Grillo ergo sum

So in reply to Monti's Agenda, Beppe Grillo has decided he also ought to come up with a programme. Grillo's '16 points' is a pretty depressing read, confirming the total lack of any innovative thinking on the Italian political scene at the moment. Grillo's party basically represents the traditional 'antipolitica' - populist, pseudo-Poujadiste hatred of the political class - which has long been a powerful force in Italy, coexisting oddly with what has actually been a very stable party system for a most of the post-war period.

Italians have comparatively very low levels of trust in their political leaders, yet take a very long time to replace them. The last big political earthquake was in 1992-94, when the post-war political elite revolving around Giulio Andreotti and the slightly younger cohort of Bettino Craxi and Arnaldo Forlani was swept away by the Tangentopoli revelations of entrenched and often spectacular corruption. After the 1994 elections, a new elite based around Berlusconi's dominance of the right (alongside the former Fascist Gianfranco Fini and the Northern separatist Umberto Bossi), former Christian Democrats Romano Prodi and Pierferdinando Casini in the centre and the d'Alema generation of ex-communists on the left, took control and remained at the commands until now. A TV news programme in the UK in 1994 would have featured figures such as John Major, Michael Heseltine, Tony Blair and Gordon Brown. Italian telegiornali still revolve around Berlusconi, Fini, and Casini on the centre-right, and Bersani was already a minister in the first Prodi government elected in 1996.

The forthcoming elections look likely to change all this, with Bossi now off the scene (largely due to illness)) and Berlusconi fighting a last battle to remain relevant. But the novelties on the political scene - Grillo and Monti - seem themselves to be fighting the battles of the past. Monti, himself just short of 70, represents the generation of Eurocrats responsible for designing European Monetary Union, determined to apply the orthodox medicine of austerity to reassure the markets and senior European partners that Italy will keep its side of the eurodeal. Grillo, a comparatively youthful 64, proclaims a sweeping condemnation of the entire Italian political class, and offers a programme in which 10 of the 16 points are focused on reducing the financial costs of professional politicians and eliminating political parties from the decision-making process. On the economy, Grillo suggests a referendum on the euro, a guaranteed minimum income (in which currency?), a stop to big infrastructure projects and a vaguely defined programme to help small and medium-sized businesses. As an economic programme, this could have come straight out of the vague autogestionaire thinking of 1970s eurocommunism.

Faced with this choice, emigration looks the best bet for Italians who have not yet claimed their pensions. Torn between a dour and self-interested technocracy and an opportunistic and ignorant populism, the only viable choice is Bersani's stale recipe of timid liberalization and maintenance of a notoriously unjust and unbalanced welfare state. More than ever, Italy is suffering from its failure to develop a mainstream, social democratic, egalitarian and pro-market party on the left. The PD is trying to become this, but remains trapped by its conservative Catholic wing on the right and its traditional communist wing on the left, neither of whom seem to understand how markets need to be regulated in the modern age.

Privatize and be damned

The Italian elections are looming, and amidst the chaos of elite manoeuvrings there is the glimmering of a policy debate (a bit of a rarity in Italian election campaigns). Mario Monti, despite announcing he would not personally stand in the elections (being a life senator, he will be in parliament anyway) has nailed his colours to the mast publishing an 'agenda' (basically a manifesto) and inviting party lists to commit to electing him Prime Minister once the new parliament is formed.

Interestingly, Monti's programme has already been condemned as 'statist' by Alberto Alesina and Francesco Giavazzi, the economist duo that have spent the last few years vainly demanding liberalization and reform of the Italian economy. Alesina and Giavazzi's argument is that the Italian state acts as a break on economic activity, and a large-scale programme of privatization is needed to liberate Italians from one of the heaviest tax-burdens in the OECD. Rather than taxing the income of productive sectors and then giving them free services, for A % G richer citizens should be offered lower tax rates and invited to take out private insurance policies for healthcare and pay market-based fees for school and university. Mmm, it would be fascinating if that had ever been tried somewhere - then we could maybe get to see what would happen! Of course we have the natural experiment of the US, whose healthcare system is the most expensive and almost certainly the least efficient of any advanced nation. And sure, it has great universities, but I can't remember any studies showing US private high schools as being better than the largely state-funded systems in Europe.

But actually it's even worse than that. Privatization can be at best a modest improvement (for instance, airlines in the 1980s and telecoms, for the most part), a lot of the time, pretty disappointing (utilities without adequate regulation), and sometimes, totally catastrophic (UK railways, Russian... well, just about everything). The point being that even if you believe the market is likely to perform better than the state, privatization isn't enough on its own - it needs to be done properly. And the institutions that determine whether or not a privatization is done properly are precisely the same ones that determine whether or not a state company will fail. So privatization and liberalization in themselves don't solve anything, unless you manage to solve the original problem which is the failure of the political system to nationalize or privatize, regulate or liberalize, efficiently.

