Krugman Baltic Bashing 2.0

It would seem that after a tweeter row with Estonian President, Krugman hasn’t had enough fun senselessly putting down Baltic States. In his new blog post, Krugman turns against Latvia in his anti-austerity tirades. While he initially criticized pro-austerity commentators for ‘lionizing’ Estonia as a standard bearer for successful austerity policies, he know seems to believe that Latvia was the lionized example for austerity. Leaving aside Krugman’s inability to decide which austerity policy orientated government is easiest to criticize let’s take a closer look at his accusations.

Krugman quotes Eurostat numbers for real GDP levels, showing that Latvia has had the deepest contraction of the Baltic States, Ireland and Iceland, also showing Latvia having the smallest recovery of pre-crisis level GDP. A few notes must be added to his demonstration. Firstly, both Ireland and Iceland received EU/IMF bailouts to stabilize GDP and also e currency’s value in Iceland’s case, none of the Baltic States received such external inflow of capital to buttress government spending.

Furthermore, both Latvia and Lithuania racked in relatively big budget deficits during the crisis in comparison to Estonia. Why attack the Baltics states least keen on austerity for their austerity policies, why stop talking about Estonia, the real standard bearer for fiscal hawkishness. Again leaving aside this Krugmanesque inconsistency let us look at Baltic States in Comparison to other Euro economies many of which signed on to the G20 pledge for stimulus spending during the crisis.

 Here, seasonably and daily adjusted quarterly per capita real GDP numbers from Eurostat (same source as P. Krugman) tell a different story. This chart shows that while the recession was deep in the Baltic States the recovery was strong, leading all Baltic Nations to have caught to their pre crisis levels (per capita of course) and to the EU as a whole. While Germany, arguably the strongest economy in Europe is above its pre crisis level, there should be no denying that the Ba;tic States chose to bite the bullet early but recover quickly. One wonders if so much can be said for the PIIGS. So without a European bailout Latvia and its Baltic colleagues don’t seem to be doing all that bad. As has been argued before Krugman fails to take into consideration decline population into his thinking when using national GDP numbers. A guess can also be ventured that depending on what time series he chooses to use (constant vs market prices) numbers may vary substantially when evaluating economic performance, no nuancing words from him on that subject.

In any case to better understand recovery dynamics between nations attention must be paid to the depth of contraction as well as the magnitude of recovery. The above chart shows the ratio of real per capita GDP recovery to real per capita GDP contraction. With an EU average a smudge over 1, one can see that the strength of the recovery has been stronger in the Baltic States than in most of Europe. Only the Norther nations of Germany, Austria, Finland, Luxembourg and a few others have been stronger.

So how to explain the difference between austerity in the south and in the Baltic region. The most obvious answer is that states that don’t rely heavily on Government spending during the good times stand to loose less from tight fiscal policy in the bad times. Ireland and Spain do of course buck that trend but the conjecture of their recessions were different in nature than in most of Europe. 

Again it must be repeated that much of the superficial weakness in the Baltic States must be attributed to Europe in general and the rest of the sluggish growth in the World. As export dependent nations they should not be expected to outgrow other regions when there is only week growth in consumption outside their borders. There is however much hope for the Baltic tigers future prospects. As export dependent nations who have refused to transition to internal consumption driven economies, they remain leveraged to an eventual uptick in World growth and are less dependent on foreign capital flows to pay for their growth.

Small open economies the World over should learn from the Baltic experiment that is unfolding and look forward to the next chapter that will surely put stubbornly uncompetitive economies to shame. Let’s hope Krugman can remember his own writings when that happens, so that the rest of us can enjoy his efforts at keeping a straight face when attempting to convince us he was right all along.

Germany Chastises Canada, Sort Of…

Germany reiterated calls today for Canada to participate in the beefing of the IMF funding. The IMF is currently seeking to raise its war chest to 430 Billion dollars in preparation of possible new bail-outs in Europe to serve as a firewall against liquidity contagion of sovereign debt financing. Canadian Prime Minister Stephen Harper and his finance minister Jim Flaherty have resisted demands for the country to participate. While Canada has received praised from Germany for its take on austerity it continues to be admonished for showing little ‘solidarity’ in matters of bailing out Europe.

