Winner of the New Statesman SPERI Prize in Political Economy 2016


Showing posts with label Gechert. Show all posts
Showing posts with label Gechert. Show all posts

Monday, 30 March 2015

Greece and other benefit scroungers

Whenever I write a post critical of German views on Eurozone policy, I get comments which can be paraphrased in the following way. Greece (and maybe other Eurozone countries) are incapable of governing themselves properly, and when they get into difficulties Germany has to bail them out, so it is only reasonable that as a price for this Germany should insist on imposing changes to the way these countries do things.

To say such an attitude is inherently wrong (wrong in any possible circumstances) seems to be too strong. The IMF, after all, has played a very similar role many times. Many may criticise the kinds of reforms that the IMF has demanded as part of its conditionality, but to suggest that conditions are never made as part of such a loan package seems unrealistic.

But while conditionality of any kind cannot be ruled out, it can also go far too far. It should never become imperialism, and the choices of a sovereign people should be respected and accommodated, not ignored.

It is clear that the Greek government ran up unsustainable debts, and tried to hide these. As a result, it was bound to default on those debts. As doing so would exclude it from the markets for a time, it was also reasonable to lend (not give) Greece money to enable it to gradually rather than immediately achieve primary balance. Some conditionality to correct any underlying weaknesses in the openness and accountability of the budgetary process would seem reasonable in such circumstances.

Contrast that with what actually happened. First the Eurozone resisted default, and then it was only partial, which meant providing far larger official loans than were needed. The beneficiaries of this were mainly the financial institutions (e.g. Eurozone banks) who would have otherwise lost money. Second, ridiculously severe austerity was imposed, which crashed the economy and made it much more difficult for Greece to adjust. Third, conditionality far in excess of what was required is being imposed.

I have argued before, based on very rough and ready calculations that the fall in Greek GDP since 2010 could be entirely accounted for by fiscal austerity. This conclusion has now been backed up by rather more rigorous analysis in a new paper by Sebastian Gechert and Ansgar Rannenberg. As we both acknowledge, some GDP loss was inevitable because the deficit had to be reduced (and Greece does not have an independent monetary policy which could offset the impact of deficit reduction). However, as always, timing is everything. The paper argues that “most of the costs of fiscal consolidation could have been avoided by postponing and gradually implementing it after the recovery of the Greek economy, due to the lower expenditure multipliers during normal times.”

The delay in default, its partial nature and a degree of austerity that Gechert and Rannenberg describe as ‘biblical’ and which did such damage are all acutely embarrassing for the Troika. But instead of criticism being directed at these governments, we see a narrative that tries to blame what happened from 2010 onwards on Greece itself, and the Greek people in particular. The economy has crashed because the Greek people do not work hard, austerity has not worked because it has not really happened, and there have not been enough reforms. None of this is true, but the narrative seems largely impervious to facts. (On reforms, for example, see here.)

All this reminds me strongly of how certain attitudes to beneficiaries of the welfare state have been encouraged by the UK coalition government. Rather than admit that unemployment benefits had risen because of the recession and the absence of a recovery (itself a result of austerity), the focus became on the personal failings of the unemployed themselves. The media (TV as well as the tabloids) are still full of examples of supposed ‘welfare cheats’, but they rarely put such examples into context: how tax evasion is a bigger problem that benefit fraud, for example.

People do hate the idea of ‘their taxes’ allowing ‘other people’ to get ‘something for nothing’. In contrast tax evasion does not sound too different from tax avoidance, which many people do as much of as they can. Condemning one and ignoring the other may be human nature. What is clearly wrong is politicians playing on these feelings to misdirect anger away from their own mistakes, or undertaking unnecessary or even harmful policies to play to the gallery. A clear case of the latter is the recent increase in benefit sanctions, which are being applied in an excessive and unfair way, greatly increasing the use of foodbanks as a result. That a committee of MPs where the government is in a majority have expressed grave concerns about the policy just before an election gives an indication of the scale of the injustice that has been taking place.

When politicians do this, it is a sign of chronic political weakness: a desperate attempt to cover up past mistakes. There is a strong danger that the same dynamic may occur in the continuing standoff between Greece and the Eurozone. Having encouraged a rhetoric where a virtuous Eurozone has shown nothing but generosity to a feckless Greece, politicians feel compelled to live up to that false narrative by acting tough in negotiations, which does no one any good to put it mildly. When Putin behaves recklessly to boost his popularity and succeeds, we can blame the lack of press freedom. When political leaders in the UK or Germany play the same trick, do we blame the media for playing along or the people for falling for it?

