The Greek Crisis: Uttering the Other "D Word"

Matías Vernengo

Default is not the dirty word that nobody wants to say.  Almost everybody now accepts that Greece will default.  Several people will prefer to use the euphemism of “re-profiling debts,” but we all know what it means.  The interesting thing is that at least some authors, like Martin Wolf in a recent Financial Times column, also acknowledge that default is not sufficient.  The surprising thing that almost nobody asks is whether a default would actually solve the Greek problem.

Of course that would require understanding the problem in the first place.  And herein lies the problem, since most people still argue that the Greek problem is fundamentally fiscal.  In other words, in the conventional view the Greek government spent too much (and lied about it), and the solution must rely on the generation of sufficient fiscal surpluses to pay for the outstanding debt.  Further, to obtain the funds it is assumed that austerity is the way to go, privatizing public firms, cutting public sector wages, and reducing pensions.

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Can’t Pay? Won’t Pay!

Edward Barbier

What do the worldwide debt crisis and global warming have in common?

They both represent economies drawing down assets faster than they can replenish them.

In the case of the debt crisis, economies are spending more wealth than they are accumulating.  In the case of global warming and other symptoms of ecological scarcity, we are using up nature’s capital and its vital services at an alarming rate (see my forthcoming book, Capitalizing on Nature: Ecosystems as Natural Assets).  Rather than adding to wealth – both financial and natural – economies are squandering it.  This is not a new problem but has occurred throughout history, although this tendency has accelerated in recent times, as I show in my recent book, Scarcity and Frontiers: How Economies Have Developed Through Natural Resource Scarcity.

The connection between economic and natural debt is revealed if our conventional measure of economic progress – Gross Domestic Product (GDP) per capita – is replaced with an alternative indicator – Adjusted Net Domestic Product (ANDP) per capita.  As explained in my article, “Tracking the Sputnik Economy” in The Economists’ Voice, calculating ADNP per capita for most economies is straightforward.  ANDP is also a better indicator than GDP per capita of whether or not an economy’s real income is spent on adding to capital – human, reproducible and environmental.

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What about Capital Controls on Outflows?

Kevin P. Gallagher and Stephany Griffith-Jones

In the wake of the financial crisis, Western economists and policy-makers are to be applauded for recognizing that financial globalization has its limits and that capital controls may be necessary for emerging and developing nations to defend their economies from volatile capital flows.   Most of the discussion to date has focused on controls on capital inflows, but could there be a role for controls on outflows as well?

Perhaps controls on outflows in the US would have bolstered the effect of quantitative easing.  There may be situations where developing countries will need to resort to controls on outflows in order to prevent de-stabilizing outflows of capital from their countries as well.

Keynes thought so.  He said that, “control of capital movements, both inward and outward, should be a permanent feature of the post-war system.”  Indeed, Keynes and Harry Dexter White each argued that in order for capital controls to work coordination was needed at “both ends” of a capital flow, meaning at the source of the capital outflow and the receiving end or in terms of capital inflows.

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Whatever happened to stability analysis?

Alejandro Nadal

Once upon a time, stability of the general equilibrium was considered an important element in the education of students in economics. Today it seldom receives the attention it deserves and this is regrettable. Stability is one of the most important aspects of neoclassical theory because it addresses the question of just how the mechanism of free competition in the marketplace actually leads to the formation of equilibrium prices.

This crucial aspect of microeconomics is seldom covered adequately (if at all) in recent textbooks and university programs, whether at the undergraduate or post-graduate levels. Most students spend years learning how individual agents maximize, or exploring cases of oligopoly, or playing around with game theory, but when it comes to stability, their teachers skirt around the main issues.

As a result, a cloud of confusion persists. Students come to believe that somewhere in the sacred scriptures of the discipline there exists a theory that accurately reproduces just how the market forces of competition guide an economy through a price adjustment process that leads to the formation of equilibrium prices. In fact, if stability analysis received the attention it deserves, students would be able to see that it is the most important failure of general equilibrium theory.

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Majority Rule at the IMF

The following post was originally published by the World Policy Institute’s blog, a Triple Crisis partner, by Martin S. Edwards. Edwards argues that the selection of a new IMF leader needs to take all members’ interests into account.

