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Wrong Lessons from Latvia for the Eurozone

By Mark Weisbrot

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This article was published in Al Jazera English on June 14, 2012. If anyone wants to reprint it, please respond to this email.

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Latvia, a Baltic country of 2.2 million that most people could not find on a map, has suddenly gotten more attention from economists involved in the debate over the future of Europe and the global economy.  I responded in a column last week to remarks by Christine Lagarde, IMF Managing Director, who on June 5 said that Latvia’s policies in response to the economic crisis had been a “success story.”  Paul Krugman has also weighed in several times, and has been joined by Harvard international economist Dani Rodrik, and now by the IMF’s Chief Economist Olivier Blanchard.

The reason it’s important to have an honest and realistic assessment of what happened in Latvia is that for the first time since the country suffered the world’s worst economic losses during the world recession (2008-2009), there are mainstream voices suggesting as Lagarde did, that it “could serve as an inspiration for European leaders grappling with the euro crisis.” Prior to the last week or so, it was only right-wing economists such as Anders Aslund who were willing to even consider this idea.

This is terrible because if there’s one simple lesson that most of the world – if not the European authorities – seems to be learning from the prolonged crisis in Europe, it’s that fiscal tightening is not the proper response to a recession.  So I hope the reader will forgive me for including more technical detail than normal in what follows, because it is important to get this straight.

First, all are agreed that the social and human costs of what Latvia did were huge for the country.  Latvia lost about a quarter of its national income. Unemployment rose from 5.3 percent to over 20 percent of the labor force and, counting the people who dropped out of the labor force or were involuntarily working part time, unemployment/underemployment peaked at more than 30 percent.  Official unemployment remains at more than 16 percent today, even after the economy finally grew by 5.5 percent last year (it is projected to grow just 2 percent this year).   And about 10 percent of the labor force has left the country. 

The first big question is whether Latvia could have done better with another strategy, which would have included a devaluation of its currency.  Blanchard says that we “we shall never know.”

Of course this is technically true, but not all that relevant.  For example, most economists would scoff at the idea, held by hardcore supply-siders, that if the U.S. Congress had given Ronald Reagan everything he asked for in terms of budget policy, the economy would have grown so fast that it would have  produced budget surpluses instead of huge deficits. 

In the case of Latvia, we can compare their results under “internal devaluation” – keeping the exchange rate fixed and going through a deep recession to lower wages -- to other countries that had financial crises and recessions associated with external devaluations.  These are shown in the table below.  As can be seen, some of these are large devaluations, with very severe financial crises – including the Asian financial crisis of 1997-99 (Indonesia, Thailand, South Korea, Malaysia) and Argentina (2001-2002).

The Argentine case is in many ways analogous to the choice that Latvia was facing when its economy began to shrink.  Argentina tried an “internal devaluation” for three and a half years, and the economy continued to worsen.  After its default and devaluation in December 2001/January 2002, the country suffered a serious financial collapse. But it only lasted for one quarter and was followed by rapid growth; within three years the country was back at pre-crisis GDP.

The table shows that Latvia’s decline under its austerity strategy was quite severe not only compared with Argentina, but to all of the other countries that devalued.  On average, they lost about 4.5 percent of GDP, while Latvia lost 24 percent.  Similarly, three years after devaluing, the average economy was up  6.5 percent of GDP from its pre-devaluation level of output, while Latvia was down 21.5 percent three years after its recession began; as Blanchard points out, it is still down 15 percent today.  And according to IMF projections, it will take a full decade (until 2017) to reach pre-crisis GDP.

Of course every case is different, and some countries, for example, adjusted current account imbalances before they devalued. But Latvia’s losses have been huge by any comparison with countries that devalued.   Blanchard’s statement that Latvia “satisfies some definition of success” because the economy is recovering, is misplaced.  I also disagree with Dani Rodrik’s  more qualified conclusion that it is “too early to say Latvia has been a failure.”  I think the relevant comparison is with what the country could have done – not whether the economy eventually recovered.  Almost all economies do eventually recover.

Blanchard lists a number of reasons why Latvia’s strategy wouldn’t work in the eurozone, and these are valid.  But it is important to see that the policies didn’t lead to recovery in Latvia, either. In fact Latvia might still be in recession if the government hadn’t abandoned the austerity policies that plunged the country into depression.