So to take an example, cited in the comments to A & G's article, car insurance in Italy before 1994 was a cartel regulated by the state, which fixed prices and allowed insurance companies to enjoy profits without competitive pressure. Then, liberalisation came along with the removal of price controls, and hoopla! Italian car insurance prices increased by 464% in less than two decades. The reason presumably being that the state failed to regulate competition properly in the market, and therefore the removal of price ceilings left the insurance companies free to fix prices at a higher level.

What makes Alesina and Giavazzi sure that privatization in Italy would not be just as bad as statism? No idea. But the fact is that wholesale privatisation - especially of delicate sectors like healthcare and education - would be an accident waiting to happen unless Italy manages to reform its politics. And pushing hard for American-style solutions, precisely when the US is in almost as bad a mess as Italy, doesn't seem politically smart to me.

Catalonia: First Step Towards Independence?

Some more thoughts on Catalonia, this time on the LSE EUROPP blog:

http://blogs.lse.ac.uk/europpblog/2012/11/27/catalonia-election/

Catalonia: a nation with a state?

After spending the last few weeks observing the slow-moving collapse of the Spanish state, the time has come to put down my thoughts on the idea of Catalan independence. Like in any debate on nationalism, these thoughts are part rational, part emotional, and like in any debate relating to identities, someone will probably be offended (for this reason I never blog on the Middle East). So here goes.

The first point is that there is something vaguely insane about using the term 'independence' to describe the putative creation of a Catalan state. As a small European economy, Catalonia would be totally dependent on its neighbours for trade, and assuming it is allowed to seamlessly remain in the European Union, it will have little to no real decision-making power over the issues of the future of the Eurozone and the European integration process in general. Even more than that, nearly four centuries of political integration into the rest of Spain has meant that the Catalan economy is deeply interconnected with the rest of Iberia. Again, decisions made outside Catalonia - potentially by a bitter Spanish electorate sour at the 'divorce' - will have a major effect on its future.

That of course doesn't mean Catalonia can't be a successful state in economic terms. Given the Catalans' famed parsimony, it was predictable that the debate on 'independence' has actually revolved around the economic consequences of the split with Spain. As one of the richer regions in Spain, located closer to the main European markets than other regions, there is every chance the Catalan economy will do just as well if not better outside of Spain. But here's the rub - Spain is in colossal economic trouble, and Catalonia, notwithstanding the supposed 'fiscal dividend' it would gain from no longer subsidizing poorer Spanish regions, is not significantly less exposed to the problems facing the Southern eurozone. Like the rest of Spain, it had a housing boom and bust, its government has racked up huge deficits since the crisis, and its wage costs are uncompetitive. However well the secession negotiations could go, the new Catalan state will remain in the group of troubled Eurozone economies, and all the signs are that these economies will take a very long time to return to growth. NB, no Catalan nationalists are advocating leaving the euro or defaulting on their share of the debt.

The economic crisis has clearly acted as a trigger for the calls for independence, but of course Catalan nationalism has long been about much more than economics. The centrality of the Catalan language and hostility to the reactionary nationalism of the Spanish right have been if anything more important in the period since Franco's death, in which Catalonia, like other 'historic nationalities' in Spain, has acquired significant powers of self-government. The autonomy enjoyed by the Catalan government, the Generalitat, has allowed it to push hard on linguistic policy, ensuring that recent generations of Catalans have been educated in the Catalan language (as well as learning a Catalan-centric version of Spanish history). Until recently, most Catalans were quite happy with their status as a decentralized region within Spain, which correponded to the largely dual national identity of the population (which the plurality of Catalans regarding themselves as both Catalan and Spanish in some measure). The push to independence marks a significant radicalization of Catalan national claims, and although it has clearly been building as a strand of Catalan identity over the past couple of decades, the shift towards independence of the centre-right CiU party led by Artur Mas is a major departure.

So the elections will be worth watching for signs of hesitation amongst the electorate. It is true now that a sizable majority of parties currently present in the Catalan Parlament are advocating independence, but these parties represent a percentage of the electorate which is clearly superior to the numbers expressing support for independence in the opinion surveys we have available. So the question is, will CiU be able to drag its more conservative electorate to the pro-independence camp? The weakness of the two main anti-independence parties - the Spanish Popular Party and the Catalan affiliate of the Socialist Party - makes them unlikely beneficiaries of any hesitance in the Catalan nationalist electorate. But it will be worth taking a close look at turnout. The Catalan population is actually fairly divided between a majority of Catalan speakers and a large minority of Castillian speakers, many of whom are now migrants from Latin America, rather than from Southern Spain as in the past. Will Spanish-speaking or Spanish-identifying Catalan citizens really want to go for an independent state? Will the older generation of Andalusian-born immigrants who have historically supported the Spanish national level parties really accept independence? It is true that Catalan nationalism is more civic and inclusive than, say, Basque nationalism, but how would non-Catalan speakers feel about the official status of Castillian in a new independent state?

