Its ideology, stupid

Wolfgang Münchau takes to task in today’s FT the latest example of German opposition, and in particular opposition from finance minister Schäuble, to ECB policies. However I think he ends up missing the obvious target. He discusses the particular problems negative rates pose for Germany’s financial sector, and in his last paragraph writes

“This episode is a reminder that the collective spirit that was so strongly present in the first years of the eurozone has gone. That — not the presence of imbalances or other technical problems — constitutes the single biggest danger to the long-term viability of Europe’s monetary union.”

I would suggest this has the causality wrong. Any collective spirit has gone because of these ‘technical problems’. The biggest technical problem is an obsession with inappropriate collective fiscal consolidation (austerity). In the Eurozone the ECB is being forced to try negative interest rates because it is having to undo the impact of fiscal consolidation. And the man most responsible for this obsession is Schäuble.  

Gavyn Davies nicely sums up my own view about negative interest rates. Without radical institutional and social changes (which may not be desirable), bank profitability puts a limit on how far central banks can go, and for that reason exploring these frontiers could be counterproductive. But the alternative of more QE, possibly directed at other assets besides government debt, is way down the list of effective and reliable instruments for managing aggregate demand right now. Helicopter money is a much better way of giving central banks more ammunition. But the focus right now should not be on any of this, if we are genuinely concerned about social welfare. As John Kay says, “we need less financial ingenuity and more common sense”.

What we should be talking about is why governments are not doing much more public investment. Yet in the US, Germany and the UK any dramatic increase in public investment seems out of the question. Barry Eichengreen, in an article entitled “Confronting the Fiscal Bogeyman”, writes of Germany:

“The ordoliberal emphasis on personal responsibility fostered an unreasoning hostility to the idea that actions that are individually responsible do not automatically produce desirable aggregate outcomes. In other words, it rendered Germans allergic to macroeconomics.”

In the US, antagonism to the Federal government rooted in the past has meant Republican leaders are  

“antagonistic to all exercise of federal power except for the enforcement of contracts and competition – a hostility that notably included countercyclical macroeconomic policy. Welcome to ordoliberalism, Dixie-style. Wolfgang Schäuble, meet Ted Cruz.”

He ends

“Ideological and political prejudices deeply rooted in history will have to be overcome to end the current stagnation. If an extended period of depressed growth following a crisis isn’t the right moment to challenge them, then when is?”

He does not mention the UK, where the antagonism to public investment seems to lack any deep historical explanation, and may just reflect stupidity or an ideology imported from the US.

When I talk about public investment people normally think about big projects, like HS2 in the UK. I like to point out that simpler and perhaps more boring things, like repairing roads, are at least as important, and can be done immediately. But if there is one area above all else where much more needs to be done right now it is investment in renewable energy.

The recent news on climate change is not good. It is foolish to read too much into one or two months figures, but this chart is nevertheless quite scary. It is scary because we know of various possible ‘tipping points’ (like the melting of all Arctic ice or the mass release of methane from permafros) which could accelerate global warming. Most climate models assume we will control carbon emissions in time to stop that happening, but we cannot be sure of that, because we are in uncharted territory.

We know we need a massive expansion of renewable energy, but one problem that has so far stopped that being a complete solution to climate change has been that sometimes the wind neither blows nor the sun shines. We need to be able to cheaply store electricity, but our current battery technology is not good enough. Battery technology is also crucial in making electric cars as attractive as petrol based cars. But technology could come to the rescue. Existing batteries could be made much more efficient, or completely new battery technologies could be made viable. Much more efficient transmission could also help. And if you look at all three links, you may notice one common factor. These potential breakthroughs have all come from research undertaken in the public sector. As Mariana Mazucato has argued, the state is “better able to attract top talent and pursue radical innovation”.   

China put over $80 billion into the renewable energy sector in 2014. That is nearly 1% of its GDP. It has committed to spend 25 times that amount over the next 15 years on clean energy. Both the US and Europe spent much smaller amounts ($38 and $58 billion respectively), even though their economies are much larger (the US figure is around 0.07% of its GDP). In dollar terms, the Chinese government also spent more on Green R&D than Europe or the US. [1] The scope for US and European governments to spend more on researching and help with developing green technology is huge. Yet in the UK the government has recently cut back its support for renewable energy, even though the UK’s need for renewable energy is urgent.

