Wednesday, March 31, 2010

France as a Most Taxed Nation

Greg Mankiw has an excellent post today comparing taxes paid per person in some developed economies. Here are his results for some of the largest developed nations for (Taxes/GDP)/(GDP/Person) = Taxes/Person:

“France.461 x 33,744 = 15,556
Germany.406 x 34,219 = 13,893
UK.390 x 35,165 = 13,714
US.282 x 46,443 = 13,097
Canada.334 x 38,290 = 12,789
Italy.426 x 29,290 = 12,478
Spain.373 x 29,527 = 11,014
Japan.274 x 32,817 = 8,992

The bottom line: The United States is indeed a low-tax country as judged by taxes as a percentage of GDP, but as judged by taxes per person, the United States is in the middle of the pack.”

France however is an undisputed leader, whether judged by taxes per person or by taxes as a percentage of GDP (just behind Nordic countries and Belgium) as shown here .

EU Facing Tough Choices

Even though the EU has been evolving from “crisis” to “crisis” since its inception, the crisis is real this time, writes Iain Martin in the Wall Street Journal .

“The architects of the euro were warned that, on its own, a currency union wouldn't magically encourage southern European states to start producing, saving and managing their nation's affairs in the manner of the Germans. Those offering warnings have been proved correct and the flaws in the euro's design are now apparent to even those who insisted at the time that there were none.

Yes, after much wrangling a deal to support stricken Greece is in place, but only with the Germans enforcing strict conditions. This is a sticking plaster solution. What must come, logically, is something close to a form of economic government by those states that want to stay as the inner core of the euro. It might be called by another name, but that is what it will be.

And that leads to a full-blown political crisis for the EU itself. The choice for various countries then is between trying to be part of an inner core organized around the euro with coordinated fiscal policy, or standing outside it in a trading zone built on cooperation rather than coercion.

The Eurosceptics, in countries such as Britain, are just starting to realize this. The euro's problems will force its strongest members into much closer integration than even they currently envisage. Other than breaking up the euro they can do nothing else—standing still isn't an option. In this way that old discussion about there being two distinct Europe's inside the EU is coming back rapidly into fashion. Sounds like it has the makings of a proper crisis.”

My comment: It is now widely recognized that the Eurozone is not an optimal currency area, a conclusion that a few economists reached many years ago. But it is not either an "optimal state area", first, because of its heterogeneity, and second ,because the global organizational trend is favoring smaller rather than larger size of hierarchies, a change which is also valid for state hierarchies.

Let us add a third reason: having been used to benefit from a peace dividend under US protection since WWII, European states are not ready to sacrifice welfare state spending to increase their military spending.

Monday, March 29, 2010

The Euro Chasm

A German economist, Joachim Starbatty, clearly explains the source of the present European monetary predicament:

« The European Monetary Union, the basis of the euro, began with a grand illusion. On one side were countries — Austria, Finland, Germany and the Netherlands — whose currencies had persistently appreciated, both within Europe and worldwide; the countries on the other side — Belgium, France, Greece, Italy, Portugal and Spain — had persistently depreciating currencies. Yet the union was devised as a one-size-fits-all structure. (...)

Germany and other “euro-optimists” hoped that the introduction of a common currency and the global economic competitiveness it spurred would quickly lead to sweeping economic and societal modernization across the union. But the opposite has occurred.

(…) the solution is clear: the only way to avoid further harm to the global economy is for Germany to lead its fellow stable states out of the euro and into a new and stronger currency bloc. »

The complete paper in the New York Times is well worth reading.

Sunday, March 28, 2010

How to Prepare for the Next Financial Crisis

Greg Mankiw develops some sobering thoughts in his tomorrow’s article in the New York Times.

Saturday, March 27, 2010

The Euro Crisis Seen from Berlin

Jess Smee reports in the Spiegel Online International that Merkel's Greece Deal 'Betrays the Concept of Europe' (March 27). He quotes the Financial Times Deutschland analysis:

"This compromise puts the Greek patient out of danger, for now. But at the same time there is a new arrival in intensive care: the European currency union. And its plight will be passed on to a working group, or, in other words, it will be more or less ignored."

"Regardless of whether the euro group helps Greece directly or whether member states opt for bilaterally coordinated loans, the Stability Pact has been made obsolete. The so-called no-bailout clause in the Maastricht Treaty is formulated with such clarity, its intention so obvious, that as soon as a euro zone member is given financial help, it will represent a violation both in word and spirit of that treaty. It is possible to consciously decide to break the rules if a situation demands it, such as in the case of Greece. But then, at the same time, you have to hammer out new mechanisms to ensure the stability of the euro -- but this issue has been buried in a workgroup."

