The wheels on the bus

I have an image in my mind. Its a bus running downhill, and its brakes have failed. There are four men in the front cab. The two men in the middle are both trying to control the steering wheel to keep the bus on the road. The man to their right has control of the accelerator, and is pushing on the gas hoping this will crash the bus to the right. The fourth man to their left controls nothing, but as his pleas to stop pressing the accelerator fall on deaf ears, he begins to wonder whether it would be better for the passengers to grab the wheel and crash the bus to the left. The three other drivers do not agree on very much, except that it is all the fault of the guy on the left, and now appear to be thinking about throwing him off. As the bus hurtles downhill swerving from side to side, its passengers are battered, some injured, and a few are jumping off.

I do not need to explain the symbolism. I tried to change the image to explain why the man on the right refuses to stop pressing on the accelerator of growing primary surpluses, but gave up because the real reason is that he wants to crash the bus anyway. (The argument that the Eurozone’s rules do not allow debt write-offs is just nonsense.) Otherwise I think the image works well. The two men in the centre represent Tsipras and maybe Hollande. Hollande is saying that if only you would let me have the wheel (‘structural reform’) all would be well, but in truth the main reason the passengers are being injured (unemployment and welfare cuts) or are jumping (migration) is the speed of the bus.

The central question is whether the men in the middle are delusional. By keeping the Greek economy on the road that is the Eurozone are they only going to prolong the agony with the same inevitable crash which is Grexit?

There is only one reason for optimism that I can see, although it assumes yet further reductions in Greek living standards. The hill the bus is travelling along will begin to flatten out and the road might even start to rise as Greece becomes more competitive in terms of price. I outlined here why that has not yet boosted the Greek economy to the extent it has in Ireland, but if unemployment remains at or above 25% Greece should get even more competitive. Instability and unwise Troika interventions may delay the process, but eventually the tourists will come. The Eurozone does contain a natural correction mechanism: it is just slow and painful.

If this does eventually lead to sustained growth in Greece, it does not excuse what has gone before: recoveries do not justify recessions, and government profligacy does not have to imply a 25% fall in GDP! However this correction mechanism is not bound to succeed, if it is countered by another dynamic, which is one that has been and continues to be imposed by the Troika. That dynamic is austerity chasing primary surpluses when that austerity makes the economy shrink. Macromodels would probably tell us which dynamic will win out, but they will not factor in a deterioration in the financial position of banks (already not good as Frances Coppola points out) as the economy stagnates, and the deteriorating social and political situation that austerity brings.

So the eventual outcome still depends on the decisions of the Troika. It always has of course. The truth that their apologists find so uncomfortable is that the Troika has been in charge of the economy since 2010, and therefore is responsible for the mess we are now in. The idea that all would be well if only Greece had undertaken every item of structural reform they specified (and a lot was done) is just silly. Now it appears as if it is all the fault of the former Greek finance minister, because he dressed funny, or kept wanting to talk about economics, or did some contingency planning - it is so absurd you couldn’t make it up.

One ray of hope offered by Anatole Kaletsky is that now “ritual humiliation” has been achieved, the Troika will be more forgiving. I wish he was right, but this argument fails to account for the German finance minister who clearly believes that exit is the best option. He wants the bus to crash for the sake of the other cars on the road. An optimistic view would be that the shock [1] of what was done to Greece a few weeks ago will bring others to their senses, and Schäuble’s influence on the Eurogroup (and strangely the IMF) will decrease. I fear the larger truth is that the non-German bloc in the Eurozone does not have an alternative economic vision to offer (although it clearly exists), and will never face Germany down.

[1] Link added 31/07

Austerity, France and Memories

Just a day after ECB President Draghi acknowledges the problems caused by European fiscal consolidation, President Hollande of France effectively sacks his economy minister for speaking out against austerity. There was a key difference of course: Draghi was careful to say that “we are operating within a set of fiscal rules – the Stability and Growth Pact – which acts as an anchor for confidence and that would be self-defeating to break.” In contrast French economy minister Montebourg apparently called for a “major change” in economic policy away from austerity, and complained about “the most extreme orthodoxy of the German right”.

Whatever the politics of what just happened in France, the economic logic is with Montebourg rather than Draghi and Hollande. Once you acknowledge that fiscal consolidation is a problem, you have also to agree that the Stability and Growth Pact (SGP) is also a problem, because that is what is driving fiscal austerity in the Eurozone. The best that Draghi could do to disguise this fact is talk about an “anchor for confidence”, to which the response has to be confidence in what? He must know full well that it was his own OMT that ended the 2010-12 crisis, not the enhanced SGP.