With the recent resignation of IMF managing director Dominique Strauss-Kahn, the issue of IMF governance is on the front burner of international policy. At a time in which there are crucial issues at stake in the global economy, one of the most important international organizations has a very large “HELP WANTED” sign in the window.  There’s already been a great deal of talk about the selection process, and one can even place wagers on who is going to be named as the next Managing Director. The concern, however, should be less with who gets the job than with how they get it.

At the time that these organizations were founded, the unwritten rule was simple – the IMF was to be run by a European, and the World Bank was to be run by an American. Today, it seems that Europe is speaking with one voice in favor of Christine Lagarde, the French finance minister. With a decisive level of support and a large bloc of votes, Lagarde’s candidacy for the next Managing Director looks hard to stop.

The problem for Lagarde is that the world of 2010 is very different than the world of 2000. The IMF’s most important borrowers are now in the Eurozone, rather than in the developing world. The IMF’s message of fiscal consolidation and cutting government spending is not being heard across Europe and the U.S. as these countries struggle to produce vigorous growth. Meanwhile, many developing countries have gone from borrowing from the IMF to lending to it. Brazil, Russia, India, and China have invested a total of $80 billion into the Fund in recent years. This expansion of the IMF’s coffers—which has only come about because of rapid growth in the BRIC countries—has given it more flexibility in dealing with the economic crisis in Europe.

Read the full post at the World Policy Blog.

Towards Productive Forestry

Sunita Narain published the following article in  Business Standard, on the need to re-position forests in development and assess the tangible economic returns of forests.

My position on the need to re-position forests in development has invited a huge response. On the one hand are those who argue that the functions of forests already include conservation vital to life; they need to be valued and protected. The unsaid – but often stressed – corollary is that any discussion on the need to improve productivity of forests through the involvement of people needs to be shunned. The stretched and simplistic position that this view takes is that forests and people cannot go together. One letter writer has even argued passionately that the government should think of taking over – buying out – large areas of forests from people and then protecting them for future generations. On the other hand are those who argue for further engagement of people with forests.

The discussion on this matter is deeply polarised. The two sides are at war, in which both forests and wildlife are the losers. But let me stress again that the stalemate in the forest policy is not tenable.

With each passing day, the constituency for forest protection is shrinking. And this is when forest land in India is under a big threat — not necessarily from the people living in forests but from developers who want the land, minerals, water and other resources. Over time, the infrastructure imperative will take away forests, which have become the only “free” and “available” resource in the time of scarcity. The demand to open up forests will grow.

Read the full article in Business Standard.

The IMF’s ‘social justice’ ruse in Cairo

Patrick Bond, Guest Blogger

After the International Monetary Fund’s long support for tyranny, dictatorship and rampant corruption in Egypt, the last few weeks have witnessed the incongruous appearance of the two words, ‘social justice’, in official statements. The June 4 loan of $3 billion adds to an existing $33 billion in foreign debt inherited from Hosni Mubarak’s regime, which a genuinely new, free democracy would  have grounds to default on because of its ‘odious’ nature in legal and technical terms.

To legitimize that debt requires new loans that have an aura of relevance. As Ratna Sahay, IMF mission head in Egypt, said on June 2, “We share the draft budget’s overarching goal aimed at promoting social justice. The measures go in the right direction of supporting economic recovery, generating jobs and assisting low income households, while maintaining macroeconomic stability.”

Three days later, acting Managing Director John Lipsky claimed, “We are optimistic that the program’s objectives of promoting social justice, fostering recovery, and maintaining macroeconomic stability and generating jobs will bring positive results for the Egyptian people.”

The same day, Sahay repeated, “Following a revolution and during a challenging period of political transition, the Egyptian authorities have put in place a home-grown economic program with the overarching objective of promoting social justice.”

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Financial Reform: Why credit the rating agencies?

Ilene Grabel

The credit rating industry is firing from both barrels.  The industry has launched a public relations effort that aims to delegitimize proposed regulations announced for public comment last month by the US Securities and Exchange Commission (SEC). The proposed regulations stem from the Dodd-Frank Act of 2010. At the same time the industry is taking its hubris to new levels by inserting itself aggressively and directly into public policy debates in the US and Europe.

