Italian Luxury Eyewear Maker Luxottica to Offer Recession Benefits

From WSJ:

"Italian eyewear maker Luxottica SpA is expected to unveil a new social-benefits program for its domestic work force, an attempt to ease the pain as the global economic downturn hits Italy's industrial north.
Cities in northern Italy are home to some of the country's biggest employers. But they've been hard hit as demand for luxury goods has dried up.
Luxottica, which produces eyeglasses under license for brands such as Prada and Salvatore Ferragamo near the Belluno district of Northern Italy, announced plans earlier this year to place about 6,000 workers on temporary, state-subsidized leave for a total of four days during January and February. Last month, Safilo SpA, Italy's second biggest eyeglass maker, said it will idle plants for two months as it grapples with slumping sales and a heavy debt load.
The shutdowns are taking a toll on factory towns, as households scrimp on spending to offset lost wages. Workers who are placed on state-subsidized leave take an average 20% pay cut while their jobs are suspended.
Associated Press
Eyewear maker Luxottica is among Italian companies hard hit as demand for luxury goods fades.
Under the terms of an accord reached after 15 months of negotiations with unions, Luxottica will spend more than €2.5 million ($3.2 million) a year on benefits for its workers ranging from dental care to scholarships. The measures are apart from union contracts that cover wages and working conditions. Employees' health care and social services are covered by the state social welfare system.
"The assumption is practical: You cannot deliver and produce quality products unless people enjoy a decent quality of life and have the basic needs fulfilled," said Nicola Pelà, Luxottica's head of human resources.
Under the new system, Luxottica aims to leverage its scale to buy basic goods, such as baby food, and services at discount prices and distribute them to employees who reach production and efficiency targets.
Luxottica will distribute scholarship money for the children of employees to attend local vocational schools and colleges. In the luxury industry, where know-how is often passed down through generations of craftsmen, keeping young people close to home is essential.
Even before the economic downturn gripped the luxury industry, towns specializing in luxury goods faced tough odds. Over the past decade an increasing number of brands have begun to buy textiles and semifinished materials from countries with lower-cost labor like China.
As competition with China tightened, worker wages across the luxury industry stagnated and workers struggled to keep apace with a rising cost of living. Luxottica's average monthly salary of €1,200, Mr. Pela said, was "above market rate," but needed a supplement. At the same time, Luxottica didn't want to simply raise wages, which are heavily taxed in Italy, he added.
Valeria Fedeli, a union representative for Luxottica's employees, applauded the benefits program, but added: "We're still in a crisis situation."

Obama administration should radically change the terms of stimulus plan(if they designed the previous to get a bit of bi-partisanship)

People will take you responsible for any failure.
If you are gonna be charged so be by playing according to your belief.
If you believe that tax cut's bang for the buck is way lower than government spending, well go for it!!
Soon!

The Smart Growth Manifesto

Umair Haque from Harvard Business blog:

Obama is stimulating. Davos is deliberating. C-levels are eliminating. Wall St is recriminating. Welcome to the macropocalypse: no one, it seems, can put the global economy back together again.
It's time to reboot capitalism. So where do we begin?
Here's a suggestion for what should be at the top of agenda of every decision-maker across the economy, from Davos, to Obama, to Sand Hill Road, to the revolutionaries in tiny garages hatching tomorrow's Googles: reconceiving growth.
Why?

20th century capitalism is eating itself. For the first time since World War II, global growth is forecast to turn negative -- and that's an optimistic forecast, relative to the possibility of a global lost decade.Today's leaders are plugging dikes, bailing out industries and banks as they fail. Yet, what negative global growth suggests is that the problem is of a different order: that we have reached the boundaries of a kind of growth.

Reigniting growth requires rethinking growth. The question Davos -- and most leaders -- are asking is: where will tomorrow's growth come from? Will it result from oil, cleantech, bailouts, China, or Obama? The answer is: none of the above. Tomorrow's growth won't come from a person, place, or technology - but from understanding why yesterday's growth has failed. The same growth models applied to new people, places, and technologies will simply result in the same crises, over and over again. We have to reboot growth: the problem is not what is growing versus what is not, but how we grow.

20th century growth was dumb. The central, defining lesson of the macropocalypse is that 20th century growth wasn't built to last. Dumb growth is unsustainable - if the world grows the same way that developed countries did, well, there won't be a world. Dumb growth is unfair: it's growth that's an illusion for many; just ask the American middle class. And, ultimately, perhaps most dangerously, dumb growth is brittle: it falls too easily into collapse, reversing many of yesterday's gains; just ask Iceland.

21st century economies will be powered by smart growth. Not all growth is created equal. Some kinds of growth are more valuable than others. Where dumb growth is unsustainable, unfair, and brittle, smart growth is sustainable, equitable, and resilient.

Here are the four pillars of smart growth - for economies, communities, and corporations:

1. Outcomes, not income. Dumb growth is about incomes - are we richer today than we were yesterday? Smart growth is about people, and how much better or worse off they are - not merely how much junk an economy can churn out. Smart growth measures people's outcomes - not just their incomes. Are people healthier, fitter, smarter, happier? Economics that measure financial numbers, we've learned the hard way, often fail to be meaningful, except to the quants among us. It is tangible human outcomes that are the arbiters of authentic value creation.

2. Connections, not transactions. Dumb growth looks at what's flowing through the pipes of the global economy: the volume of trade. Smart growth looks at how pipes are formed, and why some pipes matter more than others: the quality of connections. It doesn't just look at transactions at the global, regional, or national level -- how much world trade has grown, for example -- but looks at how local and global relationships power invention and innovation. Without Silicon Valley's relationships powering the development of personal computing and the internet, for example, the volume of trade between Taiwan, Japan, and China, would be a fraction of what it is. Smart growth seeks to amplify connection and community -- because the goal isn't just to trade, but to co-create and collaborate.