Sunday, 1 March 2015

Eurozone fiscal policy - still not getting it

The impact of fiscal austerity on the Eurozone as a whole has been immense. In my recent Vox piece, I did a back of the envelope calculation which said that GDP in 2013 might be around 4% lower as a result of cuts in government consumption and investment alone. This seemed to accord with some model based exercises of the impact of austerity as a whole, but others gave larger numbers.

We now have another estimate, which can be thought of as a rather more thorough attempt to do what I did in the Vox article. This paper by Sebastian Gechert, Andrew Hughes Hallett and Ansgar Rannenberg uses multipliers and applies them to the fiscal changes that have occurred in the Eurozone from 2011. Apart from the later start date, the first difference compared to my back of the envelope calculation is that they include all fiscal changes, and not just government consumption and investment. As a large part of the fiscal consolidation in the Eurozone has involved reducing fiscal transfers, this is important.

The second, and more interesting, difference is that rather than pluck a multiplier out of the air, as I did, they use a meta analysis of other studies. I have previously mentioned this meta analysis by Gechert: this paper is based on a follow up by Gechert and Rannenberg. [Correction from original post.] The studies on which these meta analyses are based are not ideal from my personal point of view (more on this later), but what this second paper shows is that fiscal multipliers are larger in depressed economies. Applying these ‘meta multipliers’ to the Eurozone fiscal consolidation implies that GDP was 7.7% lower by 2013 as a result. These numbers are more in the ballpark of the Rannenberg et al paper that I have discussed before.

All these estimates point to huge losses, which monetary policy has neither been willing or able to counteract. Yet the speed at which those in charge of the Eurozone begin to realise the mistake that they have made is painfully slow. Take this recent Vox piece by Marco Buti and Nicolas Carnot. Thankfully they ignore all the Eurozone’s tortuous and sometimes contradictory rules, and just look at two numbers: a measure of ‘economic conditions’ (like the output gap), and a measure of the fiscal gap, which is the difference between the actual primary balance and what it needs to be to get debt falling gradually.

They argue that policy needs to balance the need to reduce both gaps. Looking at these two numbers, they conclude that Germany is overachieving on fiscal adjustment and has a need to increase activity, but although France and Spain also need to increase demand they have a long way to go to eliminate the fiscal gap, so this should dominate. The conclusion is that Germany should go for fiscal stimulus, but “moderate consolidation appears warranted in both France and Spain”. Overall “the Eurozone should conduct a close-to-neutral fiscal stance”.

Let’s deal with that last conclusion first. The mistake there is simple. When monetary policy is stuck at the Zero Lower Bound, it is crazy to balance the output gap with what is your main instrument for correcting that gap, which is fiscal policy. Getting the fiscal gap right is important in the longer term, but in the short term it is the means by which you get the output gap to zero. As the studies mentioned at the beginning of this post show, the current recession is the result of trying to correct the fiscal gap at completely the wrong time. The right policy is to get the output gap to zero, so interest rates can rise above the ZLB, and then you deal with the deficit. Readers of this blog and the blogs of others must be sick and tired of seeing us make this same point over and over again, but the logic has yet to get through to where it matters.

The same principles apply to countries within the Eurozone, except with an additional complication of within Eurozone competitiveness. If a country is too competitive relative to the rest of the Eurozone, it needs to run a positive output gap for a time to generate the inflation that will correct that position, and vice versa. For that reason Germany needs a large positive output gap at the moment (compared to an estimated actual negative gap), and therefore a much more expansionary fiscal policy - not because it is overachieving on debt adjustment. France and Spain now look roughly OK in terms of competitiveness relative to the average (see chart below, and assuming that entry rates in 2000 were appropriate), so there we need fiscal expansion to close the output gap.

So at both the aggregate and individual country level, the inappropriate bias towards fiscal contraction that caused huge losses in the Eurozone in the past continues to operate. Which means, unfortunately, that the needless waste of resources caused by austerity continues to get larger by the day.

Relative Unit Labour Costs, 2010=100, from OECD Economic Outlook