A Plan B for the World Economy

Christian Kellermann

‘Capitalism’ is back on Main Street. Crashing, dismantling, reforming, repairing, restoring – all kinds of approaches to capitalism are discussed in the wake of the recent crisis. The debate has gained far more momentum today than it had during the past decade, though we had already witnessed a number of such crises. However, in practice, the gap between regulatory rhetoric and actual reform of our economies and the world economy as a whole is still considerable. Our systems remain at risk of on-going instability. Crises will continue to be the norm rather than the exception if we keep on working with the dysfunctions of current capitalism. Many of us will be unable to live a decent life under conditions of increased insecurity, inequalities and pressure in terms of wages, jobs, raising children and providing for old age. An excessive degree of unequal income distribution and personal insecurity is not only detrimental to a good life; it is also economically dangerous and inefficient. The reasons for economic crises and increasing inequality, which are symptom and root of personal and systemic insecurity and inefficiency alike, are manifold.

Finance has played a crucial role in most of the economic crises we have experienced since the 1990s. Financial markets are both gigantic amplifiers of imbalances within and between our economies and a root of imbalances themselves. Illuminating the cracks in finance is therefore the logical starting point for the Plan B of fixing our current capitalistic system. The excesses of finance are only one part of the fundamental problems economies and societies are facing and which have contributed to the recent crisis. There are at least three dimensions of instability which are related to finance but go beyond the narrow instabilities of the financial system. First, imbalances between different sectors within economies have escalated. One expression of this is highly indebted private households as well as governments, as a consequence of real-estate and other bubbles which were fuelled by the financial system. Second, international imbalances have never been as big as they are today. Third, together with financial deregulation the shareholder-value principle of corporate governance became dominant. This led to a short-term orientation of management and high bonus payment for management at the cost of long-term sustainable development of companies and firms.

Besides these developments, the radical market globalisation of the last decades led to a huge increase in wage dispersion and an ever-growing low-wage sector which had not been seen since the early times of capitalism before the First World War. Labour markets in almost all industrial countries became more deregulated while at the same time trade unions became weaker. In many cases economy-wide or sector level collective bargaining was eroded. Firm-based wage negotiations or individual working contracts without any collective agreements started to dominate.

Increasing inequality is a phenomenon which can be found in almost every country. High inequality does not only provoke a feeling of ‘unfairness’ in and between societies; it also hinders social mobility and has negative impacts on health and productivity. Hungry wolves do not hunt best – in fact, the very opposite is true for present day economies. The American dream of high social mobility within a society and the opportunity for anyone to become rich if they work hard enough is in fact little more than a mirage. Today, mobility within society is more of a reality in the Nordic countries of Scandinavia where equality is higher than in the Anglo-Saxon world of capitalism.

Capitalism has more problems: in the past, it led to a very special type of technology, production and consumption growth which is blind to ecological problems and the fact that natural resources are limited. Prices systematically fail to adequately incorporate ecological dimensions and the deterioration of nature. Prices also give the wrong signals for the direction of innovation as well as of production, consumption and the way we live. After experiencing a number of regional ecological disasters in the past century, the world is now heading for a global ecological disaster, unless fundamental changes take place very soon. This makes the search for solutions very complicated: the present crisis is not only a deep crisis of traditional capitalism, but it has emerged at a time when a deep ecological crisis is also evolving.

A global Plan B should therefore include three interrelated dimensions. First, the model should be ecologically sustainable: preventing global warming, changing to a renewable energy basis and preventing other problematic developments such as a reduction in biodiversity. Second, it should be formed in such a way that the growth process is not jeopardised by either asset-market bubbles or goods market inflation or deflation, and does not result in the excessive indebtedness of individual sectors or even whole economies, thereby leading inevitably to the next crisis. At the same time, such a model should promote innovation and, therefore, technological development necessary both for solving ecological problems and, in the medium and long term, increasing labour productivity and so holding out the possibility of growing prosperity for all. Third, it is critical that all population groups have a share in social progress. Inequality of income and wealth distribution must be at politically and socially acceptable limits.