Climate change may be the most important example, but it is not alone. It is absurd that when the potential for technological change leads people to write about robots taking over, actual productivity growth is slowing everywhere. As an IMF report says, "innovation [is] highly dependent on government policies." I think Brad DeLong, in commenting on Eichengreen’s article, has it exactly right when he writes “it is long past time for a frontal intellectual assault on the[se] dangerous and destructive ideologies”.   

 

[1] If we include corporate R&D, Europe moves ahead of China in $ spend, but China is still ahead of the US.       

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

Greece: of parents and children, economists and politicians

Not part of the mediamacro myths series, but in a way related.

Chris Giles has a recent FT article where he describes how non-Greek policymakers (lets still call them the Troika) see themselves like parents trying to deal with the “antics” of the problem child, Syriza in Greece. He splits these parents into different types: those that want to act as if the child is grown up (though they believe they are not), those who want to be disciplinarians etc. As a description of how the Troika view themselves, and present themselves to the public, the analogy rings true. It certainly accords with the constant stream of articles in the press predicting an impending crisis because the Greeks ‘refuse to be reasonable’.

In FT Alphaville Peter Doyle writes about a recent meeting at the Brookings Institution in Washington, the highly respected US social science research/policy think tank. In that meeting Wolfgang Schäuble and Yanis Varoufakis, finance ministers of Germany and Greece, gave back-to-back presentations. He describes how “Schäuble was avuncular, self-effacing, and Germanic, and was tolerated rather than warmly embraced by his hosts.” In contrast “when Varoufakis spoke, eyes burning with anger, his hosts were animatedly engaged.” The audience actively sympathised with the position of Greece, and asked “how it felt to be right but penniless”. He writes “There was no doubt where the hosts’ sympathies lay between their two guests.”

I am not surprised at all by this account. The arguments that many of us have made about how far Greece has moved and what agonies it has endured in order to satisfy the unrealistic wishes of their creditors are I think widely shared among our colleagues. We know that if Greece was not part of the Euro, but just another of a long line of countries that have borrowed too much and had to partially default, its remaining creditors would be in a weak position now that Greece has achieved primary surpluses (taxes>government spending). The reason why the Troika is not so weak is that they have additional threats that come from being the issuer of the Greek currency.

It is important to understand what the current negotiations are about. Running a primary surplus means that Greece no longer needs additional borrowing - it just needs to be able to roll over its existing debts. Part of the argument is about how large a primary surplus Greece should run. Common sense would say that further austerity should be avoided so that the economy can fully recover, when it will have much greater resources to be able to pay back loans. Instead the creditors want more austerity to achieve large primary surpluses. Of course the former course of action is better for Greece: which would be better for the creditors is unclear! The negotiations are also about imposing additional structural reforms. Greece has already undertaken many, and is prepared to go further, but the Troika wants yet more.

As Andrew Watt points out, from the perspective of the Eurozone and IMF, this is all extremely small beer. [1] You would think the key players on that side had more important things to do with their time. The material advantages to be gained by the Troika playing tough are minimal from their perspective, but the threats hanging over the Greek economy are damaging - not just to investment, but also to the very primary surpluses that the Troika needs. So why do the Troika insist on continuing with brinkmanship? Can it be that this is really about ensuring that an elected government that challenges the dominant Eurozone political and economic ideology must be forced to fail?

In a recent post that I (jokingly) entitled ‘Should economists rule?’ I suggested that much of the debate about the delegation of economic policy to economic experts was really an issue about political transparency rather than diminished democracy. Elected politicians normally always have ultimate control. Sometimes ‘delegation’ amounts to little more than making the advice they receive transparent: contracting out the fiscal forecast to the OBR would be an example. [2] All that democracy loses in this case is the ability of politicians to conceal or manipulate the advice they receive, and to fool the public as a result. Greece may be (unfortunately) a good example of how far politicians are prepared to go in misleading their own electorates to cover-up their mistakes and achieve their own political ends.

  

[1] The IMF mainly consists of hundreds of economists, but it is run by politicians, and on issues like this the politicians tend to take control.