3. People, not product. The next time you hear an old dude talking about "product", let him know the 20th century ended a decade ago. Smart growth isn't driven by pushing product, but by the skill, dedication, and creativity of people. What's the difference? Everything. Globalization driven by McJobs deskilling the world, versus globalization driven by entrepreneurship, venture economies, and radical innovation. People not product means a renewed focus on labour mobility, human capital investment, labour market standards, and labour market efficiency. Smart growth isn't powered by capital dully seeking the lowest-cost labour -- but by giving labour the power to seek the capital with they can create, invent, and innovate the most.

4. Creativity, not productivity. Uh-oh: Creativity is an economic four-letter word. Why? Because it's hard to measure, manage, and model. So economists focus on productivity instead -- and the result is dumb growth. Smart growth focuses on economic creativity - because creativity is what let us know that competition is creating new value, instead of just shifting old value around. What is economic creativity? How many new industries, markets, categories, and segments an economy can consistently create. Think China's gonna save the world? Think again: it's economically productive, but it's far from economically creative. Smart growth is creative -- not merely productive.

Here's a final point -- and a question.

Smart economies are driven by smart growth. The four pillars of smart growth are design principles for next-generation economies. 20th century economies are limited to unsustainable, unfair, brittle, dumb growth. Smart growth is more sustainable, equitable, and resilient.
Capitalism 2.0 cannot be powered by growth.1.0: that's why the race for smart growth is inevitable. The economic pressure -- the potential for value creation, in a world being ripped apart by value destruction -- is simply too great.

Can you build a business powered by smart growth? The four pillars of smart growth aren't just design principles for next-generation economies: they're also design principles for next-generation businesses. Already, tomorrow's radical innovators don't accept yesterday's toxic, tired consensus. Revolutionaries like Apple, Threadless, Etsy, Whole Foods, American Apparel, and Google are already reinventing better ways to grow - from the grass-roots up.
Yesterday's incumbents are beginning to fail en masse, while these revolutionaries remain resilient. Why? As our research at the Lab suggests, getting smart is a better choice than staying dumb: smart growth results in more creativity, innovation, effectiveness, and power than dumb growth.
For now, fire away in the comments with questions, examples, or criticisms. Which other companies are seeking smart growth? Is your organization building any of the pillars of smart growth? Are there countries or cities that are pockets of smart growth?

Here Ibn Battuta: I don't share the manichean polarization and the idea that XXth century growth was dumb.
This is not to say that it wasn't, at all! Just that to judge history is not that wise, let alone productive.

For the general approach, what should I say, I enjoy greatly the fact that somebody is writing something that close to my ideas that just allows me to use it a sample to remix.
Since english is not my native language this is quite important.

Protectionism and stimulus

Paul Krugman lucid as ever:

Should we be upset about the buy-American provisions in the stimulus bill? Is there an economic case for such provisions? The answer is yes and yes. And I do think it’s important to be honest about the second yes.
The economic case against protectionism is that it distorts incentives: each country produces goods in which it has a comparative disadvantage, and consumes too little of imported goods. And under normal conditions that’s the end of the story.
But these are not normal conditions. We’re in the midst of a global slump, with governments everywhere having trouble coming up with an effective response.
And one part of the problem facing the world is that there are major policy externalities. My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt. As I explained a while back, this means that the bang per buck on stimulus for any one country is less than it is for the world as a whole.
And this in turn means that if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere.
Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap.
Let’s be clear: this isn’t an argument for beggaring thy neighbor, it’s an argument that protectionism can make the world as a whole better off. It’s a second-best argument — coordinated policy is the first-best answer. But it needs to be taken seriously.
What’s the counter-argument? Don’t say that any theory which has good things to say about protectionism must be wrong: that’s theology, not economics.
The right argument, I think, is in terms of political economy. Everything I’ve just said applies only when the world is stuck in a liquidity trap; that’s where we are now, but it won’t be the normal situation. And if we go all protectionist, that will shatter the hard-won achievements of 70 years of trade negotiations — and it might take decades to put Humpty-Dumpty back together again.
But there is a short-run case for protectionism — and that case will increase in force if we don’t have an effective economic recovery program.

And Now For Something Completely Different: Davos Features “Refugee Run”

From the much needed, long waited blog of William Easterly:

"When somebody sent me this invitation from Antonio Guterres, the UN High Commissioner for Refugees, I thought at first it was a joke from the Onion. What do you think of the Davos rich and powerful going through the “Refugee Run” theme park re-enactment of life in a refugee camp?
Can Davos man empathize with refugees when he or she is not in danger and is going back to a luxury banquet and hotel room afterwards? Isn’t this just a tad different from the life of an actual refugee, at risk of all too real rape, murder, hunger, and disease?
Did the words “insensitive,” “dehumanizing,” or “disrespectful” (not to mention “ludicrous”) ever come up in discussing the plans for “Refugee Run”?
I hope such bad taste does not reflect some inability in UNHCR to see refugees as real people with their own dignity and rights.
Of course, I understand that there were good intentions here, that you really want rich people to have a consciousness of tragedies elsewhere in the world, and mobilize help for the victims. However, I think a Refugee Theme Park crosses a line that should not be crossed. Sensationalizing and dehumanizing and patronizing results in bad aid policy – if you have little respect for the dignity of individuals you are trying to help, you are not going to give THEM much say in what THEY want and need, and how you can help THEM help themselves?
Unfortunately, sensationalizing, patronizing, and dehumanizing attitudes are a real ongoing issue in foreign aid. David Rieff in his great book A Bed For the Night talks about how humanitarian agencies universally picture children in their publicity campaigns, as if the parents of these children are irrelevant. A classic Rieff quote: “There are two groups of people who like to be photographed with children: dictators and aid officials.”
Former World Bank President Wolfowitz with a few children
Alex de Waal in his equally great book Famine Crimes (and continuing writings since) writes about “disaster pornography.” He gives an example of a Western television producer in Somalia in 1992-93 who said to a local Somali doctor: “pick the children who are most severely malnourished” and bring them to be photographed.
Here’s a resolution to be proposed at Davos: we rich people hereby recognize each and every citizen of the globe as an individual with their own human dignity equal to our own, regardless of their poverty or refugee status. And Davos man: please give Refugee Run a pass.

