23 December 2012

The Decline of Europe - Not

From time to time over the last few years I have heard serious pundits bemoan the relative decline of Europe. It is a sentiment which infuriates me.

It is true that Europe commands a declining share of global GDP. That is a fact we should welcome not fear. For at least 50 years the rich countries of Europe have promoted the development of the poor countries in other continents. The fact that so many are now making progress is a cause for celebration not anxiety.

The thought is prompted by an execrable book I picked up in Waterstones while Christmas shopping. For Europe is a federalist manifesto which declares on page one that:
We are being overtaken by the emerging economies at lightning speed.
The first problem with this perspective is that it is morally and politically wrong. The fact that poor countries are catching up is a major human achievement.

Source: IMF
The second problem is that the statement is factually wrong. Per capita GDP in the EU is double that in Russia, 4 times that in China and 8 times that in India. Even fast growing China will need decades to catch up.

Don't get me started on this one:
...we are still required to compete against economic and political powerhouses of the calibre of China, India, Brazil, Russia or the United States.
There is so much nonsense in that phrase I don't know where to begin. I'll just point out that the rise of poorer countries does not harm us and indeed holds many opportunities for developed countries.

The authors of this terrible book are serious politicians: Guy Verhofstadt, leader of the Liberal faction in the European parliament and former prime minister of Belgium and Daniel Cohn-Bendit, leader of the Green faction in the same parliament and former soixante-huitard.

17 December 2012

Angela's Ashes (and Sackcloth)

My nomination for scariest comment of the year is by Angela Merkel in an interview with the Financial Times:
“All of us have to stop spending more than we earn every year.”
Who does she mean by we? If it is countries then the comment is nonsense. As I mentioned recently, countries can sustain a stable debt level while spending more than their income. So long as the deficit is less than the nominal growth rate multiplied by the debt ratio, the debt will not increase as a proportion of GDP. For example keeping the debt below 60% of GDP in a country with 5% nominal growth means keeping the deficit on average below 3%.

If she means businesses then how are they to finance investment? A small business with an opportunity to expand typically borrows from a bank. A large firm may borrow by issuing bonds. Without "spending more than they earn", businesses would have trouble to grow, modernise or innovate.

If she means households, then it is sensible not to spend more than you earn, but only measured over a lifetime. In youth, people borrow to fund education, buy a house, etc. In middle years people may save to fund retirement when spending is based on past income.

Even stranger was her claim that East Germany failed due to a lack of competitiveness:
“We witnessed in the GDR and in the entire socialist system that an economy which was no longer competitive was denying people prosperity and ultimately leading to great instability.”
I can think of many reasons why the GDR economy collapsed, but wrapping them up in one portmanteau word is a feat beyond even Humpty Dumpty.

Finally, Mrs Merkel hinted at even scarier ideas to come:
Although Ms Merkel stopped short of suggesting that a ceiling on social spending might be one yardstick for measuring competitiveness, she hinted as much in the light of soaring social spending in the face of an ageing population.
The right is out to cut the welfare state and Mrs Merkel is aiming to cut social spending in pursuit of the chimera of competitiveness.

10 December 2012

Deficits For Ever

If Dean Baker were writing this blog, the headline would probably be "Janan Ganesh doesn't know that the national debt has fallen in the last 50 years."

At the weekend Janan Ganesh, an FT columnist, argued that Britain can no longer afford the welfare state. Underlying the deficit hysteria there lurks a right-wing ambition to roll back the welfare state. Unfortunately the case for blaming social spending for debt and deficits doesn't hold up, not in the UK nor anywhere else.

Government deficits exploded after and in response to the financial crisis.

Now right-wing pundits are making the argument for cutting the welfare state more directly. Sadly, the same flawed understanding of the economic facts wounds their case. Mr Ganesh, for example claims:
"The Treasury has run budget deficits for much of the postwar period.
"...Not even Labour entertains the notion that, once the current crisis is over, deficits can again become as common as they were in the last half century."
Deficits have indeed been the norm in the postwar period; but that is not a problem. Mr Ganesh seems to be unaware that government net debt 50 years ago stood at 99.9% of GDP. Forty five years later, in 2007, it was 36% of GDP. It has gone up since the crisis and is now around 66%. If we go all the way back to the start of the postwar period we find debt at 237% of GDP in 1946.

So governments have run deficits more often than not and the national debt has come down. How is this possible?

The answer lies in this equation: d=gD.

In a stable state (ie the debt ratio remaining constant), deficit (d) should equal the nominal growth rate (g) times the debt ratio (D). So if nominal growth is 5% and the government wants to keep the debt to 40% of GDP then it can run a deficit of 2% of GDP (5% x 40%).

Governments do not need to balance their budgets; a little bit of inflation and a little bit of growth allow government to maintain a sustainable debt level while regularly running a deficit. Unlike Mr Ganesh, I think deficits will be just as common in future as they have been in the last half century.

06 December 2012

Cameron Gives Eurocrats a Pay Rise

In a strange irony, the British PM who wants to cut the cost of EU administration has given EU employees a tax cut which will raise take home pay from January.

The tax, known as the solidarity levy, was imposed during the reform of Brussels administration led by Niel Kinnock. As a quid pro quo Eurocrats had their salaries linked to that of civil servants in member states. Instead of negotiating on salaries each year EU salaries were uprated according to the salary rises (or cuts) of national civil servants.

The rule expires at the end of this year. The European commission had proposed to extend the salary method and increase the levy as part of its package of reforms that would see staff numbers fall by 5%. When this was rejected by Britain and other contributors to the EU budget, the commission proposed to extend the current tax and salary method for one year. Mr Cameron and his counterparts rejected the idea out of hand.

The consequence is that take home pay will go up until there is an overall agreement on budget.

Brussels unions suspect that far from being a mistake, some governments want to use the rise to stir up antipathy the European civil servants, to soften them up for bigger cuts next year.

05 December 2012

Doing the Same Thing and Expecting Different Results

This is a quick reaction to today's Autumn statement. I have used data from three reports by the Office for Budget Responsibility, including the one released today. In June 2010 the OBR produced its first report on the fiscal outlook which was based on the plans bequeathed in Alistair Darling's last budget. It followed up with a report based on the new chancellor's budget. I have put on a chart the projections for government debt from these two reports. I have added the projection for debt contained in today's report.

Source: OBR; click to enlarge
Where the Darling plan saw debt peak at 75% of GDP, the latest projection has a peak just shy of 80%. The excuses for this predictable failure do not stand up. Yes, the eurozone has stagnated - but they are following the same wrong-headed austerity policies.

Time for Mr Osborne to go.

03 December 2012

"Failure was Predictable"

In anticipation of the chancellor's Autumn statement, Lord Skidelsky goes on the attack:
The chancellor’s policy is based on the wrong theory of the economy; the BoE’s on the wrong theory of money. Failure was predictable.
 His argument is simply Keynesian. Keynes would have argued that:
 ...cuts would reduce the level of total spending in the economy and thus perpetuate the slump.
As for the bank:
The BoE’s mistake has been to believe it is the supply of money that is critical for economic recovery; Keynes said it was the demand for money.
His solution is to restore the programmes of capital investment, accelerate infrastructure projects, expand the programme of the Green Investment Bank and  replace the bank's inflation target with a nominal income target.

As Will Hutton once said - Keynes is best.