The debate so far has barely registered these themes. In fact one of the oddest features of the campaign has been the intervention of overseas-based academics, most notably the economist Xavier Sala-i-Martin, becoming vocal and emotive advocates of Catalan 'patriotism', revealing an uncharacteristic lack of seny (Catalan for a kind of pragmatic common sense). Nationalism is ultimately an emotive construct which fits ill with rational debate. For this reason, debate around identities is rarely conducive to sensible decision-making, as the history of the last couple of centuries has clearly established. Catalonia does not have to fall into the kind of disastrous traps of other secession processes, but the insouciance with which such a major change is being contemplated suggests a lack of awareness or a short historical memory.

The Economist discovers social democracy

Interesting to see The Economist lauding Sweden: The new model. Sweden has a generous welfare state, strong trade unions, and high living standards. What's more, at the moment Sweden is one of the few advanced democracies that is growing and has a budget surplus. So it's about time some of the mainstream commentariat starting to notice what was going on.

In fact Sweden is not really an outlier or an exception. If we look around the advanced democracies, the best performing countries have been those with the most generous welfare states and most entrenched trade unions (Sweden, Netherlands, Finland, and of course Germany). In contrast the countries with deregulated financial markets, weak trade unions and limited welfare states are mostly suffering, and the PIIGS of the Eurozone periphery, despite popular myth, also have weak unions and patchy social coverage.

So the crisis, in fact, has exposed the bankruptcy of the free market, anti-social model that has dominated politics and economic policy since the 1980s. Strangely, political leaders have failed to catch on, and continue to plug the same snake oil, in the guise of 'structural reform', which has brought disaster. The misery of the current recession, instead of sparking a search for equitable solutions, has instead led to a descent into masochistic and self-defeating austerity policies, with a bit of free market liberalism thrown in. After 2-3 years of this medicine has failed to turn around any of the economies it has been applied in, a rethink is overdue. Unfortunately it will probably take total social breakdown (probably in Greece and/or Spain) before the humble pie is consumed.

'via Blog this'

Stress-testing European democracy

One thing we have learned so far in the Great Recession is that stress tests for banks are pretty much a waste of time, because nobody seems to take them that seriously. Like all other estimates of the depth of our financial crisis, the stress tests understate the scale of banking losses and overstate their ability to withstand further shocks. Current estimates of Spanish banks' shortfall -  around 60 billion euros - are scarcely believable, given that the collapse of the housing bubble in Ireland - a country with a tenth of the population of Spain, was over 50 billion. So much for stress tests for banks.

But we are doing quite a lot better at stress-testing the democratic regimes of periphery countries. Yes, that's right, those countries with the most recent experience of dictatorship, the ones whose democracies are scarcely two generations old. Greece, Spain and Portugal began the 1970s, the last great economic crisis, as authoritarian regimes of varying degrees of brutality. By the time the years of stagflation were over, dictators had been booted out of all three countries and replaced by democracies which, on the whole, have been as successful as anyone observing events in the 1970s could have hoped.

Until now. Unemployment of 25% in Spain and Greece, well over 50% youth unemployment, a total GDP contraction in Greece of 25% since 2007, and more austerity to come.

I'm still pretty confident of democracy in Spain and, as far as I can tell, Portugal. And I think Italy, with all its huge failings as a political system, has far too powerful a democratic majority to regress to where it was in the 1930s.

But Greece, I have to say, really worries me now. Stories of the police referring citizens to the viligante arm of Golden Dawn, and the recent polls placing the thugs as third party ahead of PASOK, set my hair on end. In Spain, democracy is being stressed in different ways - not only on the streets, with increasingly tense demonstrations by the real victims of the crisis, the young (and a nostalgically brutal response by the police), but also with the Catalan challenge to the 1978 constitutional settlement, which has the potential to create political chaos.

Not only are we unlearning the economic lessons of the 1930s, as Paul Krugman keeps reminding us, we are also unlearning the political ones. When placed in an impossible situation, there is no guarantee voters will respond with trusting patience in the established elites when there are political entrepreneurs out there with easy solutions to their problems. So far, only Angela Merkel amongst major European leaders has survived an election since 2008. In Greece, rapid turnover has decimated the party system and opened up a huge space for the worst kind of racist nationalist demagoguery. And the worst thing is, that the mainstream parties are, generally speaking, at a loss to respond to the crisis, so we can hardly blame people for turning to the alternative.

There's more at stake here than economic growth. The EU elites need, as Samuel L. Jackson might say, to 'wake the f*** up'.

Italy and the EU debt crisis

Commentary on the Euro crisis to be published in the autumn:

In 2012, the Eurozone crisis has begun to follow a predictable script. First, a member state begins to show signs of financial stress, with a growing public deficit and debt burden alarming markets. The spike in borrowing costs sparks a policy response by the member state government, raising taxes and cutting public spending, which depresses economic activity further. The resulting poor growth data leads to further increases in borrowing costs. When these costs hit an unsustainable level, the European Union institutions intervene by lending the struggling country bailout money, in return for further commitments to reduce the deficit.  A further fiscal squeeze follows, sending the debtor nation into what economist Paul Krugman describes as a ‘death spiral’.

