May 08, 2003
Monetary union and economic flexibility

The question whether the euro will in the long term benefit Europe or harm it cannot be answered at this point with any certainty. I have been skeptical about monetary union in Europe as it is constituted now, as there are serious divergences undermining EMU. There is no agreement between economists (is there ever?) on whether even in theory it is better to have fixed exchanged rates or floating ones. And the split goes right down the middle of the free market camp too, with both views represented by the Big Names of Economics.

So I was very interested to find a discussion between Milton Friedman and Robert Mundell on this very issue. (I came across it via Arnold Kling, whom I found through this post at Asymmetrical Information). The discussion goes around in circles to a certain extent, but in the end it boils down to the issue of economic flexibility. As exchange rates are prices, they convey information on supply and demand of currencies, which again is based on numerous other factors in the real economy. By shutting down a mode of expression for the information by fixing currency prices, you can't make the information go away. It will have to express itself by other means, and that's where economic flexibility comes into play.

Mundell argues that having a sound monetary policy is of vital importance, and that economic benefits will follow if only there's stable money. In fact, he takes the argument to its logical conclusion and advocates having a world currency. The larger an area a currency covers, the greater the stability will be. Mundell does say he does not advocate a single world currency, but just a world currency; the difference though seems to be semantic rather than substantive. He says:

My ideal and equilibrium solution would be a world currency (but not single world currency) in which each country would produce its own unit that exchanges at par with the world unit. We could call it the international dollar or, to avoid the parochial national connotation, the intor, contraction of “international” and the French word for gold. Everything would be priced in terms of intors, and a committee—in my view, say, open market committee designated by the Board of Governors of the International Monetary Fund—would determine how many intors produced each year would be consistent with price stability. Every country would its currency to the intor following currency-board system principles.
This is different from having a single world currency only in that it retains the option of re-floating national currencies, which would be harder if they were abolished altogether. And the practical difficulties are enormous too, as its ultimate viability would depend on the proposed "G3 Open Market Committee" being able to determine the right amount of intors to issue. In effect, this creates a single fiat currency for the whole world. I get nervous with three fiat currencies being dominant. The art of central banking has not evolved to the point where one would wish to bet the world's economic future on central bankers getting it right.

Friedman argues for flexible exchange rates, arguing that they provide an important escape valve for the adjustment of prices within an economy. Mundell counters that the same adjustment can take place by changing domestic price levels, and that it can be done more effectively that way. In theory, Mundell is right, but in practice it does not work that way, and this is what Friedman argues too. The case of Argentina is instructive in this regard, as it had a fairly orthodox currency board which ultimately failed. The discussion between Friedman and Mundell took place before the Argentinian currency board collapsed in late 2001, so there are no port-mortems of this event, nor do they spend much time discussion the Argentinian situation.

By tying the peso at parity to the US dollar, Argentina did get the immediate benefit of vastly improved monetary policy in 1991, just as Mundell argues. It also introduced thitherto unheard-of macroeconomic stability, and the Argentinian economy prospered. But Argentina was pricing itself slowly out of the market by maintaining convertibility with the dollar. It simply wasn't producing enough economic added value to justify charging the prices in a convertible peso, nor did it have the productivity gains that would allow the economy to remain competitive internationally. The 2001 collapse in Argentina came after Brazil had unpegged the real from the dollar in 1999, which added to the competitive pressures on Argentina. At this point, Argentina had the choice of adjusting its domestic price level downward, or achieve a similar result by devaluing the peso and thus breaking the currency board. In a very messy process that exacerbated the outcome manifold, it ultimately defaulted on its debt and devalued the peso. It sank from parity with the dollar to 4, essentially wiping out 75% of Argentina's wealth if measured in dollars.

The key again is economic flexibility here. Had Argentina possessed an economy flexible enough to adapt quickly to competitive pressures by improving productivity and reducing the domestic price level, it would have been able to keep the peso convertible to the dollar at parity. Looking at a single dimension of productivity, it might have had to reduce aggregate labor costs by, say, 25% in the mid-1990s. Firing 25% of all workers is one way of doing that, or by all workers taking a 25% pay cut. Neither is very appealing.

One of the architects of the Argentinian currency board, Steve Hanke, defended the currency board against the critics (such as Paul Krugman):

And how did the Argentine economy fare during the Menem decade? As Table 1 shows, Argentina responded with a growth spurt that left its neighbours in the dust. All this is not an anomaly. Since 1950, countries with currency boards have realized average GDP growth per capita that is 54% higher than comparable countries that had central banks with discretionary monetary powers.

This is not to say that a sound currency is everything. Indeed, Argentina desperately needs a good dose of supply-side economics. Unemployment is high because labour market regulations are burdensome and taxes are too high and complex. Bring on deregulation and a flat tax. Clone Hong Kong, please. And that's not all. The government apparatus needs a complete overhaul. The only way to attack the endemic corruption spawned by the state is to shrink it. Those reforms, on top of its sound money, would put Argentina back on a high-growth track.

The table at the bottom of his article shows that Argentina's economy grew by 230% in the years 1989-1999 in US dollar terms. The devaluation of the peso (now trading at about 3 to the US dollar) means that all that growth and then some has been wiped out if measured in dollars. In fact, in dollar terms the Argentinian economy contracted about 25% in the period of 1989-2002. Hanke actually sees the seeds of demise for the currency board when he argues for structural reforms. (As an aside, the picture for the Asian economies he mentions would now be different, as some floating-rate countries like South Korea have done pretty well since the crisis of 1997.)

Using the currency board as both the carrot and the stick in Argentina failed to get the necessary structural reforms get implemented. The members of the European Monetary Union are no Argentinas, but there are a number similarities. Structural problems are contributing greatly to the current economic weakness in the entire Eurozone. The problems are the same as in Argentina, although probably not as severe: rigid labor markets and high non-wage costs are preventing European companies from adjusting to the weak global economic environment (and the strong euro too). Mundell's argument is that the single currency will be a driver of reforms, making it more likely that these structural problems will finally get tackled. Are reforms a necessary precursor for monetary union, or is monetary union a catalyst to bring these changes about?

There has been some progress in Europe on structural reforms, but overall far too little has been achieved. While there is a reasonable single market now in goods, the services sector is still highly fragmented. And even the European directives establishing the single market for goods are poorly implemented, with France being one of the biggest offenders. Not very surprising, that. It does show that there is a difference between the Single Market on paper and the reality on the ground. But the intentions here of the EU are good for a change, and Brussels will be trying to create a true single market for services. It's not going to be easy:

A commission report published last year listed 92 barriers encountered by businesses wishing to offer their services in more than one EU country.

The report found problems began with the founding of businesses, which can be hindered by local and national requests for several authorisations.

The distribution of services was also made difficult by laws forcing the provider to have a physical base in the country.

The advertising industry was hampered by a maze of different national regulations.

Belgian electricians have to pay three times the Belgian rate to register with the authorities in neighbouring Luxembourg for a one-day job. And Austrian bakers need eight different licences if they want to set up in Italy.

If the euro is to become successful, it is vital that the internal market be as free as possible. This still does not address the issue of structural reforms within member countries, though. Eurosclerosis is a problem that won't go away easily. Having a true single internal market will make cross-border competition more intense in many more areas than is possible now. This could be one of the great strengths of the European Union, by allowing countries to experiment with their domestic economic policies by competing against one another. Competition is an essential tool in the economic discovery mechanism of what works and what doesn't. But competition is scary to those who like the status quo, and especially those who like the power they wield in their own countries. So plans are afoot to stifle competition between countries, because it's so unfair:
Plans to scrap the national veto on tax to eliminate "unfair" tax competition in Europe will this month be proposed by Valéry Giscard d'Estaing, the man drawing up a new EU treaty.

His plan, designed to stop some EU members poaching inward investment and savings by setting very low tax rates, has the backing of most member states, including France and Germany.

According to aides, Mr Giscard d'Estaing is determined to press the issue, even though Britain and Ireland are opposed to deciding any EU tax issues on the basis of majority voting.

The former French president believes that without reform, the EU's single market will be distorted as countries embark on a damaging race to undercut one another's company tax rates.

It's the same old argument against capitalism and competition, but transported into a different context. It shows that the European elites still don't understand why an economy works and prospers. It's not a new insight, but it's the statists of d'Estaing's ilk who are drawing up the new EU constitution. That does not bode well for the future, but that's not news either.

There is some evidence that the euro has indeed spurred greater economic integration and flexibility in Europe. But this enforced discipline has not extended very far, nor is it making much of a difference in the discussions about structural reforms. My view remains that European Monetary Union is currently doing more harm than good.

Meanwhile, in Latin America, the idea of monetary union seems to be catching on. Brazil and Argentina have floated the idea of moving to a joint currency. Coordinating economic policy is one thing, but moving to a joint currency at this stage seems foolhardy in the extreme. Moreover, one report quotes deputy foreign minister Martin Redrado as saying:

"The currencies are worth almost exactly the same, this is the time,"

Yes, the exchange rate between the real and the peso happens to be close to one at the moment, but that is utterly meaningless. You could multiply either currency's nominal value by a constant and it would not change underlying economic reality one bit. If they're going to base a single Latin American currency on this kind of reasoning, it's doomed before they even start.

May 01, 2003
Careful what you wish for

The euro is a political construct. While the idea may have its roots in economics, the introduction of the single European currency was always a political project, meant to solidify European integration and to give Europe a bigger say in the world. The French definitely did see it right from the start in political terms too, as they wanted the euro to provide a counterweight to the almighty US dollar. It's the old French obsession with their own irrelevance, and the euro was a way of reasserting French relevance in the world, channeled through the dank sewers of the European Union.

Given what's riding on the euro for Europe's ruling elite, the first years of its existence were a bitter disappointment. Virtually since the introduction on January 1st, 1999 the euro fell like a brick against the dollar. This in turn led to much gnashing of teeth of the European elites, because it wasn't supposed to be like this. The value of the currency was seen as a sign of Eurocratic virility, and all it was producing was a high falsetto squeak. It's dangerous to look at the value of the currency in these terms, because it leads to even more contorted economic policy than usual. But there you had it: a massive outpouring of anguish from the ruling elite about the euro's weakness and constant reassurances that the euro was a strong, viable currency.

The United States has long had a "strong dollar" policy going back to the Reagan years. A strong dollar meant a strong America. Intertwining a political message with the external value of the currency was politically opportune, and perhaps even useful as a short-term expedient. The dollar had been on a continuous slide before then, and the external value of the currency does matter. If your currency goes down in value relative to others, then your entire currency area is impoverished by a corresponding percentage. In the long run, currency prices are best left to the interaction of supply and demand on the international markets rather than used as totems in policy making. An agnostic approach from politicians is best.

However, that's not how real life works. The danger of making a wish is that it might come true, and the Euro-elites are now discovering the hard way that the consequences of their wishes are in reality different from their imagined outcomes. The strong euro is a perfect example of this. Over the last year, the euro has gained almost 20% in value against the dollar, granting the Euro-elites their wish. But they're not exactly reveling in the experience, because exchange rate movements have effects in the real economy and do not exist merely to accumulate international bragging rights. Why is the dollar falling though? There are a number of reasons for that: the external financing requirement of the United States is huge. The current account deficit stood at about $500 billion in 2002, meaning that the US had to attract almost $2 billion every working day of the year to finance the deficit. At 5% of GDP it is clearly in a fairly extended position, and coupled with a federal budget deficit, the financing requirements of the US are pretty hefty. This is part of the reason why the dollar has been declining. Other reasons are the low yields on US cash and US Treasury bonds; US cash yields only 1.25% at best, while the euro short-term interest rate stands at 2.5%. Keeping cash in US dollars at the moment does not even get you compensation for inflation.

The flip side is that these low interest rates are stimulating the economy, or at least they should be. There's now an impressive array of positives for the US economy: negative real interest rates, falling oil prices, tax cuts and the weak dollar. In the past, this combination has led to a resurgence of economic growth and risks the reemergence of inflationary pressures. If all of these factors don't produce an economic rebound, then the old metaphors of pushing on strings become eerily appropriate. The next months will tell.

The weak dollar is a positive for economic growth because it makes American industry more competitive internationally, at the expensive of lowering the aggregative relative wealth of all dollar-denominated assets. The effects of the weaker dollar could already be seen in the first quarter earnings season, where both the top and the bottom lines were lifted by the currency effect. The weak dollar is helping America export more.

If the weak dollar is helping US exporters, then European exporters must be suffering, and they are. Interest rates in Europe are higher than in the US, especially at the short end of the yield curve, there is at best a neutral fiscal impact on economic growth and the strong euro is eating into sales and profits. Only the falling price of oil is helping here, but not as much as it is in the US, because of the strength of the euro and because energy is so heavily taxed in euro that swings in the underlying commodity have a smaller percentual impact on the final price than they do in the US.

So now that the Euro-elites have their stronger euro, its effects are not quite what they had in mind. Instead of basking in the warm glow of a rising currency, their exporters are hurting. During the period of dollar strength it was US exporters who suffered, but even during that time European economies underperformed the US. The growth differential between the US and Europe is not likely to close anytime soon. The secret is the more flexible US economy, where it is easier for companies to adjust to changing circumstances by cutting costs and firing people. This is painful in the short term, but has the long-term benefit of building more resilient companies and increasing aggregative wealth in the long run. Europe's labor markets are ossified, locking employers into costly arrangements, that make employing people unattractive and that erode the long-term profitability and even viability of companies.

The strong euro is therefore a problem because the domestic economic price structure is not flexible enough to respond. The cost of labor is high, and not amenable to downward adjustment. After all, people don't like taking a wage cut. The ultimate wage cut is to be laid off, and with unemployment creeping upward in all of Europe, that is what's happening.

There's also a different problem that is new to the Eurozone, and that is the existence of the Eurozone itself. Or rather, it's the single currency that has now put companies into the (for them novel) position where they are faced with strong currency and no escape valve. Countries like Italy used to devalue to their way out of trouble whenever Italian industry had lost competitiveness against, say, Germany. That sort of works, in that it keeps the country in business, but it does impoverish the entire nation and it imports inflation. But now that escape valve of devaluation is no longer there, so the adjustment will have to take place through other means, and that's going to be very hard in an environment of rigid labor markets and no structural flex.

Devaluations are not the way to go, but regional (i.e. national) responses were still possible in the sense that national monetary policy could account for the impact of a strong currency. The strong euro is an asymmetric shock that affects the Eurozone. Some economies (like the Netherlands and Ireland) are much more trade-oriented than others (Italy or Spain). So a strong euro has a much greater impact in the countries with open economies than in those with a less international focus. This brings us back to square pegs, round holes and the European Central Bank. It has to find a single interest rate to deal with the inflationary pressures and the impact of a strong currency on very different underlying economies.

Some time ago, I looked at a simple Taylor-rule approach to EMU, which is a way of trying to find the "right" interest rate by looking at inflation and the output gap. Another approach is to use a Monetary Conditions Index (MCI), which attempts to gauge the effect of real interest rates and exchange rates on the economy. Central banks in Canada, Norway and Sweden use MCIs as a policy instrument. Essentially what the MCI does is to try to find a trade-off between interest rate movements and exchange rate movements. For instance, for an open economy, a 3% change in the value of the currency has the same impact on growth as a 1% change in real interest rates. For closed economies, the multiplier will be bigger.