But the Latvian government didn't do the huge budget tightening that it promised the IMF in 2010.  Rather, the deficit was reduced after the economy started growing again.  This is also vitally important when considering whether the strategy “worked.” And there was also a burst of unanticipated inflation that changed the government’s monetary policy – which had been overly tight because the government was committed to keeping the pegged exchange rate – and lowered its debt burden.

Finally, the Latvian economy pulled out of recession without any help from its trade balance.  This completes the argument that “internal devaluation” didn’t work.  For an internal devaluation to work, the steep recession would have to lower labor costs enough to increase exports and/or reduce imports, to boost the economy through an improving trade balance.  Krugman provides further evidence that this didn’t happen, and isn’t happening in the eurozone.

Ironically, although Blanchard doesn’t say it explicitly but rather hints at it, the IMF itself was opposed to the Latvian government’s strategy, and favored devaluation.  Although devaluation also has costs and risks, if the IMF and European authorities were willing to provide funds to help manage the transition, it is likely that Latvia would have done even better than other countries in similar situations.  Of course the Fund may have been overruled in any case, since the Swedish banks – which own much of Latvia and also have a strong influence among the European authorities – may have rejected this route because of the losses they would have taken on lending there.

But the bottom line is that no country with three times the unemployment rate that it had before the world recession, and Latvia’s huge income losses, should be considered even a qualified success story.  It would be a shame if these unwarranted conclusions from Latvia’s experience were to help prolong theunnecessary suffering in the eurozone.

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Το κυνήγι μαγισσών δεν είναι μόνο ελληνικό φαινόμενο!!!

The War on Public Sector Workers

By Dean Baker

Politicians across the country are using heaping doses of the politics of envy to try to arouse the anger of workers. However, their targets are not the corporate CEOs pulling down tens of millions of dollars a year in pay and bonuses. Nor is it the Wall Street crew that got incredibly rich inflating the housing bubble and then took government handouts to stay alive through the bust. The targets of these politicians’ wrath are school teachers, firefighters and other public sector workers.

They are outraged that many of these workers still earn enough to support a middle-class family. Even more outrageous, many of these workers have traditionally defined benefit pensions that assure them of a modicum of comfort in retirement. Having managed to ensure that most workers in the private sector did not benefit much from economic growth over the last three decades, the same upward redistributionist crew is turning their guns on public sector workers.

There are two major deceptions in their story. First, after working to eliminate traditional pensions in the private sector, they now tell us that getting a pension in the form of a guaranteed benefit is hugely more valuable than having the same money placed in a 401(k) type defined contribution account. Second, after shoving stock down everyone’s throat in the bubble years, they now tell us we cannot expect a very good return from investing pension funds in the market.

Starting with the pension story, it is really touching to hear conservatives singing the virtues of defined benefit pensions. They argue that if a state or local government puts $1,000 a year in a defined benefit pension and guarantees the market return for its workers, this is hugely more valuable than if it takes the same $1,000 a year and puts it into a 401(k) type account.

Since most public sector workers still have defined benefit pensions, this is a central part of their story about public sector workers being overpaid. By their calculations, the $1,000 that a government puts into a defined benefit pension today should be counted as being worth close to $2,000 since the government guarantees the return. Doing the math this way goes a long way toward showing that public sector workers are overpaid.

There are a few points that jump out here. First, it is amazing to hear many of the same people who touted the replacement of defined benefit pensions with 401(k) accounts now tell us about the great value of a guaranteed pension. When we do the math their way, it means that ordinary workers have even less to show from economic growth over the last three decades, since so many workers have lost pensions in this period.

The complaints of these conservative economists also make great reading when put side by side with their plans to privatize Social Security and get rid of its guaranteed benefit. When we were talking about cutting back protections for hundreds of millions of workers and their families we were not supposed to take into account the value of a guaranteed benefit. Now that we are talking about cutting the pay of public sector workers, it is essential to include the value of the guarantee in the calculation. Is it any wonder that so many people have contempt for economists?

Finally, it is important to keep our eye on the ball here. The extra value comes from the guarantee. There is no gain to the government if it replaces pensions with 401(k) accounts as many have advocated and some governments have done. The argument is not that the state is paying too much; the argument is that the worker is getting too much because of the value of the guarantee. If we eliminate a guaranteed benefit we have just taken away the workers’ retirement security, we have not saved the taxpayers a penny.

The other part of the story is the claim that the returns being assumed by public pensions on their investments are overly optimistic. This one is really, really painful.