A footballing lesson

So Spain triumph again.

Not just triumph, but crush an Italian side that in turn had crushed the fancied Germans the other side. Maybe a game too far for the azzurri, they looked tired and barely got into the game. But how on earth do you play against this team?

And team is the operative word. Great international sides of the past have often been associated with one great player: Pelé's Brazil, Maradona's Argentina, Cruyff's Holland, Zidane's France and so on. And sure, Xavi and Iniesta have stood out in particular. But what is striking about Spain is that they could probably put out two elevens that would give any other team a game. Villa breaks a leg? Never mind, there is Jordi Alba. Torres is out of form? Who cares, we'll just play 8 attacking midfielders and let Fabregas and Silva score the goals. Puyol injured? No worries, play Arbeloa alongside Piqué and Ramos. If Casillas ever got hurt, you would get Pepe Reina, maybe the best keeper in the Premiership. Arsenal's Arteta doesn't even make the squad. In the end, Italy's players expended so many resources to get to the final they had little energy left, Spain could rotate and give key players a break without missing a kick.

God knows what would have happened had England encountered this team.

So much for dynamic provisioning

Nice piece in Bloomberg by Jonathan Weil (The EU Smiled While Spain’s Banks Cooked the Books), pointing out the perverse effects of the Spanish regulatory practice of demanding that banks adjust their accounts for the potential vagueries of the economic cycle ('dynamic provisioning'), supposedly giving them a buffer against downturns.

Turns out that Spanish banks were able in this way to hide their losses from the popping of the housing bubble until quite recently. Has this helped smooth the financial consequences of the downturn? No need to answer that question.

All this goes to show that tweaking accounting practices is never going to achieve much if the financial system is based on the kind of Ponzi schemes we've been seeing in the past two-three decades. Governments are going to have to start getting on top of what banks do, and providing better regulatory and fiscal incentives to real investment in real productive activities. How do they do this? Don't ask me, I'm not an economist.

From technocracy to populism

A blog post for the LSE's EUROPP blog:


In upcoming elections across the Eurozone periphery, voters are likely to react to austerity by replacing technocracy with populism | EUROPP

"As Spain lurches into economic and financial collapse only months after electing a new government with a landslide majority, the difficult relationship between crisis management and democratic politics once again comes into view. Spain’s rapid descent into economic meltdown has been greeted by anti-austerity commentators such as Paul Krugman and Martin Wolf as further evidence of the need for fiscal and monetary expansion on a massive scale in the Eurozone. But it also has important implications for the nature of democracy in the European Union...."

The myth of moral hazard, or why punishing debtors is futile

This crisis, and its Eurozone variant in particular, is teaching us an awful lot about the political economy. Sadly, most of what we are learning is entirely at odds with the conventional wisdom which still informs policy. And a good part of the wrongheadedness that we are subject to revolves around the concept of moral hazard.

The plausible expectation of bailouts creates moral hazard, we are told. Yes, it does. There is plenty of evidence that big financial institutions take risks because they expect governments to pick up the pieces if everything goes pear-shaped. Certainly, if top bankers are anywhere near as smart as their paypackets suggest, they should lever up and max on risk, confident that governments will plug the gap if their bets go bad.

Trouble is, we also know that finance is also prone to bouts of irrational exuberance and panic. Moral hazard may exacerbate the exuberant parts of the cycle, but it also mitigates the panic when things turn bad. Part of (maybe most of) the reason that the Eurozone periphery is in such a self-fulfilling debt trap is that there isn't enough moral hazard around - investors are terrified that if their paper goes bad, they will lose everything. And so the downward spiral accelerates, making bailout infinitely more expensive as panic sets in.

What about governments? Well here the virtuous Northern economies in the Eurozone are afraid that bailouts now will encourage Southern sovereigns to ignore their fiscal problems in the future, leaving Germany and the others on the hook forever. Moral hazard here gives politicians an incentive to run deficits and buy popularity, whilst others pick up the tab.

The trouble with this one is that the politicians that are punished are not usually the ones who exploited moral hazard. Mariano Rajoy took over when Spain's fiscal situation was already out of control, yet he is the politician being exposed to popular anger now. For the anti-bailout policy to work, voters would have to be sophisticated enough to gauge how likely it is that a party's fiscal proposal at time t will result in another party having to impose brutal austerity at time t + 1. Very often, as in Greece, successive alternating governments are responsible for the fiscal mess. How can voters cast a partisan vote that sends the correct signal to politicians, so that the risk of irresponsible policy is averted? Do we really think that if this crisis ever ends Greek voters will become eager observers of fiscal rigour on the part of their politicians, anxious to avoid this all happening again? For this to happen some Greek politicians would have to offer voters fiscal prudence whilst others stuck to deficit-fuelled patronage politics, making elections a clear choice between happiness and hazard. That's rarely the way politics works.

In short, moral hazard is a red herring, and theorizations of its role in the crisis are crude, confused and make no historical sense. In the real world of politics and markets, when you get to the point where bailouts are necessary, it's far too late to worry about moral hazard. This is what we should be worrying about.