At the core of Plan B is a more equitable income distribution. It is crucial to reverse the negative changes in income distribution and grant all population groups an adequate share in the wealth created in society. One secret of the success of regulated capitalism after the Second World War was the increasing mass purchasing power of workers, based on growing incomes and relatively equal income distribution. It is now becoming clear that the old model has to be regenerated.
Income distribution has three important components: functional distribution of income in wages and profits, distribution within the national wage sum and the national profit sum, and state redistribution policy. A fall in the wage share is the result of a higher profit mark-up. The latter was possible on the basis of deregulation, particularly due to the increasing power of the financial sector and its willingness to take risks in pursuit of higher returns. The shareholder-value approach and the increasing role of institutional investors drove enterprises to pursue higher profit mark-ups. Correspondingly, the structures and rules of the game in the financial sector must be changed in such a way that the profit mark-up falls again.

Recent decades have been characterised by significant wage dispersion. In almost all countries in the world the low-wage sector has increased. Precarious employment and informality have also increased, especially in the sector of non-tradable goods and services. Globalisation trends, therefore, cannot directly explain the emergence of these sectors. They are the result of labour market deregulation. These unjustified income inequalities among wage earners must be dismantled by means of labour market reforms. The collective bargaining system must be strengthened, backed up by other labour market institutions to achieve the decent work conditions stressed by the International Labour Organisation. Minimum wages and social security guaranteed by the state also play a crucial role in this. Such labour market regulations are not only important to reduce income inequality, they are also important to establish a nominal wage anchor against deflationary money wage cuts.

Even with strict regulation, markets do not lead to a politically acceptable income distribution. In addition to that, not everyone has equal chances in the market. The disadvantaged – whether on the basis of gender, childcare responsibilities, handicap, age, race and so on – can drop out of the market and be deprived of an income, or at best obtain only an inadequate one. Ultimately, by no means are all incomes obtained on the basis of personal achievements; consider, for example, large inheritances, which are an intrinsically alien element with regard to capitalism. Tax law and social systems must be deployed in order to organise income distribution in a socially acceptable manner. Tax law should therefore include a clear redistributive component, and this need becomes more pronounced the more evident it is that market outcomes alone will lead to growing inequality. Against this background, not only is a markedly progressive tax system important, but above all, regulations which ensure that incomes from capital are adequately taxed.

This Plan B might sound good, but is it not completely unrealistic? Change the rules of the game and shift the roles of governments, society and the market at the local, national and global level – and the powerful few who have been benefiting greatly from the current brand of capitalism might actually lose out. However, the outlook for change is not that bleak. Economic history is full of deep shifts in opinion, followed by deep shifts in the structure of economic institutions. Crises allow us to call into question all doctrines and interests which have been disseminated virtually unquestioned.

One thing is very clear, however: a more ‘decent capitalism’ will not be created by the profiteers of the current system of non-regulation. Their profits are built too heavily on certain prerogatives, which they will not just hand over to public control. Quite the opposite is true: it is mostly mere placebos that have been rubber-stamped by the global financial elite so far. For deeper reform the underlying power relations of current finance capitalism will have to change, which means that the relationship between states and markets will have to be radically rebalanced.

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Christian Kellermann is the Director of the Nordic Office of the Friedrich Ebert Foundation (FES) in Stockholm. Before joining the FES, he worked as a financial market analyst in Frankfurt and New York.