Price Waterhouse Auditors Arrested in Satyam Inquiry

From Bloomberg:

PricewaterhouseCoopers LLP’s Indian affiliate, the auditor of Satyam Computer Services Ltd., said two partners were arrested by police as authorities extended the nation’s largest fraud inquiry.
Srinivas Talluri and S. Gopalakrishnan were remanded to judicial custody on charges of “conspiracy and co- participation,” A. Shivanarayana, a police spokesman in Andhra Pradesh state, said from the province’s capital Hyderabad, where Satyam is based. Price Waterhouse said in an e-mailed statement it didn’t know why two partners were detained.

Seven years after the implosion of Enron Corp. led to the dissolution of accounting firm Arthur Andersen LLP, the Satyam case has put PricewaterhouseCoopers in the spotlight. Indian police, fraud squad, markets regulator and accounting body have started investigations after Satyam founder Ramalinga Raju said Jan. 7 that he had fabricated $1 billion of assets.
“Over the last fortnight, the firm has fully cooperated in all inquiries and has provided the documents called for by the Indian authorities,” Price Waterhouse said today in a statement from New Delhi. “We greatly regret that two Price Waterhouse partners have been detained today for further questioning.”

PricewaterhouseCoopers LLP may also face scrutiny in the U.S. after Satyam’s New York-listed equities lost 82 percent of their market value in two weeks. The U.S. Securities and Exchange Commission is investigating whether Satyam misled investors and officials from the SEC plan to coordinate inquiries with counterparts in India.

The auditing firm said Jan. 15 that its reports could no longer be relied on after former chairman Raju said he’d fudged the accounts. The Institute of Chartered Accountants of India, a statutory body which oversees auditors, will report on its investigation into Price Waterhouse on Feb. 11.
Prosecutors allege Satyam padded employee numbers to siphon off cash and forged documents to support fake bank deposits.
Satyam had about 33 billion rupees ($674 million) of “fictitious and non-existent” accounts, public prosecutor K. Ajay Kumar told a hearing on Jan. 22. The company had about 40,000 employees, compared with the 53,000 claimed by Satyam, he said.

Can we learn from the “Italian Miracle” Formula?

Carlo Resta from RGE:

"In the 1960s, while the Italian economy was booming, such to talk of “The Italian Economic Miracle”, IRI - Istituto per la Ricostruzione Industriale S.p.A. - was among its most important factors[1]. The IRI, (Institute of Industrial Reconstruction) was a conglomerate owned by the Italian government and inherited by the Great Depression period. By the 1960's it was growing at rates that were more than double those of the national economy and it was once the largest non-oil producing company in the world outside the United States. It had stakes in a multitude of sectors of the Italian economy, ranging from infrastructure and manufacturing to telecommunications.
This experience of the IRI contains some valuable precedents and lessons for policy makers today in the midst of the extreme economic difficulties.
When the 1929 market crash initiated the worldwide depression of the 1930s, few countries were as adversely affected as Italy, even though this propagated with a certain delay. Italian banks had a history of purchasing substantial interests in Italian industry, and when those industries began to fail it appeared that the nation's banking system might well collapse. The Fascist government of Benito Mussolini created IRI in January 1933 to bail out Italy's three largest banks, Banco di Roma, Banca Commerciale, and Credito Italiano. As a result, wrote Stuart Holland in: The State as Entrepreneur. New Dimensions for Public Enterprise: The IRI State Shareholding Formula, “the new state holding company found itself responsible for major proportions of the main industrial and service sectors in the economy.”
During the years of its intense growth, IRI behaved unlike any corporation seen before. Because it served the interests of the state, it did not have to concern itself with short term profits. Thus IRI could sink millions of lire into enterprises, like steel and road building that private companies shied away from. The effect of such government investment was to create markets in which other companies could then compete, thereby expanding the economy as a whole. The U.S. government was using tax-breaks and incentives, but their situation was different, so Italy employed IRI. Not only did IRI create economic markets, it did so in areas thought to be most beneficial to the country as a whole or in areas of strategic importance.
It is crucial to remember that IRI avoided the pitfalls of most state-run businesses. The problem with most state-run businesses, especially in the formerly communist countries, was that there were few incentives to be productive or efficient. Thus, state-run companies often became notorious for mismanagement, creating unnecessary jobs and spending public money unwisely. IRI avoided these drawbacks by creating a level of distance between itself and its subsidiary holding companies. IRI's subsidiaries were put in a position to behave as if they were private enterprises; they were encouraged to be entrepreneurs, while the small core of IRI management acted as investors, backed by the financial might of the Italian government. While IRI was 100 percent government owned, the subholdings were not, and thus these subholdings could attract private investment as well. And so they did.
When IRI was working well, it combined the dynamism of entrepreneurial capitalism with some sort of social guardianship and long term forward looking common purpose. The success that IRI had in the 1950s and 1960s, during what was dubbed: “The Italian Economic Miracle”, made it the model for governmental involvement with industry around the world. In the 1960s, Great Britain, France, Australia, Canada, Sweden, and West Germany all initiated programs that were based at least in part on the IRI formula of mixed state/private investment formula.
Many European countries, particularly the UK, were looking at the “IRI’s formula” as a positive and effective example of a proper state participation in the economy. It was better than the straightforward “nationalization” because it allowed a direct cooperation between public and private capital. Many of the companies of IRIs’ group had mixed capital, partly from public government, partly from private investors. Many of IRI’s enterprises were listed and the bonds issued by IRI to finance its own companies were massively subscribed by savers.

Here are the main functions of the newly proposed Institutes for Economic Reconstruction:

1.Be of immediate support to companies in strategic sectors of the economy; prevent their collapse, avoiding catastrophic impacts by taking over preferred shares, (a midway instrument between shares and bonds with no voting rights), taking control only where strictly necessary.

2.Acquire stakes in small and medium size businesses (SMEs) to protect them for being indirect contagion casualties, facilitate their financing, their international development plans.

3.Acquire preferred stakes in new enterprises with strong growth prospects, to promote new technologies, new inventions, more exports to BRICs, vital sectors of the economy …

4.Act as a traditional institutional investor in search of long term returns, acquiring assets domestically but also abroad, restoring confidence and stabilizing markets in coordination with the necessary general economic reforms of each of the western countries.