Angela's dilemmas and the nightmare scenario

The FT has a nice piece today about the loneliness of Angela Merkel, torn between seeing the Eurozone fall apart and taking decisions that would rescue the periphery but provoke a furious backlash at home. It is indeed easy to criticize Merkel for her cagey approach, which given the fear in the markets seems almost designed to make the costs of rescue as high as they could possibly be. I agree completely with these criticisms, but what people like Martin Wolf and Paul Krugman often miss - focused as they are on debating the stupid austerian policies advocated by many economists - is that this is a political process.

Merkel is not doing what is necessary, but the reason may not be just that she doesn't know what she's doing. First, she is a government leader in a consensus-oriented democracy, with coalition government and federal institutions, and like any other party leader she faces the constant threat of dissent from within her own party. Juggling these various threats to her position are probably her main concern, regardless of how much she understands about the nature of the Euro crisis. It could well turn out that a plan for economic recovery, involving massive bailouts, permanent ceding of German fiscal autonomy, and the collapse of the Euro's monetary conservatism, would cost her her job.

Second, even if Merkel understood what Krugman and Wolf eloquently argue day after day, and had the political authority to convince the German political class and electorate of what needed to be done, she would run into another problem - the European-level joint decision trap, Fritz Scharpf's well known conceptualization of the restraints on policymaking in federal states like Germany and intergovernmental organizations like the European Union. What if the European Commission, the ECB and the other Northern Euro member states said no? Merkel would have blown her political clout in Germany for nothing. Getting anything through the European institutions is complicated and time-consuming. Add the permanent subsidizing of the hapless 'Club Med' nations by the virtuous Weberians of Northern Europe, and you get a recipe for the worst kind of Euro-paralysis.

Finally, we get to a further dimension to the politics of crisis that has been widely ignored, even by the smartest commentators - democracy and the people (easy to forget about, I know). Even if all the dilemmas outlined above could be resolved, there is no way a solution to the Euro mess can be sustainable if it doesn't have popular support. So far, this point has been made most obviously in the struggling periphery, where elections have wiped out the governments responsible for crisis and austerity in Ireland, Spain and Greece, whilst Berlusconi has been forced out in Italy. Yet the same problem could easily arise in the North, as Geert Wilders' recent departure from the Dutch governing majority shows. If Merkel signs up for a Eurozone welfare state, there's every chance that an electoral earthquake could shake the German party system just as it already has in Greece.

Which brings me to my nightmare scenario. I still believe that politicians will blink before allowing the Eurozone to implode, wreaking havoc all around. The reason for this is that I think most policymakers are sufficiently aware of what the consequences could be, and are rightly terrified. But democratic elections are a cruder instrument for making decisions. Greek and German voters, exercising the democratic right to express their outrage, could place Europe in an impasse which would lead inevitably to the catastrophe we all fear. Popular pressure for intransigence in the North, to match popular pressure against austerity in the South, could place Europe's leaders in a chicken game that will end badly for everybody.

The only way out is leadership. Come out, explain to people what is going on, and hope for the best. But that has never been the way European integration works.

The Eurozone: an economy without a state

In today's FT Martin Wolf, as ever, nails it (The riddle of German self-interest - FT.com). One of the peculiar features of the crisis is that the Euro was created with the express purpose of facilitating financial and commercial integration, and yet at the first crisis the Eurozone institutions have refused to backstop the cross-border financial commitments that have been made, leading to a flight for safety which has created havoc. Didn't anyone think this could happen?

Certainly the history of financial globalization offered a few hints. Eric Helleiner's excellent book States and the Emergence of Global Finance details the myriad ways in which governments backstopped the increasing financial integration of the period after the 1970s, most notably by stepping in to halt financial crises with bailouts. These bailouts confirmed governments' commitments to the newly integrated financial order and gave investors the confidence to continue treating the global financial arena as a properly functioning market.

The saddest thing about this whole crisis is that it underlines the fatal lack of understanding on the part of policymakers, and the academics who advised them, of how markets actually work. They designed institutions which essentially, like in Alan Greenspan's 'flawed' model, relied on market participants behaving rationally (whatever that means). Rational behaviour is, of course, difficult to define and operationalize, but one thing that we know for sure is that piling money into indebted states with a history of reneging on commitments and overinflated real estate markets was obviously outside any meaningful theory of the self-regulating market. It's time to recognize that the theory was wrong, and that the Eurozone, like any other economy, needs a government.

Why Spain is bust and Italy is simply broke (again)

Despite a bad auction today, Italy seems overall in better shape than the rest of Southern Europe as the FT recognized today (Are Italy and Spain decoupling? | Brussels blog). It has run a primary deficit ever since the early 1990s, something way beyond the abilities of the other periphery countries at the moment. The reason for this is, ironically, the fact that Italian public debt has been at crisis levels for a couple of decades - Italy faced a huge fiscal crisis back in the early 1990s, which was resolved thanks to fiscal reforms and spending adjustments pushed through by more or less technocratic governments headed by Giuliano Amato, Carlo Azeglio Ciampi and Romano Prodi. Italy would never have qualified for the Euro had it not made this herculean effort. And although Berlusconi failed to maintain this downward pressure on the debt, his governments continued to run primary surpluses up until the crisis of 2008.

