Will Greece default?

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Adam Smith had an insight that elegantly answers the question:

The practice of funding [i.e. borrowing to pay for government spending] has gradually enfeebled every state that has adopted it...where national debts have accumulated to a certain degree there is scarce I believe a single instance of them having been fairly and completely paid.

He, of course, was writing about England. And with the UK government now repaying its creditors in devalued, inflated sterling, he seems to be right there, too.

Capping the national debt (and the rest)

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Over on ConservativeHome yesterday, Sajid Javid MP argued that the Britain should cap its national debt. Next month, he’ll be introducing a National Debt Cap Bill in the House of Commons to this effect. Bravo, Sajid!

I’m a big fan of the idea. The simple truth is that you can’t trust government to be fiscally responsible. Political imperatives mean they will almost always prioritize the short-term over the future. In spending terms, what’s a little more debt if it lets you carry on with the bread and circuses? The result is that governments tend to adopt a buy-now, pay-later attitude. All the incentives point in that direction.

That’s why rules are important. You need to impose limits on governments; you can’t just rely on their discretion. And a debt cap is the perfect place to start. But I’d like to see much more besides. Indeed, I’d like to see the government introduce a fully-fledged Economic Responsibility Act, like the one Eamonn outlined in this briefing paper.

As Sajid suggests in his ConHome piece, we should cap the national debt at 40 percent of GDP. We’re a little over 60 percent at the moment, so this cap should start as a binding legal target for, say, ten years hence – with clearly defined checkpoints along the way. Once we got there, the government’s hands would be tied.

We should cap the budget deficit – at 3 percent of GDP – and the overall size of the state – at one-third of GDP. Again, these should begin as legally binding targets, to be achieved by a specified date. We should also have clear rules on what the government can borrow for (capital investment) and what it can’t (current spending), and ensure that all government is transparent and ‘on-the-books’.

Finally, we should limit the government’s ability to raise taxes arbitrarily. I’d say that any tax rise not specifically detailed in a governing party’s general election manifesto should have to be approved in a referendum. That, taken together the deficit limit, would make it very difficult for future governments to ramp up spending the way Gordon Brown did.

Of course, it is true that – constitutionally speaking – Parliament cannot bind its successors, so these rules could always be changed at a later date. But the very existence of the rules, and the need to explicitly repeal or amend them, would act as a powerful counter-incentive against ever-larger government.

But that’s all some way off. For now, good luck to Sajid Javid and his National Debt Cap Bill.

Who is to bear the losses?

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Philipp Bagus is an associate professor at Universidad Rey Juan Carlos in Madrid. He is the author of The Tragedy of the Euro. Visit his personal website here. 

Police and rioters are clashing in the streets of Athens as the Greek government approves further austerity measures. Indeed there are conflicts over austerity measures all over Europe. At the root of these conflicts lies an interventionist banking system, credit expansion and the perverse setup of the European Monetary System as described in my book The Tragedy of the Euro.

During the 2000s artificially low interest rates lead to an impressive boom, asset price bubbles and malinvestments. Real resources were wasted in building houses that no one wants at bubble prices, in the overexpansion of certain industries and in countries such as Greece in maintaining and expanding an immense public sector.

When Lehman Brothers collapsed governments came to the rescue of industries such as the automotive sectors and, of course, of the banking industry. The losses of these sectors were, thus, partially transferred to the governments. Government deficits and debts soared. The result is the sovereign debt crisis.

Now, European governments like the Greek one are on the border of default. If Greece would be allowed to default, its banks holding Greek government debts and experiencing a run would go bust. In a European banking crisis, French, German and British banks could go insolvent.

While society in general is already poorer due to the malinvestment of the artificial boom, the burden of the losses has not been finally assigned. And losses have not disappeared. They were partially shifted from banks and companies to governments.

