Politics first...then economics

Ken Worsely brings to attention an interesting (although known)fact - Sound economic policies cannot do much on their own. They need to be backed by political will.

This is from his blog:
...The IMF suggests that Japan increase its consumption tax by 5% as a step towards reducing its public debt.

Of course, consumption tax hikes tend to spell political disaster in Japan, as Prime Minister Noboru Takeshita learned after introducing the consumption tax in 1989 and PM Ryutaro Hashimoto discovered after raising the tax to 5% in 1997. While both the former and current ruling parties have acknowledged that consumption taxes need to be increased, neither party has shown a willingness to say so in their election manifestos.

Until now. Today it was reported that a DPJ joint election panel agreed to include language promising to increase consumption taxes as part of the DPJ’s Upper House campaign. However, it was also agreed that the tax should not be raised until after the next Lower House election, which would be as far away as 2013. And there was no discussion of just how much the tax should be increased.

If that seems vague, the leading opposition party’s stance is not much better. The LDP has called for an increase in consumption taxes in its election manifesto, but does not say when or by how much
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And again - Political will is always required to implement sound economic policies. But in a multi-party democracy, gathering political will is not easy. Different political parties have different agendas. If they are in the opposition, it is in their interest to block any reasonably controversial bill in the parliament. This task of gathering political will gets even more difficult when there are various parties in power- i.e., a coalition government. In such a government there will always be compromises made by parties. Party agenda will always come first. In such economies, decision making becomes difficult. Legislations are passed less frequently. Development happens more slowly.
Unfortunately, we are moving towards such a system. There are lots of countries now which do have coalition govts in the power. Britain, India, Czech Republic...and many others.
I am interested to see if any data exists related to GDP growth of countries during coalition govt Vs. single party government.

Yes, Keynesian policies work

Source: Lefty Cartoons













Several economists (or rather monetarists) are taking advantage of the present fiscal situation of the Greece and other countries to rubbish Keynesian demand theory.

Here is another article from another well known economist, Swaminathan Aiyar
Fiscal lessons from the eurozone

Many economists say fiscal deficits don’t matter: India has run fiscal deficits of up to 10% of GDP for three decades, yet has enjoyed record growth. Many are Keynesian enthusiasts, seeing government spending as the solution to any growth slowdown. These economists must think again after the fiscal crisis in the Eurozone.
Source: EconomicTimes
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Let me start my saying that I repeatedly mention in my posts- I am a Keynesian. That is the reason why I want to comment on Swaminathan’s article (and also respond to other economists).

About Greece
Some say this is the ideal example of how Keynesian theories could ruin an economy. I don’t think so. Greece is unique because it didn’t implement the policy properly. Ofcourse you can’t keep spending money blindly. There has to be accountability. Greece deliberately hid its fiscal facts from the market. Angela Merkel recently said-
“We’re right to tell the Greeks: you have to save money, you have to be candid and you have to work on your honesty, otherwise we can’t help you”
Source: Europe.getsomenews.com
So overall, it is not about keynes, but about greece and its dirty,corrupt politics

Keynesian in general
Now to a more broader point about whether Keynesian works. Yes, it does. But you need to have vigilance on where/how much you are spending. It natural. Even at home we keep an eye on our budgets and take loans in limits. Keynes never advocated borrowing from the market endlessly.Even excessive monetary expansion can destroy economies. I don't have to quote any examples here.

Another point is that Keynesian policies actually worked. It saved the world from the greatest depression ever (remember last year when most of the developed countries released bail-out packages).
If countries are continuosly running a deficit of ~10% then they should try to make structural changes in the economy. Something somewhere must not be right. After all, govt spending is expected to boost the overall demand in the economy. Where is all the money flowing?

Greek crisis timeline

Here is a crisis timeline from Reuters-

TIMELINE-Greece's debt crisis
Jan. 2010 - Greece unveils a stability programme on Jan. 14 saying it will aim to cut its budget gap to 2.8 percent of GDP in 2012 from 12.7 percent in 2009. Unions protesting against the austerity plan announce strikes for February.