He also mentions the conservative Die Welt that writes:

"To be sure, Greece has violated the letter of the Maastricht Treaty, thereby jeopardizing the euro. But Germany has also gone against the spirit of the treaty -- thus endangering Europe. The strong man strategy currently being pursued does not only block the road to further European integration, it also threatens to destroy decades of progress towards integration".

"To restore the competitiveness which Spain and Greece have lost compared to Germany since the introduction of the euro, wages there would have to fall by about 20 percent. And to have a state deficit of up to 3 percent by 2013 would mean each one would have to put up with a (cumulative) reduction of gross domestic product by about 15 percent. No population would want to put up with such changes for three years."

"There are surely better solutions than simply shoveling money from north to south. But Berlin is not even open to discussion -- instead it simply refuses to acknowledge that Germany itself is part of the problem too."

Is the "German export machine" -- as The Economist puts it -- responsible for the economic decline of Greece, Spain and Portugal, as well as for France's problems? The question is well explained, always in the Spiegel Online (March 22).

"The campaign against what The Economist called the German "export machine" gathered speed last week. Representatives of the southern EU countries, in particular, held the Germans partly responsible for the

Some economists, including United Nations Conference on Trade and Development (UNCTAD) chief economist Heiner Flassbeck, agree. The Germans, they argue, cause problems for their neighbors with the practice of "wage dumping."
From 2000 to 2008, unit labor costs in Greece -- and, similarly, in Portugal and Italy -- increased by 26 percent, compared with a 17-percent average increase throughout the euro zone. In Germany, however, wages increased by only a marginal 3 percent.

This created an enormous competitive advantage for the Germans, and Flassbeck isn't the only critic who says so. Peter Bofinger, a member of the federal government's council of experts, said in a SPIEGEL debate: "We were far too one-sided in emphasizing exports, while the Irish, the Greeks and the Spaniards focused much too heavily on their domestic demand."

My opinion: it is difficult to ask Germany to reduce its exports, as well as to criticize the country for being economically "too virtuous". The real source of the problem comes from the initial nominal exchange rate "frozen" into the euro when created in 1999, that gave an excessive competitive advantage to the German exports over its neighbors. And since then, real exchange rates (that is the relative evolution of wages and prices in member countries) have been diverging in a way that has increased that competitive advantage even more.

The cause of the problem is not Germany by itself: it is the system of "definitively fixed" nominal exchange rates, that is the euro, which is unbearable in the medium term when national macroeconomic trends diverge, which they do and will continue to do in the future. Trying to force different countries to balance their trade balance through policy induced variations in their rate of growth cannot succeed any more than forcing them to respect a common budget deficit norm (the now defunct growth and stability pact). It would consist in adopting a distorting policy ( a trade balance artificial target) to compensate for a previous distortion-creating policy of fixing (at a disequilibrium level) the nominal exchange rates. It is pure nonsense.

It follows that the real debate is about the impossibility of a "single currency-multiple state" system in a non optimal currency area. The sooner the impossibility is recognized, the better for consumers and citizens.

Tuesday, March 23, 2010

Greece Should Opt for Partial Default

“With each passing day, it becomes more apparent that a restructuring of Greek debt is unavoidable. Some form of default will almost surely be forced upon Greece, and this may be the most preferable alternative” write Simon Johnson and Peter Boone in Project Syndicate .


“If Greece is to start paying just the interest on its debt – rather than rolling it into new loans – by 2011 the government would need to run a primary budget surplus (i.e., excluding interest payments) of nearly 10% of GDP. This would require roughly another 14% of GDP in spending cuts and revenue measures, ranking it among the largest fiscal adjustments ever attempted.

Worse still, these large interest payments will mostly be going to Germany and France, thus further removing income from the Greek economy. If Greece is ever to repay some of this debt, it will need a drastic austerity program lasting decades. Such a program would cause Greek GDP to fall far more than Ireland’s sharp decline to date. Moreover, Greek public workers should expect massive pay cuts, which, in Greece’s poisonous political climate is a sure route to dangerous levels of civil strife and violence.”

Monday, March 22, 2010

Where Consciousness Comes From

Stanislas Dehaene of the French National Institute of Health and Medical Research (INSERM) in Gif sur Yvette and Jean-Pierre Changeux of the Pasteur Institute in Paris have updated the 1983 theory of Bernard Baars of The Neuroscience Institute in San Diego, California, with the latest findings on the brain's wiring.

