Tag Archives: EU

No, bailouts are not something to celebrate

Robert Samuelson at the Washington Post is celebrating the auto bailout.

Last December I had a piece in the Post in which I argued that “pro-business” policies like bailouts are actually bad for business. I offered five reasons:

  1. Pro-business policies undermine competition.
  2. They retard innovation
  3. They sucker workers into unsustainable careers.
  4. They encourage wasteful privilege seeking.
  5. They undermine the legitimacy of government and business.

Read my piece for the full argument.

But aren’t things different in the midst of a major economic and financial crisis? Shouldn’t we have more leeway for bailouts in exigent circumstances?

No. Here is why:

First, we should always remember that the concentrated beneficiaries of a bailout have every incentive to overstate its necessity while the diffuse interests that pay for it (other borrowers, taxpayers, un-favored competitors, and the future inheritors of a less dynamic and less competitive economy) have almost no incentive or ability to get organized and lobby against it.

Bailout proponents talk as if they know bailouts avert certain calamity. But the truth is that we can never know exactly what would have happened without a bailout. We can, however, draw on both economic theory and past experience. And both suggest that the macroeconomy of a world without bailouts is actually more stable than one with bailouts. This is because bailouts incentivize excessive risk (and, importantly, correlated risk taking). Moreover, because the bailout vs. no bailout call is inherently arbitrary, bailouts generate uncertainty.

Todd Zywicki at GMU law argues convincingly that normal bankruptcy proceedings would have worked just fine in the case of the autos.

Moreover, as Garett Jones and Katelyn Christ explain, alternative options like “speed bankruptcy” (aka debt-to-equity swaps) offer better ways to improve the health of institutions without completely letting creditors off the hook. This isn’t just blind speculation. The EU used this approach in its “bail in” of Cyprus and it seems to have worked pretty well.

Ironically, one can make a reasonable case that many (most?) bailouts are themselves the result of previous bailouts. The 1979 bailout of Chrysler taught a valuable lesson to the big 3 automakers and their creditors. It showed them that Washington would do whatever it took to save them. That, and decades of other privileges allowed the auto makers to ignore both customers and market realities.

Indeed, at least some of the blame for the entire 2008 debacle falls on the ‘too big to fail’ expectation that systematically encouraged most large financial firms to leverage up. While it was hardly the only factor, the successive bailouts of Continental Illinois (1984), the S&Ls (1990s), the implicit guarantee of the GSEs, etc., likely exacerbated the severity of the 2008 financial crisis. So a good cost-benefit analysis of any bailout should include some probability that it will encourage future excessive risk taking, and future calls for more bailouts. Once these additional costs are accounted for, bailouts look like significantly worse deals.

Adherence to the “rule of law” is more important in a crisis than it is in normal times. Constitutional prohibitions, statutory limits, and even political taboos are typically not needed in “easy cases.” It is the hard cases that make for bad precedent.

What is the greatest threat to freedom and prosperity?

FLORENCE— Bernardo Caprotti was a 45-year-old entrepreneur when he agreed to buy a suburban plot of land for a new supermarket.

Building permits recently came through. He’s now 88.

So begins an enlightening story in today’s Wall Street Journal on Italy’s sclerotic economy. The story continues:

Italy has emerged as a Technicolor example of the [EU’s] problems. Its growth has been stuttering for 20 years. Since 2008, its economy has shrunk by 9%, and this year it is struggling to expand by even 1%.

It is tempting to think that a simple solution is new leadership, that Italy just needs to elect more market-oriented politicians to sweep away the layers of red-tape and barriers to entrepreneurship that have ensnared the country’s entrepreneurs.

But the problem is much more intractable because established businesses benefit from the status quo:

The roots of the problem, say many Italians, lie in how vested interests in the private and public sectors gum up the economy, preventing change that replaces old practices with new, more efficient ones, and repeatedly frustrating political attempts to shake up the country.

It adds up to “deep-seated cultural obstacles to growth,” says Tito Boeri, a professor at Milan’s Bocconi University who is one of Italy’s top economists.

Years ago, Milton Friedman put his finger on the problem:

A few months ago, I attended a conference on the intersection between politics and capitalism (what we’ve called government-granted privilege). The eminent economic historian Robert Higgs was there and he said something that has stuck with me (I’m paraphrasing, but he just approved the quote):

I believe crony capitalism—the alliance between business and government—is the biggest problem of our age. And the reason is that it is robust. As alternatives to free-market capitalism, communism and old-fashioned fascism are thankfully dead. And genuine socialism has no real constituency in America. But crony capitalism, unfortunately, has a very active, organized, well-funded, and vocal constituency. It is the greatest threat to our prosperity and our freedom.

