Monday, February 13, 2012

Greek Crisis: Shock Doctrine Comes to Europe

Brussels Praises While Athens Burns
On February 7th, 2012, the BBC reported that the troika was finalizing the deal with Greece.  What we must really ask is, what does this deal consist of, and will it help resolve Greece’s economic problems. In other words, is this deal right for Greece and for Europe?

Shock Doctrine
In 2008, Canadian Economist Naomi Klein published an account of the international rise of the neoliberal economy. The story she tells in one whereby neoliberal economic principles arise in country after country in the aftermath of a crisis or shock. These crises have been both of the economic variety and of the more conventional sort, such as earthquakes, hurricanes, tsunamis, or even wars and military shocks.
The narrative is one of the overnight imposition of austerity, privatization, and cuts in wages and benefits via the circumvention of democratic means. This is ostensibly done as a form of crisis-response. As Klein tracks the imposition of these polices through crisis after crisis, one facet becomes clear, the details of the crisis itself do not seem to matter.

"Blaming the Locals"
This phenomenon as a response to the failure of neoliberal policies in country after country to create growth, improve people’s lives, or even restore pre-crisis normality. Essentially, proponents draw on Samuel Huntington-style arguments to explain the failure of the neoliberal policy changes. In other words, the narrative that emerges is one saying “it’s not that privatization and wage cuts are bad policy, it’s that the people in this country do not have sufficient work ethic and/or entrepreneurial spirit”.

The Greek Crisis
One thing about the crisis has become clear, the response to the crisis has become about austerity. The BBC reports that Greek austerity cuts include:
  • 15,000 public-sector job cuts 
  • liberalization of labor laws  
  • lowering the minimum wage by 20% from 751 euros a month to 600 euros

As an economist, it worth noting that while lowering the minimum wage and making it easier to fire people will certainly increase poverty and unemployment, it is hard to see what upside this would bring. Within the economics profession, there is no consensus that these measure would in any way have a positive outcome. 

Not surprisingly, the Greek public does not accept the economic suffering, and has taken to the streets, giving Athens its worse riot in years. 45 building have been burned so far according the BBC. Sadly, the BBC was more interested in covering the austerity deal than the resulting protests and riots.

As for fairy tales about improving competitiveness and “expansionary austerity”, this is the same thing that IMF experts told Argentina. How did things work out then? Sadly, there will always believe that “That is South America, such things will never happen here” Last year, Europeans believed that. In fact, the plain and simple truth that austerity leads to violence. If we can solve a crisis without it, then we should. What we shouldn’t do is allow ourselves to be swayed by phony doomsday arguments. 

Sunday, February 12, 2012

Skidelsky on Keynes and Hayek Similarities

Only Two Schools of Thought to Model Crises & Slumps
Sets apart from Classical & Neoclassical schools

Professor Lord Robert Skidelsky, member of the House of Lords, and the one of the UK's preeminent Keynesian economists discusses similarities between Hayek's and Keynes' schools of thought. In this 20 minute clip, Skidelsky explains that during an economic crisis, the Keynesian and Hayekian (Austrian) schools of thought are the points of view which matter most. This is because these are the two most prominent schools of thought which recognize that markets fail and that crises form with some regularity. Aside from predicting that economic and financial crises occur, both school of thought make the attempt to explain how this process occurs.

Under Hayek, it is mal-investment which leads destruction of the capital stock, and ultimately to crisis. Under Keynes meanwhile, elaborated on the effects of uncertainty and volatility, and drops in demand leading to economic contraction. With Classical and Neoclassical schools on the other hand, these events -ARE NOT- predicted to occur. Rather, the assumptions are that all markets clear and that all markets are efficient. Any deviations from this outcome are strictly due to exceptional circumstances and are not really part of the model. Obviously, during a crisis, it does us no good to assume that crises do not occur, except for exceptional circumstances. 

Although the Keynesian and Austrian schools of thought come up with different explanations, and hence different policy solutions, it can be said that both schools of thought have crisis resolution at the center of their intellectual traditions. Furthermore, both schools of thought cite the dislocation and mis-allocation of savings and investment as central to an economic crisis. As such, both schools of thought should be considered to have at least a kernel of useful analysis during and economic crisis. Moreover, the analysis and lessons of both should be considered during times of economic crisis and slump. 

About the Speaker:

Robert Alexander, Barron of Skidelsky is an emeritus professor of economics at Warwick and a member of the House of Lords in the UK. He was elected a Fellow of the British Academy in 1994 and has published an award-winning three-volume biography on J.M. Keynes. 

Sunday, February 5, 2012

WSJ: EU May Back Away from Basel

Regulators Under Pressure from Lobbyists 
On February 2nd, the Wall Street Journal reported that European regulators are considering loosening rules on Capital Requirements. EU Policy makers and regulators are weighing whether to permit banks to hold a broader variety of assets to meet new safety standards. Because the current rules are the product of G20 negotiations and have been implemented across the OECD, relaxation of the rules is likely to spark a fight with policy makers across the world. 

As if we learned absolutely nothing from 2008, EU regulators are considering allowing “Asset-backed instruments [ABS] of high liquid and credit quality”. In other words, banks will be allowed to have "AAA-rated" Mortgage-Back Securities instead of actual safe assets in order to meet their capital requirements. 

