection of the terms of the bailout and a fragmentation of the vote so severe that the front-runner is expected to have extreme difficulty in forming a government, let alone one that can either enforce or renegotiate the terms of the bailout.You can see what you want to see here. If you think that materialist concerns will dominate European identity in determining the path of the European Union, then there's plenty here for that: the rise of far-right nationalist parties especially, and not just in France and Greece. On the other hand, you could view Hollande's election as a sign that the austerity regime is on the verge of being replaced by a more generous system of transfers that will reinforce European solidarity and identity.
The elections were seen as a pivotal test, determining both the country’s future in Europe and its prospects for economic recovery and the outcome, along with that in France, could resonate far beyond Europe, possibly leading to more upheaval in the euro zone. The early results were also a clear rebuke to European leaders that their strategy for Greece had failed.
Many Europeanists have been expecting such a transformation of identity, from a nationalist identity to a European identity, over time. This is certainly possible in the long run -- think about how we used to refer "These" United States and now refer to "The" United States -- but there are a lot of short-run pitfalls that the European project will have to overcome first. We've had many reminders of these difficulties over the last few years, and for now it appears that the materialists have the upper hand.
I would be shocked if markets didn't respond negatively to these developments, and ultimately markets (and German voters) will decide the eurozone's future whether anyone wants them to or not. Greek voters have lashed out a number of times, but each new incoming leader finds themselves operating under the same constraints. They need money, and to get it they have to do what the lenders want them to do. If German and French voters decide that they're sick of paying then it doesn't matter who runs the Greek government... they'll have no choice but to default.
That, to me, is still the most likely outcome.
Thursday, February 16, 2012
Henry Farrell has written a very useful post describing the eurozone crisis in terms of Schelling's conception of brinksmanship as a negotiating ploy. I am in broad agreement with everything he says about the theory of strategic interaction itself, and in particular this part:
There is a fundamental internal contradiction in Kirkegaard’s argument. You can’t simultaneously claim that we are in that happy world where we can effectively disregard the possibility of disaster, and tell us that actors are using brinkmanship to convince Greece that it needs to undertake internal reforms. Either we are in a world where there is a real risk of disaster, which is what allows Germany and northern European states to engage in brinkmanship. Or we are in a world without such a risk, in which case there is no space for brinkmanship. You can’t have your theoretical cake and eat it too.I'm a big fan of incorporating concepts generally applied to "high politics" -- guns and bombs -- to IPE, and it is easy to conclude that the tactic of brinksmanship may have its uses in situations like these. While I agree with Farrell's take on the theory itself, I'm not sure how well it applies to this particular situation for the reason he lays out: either there is a "real risk of disaster" or there isn't. I don't think there is.
In brinksmanship situations the risk of disaster must be mutual. To stick with Schelling's example -- two men, chained together, dancing ever closer to the edge of a cliff -- the risk must be that both parties will tumble over into oblivion. In a nuclear exchange between the U.S. and U.S.S.R. that was a very real risk; in the E.U. debt negotiations I am not sure that it is. The risk is that Greece tumbles over the cliff, while the rest of Europe watches them fall from above. That is not to say that Greece's collapse would have no adverse consequences for the rest of Europe, but there is nothing close to symmetry: Greece needs Europe much more than Europe needs Greece. If this were not the case, the terms of the proposed bailout -- which, in addition to another round of exceptionally austerity, now includes the virtual abolishment of the democratic process in Greece -- would be nothing like they are.
Throughout this process Greece has had two big plays: default -- which would hurt European creditors, including many banks in northern Europe -- and exit from the eurozone -- which would damage the credibility of the European political project. Both have become less worrisome to northern Europe over time. In the first case, the cost of bailing out Greece now exceeds the cost of bailing out the banks, particular if the ECB continues to make funds available to major European financial institutions. Moreover, European banks have known for a long while now that some form of default was coming, and have (I hope and expect) already made preparations for it. This doesn't mean that a Greek default would be painless, but given the enormous sums of money already committed to Greece and the €200bn now being proposed, shoring up the banks would almost surely require less of a fiscal commitment from other European countries. Moreover, it is more likely that that money will be recouped in full from the banks than from Greece, whose politics are unstable. If done correctly a European "TARP" could even end up breaking even or turning a small profit, as it has in the U.S.