 

New Public Choice Papers

Last week I attended the annual Public Choice Societies conference in Miami, Florida. Among the most interesting papers were:

Does Economic Freedom Foster Tolerance?” by Niclas Berggren and Therese Nilsson:

Tolerance has the potential to affect both economic growth and wellbeing. It is therefore important to discern its determinants. We add to the literature by investigating whether the degree to which economic institutions and policies are market-oriented is related to difference measures of tolerance. Regression analysis of up to 65 countries reveals that economic freedom is positively related to tolerance towards homosexuals, especially in the longer run, while tolerance towards people of a different race and a willingness to teach kids tolerance are not strongly affect by how free markets are….We furthermore find indications of a causal relationship and of social trust playing a role as a mechanism in the relationship between economic freedom and tolerance and as an important catalyst: the more trust in society, the more positive the effect of economic freedom on tolerance.

Governance, Bureaucratic Rents and Well-Being Differential Across U.S. States” by Simon Luechinger, Mark Schelker and Alois Stutzer:

We analyze the influence of institutional restrictions on bureaucratic rents. As a measure for these rents, we propose subjective well-being differentials between workers in the public administration and workers in other industries. Based on data for the U.S. states, we estimate the extent to which institutional efforts to strengthen bureaucratic accountability affect differences in well-being. We find that the differences are smaller in states with high transparency, elected auditors, and legal deficit carryover restrictions. These findings are consistent with limited rent extraction under these institutional conditions. No effect is found for performance audits and regulatory review.

Economic Performance and Government Size” by António Afonos and João Tovar Jalles

Our results, consistent with the presented growth model, show a negative effect of the size of government on growth. Similarly, institutional quality has a positive impact on real growth, and government consumption is consistently detrimental to growth. Moreover, the negative effect of government size on growth is stronger the lower institutional quality, and the positive effect of institutional quality on growth increases with smaller governments. The negative effect on growth of the government size variables is more mitigated for Scandinavian legal origins, and stronger at lower levels of civil liberties and political rights. Finally, for the EU, better overall fiscal and expenditure rules improve growth.

Leaders, Institutions and Fiscal Discipline” by Heiner Mikosch:

In particular, I find evidence that pure career politicians are fiscally more disciplined than politicians with working experience outside of politics. This contradicts a popular claim that people who have been working in the “real world” outside of politics, are better politicians.

Institutions, Lobbying, and Economic Performance” by Jac Heckelman and Bonnie Wilson:

They find that economic freedom improves growth but that lobbying detracts from it. Moreover, there may be an interaction between the two. It might be that in economically free societies, lobbying is particularly bad for growth whereas in less-free societies it actually enhance growth. This lends support to their basic hypothesis that:

while economic freedom that emerges spontaneously may be growth promoting, economic freedom that emerges as a result of costly lobbying efforts may be less fruitful.

And here’s one that made me smirk:

The Right Look: Conservative Politicians Look Better and Voters Reward It” by Niclas Berggren, Henrik Jordahl and Panu Poutvaara:

Political candidates on the right are more beautiful or are seen as more competent than candidates on the left in Australia, Finland, France, and the United States. This appearance gap gives candidates on the right an advantage in elections, which could in turn influence policy outcomes. As an illustration, the Republican share of seats increased by an average of 6% in the 2000–2006 U.S. Senate elections because they fielded candidates who looked more competent. These shifts are big enough to have given the Republicans a Senate majority in two of the four Congresses in the studied time period. The Republicans also won nine of the 15 gubernatorial elections where looks were decisive. By using Finnish data, we also show that beauty is an asset for political candidates in intra-party competition and more so for candidates on the right in low-information elections. Our analysis indicates that this advantage arises since voters use good looks as a cue for conservatism when candidates are relatively unknown

This last one reminded me of this famous paper from a few years ago showing that inferences based solely on appearance predicted 68.8 percent of U.S. Senate races in 2004. (It isn’t good to have a baby face).

Will We Learn From Greece?

A few weeks ago Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, warned, “Greece is a lesson for us…. We shouldn’t be so arrogant to think that that couldn’t happen to us.” Mr. Hoenig was talking about our “very, very significant deficit” at the federal level.

Mr. Hoenig is right to worry about the Federal Government’s financial footing, but as a growing number of commentators have argued, the comparison between Greece and the U.S. states may be more apt than that between Greece and the U.S. Federal Government.

Like Greece, nearly every state in the union faces a major budget gap. The National Governors Association and the National Association of State Budget Officers estimate that these gaps total $127.4 billion for the remainder of 2010, 2011 and 2012. Like Greece, these gaps manifested themselves during the recession but their underlying cause is unsustainable levels of government spending. Like Greece, the states have made unrealistic promises to their public employees in the form of unfunded pensions and health benefits. Like Greece, these promises loom as the single largest threat to fiscal solvency in the coming years. And like Greece, the states have a limited number of ways to deal with the situation: they may not declare bankruptcy and they may not inflate their way out of the mess.

In both situations, however, the governments can appeal to the next level of government for aid. In the US, the states received some $135 billion from the Federal Government in the stimulus package passed last spring. And in Europe, the EU has promised to bail out Greece to the tune of $146 billion. These actions send the signal that the US and the EU apparently think that some governments are too big to fail. They also establish a strong incentive for US state and EU member nations to live beyond their means.