Who will be the final bearer of these past losses? Will banks, that bought government bonds, finally be the bearer of losses because governments default on their bonds? Will governments suffer the losses as they lose in power when they are forced to auction off public resources and reduce their spending? Or will taxpayers bear the losses? And finally, which countries’ taxpayers will bear the losses? A huge struggle has started in the Eurozone on how to split the losses between governments, banks and tax payers in the periphery and the core.

The fastest and cleanest solution would be that the responsible actors bear the losses themselves: governments and banks. They would have to default. Banks have lent to irresponsible governments or granted loans flowing into asset price bubbles. Their shareholders would lose everything. Unsurprisingly, politicians and bankers suggest that this would lead to chaos and trigger a long depression. They want taxpayers to pay their bill, at least partially.

Yet, in the case of non-intervention, the world would not come to an end. More realistically, there would be a short and sharp crisis and a fast adjustment. Economically unsustainable business models in the financial sector would disappear. Sounder banks could raise new capital and creditors could agree to a debt to equity swap if a bank´s business model was judged sound.

The alternative is that the past losses are not realized at once but stretched through a long crisis and put on the shoulders of innocent parties. Banks could be sustained with unrealized losses similar to Japanese zombie banks. Taxpayers and users of the single currency could be made reliable for losses. The Eurozone would then stagnate for years.

Through the bailout of irresponsible banks and governments, irresponsible behavior is encouraged. Past malinvestments are not dismantled and new ones are added. A taxpayer bailout reduces the pressure on the Greek government to sell its assets and cut its spending – i.e. malinvestments are not liquidated and continue. Similarly, banks can maintain their support for irresponsible government and prevent the fast liquidation of malinvestments such as unsold housing units. Ordinary people in the Eurozone then suffer through price inflation and a greater tax burden, as well as a long, drawn out crisis.

By contrast, ordinary Europeans would strongly benefit from a liquidation of malinvestments following a Greek default and a European banking crisis. This would not be the end of the world, but the beginning of a short, efficient adjustment process and the just distribution of the burden of losses.

China and the West

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The visit of the Chinese premier Wen Jiabao to the UK this week naturally makes one ponder the role of China in the world economy. After years of China selling us cheap clothing and electronics, British and American consumers are getting used to paying a lot more for their imports as their currencies slide gracefully towards oblivion, thanks to quantitative easing. In China, meanwhile, the expansion of the cities and the movement of people off the land is turning the economy more middle class – more interested to supply its own needs rather than be cheap producers for the rest of the world.

British and, particularly, American influence in world affairs has been given a knock by the financial crisis. China was already catching up fast, in terms of overall GDP at least, if not per-capita. The crisis is just hastening the eclipse of the West. The old G8 hardly matters these days, it is the G20 that pushes the world economic agenda. Indeed, the emerging economies of Brazil, Russia, India, China, Mexico, Indonesia and Turkey are becoming a power in themselves. And Europe is of course embroiled in its own crisis, thanks not so much to the banking crisis as to the inconsistencies of the single currency.

On the other hand, the West's self-inflicted hurt is not really good news for China. It has its own problems. Its decades-long manipulation of the exchange rate has produced a lot of them. Inflation is alarmingly high. Growth has slowed as China's customers, like America, have been spending less. Commodity prices are rising again as other parts of the world recover. It has a terrible demographic problems, with its ageing population and one-child policy. And when you go to China and see millions of them jabbering into their mobile phones, you wonder how the central administrators in Beijing think they can resist the rise of democracy. Sure, China is growing, more of its population are being taken out of poverty, its muscle in world affairs is getting stronger. But it would be a lot stronger still if it maintained more sensible economic policies, rather than its politicians thinking that they can defy economic laws of gravity. If China really goes capitalist, we had better all watch out.

Free trade in South America

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I breakfasted yesterday with Felipe Larrain, the finance minister of Chile. One of the interesting points that came up is why the countries with the most developed economies in South America don't have more of a say in world affairs. Their combined GDP does, after all, match up to China's and overtakes India's – yet those to countries have a much greater presence.