Looking at a simple MCI for the US, it's clear that monetary conditions in the US have been easing for a long time now. It's actually somewhat worrying that this has not translated into stronger growth yet, but the terrorist attacks and the wars in Afghanistan and Iraq are plausible explanations for the muted recovery thus far. The graph shows the year-on-year change in MCI for the US, but in absolute terms monetary conditions as defined by the MCI are now at their most expansionary in a very long time. Overall monetary conditions in the Eurozone are stimulative too, but as the MCI graph for EMU shows, the effect of the strong euro has meant that monetary conditions have been contracting a little for the last year. This is obviously not helping economic growth in the Eurozone. (MCI constructed with data from the ECB.)

A strong currency is not necessarily a good thing, nor a necessarily bad thing. You don't want a currency that's perennially weak, because that sets you on a course for long-term national indigence. What's more important is how you deal with changes in the exchange rate, and that depends on the flexibility of the economic structure. In that regard, the US is better off than Europe. If and when the US economy starts to pick up more decisively again, the dollar's slide will likely come to an end. The positive scenario for Europe would be that the strong euro forces the politicians into action and compels them to fix the structural problems that afflict Europe. It's a low-probability scenario though.

Posted by qsi at 09:49 PM | Comments (1) | TrackBack (0)
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April 07, 2003
The farce at the ECB continues

Central banks wield enormous influence over the world economy, and we're in a year in which we are seeing big personnel turnover at two of the biggest. The new governor of the Bank of Japan has just been appointed, while Wim Duisenberg (Gretta's husband)is due to retire later this year. Well, he was due to retire in July, but that now appears to have been postponed. This is no way to run a central bank. The ECB has enough problems as it's trying to deal with diverging economies under its care without having to worry about the farcical nature of the succession.

When the ECB was founded, the French wanted the top job as a consolation prize for allowing the ECB to be based in Frankfurt. Of course, the French only act in the best interests of the European Union as a whole, that great organization that is making the nation state and national allegiances obsolete. In the French view of the world, the best interests of the EU coincide with surprising frequency with the narrow national interests of France. Funny, that.

In any case, the French wanted their man at the top of the ECB, but in the horse-trading that followed a compromise was struck. The smaller countries got their man in (in this case, Wim Duisenberg, who became quickly known as Dim Wim), but he agreed informally to step down halfway through his tenure. So he duly announced last year that he would be stepping down in July of 2003. There is a hitch though: the successor-designate, the Frenchman Jean-Claude Trichet, is in a bit of a pickle. In fact, he's being investigated and tried on charges of corruption stemming from his tenure as finance minister in the early 1990's. A corrupt French government minister? I'm shocked, shocked!

While the trial continues he can't really be appointed as the head of the ECB, so now Dim Wim has been asked to stay on a bit longer, so the French can clear their man of the charges and put in charge of the ECB later this year. As I said before, this is no way to run a central bank. In an era of fiat money, a central bank's credibility is its greatest asset. The ECB has struggled since its inception to gain credibility as an inflation-fighting central bank in the mould of the old Bundesbank, but by doing so it actually undermined that same credibility. It's been fighting the last war, while the Federal Reserve was trying to stave off deflation in the wake of the internet equity bubble. The Bank of Japan has dug in in the poppy fields of financial Flanders, sending wave after wave of monetary cannon fodder into the mud.

But the ECB's job is not easy to say the least. The structural economic problems that afflict Europe are severe, and much of the blame for Europe's poor economic performance can thus justly be laid at the feet of Europe's politicians. However the entire project of monetary union was always politically driven, without paying too much regard to economic fundamentals. The 12 economies of the European Monetary Union are diverging, and in need of different monetary policies. That's not a problem the ECB can solve, no matter who's in charge.

Posted by qsi at 12:47 AM | Comments (0) | TrackBack (0)
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March 11, 2003
Strong odors from Denmark

The situation in Denmark has long since passed the early stages of decomposition, as the smells coming from that country are overpowering. A reader forwarded me an email from "a Danish Jew," dated March 5th:

An open letter to Danish MP's, European MP's, the Danish and foreign press and defenders of freedom everywhere:

Gangs of muslim immigrants demostrated openly in the streets of Copenhagen yesterday to kill DANISH JEWS!!

Believe it: An open call to violence and terror in the streets of Copenhagen, confronting Danes with a call to terror against Danish citizens!!! This is not a hoax. It is horribly real.

The question remains if political responsibility and will still exists amongst Parliamentarians and the Courts to stop this here and now!!!

Now Denmark is saddled with a problem of radical, fundamentalist activity by a growing group of young muslims. They are being bred, fed, co-ordinated and inspired by foreign terror and hate cells in the Middle East and in other European cities. With birth rates that far exceed that of the Danish population, and an hostile ideology of world conquest and essentially "religious imperialism" this radical population now open calls for killing Danish Jews - a group they outnumber by 40 to 1.

Their overwhelming numbers and a suspended sentence of 3 months in jail for a radical Hizb-ut-Tahrir fundamentalist hate calls to "kill Jews where you find them" on their website, seems to encourage even more activity and calls for violence, terror and death in Denmark!!

Danes have to be able to walk their streets without feeling intimidated. Parents should not have to have their children see this kind of violence, hatred and sociopathy in the streets of Copenhagen. PArents shouldn't have to worry about their children's safety.

Danish politicians have to take upon themselves the responsibility of dealing with this! Without regard to consequences, a foreign population with a hostile ideology is being allowed to create a slow acceptance of violence and change in the Danish society.

The evidence is overwhelming of a growing violence in schools, a lower educational level, hostility and crime on the streets, an explosion of gang rape against Danish girls, economic crime and tax and toll evasion in the kiosk's and vegetable shops muslims have all but taken over, along with open calls of violence toward Jews is the result of a Danish invitation to a new chance, and a new life, in democratic Denmark.

This abuse of freedom must be stopped before lives and liberty are lost. Before Denmark is changed irreparably.

Legislators in Denmark have to do something NOW, before someone is killed and injured.

The reader who forwarded me this email asked me to look into, wondering whether it could be true. Now, I can just enough Danish to get the main point of a newspaper article, but I was not able to find any reports of this demonstration in the Danish press (but my Danish is sufficiently poor that this could very well be my fault.) The English-language press does not contain any references to this demonstration either, so I can neither confirm nor deny that it took place. I would have thought that something like this would have attracted attention in the Israeli press, but I have not been able to find it (my knowledge of Hebrew is negligible, so I only searched the English-language publications in Israel).

However, the email does mention an organization called Hizb-ut-Tahrir, and they're not very hard to find on the web. The blogosphere's favorite expert on Islamofascism Daniel Pipes wrote about Hizb-ut-Tahrir last September:

A Muslim group in Denmark announced last month that a $30,000 bounty would be paid for the murder of several prominent Danish Jews, a threat that garnered wide international notice. [....] Muslim violence threatens Denmark's approximately 6,000 Jews, who increasingly depend on police protection. Jewish parents were told by one school principal that she could not guarantee their children's safety and were advised to attend another institution. Anti-Israel marches have turned into anti-Jewish riots. One organization, Hizb-ut-Tahrir, openly calls on Muslims to "kill all Jews . . . wherever you find them."

The theme of Hizb-ut-Tahrir calling for the murder of Jews in Denmark is not a one-off. An organization linked founded by a defector (who thinks Hizb-ut-Tahrir is too moderate), openly calls for the destruction of democracy in Denmark. The Danish website of Hizb-ut-Tahrir still contains the exhortation to kill Jews: "And kill them, whereever you find them." (The Danish for this is "Og dræb dem, hvorend I finder dem.") There are reports in Belingske Tidende and Politiken in Danish on this. Given this background and the brazen nature of these threats, it would not surprise me in the least that Muslims in Denmark would be willing to go out on the street and chant death threats to the Jews.

The weak response thus far from the Danish authorities to these threats from the Islamofascists is deeply worrying. Something as blatantly despicable as this should show up as a blip even on the radar of the most deranged multiculturalist. But apparently the decades of multiculturalist propaganda have led to the evisceration of any sense of right and wrong, giving a pass to anyone who is the Officially Recognized Victim Groups.

This is a serious threat to our way of life, the values of liberal democracy, and in fact all we hold dear; the things that make life worth living, the foundation of our freedom and prosperity, that which sets our minds free to create, argue and think without fear. Whether it's the Dutch AEL calling for the destruction of Israel, or these calls for the extermination of Jews in Denmark, they're part of the forces that arrayed against us. Not just the US and Britain, as the appeasers delude themselves, but they're arrayed against all of us in Europe. We'd better start dealing with the problem.

Posted by qsi at 10:47 PM | Comments (7) | TrackBack (0)
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February 24, 2003
Another Round in Old versus New Europe

My apologies for the lack of blogging recently, but travel had taken up some time, and then (with all the recent travel), there were some remedial activities to be undertaken on my apartment, which was quickly becoming chaotic even to the extent that it was beginning to make me feel uncomfortable. Speaking of chaos, there is quite a bit of it going on in Europe. The reshaping of the continent is proceeding apace, and the blogosphere has been pretty good about documenting the political coming of age of the New Europe, which refuses to be bullied by the Old. Another such example came from the Visegrád Group of nations, which consists of Poland, the Czech Republic, Slovakia and Hungary. They've been formally cooperating on various matters that affect their four countries, including accession to the EU. As recently liberated countries, they also share a particular view of the world that is deeply different from the Old Europe.

I've only been able to find this German-language version of their latest exploits, but the gist of it is that they've said in no uncertain terms that they're not going to be bullied around by France. After a meeting in Prague with the Czech foreign minister Svoboda, Polish foreign minister Cimoszewicz made the important announcement that the Visegrád Group would continue its work and cooperation also after the countries had become members of the EU. And just to underscore the point, he he drew attention the fact that the four Visegrád Group countries are going to have 58 votes in the Council of Europe, the same number as Germany and France combined. That is another reason why the New European Insurrection is giving the French fits. The other part of it is that France still thinks it's a world power and deserves respect for that reason alone; she still thinks she's a pretty young girl, when in fact she's become an old whore with drooping breasts and way too much make-up who bitterly wonders why business is down so much.

Economically the new member countries are still fairly insignificant compared to the rest of Europe, as this graph shows. Even adding up the four countries' GDP, it still comes to only 4% of the current 15 members' total GDP. So their economic clout is going to be limited in an absolute sense. On the other hand, the New European economies have much better growth prospects than Old Europe (unless there's a complete collapse in western Europe). New Europe's influence will come from the population that it brings into the fold of the EU, and not so much from the direct economic impact. Indirectly EU accession is going to remake the economic map of Europe; having Poland on its eastern border might just be what Germany needs to wake up from its stupor.

Posted by qsi at 11:12 PM | Comments (8) | TrackBack (0)
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January 26, 2003
The breeze of change

Now that my cable modem seems to have recovered again after several days of intermittent service, I can go back to blogging. There is something very peculiar about writing these blog entries. Writing for the blog is deeply associated with the Movable Type interface, the web browser, the colors and the font. Somehow it puts me in the right frame of mind for writing here. I tried to write up some entries in word processors for posting later, but the daunting white emptiness of the page did not give way to the almost automatic writing here on the blog. There's also the association with the style of writing. Whenever I fire up Word, it is for work-related documents. The style is formal, the content has meet much higher standards than my writing here on the blog. Apparently that association runs deeper than I thought. I'm sure with sufficient mental effort I can overcome it, but I did not feel like spending the energy. I took the easy way out and hoped that the routing problems would soon resolve themselves. I am distinctily unhappy with chello, which is my ISP.

This is of course just a minor thing. It does show how the context of one's activities is determined by more than just the functional interface, but various less tangible factors play a role too. There's no technical reason why I should not be able to write in the same way in Word as I do in Movable Type. It's a small example of habit, or indeed conservatism if you will. The familiar is more comforting, easier to use than even a simple change. Again, in this instance it would have been relatively trivial to put myself to writing in Word. The context for our daily lives, from the personal all the way to the level of international politics is also influenced by habit and familiarity. Over time you start to take things for granted. The reason for the existence of an institution becomes less relevant, and it the acceptance simply coasts on the inertia and innate conservatism that most people (irrespective of their political outlook) exhibit.

Living in a state of constant change, constant revolution is not a good way to be either. But when circumstances change, the outlook must change too. Supporting institutions simply because they've always been there, and "that's the way things are" is no longer good enough. It is now obvious in hindsight that the fall of communism and the liberation of eastern and central Europe has taken the world into an era in which the very foundations of the geopolitical order are being redrawn. The old foundations of the post-World War II era are being washed away in this tide. Spoken in a different time of upheaval, Lincoln put it thus: "The dogmas of the quiet past are inadequate to the stormy present."

And despite the dangers that the world faced during the Cold War, the current present is much stormier than that era. The simple bipolar conflict with the threat of global armageddon is now replaced with the shifting sands of a more fluid conflict. The conflict itself and its outcome will shape the world that will come after this. But the first realization is that the Cold War structures have become obsolete. Much has been written about the demise of NATO in recent days, as the French and the Germans weasel out of the war against the Islamofascists. NATO is the quintessential Cold War institution, and it has served us well. Its role in post-communist Europe has always been a difficult one, but now we are very close to the point where we might as well have it close up shop altogether. I don't actually favor this, as there is residual value in maintaining the structures of NATO, but it would be better to transform it from its current form into a smaller organization where only those countries remain who are indeed true allies of the US, and not pusillanimous weasels of the Franco-German axis. Make NATO the alliance of the strong-willed, those who can and will defend themselves in the face of threat. Cut the others out.

Other institutions of the post-war era are also losing their significance. The Bretton Woods institutions have been grappling with their role since the collapse of fixed exchange rates in the early 1970's. Neither the IMF nor the World Bank are essential to the functioning of the world economy. More importantly, the biggest post-war contraption of them all, the United Nations is overdue for retirement. It has become a huge, unworkable, vastly expensive boondoggle. And that's the charitable reading of its role in the current world. I don't see why the US (or any other western country) should finance an organization where every tin-pot dictator of your average third world country should use our money to work against us. The UN needs to go too. The upcoming war in Iraq will add to the growing irrelevance of the UN, and the French and the Germans are doing us all a favor by accelerating the process. The sooner the UN collapses, the better. The new world that will emerge after the conflict against Islamofascism has been won will have some kind of successor organization to the UN, but it will be radically different. Even the European Union is faced with strong centrifugal forces as a result of the changing landscape. The accession of new countries to the EU will forever change the organization.

The obstructionism of the French and the Germans has the sole aim of undermining American power. There's nothing noble or high-minded about it. It's just a spoiler tactic, the kind of thing adopted by the weak and powerless who hope to ruin someone else's chances of doing good. They simply can't stand the fact that there's another kid on the block who has better toys, drives a nicer car and is smarter to boot too. So they try to trip him up, even if that means they'll be left unprotected against the bullies on the southern doorstep. Such the myopia of minds that have been perverted by envy. The French policy of hysterical anti-British and anti-American paranoia goes back a long, long way. Indeed, even during the second world war Charles de Gaulle was often virulently anti-British in his policies, even as the Brits were providing him with a base for his operations and help with his armed forces. At one point Churchill came close to stopping all cooperation with de Gaulle after he'd made some particularly absurd remarks. French policy has ever since been aimed at thwarting the Anglo-Saxons, irrespective of what the long-term effect would be on France itself. Spoiling is the goal, not the means. And since the French built the EU to suit their needs, it is not surprising to see this anti-Americanism carry over into that institution as well. It's become part of the chattering classes' Required Opinions.