5.Defy fears that external SWFs investment reasons are other than portfolio diversification and that by investing in other countries they could take control of crucial national interests, or could influence other sovereign states. Consider co-investments with SWFs with the aim of contributing to a globally coordinated stabilization effort.

Now, the big problem facing this depressionary period is that there is strong general reluctance to undertake any investment at all. There is widespread fear. The risks are perceived to be too high; a vicious “Trust Crunch” circle is generated, and that brings to a compression and ultimately to the freezing of any exchange in the economy. If the blood stops circulating even the healthiest individual will eventually die. The banks stop lending, even to themselves; consumer confidence plummets at its lowest, panic spreads across and creates damage to fundamentally sound businesses. The above curve gets flatter and it moves more and more to the extreme right of the graph. This deadly spiral must be “unlocked”!

The implementation of a proper “State/Private Co-Investment” formula allows reducing enterprise risks, guarantees a long term view horizon, reestablishes trust and confidence in the markets for investments to take place, gives a positive boost to all of the firm’s constituents, and thus decreases risks. The presence of such a ‘Strong hand’, enhances the value of a company for all the parties involved: employees, management, suppliers, customers, shareholders, bondholders, financing banks, insurers, regulators, local administrators. The positive impact reverberates also into other companies of the same sector, creates a compounding positive virtual circle, a psychologically positive impact into the entire system.

... The impact of the “State/Private Co-Investment Formula” is obviously of superior significance in periods of deep dislocation and depression like those we are currently going through. Historical examples show also that where there is a public presence, growth is even faster than the market average at times of expansion. Last but not least, history reminds us that the most important element will be, much further down the line, a proper ‘exit strategy’ for the public money. This is a relevant aspect but it can be addressed later on.

Furthermore, a renewed formula of the Italian I.R.I., a new breed of western Sovereign Fund which I call Institutes of Economic Reconstruction (IER), can be viewed exactly as a portfolio manager, having to allocate capital among different selection of enterprises and industrial sectors.

...The IER holding company can also be viewed as a fund manager and similarly, if successful in allocating its asset among best performers and diversifying risks accordingly, generating return higher than the market. ...The value generated by these asset allocation strategies will also improve because the allocation process itself is made easier by the presence of a “strong hand” that reduces fears and uncertainties. And we know that asset allocation is the most important factor in successful value creation and preservation. From the case study of IRI, we see that when the Italian economy was growing 8%, IRI was growing more than double that.
The stronger the depression, the higher is value of the “State/Private Co-Investment Theory”. Same was for the Great Depression and for other similar historical periods. After all the creation of “Sovereign Alpha” does not just come automatically, but it is also be the result of a selection and an enhancement process; the enterprise will have to improve its values and standards, requirements, conditions, and keep them that way.

If IRI chemistry allowed to flourish the unstoppable Italian art of making do with what available; if that formula allowed the unfolding of the fantastic creativity of the Italians and their relentless ‘trial and error’ mentality that brought to life world icons like Ferrari or Espresso, Versace and Armani,… up to the helicopters currently used by the USA President and much more, think what a similar formula could do to revamp a United America and the western economies today. Not only the historical comparables match, but the advantage of available technology and knowledge make possible a more effective and controlled use of the “State/Private Co-Investment” formula. Yet, time is of the essence.

A new breed of Sovereign Wealth Funds, the Institutes for Economic Reconstruction (IER), based on the “State/Private Co-Investment” formula with the crucial goal of reestablishing confidence in each of the national markets, and restarting the much needed economic growth, appears to be the only way forward and a viable one. Not Von Hayek but not really Keynes either. It is going to be a balanced, comprehensive approach, a real generator of modern value.
This approach not only will benefit the individual enterprises which receive the participation from the State, but it will also generate a positive crucial impulse to the global economy, increasing overall market returns and reducing risks. Last but not least, ethical and sustainable growth considerations will be able to receive a reasonable place in a much needed restructuring of the world order. Markets will come out different from this crisis but ultimately stronger.
We have the means, the expertise, and now a good impending necessity to make it happen.

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty”. Winston Churchill




Carlo Resta is the founding Partner and President of Oraculum Advisors Limited, an investment banking boutique consultant to global financial services institutions for their business development, marketing, partnerships andalliances activities.
As a wealth manager, Carlo was the Managing Director of Global Investment advisory at Chase Manhattan Bank, for Europe, Africa and the Middle East from 1999-2001. The group was responsible for all client-directed investment business in this region within Chase’s Private Bank. As a start-up and product specialist in equities, Carlo was formerly a Director of the Client Strategies Group for the Merrill Lynch International Private Bank from 1997 to 1999. From 1995 to 1997 he was a Director, Global EquityDerivatives, at Merrill Lynch where he developed and expanded the derivatives business of Merrill Lynch in Southern Europe. He was also responsible for marketing Merrill’s entire range of financial products and services to his client-base. Carlo’s team launched the first Equity Linked Capital Protected Investment Product for the Italian,Portuguese and Spanish markets. Most recently in 2002 and 2003, Carlo worked for the Old Mutual Group on projects dealing with their expansioninto new financial products and services. Prior to joining Merrill Lynch in 1993, Carlo spent eight years at San Paolo Bank in their headquarters in Turin and in New York. Carlo holds a degree in Economics and Banking Sciences from the University of Siena, Italy, and an MBA in Finance and International Business from New York University, Leonard Stern School of Business.

Culturally constructed ignorance

Clive Thompson from Wired:

"...Normally, we expect society to progress, amassing deeper scientific understanding and basic facts every year. Knowledge only increases, right?
Robert Proctor doesn't think so. A historian of science at Stanford, Proctor points out that when it comes to many contentious subjects, our usual relationship to information is reversed: Ignorance increases.
He has developed a word inspired by this trend: agnotology. Derived from the Greek root agnosis, it is "the study of culturally constructed ignorance."