I guess the answer is that countries like (to take them in order of GDP per capita) Uraguay, Chile, Brazil, Venezuela, Argentina, Costa Rica and Peru are all very different places. They have different histories and different historical links to other countries. Brazil even has a different language. It seems to have been hard enough for them even to establish free trade between them. Although Chile has free trade agreements with 59 countries, other countries put astonishing tariffs on their trade to keep out competitors.

But free trade in goods probably has to come before anything else. Then maybe the free movement of capital. The free movement of people – that is, immigration – is always treated with suspicion, in any part of the world. But it becomes feasible, almost natural, once you are locked into close trading relationships with other countries. South America is still a long way off that. And Brazil, he country which dominates the region on account of its vast area and vast population, is hardly a free-market paradise. It is more keen to go its own way in the world, rather than form alliances with the likes of market-oriented Chile. So the more market-driven economies of South America seem destined, for some decades at least, to punch below their weight in world affairs, while more coherent regions have undue influence.

Greece's problematic privatization

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Greece aims to raise €50bn from privatizations between now and 2015. Good luck. Since 2000, the country has already netted €10bn through privatization, but the new target means doing five times more, in half the time. And although many of the properties in the privatization list are already on offer, there have been no takers so far. Maybe it is not surprising that people are reluctant to invest in a country so corrupt, or in companies with such an appalling work culture. Meanwhile, other countries like Ireland and Portugal are trying to interest investors in their state businesses too. So it looks like a tough sell.

Among the companies on the privatization list are a telephone operator, shares in half a dozen banks, a couple of water companies, a gas company, train operators, airports (including defunct ones), a weapons contractor and regional ports and highways. No doubt there will be public resistance to all of these on the grounds that they are 'priceless national assets'. If only.

Meanwhile, the Greek government will be trying to sell off old Olympic venues, a state lottery, a horse-racing concession, a stake in a casino, a nickel mine, and thousands of acres of agricultural land. Which begs the question of why it owns these things in the first place. They are hardly matters of national security or prestige.

If Greece's privatizations are aimed just to make money to fill a black hole, they will not work. For a start, the black hole is far too deep for €50bn to fill. And right now, with the market low and lots of other governments holding fire-sales too, it is not exactly the right time to get a good price for any business. And if privatization is to work, it needs to involve the whole population – and not just sell companies to China or some other wealthy overseas power, which would be deeply unpopular. But with the Greek public already complaining that their pockets are empty, the chance of getting a good price from them is vanishingly small.

The real objective in Greece should be to turn round loss-making state-owned monopolies and make them profit-making, tax-paying, competitive enterprises. Having a privatization deadline might help that process. In the UK, it was only the fact that nationalised industries like British Steel and British Airways knew that they would be privatized that made them squeeze out waste and make themselves into proper commercial companies. Once you have made a company fit, paid off its debts and cleaned up its accounts, then you can sell it. Not before. So the prospect of future privatization presents a real reform opportunity. And it sends the markets a message too that Greece is serious. Whether any of that will happen, though, I doubt. This is Greece, after all.

Clarification on the Police National Database

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Last week Anna wrote a piece on ‘The fatal conceit of the Police National Database’. It raised concerns about plans to store the details of 10-15 million people in this database, on the basis that there are only 9.2 million people in the UK with criminal records. By implication, Anna wrote, up to 6 million people without criminal records would be on the database. And given the British government’s less-than-stellar track record with data security, this poses a worrying threat to privacy. I stand behind all of that.

However, the National Policing Improvement Agency (NPIA) has written in to say that Anna’s piece contained a factual error that they would like us to clarify. They say Jennie Cronin, director of the NPIA, never said that, “many of these people [the additional six million] are victims”. In fact, they say that victim data will only be held in a limited number of cases, where it relates to sexual offences for which a court can grant a sexual offences prevention order.