Feb. 2010 - Prime Minister George Papandreou says on Feb. 2 the government will extend a public sector wage freeze to those making below 2,000 euros a month for 2010, excluding seniority pay hikes.

-- Feb. 3 - The EU Commission says it backs Greece's plan to reduce its budget deficit to below 3 percent of GDP by 2012 and urges Greece to cut its overall wage bill.

-- Greece must refinance 54 billion euros in debt in 2010, with a crunch in second quarter as more than 20 billion euros becomes due. A 5-year bond issue in January is five times oversubscribed but the government has to pay a hefty premium.

-- A one-day general strike on Feb. 24 against the austerity measures cripples Greece's transport and public services.

-- An EU mission to Athens with IMF experts delivers a grim assessment of the nation's economy on Feb. 25.

March 2010 - EU Economic Affairs Commissioner Olli Rehn asks Greece to announce further measures to tackle its budget crisis.

-- March 5 - New package of public sector pay cuts and tax increases is passed by the government to save an extra 4.8 billion euros. The measures include raising VAT by 2 percentage points to 21 percent, cutting public sector salary bonuses by 30 percent, increases in tax on fuel, tobacco and alcohol, and freezing state-funded pensions in 2010.

-- March 11 - Public and private sector workers strike.

-- March 15 - Euro zone finance ministers agree on a mechanism that will allow them to help Greece financially if needed, but reveal no details.

-- March 19 - European Commission President Jose Manuel Barroso urges EU member states to agree a standby aid package for Greece.

-- March 25 - European Central Bank President Jean-Claude Trichet says the bank will extend softer rules on collateral for ECB loans, easing the risk of Greek institutions being cut off from funding at the end of 2010.

-- Euro zone leaders agree to create a joint financial safety net, with the IMF, to help Greece and to try to restore confidence in the euro. Under the accord, Athens will receive coordinated bilateral loans from other countries that use the euro and money from the IMF, but only if all states agree to the bailout and if it has exhausted its borrowing options.

April 2010 - On April 11 Euro zone finance ministers approve a giant 30-billion-euro ($40 billion) emergency aid mechanism for Greece but stress that Athens has not yet asked for the plan to be activated.

-- April 13 - ECB policymakers give the thumbs-up to the euro zone's rescue package as Greece passed a key test of its ability to raise fresh funds.

-- April 15 - Parliament adopts a tax reform bill, backing government moves to tackle tax evasion and shift the fiscal burden to higher-income earners as Athens.

-- April 21 - Greece starts talks to hammer out details of a potential aid deal but investors dump Greek assets on a lack of clarity over whether the funds would come in time. Germany's opposition Social Democrats say they oppose "fast-track" approval for the deal in parliament. The yield on the Greek 10-year government bond rises to 8.4 percent.

-- April 22 - Moody's Investors Service downgrades Greece's sovereign rating by one notch to A3, placing it four notches above speculative, or "junk" status.

-- Greece posts a budget deficit of 32.34 billion euros or 13.6 percent of GDP in 2009, not the 12.7 percent it had reported earlier, Eurostat says.

-- April 23 - Prime Minister George Papandreou asks for the activation of an EU/IMF aid package aimed at pulling the euro zone member out of a debt crisis.

-- April 25 - Finance Minister George Papaconstantinou says bailout talks with the IMF and European partners in Washington go well and he is confident Greece will secure help in May to finance its debt.

-- April 26 - Striking dockers and protesters at Greece's largest ports.

-- April 27 - Standard & Poor's downgrades the credit rating of Greece to junk status.

-- April 28 - Bank stocks jump as much as 6.2 percent after securities regulator says it has banned short-selling in Greek shares on the Athens bourse until June 28.

-- May 1 - Thousands of angry Greek protesters march through Athens to protest against austerity measures they say only hurt the poor.

-- German Chancellor Angela Merkel says she will welcome a contribution from Germany's private sector to support a Greek rescue package.