As Proctor argues, when society doesn't know something, it's often because special interests work hard to create confusion. Anti-Obama groups likely spent millions insisting he's a Muslim; church groups have shelled out even more pushing creationism. The oil and auto industries carefully seed doubt about the causes of global warming. And when the dust settles, society knows less than it did before.
"People always assume that if someone doesn't know something, it's because they haven't paid attention or haven't yet figured it out," Proctor says. "But ignorance also comes from people literally suppressing truth—or drowning it out—or trying to make it so confusing that people stop caring about what's true and what's not."
... continues...

Paul Krugman: The pain in Spain …

… isn’t hard to explain. Spain was basically Florida, with a housing bubble inflated by both resident and holiday purchases, and now the bubble has burst.
But Spain is in worse shape than Florida, for two reasons — reasons familiar to anyone who was involved in the great debate about whether the euro was a good idea.
First, Europe doesn’t have a central government; Spain, unlike Florida, can’t draw on Social Security and Medicare checks from Washington. So the burden of recession falls entirely on the local budget — hence the country’s declining credit rating.
Second, the United States has a more or less geographically integrated labor market: workers move from distressed regions to those with better prospects. (The housing bust has, however, reduced mobility because people can’t sell their houses.) Europe does not: yes, there’s a fair bit of mobility both among the elite and among low-wage workers at the bottom, but nothing like the US level.
So what can Spain do? It needs to become more competitive — but it can’t have a devaluation, because it’s a euro country. So the only alternative is wage cuts, which are desperately hard to achieve (and create big problems for debtors.)
Contrary to what everyone seemed to be saying even a few weeks ago, being a member of the eurozone doesn’t immunize countries against crisis. In Spain’s case (and Italy’s, and Ireland’s, and Greece’s) the euro may well be making things worse.
And Britain’s plunging pound, unpopular though it is, may turn out to have been a very good thing.

On the same topic Ambrose Evans-Pritchard, although, ubi major minor cessat.

Can Economists Be Trusted? Are There Any Wrong Answers in Economics? - Part II

Mark Thoma:

"I wasn't completely happy with my discussion in Can Economists Be Trusted? Are There Any Wrong Answers in Economics?. I talked about cherry picking results to serve political aims, but I didn't talk about or come down hard enough on the misrepresentation of results for political purposes.
So I'm glad to see Andrew Gelman continuing the discussion:

"Can economists be trusted?," by Andrew Gelman: Mark Thoma has an interesting discussion of the challenge that the economics profession, and individual economists, have when they give policy recommendations.
Mark's basic point goes as follows. Consider the following four stages of a model:
(a) assumptions about fundamental principles of how the world works,(b) normative principles (that is, fundamental goals, views about how the world should be),(c) conclusions about the likely effects on policy,(d) recommendations about policies.
In any rigorous economic model, there should be a mapping leading from (a) to (c). Further reasoning (possibly mathematical modeling, as in cost-benefit analysis) will take you from (b) and (c) to (d).
That's all fine. But Mark's point is that the reasoning can go the other way too: start with (b) and (d), and then you can figure out what (c) needs to be, and then you can go back one more step and figure out what model (a) you need to get started! Even if economists are not doing this reasoning-from-conclusions-to-assumptions explicitly, you could well believe it's going on implicitly as well as being induced by various pressures such as the selection of what research results to report and even what problems to work on.
This is inevitable, and I discuss it in ... Bayesian Data Analysis. We call it the garbage-in-garbage-out problem: If you can come with any decision you'd like by just altering the inputs of your analysis, then what's the point of decision analysis (or, by extension to the above-linked example, economic modeling) at all?
My answer is something that I call "institutional decision analysis," which has two principles:
1. It can be a good idea to provide reasoning to justify your decisions. ...[A]n institution--whether it be a business, a government agency, a nonprofit organization, or some other grouping--often needs some path of bread crumbs connecting assumptions to recommendations. ...
2. As Mark noted, an overall decision recommendation on anything important is likely to be so dependent on assumptions to such an extent that it's probably fair to say that the analyst is reasoning from conclusions to assumptions (from (d) to (c) and then to (a), in my above notation). But, even then, formal decision analysis can be useful in making relative recommendations. This is the point that we made in our article about decision making for home radon. In the economics context, this might suggest that economists of different political persuasions could still give useful recommendations about how to spend money or cut taxes, or where in the economy such policies would make more or less sense.


There's always a temptation to act as a lawyer - to use theory and empirical evidence, your own if necessary, to make the best possible case for the policies you would like to see enacted.

Lobbyists certainly do this, consultants do this in some cases (though they ought to advise their clients of the full spectrum of evidence), politicians don't hesitate to shade things to make themselves look good, and some think tanks are also fully engaged in this type of activity (in a few cases, to the point of blatantly misrepresenting theory or evidence in order topromote their point of view ).

But lawyer like advocacy for preferred policies is not how academic economists ought to present evidence to policymakers and to the public. This does not mean economists should always end up in some wishy-washy, on the one hand, on the other hand position due to unavoidable uncertainty involved in the decision-making process, they can still come to firm policy recommendations. And in this regard point 1 above - connecting assumptions to recommendations - is helpful in explaining the basis for the decision (I'd add the connection between the empirical evidence and the recommendations as well). But I'd also like to see a bit more than that, including how robust the recommendations are to changes in the assumptions, whether there are other common assumptions that lead to different outcomes, and if so, why these assumptions were ruled out, and the strength of the empirical evidence being used to support the policy position.

Time to take the banks into full public ownership

William Buiter from Maverecon, FT:

Even if you do not share my view that all UK high street banks are dead banks walking...
these banks do act like zombie banks. They have enough capital to stay on their feet and stumble around a bit, but they are doing rather little of what banks are supposed to do: lending to the non-financial private sector - households and non-financial enterprises.
There are many factors contributing to this reluctance of the banks to engage in new lending.

Normal, sensible commercial prudence in the face of a severe cyclical downturn is one reason. In a recession, lending is riskier.

Irrational fear and near-panic, resulting in excessive caution and risk aversion is another reason for low volumes of new lending, for higher interest costs and for more stringent loan conditions. The balance of power inside banks has shifted dramatically to the risk controllers and bean counters. Loan officers are being kept on a very short leash. ‘When in doubt, don’t lend’ is the motto above the employee’s entrance at our high street banks.