This is ostensibly being done as a short cut to make it easier for banks meet core capital requirements. Because one aspect of the current recovery period is marked by the reluctance of banks across the OECD to engage in new lending of any kind, such a step might encourage banks to start lending again. If only things were so simple. While restarting lending is critical to economic recovery, we should not be so naive as to do this by feeding the underlying cause of the crisis. Certainly, the Vienna Agreement whereby bankers from across Europe were encouraged not to pull out of Eastern Europe, where the primary bank activity consists of private lending and project finance demonstrated the importance of the role of lending. 

In this spirit, it may be a good idea to try to think outside the box. While we need to restart lending in productive areas of the economy, we also need to ensure that bank capital is as solid as possible. In other words we need to leave the capital rules as they have been established, and engage in lending by alternate means. 

What Would Hayek Say?
To state is plainly, von Hayek believed that mal-investments wreck the economy. According to the Austrian school what we really need to be concerned about is care-less investments which do not yield what they should and do not add to productivity. This is how economics slumps are born, and they start out as bubbles. This sort of relaxation of financial rules would lead to exactly the type of mal-investment Hayek and the Austrians were talking about.

What Keynes Would Say
As Skidelky has noted, Keynes was a proponent of directly addressing the sources of economic troubles. generally, he was a proponent of using the influence of the state as an alternate means of distribution in both the fiscal and the monetary sense. 

German Historical School Would Say...
The doctrine of Historical School is established (as the name states) based on a study of economic history. To that effect:

1: ABSs under questionable AAA rating being used as Basel II capital was at the core of the 2008 financial collapse. Letting ABS be considered as capital yet again cannot lead to anything good.

2: More generally, we should examine post-crisis economic recovery periods which came after the collapse of the bubble. While it is true that employment and economic growth lag for as much as a decade after the collapse, stable economic recovery has only been possible under the auspices of smart regulation which addressed the underlying causes of economic stability. Its as true for the tulip bubble as it is in 2012. 

What We Need 
Simply stated, the capital rules and financial regulations established by the G20 and the Basel III rules need to stay in place if we are to have a stable recovery built on the recovery of real, tangible economic output. While the process may be slowed by bank lending reluctance due to the new capital requirements, we can use alternate means to distribute lending to the productive real economy. For example, project finance and real estate lending could be distributed by municipal authorities under central bank auspices. This would restart lending and reduce some of the need for radically expansive monetary growth in one bold stroke.

About the Author:
Max Berre is an economist at the EDHEC-Risk Institute who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands

Thursday, February 2, 2012

Software Patents vs Competitiveness: Less is More

Less is More   (Madrid-based EU Study)  (Boston Law + Federal Reserve Study)

A pair of studies on the effect of software patents on innovation and competition in the marketplace. Both studies take a negative view on the effect of software patents. 

Fundamentally, this should come as no surprise to economists. While the pro-intellectual property rights side of the argument sees intellectual property rights as being equivalent to all other property rights (tangibility and duplicability characteristics notwithstanding) and consists mostly of legal professionals and law scholars, economists see it differently. What economists see in this debate are market-distorting monopolies. Everyone who ever took a first-year economics course is trained to think that monopolies cause inefficiency and should be avoided, or at least limited as much as possible. In the case of the IPR debate, a rat by any other name, still smells as strong. 

Lately however, legal scholars in the EU have begun to see the IP issue in the same skeptical light that most economists see it in. This is due largely to the role that patents have in emerging anti-competitive behavior in the I.T. industry. The list of emerging anti-competitive crimes includes frivolous patents, patent trolling, use of patents as competitive-entry barriers, and patent-based M&A. While many of these actions are not yet illegal in most first-world countries, the growing chorus of voices on this issue in both the EU and Switzerland may soon change that. 

Madrid-Based EU Study
This study finds that software patents have the effect of reducing competition, encouraging obvious and frivolous patents, fostering the emergence of artificial entry barriers, and the replacement of both education and R&D-based competition with litigation-based competition and patent-portfolio-based competition  (patent trolling). The study also finds that software patents favor a smaller number of large, rigid companies (oligopolistic firms), who channel resources into claiming patents rather than R&D. In short, the growth of software patents has been harmful to the software industry in general and to the European software industry in particular. 

Boston Law and Federal Reserve Study
On the other side of the Atlantic, an empirical look at the effects of software patents in the US in the wake of recent legal changes. Whereas during the 1970s, federal court decisions typically described computer programs as mathematical algorithms, which are unpatentable subject matter under U.S. law, court decisions in the 1980s and 1990s lowered the standards, allowing software to be patentable. 

The study finds a disconnect between software patent propensity of software patents and R&D investments or productivity growth.  Furthermore, the study finds that software patent acquisition acts as a substitute for firm-level R&D. In short, legal changes in the US software patent system has failed to incentivize R&D in the software sector, as classical theory has established. Rather, legal changes encouraged more strategic patenting and less innovation.

What Do We Need?
Essentially, IPR and patent law needs to be reformed in order to curtail anti-competitive activity. In the future, it is likely that competition law will evolve to the point that patent trolling will be as illegal as collusion, price fixing, and other monopolistic behavior.

While there are many directions in which reform can go, the moderate course is one of simply watering-down existing IPR law in order to limit anti-competititive behavior. In the future, it is likely that there will be limits on what  can be patented. The list should include obvious technology, traditional technology/medicine, life forms, genomes, and algorithms (all of which can currently be patented in the US). Furthermore, in order to increase competition, the protections granted by patents should be continually reduced, thereby stopping patent-holders from resting on their laurels. Lastly, IPR infringement lawsuits should be subjected to stricter burdens of proof. This measure could discourage patent-trolling in a big way.    (Madrid-based EU Study)  (Boston Law + Federal Reserve Study)