Which brings me to the second potential worry. The exit of Greece from the eurozone would not harm the real economy very much -- Greece's GDP contributes only 2% to the eurozone total -- but could potentially damage the progress of the political union. This is a real concern, but the alternative now appears to be the abolishment of the democratic process in Greece altogether. European leaders are now negotiating with an unelected Greek government, and as a precondition for the release of funds are demanding adherence to the bailout terms from all political parties in the country. Previously they had asked for approval of future Greek budgets. This usurpation of Greek sovereignty, and the derogation of the democratic process within that country, should be as much of an affront to the European political process as the exit of one its least consequential members -- which cooked the books to join the union in the first place and may have never been in compliance with its obligations. Anyway, if a major worry in Europe is the dominance of Germany on the continent, then giving them and their friends such authority over the politics of a member state is not likely to be reassuring.
Another concern has often been expressed: that a Greek default will lead to "contagion". This fear rests on a misunderstanding of what contagion is. If a Greek default led to insolvencies in the banking sectors of other European countries, which then led to the inability of those banks to repay their counterparties in other countries, then this would constitute contagion and might be a real worry. But given the fact that European banks have been preparing for this possibility, given that European governments have already earmarked hundreds of billions of euros for bailout funds, given that the European central bank is finally (sort of) acting like an actual central bank, this should be less of a concern than at any point in the past few years.
The fear that a Greek default will have a negative effect on Portugese bond rates, say, is not about contagion. If investors observe new developments in the European political economy and revise their attitudes towards the riskiness of bonds, that is not contagion. It's simply a rational response to changed circumstances. The European authorities can deal with this in a number of ways, but the most important thing is that no country in Europe is in as desperate of a situation as Greece, or has a real economy in as poor of shape as Greece.
European leaders may believe that Greece -- which now (astoundingly) has a primary budget surplus -- is still capable of generating growth sufficient enough to repay their creditors and remain in the eurozone. If that's the case, then harsh terms on bailout funds are counter-productive. Yet what we observe are the harshest conditions demanded to this point in the process. Given all of the above, it is almost impossible to come to any other conclusion than that European leaders are trying to force Greece out in a way that they can then claim that it was Greece's choice, not theirs.
That is not brinksmanship. That is something else entirely.
UPDATE: See Daniel Davies's "Choose your own adventure" view of the situation, which maps out the difficulties and options nicely and thoroughly.
Monday, January 30, 2012
Major U.S. banks have about $80bn in exposure to troubled European sovereigns, about $30bn of which is protected via CDS. Think $50-80bn is a lot? It is. But remember that TARP was a $700bn program. Remember that the Fed will hold interest rates at zero percent through 2014. Remember that these same five banks control over $9tn (with a 't') in assets. $50-80bn isn't very much for these companies.
Yes, there is still secondary risk from a sovereign default tipping over European banks, which then hold up U.S. banks. That's not nothing at all, but isn't everything either: unless it's a huge event, large enough to take down all the big banks in Europe, then I wouldn't be exceptionally worried about it. And if it's that big then there's likely nothing you can do about it anyway.
The European mess is mostly a European mess. We're not nearly as susceptible to them as they were/are to us.
Sunday, January 22, 2012
It may not be easy to see (click here for a bigger image, and here for some discussion at TMC), but the above graph shows the probability that a political scientist will think that the eurozone will split up versus stay together. The group in the top left are IPE scholars, the middle are International Org scholars, and the bottom are comparativists who study Europe. I'm not a big fan of this graphing style, as it seems to obscure nearly as much information as it illuminates, but it's fairly easy to see that IPE folks are the most convinced that at least one country will leave the euro. More than half of us. Meanwhile, only about 37% of IO folks and 30% of Europeanists think a country will exit the common currency.
I find this interesting for a lot of reasons, but mostly because I think provides a pretty stark reminder that political scientists think very differently about politics. This could break down along paradigmatic lines -- the authors of the report note that constructivists tend to be comparativists, while realists tend to be in IR. I still think that a materialist conception of politics carries me farthest down the road I wish to be on, so I think it is fairly likely that a country will drop the euro if things continue to deteriorate.
I've had many conversations with Europeanists on this point. All of them are enamored of the EU. For them the collapse of the EU is unthinkable. I can't understand why. It's not as if fixed exchange rate regimes -- and political unions -- haven't collapsed before, particularly when subjected to this level of stress. That said, they certainly know more about Europe and the European identity than I do, and they take it very seriously.