The enmity is being ratcheted up by the Europeans in the current conflict. Judging the US to be a greater danger than the Islamofascists, they are ideologically oblivious to the real world. This will cost them dearly. The relationship between the US and Europe has benefited both enormously over the last half century, and it would be a tragedy if it were to become eviscerated. But it is happening, and the negative effects will be felt much more keenly in Europe than in the US. Simply put, the US is more important to Europe than vice versa. The American economy is healthier, the demographics are more favorable, the military is infinitely superior, the political system is more unified. In any conflict the US will win. And Europe will lose.

There's another aspect to this also, and that's the declining relative importance of Europe, and especially the Old Europe. The Eurosclerosis that has been gripping the economies of the Old Europe are wringing any long-term vitality from it. And the demographic tipping point is coming ever closer; by 2010 both Germany and France will be in deep demographic trouble unless they undertake painful reforms fast. Time is running out, and it does not look like they'll be able to pull off their reforms before then. With a stagnant prognosis for the European economy, the sources of growth must be found elsewhere. And the biggest one of all is China.

China's importance in world trade is growing dramatically. It's already the world's largest cell phone market, it's the world's fourth-largest car market and the fifth largest economy of the world. The per capita GDP is still very low, but with growth rates of 8-10% per annum, China will be by 2004 the world's fourth largest economy behind the US, Japan and Germany. And in relative importance to the US, it will be more significant than that. Already US exports to China are bigger than exports to Germany and France combined. The center of gravity of the world economy is shifting away from slow-growth Europe and moving to fast-growth Asia. (Japan being the obvious exception here). Few, if any of the policymakers in Berlin or Paris (or elsewhere in Europe) realize that they are steadily losing influence and clout. Perhaps they feel it subconsciously, which is why they are thrashing about so much, but fundamentally, they don't understand the reasons for the decreasing relevance to the United States. They think they're entitled to that influence and are hopping mad for losing it.

It's extremely sad to see this happening. Both the US and Europe have much to gain from continuing as allies rather than adversaries. But the Gaullist psychopathology that's driving Europe into conflict with the US is too deeply rooted at the moment for a different outcome. I can only hope that the Europeans come to their senses before it's too late altogether. The winds of change are not quite blowing at full force yet, but the breeze is definitely in the air. I'll close with more words by Abraham Lincoln:

The occasion is piled high with difficulty, and we must rise to the occasion. As our case is new, so we must think anew, and act anew. We must disentrall ourselves, and then we shall save our country.We cannot escape history. We will be remembered, in spite of ourselves. The fiery trial through which we pass will light us down in honor or dishonor, to the last generation.

Indeed. (Do any European politicians even know what honor means?)

Posted by qsi at 11:50 PM | Comments (10) | TrackBack (0)
January 01, 2003
The Taylor Rule and EMU

Happy new year everyone! The Wiener Philharmoniker are going through their New Year's tradition while I'm typing this. I just can't believe it's Nikolaus Harnoncourt conducting Strauss (any of them); I still associate him primarily with earlier composers. There is a guest appearance by Johannes Brahms this year in the form of his Hungarian Dances, which makes the Harnoncourt association somewhat more plausible. But in any case, with the effects of the fireworks dissipated and a whole new year to trudge through, how can I resist writing about monetary policy in the Eurozone?

I have written before about the stresses in the European Monetary Union, focusing mostly on the divergent inflation rates within the member states. Looking at real interest rates deflated by the harmonized inflation indices there is a huge difference between large member states of EMU such as Germany and Italy of almost 200 basis points. Trying to refine this analysis a bit further, I've been playing with Taylor-Rule implied interest rates.

The Taylor Rule was first formulated by economist John Taylor in 1993 with European Monetary Union in mind. The rule is fairly simple: it says that the nominal interest rate is determined by four things: the real equilibrium interest rate, recent inflation, the central bank's inflation target and the output gap. Conecptually it's one of those things that make good sense, but in practice it's hard to get much out of it. The problem is that out of the four quantities you need to calculate the nominal interest rate, two are hard to quantify. The real equilibrium interest rate is usually approximated by taking a long-run average of real interest rates in the past, which of course have been influenced by monetary policy. Inept monetary policy in the past will lead to higher real interest rates as a "credibility premium" that the market demands. Even hard to estimate (especially contemporaneously) is the output gap. This is the difference between actual growth and potential growth in the economy. Actual growth is simple to measure, but how do you come up with potential growth? This is usually again calculated by taking a long-term trend growth rate for the economy. Neither of these two approximations is perfect (or even close to it), but the Taylor has gained widespread currency as a rule of thumb for assessing monetary policy. Many of the practical problems are explored in this paper by Robert Hetzel of the Federal Reserve Bank in Richmond.

In the case of European Monetary Union, the Taylor Rule does a remarkably good job (pdf) in explaining central bank policy. Graph 2 on page 7 of the linked document shows the Taylor Rule interest rate set against the actual interest rate prevailing at the time. In order to see what the Taylor Rule is telling us now about the proper level of interest rates for the member countries of the European Monetary Union, I used the latest OECD data, which includes estimated output gaps, nominal interest rates and inflation rates. From this I calculated the average real interest rate over the 1994-2001 period and used that as the equilibrium value in the Taylor Rule, except for the EMU countries where I used the 3.55% value calculated in the BIS study linked above. As an inflation target I used 2% for EMU (which is the ECB's "reference value"), and 2.5% for the UK and the US. The Federal Reserve does not have an official inflation target though. The results are very interesting. This graph shows the Taylor Rule implied nominal short rates for most of the OECD countries, while this graph shows just the EMU data.

There are two immediate observations: first, the Taylor Rule comes up with much higher interest rates than the current ones in most countries and second, there is a very substantial dispersion in Taylor Rule rates for the EMU countries. The first phenomenon can be explained by the fragile state of the world economy. The threat of deflation is bigger than the threat of inflation, so the Federal Reserve is erring very much on the side of loose monetary policy. Curing inflation is easier than curing deflation. The ECB has grudgingly followed the Fed's lead, although the widespread perception still is that the ECB is still fighting the last war rather than the current one. This explains the very low interest rates that we're currently seeing. The equilibrium real interest rates that went into the calculation are higher than the currently prevailing nominal interest rates for both EMU and the US. Obviously the judgment now is that such high levels of real interest rates are inappropriate. Reducing the equilibrium real interest rate is a translation: all levels of Taylor Rule rates shift down by the same amount. If one were to assume that real rates should be 3% lower than the equilibrium used in the calculation, one should subtract 3% from the values shown in the graphs.

But as for the second phenomenon, why is there such a huge divergence within EMU countries when the BIS study showed that the Taylor Rule did such a good job explaining monetary policy? The reason is that the BIS study used a weighted average of EMU countries' economic data. This means that within that average, each country was able to fine-tune its monetary policy to the prevailing domestic circumstances. Having a single interest rate for all 12 EMU countries means that this fine-tuning of monetary policy to local output gaps and inflation is no longer possible. Thus the single interest rate set by the ECB is wildly inappropriate for a number of countries. The only ones within a 25 basis point range of the Eurozone Taylor Rule rate are Italy and the Netherlands. As noted above, this dispersion is not affected by assuming a different equilibrium real interest rate for the Eurozone. The dispersion would be affected if one were to calculate an equilibrium real interest rate for each of the countries, resulting in a lower rate for Germany and higher for Italy (a gap of 110 basis points). In other words, the Taylor Rule dispersion would be even bigger in that case, from 151 basis points to 261 basis points. Either one is a huge difference in monetary policy.

The Taylor Rule is not explaining current monetary policy very well, even if it has a decent track record in the Eurozone. Real interest rate are now much lower due to the balance of risks in the world economy. Whatever framework one uses, be it simple real interest rates or a Taylor Rule, the divergence within the EMU countries is still substantial and shows that having one interest rate for all the EMU countries is far from an optimal situation.

Posted by qsi at 02:44 PM | Comments (0) | TrackBack (0)
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December 27, 2002
The Gulag on Europe's doorstep

When Poland joins the European Union next year, the EU will border a state that is still in the grip of communist-style totalitarian rule. The country is Belarus, or White Russia, where president Alexander Lukashenko rules with an iron fist. The Czech newspaper Lidové Noviny ran a report on the sad state of human rights in Belarus. It tells the story of two journalists who have been sentenced to "limited freedom" for publishing articles critical of the government. In practice, this "limited freedom" means forced manual labor, also during the Belarussian winter which sees temperatures far below freezing. The journalists say with a wry sense of humor, "If we had Siberia, we'd be moving there."

The journalists are Pavel Mazheiko and Mikola Markievich, whose newspaper Pahonia was shut down after Mazheiko wrote an article before the last presidential election in which he said that no-one, who did not respect others' rights, should be president. He never even named Lukashenko (or anyone else specifically) in the article, yet it was enough to sentence both him and his editor in chief Markievich to forced labor. The authorities also shut down the newspaper. The paper's web site is still up, and on the left column they're counting down the days of forced labor for Markievich (top, 427) and Mazheiko (middle, 246). There's a third, Viktor Ivashkievich at the bottom, who's still got 719 days to go. After some googling, I found this article which identifies him as the editor of the paper Rabochy. Apparently since that page was written he's been imprisoned too.

Aside from the minor issue of commitment to human rights and foreign policy high horses and all that, there's also a selfish reason for Europe to work towards toppling Lukashenko. Although it's not a threat to us at the moment, having a totalitarian regime like this on Europe's doorstep is not a good idea. It's only a matter of time before Lukashenko joins the ranks of other unsavory regimes in the world in actively aiding anti-western forces. Luckily the country land-locked, but the borders with the Ukraine and Russia are porous. It's not a matter of highest urgency from a selfish point of view (the people of Belarus would very much disagree), but we're storing up trouble if we allow Lukashenko to run a totalitarian regime right on our border. The sooner we get rid of him, the better.

Posted by qsi at 06:59 PM | Comments (1) | TrackBack (0)
Poland's eyes on the future

There are reports that Poland will be buying F-16's from the United States, rather than European-built combat aircraft. The news was leaked by the chairman of the French defense contractor Dassault, which had been hoping to sell its Mirage fighters to the Poles. Aside from the technical aspects the deal has obvious political symbolism too, and this was not lost on Dassault's chairman:

Dassault broke the news of its own defeat, saying it dealt a blow to attempts to build a common European defence identity less than two weeks after the European Union invited Poland and nine other countries to join in 2004.
Good! Talk about positive externalities.
"I felt for a long time that they were very much in favour of the Americans," Dassault chief executive officer Charles Edelstenne told French radio.
Puzzling, isn't it? What have the Americans ever done for Poland? Especially compared to the French, whose contributions in selling them out have been so memorable. Have the Poles forgotten already?
"The political element was the dominant element, well above the quality of the equipment and its price."
Ooooh, overly acidic grapes anyone?
"Above all, they have made an American choice," he said.
Absolutely. It's a very wise move too. Staying friends with America is far more important than ingratiating oneself with the garlic munching capitulation weasels. At a time when it's popular in western Europe to bash the Americans, the Poles can be sure that President Bush will remember. The Poles have chosen wisely.

Dziękujemy bardzo!

Posted by qsi at 10:11 AM | Comments (5) | TrackBack (0)
December 23, 2002
Fishing for sanity

he idiocy and inefficiency of the European Union's Common Agricultural Policy is well-known and well-documented. A less well know offshoot is the Common Fisheries Policy which is just a perverse in the effects that it has on the market, fishermen and fish stocks. The setting of new quotas by the EU over the weekend has been hailed as a major reform of the CFP. It's anything but. In true EU fashion, the real source of the problem has been left unaddressed while lots of tax payer money is still being distributed freely. The immediate problem is that fish stocks are becoming seriously depleted. In the case of cod, it's now in danger of becoming extinct in EU waters.

How did it ever get to this point? Two things are to blame. First, the fish stocks have been treated as common property, and secondly the EU's subsidies have been encouraging fishermen to fish more. Treating the fish stocks as common property means that nobody owns the fish, which in turn means that whoever fishes most gets the maximum benefit. Even if individual fishermen wanted to conserve fish stocks and were to fish less, this would simply mean a bigger catch for the more aggressive fishermen. There is no incentive whatsoever in a common property system to conserve: a classic case of the tragedy of the commons. Abolishing individual property eradicates the incentive to make good use of common property. Of course, nobody used to "own" the fish stocks in the past, but the amount of fish was so large relative to the harvesting capacity that it did not matter. With the introduction of modern, highly efficient fishing techniques the balance has shifted to the point where fish stocks are no longer a de facto infinite resource. On top of this comes the second problem, which is the EU's subsidy program. Some of the subsidies the EU disburses are specifically targeted for increasing capacity by modernizing the fleet. At the same time, the EU is also subsidizing the removal of capacity because there's already too much of it. It's the worst of all worlds: not only are fish stocks common property, the EU is encouraging capacity expansion and then paying others to reduce capacity.

This is of course completely ridiculous, but that has never stopped the EU before. The current system is not only tremendously wasteful, it also generates a lot of ill will on the part of the fishermen, who are dependent on whatever the EU decides in terms of quotas and subsidies. Cutting back on quotas and stopping any further capacity-enhancing subsidies, as decided this weekend, is hardly a serious reform of the system. The solution to the problem is known and workable, but there is no political will to implement it, as European politicians are far too fond of their roles as Wise Regulators and Santa Claus.

The solution for the first problem of common property is to assign property rights to fishermen in the form of Individual Transferable Quotas, or ITQs.These are already in use in various parts of the world, such as the Chile, Canada, the US and Iceland. The ITQ system allows fishermen to buy and sell a quota of the Total Allowed Catch (TAC) at a market price. The TAC is determined by looking at how depleted the fisheries are and is adjusted accordingly. The ITQs the fishermen buy make them owners of a share of the TAC, which also gives them a vested interest in maximizing the value of their ITQs, which is not the same as maximizing the TAC. This actually aligns the interests of the fishermen with those of conservation as fishermen will want to preserve the market value of their ITQs. If the TAC is set too high, this will reduce the prospects for future TACs, which in turns means fewer fish to be caught per ITQ. The situation now is that fishermen only take the amount of fish they can catch now into account, so it is always in their interest to have as large a TAC as possible, which leads to horrible overfishing. Introducing a market mechanism based on property rights is the way to create a self-sustaining fishing industry. This is not just idle theoretical speculation. The report linked to above lists the experiences with ITQ systems, and in virtually every instance these effects have been seen. Instead of arguing for higher TACs every year, the fishermen have become interested in conservation too, because it affects the capital that's tied up in the ITQs.

The second part of the problem is the subsidies. The solution there is simple: abolish them. The effects of subsidies are negative in all realistic scenarios. Subsidies result in lower equilibrium biomass (i.e. fewer fish) with lower profits and higher effort. It's a loss all round. But this study assumes that there is some form of a market mechanism at work, which will reduce harvesting capacity when profits are low or negative. Due to the market-distorting policies of the EU, the situation is even worse because overfishing has been allowed to go on for so long, and losses have been compensated by increased flows of money from Brussels. Right now most of the European fisheries industries are in a situation where subsidies have a short-term positive effect on fishermen's profitability at a long-term cost.

So by moving to a property-based system of ITQs the recurring whining and moaning of the fishermen and the posturing of politicians can be eliminated. Fish stocks will be preserved, a profitable and self-sustaining industry will be created. Most importantly of all, it will give to fishermen hope for the future by allowing them to work as entrepreneurs in a business. Some will fail, others will prosper. But they no longer will be supplicants living on welfare.