Writing for the Washington Post recently, Matt O’Brien asks didn’t you guys learn anything from the 1930s? That the left in particular appears to ignore these lessons seems strange. In the UK part of the folklore of the left is the fate of Ramsay MacDonald. He led the Labour government from 1929, which eventually fell apart in 1931 over the issue of whether unemployment benefits should be cut in an effort to get loans to stay on the Gold Standard. The UK abandoned the Gold Standard immediately afterwards, but Ramsay MacDonald continued as Prime Minister of a national government, and has been tagged a ‘traitor’ by many on the left ever since.

Not that France needs to look to the UK to see the disastrous and futile attempts to use austerity to stabilise the economy in a depression. By at least one account, the villain in the French case was the Banque de France, which in the 1920s used every means at its disposal to argue the case for deflation in order to return to the Gold Standard at its pre-war parity, and it was instrumental in helping to bring down the left wing Cartel government. When it did rejoin the Gold Standard in 1928, the subsequent imports of gold helped exert a powerful deflationary force on the global economy.

So why has the European left in general, and the French left in particular, not learnt the lessons of the 1920s and 1930s? Why do most mainstream left parties in Europe appear to accept the need to follow the SGP straightjacket as unemployment continues to climb? Perhaps part of the answer lies in more recent memories. After many years in the political wilderness, François Mitterrand was elected President in 1981, and his government became the first left-wing government in 23 years. In the UK and US high inflation was being met with tight monetary policy, but he and his government took a different course, using fiscal measures to support demand, and hoping that productivity improvements that followed would tame inflation. Although the demand stimulus did help France avoid the sharp recession suffered by its neighbours, inflation remained high in 1981 (not helped by increases in minimum wages and other measures that raised costs) and rose in 1982, at a time when inflation elsewhere was falling. The sharp deterioration in the trade balance that followed led to pressure on the Franc, and the government’s fiscal measures were reversed. Economic policy changed course.

To a macroeconomist, this story is very different from today, where Eurozone inflation is 0.4% and French inflation 0.5%. However, the political story of the early 1980s associates fiscal stimulus and demand expansion with ‘socialist policies’, and their failure and abandonment is associated with Mitterrand staying in power until 1995. When the markets again turned on fiscal excess in Greece in 2010, perhaps many on the left thought they would once again have to subjugate their political instincts to market pressure and undertake fiscal consolidation. Unfortunately it was not the 1980s, but events over 50 years earlier, that represented the better historical parallel.

French macroeconomic policy improvisation

I’m confused about macroeconomic policy under François Hollande. When he came to power in 2012 he made deficit reduction a priority. The chance to lead some opposition to the dominant policy of austerity was lost. However where French policy did seem to differ from some other Eurozone countries was that tax increases rather than spending cuts would play a prominent role in deficit reduction. As I noted in this post, the Commission’s austerity enforcer, Olli Rehn, was not pleased.

However policy in France now seems to have taken a rather different turn. In January Hollande announced cuts to social charges paid by business. Many outside comments declared that this was a move ‘to the centre’. His speech also seemed to imply that he had become a convert to Say’s Law. But maybe there was a more modern logic to this policy: by reducing employment costs, perhaps the government was trying to engineer an ‘internal devaluation’.

Yet more recently, Hollande has appeared to pledge tax cuts to middle class voters. With non-existent growth and a rising budget deficit, the macroeconomic logic behind this policy escapes me. Many taxpayers will quite reasonably assume that any tax cuts will turn out to be temporary and will therefore save a good proportion of them, so the impact on demand will be weak compared to the cuts in public spending required to pay for them. A deflationary balanced budget cut in spending is the last thing you want with an estimated negative output gap of 3% or more. On a more positive note, he also appears to be trying to form alliances to loosen the eurozone fiscal straightjacket, although what success he will have remains to be seen.

The latest OECD forecast predicts a gradual pickup in growth, despite a sharp fiscal contraction, although this fiscal contraction is not enough to stabilise the debt to GDP ratio by 2015. The danger is the by now familiar one: that fiscal contraction will inhibit growth by more than forecasters expect, which will generate pressure to undertake additional fiscal contraction. Is there a clear strategy to avoid this outcome, or is Thomas Piketty correct when he says: "What saddens me is the ongoing improvisation of François Hollande.”