Clearly Italy has intractable structural weaknesses and the future is far from rosy. But at least it didn't delude itself with a glorious decade of debt-fuelled growth, like its Mediterranean neighbours to the East and West. This made the reckoning a lot easier to cope with, particularly since Italian banks don't seem to have abandoned their traditional caution when it comes to home loans and consumer credit. Things are bad, but not as bad as they could be, and if Italy is dragged into default, it will largely be the result of Eurozone-wide contagion, rather than its own specific weaknesses.

Anyway, the point of this post is largely to crow about the fact that I made this point a couple of years ago.

Spain heading for bailout

It's hard to imagine anything more inevitable than Spain needing a bailout, and soon. The Rajoy government's latest trick - recapitalizing a bankrupt bank, Bankia, with bonds from a near-bankrupt state, Spain, is probably the final straw for investors who are paying attention. Bankia, in turn, has been suggesting that one way to return to profitability is to reduce its tax liability: in other words, to help the Spanish government get its money back, they will endeavour to pay less money to the Spanish government.

This is what hiring the likes of de Guindos achieves. After all, employees of institutions like Lehman Brothers are essentially trained to make money through tax avoidance/arbitrage and clever accounting, rather than generating real wealth through smart investment. The Spanish government is now in the hands of people whose ignorance and arrogance led the country into this mess, in both the political and the financial institutions. Rajoy turned a blind eye whilst corrupt regional leaders like Camps and Aguirre fuelled real estate booms which paid for their vote grabbing and created the conditions for today's tragic scenario.

Now it's all down to Europe. Will they blink, or will they bail? Almost certainly they will bail, just like in Greece, but in such a way as to make recovery impossible. If they let Greece go, who will buy into Spain? The endgame approaches.

No democracy please, we're Europeans

So David Cameron wades in on the Greece crisis - sense of irony failure there I think.

Anyway, the Greeks are coming under pressure to vote for mainstream, pro-austerity parties, despite having voted for something else less than a month ago. This tells you everything you need to know about the role of democracy in the Eurozone.

In fact, the decline in democratic accountability is not an accident: it is the result in part of a certain demobilization of mass electorates in western countries, which has a variety of structural causes, but in part also of the determination of powerful interests to remove popular consent from a range of key economic decision making arenas. This, in turn, exacerbates the trend towards popular apathy, or at least resignation.

So currently, a set of institutions of 'governance' in the Eurozone have not only allowed a disaster to take place, but have also blocked any proper discussion of alternative ways out of the disaster. So the key actor in the management of the crisis is the ECB, an entirely unelected and unaccountable body with a tight connection to the world of finance, and largely impermeable to other interests. What makes you think that an institution like the ECB would ever be inclined to adopt policies in the interests of the non-rich majority of the Eurozone population?

The role of electorates, in the ECB/Merkel view, seems to be to elect governments that will follow policies the ECB, and by extension financial interests, want, even if this is going to lead to all of the burden of adjustment falling on the bottom 90-odd%. The Euro system was deliberately designed in this way to avoid politicians responding to popular demands for spending and low taxes. Clearly popular policies are not always in the long term interests of an economy, but surely it is the job of the democratic institutions to determine what those are?

What we have now is a technocratic approach to government which is not only democratic, it is very likely applying the wrong policies. If we have to have wrong policies, let's at least choose them through democratic means. And who knows, given the chance people might surprise the political class and the economics profession by choosing governments and policies that work in their interests.

The impossibility of austerity

One of the best pieces I've read on the Southern Europe debt crisis: EconoMonitor : EconoMonitor » Europe’s Depressing Prospects: Two Reasons Why Spain Will Leave the Euro

The following (a quote from Ambrose Evans-Pritchard) is particularly eloquent:


Berlin seems to think it can lock in a current account surplus with Club Med in perpetuity. Clearly, such as an arrangement is mathematically impossible within a currency union – unless Germany is willing to offset the surplus with flows of money for ever, either through fiscal transfers or loans or investment. These flows have been cut off.

So simple, and yet so difficult for many powerful people to grasp.

I still think Germany and the EU powers that be will blink first. But if they don't change course soon this will be a catastrophe.

Politics against markets - again

With the imposition of technocracy in the Southern periphery of the Eurozone and the challenge from extreme right parties in France and Holland, commentators are starting to notice that there is a legitimacy problem in European politics (for instance, Tony Barber Europe must confront crisis of legitimacy - FT.com). Political parties were accepted by mass publics in the postwar period because they guaranteed economic progress and security through the welfare state; the turn to austerity breaks this pact and throws the party system into disarray.