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Further reading:
Decent Capitalism. A Blueprint for Reforming our Economies, by Sebastian Dullien, Hansjörg Herr, Christian Kellermann, Pluto Publishers, London, 2011
http://www.plutobooks.com/display.asp?K=9780745331096&

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The True Cost of Doing Business

Conor Cradden[1]

There is a belief widely shared among policymakers that if arguments for a proposal or decision are supported by numbers on a page then somehow this makes that choice less political. It permits the claim that what is being proposed is not really a choice at all but something that the ‘evidence’ demands. This emphasis on quantitative indicators has meant that much policy argument has been displaced into the design of the indicators themselves. Rather than being grounded on purely technical criteria, the design of statistical indicators is a highly politicized process in which different stakeholders struggle to ensure the numbers that emerge will be more compatible with arguments in favour of their policy predilections than those of the opposition.

The World Bank’s ‘Doing Business’ (DB) indicators are a shining example of statistics that come with this kind of built-in value judgment. The DB indicators claim to be a guide to the relative ease of establishing and running a business in different countries. This is ‘measured’ on a number of dimensions, including starting up, paying taxes, getting construction permits and enforcing contracts. The indicators allow the construction of rankings, including an overall global ranking that places Singapore at the top – making it the world’s easiest place to do business – and Chad at the bottom.

This might appear to be an innocent enough endeavour. While states obviously have the right to ensure that there is a proper measure of social and political oversight of economic activity, it is also obvious that oversight procedures can be more complicated and more expensive than necessary. However, although the Bank denies that the DB indicators encourage deregulation, the information the indicators provide gives no way of judging whether the cost of conforming with regulation is reasonable in the light of the social, economic and environmental benefits that it produces. They have nothing to say about whether a country might on the whole be better off because of regulation. Since the social costs associated with deregulation are invisible to the DB indicators, governments whose concern is to improve their position in the DB ranking – and in some cases this is even a condition of financial aid from the Bank – have no incentive to take the potentially negative effects of deregulation into account.

Nowhere is the assumption that regulation is only a cost clearer than in the case of the ‘employing workers’ (EW) sub-indicator. A country’s EW score depends on the cost of making employees redundant and a measure called ‘rigidity of employment’, which is a composite index where the highest possible score corresponds with a low minimum wage for beginning employees, easy availability of fixed-term rather than permanent contracts, minimal restrictions on night and weekend working, high maximum permitted weekly working time, a low number of days of paid holiday and minimal requirements for notice and consultation when making redundancies.

Not surprisingly, the EW indicator has attracted criticism from many directions, but most notably the global labour movement. The ICFTU criticised the DB indicators within weeks of their first publication in 2003. Since then the Confederation, and subsequently the ITUC, has set out objections on a number of occasions, both in direct communication with the Bank and in public papers. In 2007, the ILO joined the debate, producing an official paper[2] that criticised the EW indicator on technical grounds, but also because of what it called problems with ‘policy coherence’ – in other words, the EW indicators cut directly across the ILO’s own, arguably more legitimate policies. The ILO argued that the view that “reducing protection to a minimum and maximizing flexibility is always the best option” was badly mistaken and that the EW indicator was “a poor indicator of the investment climate and labour market performance”.

The paper sparked a series of exchanges between the ILO and the Bank that culminated in the establishment of a consultative group (CG) to serve as a ‘source of advice’ on revising the EW indicator. Around the same time – early in 2009 – pressure from the global unions led to the Bank agreeing that at least until the group reported, the EW indicator would not be included in the calculation of the overall DB ranking nor used as a basis for policy advice. The consultative group included senior Bank and ILO officials together with global union, employer and OECD representatives. There were also three independent members, a labour law expert, a social entrepreneur and a public servant.

The ILO’s decision to participate in the CG will not have been taken lightly – even though in principle all of the members were acting in their personal capacity. Not participating would have meant missing a rare opportunity to have an impact on an influential indicator, but participating was arguably a gamble. The risk was that the group would come up with conclusions that did not adequately respond to the ILO’s criticisms but that the Bank would put its recommendations into effect anyway. If the ILO wanted to object, it would be forced to get into a public argument with the Bank about the adequacy of an indicator in whose revision two of its senior officials had just participated.