Contradictory messages from the authorities are a third reason. The Treasury and the PM shout ‘lend, lend!’. They also shout ‘pass on all rate cuts fully to the borrowers’ thus ensuring that new lending won’t be profitable. The FSA admonishes: ‘reckless lending is part of what got you into trouble! De-leverage and raise your capital ratios. And if you have any money to invest, put it into Treasury Bills and Bonds, to ensure adequate liquidity in the future‘.

But I believe that costly partial state ownership and the fear of future state ownership (partial or complete) are themselves discouraging banks from lending. To minimize moral hazard, capital injections into the banks by the state and other forms of financial assistance by the state should be priced punitively and have other conditionality attached to it that is unpleasant for current shareholders and management (the dismissal of the incumbent top executives and the board; restrictions on dividend payouts and share repurchases until the state has been repaid; restrictions on executive pay and on bonuses etc.).

But if the state’s financial assistance is priced punitively or has other painful conditionality attached to it, existing shareholders and management will do everything to avoid making use of these government facilities. If a bank has no option but to take the government’s money, it will try to repay it as soon as possible - to get the government out of its hair. Such a bank will therefore be reluctant to take any risk, including the risk of lending to the non-financial private sector. Such a bank will hoard liquidity (sometimes in the form of deposits/reserves with the central bank) to regain its independence from the government. Still independent banks will hoard liquidity to stay out of the clutches of the government.

I believe that this mechanism is at work in a powerful way both in the UK, the US and in continental Europe. Hans Werner Sinn in a recent Financial Times OpED piece pointed out that the German rescue package for banks was fatally flawed for precisely this reason: the acceptance by banks of an injection of public sector capital brings with it a cap on managerial salaries.

Rather than accepting a cap on their salaries, managers would prefer to totter along with an under-capitalised bank and restrict the scope and scale of their lending operations.

...There are two ways of resolving this problem and of incentivising the capital-deficient banks to lend again.

The first is to make the capital cheap (gratis, in the limit) and to minimize the onerousness of the rest of the conditionality. This is the road taken in the US. The US Treasury injected capital into Goldman Sachs at less than half the cost to Goldman Sachs of a capital injection by Warren Buffett a few days earlier. AIG got a tough deal from the Fed and the US Treasury at first, but obtained much sweeter terms less than a month later. The latest capital injection into Citi by the US Treasury (preferred stock with a dividend yield of eight percent) is very cheap.

By throwing cheap money with little conditionality at the banks, the Fed and the US Treasury may get bank lending going again. By subsidizing new capital injections, they reward bad porfolio choices by the existing shareholders. By letting the executive leadership and the board stay on, they further increase moral hazard, by rewarding failed managers and boards that have failed in their fiduciary duties. All this strengthens the incentives for future excessive risk taking.

There is a better alternative. The alternative is to inject additional capital into the banks by taking all the banks into full public ownership. With the state as sole owner, the existing top executives and the existing board members can be fired without any golden handshakes. That takes care of one important form of moral hazard. Although publicly owned, the banks would be mandated to operate on ordinary commercial principles. Managers could be incentivised by linking remuneration to multi-year profitability. The incentives for excessive liquidity accumulation and for excessively cautious lending policies that exist for partially nationalised banks and for banks fearing nationalisation would, however, be eliminated.

In addition, full public ownership of the banks would greatly facilitate the creation of a ‘bad bank’ that would hold on its balance sheet all the toxic assets (illiquid assets of highly uncertain value) currently held by the high street banks. The key problem with any bad bank proposal is the price it pays for the toxic assets it acquires from the banks. If all the banks, and the bad bank, are publicly owned, this problem goes away. The toxic assets are simply moved to the balance sheet of the bad bank. They could be valued at anything from zero to their notional value or historic cost (or even higher). It would be a redistribution of wealth from one state-owned entity to another state-owned entity.

Note that the guarantee component of the Bank of America package (like the earlier insurance of/guarantee for $300bn worth of Citigroup toxic assets provided by the US Treasury) does not avoid the problem of valuing the toxic assets. The problem of determining a price or value for the illiquid assets stopped the TARP from being used as originally intended - for buying toxic assets from banks and in the process becoming a price and value revelation mechanism for illiquid assets. There is a valuation embedded in the guarantee or insurance offered to Bank of America and Citigroup: the state will compensate the banks if the value of the securities falls below a certain level. But the valuation is rather well hidden, and may not be revealed unless the guarantee is actually invoked. Also, guarantees are off-balance sheet, and politicians, like bankers, like that.

The bad bank would hold the toxic assets and collect the cash flows associated with it until a liquid market for these assets is re-established. This may never happen, in which case the bad bank would hold the toxic assets to maturity.

The publicly-owned banks would be reprivatised when financial markets stabilise and the economy recovers. It would be good if a better regulatory and supervisory regime for banks and other highly leveraged entities were in place by that time.

Ironically, by partially nationalising some of the banks, by making this injection of public capital expensive financially and as regards other conditionality, and by holding the threat of possible future (partial) nationalisation over the remaining banks, the authorities created an incentive structure that is biased strongly against bank lending, and against bank risk taking generally.

The best escape from this unfortunate halfway house is to go to temporary full public ownership of all the banks. It would be cheap. It should not cost more than £50bn for the state to buy the rest of the UK high street banks. It could wait a while and get them even cheaper - possibly for nothing. But time is more precious than money in this case.

As Brown poses as FDR, look ahead to a very new capitalism

Charles Leadbeater from The Spectator:

"We should be searching for a new kind of capitalism, and not just according to the far Left.

That is the message from Washington dinner parties and in the pages of the Financial Times.


For most people the next year will not feel like a search for a brave new economic model: it will be more like hand-to-hand combat to keep hold of what you have.


Yet the world is being turned upside down not by wild-eyed revolutionaries but sober central bankers and civil servants. High-octane, free-market financial capitalism has been devoured from within as the financial markets lost faith in the system they created. The City of London, once the jewel in the crown of the free-market empire, is being turned into a toxic debt recycling plant.


Bankers may become a bit like trade union leaders. After the excesses of the 1970s and the reforms of the following decade, the trade unions became just another part of the economy in the 1990s. They are still with us and occasionally make news, but they are not a power in the land. Something similar may happen to bankers.