Some of us were making this argument at the top of our lungs back in the late 90s, when price to earnings ratios in the stock market were over 30. We continued to make this argument in the last decade when price to earnings ratios were still well into the 20s, far above historic averages. However we couldn’t get anyone to listen back then, because the complaint about exaggerated stock returns did not fit the agenda of the upward redistributionists.

Now that the upward redistributionists have put the attack on public pensions at the top of their agenda it is convenient to raise concerns about overly-optimistic returns. However now that the stock market has plunged (pensions have already taken their hits) their concerns are wrong. In fact, pension funds are being very reasonable in their return projections. Those familiar with arithmetic know that it would be almost impossible for them to earn a substantial lower rate of return, barring a complete collapse of the economy.

So, welcome to the latest episode in the long-running battle to redistribute ever more income to the rich. Having already achieved great success in depressing the pay of workers throughout the private sector, the call is to cut the pay and benefits of workers in the public sector. Won’t you join the cause?

--This article was originally published on April 16, 2012 byTruthout.

Ο πληθωρισμός ΠΡΕΠΕΙ να αυξηθεί!

Επιμένω στο θέμα του πληθωρισμού...ο συγκρατημένος πληθωρισμός μπορεί να δώσει μία ανάσα στις υπερχρεωμένες οικονομίες,επιχειρήσεις και νοικοκυριά....Άλλο ένα σχετικό άρθρο!

Faith-Based Economics at the European Central Bank

By Dean Baker

In the build-up to World War II, the French military created the Maginot Line. This barrier, which utilized state of the art military defenses, was intended to defend France from a ferocious assault by Hitler’s armies. When the attack ultimately came, the Germans made quick work of the Maginot Line by going around it through Belgium.

The European Central Bank’s (ECB) obsession with a 2 percent inflation target can be seen as similar to the construction of the Maginot Line. The ECB sees achieving this inflation target as the sum total of the central bank’s responsibilities for maintaining stable growth in Europe, just as the French generals viewed the construction of the Maginot line as defending France from a German invasion.

The main difference is that after that German conquest, the French generals recognized their mistake. By contrast, even after their 2.0 percent inflation obsession led to economic disaster, the people running the ECB are still in charge and still pursuing the same policy.

At this point it is difficult to imagine what set of events in the world could persuade the ECB to pursue a different course. As the crisis demonstrates, an improperly regulated financial and economic system can produce massive asset bubbles. The collapse of these bubbles can lead to prolonged periods of high unemployment and below potential output of the sort that the eurozone, the United States and the United Kingdom are now experiencing.

This means that responsible central banks that are concerned with stable growth cannot just focus on a 2.0 percent inflation target. They must be prepared to take the steps necessary to counter the growth of asset bubbles before they get large enough to endanger the economy. This was evident to many before the crisis; it should be evident to everyone now.

Central banks also have the responsibility to shore up the economy and help to move it back toward full employment. This policy can include the sort of quantitative easing designed to lower long-term interest rates that has been pursued by the Federal Reserve Board and the Bank of England and less aggressively by the ECB.

It should also include targeting higher inflation rates in the range of 3-4 percent, as has been advocated by Paul Krugman, Ben Bernanke in his Princeton professor days, and Oliver Blanchard, the chief economist at the IMF. Ken Rogoff, a former chief economist at the IMF, has suggested inflation target as high as 6 percent.

There are two reasons for targeting a higher rate of inflation. First, it will reduce real interest rates. If businesses expect that prices will be 15-18 percent higher three years from now it will give them more incentive to invest today, since they will be able to sell what they produce at these higher prices. Higher inflation will also reduce debt burdens. If prices and wages rise on average by 15 percent over the next three years, many underwater mortgages will be back above water as the house price can also be expected to rise by 15 percent. Similarly, if wages rise by 15 percent then a fixed monthly mortgage payment will pose a much smaller burden.

These are reasons that the ECB and other central banks should be pushing for a higher rate of inflation. But instead of looking in this direction, the ECB is doubling down on its 2.0 percent inflation commitment. The fact that unemployment is high and rising across the eurozone seems to have no impact whatsoever on this policy.

In fact, the ECB is actually making things worse with the austerity policies that it is imposing on the heavily indebted countries across the eurozone. Reductions in government spending and tax increases in the middle of a recession have the predictable effect of slowing growth further. The ECB’s persistent refusal to act as a lender of last resort also exacerbates the crisis by raising interest rates, and therefore debt burdens, for highly indebted countries.