The Left and Economic Policy

Why does the economic policy pursued or proposed by the left in Europe often seem so pathetic? The clearest example of this is France. France is subject to the same fiscal straightjacket as other Eurozone countries, but when a left wing government was elected in April 2012, they proposed staying within this straightjacket by raising taxes rather than cutting spending. Although sensible from a macroeconomic point of view, this encountered hostility from predictable quarters, as I noted here. But in January this year President François Hollande announced a change in direction, proposing tax cuts for business and public spending cuts. When your macroeconomic announcements are praised by Germany’s foreign minister as courageous, you should be very worried indeed. Any hopes that Hollande might lead a fight against austerity in Europe completely disappeared at that point.

You could argue that France was initially trying to oppose irresistible economic and political forces, and no doubt there is some truth in that. But what was striking was the manner in which Hollande announced his change in direction. He said “It is upon supply that we need to act. On supply! This is not contradictory with demand. Supply actually creates demand“. This is not anti-left so much as anti-economics. Kevin O’Rourke suggests this tells us that to all intents and purposes there is no left in many European countries. It would indeed be easy to tell similar stories about the centre left in other European countries, like Germany or the Netherlands. With, that is, the possible recent exception of the Vatican!

Unfortunately Europe here includes the UK. Labour’s shadow chancellor, Ed Balls, was correct in saying that the government’s austerity measures were too far, too fast, yet the party now seems to want to show they are as tough on the deficit as George Osborne. (Its opposition prior to that often appeared half hearted and apologetic.) Again you could argue that they have no choice given the forces lined up against them, and again I would agree that this is a powerful argument, but I cannot help feeling that this not the complete story.

I am not trying to suggest that if Labour had taken better positions, it would have necessarily made much difference. Take the issue of flooding, where Labour did try. The BBC failed to ‘call’ this issue, by for example reproducing the official data shown here, and instead fell back on ‘views on shape of the earth differ’ type reporting. Here the BBC failed in its mission to inform, and instead behaved in a quite cowardly manner. But at least in this case Labour tried.  

What strikes me about the economic pronouncements of the Labour Party is the number of tricks they miss. On too far, too fast, for example, an obvious line of attack would have been to note how Osborne did change his policy (proclaiming U turn! finally followed our advice etc). In addition they could say the recovery only took place once austerity was (temporarily) abandoned. Simplistic stuff I agree, but this is politics. To take a much more recent example, an easy line for Labour to take on the last budget and pensions was that Osborne’s policies would reduce incomes for prudent pensioners. Yet all Labour seems to be saying is that they will support the reforms, but want to wait to see the details. In other words, there is no opposition to the government’s claim that this was a budget for savers and pensioners.

With austerity and pensions there may be subtle factors that I have missed, but in their absence one conclusion you could draw is that the Labour Party in the UK is not getting good economic advice. I’m afraid I have no deeper knowledge on whether this is true or not. That has to be the conclusion in the case of Hollande’s apparent embrace of Says Law. Yet I doubt that the left does not want good economic advice. As I noted here, in the last Labour government the influence of mainstream economics had never been greater. Is this a paradox?

Perhaps not, if you think about resources and institutions. Seeking out good advice (and distinguishing it from bad advice) takes either money or time. An established government finds this much easier than an opposition or a new government. When labour came to power in 1997 they did immediately introduce well researched and judged innovations in monetary and fiscal policy, but they had had 18 years to work them out.

In addition, with the Eurozone there may be a factor to do with governance. I have just read a fascinating paper by Stephanie Mudge, which compares how economic advice was mediated into left wing thinking in the 1930s compared to today. To quote: “it stands to reason that an economics that works through inherently oppositional national-level partisan institutions would be especially fertile terrain for the articulation of alternatives; an economics that keeps its distance from partisan institutions and is more removed from national politics, but is closely tied to Europe’s overarching governing financial architecture, probably is not.” What is certainly true for both the Eurozone and the UK is that leaders of independent central banks often appear naturally disposed to fiscal retrenchment.

This gives us two problems that occur for the left and not the right. However the right has two problems of its own when it comes to getting good policy advice. The first comes from a key difference between the two: the right has an ideology (neoliberalism), the left no longer does. The second is that the resources for the right often come with strings that promote the self interest of a dominant elite. So although the right has more resources to get good economic advice, these strings and their dominant ideology too often gets in the way. But what this ideology and these resources are very good at is providing simple sound bites and a clear narrative.