Harper has repeatedly said that taxpayers in Canada would not participate in financing the welfare state of some of the Richest nations of the World. It must be noted however that Germany is showing a little lack of consistency in its criticism. Much of the political difficulties in the current European sovereign debt crisis stems from Berlin’s refusal to risk its own taxpayer moneys on alleviating required austerity in the Eurozone periphery, so how can Angela Merkel, Germany’s Chancellor, turn around and ask of Canadians what it won’t ask of its own people.

When a country goes bankrupt it makes sense to stabilize that country’s finances and currency through an IMF led debt restructuring with the objective in mind to return that country to a sustainable growth path and government spending. But when the World is faced with the likes of Greece whose sense of state welfare entitlement is so strong that it refuses the policy prescriptions attached to IMF lending, why should the World backstop its governmental spending. European style welfare states require generous taxpayer funding and strong longterm growth to be sustainable, countries desirous of receiving lending from the IMF must accept a model that both generates growth and taxes heavily. For countries to achieve those dual requirements they cannot be hampered by distorted fiscal incentives, which lax IMF lending standards embody.

It should be unacceptable that the IMF, funded by every country in the World including its poorest, should serve as a tool to preserve un merited entitlements in the richest nations of the World. The Conservative governments stand is that the IMF should only serve the Worlds poorest governments, this isn’t right, the World Bank is there to help the poorest, the IMF’s role should be to stabilize the World’s financial system by increasing sovereign liquidity to governments hampered by temporary market pressures.  But Harper is right with regards to who those fledging governments are.

Spain is a prime example of a relatively responsible government facing pressures outside its control and in need of a temporary backstop. Greece however is the antithesis of a responsible nation, underserving of outside help since all its problems are internal. Canada should increase its participation in funding the IMF, but this extra funding should come with conditions. Those conditions should be that the IMF serve strictly the needs of governments willing to accept the longterm rebalancing of their public expenditures, as has been the historical norm. Countries that dither and object to bail-out conditions ex-post, should be blacklisted so that the IMF may concentrate its ressources on countries like Spain who can actually benefit from it and Ireland who has shown responsibility and a willingness to proactively deserve it.

Germany has made many correct economic arguments over the course of the current crisis, let’s hope she can continue to make them consistently going foreword.

“Francois Hollande” or “Homo Economicus Has Left the Room”

Many people may be forgiven for forgetting that France is one of the Worlds great nations. Let’s gloss over some of France’s economic credentials. Fifth largest nominal GDP, ninth largest in PPP adjusted terms and second largest economy in the European Union. Fifth largest exporter in the World, with over half a trillion of exports annually. Member of the G8 countries, G20 group, OECD, third highest military spending in the World and second largest gross foreign aid provider. Needless to say this stature and success has arisen because of the hard work, industriousness, and entrepreneurial spirit of the French people. The French people while reveling in their stature externally are much more cynical about their successes at home. Most Frenchmen speak of the “Glorious Thirty” and the “Pitiful Thirty” years, eras of post-war economic boom and subsequent economic stagnant malaise. Much attention and commentary is dedicated in political and intellectual circles to restoring the lost equilibrium of previous times of plenty. Much media analysis revolves around the stagnant fortunes of the French way of life and the middle class’ dwindling standard of living.

The French are also quite the political people. A country were successive constitutions have put the onus of wealth creation on governments and on individuals but only through their political choices. France thus, has seen successive ideologies and political currents wrestle with the central question of balancing collective wealth and well being with that of the individual. One might assume that through its rich political and governmental experiences certain lessons of history might have been learned. Moreover, the French being great internationalists and multilateralists, one might further assume that the country strives to benefit from the experience of its fellow nations with regard to its great equity dilemma. One would, seemingly, be wrong to assume these things. The popularity of France’s current presidential candidate front-runner would leave any Homo economicus perplexed.

The first big splash by the ‘Parti Socialiste’ presidential candidate came when he announced on live television that he wanted to impose a 75% top marginal income tax rate for revenues over a million euros. Other policies announced supposed to reduce ‘inequality’ were; a maximum lowest paid worker to CEO salary ratio of 1 to 20 and a new tax bracket from 150 000 euros to 1 000 000 at a higher 45% marginal rate (currently standing at ~41%). In Hollande’s campaign platform other musings are added to the effect of reducing income tax deductibles for the wealthy. Now, what might be the effect of such policies? (aside from giving Swiss bankers a collective orgasm). One effect would be to vilify the wealthy, to the point where many might leave, if not most. Since most wealthy people (first generation at least) are entrepreneurial and industrious business builders, maybe the intention is to reduce wealth and job creation? One French daily has aptly called the phenomenon of geographical tax jurisdiction arbitrage “Fiscal Exodus”. If the Laffer curve central thesis remains correct, all other things equal, the number of wealthy Frenchmen in Brussels, Geneva and London may well continue to swell.