I don't really have an answer here. I hope that conditions in the EU improve enough that we don't have to test these paradigms this time. A confederal Europe is good for the world, on net, particularly if they can figure out how to manage the broader economy in ways that don't lead to periodic crises. But I have my doubts about that.
Saturday, January 14, 2012
The decision of S&P to downgrade more or less the whole of Europe has made a lot of headlines, but I'm not sure how much it matters. The plan for Europe before that happened isn't much affected by the downgrade: the ECB prints money and gives it to the banks, accepting EMU sovereign debt as collateral. The banks use the funds to buy sovereign debt. The banks get financing for sure, and if all goes well so do the governments. As far as I can tell, for regulatory purposes all OECD sovereign debt still counts as "risk-less" -- meaning that banks are not forced to hold any capital against it -- under the Basel accords, so there is a regulatory incentive for banks to buy some of this stuff.
There's something absurd about all of this... every step in the chain is an attempt to hear no evil by sticking fingers in one's ear. But if the eurozone is going to survive the European banking system has to stand upright and be able to finance governments. That requires ECB support.
JP MorganChase CEO Jamie Dimon, who often says things in public that are more revealing than he perhaps realizes, recently claimed to believe that there is no banking problem in Europe:
“It eliminates bank liquidity or funding problems for at least the next year, that’s a pretty powerful statement,” Dimon said today after his company reported a drop in fourth-quarter net income. “That was the biggest single risk of an uncontrollable surprise right there, so if that’s taken off the table, that’s a good thing.” ...
“Europe is trying mightily to solve its problems. I still think the likely outcome is they will muddle through,” Dimon said. “The longer you wait, the higher you run the risk of something disorderly that you can’t really control. I think the ECB took off the worst outcome, i.e. a bank failure.”Dimon might be right about Europe being able to muddle through, although I still have my doubts. He might even be right that a bank failure is the "worst outcome" in Europe, although I can think of some worse outcomes. But what he doesn't say, indeed what no one has much talked about, are the negative effects this will likely have in the European banking sector if the plan works.
The problem that the new ECB policy is supposed to resolve is this: banks won't lend to needy European governments except at punitive rates. Why? Because those governments are highly likely to default. This is exactly what we want a responsible, healthy banking sector to do.* What we don't want is what we're now hoping to get, which is to say that we don't want a banking sector whose investment behavior is skewed by political institutions pursuing dubious policy goals. We don't want a banking sector that has an expectation of future support if their investments go bad, and we don't want a banking sector that cannot discipline either itself or those to whom it lends.**
We don't, in short, want a situation in which government interventions make Jamie Dimon smile. (Or interventions that make him rich.)
Is this road less bad than the one Europe was on previously? In short run, surely. In the medium-to-long run it's hard to say. Perhaps we think that once the crisis is resolved the ECB can make a credible future commitment to be more standoffish towards the European banking sector. Perhaps we think that we can rein in banks and national governments in other ways, via strict capital standards for the banks and "Hard Keynesianism" for the governments. But I have little confidence that those things are likely. They cut against almost every identifiable political current.
The only way it works is if this crisis really scares everybody so much that a significant (and durable) shift is made in the regulatory and fiscal infrastructure of Europe. While not impossible, I remain highly skeptical that that will happen. I believe it's more likely that policymakers will conclude that the institutions in place are pretty resilient already -- "How else could we have pulled through this crisis?" -- particularly when coupled with a more activist ECB that will support the banking sector when needed. I believe the banks will conclude that the ECB is their friend, and will therefore count on support when needed, particularly if the cause of the trouble are the member nations of the EMU. That is a recipe for a lot of future financial instability.
The ECB cannot, and should not, be in the business of resolving Europe's political problems. Forcing it into that role is likely to make things worse in the long run.
*The "we" here being an imagined societal consensus in possession of the general will, which reflects more-or-less center-left neoliberal technocratic principles. Yes, I know this "we" does not exist in nature.
**I have a paper, currently R&R, that argues that when banks expect preferential policies from governments they act less prudently. Simple argument, I know, but it's not in the literature yet. I find statistical support. I'll post it if/when it gets accepted somewhere; if someone wants it sooner e-mail me.