Posted by qsi at 06:33 PM | Comments (1) | TrackBack (0)
December 14, 2002
EU enlargement

Here's a story that goes around in business school and consultant circles. I heard it from a colleague who picked it up during his education at INSEAD, a prominent European business school in France. The story concerns an experiment with a number of monkeys. They're placed in a room which contains a climbing pole. At the top of this pole, some nice juicy bananas are placed, so obviously the monkeys try to get at them. When any monkey climbs high enough to reach for the bananas, the entire room is soaked with cold water, which results in very unhappy drenched monkeys. This happens every time a monkey goes for the bananas and as they're pretty smart primates, they catch on. So when any of them makes an attempt at the bananas, the others quickly give him a good old pummeling to prevent getting drenched. Now the researchers remove one of the original monkeys in the room, as replace it with another one. The new one sees the bananas and tries to get at them, but gets a hefty beating at the hands of the drench-conditioned monkeys. The researchers keep on replacing monkeys in the room until none of the original ones remain. None of the monkeys in the room has ever gotten drenched or eaten the bananas. Yet the group still enforcers the no-pole-climbing rule, but without knowing why.

This story reminds me of the behavior of European politicians. They're stuck on autopilot where the future of the European Union is concerned, moving boldly forward into the barren snowcovered tundra of a European Superstate without exactly knowing why. Their predecessors set out on this course, and so did theirs, going back all the way to the times of Adenauer and De Gaulle. After the carnage of the Second World War, the post-war generation of politicians in Germany and France wanted naturally to make sure no such catastrophe could ever again befall the European continent. Aside from the military framework of NATO that extended American protection to Western Europe from the Soviet threat, the European set out on trying to integrate their economies. Prosperous and closely integrated economies would be less likely to attack one another militarily. The Treaty of Rome signed in 1957 established the European Coal and Steel Community, the precursor organization of the European Economic Community which in turn became the European Union.

Much has changed since 1957, of course. The ECSC consisted of six countries: France, Germany, Italy, the Netherlands, Belgium and Luxembourg, and the level of integration was minimal. The European Economic Community which flowed forth from it was essentially a customs unions, and later turned into a free trade zone. But the tone was set in the Treaty of Rome, which contained the fateful phrase of working towards "ever closer union." And thus it came to be. The ever closer union of European countries has been propelled by this original visionary document.

The key issue which the EU has never come to grips with is that the organization has been gathering new members through the years. The original structures, set up for six members, are already under severe strain from the current 15-strong membership. The Copenhagen summit has just resulted in the admission of a new wave of countries to the EU in May 2004. This will exacerbate the problems even more. The conceptual flaw that underlies the EU is not going to be addressed though, as solutions are going to be sought in reforming procedures rather than fundamental concepts. It's that vision thing.

The EU's problem is that none of the European politicians has a realistic vision for its purpose. They're still on the course of "ever closer union" that had been 45 years ago without really knowing why anymore. Aiming for ever close union is what European politicians do. Questioning this is just not done in polite (dare I say sophisticated) political circles. The process of integration pushed by the political elites has run far ahead of what the domestic electorate is willing to put up with, creating an internal problem. Thus far, it has been containable.

The EU will not survive in its current form. The imprint of the original small club of industrialized countries has already been coming under pressure with the admission of poorer countries like Spain, Ireland, Greece and Portugal which have economies greatly dissimilar from the original member countries. The Scandinavians and the British could be accomodated relatively easily. The others have received massive subsidies from the richer members. Only their relatively small size in relation to France, Germany and Britain made it possible to pull them along. Ireland in particular has done very well out of all this, in large part because of its domestic policies. In in its current state, it's doubtful whether enlargement is a good thing for the new entrants. They're more likely to get slowed in their economic development rather than helped with the ponderous weight of EU regulations weighing down on them. They may yet decide to decline the invitation.

There are two reasons why the new entrants will change the EU. First, the per-capita GDP of the new entrants is on average substantially below that of Portugal and Greece, the current worst performers in that regard. The gap now between the top and the bottom and per-capita GDP is going to be bigger than it ever has been within the EU. The second reason is the numbers. Ten new members with over 50 million extra inhabitants makes this the largest expansion the EU has seen thus far. So the EU is going to be much bigger and much more diverse than it ever has been. That's why it can't survive in its current form.

That could be a good thing. Could the EU become even worse than it is now? If the Euro-federalists get their way, certainly. The staggering inertia of the bureaucracy that has accumulated will not be deflected easily. But the changes that the EU will have to face are more fundamental than that. What is the purpose of the EU? Does it really want to become a country? Does it want to promote prosperity, civil society and a liberal democracy? The latter goal is much more achievable than the former, and more desirable too. The problem is of course that the EU is no place of moral authority to lecture on any of those subjects. Lately the EU's meddling with the economy has led to decreasing prosperity, while its opaque and elitist power structures have eroded the foundations of the social compact that makes civil society possible and democracy and the EU have been kept firmly separated.

Yet the EU's best chance for success and survival is to abandon its ambitions for creating a United States of Europe, and focus on more practical goals. Make the free trade area work. Help the new entrants in establishing and engraining the insitutions of a pluralistic society. Once you remove the prospect of the "USE" from the equation, many issues become more tractable. The key here is Turkish accession to the EU. If the goal is to create a single European Superstate, then there is no way Turkey can be admitted. But the Superstate idea would not work even now with the 15 members, as the divergences in culture and mores are too large to become part of a single country. If the EU becomes an enabler rather than the petri dish for a Superstate, then Turkish entry is no problem. In this whole debate it's not the Turkish domestic issues that are the impediment, it's the unresolved fundamental dilemma at the heart of the EU that has paralyzed the situation.

By allowing these 10 new countries into the club, the EU will be changing; it will never again be as politically or culturally homogenous as it was in 1957. The rearguard action to maintain the old spirit of those days (and the French vision of a Europe in its image) is now being fought at the constitutional convention. The new EU constitution will try to preserve the original spirit, and it may succeed in that on paper. But it will be overtaken by events on the ground. The positive outcome would be a reformed EU that makes more sense than the current structure, a Free Trade Area Plus. If things get ugly, then the EU will slowly disintegrate as it loses its relevance, and we'll see a Core EU develop in the west of the continent.

The is Old EU is dying. Let's hope the new one will do better.

Postscript: the story about the monkeys with which I started this article can be traced back to Competing for the Future by Gary Hamel and CK Prahalad. No references to any actual study can be found, so it's likely to be just a fable. These things tend to take on a life of their own and become a standard part of management consulting. As a parable they work fine, but it would have had much more impact if the story had been true. Oh well... welcome to the world of management consultants and their ilk.

Posted by qsi at 11:55 PM | Comments (0) | TrackBack (0)
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December 12, 2002
Fixing the euro

No, they're not talking about the fundamental problems of the euro. That would be too much to hope for. However, one of the complaints of consumers in the Eurozone has been that prices have gone up in the past year as a result of the introduction of the single currency. It has been one of the big discrepancies between what people think they're experiencing and what the official inflation statistics are telling them. Looking at the Harmonized Indices of Consumer Prices (HICP), most European countries have fairly low inflation; it varies between 1% for Germany and around 3% for Italy, plus some outliers on either side. Yet in both Germany and Italy, consumers are up in arms about huge price increases.

The difference is due to the composition of the inflation indices and a bit of psychology as well. The inflation indices try to measure the overall cost of living, which includes longer-term purchases, such as computers and printers, as well as everyday items such as groceries. The biggest increases have been in the lowest-priced items, which people buy all the time. But in the inflation index, these rises are offset by cheaper inkjet printers, for instance. This accounts for some of the difference. But psychology also plays a part, as people feel the impact of high-frequency purchases more keenly than the low-frequency ones.

But there's another psychological effect here, at least according to politicians from certain European countries: the euro coins. Apparently people put a higher notional value on banknotes than on coins, so they're much more likely to spend a one euro coin than a one euro bill. So the ECB is now considering the introduction of one euro notes. I don't know whether this would work though. Prices have already been set, and printing one-euro notes now would take quite a while and of marginal impact. As with many things connected to the euro, this is going to be a political decision in the end.

What is amusing though is how deep the European inferiority complex runs though. Witness this comment from Guy Quaden, the governor of the National Bank of Belgium:

He suggested the introduction of one euro notes could be a boost to the internationalisation of Europe's single currency. "The one dollar note is one reason for the popularity of the US dollar . . . everybody knows and uses this note."
The dollar's popularity has very little to do with the one dollar note. It's more a function of the trust that people all over the world place in the US government to maintain the purchasing power of the dollar, especially in countries where the people have repeatedly been robbed by their own government's actions. The German mark had a similar status in parts of the Balkans, where the euro has succeeded it. But worldwide acceptance of the euro as a serious substitute for the dollar will only come if the euro is seen to be as stable, reliable and trustworthy a source of value as the dollar. It's going to take a long time to build that kind of reputation. In any case, the ECB and European politicians would be better advised to stop obsessing about the dollar and start focusing on the economic problems that beset the European continent. Once they fix those problems, the euro's acceptance will increase too. One euro notes are not going to make the slightest bit of difference.

Posted by qsi at 11:15 PM | Comments (2) | TrackBack (0)
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Immigration to the rescue

Although this blog is in danger of becoming completely obsessed with the dismal demographics of Europe, I will venture forth once more, this time to comment on Samizdata's lament about the treatment of immigration in the British press. Especially the right-wing British press, which is whipping itself into ever greater furore over the threat that immigrants supposedly pose.

The other right-wing broadsheet in Britain, the Times, ran op-ed on the same topic this morning by Anatole Kaletsky, himself an immigrant (or refugee) from Russia. Kaletsky's columns are usually interesting, although on many an occasion I have wondered what on earth he was smoking. Last year, he predicted for instance that the Republicans would get punished by the electorate for the Bush tax cut. Admittedly, this was before September 11th, but still... Anyway, back to the issue at hand. His column today is title "Why Britain needs more people like me," and makes the case convincingly. Excerpts:

As an Eastern European immigrant myself, I find this a difficult subject. I am very well aware of the benefits I have received from Britain – starting from the inspiring statefinanced education I received at grammar school and then at Cambridge, to the ready acceptance I enjoyed from the British Establishment, which seemed to be almost oblivious to my foreign birth. As someone who has gained so much from Britain’s openness to foreigners and foreign cultures, I know that it may be considered self-indulgent for me to argue that Britain, too, has benefited from this flow – and could benefit even more. But with antiimmigration sentiment still strong and now enjoying an upsurge among environmentalists and other “progressive” movements, it would be even more churlish to stay silent. Mr Straw’s bold decision deserves an enthusiastic welcome. And if a Russian immigrant fails to endorse it, who else will?
This is a very valid point, one that underscores how those who call themselves "progressives" have become the reactionary custodians of a statist past. The luddite anti-technologists who fight genetically modified foods, nanotechnology, and any electronic gadget more complicated than a 1960's IBM electric typewriter somehow manage to call themselve "progressive" without so much as feeling the slightest bit of etymological dissonance.

First, the Government’s new attitude should help Britain to recognise that it is already a country of immigrants – and always has been. What, after all, were the Angles and Saxons themselves?
This is probably the weakest argument in his entire column. Theoretically, they were immigrants indeed, but there's a difference between your ancestors of 1,500 years ago roaming through Europe and having a society of that is considers itself to be of immigrant descent. You need constant immigration over the ages for that. But this is a minor quibble.
For politicians to pretend that immigration is some kind of new and unwelcome development, as they often have in the past, is a recipe for social dislocation and economic under-performance. Immigrants (defined as all British residents who were not born in this country) comprise 8 per cent of the UK population and 10 per cent of the people of working age. This is only slightly smaller than the 11 per cent share of the US population that was born abroad. London, where immigrants now make up 26 per cent of the population, is just as cosmopolitan as New York, whose immigrant population is 28 per cent. [...]

The fact that immigrants contribute more to the Exchequer in taxes than they take out in public spending may surprise many Tory politicians, not to mention readers of the Daily Mail and other jingoistic tabloids. But this is one of the many important conclusions of detailed research commissioned by the Home Office and published this week in the first of a series of studies into the economic and social impact of immigration.

Read the whole thing, as they say. Large-scale immigration from eastern Europe can be mutually beneficial for both Britain and the countries themselves, as the immigrants send money back home. The payoff could become asymmetric in favor of Britain if the flow of people becomes an brain-draining exodus, leaving eastern Europe for good. Ultimately, the demographics of eastern Europe are no better than those in the west.

Immigration has also been a hot issue here in the Netherlands. Ever since Pim Fortuyn brought it to the fore, it has been in the forefront of political debate. The main question is what to do about the unassimilated immigrants, who've live in self-imposed segregation in depressing inner-city ghettos, such as Amsterdam West. I'm not sure how many of his supporters see the immigration problems purely in terms of assimilation, or whether they're just pining after ethnic purity. In any case, the governor of the Dutch Central Bank (De Nederlansche Bank) has been banging the immigration drum too, but he's been warning the Dutch that the country is going to need increasing numbers of foreigners, lest we come eye-to-eye with demographic armageddon. In a recent interview in Trouw, a daily newspaper, reinforces his message. He warns about the great disparity in economic development between the new countries joining the EU (an item for another blog entry someday), but then goes on to speak about immigration from even outside of the EU. Translated excerpt:

A very sensitive subject, he has found, because since he first mentioned this some time ago he's gotten an unprecedented amount of personal letters, 'some distasteful.' "Closing the borders, that's really the wrong argument. It's in our own interests to steer the migration process in a partnership with the affected countries. Then you can talk, for instance about a smooth return. Look at Germany, that's always had an open policy, there two-thirds of the 25 million migrants has returned to their native countries."
Quoting Germany as a country that has been successful in managing the immigration process is saying something about the poor state that the Netherlands is in. But the problem that exists now here is that we have a fifth column of immigrants who have irredentist fantasies of establishing an islamic theocracy here, while the demographics still argue for a big increase in immigration. And there's precious little sign of awareness of this on the part of politicians. Trouble ahead.

Posted by qsi at 10:12 PM | Comments (2) | TrackBack (0)
December 10, 2002
Subsidizing the paper & pulp business

In response to my entry "Nothing to worry about", Ellie comments:

How many pages of treaty, regulations, etc. has the EU produced? We (yes, the US does this too)seem to LOVE paper. I'm especially fond of the Negotiated Agreement with North Korea. I wonder how many pages that was?

Well, never fear, Ellie! The legions of Dilacerator ferret gnomes have been scouring the internet in search of answers. Tabulating the sum total of all EU regulations would instantly throw the server farms at Google into meltdown, so my crack team of deaf-mute moles limited the search to just the acquis communautaire. This is the basic body of laws, rules and regulations which all EU countries much have implemented. And new entrants must also push the acquis through their parliaments in order to be allowed to join. So how big is it? The Greek-Cypriot EU accession site has the answer:
Today the acquis communautaire consists of about 80,000 pages, but it is continually being changed, improved and increased as the EU continues to more forward.

And this is a from a site that's actually in favor of Cyprus joining the EU! Yes, it's only 80,000 pages now, but don't worry, they're making more laws! Jeeez folks, what a mindset...

As for the page count of the Agreed Framework with North Korea, the underlings and servitors are Dilacerator Mansion are being spurred to erase their sinful failure of finding the answer. Gentle electric shocks and the occasional flogging will, ultimately, produce results.