Ultimately these measures are only for show. They only serve the populist and demagogic purpose of insuring the poor and disenfranchised vote with the socialist. A Hollande aide confessed that the measure might only bring in 250 million extra euros to the treasury, a paltry sum compared to the economic damages the policies will wrought. A policy that is sure to impact the treasury much more severely will be the promise to return the minimum legally insured retirement age back to 60 years of age. The present right of center French administration pushed through an increase in the minimum legally guaranteed retirement age to 62 from sixty back in 2010. The measure was put into place to more or less avoid a Greek fiscal fiasco when baby boomers begin to retire ‘en masse’. Francois Hollande plans to jettison that law, because he believes, apparently, that for every 2 years worked in one’s life, one deserves a year of retirement on average. Add on to that policy his intention to re-tinker the corporate tax rate (35% for large co.’s and as low as 15% for very small enterprises) this would cement France’s third place in the highest corporate tax rates for industrialized nations category. Combine the fact that progressiveness in corporate tax rates is just an incentive for small corporations to generate a maximum of dividend by not reinvesting profits into growth and the fact those marginal rates are going up and it would seem the French Socialist Party is on a war against international competitiveness!

While the above policies don’t really hold up to current economic thought standards, they can be forgiven as staples of the Left’s campaigning and showmanship. The policies that really drive me up the wall are Hollande’s policies towards the Euro. The first policy is one of negotiating a new fiscal treaty where Euro bonds would be issued. With benchmark French 10 year bonds yielding over 90 basis points over similar maturity German Bunds, the trans-Rhine cash grab is barely veiled. No wonder Angela Merkel does not want to meet her greedy potential counterpart. The second Euro Zone focused policy is even more morally hazardous than the first. The socialist candidate wants the ECB to adopt a dual mandate of inflation targeting and growth promotion. Never mind the moral hazard of bailing out broke Euro members, has nobody in the socialist party opened a Monetary Policy introductory book in the last 20 years? Since the early 1990’s central bank after central bank have shifted their monetary policy objectives from currency targeting and growth maximization to inflation targeting with invariably positive results. For a leading candidate to the highest public office of one the greatest nations of the World, to have such a crass and laymen understanding of fundamental economics is astounding to say the least.

So, while arguably the most archaic central bank of them all (the Fed) moves towards greater transparency and is subtly shifting its policy onus from a balance between inflation and growth towards inflation targeting, the French socialists want the ECB to move 20 years backward and forsake its stellar inflation record. Hollande could just as well shout out “To hell with responsibility and orthodoxy”. So let us recap. While the American Left embodied by the democrats and President Obama talk of lowering corporate taxes (to 28% at last check) and encourage the Fed to be more contemporary, the French Left embodied by Hollande wants to turn back the clock of time to a time were symbolism and intentions matter more than results, where its central bank would be ‘nicer’ to poor countries and its corporate tax rate would be higher. Let’s hope that sober economic thought prevails at the end of this campaign, because so far it’s only been mired in intellectual mediocrity. France has always wanted to go against the grain of conformity, who would have know that being conform even in success was so distasteful.

Shout out to our Ghanaian readers!

Cius

In praise of all that is German

Germany hasn’t been getting a lot of slack of late. Between accusations of trying to succeed where they’ve failed in two previous World Wars – dominating Europe – or accusations scuttling the European Project out of selfishness, and again with cries that Germany is abandoning the Euro, the nation of sauerkraut and beer is in the throws of a full blown Greek tragedy (lol pun intended). Asides from the on camera superficial Merkozy marriage, no french love seems to be crossing the Rhin. Further compounding the courteous hate fest, Italian flirting has gone from invitations to the bunga bunga parties (most often refused anyways) to the sober and stale Monti ear whispering for more cash. Somehow, I don’t think encouragements from the euro-sceptic nationalisty Finns was the recognition Berlin technocrats were looking for. The Euro area is eerily looking like an Animal Farm in the throes of its Orwellian infancy. Need I really specify which Euro countries are acting like over-eager egalitarian PIIGS, hrum I mean pigs, seeking the overthrow of opulent and oppressive markets, hrum… I meant masters. All punning aside, I believe there may be a little lack of balance in the debate over fiscal and monetary policy proposals to the Euro area mess.