The Economist recently noted another similarity between Greece and the US states: as in Greece, many leaders at the state government level are reluctant to make the tough choices necessary to deal with the problem.

This last comparison, however, may prove false. That is because the Greeks may finally be on the verge of addressing their problem. This week, the ruling Socialist Party, PASOK, unveiled their reform proposals and on Friday, the government agreed to the bill. According to Reuters, “The reform cuts benefits, curbs widespread early retirement, increases the number of contribution years from 35-37 to 40 and raises women’s retirement age from 60 to match men on 65.”

My colleague Eileen Norcross has just written a paper with AEI’s Andrew Biggs which reveals the scope of the pension problem in the state of New Jersey. They found that the pension system there is underfunded by as much as $170 billion. Note that this one state’s pension problem dwarfs the $127.4 billion sum total of all state budget gaps over the next two and a half years.

Worse, these unfunded liabilities will come due soon. A series of studies by Joshua Rauh (Northwestern) and Robert Novy-Marx (University of Chicago) find that seven states will run out of pension money by 2020. And when they do, the costs will be enormous. When Illinois’s pension system goes broke in 2018, for example, the state’s pensions costs will be nearly half the size of the entire 2008 state budget.

If Mr. Hoenig is right and Greece is a lesson, let’s hope that policy makers in the US learn it before the pension crisis hits.

Is California’s Debt a Greek Tragedy?

James Surowiekci writing at The New Yorker considers whether there is good reason to think California’s fiscal plight puts it on course for a Greek-style collapse. Greece is not the only EU nation in trouble. Add in Portugal, Ireland, Italy and Spain to the massive debt club (a.k.a the PIIGS), with debt levels at 60% of GDP in 2008-2009. By contrast the most fiscally troubled states of California, New York, New Jersey and Illinois had debt-to-GDP ratios of 15% during the same period.

Surowiecki suggests this may be reason to breathe a little easier. The biggest debtor nations in the EU owe three times as much relative to GDP as do their high-debt counterparts in the US. Plus, the states can count on a federal bailout.

Yet, neither of these thoughts are entirely comforting.

First, states have underestimated their pension obligations by threefold. Official reports estimate New Jersey’s unfunded pension obligations at $45 billion. Using more reasonable discount rates to estimate New Jersey’s pension obligation reveals an unfunded liability of $137.9 billion, or 261% of total state debt. That’s before adding in Other Post-Retirement Benefits (OPEB) and health care for public sector workers.

Secondly, a half century of  intergovernmental infusions from D.C. in the form of transfers,Medicaid, and stabilization money hasn’t kept the states afloat. Quite the contrary the erosion of fiscal federalism has meant a loss of states’ control over spending and policy.

The FY 2009 stimulus has been as effective as a shot of morphine. States have now spent their education money to expand spending and avoid cuts. Fast forward to FY 2010. Revenues haven’t recovered. Pension obligations loom larger and those “saved and created” jobs are now in search of funds.

Factor in the growth in Social Security, Medicare, health care spending, and annual deficits projected to average $1 trillion over the next  decade and America 2030 looks alot worse than Greece 2010.

Preservation Overload

Since the European’s Union establishment in 1993, the organization has taken steps to protect local and traditional culinary traditions.  This practice has reached a new heights in the United Kingdom, where the town of Stilton is challenging a ban against producing the cheese named after it.

The Wall Street Journal reports:

The EU’s protected list of more than 800 foods and drinks includes famous names like Champagne and Parma as well as lesser-known delicacies such as Moutarde de Bourgogne, Munchener Bier and a Spanish chili pepper called Asado del Bierzo. It even covers Foin de Crau, a hay for animals from the fields of Bouches-du-Rhône in southern France.

But to the chagrin of locals, no cheese made here can be branded as Stilton. That’s because a group of outsiders, called the Stilton Cheesemakers Association, raised a formal stink.

The association, whose members have been making the cheese for more than a hundred years, in 1996 sought to protect the “Stilton” name by applying for a Product Designation of Origin from the EU. In its application, the group wrote that “the cheese became known as Stilton because it was at the Bell Inn in this village that the cheese was first sold to the public.” The 17th-century inn, which still stands in the main street, is the village’s oldest.

In recent memory, Stilton cheese has been produced outside of the village, but the Journal explains, a historian recently found evidence of the cheese being made within the eponymous municipality in the 18th century. The record failed to sway current cheese producers who assert that the recipe has most likely changed since then. This suggests the question — in their effort to preserve historical practices, how far back should bureaucrats look?

Advocates of limiting food production suggest that it protects gastronomic quality and heritage. The darker, unseen consequences, however, are government-sponsored monopoly food production and quantity restriction.  Paradoxically, earlier this spring, the EU increased enforcement of its antitrust regulations. The international governing body is becoming increasingly involved in the private sector by taking it upon itself to decide politically acceptable business practices.