-- May 2 - Prime Minister Papandreou says Greece has sealed a deal with the EU and IMF that opens the door to a multi-billion euro bailout and budget cuts of 30 billion euros ($40 billion) over three years, on top of measures already agreed.

-- The aid package is expected to total up to 120 billion euros ($160 billion) over three years and represents the first rescue of a member of the 16-nation euro zone.

Greek Bonds are Junk- S&P

Greece’s credit rating was cut three steps to junk by Standard and Poor’s, the first time that’s happened to a euro member since the currency started, as contagion from the nation’s debt crisis spread through the bloc.

Greece was lowered to BB+ from BBB+ by S&P, which also warned that bondholders could recover as little as 30 percent of their initial investment if the country restructures its debt. The Greek move came minutes after the rating company reduced Portugal by two steps to A- from A+. The euro weakened, stocks plunged and the extra yield that investors demand to hold Greek and Portuguese bonds over German bunds surged.

Source: Bloomberg

India becomes seventh largest shareholder in World Bank

Here is the full story on Economic Times
I do expect India's credit rating to improve. But the biggest achievement on the international scene would be to get a permanent position in United Nation's Security Council. I believe India is flexing its muscle to get that this time. It has been long overdue.

More on Eurozone's Greece...

Two questions that people want answers to are-
1. Whether this crisis is bound to have an impact on other European partners
2. If the assistance from Euro partners and IMF would solve the crisis

There are several talks about this crisis. Economists (as usual) do not have a consensus on it.
Answer to my first question is a big YES. Greek crisis could badly damage Europe. In a globalized economy, you do expect any single failure to have a cascading effect on other parties in the ecosystem. Yes, the degree of impact may vary. In this case Euro partners of Greece are at risk through their common currency-Euro. A mammoth deficit for Greece is putting downward pressure on Euro. This is a reflection of the low confidence people have in the currency.
Here is a story on that-

Greek shares led the global stock market retreat Tuesday amid mounting concerns about the country's ability to tap a bailout facility. Portuguese shares were also heavily sold off as investors worried that the debt crisis could spread to another euro country.
In Europe, the FTSE 100 index of leading British shares was down 81.33 points, or 1.4 percent, at 5,672.52 while Germany's DAX fell 59.78 points, or 0.9 percent, at 6,272.32. The CAC-40 in France fell 78.78 points, or 2 percent, at 3,918.61.
On Wall Street, the Dow Jones industrial average was down 15.04 points, or 0.1 percent, at 11,189.99 soon after the open while the broader Standard & Poor's 500 index fell 5.51 points, or 0.5 percent, at 1,206.54.
Those falls, though, are dwarfed by the route in Greece and Portugal — the Athens composite main index plunged 6.5 percent to 1,687.80 while Lisbon's main PSI 20 index slid 3.4 percent to 7,298.72. Source: Associated Press

Next few days are going to be important. Watch the markets carefully

On the second question- My answer is NO. The loan assistance would be not be sufficient in the near-mid term or in the long run. I believe that this situation has gone out of hand. Greek govt has to fight battles on two fronts simultaneously:
1. Introduction of austerity measures- Govt already has taken a lot of steps. Tax rate on bonus of pvt bank employees is 90%. No bonus for public sector employees. Wage freezes, etc. Now the point that there is already public dissatisfaction in Greece. There is a limit to which govt can impose taxes and fines. The last thing they want is a cocktail of economic disaster and political backslash
2. Arrangement of loans- Through Euro partners and IMF, Greece hopes to get about US$ 45 billion. But is it enough? I don't think so. Some estimates point to the need for about US$ 300 billion. Even if the Euro partner-IMF loans get sanctioned, the skeletons will come back again after 6 months. Then the fall will be much greater

So now what?

I have no answer right now. Stefan Karlsson suggests a mechanism through which loans can be indefinitely available to Greece. He reckons that this would boost investor's confidence in the economy.
Not sure if he is serious about it because I am still laughing (at his suggestion)

Timeo Danaos et dona ferentes

A phrase that is apt for the greeks in this situation. Except for the fact that it is not the greeks who are bearing gifts, but its eurozone partners.