I’m happy to admit it when we get something wrong, and I apologize for us putting inaccurate words in Ms Cronin’s mouth.

The NPIA go on to say that holding such victim data is important because it will help the police to realize when vulnerable people are being repeatedly targeted and prompt them to provide additional protection. The example they cite is of a recent Police National Database (PND) search on a victim of domestic violence, which revealed a pattern of abusive relationships across the country. They say that now the police force in question is fully appraised of the situation, they are in a better position to protect her and to “help her to break the pattern of abusive relationships.” Similarly, they believe the victim data on the PND will help police to protect “children and young people being ‘groomed’ for prostitution and then trafficked across local police force borders”.

The NPIA also argue that they are justified to put the details of people who haven’t been convicted of any crime on the PND. They say that individual police forces already hold information on such people, and that all that is in question is sharing it between forces. They also say that Ian Huntley, the murderer of Holly Wells and Jessica Chapman, came to the attention of Humberside Police in relation to allegations of eight separate sexual offences between 1995 and 1999, was investigated in yet another, but was never convicted. They do not claim that the PND would have prevented the Soham murders, but do say it would help to prevent people like Huntley slipping through their net in future.

Now, the NPIA advance valid arguments on both victim data and sharing information on those who have not actually been convicted of any offence. And I think it is important that even those of us are deeply concerned about the over-extension of police powers and the inexorable rise of the database state acknowledge that such policy shifts are often driven by noble intentions.

But I’m still not sold on the whole thing. The trouble is that we’ve been here so many times before: we’re told that new police powers are needed to tackle terrorism, and before you know it they’re being used to arrest people for walking on cycle lanes or heckling at the Labour Party conference. We assume that the police will only arrest you for serious wrongdoing, and then we hear you can be banged up for dropping an apple core and prosecuted for overfilling your wheelie bin.

If I still believed that the police could be trusted to exercise their powers fairly, proportionately, and responsibly, I wouldn’t have to be writing this blog. But I don’t believe it, and many others feel the same way. Whatever the rights and wrongs of the Police National Database, the National Policing Improvement Agency has its work cut out to convince us we’re wrong about that.

Why students benefit from fees

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The universities are very keen indeed to extract the maximum £9,000 a year fees from their students. Indeed, half of them have already said (to the government's initial shock) that they would indeed charge this maximum figure. But the universities may get something they weren't bargaining for in return. Namely, much more discerning customers.

To a student in particular, £9,000 a year is a lot of cash. If they are spending that sort of money, they will be asking some pretty sharp questions about teaching standards, course quality, and their job prospects after they get their degree. And the universities will have to have answers to those questions – or see students drift away to other universities that have better answers. Universities will find that they can no longer drift along doing things as the academics and administrators deem fit. They will need to ditch that public-sector ethos and actually start doing this in the way that best suits their student customers.

For a time I taught at a small private college in the US, and I saw this first hand. There was fierce competition between colleges, so teachers were all expected to go out on a schools roadshow to show the college's wares to prospective students – exactly the sort of thing which will come as a shock to British academics. If I was late marking an essay, the students would be banging on my door wanting to know why – not as sheepish supplicants, but as rather irritated customers. If they didn't understand something, they figured it was more likely to be because I had not explained it well enough, rather than that they were too dim. And they wouldn't let me go home until I had explained it better, and they had properly understood it.

At last we are getting the same competitive pressures here. And about time. For as Adam Smith put it, "The discipline of the colleges and universities is in general contrived, not for the benefit of the students, but for the interest, or more properly speaking, for the ease of the masters."