Now that the CG has produced its final report[3] it is not obvious that the gamble paid off. The solution proposed to the principal problem – the fact that lower standards of labour protection receive a higher score – is hardly adequate. Three elements of the indicator – minimum weekly rest periods, paid holiday entitlement and the level and means of setting the minimum wage – have been changed from being in a simple inverse relationship with the indicator score (the lower the better) to a kind of ‘banding’ system in which the policy target is to have these protections fall within a lower and an upper limit. Not enough holiday and a country will not receive the maximum possible score, but the same is true for what is deemed to be too much holiday. A similar change is proposed for maximum weekly working time. The ranking on the minimum wage indicator for countries that have one remains inversely related to the ratio of the wage to the average value added per worker, but countries that have no minimum wage no longer receive the best possible score. This is reserved for systems in which the minimum wage is set by collective bargaining – as long as it applies to less than half the manufacturing sector, or does not apply to firms not party to it – and systems in which trainees or apprentices are excluded.

The report of the CG makes it clear that it was split on whether the changes to the EW indicator are adequate. ‘One view’ was that the modifications dealt with the substantial problems and that the EW indicator should be reintegrated into the overall DB indicators. A ‘second view’, on the other hand, “noted that EWI did not adequately reflect worker protections even after the amendments made, and that the Doing Business report should reflect labour regulations holistically, or not at all”. This second view also argued that if the EW indicator was to continue to be used, there should also be a separate, quantitative ‘worker protection measures’ indicator published alongside the DB indicators. However, although this idea was discussed by the CG[4], it failed to agree a recommendation on the issue.

The ILO now has to decide whether to carry on working with the Bank. If it does not, the Bank will probably put the modified indicator back into use, and may also go back to basing policy advice on the EW indicator. Certainly the ILO doesn’t have to endorse the revised indicator, but if it wants to avoid a public argument, the best it can do is maintain a studied neutrality on the issue. The fact remains, though, that the DB indicator is still a barrier to the improvement of working conditions and quietly accepting its existence would be cowardly at best. The obvious question is why the ILO does not try to take the collaboration implied in the consultative group one step further and to work to persuade the Bank that there ought indeed to be an official, jointly developed worker protection indicator. The stakes are not so high here since the ILO clearly has moral and technical authority on the issue that the Bank cannot claim.

So why the deafening silence from the ILO? There has been no comment on the report of the CG, still less any indication of whether the ILO wants to carry on working with the Bank. In fact, the problem for the ILO is less with the outside world than its own constituents. The possibility of producing a ‘decent work’ indicator has been floating around for more than 10 years. That such an indicator has not (yet) been developed is partly a reflection of the traditional reluctance of employers and governments to allow themselves to be ranked, and partly a reflection of disagreement about whether such an indicator should be focused on outcome measures – the extent to which decent work is a reality for workers on the ground – or regulation – the extent to which the formal rules conform with ILO policies. These are difficult questions, but making a determined effort to resolve them is likely to be less costly for the ILO than allowing the Bank to continue to use and promote its EW indicator.

[1] Disclosure: the author is married to an ILO official. The official in question has no input into ILO policy-making in the areas under discussion in this article.
[2] http://www.ilo.org/wcmsp5/groups/public/---ed_norm/---relconf/documents/meetingdocument/wcms_085125.pdf
[3] http://www.doingbusiness.org/methodology/~/media/FPDKM/Doing%0Business/Documents/Methodology/EWI/Final-EWICG-April-2011.doc
[4] http://www.doingbusiness.org/methodology/~/media/FPDKM/Doing%20Business/Documents/Methodology/EWI/Annexes-EWICG-April-2011.doc

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Conor Cradden is a research fellow in the Department of Sociology at the University of Geneva and a partner in Public World, a London-based research and policy consultancy.

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Is the Eurozone doomed to fail?