Capitalism’s strength is its capacity for evolution. In the mid-1970s managed, national Keynesian capitalism gave way — in the US and the UK at least — to a more international, market-driven variety, a shift that gathered pace after the fall of the Berlin Wall in 1989. Will this year mark a further mutation to a new model of capitalism that could be with us for the next three decades?


The answer will depend on the severity of the looming recession, the pain it inflicts on people’s finances and the shock it delivers to conventional wisdom. How we end up striking the balance on three central issues will be crucial to the kind of capitalism that will emerge. The first is the balance between regulation and deregulation, the state and the market. This balance continues to shift daily




A free-market economy needs a state with substantial reserves of power to call on, especially as interconnected, fluid societies are so prone to crisis, from freakish summer floods to terrorist attack and financial contagion. Governments will use more ‘soft power’, incentives and persuasion to nudge people to become fitter, healthier and greener. But the last three weeks have shown that ‘hard power’ — the ability to mobilise massive resources at scale in a crisis — is still a job only government can do. Gordon Brown has relished playing the role of a latter-day FDR, leading the blitzkrieg into the financial equivalent of a failed state.


This is the high-water mark of the deregulated, bonus-driven, free-market triumphalism that blossomed after 1989. For years to come people arguing for a laissez-faire approach to any issue — health, transport, carbon trading — will be met with as much scepticism as advocates of state planning.


The government’s guiding role is unlikely to be temporary even if its stakes in the banks are. As 2009 unfolds, government will come under pressure to revitalise property markets to protect the value of public shareholdings in banks and to soften the blow of recession on businesses and households. People will be prepared to pay the price of a little more regulation if that brings a more dependable and less destructive capitalism.
Yet progressive euphoria over the state’s new-found economic confidence may be short-lived.




The state may be good at saving losers; that does not mean it is any better at picking winners. This year’s crisis of legitimacy in financial markets may become the state’s crisis next year as its resources are stretched to breaking point as borrowing rises to more than twice national income and recession takes its toll on already depleted public finances. Demand for good schools and hospitals will not lessen, but the short-term priority will be to slow the rise in unemployment. Everything else will take a back seat for a while.




National crisis — war and depression — is a crucible for social and public innovation, from FDR’s New Deal in America to the postwar European welfare state. The Labour government has often put off radical public services reform in favour of more investment to modernise services. That recipe will not work over the next two years. The only way to avoid cries of ‘cuts, cuts, cuts’ will be to deliver better public services at much lower cost through radical innovation — the Conservatives call it the post-bureaucratic age — to break down the silos, bureaucracy and duplication that still characterise public services. This will be the first real test of the strength of the social enterprise movement that was in its infancy during the last recession. The state is in for a torrid time. But the idea that societies in the developed world would be made safer, more productive and stable by having a smaller state is dead.


The second big issue is the balance between being networked and feeling safe.
The crisis was brought on by densely connected, tightly coupled, far-flung financial networks: it was like a high-speed motorway pile-up. Nick Leeson was a rogue trader. Enron was a rogue company. Financial markets have become a rogue system.


The complex maze of financial relationships has allowed a shadow banking system of hedge funds to trade financial instruments few understood, generating unfathomable risks in the wings of mainstream banking. This is further proof that the apparently marginal and insignificant — some subprime loans in the US Midwest — can up-end an entire industry, especially if it is densely networked.


As banks stopped lending to one another they retreated from these networks. Repeated across the economy as a whole, this would mean people hoarding resources and countries resorting to protectionism. The economy could yet shudder to a halt.
The crisis may make us turn away from cosmopolitan connections. The most significant banking casualties were formerly solid, proudly provincial institutions — Northern Rock from Newcastle, the Halifax, banks with their roots in respectable Edinburgh — who were seduced by the lure of international expansion through the cosmopolitan City. Many people will want a return to down-to-earth provincialism.
Yet we will not be able to retreat far from the cosmopolitan networks we have come to depend on in the last two decades. Hopes for avoiding deep recession depend on unprecedented levels of co-ordination among economic policy-makers. The cities and regions most likely to prosper will be those with outward-looking, entrepreneurial civic and business leaderships. Companies will learn to innovate and produce more through networks that allow them to share resources and defray risks. Many will be forced to look East for markets.
The eastward shift of capitalism’s dynamic will accelerate and so will its mutation in places with very different cultures and political regimes — Dubai, Shanghai and Kerala. That will create many more alternate forms of capitalism.



Networks will also be critical for individuals. This is the first downturn we have faced with the web woven into our lives. A recession will be a boon for the web’s pro-am, do-it-yourself ethic. Professional social networks such as Linked In may come into their own as out-of-work people look for jobs. There may be more Popbitch and less Heat magazine; more use of free, open-source software than expensive offerings from Microsoft; more recycling of secondhand goods through eBay and freecycling schemes; more sharing of resources like cars through websites like GoLoco and Liftsharing. The collaborative, low-cost organisational models the web allows will come into their own; high-cost industrial-era models will suffer.





Third, a downturn may lead people to a more balanced perspective on money and wealth.
In the next year money will become more important to people: credit will be scarce, getting hold of money will be harder. We will all learn to haggle and bargain. The foundations of future fortunes will be laid, as those with the money buy distressed assets at knockdown prices to set off a new cycle of wealth creation.

Yet the capitalism that emerges will be more modest, thrifty and subdued. Shows of wealth acquired through speculation will attract resentment. Ostentatiously overpaid footballers may fall out of favour. When Lehman Brothers could be worth $15 billion at the start of a week and next to nothing at the end, people may wonder what money really means.

Many people want a simpler, back-to-basics capitalism, one that does what it says on the tin. The crisis may encourage more people to place more value on what cannot be bought and sold, realising that relationships underpin our wellbeing more than money.

Capitalism will emerge more chastened and subdued. After the bubble burst in the early 1990s, Japan became just another productive, well-educated, slow-growth economy. It was no longer a wonder economy. But nor was it a basket case.