It has been roughly two years since the ECB has adopted the austerity route. The results have been almost uniformly negative. Unemployment rates have consistently come in higher and growth lower than had been projected. Needless to say, this also has meant that country after country has missed the deficit targets that were supposedly the main point of the austerity plans.

If we had serious economists setting policy at the ECB, this pattern would be a basis for reconsidering the policy. However instead of a rethink, we get a doubling down with the ECB’s leadership continually reasserting their commitment to stay the course. (It even produced a short propaganda piece about the “inflation monster” for the doubters.) It seems that there is no set of events in the world that can lead the generals at the ECB to question the wisdom of the Maginot Line.

--This article was originally published on April 11, 2012 by the Guardian Unlimited.

Ενδιαφέρον Blog εκτός "γραμμής" των νεο-κλασικών

http://www.debtdeflation.com/blogs/

The Rent Is Too Damn High: Apple Edition

The Rent Is Too Damn High: Apple Edition

By Dean Baker

The basic facts of inequality are beyond dispute: The top 1 percent sucked in more than 42 percent of the gains of economic growth over the last three decades, with the bottom 90 percent sharing less than 37 percent. This means that most of the population has seen little improvement in living standards over this period in spite of the great breakthroughs in technology and increases in productivity.

This background provides the fuel of the Occupy Wall Street movement and its sympathizers around the country. However there is a counter-story that the media continually bombard us with. This counter-story has its hero, Steve Jobs.

The counter-story is that under Jobs’ leadership, Apple has produced one breakthrough after another, revolutionizing the way that we use computers, listen to music, make phone calls and live our lives. Jobs died a very wealthy man because of his success in bringing great products to the market.

The pushers of the counter-story ask us if we would be happier if Steve Jobs had not been rich, but we didn’t have the iPod, the iPad, the iPhone and all the other products developed by Jobs and Apple over the last three decades. The moral of this counter-story is to shut up and eat your inequality.

This counter-story might provide good rhetoric, but it suffers from bad logic. The question is not whether we are better off with Steve Jobs getting very rich and all the products that Apple developed, or having Steve Jobs be poor and not having these products, the question is whether it was necessary for Jobs to get quite so rich in order to get these products.

The difference is the concept of economic rent. Rent is the additional money that Jobs collected beyond what would have been needed to get him to innovate great products. This rent was likely substantial in Jobs’ case and is probably even higher for other members of the 1 percent.

To see the logic of this issue, let’s imagine that firefighters were paid in a somewhat different manner. Instead of paying them a fixed monthly wage, suppose that fire crews would show up at the scene of the fire and then negotiate their payment with the property owner.

In this payment system it is likely that firefighters, or at least some of them, would become very rich. Imagine that a crew showed up at the burning home of a billionaire whose family was trapped inside of her house. No doubt she would be willing to give her fortune to the fire crew to save her family.

It could even be extremely lucrative to show up at the burning homes of middle-income families. After all, getting two or three hundred thousand dollars for a couple of hours work (albeit extremely dangerous work) is pretty good pay.

Of course we don’t pay our firefighters this way for the obvious reason that it would allow them to collect enormous rents. Firefighters generally get decent salaries, but none of them are pocketing millions of dollars a year.

But if we did pay our firefighters by negotiating million-dollar deals at the scene of the fire, the counter-story told by the defenders of the 1 percent would apply perfectly. After all, aren’t we better off having the firefighters get rich and having our families be saved than if the firefighters remained poor and our families were killed?

But that is not the question that serious economists ask. Serious economists ask whether we could get the same effort from the Steve Jobs of the world under different payment schemes. There is good reason to think this is the case for many members of the 1 percent.

Let’s start with the situation that is most analogous to the firefighters negotiating payment on the lawn of the burning house. Suppose we paid for the research and development of prescription drugs upfront rather than by giving drug companies patent monopolies. As a result of these monopolies, drugs that would sell for $5 per prescription in a free market sell for hundreds or even thousands of dollars. The savings from this switch could potentially save us more than $200 billion a year and provide us with better health care.

We could have a similar situation with software development. Some of the best software available in many areas has been developed as Free Software.

In some cases huge rents are not associated with anything of obvious value. For example, when the Goldman Sachs trader Fabrice Tourre (a.k.a. “Fabulous Fab”) designed a guaranteed-to-fail collateralized debt obligation and foisted it off on unsuspecting clients, it is not clear what productive purpose was being served. If Mr. Tourre was deprived of his seven- or eight-figure bonus, it doesn’t seem like the rest of us would suffer in any obvious way. Much of the financial sector has this character, which is why many economists are supportive of financial speculation taxes.