Jacques Sapir

The eurozone is currently undergoing a crisis of historic importance, which results in the accumulation of sovereign debt in eurozone countries and reveals the internal defects of the eurozone.

Since the beginning of 2010, the crisis in several EU countries has resulted in a faster growth of interest rates compared to those of Germany. This is known as interest rate “spreads” and has challenged the single real accomplishment of the eurozone: the relative convergence between countries on the debt market that began in 2000. This has been fuelled by the huge growth of sovereign debts in the wake of the 2007 crisis. But even this development could be linked to the euro as prior to the crisis it allowed a downturn of interest rates, which then facilitated the build-up of the large debt, both private and public, in most eurozone countries.

Table 1: Situation at the beginning of the crisis (December 31 2009) 

Source: C Lapavitsas et alii, “The Eurozone Between Austerity and Default”, RMF-Research on Money and Finance, occasional report, September 2010, available at www.researchonmoneyandfinance.org

When the difference between the interest rates of one country and those of Germany exceeded 300 points (the Irish debt reached its peak at 399 points[1]), it was clear that the eurozone had entered troubled waters. The homogenization process had been suspended, and the rates in Greece remained very high. The growth of the rate spread was actually caused by the deterioration of the debt situation in Greece followed by Spain, Portugal and Ireland[2].

Beyond the “at risk” countries, we can see the process of interest rates divergence going one step further. For example, Italy resumed issuing futures on government bonds in September 2009 (a practice that was suspended in 1999 when the euro was introduced). This shows operators are seeking to prevent new problems in this segment of the government securities market[3]. The fact that Italy reverted to this type of emission indicates that the euro is fast losing its protective role. The same can be said about worries now openly voiced on Belgium.

Yet, advocates of the euro stressed this role during the crisis. They argued that the euro helped member countries to avoid the consequences of their currencies fluctuating violently against one another. Nevertheless, these fluctuations have been possible because of the long standing decision to move to complete convertibility (capital-account convertibility). Note also that the speculation on exchange rates has been replaced by speculation on interest rates. One wonders what would have been the outcome had capital controls been introduced. But capital controls have been strictly prohibited under the provision of Article 63 of the Lisbon Treaty.

However, it is important to note that the introduction of capital controls is recommended by the IMF[4] to fight speculation. They could have helped avoid currency swings while giving eurozone countries the possibility to adapt their exchange rate to the massive divergence in the real cost of labour experienced in Europe since 2002.

This openness has made countries totally dependent on the eurozone. The adoption of a single exchange rate and the overvaluation that has characterised the euro since 2003 has also increased the economic pressure on certain members.

The rigid pressure of the single currency “noose” forces some eurozone countries to resort to ongoing growth of their budget deficits[5], which raises questions on the competitive deflationary policy of the Stability and Growth Pact within the Treaty of Maastricht (1992) and might have serious recessionary consequences for Europe. We cannot exclude the possibility that some countries may leave the eurozone[6]. Even the withdrawal of one country would cause a strong speculative movement, which would make the participation of others ever more expensive and eventually impossible.

When the euro crisis broke in April 2010[7], it had two dimensions: momentary dimension (the debt crisis in Greece, Portugal, Spain and Italy) and a more important structural dimension. The crisis was triggered by the growing lack of confidence among financial markets that countries with large debts were going to be able to repay them. The crisis began in Greece and then attacked Ireland, Portugal and Spain. It is now obvious that Italy will be next, as it was already the target of speculative attacks in July.

The plan adopted on May 9–10 2010 was supposed to put an end to the crisis. However, the market response shows that the lack of confidence has increased. The plan has been revamped several times, but each modification has only served to push back problems for one or two months. Market speculation reveals the following:

(1) This plan does not announce a clear commitment by donor countries as a large part of the funds are just a credit guarantee.