Posted by qsi at 10:24 PM | Comments (1) | TrackBack (0)
December 09, 2002
President Tony Blair?

The current British Prime Minister is a strange animal. Having come from a socialist background, he remodeled the old Labour party into the new Labour party, in the process shedding many of the old socialist policies. The rightward shift came as a response to the success of Thatcherism, which rendered old-style socialism all but unelectable in Britain. Just as the Tories were running out of steam and started to tear themselves apart, Blair's New Labour won a massive election victory in 1997, and repeated the performance in 2001. He's achieved the highest post available to a Briton. What more could he want?

Well, a Legacy of course. All politicians want a legacy, but those who deliberately set out to create a legacy end up in the most trouble. Blair's weak spot has always been Europe. The relationship between Britain and Europe has been a difficult one ever since Edward Heath took the UK into the EU in the early 70's. The Europhiles have urged Britain to join the European mainstream. It's a natural progression, away from the insular nation state to the warm embrace of the community of Europe. Not going along with the European Project would mean that Britain would get left behind, become irrelevant, its economy would suffer and its people would live in misery. Catching the European train is like catching the train to the future. Europe is the future. At least according to the Europhiles, and not being part of Europe means being left behind in the past.

It's a strain of argument that relies on the belief that the "European Project" is both benign and inevitable. It is neither. The European Union lacks democratic legitimacy. It's an instrument that the European political elites are using to remove decision-making and its accoutability ever further from the citizen. It's insulated by many layers of politicians, each of whom dilutes the message from the grassroots. Often European polticians even at the national level are well-insulated from the electorate. Nor is further integration in Europe inevitable, as the Europhiles in Britain claim. The aim of turning the European Union into a United States of Europe is more likely to be the undoing of the European Project rather than its grand achievement. But arguments about historical inevitability are dangerous too, because once you've convinced yourself that a certain outcome will happen anyway, then the temptation becomes overwhelming to take a shortcut to that outcome. Communism held that the downfall of capitalism was inevitable leading to economic collapse and poverty from which the wonderful communist future would rise. So the communists took the shortcut to poverty and misery without waiting for capitalism to deliver for them.

One of the biggest mistakes of Thatcher's career was to agree to British entry into the Exchange Rate Mechanism (ERM). This was the precursor to the fixed exchanged rates of the euro, and it served as a platform for managing currency fluctuations in Europe. Thatcher finally caved in to pressure from all sides: the usual kneejerk euro-cheerleading of the Liberals, the politically motivated euro-cheerleading of Labour and the constant harping of Europhile Tories. All of them said the same thing: the train is passing Britain by. We must jump on now. Membership in the ERM became symbolic with sound economic management. It was inevitable after all. There was no point in not joining. So finally Britain joined, and by tying its exchange rate (and thus indirectly, interest rates) to the German Mark, it almost wrecked the British economy. The early 90's saw an extremely painful and deep recession in Britain, from which the country only emerged after Britain had been forced out of the ERM by currency speculators. They did Britain a great favor by liberating it from the ERM straitjacket.

But the lessons of the past are hard to learn, it seems. The same arguments are being used now in favor of British entry into monetary union as were used at the time of the ERM debate. The difference is that escape would be a lot harder now. But Blair has that glimmer in his eye for a legacy, and he appears to have set his sights on Europe. Today's editorial in the Times by William Rees-Mogg spells it out:

The Prime Minister foresees other measures to increase the power of the European centre at the expense of the individual nations. He wants to reduce national vetoes to a minimum, though, implausibly, he hopes to keep Britain?s veto on taxation policies. He wants a large extension of qualified majority voting, even beyond what was agreed in the Nice Treaty. Tony Blair wants a ?fixed chair of the European Council?, a new President of Europe. Perhaps he sees himself in this role.

If the new constitution for Europe follows the lines of the Cardiff speech, let alone the still more extravagant federalist proposals of Romano Prodi, Europe will have a more centralised and far less democratic constitution than the United States. The European nations will have lost their independence; they will, in effect, be colonies of a centralised European empire, ruled by the Franco-German political class.

Perhaps a Blair or a Jenkins will occasionally be allowed the temporary appearance of authority as the President of the Council or the Commission. The British electorate will have lost the core power of democracy, the ability to throw out a failing government. There will never again be a 1945, a 1979 or a 1997. Even if a British government is thrown out, that will have no more consequence than the electoral defeat of a county council. The real power, the European centre, will never be thrown out. It will be a self-perpetuating bureaucratic oligarchy.

Tony Blair has his own description of this new Europe. He says that it ?can be a superpower, if not a super-state?. That is the kind of glib, false distinction that from time to time makes the Prime Minister?s rhetoric uniquely repulsive. The opening passage of his Cardiff speech makes it obvious that he has been taken over by the idea of a European empire, in which he himself hopes to be a leading figure.

President Blair of Europe? The concept must be appealing to a politician who's young enough to aspire to more. Yet he's already exhausted the opportunities at home, so the escape to some grand European role might just be the kind of escape he needs. Great schemes, great legacy: be afraid. Be very afraid.

Posted by qsi at 09:42 PM | Comments (2) | TrackBack (0)
Read More on United Kingdom
December 08, 2002
Berlusconi flaps his wing

Which wing is Berlusconi flapping? Left or right?

The labeling of political preferences in crude terms such as a "left" and "right" can be useful as a shorthand with a high information density to characterize somebody's broad outlook on life. However, it's a lossy compression algorithm, meaning that when you decompress the "right" or the "left," you will end up with less information than with which you started. Such lossy linguistic compression is often used to avoid excessive verbiage. And by turning down the level of compression you can achieve a better correspondence between your original material and the output from the compression cycle. Liberal, conservative, christian-democrat or social-democrat all have a better-defined meaning than the "left" and "right" labels. Another problem with the "left" and "right" labels is that they imply a one-dimensional spectrum along which people can position themselves politically; when's the last time someone described himself as "top-left" politican or a "front-middle-right" one? Generalized vector spaces of political preferences? Applications of linear algebra to political taxonomy? Perhaps some other time. There's also the minor issue of different labels meaning different things to different people. The canonical example is "liberal," which has many different meanings, both in Europe as well as the US.

Having said all that, there's been a shift to the "right" in many European countries over the last years, with victories in France and Italy as well in some smaller countries. One of the exponents of this new wave of right-wing governments can be found in Italy, where Silvio Berlusconi heads is prime minister. In the run-up to the election, he cited various right-wing luminaries such as Margaret Thatcher as examples for him to follow. So he's made all the right noises too. Now that the pudding has been served, the nibbling at it has commenced. The taste thus far is, well, not-very-right-at-all, at least by American standards. By European standards, Berlusconi's government is part of the "right-wing" mainstream.

The latest ingredient that has gone into the Berlusconi Pudding is the crisis at Italian car manufacturer FIAT. This is a company that has the status of a hallowed institution in Italy, as it provided Italians with a taste of motorized freedom in the 1950s. As a consequence of doing that, it also became Italy's industrial powerhouse, employing tens of thousands of people. FIAT is more than just a company for Italians; for many years, FIAT was synonymous with Business and Industry in the country. At its peak, FIAT's share of the Italian car market was far above 50%.

Now the company has fallen on hard times. The old, cozy and protected domestic market has had to be opened to foreign competitors. Management of FIAT had become part of the ruling elite in Italy, running the company more for prestige than for profit. The labor unions representing FIAT's work force were (and still are) dominated by the communists. Management happily played along with the labor unions' pro-Soviet leanings, which led to the bizarre spectacle of Gianni Agnelli, the patriarch of the family that owned a majority stake in FIAT, embracing the Soviet minister of culture at an exhibition of Soviet Communist Art at FIAT headquarters in Turin. While the red flags were flying at Lingotto, the FIAT HQ, the people of Eastern and Central Europe were busily tearing them down. Agnelli himself also had an iconic status in Italy similar to that of his company. There's also a link to Italy's formerly inbred and incestuous investment banking community, which used to be dominated by Mediobanca. The salotto buono where Italy's industrial fate used to be decided in cigar smoke and behind closed doors is no more. Neither Agnelli, nor FIAT, nor Mediobanca have much of their influence left. The main reason is FIAT's disastrous performance and the realities of a modern market economy.

FIAT is in desperate straits after producing many poorly-received cars. Its only hope for survival is a bailout by minority shareholder GM. Just ten years ago the mere thought would have been unthinkable in Italy, but it now looks as though FIAT will end up as a piece in the global GM puzzle. Even so, FIAT needs to stem the tide of red ink that is flowing. In a bid to restructure, FIAT is trying to fire 20% of its domestic work force. This has led to massive protests by the labor unions, who demand that the government Do Something. In talks between the government and FIAT management, Berlusconi blamed management at FIAT for its problems and grandly said that he "save" the company.

Speaking on Italian television tonight, Silvio Berlusconi made some further telling comments. Apart from sniping at the unions and the opposition, he obviously tried to put the results he'd gotten into the best light. What do they consist of? FIAT has agreed not to close any plants, as originally intended. The plants will be idled instead without the workers getting fired. The government will pay them 80% of their salaries in the interim and the government will also give a sweetheart deal for early retirement for 2,400 employees. In the first year the taxpayer will give them their normal salary in return for them sitting at home doing nothing, in the second it'll be 80% and normal pensions after that (which are pretty generous anyway). For all the talk about not interfering in the economy, this is a pretty hefty non-intervention, and it's going to cost the taxpayer a nice bit of money. It's an indirect subsidy to FIAT, which will be able to reduce its costs in a byzantine way (at least temporarily). Not closing the unviable plants still means that chunks of FIAT's capital will remain tied up in unproductive assets.

Probably the most remarkable comment that Berlusconi made is about the semi-laid-off workers. He said:

he most determined and the luckiest among them will definitely find a second job, maybe not an official one, that will bring the family some extra income.
It's all but encouraging workers to go find a job in the underground economy, which is a strange thing to do for a Prime Minister. The unofficial jobs he refers to are the ones that don't suffer from the enormous tax burden that the Italian state places on normal jobs, such as those at FIAT. And those taxes are then used to fund bail-outs of companies who've been made unviable (in part) by the huge tax burden placed on them. Reducing taxation and regulation in the official job market would help solve both problems: fewer companies would need bailouts, and fewer jobs would unofficial.

Berlusconi's casual acceptance that the underground economy can play a role in finding the semi-laid-off workers new jobs shows that the role of the underground economy is well known and that it fills a substantial gap in the Italian labor market. Taking the next step to fix what's wrong with the official economy by looking at why people need to take refuge in extralegal employment is still something that the Italian government can't bring itself to do.

So the "right-wing" government in Italy has announced a massive subsidy for a struggling industrial giant. It has intervened in FIAT management's responsbilities in running the company and it's using more of the taxpayers' money to try to buy off the unions (who have come out against the deal). It's all perfectly normal for a European "right-wing" government. Who needs socialists with friends like this?

Posted by qsi at 12:25 AM | Comments (0) | TrackBack (0)
December 02, 2002
Europe's dismal future

One of the subjects I have been mulling over for a blog entry for some time has hit the blogosphere: the increasingly fraught relationship between Europe and the US. There's the article by Steven den Beste, and the follow-up by Eric Raymond. Both were touched off by this must-read article. Regular readers of this blog will know that I am not exactly optimistic on the future of Europe. The economic gap between Europe and the US is widening simply because of the economic structures that have been put in place. These discourage investment, risk taking and hard work, while at the same time they provide an excellent and cozy resting place for those who want to live more or less comfortably on government handouts. But the demographics of Europe make the situation even worse. Not only are European economies not capable of generating endogenous growth, the changing age distribution of the population is going to lead to major dislocations within the next decade. Unfunded pension systems are a financial catastrophe waiting to happen, and averting disaster is becoming ever more expensive to do. This problem also exists in the United States, but to a far lesser extent. For one, immigration is keeping the age distribution more favorable (immigrants tend to be young), while many more Americans have capital-funded pensions. The only countries in Europe that have comparable funded pension coverage are the UK, the Netherlands and Switzerland. All other face a huge black hole of unfunded pension liabilities that in themselves could cause serious damage to the economy. The pay-as-you-go systems that are now in place will become too expensive to fund from taxation. This problem will also have to be faced by America's great pyramid scheme, Social Security. The relative size of the problem is still far smaller than in Europe.

America's solution to its demographic problem is not available to Europe for political reasons. Unemployment is high already, and the current immigrant population is poorly assimilated and generally a drag on the economy rather than a boost to it. To put things into perspective: America's unemployment rate is just below 6% coming out of a recession, while the recent cyclical low in Europe-wide unemployment was around 8% (and this includes some low unemployment countries such as the Netherlands and Ireland). While Europe has not been able to provide jobs to its stagnant population, the US economy has had essentially full employment while at the same time absorbing huge numbers of immigrants, both legal and illegal. But on virtually every aspect of economic performance the US is beating Europe, and it's been getting worse from the European point of view. In 1981, Europeans worked on average around 1750 hours a year, and Americans about 1820. By 2001, the American is still working about 1820 hours a year, while the average European is down to 1550. The huge improvement in US productivity, which has not been mirrored in Europe at all, has meant that even in the areas in which Europe used to have an advantage, the situation is now reversed. Real GDP per hour worked is increasing at a faster pace in the US than it is in Europe.

Steven den Beste spends much of his article talking about the brain drain from Europe to the US, and the relative paucity of high-tech companies here. A big part of the problem is the lack of entrepreneurial spirit, which the socialist welfare state sucks out of all but the most enterprising soul. It also reminds me a joke a German friend of mine (now living in the US) told me (except when he told it, it was funny): if Steve Jobs and Steve Wozniak had been Germans, they would never been able to build a big successful company (Apple), because running a business in a garage is illegal in Germany. It does not meet the regulatory requirements for work-spaces (Thou Shalt Have Daylight), and besides, incorporating is an amazing bureaucratic hassle that takes forever. Or how would brilliant minds (well, Woz's anyway) have fared at a big European company? By now, they might have done all sorts of brilliant things for the company, and risen to the ranks of middle-management making $60,000 a year. Then again, since they were college drop-outs, they would not have been hired in the first place. Actual achievement is not the criterion; the right papers are.

In listing the European companies that den Beste thinks are worthy of being called high-tech, he mentions amongst other Siemens and Philips. Now, it is true that both these companies have good research staff and have produced some interesting advances in technology. However, as companies, they're not doing well at all. Siemens is a GE-wannabe, producing everything from light bulbs to nuclear reactors. Its financial performance has long been a blot on the German industrial landscape. (Whether GE's performance is as good as the myth would make it seem is a different matter. GE Capital is a large and opaque part of GE's overall balance sheet.) Philips is somewhat similar, although it's one of those companies that has been trying to find the right reorganization to really get it going. It too is a conglomerate; Philips originally started as a light bulb producer and then branched out. Everybody agrees there's a lot of potential in Philips; it just somehow seems it never gets realized. So while their research may be top-notch, the companies themselves are not. This is partly due to poor management, but to even greater degree it's also due to the fact that management's hands are tied by Europe's "social" legislation that makes firing people difficult. Closing inefficient parts of the business should be a management decision, but in Europe, it's a socialized decision in which the labor unions have considerable say. And the cost of closing down an inefficient factory or division can often exceed the drag that it poses on the bottom line. In fact, closing a marginally profitable factory is seen as an act of evil; it makes money, does it not? Never mind that the return on equity is far below cost of capital, and that having to drag these underperforming elements along hurts the company in the long term. Still, the process of moving companies abroad is continuing. At the current rate, most of the productive assets of big European companies will have been moved outside of western Europe in ten or twenty years' time, just like Sweden has been losing productive assets to lower-tax countries elsewhere in Europe.