There are many other areas where it is possible to identify large rents that allow the 1 percent to profit at the expense of the rest of us. Honest economists would be looking to design mechanisms that whittle down the size of these rents so that the bulk of the population could enjoy more of the benefits of economic growth. However, if most economists are employed by rich firefighters, then the experts will tell us that the alternative is to watch our loved ones burn to death.

--This article was originally published on March 21, 2012 byAl Jazeera English.

Σωστή διανομή πριν την "αναδιανομή"

Do Progressives Have to Be Loser Liberals?

By Dean Baker

Last week Thomas Edsall had a column in the New York Times where he directly stated that the difference between conservatives and liberals is the extent over which they are willing to reverse market outcomes to redistribute money from winners to losers:

"...the two sides are fighting over what the role of government in redistributing resources from the affluent to the needy should and shouldn’t be."

This was annoying not only because it is so seriously wrong, but also because this statement came from one of the more astute observers of American politics alive today.

Anyone trying to understand the role of the government in the economy should know that whatever it does or does not do by way of redistribution is trivial compared with the actions it takes to determine the initial distribution. Rich people don’t get rich exclusively by virtue of their talents and hard work; they get rich because the government made rules to allow them to get rich.

To take an obvious example, according to the Centers for Medicare and Medicaid Services we spend close to $300 billion a year on prescription drugs. If drugs were sold in a free market, without government-granted patent monopolies, we would spend around $30 billion a year.

The difference of $270 billion a year is more than five times as much money as is at stake with extending the Bush tax cuts to the wealthy. By making us pay far more for drugs, the government’s patent policy is redistributing a huge amount of money from ordinary people to the shareholders and top executives of the drug companies. We need a way to finance drug research, but there are far more efficient mechanisms than patent monopolies that don’t redistribute income upwards in the same way.

In a similar vein our policy on labor unions is incredibly one-sided in management’s favor. If a company illegally fires a worker for trying to organize a union, the complaint would go to the National Labor Relations Board (NLRB). It is likely to take months and possibly years before the complaint is settled. Even if the worker can prove their case (employers rarely admit that they fired someone because they were organizing a union) the fine to the company is trivial. As a result, breaking the law and getting rid of agitators can be very profitable for the company.

On the other hand, if workers stage a strike that violates the law, for example a wildcat strike at a time when a contract is in force or a secondary strike in support of other workers, a company can typically get an injunction immediately. If the workers continue their strike, their assets will be seized and their leaders thrown in jail.

Needless to say, this incredible asymmetry tilts the field in management’s favor. It is difficult for workers to organize unions and it is often difficult for organized workers to push for better wages and working conditions. That is not just a market outcome; this is the result of deliberate government policy.

The downturn we are currently suffering through is also the result of government policy. This is for two reasons. First, we got here because of the ineptitude of top policymakers in failing to recognize the housing bubble and the risks that it posed to the economy. The Federal Reserve Board just stood back and let the housing bubble grow to a size where its collapse would inevitably wreck the economy.

Furthermore, once the bubble burst, the Fed, Congress, and the White House have opted not to take the actions needed to restore full employment. While the Fed has taken steps to boost the economy, it certainly could have done more. Similarly, Congress did not approve a large enough stimulus package to offset the hit from the collapse of the housing bubble.

And, President Obama and the Fed have not tried to push down the value of the dollar to make U.S. goods more competitive in world markets. A lower-valued dollar could create millions of new jobs, most of which would be in manufacturing. However, because an over-valued dollar benefits powerful interest groups, like the financial sector, policy makers have been willing to allow the dollar to remain over-valued at the cost of millions of jobs for ordinary workers.

There are many other ways in which government policy has acted to redistribute money from ordinary workers to the 1 percent. This was done through the setting of the rules. And the amount of money at stake in designing these rules dwarfs the amount of money that we might fight over when we talk about tax policy that redistributes “resources from the affluent to the needy.”

If progressives restrict ourselves to fighting over the tax code, then we are playing in the sandbox. This is classic “loser liberalism.” The real battle is over setting the rules, not shuffling around a few crumbs after the fact.

The issue is not, as some have put it, leaving our neighbor by the side of the road. The issue is that our neighbor has been thrown off the bus. The first step toward getting him back on the bus is to say as loudly and clearly as possible exactly what happened.

--This article was originally published on January 24, 2012 by Al Jazeera English.