An attractive Danish model (for bank reform)

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In his editor’s letter in today’s City AM, Allister Heath outlines the Danish approach to bank reform:

BELIEVE IT or not but Denmark has emerged as Europe’s pioneering financial reformer. We need to learn from it. Fjordbank Mors, a small lender, has just been allowed to go bust; taxpayers are not having to shell out a penny and the world hasn’t come to an end. Senior bondholders at Fjordbank Mors are taking a massive hit, shareholders are losing everything, the management is being sacked, depositors with more than the maximum guaranteed by the deposit insurance scheme are losing out (tough, but necessary) and the taxpayer is being protected.

This is the second time this happens under Denmark’s new resolution procedures designed to allow an orderly, controlled failure of banks and thus reintroduce profit and loss discipline into the industry…

As Allister suggests, this is precisely the sort of approach that we should be taking in the UK. We need to put measures in place to allow the orderly winding up of failed banks, without them threatening the entire banking system or becoming a burden on the already overstretched taxpayer. And we need to do this urgently – if European sovereign debt goes the way of sub-prime mortgages, and another financial panic starts, not all of our banks will be able to weather the storm. In a rational world, we’d have got ahead of the game and done this a couple of years ago rather than obsessing about bankers’ bonuses. But hey, better late than never.

Allister’s conclusion is a compelling one, which I would endorse wholeheartedly:

Some Danish bankers are complaining that their cost of finance has shot up as credit rating agencies now assume a larger risk premium. But that is no bad thing. Everybody needs to face an accurate cost of capital. It should be neither artificially high nor artificially low. The removal of government guarantees is a good thing. It will lead to a better allocation of resources, a more rationally managed financial sector and correctly priced credit, reducing the risk of bubbles. Most important of all, it will allow the City to regain the moral high ground, which it lost when it was bailed out. The real problem in finance has been too little capitalism, not too much. Reforms need to be put into place to ensure that even large banks can be weaned from state guarantees and subsidies. It will be great news for the City’s long-term prospects if the Danish experiment succeeds.

Watching the watchers

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If you went to a school where you were subjected to years of Latin, or are a Star Trek: the Next Generation enthusiast, you will be familiar with the phrase, “Who watches the watchers?” Though Juvenal was decrying the corruptibility of men guarding their masters’ wives, his line is now used to refer to that quality in government—no comment on the evolution of the phrase. The problem of how to ensure government accountability is older than Juvenal, and sadly perpetual. Two recent stories on the Internet and police misconduct raise interesting questions about how technology might be used to guard the guardsmen in the modern era. Might we finally be getting it right?

First to cross my radar screen was a Telegraph article on a Merseyside Police scandal. Merseyside had 152 breaches of the Data Protection Act in 2009, an act that limits police access to information on private individuals. Most of the violations appear to have been the result of voyeuristic interest in Steven Gerrard’s affray charges, though there were a fair few private investigations into daughters’ boyfriends.

That we know of this is encouraging. It shows that the Freedom of Information Act, under which the breach statistics were released, is doing some of its job. It also shows that technology can make it easier to identify government wrongdoing; login information leaves a paper trail. The flip side, of course, is that technology in the form of databases makes all manner of unscrupulousness easier. Beyond waiting for professional standards departments to uncover misconduct and release it via the Freedom of Information Act, though, the Internet also offers citizens the opportunity to monitor police activity on their own. A piece from the Atlantic presents iPhone apps like “OpenWatch” and “CopRecorder” as story sources “for investigative reporting in an age when newsrooms are shrinking.” This may be one of their merits. The more obvious is their capacity to help keep the police honest.

CopRecorder has already been downloaded by over 50,000 users, and has spawned a webpage to which anyone can upload audio and video files of police encounters. The cynical take is that the chance of catching something truly horrendous is infinitesimal. That’s fair, but the likelihood without such programmes is much smaller. OpenWatch improves upon camcorders by allowing users to record and immediately upload files on a device to which most of us are conjoined, our mobiles. The Internet is a tool, and ultimately is what we make of it. Some police officers will abuse it, but misconduct is nothing new. More exciting are innovations that finally let the public counter-survey authority figures. Watching the watchers, indeed.