According to this theory, we only become conscious of an information if signals coming from separate regions of the brain, like the visual cortex, are broadcast to an assembly of neurons distributed across many different regions of the brain - the "global workspace" - which then reverberates in a flash of coordinated activity. The result is a mental interpretation of the world that has integrated all the senses into a single picture, while filtering out conflicting pieces of information. Dehaene's group had already shown that distant areas of the brain are connected to each other and, importantly, that these connections are especially dense in the prefrontal, cingulate and parietal regions of the cortex, which are involved in processes like planning and reasoning.

An intriguing paper published today in New Scientist.

Saturday, March 20, 2010

Greenspan, Mankiw, Leverage and Classical Banking

In his comments on Alan Greenspan's paper The Crisis, presented at the spring meeting of the Brookings Papers on Economic Activity, Greg Mankiw posts very stimulating and new thoughts on the links between the Modigliani-Miller theorem, leverage, and the “narrow banking” proposal.


“Indeed, I think it is possible to imagine a bank with almost no leverage at all. Suppose we were to require banks to hold 100 percent reserves against demand deposits. And suppose that all bank loans had to be financed 100 percent with bank capital. A bank would, in essence, be a marriage of a super-safe money market mutual fund with an unlevered finance company. (This system is, I believe, similar to what is sometimes called “narrow banking.”) It seems to me that a banking system operating under such strict regulations could well perform the crucial economic function of financial intermediation. No leverage would be required.

One thing such a system would do is forgo the “maturity transformation” function of the current financial system. That is, many banks and other intermediaries now borrow short and lend long. The issue I am wrestling with is whether this maturity transformation is a crucial feature of a successful financial system. The resulting maturity mismatch seems to be a central element of banking panics and financial crises. The open question in my mind is what value it has and whether the benefits of our current highly leveraged financial system exceed the all-too-obvious costs.”

Read the whole post here.

Dreams and Creativity

A fascinating survey of new scientific brain research by Jonah Lehrer in The New York Times.

Thursday, March 18, 2010

Liquidity Trap?

I was puzzled by Krugman’s claim here that countries representing together 70 percent of the world GDP are currently caught in a liquidity trap.

Tyler Cowen rightly points out that Krugman is defining – wrongly -- a “shortfall in aggregate demand” as a liquidity trap. Read his post in Marginal Revolution.

Martin Feldstein Was Right About the Euro

It breeds political conflict between Euro-zone countries. The German real exchange rate advantage derived from diverging inflation rates, and resulting in structural export surplus vis-à-vis partners in the zone, is now openly criticized by other governments, as well as the refusal to further help Greece. And the Chancellor, Angela Merkel, replies by now saying that expulsion from the Euro should be an option. Most other European politicians disagree.

Read the story in the Wall Street Journal.

Tuesday, March 16, 2010

The Yuan Peg Controversy

In difficult times, trade disputes grow. Paul Krugman is "Taking on China", the title of a recent column in the New York Times (March 14). The reasons of this bellicose posturing? The yuan’s peg to the dollar:

« China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done.
(…) Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.»

His recommandation to solve the problem:

… « if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent. »

Scott Sumner (The Money Illusion) disagrees and accuses Krugman of practicing “pop internationalism” (the title of a well known Krugman book and a critique of politicians’ arguments about international trade. He writes in his post “What will economists 40 years from now think of us?”:

« How many economists today honestly think that if the Chinese give us another 25% revaluation that this will significantly improve America’s economy? And how many of you think that 40 years from now, when we look back on the American economy in 2010, that most economists agree with Krugman’s argument that a significant part of our economic problems were due to an overvalued yuan? In contrast, how many people think that 40 years from now most economists will agree with Krugman’s claim that our economic dilemma is due to the stubborn refusal of the Fed to set a higher inflation target?

My claim is that in 40 years most economists will agree with Krugman. I mean the good Krugman. The guy who wrote Pop Internationalism. Not the guy who says we’re “stuck” in a liquidity trap and who ends his NYT editorial with the crude populist slogan “It’s time to take a stand.” »

The Economist finally may be right in concluding that:

« A speedy end to the dollar peg makes economic sense for China as well as for the world. A stronger, more flexible currency would make it easier for China to control inflation and asset bubbles. A dearer yuan would also help rebalance China’s economy towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits. That would put the global recovery on a steadier footing, especially if a stronger yuan were mirrored by appreciation of the currencies of other Asian emerging economies. And China would gain politically by helping to diffuse protectionist pressure from abroad.