Den Beste also mentions the large numbers of Nobel laureates (in the sciences) who live and work in the US rather than in Europe. I was in Italy when the physics nobel prize was announced, and the newspapers were full of stories about Riccardo Giacconi, an Italian who emigrated to the US after getting his degree, and who's been an American citizen since 1977. I only had time to read two newspapers, the Corriere della Sera and Il Sole 24 Ore. Both carried soul-searching editorials asking the question why. Why does Italy not have scientists who stay in Italy and win Nobel prizes? In the interview with the Corriere della Sera, I remember how Giacconi explained it (I can't find the interview online, alas). His advisor told him: Go West. He was a brilliant and ambitious man, and his advisor told him that if he wants to fulfill his potential, he has to go to a place that allows him to do that. And that place was the US.

All of this is well and good, but it's all descriptive and provides for no answers. There are two questions:

1) how can Europe escape from its trap?
2) what should be done about US-European relations?

Answer to question 1 is simple in the abstract: unshackle the economy, let inefficient companies die, encourage risk-taking. In short, make Europe more like the US. That's where the abstract part ends, because that's not going to happen. At least, it's not going to happen fast enough. Compared the European economies now and 10 or 20 years ago, there is considerable progress on liberalization and privatization. The job needs to be carried much further, without being undermined by statist ruses such as "tax harmonization" or "social protection." Moving to a more efficient economic structure ultimately can only be done with the consent of the European electorate, and there's pain involved. Voters don't like pain, not unless the pain of not doing anything is greater. We are nowhere near that point yet. Although the pain threshold for Europeans is likely to be lower than for the Japanese, the situation will have to deteriorate further before the electorate is ready to accept radical economic surgery. The problem is that time is running out. By 2010, the demographics in countries like Germany will be tipping into the danger zone.

The second question is much harder to resolve. It pains me greatly to see this upsurge of anti-American sentiment washing over the continent, so soon after the end of the cold war which was won for us by America. Yet I fear I must agree with Zinsmeister's analysis that Europe and America are growing apart. This is actually more important from a European point of view than an American, as Europe is sliding into irrelevance, so the tension between the US and Europe will be of ever less important over time. But as America's position relative to Europe will strengthen, Europe will have the choice of either being friendly with the most powerful country in the world, or whether it will make life difficult for itself by antagonizing the US. The process of accepting the reality of European decline will probably tend to the latter option; countries who've lost their empires have seldom taken it well. Although Europe is not losing an empire, it will be losing its pre-eminent position as the center of civilization. Europe will become Greece: a place that once upon a time had a sparkling civilization, but whose vestiges are only found in museums now. Worse, because it did have that contribution to the world all those centuries ago, it will feel entitled to be respected for that. And when that respect (and its attendant freebies) are not forthcoming, it will add further to the psychopathology that's poisoning the mind. Can you say "victim complex?"

The accumulated wealth of Europe will keep it muddling along for many decades yet. I also agree with Eric Raymond's conclusion that the situation in Europe could turn very nasty indeed if the economy collapses and ethnic tensions burst into flame. The first signs are already upon us.

None of this makes me feel better about living here, but I do not feel an immediate urgency to leave. There's still time, and my situation is not so desperate that I have to pack up and leave immediately. It's just a matter of finding the right job and I am out of here.

Posted by qsi at 11:34 PM | Comments (8) | TrackBack (0)
Read More on Demographics & Pensions
November 17, 2002
Demographics, Europe and immigration

I had forgotten how slow dial-up modems are. Does anybody really still use them? The internet in its current form is painfully slow on dial-up. That cable modem at home has really spoiled me, although I usually think it's still too slow. The transatlantic latency is one of the problems. If I'm lucky, I get ping times of around 90 ms to the east coast. If I ever feel sufficiently nerdy, I'll calculate the theoretical minimum latency for transatlantic connections.

As I mentioned in my previous blog about Rome, the Pope went to speak to the Italian parliament for the first time since the Italian state was founded. The problem is that the Popes used to rule much of Italy, and the founding of the unitary state of Italy in the 19th century took away the last bit of Papal sovereignty over what are now Italian lands. The relationship between the Popes and Italy has thus been strained with many Italians being suspicious of Papal ambitions despite the Roman Catholicism that remains widespread in the country. The Pope spoke on many issues, but one thing that struck me were his comments exhorting Italians to have more children. The birth rate in Italy is now substantially below replacement rate, with Italian women giving birth to just 1.2 children on average. To keep the population stable, the birth rate has to be just a smidgen over 2 children per woman.

This is not a problem unique to Italy. Most of the countries in the developed world are faced with declining birth rates too. The most spectacular case is of course Japan, where the population has already peaked and is projected to decline by 2050 to the same level it was in 1950. Within Europe, the worst demographics are in Italy, Spain and Germany, but virtually all countries on the European continent share in this. Aside from the social implications of a declining population, the economic consequences are far-reaching too. The economy can be expected to grow roughly in line with the population. If the population increases at a 1% per annum pace, then the economy should grow at the same pace on average. More people need to buy more food,. consume more services, buy more houses. Of course, this is a huge oversimplification. The first requirement is that you need to have an economic structure that can actually provide this kind of growth.

This is the first time in history that the human race has voluntarily limited its own growth. As prosperity expands around the globe, we can fully expect the currently underdeveloped economies to join this trend too. Sometime in the next century or two, the world population will stabilize or perhaps even start to decline. But the reality of this new trend will first be faced in Japan and Western Europe. The demographics of the United States are pointing slower growth were it not for immigration. Since this is a new situation, there is no precedent for finding an economic structure that can provide sufficient prosperity for the entire population. Until now, the increasing numbers of young people have subsidized the old. This is no longer sustainable since there simply aren't enough young people anymore.

To maintain positive economic growth in an environment of declining population, the shortfall will have to be made up by increased productivity. Adding more value per hour worked will have to counteract the demographic headwind. The answer lies in technology, and the more technology-friendly and innovation-friendly an economy is, the better it will fare.

But there is one big catch: the transition from an expanding population to a constant or even shrinking one is going to be tough. I alluded to the problem above: there aren't enough young people to subsidize the old. And the old have not saved enough money to provide for their own retirement. The state pension systems work on a pay-as-you-go basis. This means that the current tax payers are paying the retirement benefits of the current pensioners. This works fine with an expanding population, but with demographics it's no longer affordable. So what you need a funded pension system, in which the people save for their own retirement. But moving to a funded pension system is expensive and takes a long time. It's expensive because you still have to pay for current pensioners and at the same time you have to build your own pension. So it's a double pension payment. Even in countries that have a fairly well-established funded pensions systems, such as Great Britain and the Netherlands, the pensioners still depend on the extra money that comes from the state's pay-as-you-go system. In other countries, such as Germany, France and Italy, the problem is far worse because funded pensions are rare there.

There are a few options for fixing this. The intergenerational transfer payments have to be revised. You can simply tell the current tax payers that they?re out of the luck and need to pay more. Raising taxes is not the most popular of things to do as Schröder is finding out. Alternatively, you could tell the pensioners that they're going to get less money. That may not be overly popular either. Raising the retirement age will mitigate the problem as well. A combination of all three is most likely.

There is another option, and that is immigration. In fact, for Europe, it's probably the only option out of its demographic trap. Europe needs more young people to pay for its pensioners and start building a funded pension system, because paying for all of that with the currently available resources is going to be prohibitively expensive. So Europe desperately need more immigrants. And that's not going to be easy given the experience with the last big wave of immigrants from North Africa and Turkey. As I have written on this blog on previous occasions, they tend to be poorly integrated into society, and often are in fact openly hostile to the liberal democratic host-society. The past experience with immigration in Europe is indeed a bad one given the problems that the immigrants have caused.

Even that is not the whole part of the story. The overregulated and overtaxed European economies have not been able to sustain any endogenous growth. The rigid labor markets have led to sky-high unemployment. And of course, immigrants get blamed for these problems as well, which would exist even in the absence of any immigration. In many countries undifferentiated immigrant-bashing has become politically advantageous. It neatly deflects from the real problems underlying the economy and puts the blame on a clearly identifiable group. This will only go away if the European economies can liberate themselves from the state-controlled past in order to generate economic growth. But that is going to be hard to do with the large costs of the intergenerational wealth transfers hanging over them. And the problem will get worse the longer they wait. So Europe needs immigrants to solve its demographically induced economic problems, but it can't do that until it escapes from its self-inflicted economic straitjacket.

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November 11, 2002
Euro coins: a failed user interface

For those allergic to these things, let me just say that this post is not going to become a Mac versus Windows item. Having said that, I have been a Macintosh user for a very long time. One of the things that has always attracted me to the Macintosh was the superior usability of the Mac platform. The foundations for this were laid in what are now the prehistoric times of computing. While Windows has caught up to some degree, it's still a skin-deep appropriation of the user interface design principles that made the classic Macintosh interface what it was. The difference between the Mac and Windows has become even smaller with Mac OS X, which in many cases is a step backwards in terms of usability. I can understand that Microsoft has had trouble acquiring a deep understanding of user interface design, but Apple should have known better. Designing good user interfaces is hard work, but there has been a lot of research done in the quarter century since mice and GUIs were invented at Xerox PARC.

User interface design is a surprisingly neglected field, even in places where one would expect a large premium to have been placed on getting things right. The canonical example of VCRs being hard to program is harmless. But even in aviation user interface design can go horribly wrong. The crash of a commuter plane in Switzerland about a year ago was due to a poorly designed display. One display panel for landing approaches had two modes: one to show the rate of descent, the other the angle of descent. So a display of 3.2 could mean either a descent of 320 ft/min or 3.2 degrees, depending on which mode the display was in, without any clear identification of which mode was being used. The pilots had not had many flying hours in the type of aircraft, and thought they had the display in the other mode than was showing.

The best user interaces are those that you don't even notice. A hammer has a simple user interface. But even something as seemingly simple as light switches can be infuriating. Many a time have I had to wrestle with light switches in hotel rooms before I got them to work. Money has a user interface too, although in this case it's just the design of the notes and coins that matters. As regular readers of this blog will know, I am not a big fan of European Monetary Union as it exists now, but I am also unhappy with the usability of the coins specifically.

Having used euro coins for almost a year now, I still spend way too much time trying to find the right coins. This is an inordinately long time to get used to the coins, because whenever I have to use other currencies, I seem to become acquainted with the coins within days. Is it just a spill-over from my dislike for the concept of the euro?

It's more of a design problem with the euro coins. The design of euro coins was an excellent opportunity to come up with new coins and designers had a field day. The winning design is a nice, logical ordered sequence. There are three sets of coins: the 1, 2 and 5 cent pieces are reddish in color, the 10, 20 and 50 cent pieces are golden/yellow and the 1 and 2 euro coins are two-colored. The coins all have distinguishing marks with differing edges and different thicknesses. So clearly the designers did have distinguishability in mind.

But why does it not work? There are two big problems. The first is that there are too many coins. There are 8 in total, compared to the 6 we used to have in the times of the guilder. US coins are especially parsimonious with only 4 coins in common use. Sacagawea dollars are too rare to be counted. But simply the number of different coins can't be the whole story, because German marks came in the same 1, 2, 5 series up to 5 marks. So there were even more of them than euros. The British pound coins have the same face values as the euro coins, yet it's still easier to find the right coin when I am in Britain than when I am in the eurozone.

This leads to the second big problem: the euro coins are too logically arranged. They're too ordered. For all the efforts to make them different, they're still too similar in shape, size, color and weight. The old Dutch dime and the US dime shared the trait of being very small. There's no logical reason to make the dime smaller than a penny, or why a 50 pence piece should be octogonal. The haphazard historical evolution of coins led to an almost random assortment of coins in shape, size and weight. This large disparity made recognizing coins easier, especially when fumbling around under poor lighting conditions in your wallet. I find it hard to tell the difference between a 10 and 20 euro cent piece, or between 20 and 50 cents in practice. Even the different colors of the 1, 2, 5 series and the 10, 20, 50 series become less apparent in poor light. The sizes are not sufficiently different to tell them apart quickly. Even the difference between a 1 and 2 euro coin can be tricky to tell from just seeing them half-obscured at an acute angle. Yet that's how they end up jumbled in my wallet.

Euro coins need to be redesigned to alleviate this problem. We need some whacky coins, like the old Dutch rijksdaalder (2.5 guilders) which was much larger than the 1 guilder piece. Or make a big coin like the 5 mark, 50 pence and a small one like the dime. One thing though: don't make them too heavy. I hate to carry around one pound coins, as they weigh so much. And get rid of the 1 cent piece. I always end up with large quantities of those (much like pennies in the US), and they're just a damn nuisance.

It's not going to happen of course. The design of the notes and coins was politically sensitive, so re-opening this issue is not going to happen for a very long time. I also suspect the political sensitivity of the initial design led to the situation we have now. The euro coins would never been allowed to look like any existing coins of the legacy currencies, so the safe escape route of making them logical and orderly was an obvious way out. Except I don't think it works in practice. Then again, this would not be the first time that political expediency triumphs over practical concerns. I would expect that there has been research into the usability of coins and that coins designers are aware of it. But as the aircraft example shows, neither the research nor the awareness of it can be taken for granted.

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November 07, 2002
Dim Wim stands pat

After yesterday's 50 basis point rate cut by the Federal Reserve, the European Central Bank in its usual form refused to do anything, despite the fact the Eurozone economies are substantially weaker than the US economy. Unemployment is higher and economic growth is lower. The ECB insists on fighting the previous war against inflation by trying to get it under its own 2% "reference rate," which in practice has acted more as a ceiling rather than aas a symmetric inflation target. But the main problem for the ECB is the divergence of the Eurozone economies in their economic cycles and the corresponding macroeconomic indicators. The ECB has the task of fitting the one square peg of monetary policy into the 15 oddly-shaped holes of national economies. It just does not work. The Monetary Union project is headed for longer-term problems.

The German economy is now on the verge of a deflationary spiral and the current interest rate is way too high. Of course, the problem is compounded by the fact that the German government is doing exactly the wrong things by raising taxes in order to try to stick to the Stability Pact. But inflation in other parts of the Eurozone, such as in Italy and the Netherlands is much higher. Yet if Germany does indeed sink into the morass of deflation, then the whole of the Eurozone will be dragged down with it to some extent. This is the real danger the ECB should be focusing on.

This talk of what the central banks are doing also points to a scarier problem. Central bank policy has now become the choke point of modern economies. It's the single point of failure that can strangle an otherwise healthy economy, and having fewer central banks around the world just reduces variety and competition. If one of them screws up, it affects the domestic economy, but now we have the Fed, the Bank of England, the ECB and the Bank of Japan as the major players. Japan is already paddling up many creeks with miasma emanating from every pore, Europe is sickly and the Bank of England and the Fed have not screwed up in a big way recently. They still could.

Variety and competition are good things as they build resilience into the system, allowing it to function more robustly. Also, it makes the system handle failure modes more gracefully. A monetary monoculture can be wiped out by a single antagonist organism. But building more diversity into the global monetary system is going to be hard to do. Private currencies are the answer, but there are serious implementation issues with that. That's a topic for another day.