Let’s start by awarding praise where it is due and sing the virtues of the German machine, hrum… economy sorry forgot about the inter-temporal analogy bank. To my knowledge German policymakers are the only ones of any major economy who seem to have learned the lessons of history. This is no coincidence as not-repeating the errors of history has become part of German culture. Little children are taught at school about the immeasurable harm generations of their ancestors have wrought upon the world (maybe even too zealously). A cursory look at the lessons young children learn from Dortmund to Munich, leaves the history amateur with a few residual lessons in economic virtue, that we shall survey here:

1) Inflation = bad. How so? Well inflation leads to economic inefficiencies most notable of which is the rise of unemployment, which then leads to socio-political problems we need not raise here. To see just how hawkish they are monetarily, read anything on the Bundesbank or even the ECB.

2) Trade competition = good (especially when your winning). How so? The best buffer when in hard times is to have a trade surplus and savings. Germany has been at the forefront of multilateral trade talks, especially in Europe (see European Union history) but also internationally. I guess Germans remember how bad Smoot-Hawley was for everyone and how good the life has been since… well… 1946 I guess.

3) Hard work = prerequisite to 2). Now I know this might sound sacrilegious to all of us westerners getting used to resting on the laurels of previous generations hard work but bear with me. Our current level of wealth is tied if anything to previous generations working hard, earning dough, not spending but saving dough in the bank account, that dough being magically transformed by the financial industry into fixed capital formation, a.k.a. every single piece of equipment, factory infrastructure that buttresses our current economies. If you didn’t follow the flow working harder than your living standard would entail serves as the anvil of tomorrows wealth. Germans get that, they preach it, than they actually do it. This saving/underspending/fixed capital forming needs to happen at the household level, the firm’s level and the governmental one.

4) Mash up all of the above = hawkishness in every sphere of public policy (and private actually) = kicking the worlds butt economically.

So what has been going on exactly in Europe? following the above stated framework for success lets see where things went wrong. Europe was a place of high savings (or at least American savings though the Marshall Plan)a, hard working and rebuilding for while following WWII. No problems so far. Italy, Britain and France had thriving industries, peripheral Europe slowly started democratizing itself. Than they started moving towards the European Union. Savings and investment flows started getting a little complex at this point. Big Euro countries started saving for peripheral ones, sending money so that those countries could invest in infrastructure modern

isation and other stuff of the like. Eventually thy took a bunch of countries with a myriad of fiscal and monetary systems and patched them together into a big currency block. Germany kinda knew where this was going so they tried the  true and tested policies. They retrenched further into fiscal and macro-prudential austerity. So yes this national savings craze as measured by a current account surplus peaking at 7.4% of GDP just before the crisis hit in 08, did lead to some imbalances within the Euro block by depressing Euro wide inflation numbers and interest rates. The real trouble however wasn’t German economic virtue it was the rest of Euro countries, more particularly the PIIGS, reaction to these circumstances. How did they react, like all good socialisty, humanisty, mushy hearted westerners, they indulged in profligate entitlement spending. Riding on the coattails of previous generations of hard work and contemporary German virtue (i know redundant), they offered their people an easy life at low borrowing costs.

Then one day the masters hrum… markets, sorry, woke up and said “the break is over back to work”. The current crisis boils down to looking to the Germans and saying no we don’t want to work as hard as you! keep paying. Unfortunately markets tend to act like the tough love parents that they are and Germany seems content to not act like the over-indulgent parent its savings temporarily were. Now some might quibble that the crisis is one of solvency or simply liquidity needing some temporary patching to be corrected. What needs correcting is peripheral Europeans expectation of living standards they must go down! if they are one day to go up to Germany’s level. Increasing the ESM or EFSF or introducing eurobonds does not solve the problem. Even Angela Merkel’s suggestion of limiting federal governments deficits to 0.5% of GDP remains to timide a goal. Mario Monti is somewhat on the right track in Italy. Although his reforms are limited in scale they are in the right direction. A combination of fiscal austerity coupled with market liberalization is the equivalent of putting italians back to work. Less play more labour! is the key to making labour unions howl and incidentally generating long-term wealth. Let’s hope more european nations decide to go the german path to prosperity before the s*** really hits the fan.

Cius