To which I might add - welcome to the real world. The crisis of legitimacy in mainstream party politics is not a novelty, but represents trends that have been present for quite a while (even a quarter of a century in some cases). Parties are challenged because of two parallel and inter-related trends: the decline of mass participation through political parties, and the success of an economic theory that was inimical to the idea of popular intervention in economic policy. Markets would provide individuals with choices, but collective action to shape markets should be minimized, and where possible, eliminated.

In response to the depoliticization of economic policy through institutions like independent central banks, fiscal rules and European-level regulation, demands for popular participation in the management of the economy could no longer be articulated through the mainstream parties which had, almost without exception, bought into the new model. Not surprisingly, voters that were unhappy with the new arrangements turned to 'outsider' parties, and outsider parties, again unsurprisingly, tended to be populist and often extremist. A common theme in the populist turn, above and beyond the ignorant racism to which they often appeal, is the demand for an end to the 'cosy cartel' of the mainstream parties, and protection against markets (usually in the form of opposition to globalization and immigration).

So the trend towards populism has old roots, although the crisis and the absurd reliance on austerity to respond to it has thrown fuel on the fire. In dire economic times, governments tend to be thrown out. If oppositions offer no alternative to incumbents, then populist success is to be expected. If anything, it's surprising that Marine Le Pen won only 2-3% more votes than her father had in much happier economic times a decade ago.

All this points, at least for me, to one conclusion: that the attempt to take the politics out of economic policy has failed. It has failed economically, that much is obvious, but it has also failed politically, by alienating people from a political process that they sense is designed to ignore their views. The crisis is not just the result of reckless greedy private bankers, it is also a failure of the central bankers who were protected from democratic pressures because that was supposed to allow for better policy.

We need new economic institutions, and we need to build popular support for these new institutions. Politics and markets have got to be made to coexist.

I unlike technocracy

Just did a blog post for the LSE European Politics and Policy Blog (EUROPP): link here.

European democracy?

So, a busy week next week. First up, a conference on the Euro crisis at Brown University. I'm going to be on a panel entitled Can Europe survive the Euro? I thought it might be an idea to write down a few ideas beforehand, so here they are:

Being British is not usually a qualification for balanced comment on the state of the European Union and, particularly, the Eurozone. However, UK nationality and residence does provide an interesting vantage point on the Euro’s problems, particularly for those of us who are instinctively pro-European. Unlike in more traditionally pro-integrationist countries, supporters of the EU have had to try very hard to justify pro-European arguments to a largely sceptical population. Ignoring the risks and costs of EU membership has never been an option.

Spain, again

Now that Greece is off the front pages for a few days, we all turn our attention to Spain (Spanish bonds hit by poor auction - FT.com).

Spain's problems are rather different from Greece's, and those differences are now widely understood: Spain had a balanced budget and a small public debt before the crisis, but ran up a crazy amount of private debt, largely backed by a property bubble in a largely saturated housing market. The result is that Spain has a British-style deleveraging recession, which is starting to become a sovereign debt crisis too as investors wonder whether it can sustain high budget deficits in the absence of growth.

The irony of all this is that the markets now that austerity won't work, but insist on it anyway. What do I mean by this? That investors want some kind of guarantee that deficits will be reduced so that the state debt burden will be sustainable, but know perfectly well that retrenchment now will make the recession worse, making everything less sustainable.

So what indebted governments need is a mechanism for convincing the markets that deficit reduction will come, but not yet. This mechanism has to be some kind of credible European-level institution, that can commit to both sovereign solvency and growth. The current German obsession with punitive deficit reduction strategies is the last thing we need, since the alternative - euro exit and default - is in no-one's interests, yet may end up happening anyway because of the impossibility of everyone deleveraging at once.

Inside the German mind

In case you're completely flummoxed as to why Germany insists on the self-defeating austerity policy, and have read too much Paul Krugman, you should really check out this great policy brief from the European Council for Foreign Relations - it explains the German economic policy paradigm and its roots in the tradition of ordoliberalism.

The conclusion: don't expect the Germans to give way on this. You have been warned.

Merkel's vision for Europe

Angela Merkel has made an interesting and depressing speech about the Euro situation, reported here (Germany and Europe: A very federal formula - FT.com).

My first reaction is - good luck with that. Events today in Greece suggest it is entirely fanciful to imagine that such a fiscal union could ever get off the ground. Inviting countries that are suffering the worst crisis for the best part of a century to give up what is left of their political independence is an ambitious project indeed. Actually, for ambitious read ridiculous.

But quite apart from the practicalities, it is the wrong objective for a whole host of reasons.

First, not satisfied with designing a currency union which tried (and failed) to control some risks (government deficits) but ignored much bigger ones (volatile capital flows), the Franco-German leadership wants to entrench the same mistake in a much more rigid fiscal union. Worse, it would be a pro-cyclical fiscal union, focused mainly on preventing governments from intervening in slumps. The last three years have demonstrated that it is completely stupid to try to balance budgets in a recession. So Merkel's response is to prevent anyone from opting out of the stupidity.