But it would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers. »

Wednesday, March 10, 2010

Political Consequences of Natural Resources

Vox posts an interesting summary of a public choice study, « The political resource curse ». Excerpt:

« Is the discovery of natural resources necessarily a good thing? Examining data from Brazil, this column finds that a 10% windfall in government revenues leads to a 12 percentage point increase in corruption and a 3 percentage point reduction in the probability that politicians have a degree. The chance that an incumbent is reelected raises by over 4 percentage points. »

Read the whole paper here.

Yet Another European Bureaucracy ?

The Economist publishes an excellent post from the Charlemagne’s notebook, titled:« Why is Germany talking about a European Monetary Fund? ».

The subtitle suggests the answer: « Because talk is cheaper than bailing out Greece? »

The whole article is well worth reading, here.

Monday, March 8, 2010

The Nature of the Euro: A Public Choice Perspective

Confronted to the mounting evidence showing that the Eurozone is not an “optimal currency area” (OCA) some economists have been arguing that the very existence of the euro is powerful enough to force the zone into becoming one. A single currency, they claim, would compel heterogeneous economies to converge toward a similar rate of inflation and would synchronize national business cycles. This is a very strong assumption about the power of money on the real economy. If true, it would mean for instance that all the nations of the world could be transformed into a single economy with a single synchronized business cycle and a single inflation rate, after deciding to share a same currency. It seems a bit farfetched to say the least. If true, the design of a currency union would then be purely a matter of unconstrained political choice. But is it the case?

In an thought provoking paper, Real Exchange Rate Movements and Endogenous OCA Analysis: Lessons from the Euro Area for Asia, prepared for the EUSA International Conference, April 24, 2009, Clas Wihlborg, Thomas D. Willett, and Nan Zhang write:

“While international monetary economists seldom reach complete agreement about the application of OCA criteria to particular countries, it is rather widely agreed among them that many euro entrants did not meet the major OCA criteria”.

And they add:
“… many economists have expressed concerns that mounting disparities in national wage and price movements are foreshadowing a day of reckoning.”

The two charts below (from Nouriel Roubini, Elisa Parisi-Capone, and Christian Menegatti, “Growth Differentials in the EMU: Facts and Considerations”, RGE Monitor, June 2007) provide a clear illustration of that conclusion: the internal adjustment mechanisms within the euro area are not operating powerfully enough to prevent inflation levels (and thus real intra-zone exchange rates)from diverging ,and they show no sign of reverting toward the group average.

It was indeed relatively easy to forecast such an evolution from the start, before the introduction of the euro (see my 1998 book L’erreur européenne), but politicians and bureaucrats did not pay heed. One can wonder why. Paul Krugman diagnoses a severe case of political hubris in The Making of a Euromess.

He concludes: … "it's important to understand the nature of Europe's fatal flaw. Yes, some governments were irresponsible; but the fundamental problem was hubris, the arrogant belief that Europe could make a single currency work despite strong reasons to believe that it wasn't ready."

I almost completely agree with him, having warned of the costly consequences of a move to a single currency for the last fifteen years or so (see my papers in Le Figaro from the mid 1990s), except that I do not think that pure hubris is the only -- and irrational -- motive. I believe instead that Big Government and Big Business found some strong interests in centralizing monetary policy at the continental level rather than keeping decisions and regulations at the national level. That’s what I wrote in my 2005 paper (in French) “Arithmétique de la démocratie” (The Arithmetic of Democracy), downloadable on my homepage.

At a time when it proves more and more difficult to raises tax rates in increasingly open economies, due to the mobility of some of the taxable matter (mostly capital), regulation is a good substitute for taxes, as explained long ago by Posner and Stigler: regulations increase the cost of a good or a service borne by some agents, for instance the producers, while simultaneously decreasing the costs for other ones, for instance the buyers (but it could be the other way around). Just like tax-cum-subsidy, they are a means for redistributing wealth.

Substituting one centralized regulation for 12, 15 or 25 national ones tremendously decreases the cost of these regulations for public bureaucracies – by a factor of 10 or more – and increases their effectiveness since is suppresses the regulatory competition between various states.

For the big business lobbies it is a bargain since the cost of lobbying is also decreased by a factor of 12, 15 or 20, while cartelization is made much more efficient when all trading corporations in various national economies are constrained by a single rule. In that case, producers get rid of the regulatory competition between states to select the one most favorable to consumers. And their collusive agreements are much easier to establish and to enforce, when not disrupted by the uncertainties of multiple exchange rates fluctuations.

This is precisely why the EU regulations have been proliferating at such a mindboggling rate during the recent decades, the single currency being only the most visible and the most important one, among many others.