(2) The total sum is not enough to cover the estimated financial needs of 900–1000 billion euro for the three countries already targeted by the plan (Greece, Ireland, and Portugal). This amount is clearly short of what would be needed if Spain were to be rescued too. The default rate on bank credit has already reached 6.2% of the credit amount. With the planned end of the unemployment benefit package by December 2011, the default rate is likely to surge even higher, maybe to 10%.

(3) Some countries, such as Germany, are not ready to commit to obligations.

This plan has clearly been designed as an attempt to gain time. The only relevant action has been the ECB’s decision to buy out government and private debt, but even this is not completely satisfactory: only monetization of some part of the debt could give real breathing space. In early May Greece asked for more money, and Portugal and Ireland are asking for a renegotiation of their interest rates.

What options are left?

Fiscal austerity plans are pushing some countries to their limits. The fiscal adjustment needed to stabilize the sovereign debt is too great to be swallowed by different countries. What is more, the deflationary spill over effect has not been computed nor introduced in various forecasts presented by governments or independent research centres.

The cumulative effect of these different fiscal adjustment plans is likely to plunge the eurozone into a previously unknown depression.
The only possible solution would be a default on the sovereign debt for some countries (Greece and Portugal and maybe Ireland). But the economic competitiveness of these countries cannot be rebuilt without a strong devaluation. On the other hand, the Russian experience of 1998 is showing that long-term benefits can outweigh short-term pain. 

Table 2: Fiscal adjustment needed to keep the sovereign debt at its 2010 level

Source: Author’s computations and CEMI-EHESS database

However, such devaluation could not be obtained within the eurozone: these countries are then bound to leave it, maybe momentarily.
Problems will not stop with Greece and Portugal. While some of the eurozone countries would not benefit from a possible devaluation (Germany, Netherlands, Finland), others would, such as Ireland, France or Italy. Large budget transfers have not backed the single currency system adopted for the euro. Germany continues strongly opposing the very principle of turning the single currency into a transfer zone. But, as the single currency has prevented adjustments of the exchange rate, this left fiscal adjustment as the only way open. Fiscal adjustments will not be sustainable.

The coming crisis could mean the beginning of the end for the euro.

[1] G.J. Neuger and S Kennedy (2009), “Crisis Spawns Drive to Fixe the Euro with More Rules, ties (Update 1)”, Bloomberg, Feb 17
[2] E. Ross Thomas (2009), “Spain Downgraded by S&P as Slump swell Budget Gap”, Bloomberg, Jan 19
[3] A. Worrachate (2009), “Italian Bond Futures offer Proxy to Hedge Greek, Irish Debt”, Bloomberg, Sep 11
[4] J. Ostry et al. (2010), Capital Inflows: The Role of Controls, International Monetary Fund Staff Position Note, Washington D.C.: IMF
[5] On the depressive effects of the euro, see J. Bibow (2007), “Global Imbalances, Bretton Woods II and Euroland’s Role in All This” in J. Bibow and A. Terzi (eds.), Euroland and the World Economy: Global Player or Global Drag?, New York: Palgrave Macmillan
[6] S. Keendy and T.R. Keebe (2010), “Feldstein says Greece will Default and Portugal May Be Next”, Business Week, June 30
[7] A. Moses and D.S. Harrington (2010), “Bank Swaps, Libor Show Doubt on Euro Bailout”, Bloomberg, May 11

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Jacques Sapir is Professor of economics and Director of the CEMI Research Centre at EHESS (Paris), which focuses on Russia and CIS countries and on international development. He is the author of several books on the Russian economy, international finance and economic theory, notably (2000) “Les trous noirs de la science économique. Essai sur l'impossibilité de penser le temps et l'argent”, Paris: Albin Michel and (2011) “La Démondialisation”, Paris: Le Seuil.

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Further references
P. Dobson (2010), “European Yield Spreads Widen on Concern Debt Crisis Deepening”, Business Week, June 30
F. Cachia (2008), Les effets de l’appréciation de l’Euro sur l’économie française, Note de Synthèse de l’INSEE, Paris: INSEE

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