Second, this institutional design, as well as being bad for everyone, is also worse for some member states than others. So Germany and France will be required to do next to nothing, whilst the GIIPS countries will have to jump through flaming hoops. Guess which member states have the most power in the EU? Well, that would be the ones who won't be required to make any sacrifices. Funny that.

Third, and perhaps most important, does anyone seriously think such measures could win popular support? I'm pretty sure Merkel is under no illusions. So that means yet another backroom deal which Europe's beleaguered leaders will then have to foist on their electorates as a fait accompli. Only this time, governments are not just unpopular, they have lost all authority to ask for sacrifices. Syntagma square here we come.

So in short, we have a proposal which is undemocratic, economically insane, and can only work if the EU drops any pretence that there are EU member states that matter, and EU member states who just have to suck it up.

Blogging the Italian Crisis

Not much action on these pages in the last few days, largely because I've been writing a piece on Monti and the Italian crisis. And you lucky readers get to see the draft first. Here goes:

Italy has long been seen as a weak link in the Euro. Back in the 1980s, when plans for monetary union first began to take shape, fears that Italy’s political instability and fiscal indiscipline might derail the project were a serious obstacle to progress. The stringent criteria laid down by the Maastricht Treaty for participation in the Euro were designed with Italy and its large public debt in mind, and the Growth and Stability Pact which unsuccessfully governed the Eurozone’s public finances through the 2000s was principally aimed at curbing deficit spending south of the Alps. The current scenario, in which Italy’s creditworthiness is doubted by the financial markets and its debt problems are beginning to seem unsustainable, is the nightmare European policymakers have long dreaded. With Italy in trouble, the once apocalyptic danger of a Greek default is now seen as no more than a little local difficulty. 

Tax evasion on ice

Looks like the Italian revenue services are taking tax evasion a bit more seriously (did they read this?). Repubblica.it reports that the Venetian tax inspection office "raided" Cortina d'Ampezzo, an emblematic ski resort for the wealthy, and ran a series of inspections of bars and restaurants, with the result that their declared takings since New Year's Day have increased by several hundred per cent compared with the same period last year. A parallel investigation of over 200 luxury automobiles revealed that dozens of them were owned by people whose tax returns reported gross incomes of less than €30,000 per year.

Similar raids have happened before, and they are never sustained over time. Let's see if things change under Monti. If they do, we can be sure that Berlusconi's Pdl party will be ready to bring the government down: the only reactions from the Pdl to the Cortina operation were critical of the 'police state' tactics deployed.

Make them pay

Reflecting on the notion of collective moral hazard, I have been thinking about ways of disaggregating the responsibility for the budget crises facing most advanced democracies. Of course, I don't buy the austerity argument, and I am totally unconvinced that deficit reduction serves any useful purpose in the current climate. But if sacrifices have to be made, how are we supposed to allocate the pain?

In the Italian case, there is a pretty clear line of responsibility. In periods of centre-left rule (1995-2001, 2006-7), the deficit went down, whilst in periods of centre-right rule (up to 1995, and then from 2001 to the present, save the short-lived Prodi II government) deficits have remained stable or increased. The picture is made clear enough here:

So, we can attribute a chunk of the responsibility to the Berlusconi-led centre-right coalition for Italy's failure to reduce its debt substantially over the past two decades (an argument I made here in a piece for Foreign Affairs). We can make a case that citizens who voted for these administrations should therefore be first in line to pay the costs of their mistakes, particularly in view of the fact that the failure to reduce the deficit was also motivated by the need to distribute favours to this very electorate.

In fact, what seems to have happened is that centre-right voters got most of the benefit of deficit spending (in the form of distributive spending and tax concessions, including a light touch for tax evasion) whilst centre-left voters got little direct benefit from the briefer periods of centre-left government, in which the focus was on repairing the damage made by their opponents (as is indeed the case for the Monti government, so far robustly supported by the centre-left).

So as a matter of social justice, centre-right voters should pay more to get the deficit down. They tend to be wealthier, are more likely to have evaded tax, and are more likely to have received material benefit from the deficit-inducing policies of their governments. But more than all of this, they are directly responsible for the policies followed, in much the same way that drivers of gas-guzzling cars should pay more of the cost for addressing global warming.

Of course, a policy like this is difficult to apply, since voting in Italy, as in all democracies, is by secret ballot. Arguments have been made for changing this, to encourage voters to exercise moral responsibility for their choices (eg here). I propose a further refinement: tax liabilities should be adjusted according to the degree of voter responsibility for good and bad fiscal outcomes: so a 100% Berlusconi voting record could imply a 100% increase in the differential tax burden for deficit reduction, whilst a 100% Prodi/centre-left record could imply a 50% discount.

This is merely an extension of the notions of liability will already apply to other activities with the potential for negative externalities. And it is also consistent with the notion of applying a stricter correspondence of duties and rights in democratic societies. It won't solve Italy's problems, because the people I would target already evade much of their tax liabilities - just getting them to comply with the law would be a start. But the fact that the burden of deficit reduction in most countries is falling on those who did least to create the problem in the first place offends any notion of social justice I can think of.