This is a rather stunning reversal of fortunes for the rating agencies.  In the early days of the financial crisis, it looked as if the industry was in for a fundamental overhaul. At that time, it seemed that there was momentum in the US around the creation of a new rating industry model—in the new model they would operate as public utilities. Elsewhere in the world, discussion of the failings of this industry was part of broader conversations about the need to move away from a US-centered financial architecture. In Europe and Asia, in particular, the misdeeds of the rating industry led to calls to create new regional and/or national entities that would credibly and ethically perform this work.

An overhaul of the rating industry was long overdue. The current crisis made it simply impossible to paper over the industry’s multiple failings.  These include, but are not limited to, the conflict of interest that is an intrinsic feature of a business model wherein those whose securities are being rated pay for their ratings. Moreover, the industry’s analysts and the models they use have consistently failed to assess sovereign and private risk accurately. There is a revolving door between analysts and the entities that they rate. The structure of the industry means that rating firms have incentives to build business by offering more lenient ratings than their competitors. And the monopoly power of the industry is maintained by the fact that some entities (such as insurance companies) can only invest in assets that are rated, and these ratings must be performed only by firms that the SEC designates as nationally recognized statistical rating organizations.  And though the report by the US Financial Crisis Inquiry Commission (a Congressional panel) was disappointing in so many respects, it did correctly indict the credit rating industry, calling its three biggest firms “essential cogs in the wheels of financial destruction.” 

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What is the Correct Keynes Solution?

Paul Davidson, Guest Blogger

The financial market crisis and the Great Recession of 2008-2010 provided the empirical nails for the coffin of the efficient market hypothesis.  Since the 1970s, efficient market theorists, government policy makers, and central bankers insisted that (1) government regulations of markets and large government spending policies are the cause of all our economic problems, and (2) ending big government and freeing markets, especially financial markets, from regulatory controls is the solution to our economic problems, domestically and internationally. Stickiness in wages and prices – including financial market prices– caused our economic problems.  Flexible market prices was the solution.

The fundamental principles underlying Keynes’s theory of liquidity can explain why free markets, free trade, freely flexible exchange rates and free international capital funds mobility are ultimately incompatible with the economic goal of global full employment and rapid economic growth. Moreover, Keynes’s liquidity analysis suggests policy prescriptions to completely prevent or at least quickly alleviate the distress caused by financial market problems.

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The next managing director of the IMF

Kevin Gallagher

The Dominique Strauss-Kahn debacle has brought significant attention to the International Monetary Fund (IMF) and who might head it as next managing director.  The discussion is a vast improvement over the past, when the Europeans could simply pick their own head of the IMF, with US approval.  That said, the debate has become “who is better than Christine Lagarde?” the French Finance minister.  A handful of names have popped up, which is welcome.  Columbia University’s Joe Stiglitz has said we should just go with Lagarde, Paul Krugman has endorsed Stanley Fischer, the former MIT economist and current head of the Israeli central bank.

What is shockingly missing from these and other commentaries is a discussion regarding what a new IMF needs to do and then who is up to that task.  We know that the IMF is knee-deep in the European debt crisis with billions in commitments (whether that was the right thing to do is hardly questioned), so why don’t Stiglitz and others discuss the fact that Lagarde has been at the center of the botched bailouts there?

The IMF has made some significant steps toward reform as of late.  One key development has been their recognition that the free flow of capital is not always beneficial in terms of financial stability.  So it comes as a bit of a shock that someone like Paul Krugman would endorse Stanley Fischer.  Fischer was behind the capital account liberalization push at the IMF in the 1990s that brought down Asian governments.

The debate has brought up the valid idea that the IMF top job shouldn’t go to someone in the West given that the West it largely responsibile for the financial crisis.  The leading emerging market candidate is Augustin Carstens from Mexico.  In the following piece I argue he would be just as bad or worse than many of the advanced country picks.  His economics and record have been right out of the Fischer et al., playbook.

Read Kevin Gallagher’s full post in The Guardian, Why Agustín Carstens should not be the next head of the IMF.