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November 03, 2002
Divergence undermining European Monetary Union

When I looked at the possibility of European Monetary Union being undone, I pointed out that the strains and stresses the Eurozone is currently subjected to are already making the entire project fray at the edges. The current member nations of the Eurozone are too diverse to form an optimal currency area and labor mobility is much too low for it to function as a balancing force. The United States in its history has had periods of monetary strain too, when asymmetric shocks hit certain parts of the country much harder than others. For instance, a drought could depress the agricultural states, while the eastern seaboard still had strong economic growth. This led to conflict between the regions over the then-equivalent of money supply, namely gold. The stock of money could be expanded or decreased by adjusting the gold reserves and the areas that were in recession obviously sought relief. While these conflicts did take place, they concept of the Union was never questioned as a result. The United States was a solidly established country, with strong domestic support. The big glaring exception to this is the Civil War, but that was fought over the issue of slavery, not money supply.

The European Union lacks such strong domestic support. The "politics first" way in which the monetary union was conceived and implemented has led to irrational economic decisions within monetary union which have sewn the seeds of its eventual demise. Not all choices being made necessarily have to be economically rational; it would be nice, but reality is seldom that kind and the political reality especially can impose constraints on the freedom of action. As long as this is realized and the consequences of the irrational choices are not too grievous, it need not be fatal. Look at it as a tactical retreat to win the wider war. But the European Project as it has been in the last 20 years or so has increasingly become a plaything of the European political elites. They found themselves on autopilot towards "ever closer union" and they never stopped to question why. Post-war Europe certainly needed reconciliation between Germany and the countries it had invaded, but by the 1980?s the European Project had acquired completely new dimensions. The political elites went along with it partially out of inertia, and partially because it was a rich source of cozy jobs. It also provided a structure for them to solidify their hold on power, moving ever further from the pesky electorate that so often inconveniently ruined their domestic plans. And so the European Project steamed merrily into the turbulent waters of monetary union. The political decision for monetary union had long been made, but the consequences were certainly not understood by the politicians. Huddled in their Reality Distortion Fields they had no clue what they were letting themselves in for. More importantly, they were (and are) under the impression that political fixes can counteract the weight of economic reality; if it works in backroom deals in parliament, why should it not work in the economy?

However, a semblance of macroeconomic rigor had to be maintained. So in the Maastricht Treaty, in which monetary union was formalized, contains a number of convergence criteria that aspirant countries have to meet in order to be allowed in. The buzzword here is convergence. If the economies converge sufficiently, then they can be joined in monetary union. But they way these criteria were drafted they ended up as being coincidence criteria rather than convergence criteria. They converged much as a stopped clock converges with the time of day. Sure, it'll be briefly right, but it does not mean the clock can be relied on to show the time. It's the convergence of two elevators, one going up, the other going down. Real convergence can only happen over time, and it needs to be measured over time. The Maastricht criteria did no such thing, and even then they were subject to political fudging. The criteria were:

1. Price stability. Inflation rates had to be no more than 1.5% over the average of the three best performing countries over a period of one year. For a supposedly irrevocable monetary union, one year of roughly similar inflation is hardly convergence.

2. Government deficits and borrowing. The budget deficit should not exceed 3% of GDP and national debt should not exceed 60% of GDP. Since neither Belgium nor Italy would have had any chance of meeting the 60% criterion, this rule also gives a passing grade if the national debt is being reduced. And the 3% of GDP budget deficit rule has been fudged in many countries, by counting one-off privatization revenues as structural.

3. Exchange rate stability. Within the precursor to monetary union, the European Rate Mechanism the aspirant countries' currency had to maintain their pre-set bands. Britain almost wrecked its economy by trying to stay within the ERM in the early 90?s by trying to create artificial convergence. A very deep and painful recession was the result.

4. Convergence of interest rates. The yields on long-dated government bonds had to be within 2% of the average of the three best performing countries. This is virtually a consequence of point 1 above, although bond markets tend to be harsher than politicians. But once it was clear that political considerations would allow countries like Italy to join, the great convergence play in the bond markets was on.

None of these criteria actually measures real convergence, for that could only be observed over much longer periods of time with a number of business cycles to go through. These criteria were a political fig leaf, prone to and designed for easy and expedient manipulation.

The European Central Bank's key role is to keep inflation under control, targeting a rate of 2%. The Federal Reserve in the US has a less specific goal, as it has to keep prices stable while also taking economic growth into account. Looking at the US experience and contrasting it with the situation in Europe is instructive. How diverse is the US economy by region? It is very diverse, but it does rise and fall on the same business cycle. The Bureau of Labor Statistics has a wealth of information on regional inflation data and it's available online. It has data going back to 1915 for various conurbations, and a second set of series for larger regional areas since 1967. Using the numbers for the All Items CPI series, this graph shows that inflation did vary by region, but the moves were very highly synchronized. There's a striking divergence at the very end of the series though, as the brown line representing San Francisco, Oakland and San Jose spikes upward. This is the internet bubble and most of this rise is due to the housing component in the area. I also plotted the largest dispersion over time by taking the highest inflation rate and the lowest, and looking at the difference between the two. This graph shows two lines, one for all regions, the other excluding Silicon Valley. In post-war America the dispersion of inflation rates has been fairly low. It was only the high inflation period of the early 1980?s where the dispersion ticked up to around 4%. But with 13.5% national inflation, the difference between 15.8% inflation in Los Angeles and 11.4% in New York matters not so much. Both are way too high, and the monetary response is obvious (and Paul Volcker certainly applied it). Had the national average rate been 3% with individual regions fluctuating between 1% and 5%, then the situation changes. You don?t want to push the 1% regions into deflation, yet the 5% regions are in danger of spiraling out of control. But this situation has not arisen in the US aside from the internet bubble in Silicon Valley. Arguably the area would have benefited from higher interest rates when its inflation started to creep up as much as it did, and in that sense it's a small-scale failure of monetary policy there.

The situation in Europe is more difficult to assess, simply because data is harder to come by. I managed to scrounge together some data on Harmonized Inflation in Germany, France and Italy from various sources. Unfortunately, the amount of history is limited. Still, the graph shows that as recently as 1996 there was an almost 5% inflation differential between Germany and Italy. The last time there was a regional differential this big in the US was in 1917. It is completely unrealistic to assume that the Italian and German economies have become sufficiently similar to share the same interest rate simply because the Italians managed to get inflation down to something reasonable in the late 1990's. And the divergence is growing again as Italian inflation is almost 2% higher than German inflation. In other words, real interest rates are 2% lower in Italy than in Germany. This is exactly the opposite of what is required, as the German economy flirts with deflationary oblivion and the Italian is doing relatively OK by European standards.

Right now, the one-size-fits-all interest rate in the Eurozone is clearly and painfully inappropriate for many parts of the continent. There is no convergence, nor has there been any. These are the fault lines which lie under the exterior of European Monetary Union. The sad thing is that there were pre-programmed.

Tomorrow I will have a follow-up, focusing on the growth gap between Japan, Germany, Europe and the US.

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October 22, 2002
Can European Monetary Union be undone?

The strains on the euro have been there right from the start, but tectonic plates of European politics and economics are close to producing an earthquake. It's not going to be the Big One yet. To throw in the towel so soon after the euro's creation is politically unthinkable, even if it were economically rational to do so.

This begs the question whether it was economically rational to create the monetary union in the first place. Actually, there are two aspects to this question: is a monetary union economically desirable in Europe, and what structure should it have? The advantages of having a single currency are fairly obvious to anyone who travels quite a bit throughout the continent. It has certainly made my life a lot easier, since the only foreign currencies I now usually carry are the British Pound and the US Dollar. The benefits are also obvious in business and finance throughout the continent. By removing exchange rate risk, the euro allows European consolidation of previously fragmented industries. But this is where the first signs of trouble begin to show: politics. Obviously. Although extremely pro-European in the abstract, once it comes to the sale of a Big Domestic Company to some foreign competitor, the politicians start to protest.

But in the most immediately visible impact, having a single currency is a good thing. It also gives Eurocrats a nice warm fuzzy feeling for having taken yet another step on the path of Ever Closer Union. But a currency is the lifeblood of the economy, and in an ideal world, the currency decision would be a purely economic one. So when should countries merge their currencies? When the benefits of having a single currency and monetary policy outweigh the disadvantages. These disadvantages result from having a single interest rate for the entire area. If the regional differences are too big, then different parts will end up either being overstimulated or being driven into the ground by the prevailing interest rates. Under multiple currencies, these differences would be adjusted by fluctuations in interest rates and exchange rates.

The exchange rate is the external value of the currency, reflecting supply and demand. The interest rate reflects domestic supply and demand for a currency, usually managed by a central bank. Both in a sense are prices, and prices carry information on supply and demand. The price signals of currency fluctuations reflect the relative demand for currencies, and thus convey information about the economies. This information is an amalgam of the labor market, producitivity, tax rates, business climate, government policies, literacy rates, education levels et cetera. By moving to a monetary union, the fundamental information will still exist, but it can no longer express itself in the exchange rate, so it is going to have to find other means. Unemployment could be one of those means, if the cost of labor is structurally higher in one part than another. Adjustment of wage levels is the flip side, but generally much harder to achieve. It's easier to fire people (even in places like Germany) than to cut their wages.

Europe is naturally not the first area to implement a monetary union. There is another large economy, with big regional differences, that has a single currency: the United States. In a highly interesting paper, Hugh Rockoff of the National Bureau of Economic Research examines the question of how long it took the US to become an optimal currency area. In other words, how long did it take until the benefits of having a single currency in the US outweighed the disadvantages? The question itself may seem strange, because nowadays we have a mental mapping of currencies to countries. A country has a currency. It does not occur to us that a single country would have more than one currency; at least officially, because in many poorly developed economies a second parallel currency operates on the black market. It's usually the US dollar.

The answer is actually surprising. Depending on how you measure it, the US may not have been an optimal currency area until the 1930's. It was only when regional differences became smaller due to automatic stabilizers in the form of transfer payments such as unemployment benefits, but also due to higher labor mobility and tighter overall intergration of the economy with the advent of the telephone, radio and faster travel. Even now, regional difference obviously persist, but they tend to be cyclically aligned. The flexibility of the economy is also important, as it needs to adjust to an interest rate that may not be optimal for a particular region.

In the case of European Monetary Union, the regional differences now are much larger than they were in the US of the 1930's. Labor mobility is negligible across national borders. An unemployed plumber in Paris is not likely to move to Munich which may have a shortage of plumbers. Moreover, the disparity in economic structures and levels of development is also substantial. Is the Greek economy really sufficiently similar to the Belgian to have the same currency and interest rate?

Some countries in the current European Monetary Union could certainly be called on optimal currency area. Germany with the Benelux countries are close enough in that regard, and adding France might also work. Beyond that, it becomes harder to see an economic rationale for other member countries. But the project of monetary union was only partly about economics; to a larger degree, it was about politics. And with any politically-driven process, rational economic decision making, as it might happen in a free market, goes out the window in order to advance the Grand Schemes of politicians. This is what happened in Europe. when the idea of monetary union was born, the drivers were Germany and France, and they were none too keen on having a large group of countries join them. So they came up with the Maastricht criteria and the Stability Pact, which they thought would be harsh enough to keep party-crashers like Italy out. But it soon became obvious that by fugding the numbers sufficiently and some real reform too, Italy was going to make it. The political pressure was too big, so Italy had to join. But if Italy were allowed to join, then Spain must join too. And Portugal. And then Greece.

Thus the Big EMU came into existence. I am fairly certain that the current EMU does not constitute an optimal currency area, and the pressures are showing. The title of this post refers to the question whether EMU can be undone if the pressures become large enough. Monetary unions have been dissolved before, most recent when Czechoslovakia split apart. The Czech and Slovak economies were tightly integrated, albeit in a highly inefficient communist-imposed system. Still, having had the same currency for almost half a century (or even going back to 1918, if you count the First Republic), the split did occur, and both countries have been the better for it. The divergences in the two countries' situations were too big to accomodate a single currency, so breaking up was the sensible thing to do. Ironically, both countries may yet end up with a single currency again by the end of the decade, if both do join EMU.

So monetary union is not immutably set in stone. It can fail. And given the economic malaise in the EU, the regional economic, fiscal and structural disparities in EMU, the chances are significant that a major break could occur in the next ten or fifteen years, with the emergence of a smaller core monetary union, and reappearance of some previously extinct currencies.

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Eurobarometer poll continues to be misreported

When I blogged yesterday about the Telegraaf reporting on the latest Eurobarometer poll, I did not find any other stories related to it. The key fact that the survey actually took place in April was not reported, and more importantly, most of the key findings had already been published in June. Yet the Telegraaf presented it as new information, which it definitely was not. Then again, the Telegraaf is not exactly known as the pinnacle of journalistic excellence, as it is more of a tabloid (in content if not in form). A newspaper of similar calibre, the Algemeen Dagblad, also reported the euro data, but at least added that these results were contradicted by a Dutch poll last month, in which 44% of Dutchmen said they missed the guilder "very much." Well done AD? Not really. The poll itself was conducted on the internet, i.e. by a self-selecting group. This means the results cannot be taken to be representative of the population as a whole.

I decided to have another look today to see if there is more reporting of the new old Eurobarometer poll. Using Google's news search I managed to locate a batch of stories about this. Some were better in their reporting than others. In the Helsingin Sanomat the data gathering period is mentioned. I also found a link to a pro-Europe site called, which does mention prominently the data gathering period but still calls it a "new Eurobarometer poll." Technically that is true, but that's missing the point.

But most of the stories did not mention this salient fact. Google found this Irish newssite with a summation of key facts about Britain. Then there was this story in the Guardian, which does not mention the data gathering period either. It does, of course, put a heavily pro-EU tilt on the data, giving plenty of space to EU-boosters to make their case, while not reporting any dissenting voices. Then again, mistaking the Guardian for a serious newspaper is hard to do these days. Finally there is the Financial Times, which actually did better. The FT too omitted to mention the survey period and the highlights that were released in June, but at least this article added plenty of data that had not been released in the highlights before.

Still, this haphazard survey of reports shows that there's a lot of poor reporting going on. Most crucially, most of these pieces fail to mention that the data are almost six months old, and that most of the key numbers had already been released in June. On the other hand, I don't want to make too much of this either. It'd be interesting to see whether this double news cycle also repeats itself if the headline numbers are less favorable to the EU and the euro. We'll have to wait till the next survey rolls around, for which the fieldwork should be going on right now. The highlights are likely to be published in December if last year's cycle is anything to go by.

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October 21, 2002
To enlarge or not?

Sometimes the electorate is a bit slow. They're not very bright, you see, and thus they end up doing silly things now and then, such as the Irish voting against the Nice treaty. Fortunately, we have the wise and steady guidance of the political elites to see us through such errors. It was an error of course. A momentary lapse of reason that has now thankfully been corrected. The Irish electorate, sternly spoken to and dutifully admonished, has produced the Elitically Correct (eliticiously? elitely?) result by ratifying the Nice treaty. The grand project of European expansion can continue, much to the relief of the euro-patrician guild everywhere.

The overriding imperative of further EU expansion thus steamrollers over local opposition. The outgoing Dutch government has now also dropped its opposition to enlargement, meaning that the way is clear for the newly liberated countries of central and eastern Europe to join the EU club. It is far from clear that this is really a good thing, either for the EU or the applicant countries themselves. I am surprised that I am even writing this, for a decade ago accession to EU would have been a no-brainer for me. Binding the countries so ravaged by communist tyranny to the democratic institutions and community of the EU was an obviously good thing. Yet things have changed since then, both in the EU and in the applicant countries themselves. The Soviet Union is but a nightmarish memory, and Russia's expansionism is contained for now, and might even be channeled constructively (but that's a blog item in itself). The economies of the east have done reasonably well outside the EU, although they still have not really sufficiently advanced to "developed market" status.