The gains of such a regulatory bargain can then be shared between governments, bureaucrats and big cartelized corporations. With more powerful regulatory power at their hands, politicians and bureaucrats can satisfy both their taste for power – hubris – and their ordinary preference for income. And since the centralized regulation is much more powerful than national ones (the ratio of rents to costs being much higher), it opens a new and more rewarding echelon in the careers of bureaucrats.

Of course, the post WWII momentum towards a political integration of Western European states has many other causes such as the Cold War, and the general “first twentieth century” trend towards centralization of all hierarchical organizations (including states), or the belief in the peace guarantee that a merger of previously competing nations could provide.

But the main reason for the relentless pursuit of the political centralization of the continent, by big businesses as well as by national politicians, cannot be explained in these terms after the mid-1970s, when the previous centralizing trend was reversed by the information revolution and big hierarchies tended to break down, while markets expanded worldwide. Indeed, the very expansion of markets (the globalization phenomenon) resulted in an increase of worldwide competition, and thus a decrease of the market power of national cartels, as well as of the taxing power of states over capital. It thus became urgent for firms to reconstitute cartels on a broader geographical base, and for states to impose tax-replacing regulations upon firms and consumers, also on a broader geographical area. It is interesting to note that the 1970s were the years of disintegration of the Bretton Woods system of fixed exchange rates: floating exchange rates also contributed to dismantle national cartels.

As a consequence, big businesses and states tried to recover their market power and power to tax by the means of regulations, in a centralizing enterprise encompassing the whole continent. A move exactly contrary to the increasingly dominant trend of the “second twentieth century”.

This strategy, in my view, could meet some success in the short term, but is inevitably doomed in the end. Unable to reach a complete political unification in such an adversary context, the promoters of the Euro tried, as a first step, to establish a technical-economic, more modest, monetary union. Recent events have shown that such an instrument is too weak in itself to shield a centralizing experience from the fundamental decentralizing forces of the current era.

Saturday, March 6, 2010

Why Smaller Banks Are Better Banks

Simon Johnson explains.

Hat tip: Mark Toma (Economist’s View).

Thursday, March 4, 2010

Milton Friedman and the Euromess

« Maybe Milton Was Right About the Euro » writes Desmond Lachman in The American (February 23, 2010).

Excerpts :

« The main motivation for the euro’s creation was political rather than economic. It was thought that creating a single European currency would advance the dream of an integrated Europe that could rival the United States on the international stage. While it was recognized that the euro rested on the shakiest of economic fundamentals, it was hoped that the single currency would force economic change on its wayward Mediterranean member countries. It would do so by requiring those countries to undertake deep structural economic reforms and to abide by the strict Maastricht Treaty rules for individual member countries’ budget policies.

Sadly, economic events have not played out as the euro’s founders had hoped. »


« The main threat to the euro’s survival in its present form is the large domestic and external imbalances of its Club Med countries and of Ireland. These imbalances have reached such proportions that their correction within the straightjacket of continued euro-zone membership will necessarily involve many years of painful deflation and deep economic recession. Indeed, without the assist to competitiveness from currency devaluation, prices and wages in these countries will need to fall by around a cumulative 20 percent over the next few years if they are to regain international competitiveness. Similarly, attempting to radically reduce their budget deficits to more sustainable levels, without the boost to exports from a cheaper currency, could result in cumulative output declines for these countries well in excess of 10 percent. »


« While periodic European bailouts of the Mediterranean countries and Ireland are to be expected, the question will remain as to whether these bailouts will do much to solve these countries’ underlying unsustainable public finances and loss in international competitiveness. Rather, it seems that all that these bailouts will do is kick the can forward without averting the final day of reckoning. »

Read more.

Wednesday, March 3, 2010

The International Club for Breaking Up the Giant Banks

The membership includes Joseph Stiglitz, Edward Prescott, Anna Schwartz, Mervyn King, Nouriel Roubini, and many others, including of course Alan Greenspan, Paul Volcker, Thomas Hoenig, the President of the Federal Reserve Bank of Kansas City, and Richard Fisher, President of the Federal Reserve Bank of Dallas.

Read more here.

Tuesday, March 2, 2010

Retirement: Too Few Producers

Greg Mankiw posts on his blog the striking graph above, from The Economist.

It reminds me of the pre-Thatcher era in Great Britain, where levels of living were stagnating as a result of too few Britons actually working in the productive sector. France leads the pack, with other Europeans following closely. Beware of the welfare gifts effect on labor supply and thus on overall growth …