[2] With central bank independence they do lose control, but normally with the power to take back control in some way. Furthermore, if the undemocratic central bank persistently made bad decisions, taking back control would be popular. An exception is the ECB, which may help explain why many of its words and actions are seriously problematic.

Misleading a country

When this happens (taken from a post by Jérémie Cohen-Setton), something has gone very wrong. The Euro was meant to increase growth, not create stagnation. So what, or who, is to blame?

Many outside the Eurozone, and a growing minority within it, will say the Euro itself. But that is not a very helpful response. Given the level of commitment to the Euro, it is the only correct response if there is no version of this currency union that can be made to work better.

Others will say that the only way forward is further political integration through a fiscal union. That seems like the political equivalent of going from the frying pan into the fire. The story of the Euro is as much a political failure as an economic failure. But I also suspect support among many economists for fiscal union is built upon a questionable premise. The premise is that the current difficulties arise because it is inevitable that Germany will put its national interest above the interests of the Eurozone as a whole.

This argument goes as follows. As a result of undercutting other union members, Germany has become too competitive within the Eurozone. This will be reversed. The ECB has an inflation target of almost 2%. Therefore in normal circumstances we would see inflation above 2% in Germany for some period. This is unfortunate for Germany, but those are the macroeconomic rules of the game in a monetary union.

However we are not in normal circumstances, because the interest rate set by the ECB cannot fall any further. As a result, Eurozone inflation is well below 2%. There is an obvious solution to this problem: replace monetary stimulus with fiscal stimulus. However, this is not in Germany’s interests: as a result of becoming too competitive, their economy is relatively healthy, and they do not want above 2% inflation. Therefore we need a fiscal union to impose fiscal stimulus on Germany. (There is a variant of this argument where we focus on the failure of monetary policy and German pressure on the ECB.)

It is natural for economists to reason this way, because we are used to thinking about rational self-interested individuals. But suppose the problem with German public opinion is not that it is being narrowly self-interested, but that it has been encouraged to think about this in the wrong way. There are two aspects to this. First, although Keynesian economics is taught in all universities, in appears taboo in much German public discussion. Under this anti-Keynesian view the chart above has nothing to do with fiscal contraction, so it must be all about the lack of ‘structural reform’ outside Germany. Second, German politicians are in denial about the implications of low German inflation before the crisis. Logically the only way Germany can avoid above 2% inflation is if the Eurozone as a whole goes through a prolonged depression, but as is painfully obvious from the comments on some of my recent posts, the German public is not told about this.

The two deceptions help reinforce each other. Germany says it is doing OK without the need for fiscal stimulus, so why do other countries need it? Of course Germany is doing fine because its period of relatively low inflation allowed it to uncut its Eurozone competitors.

Never underestimate the power of bad ideas, particularly if they have ideological roots. Here we have the two mistakes that led to the Great Depression being repeated. We look back at the 1930s and think if only they had known about Keynesian economics a depression could have been avoided. However the depression was as much about countries attempting to stick with the gold standard, and the problems with that were obvious at the time. Today we do know about Keynesian economics, but both mistakes continue.

It is possible to believe that balanced-budget fundamentalism is somehow hard wired into the German psyche, and I have personally experienced moments like that described in this comment to my earlier post that seem to confirm this. So I do not want to discount such explanations entirely, but I do wonder if a powerful motive behind this is just the same anti-state neoliberalism that you see elsewhere. Those on the right appear to have a greater distrust of economists and their theories. This may be true of popular attitudes (HT Tyler Cowen), but it is also the case of those running the country.

According to Der Spiegel, the three permanent secretaries running the German finance ministry have studied law rather than economics. Among the nine department heads seven are lawyers and just two are economists. While the balance between lawyers and economists has always favoured lawyers, it has apparently become worse under Schäuble (whose doctorate is also in law).

As a result of all this, it is not at all clear to me that the current problems of the Eurozone are all down to German self-interest. The case for additional infrastructure spending in Germany looks strong, as argued by Marcel Fratzscher, head of the German Institute for Economic Research (DIW). It would therefore seem more than possible to get Germany to take part in a Eurozone wide programme of additional public investment, which can be justified on a microeconomic/supply side basis as well as on macroeconomic/demand side grounds. All that stands in the way is the power of bad ideas, and its embodiment in the Eurozone’s fiscal rules.