The EU itself is like an old, collapsing star. The gravity of the star keeps pulling mass ever inward, now that the fusion reactions of hydrogen and helium have exhausted themselves. The energy is gone, spent. With the gravitational contraction still ongoing, will the EU become a black hole, sucking everything into it without chance for escape? The bureaucracy and the institutional self-preservation it breeds is reaching critical levels. The interference from Brussels is becoming ever larger, without even the semblance of a commensurate increase in democratic legitimacy or accountability. What once was a good idea (European intergration through free trade), has now morphed into an ominous threat to self-determination, civil liberties and economic dynamism. The countries of central and eastern Europe might well be better off staying outside of the EU. In order to be allowed to join, the countries must agree to implement the basic set of EU laws, known as the acquis communautaire which runs to tens of thousands of pages. This will shackle their economies with the same kind of stifling regulatory environment that has sapped the strength of many prosperous west European countries. The countries of the east don't have the momentum that the established wealth of the west provides to keep them going. They need to keep growing, not just muddling along.

For the existing member states of the EU, there is also a danger from enlargement. Having too disparate a group will impose further strains and dilute the effectiveness of the group as a whole. The admission of Greece to the EU is in retrospect not the best of moves. We're stuck with the banana republic in the south, and some of the next wave entrants have the risk that they might join the ranks of Greece.

But there are also positive aspects to enlargement. By diluting the existing base of countries, the Franco-German axis will be of less importance, especially since the French in the past have been the dominant partner in the axis. The Germans were (and still are to some extent) fearful of asserting themselves after the second world war (and rightly so), which the French used to get Germany to back their plans for the EU, which in most cases were extensions of French national interest. But the synergistic effects of enlargement can also work to the benefit of both joiners and existing members, by injecting a points of view and new dynamism into the processes of the EU. It will also force the abominable Common Agricultural Policy to be amended, as it would cost too much to extend it east in its current form. I am too much of a cynic by now to hope that it will be actually scrapped.

My main worry is that the EU has become so intrinsically stagnant, that these effects will have not a chance to assert themselves. And giving the blighted countries of the east the chance to rejoin the broader culture and community of Europe is a good thing, even a necessary one. EU membership might help to strengthen the concepts of civil society, democracy and the rule of law. But again, the EU's shortcomings in this regard raise doubts over the effectiveness of such support. I wonder if bilateral ties with western countries might not be more effective.

So I don't know. I really think the countries of the east should be given every opportunity to join the European and global trading systems. They need to take steps to build an institutional memory of democracy and rule of law. The EU would be ideally placed to serve these purposes, but its evolution into the bureaucratic monstrosity that it has become makes this role much harder to fulfill. On balance, I do think enlargement will be positive. Grave doubts continue to simmer.

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Dutch happy with the euro (half a year ago)

Now this comes as something of a surprise to me: a poll showing 76% of the Dutch to be happy with the euro. On the other hand 69% does not seem to have any emotional affinity to the euro; it's a largely utilitarian happiness. In the EMU zone as a whole, 6 out of 10 people are happy with the euro. The report also contains the information that 50% of the population supports enlargement.

Since this appears to be a Europe-wide survey, I tried to find an English-language source to link to, but no other news outlets seemed to be carrying this story. Finally, I managed to track down the source at the EU's website, which contains the startling information that the data gathering took place in April. This is old news. In fact, highlights were originally published in June. The story I linked to in the Telegraaf contains no new information at all. Talk about sloppy reporting!

Since the survey was taken, many European economies have deteriorated substantially, which has a significant effect on public opinion. The data is almost half a year old now, and in political terms, that is a long time indeed. It's too bad the data is so stale by now, because you can download the entire report with its many detailed glimpses into European public opinion. For the psephologically inclined, it's a veritable goldmine of factoids. I don't have the time to read it all though.

Posted by qsi at 09:59 PM | Comments (0) | TrackBack (0)
Read More on The Netherlands
October 06, 2002
Government of the elite, by elite and for the elite

There was a discussion about the relative level of democracy between the US and Europe over at Bjørn Stærk's Blog. I can't seem to get the permalinks to work, but scroll down to the September 27th entry to see. [UPDATE: It's fixed now] I am not too concerned about he question how democratic Norway is compared to the US. Both countries have a democratic system in place, and indeed virtually all of Europe has functioning democracies. They may not always function well, but democracies they are.

Although it is dangerous to generalize, I am going to do it anyway to make my point without getting bogged down in too many details. There are a few big differences in the way the European democracies are structured compared to the American system. Three differences stand out:

1) Separation of the branches of government
2) The electoral system
3) The role of political parties

Most European countries have a parliamentary system. Elections are held for a parliament, and whoever can put together more than half of the votes there gets to form the government. The executive branch is closely intertwined with the legislative. In American terms, it's as if Congress would elect the President, rather than the Electoral College. Only France has a powerful directly elected president, but even there the government comes from the parliamentary majority. The cabinet reports the to Prime Minister, who forms a counterweight to the president. It is the cabinet which is the executive branch, and not the presidential staff. With a hostile National Assembly, a French President will be able to do much less than an American President faced with a Congress controlled by another party. With the executive being so closely tied to the legislative, the amount of parliamentary oversight is also less. By definition, the ruling party or coalition will be in charge of both. Similar arrangements exist in most European countries.

The ties binding politicians to political parties in Europe are also stronger than in the US. Voting can and does go along party lines, especially in controversial votes, but there are always plenty of members of Congress who'll cross the aisle on a particular issue. In many European parliaments a vote against the party whip is very rare. Party discipline is strictly enforced, to an extent that the whips in Congress can only dream of. The reason that it can be enforced goes to the heart of the biggest difference between European and US systems: politicians in Europe are loyal first and foremost to their party, and not to their voters. This also leads to much more ideologically unified parties in Europe. The variability in positions in either the Democratic or Republican parties is much larger than in any European party. A southern Democrat will have more in common with a southern Republican than with a Democrat from the Northeast.

With the first-past-the-post system in the US, the electorate votes for a specific person, not a party. In the proportional representation systems of Europe, the vote goes to a party, which then decides which politicians get to serve in parliament. This is a crucial difference. To advance your carreer as a European politician, you have to make sure that you are popular within your party's structure. In America, you have to make sure you're popular with your voters. This ties together the points 2 and 3 above: European political parties can enforce discipline within their own ranks much more thoroughly, because they can punish dissent by ending troublemakers' carreers. But by moving the incentive for politicians away from pleasing the voters to pleasing the party hierarchy, there is a disconnect between the people they are supposed to represent and the politicians themselves. Since politicians are elected on a party list system, there is also little to bind voters to politicians. The concept of "my Senator" or "my Congressman" simply does not exist in a system of proportional respresentation. It works in both directions: politicians care much less about what people think, and people can't punish politicians effectively if they break their promises.

This is an essential feedback loop in American democracy, and the electoral system that leads to the party structure in Europe lacks this. Feedback is essential to keep a system working properly. The European system, with the power concentrated in party hierarchies leads inevitably to elite rule (which is not to say that the American system is perfect, but it suffers far less from this particular syndrome). The political elites in Europe can in many cases ignore the wishes of the electorate, as long as they agree amongst themselves. A good example was the creation of the euro, where large majorities in many countries were opposed to it, yet ratification of the Maastricht Treaty in parliament was hardly an issue, and passed with huge majorities. This big a divergence between popular opinion and its reflection in parliament could not exist in the US.

An argument often heard against the first-past-the-post system is that it is unfair. Parties or candidates might accumulate a significant proportion of the vote, but end up being underrepresented or even unrepresented in parliament. In Britain, which uses this system, the party that can garner about 42 to 45% of the vote usually ends up with a working majority in Parliament. Is this fair? It's unfair to the extent that it does not represent the proportion of the votes cast for political parties. It is fair in the sense that the candidate in each constituency with the most votes gets to represent it in Parliament. But the purpose of democracy is not to find a perfect reflection of party votes in parliament. The goal is to find a way to govern the country that represents popular opinion, results in workable governments and also maintains internal regional stability. This last point is exemplified by the Senate in the US. Wyoming with 500,000 inhabitants gets two Senators, just like California with 32,000,000.

In the end, I don't think it's possible to say a priori which system of democracy is best. It can only be judged by the results its produces, and in that sense the American systems works better. Although this will sounds hilarious to American readers, the chasm between politicans and voters in Europe is much larger. That's why the European political class has been able to move ahead with its European Union project, although not that many European voters want it. And that's also what's wrong with the European Union. If politicians are out of touch within their own countries, this goes doubly so for European politicians. They are the political class of the political class, with hardly any corrective feedback mechanism from the voters. That's also why the EU is in danger of failing eventually. At some point, the stress between voters and politicians becomes too big, and a discontinuity occurs, such as the emergence of the late Pim Fortuyn in the Netherlands, which then shakes up the party landscape and realigns political priorities. For a while, to some extent.

Proportional representation can also lead to stagnation. In Germany, most changes of government occurred because a small party, like the FDP, changed its coalition preference from the CDU to the SPD or vice versa. Getting a change of government as a result of an election is fairly rare. Even in the case Holland, where the LPF stormed onto the stage, the new government still has one of the parties from the previous government as a coalition partner. So the voters do have some influence, but it's usually marginal in that they can shift the political center of gravity a bit to the left or a bit to the right. But the hope for a clean break with the previous government seldom exists.

There is a wider institutional crisis developing in Europe, and especially in the European Union. The Democracy Puzzle is one part of it, because without more democratic legitimacy the EU is going fail. And although more remote, there is also a danger to the democratic legitimacy of the individual member states if the gap between the rulers and ruled remains as wide as it is.

Posted by qsi at 06:52 PM | Comments (5)
Read More on Democracy
September 25, 2002
Your tax euros at work

Somehow this does not seem to have hit the English-language wires yet, so here is the story in Dutch about the moving costs of the European Parliament. It moves, you ask? Oh yea verily, it does. Quite a bit. Often, in fact. Regularly too.

The rational thing to do would be to have the parliament somewhere near to the rest of the bureaucratic apparatus. But the European Union is not exactly a paragon of rational thought, and pork being pork in all of the Union's languages, having a single Parliament building in Brussels was not good enough. See, Brussels has the big disadvantage (from a EUnuch point of view) of not being French. So to appease the French (appeasement is something the EU is really good at, if you hadn't noticed), we got a second parliament building in Strasbourg. So by European law, at least 12 meetings of the parliament have to be held in Strasbourg every year. The others are held in Brussels. And for some even more unfathomable reason, half the personel is actually stationed in Luxembourg.

The cost is a cool (if not positively frigid) 169 million euro a year. That's about $169 million too. That's just for the moving back and forth. And this is based on the parliament's own calculations. If more member states join, the cost will rise to 203 million a year. The Flemish MP Moerman has made this public, and demands an end to the waste.

I agree. Let's abolish the European Parliament altogether. It's an institution without any authority (moral, legal or otherwise), costs an insane amount of money, and is generally used as the refuse bin into which disgraced national politicians are retired. Nobody goes to vote for it anyway. Nobody'll miss it.

Posted by qsi at 08:49 PM | Comments (0)
September 24, 2002
Stability Pact going wobbly

The Stability and Growth Pact was designed to enforce fiscal discipline amongst member states of European Monetary Union. Key provisions are limits to the budget deficit at 3% of GDP and medium-term balanced budgets. As currently stated, the member countries have committed themselves to achieve balanced budgets by 2004. The European Commission is now waking up to reality and acknowledging that several member countries are not going to make it. In fact, even the 3% of GDP deficit limit is likely to be breached in the coming year. The culprits? Portugal, Italy, France and Germany. With the three largest Euroland economies being in breach, the Stability Pact is looking very wobbly indeed.

By tinkering with the timetable the European Commission hopes to defuse the situation and save the Pact in some form. The Pact is important because each member state can set its own fiscal policy. Absent such a Pact there is a serious risk of a free-rider problem developing in that one country could have its budget deficit balloon while others suffer through fiscal discipline. This would be an unstable situation; bond yields would rise, affect all member states, and the incentive for maintaining fiscal stability would be weakened. After all, if bond yields are higher because of other countries' fiscal irresponsiblity, why not run a higher budget deficit yourself?

Now with the adverse economic conditions prevailing in Europe, the Pact will be broken. Government expenditure is up, revenue is down. To an extent having a counter-cyclical fiscal policy is a good thing, as long as it does not run up structural deficits. But this stabilization is unavailable to countries that go into a downturn with their budgets already in deficit under the current Pact. So something will have to give.

Depending on the amount of realism that prevails, the process could become very messy indeed. The European Central Bank is going to fight it tooth and nail, and there will be a trilateral showdown between governments, the ECB and the European Commission. Within the governments' camp, some will side with the ECB. Others will welcome a relaxation of the rules. The more rancorous and chaotic it gets, the higher bond yields will rise, and the further the euro will fall.

Europe is taking the next steps with the experiment of the single currency, spread among 11 countries with different economic and fiscal policies. This is one of the fault lines that had been apparent for some time. The euro is not popular with its users, and now we will see whether it can stand the strain.

Posted by qsi at 09:52 PM | Comments (0)
Read More on Monetary Matters
September 21, 2002
The Great Italian Pizza Boycott

Since the introduction of the euro in the form of actual notes and coins, there has been a lot of grousing about the price increases that have resulted from the changeover, especially since the official inflation statistics fail to capture the full effect. In this vein, the Italian consumer advocacy group ADUC is calling on Italians to boycott pizzas today. Except what they're really complaining about is the markup that pizzerias charge, not any price increases.

The actual press release (scroll down to "Prezzi: Pizza, ma quanto mi costi?") describes how they've come up with their data. They've taken the basic ingredients of a pizza margherita at supermarket prices, added them up, and came to 49 eurocents. The 210g (about 7oz) pizza this makes sells for 5 euros, a markup of 920%. Outrage!

This is of course a nonsensical analysis. The cost of making a pizza is more than just the costs of the ingredients: there is the overhead from having a physical location to do business, paying for the employees who cook and serve the pizzas, keeping the place clean and sanitary, buying ovens and other tools of the trade. A more useful analysis would have been to look at prices now and a year ago, or to look at prices around Europe.

The whole ADUC press release is an exercise in muck-raking. It says that they simply used the logic that 2+2 equals 4, and not 4000. Then they go on to say that applying the same markup on an orata (a kind of fish) selling the stores for 15 euro per kilogram, would mean paying 150 euros (about $150) in a restaurant. Highly deceptively worded, because first of all, the economics of making food in a restaurant involve much more than just the cost of the ingredients, but also because they switch from price per kilo to claiming that it would cost 150 euros in a restaurant... but who would order a whole kilo of fish in a restaurant? That's about 2 pounds!

A rather shameful exercise in all. Apparently nobody at ADUC has actually ever run a business if they really think they can apply this kind of logic. Sadly these kinds of "consumer advoacy groups" tend to degenerate from their initial ideals into business-bashers pure and simple. And that's a real shame, becase a vocal consumer is essential in a market economy. But this is beyond vocal; it's shrill.

Posted by qsi at 01:20 PM | Comments (0)