Capitalism will be more socialised. More emphasis, at least rhetorically, will be put on social stability, responsibility and shared capacities to take risks. That might give us a capitalism that is more civic, collaborative, creative and sustainable, in which the state’s role is more accepted and firms are less driven by the short-term demands of financiers. There will be greater pragmatism about the mix of public and private.

Yet in some places capitalism could get uglier. A severe recession could provoke an unseemly fight for resources and a generalised breakdown of trust. That would not usher in a new era of co-operation but a brutal struggle in which each protects what is his. Those with money will drive a harder bargain than those without. The state will be beset by demands it may not be able to meet. In white working-class communities that gained very little even during the boom years, things could turn nasty. People already disconnected from mainstream economic activity and public life, even during the boom, will be further disconnected. People may not turn en masse to fascism and communism as they did in the 1930s, but their sense of anger and dispossession will be more difficult to contain.
In all likelihood we will get a mix of subdued capitalism, social capitalism and ugly capitalism, even within the same cities.

All of this is speculation. I am old enough to have lived through several anxiety-inducing downturns but I cannot recall ever before feeling scared, planning to grow vegetables in our garden or escape with my family to Greece to run a B&B. Personally I would settle with relief for a capitalism that was safer, more stable and accountable, less destructive. After what we have already been through, and considering what we are about to go through, a more subdued and accountable capitalism would be a good starting point in our search for something more ambitious.

Thus far this has been framed as a crisis that requires an urgent response. In time the confused and battered population may want a politician who can frame it as a challenge or even an opportunity to remake capitalism. If Gordon Brown can successfully make that pitch, he deserves to be compared to FDR and the New Deal. But he may yet turn out to be more like Churchill. Winning the war may not win him the right to guide economic reconstruction.
This still has a long way to run.


Charles Leadbeater is the author of We-Think and a visiting fellow of the National Endowment of Science, Technology and the Arts. Visit www.nesta.org for more details of Nesta’s analysis and events discussing the impact of the financial crisis.

More battles ahead in Russia's 'gas war'

M.K. Bhadrakumar from AsianTimes:

The cause of any war is difficult to pinpoint. There is always more than one cause. And they could be just causes or ugly causes. There is no objective criterion except that the right cause is constructive while the wrong one is destructive, but then, people define by their standards.

...Unsurprisingly, the ubiquitous Americans promptly put on their trans-Atlantic leadership mantle and appeared on the scene to finger-point at the unreliable, unscrupulous, venal Russian "bullies". Anders Aslund of the Peterson Institute came up with a most ingenious thesis that actually the Russians were conspiring to make Ukraine a corrupt country, destabilize it and make it unsafe for democracy. But it was most certainly a war and the Russians likely won, as Old Europe did not take the cue from Washington. The win remains indeterminate, though. That is because it has been ultimately about geopolitics, where you don't conclusively win and can only avoid losing, and as China's People's Daily newspaper noted, Russia cannot turn a blind eye towards "NATO's [North Atlantic Treaty Organization] greedy expansion" and the dispute between the United States and Russia will only become "more and more intense". War had just causes. The factors leading to the gas war are well known.

... What are Ukraine's motivations in precipitating the crisis? One, Ukraine is in deep economic difficulties and would genuinely want the deep Russian gas subsidies to continue. The point is, the US-sponsored Orange revolution of 2004 has brought an economy with the best growth rate among the former Soviet republics down to its knees. In November, the International Monetary Fund (IMF) extended a $16.4 billion credit line to Ukraine. The chief economist of the European Bank for Reconstruction and Development, Erik Berglof, recently warned that the IMF package might not suffice. He said, "Ukraine is heading toward a twin currency and banking sector crisis that could well bring down most of the economies of Eastern Europe."

Rapid currency devaluation is disrupting the banking system and a few Western banks face the risk of major exposure in Ukraine. The national currency hryvnia has lost over 80% of its value against the dollar in the past three months. Massive debt rollovers to the tune of $41.5 billion (roughly 35% of gross domestic product) are falling due and refinancing will be extremely difficult in the present climate of the world financial crisis. Ukraine's GDP may drop by as much as 10% in 2009. Industrial production contracted by 28.6% in November. A period of pain and high drama lies ahead. And Uncle Sam, engrossed in own ailments and disabilities, is in no position to bail out his progeny. To compound all this, Ukrainian politics, which has always been murky, is in an unprecedented stage of volatility with the two political personalities sponsored by Washington as the flag carriers of the Orange revolution - President Viktor Yushchenko and Prime Minister Yulia Tymoshenko - tearing into each other scandalously in a bitter, irreconcilable rivalry at a very personal level.

According to Moscow, the two Ukrainian leaders are using the gas dispute with Russia to whip up xenophobia and rally the nation and at the same time malign each other. At any rate, there is no one in charge in Kiev who has the final word in the negotiations with Russia. Tymoshenko tried to project herself as the Ukrainian leader better able to negotiate a gas compromise with Russia and pro-US Yushchenko has accused her of mishandling the crisis. There is also a likely shady part to this - typical of most government business in Kiev. Tymoshenko has accused that the joint venture company RosUkrEnergo, which handles the Russian gas sales to Ukraine with which two notorious Ukrainian oligarchs are associated, is a vehicle of corruption for Yushchenko and that this is the real reason why the president scuttled her October memorandum with Putin from implementation, since it provided for doing away with middlemen and incrementally linking Russian-Ukrainian gas transactions to market price.

Nonetheless, it is virtually impossible that Yushchenko, who is so manifestly under the American thumb, would precipitate a first-rate crisis in Europe without some sort of nod from Washington. (Curiously, in mid-December, Washington concluded a "strategic partnership" agreement with Kiev.) Alexander Rahr, the noted Russia expert at the German Council on Foreign Relations in Berlin said, "There are attempts in Ukraine to tarnish the image of Russia as a reliable energy partner. [Ukraine] is forming an image of Russia as a foe and Ukraine as a victim."

To quote the editor-in-chief of Russia in Global Politics, Fedor Lukyanov, "Ukraine chose a tactic of deliberately creating a crisis through its rejection of talks and agreement, with the expectation that ultimately any major disruption of gas deliveries to Europe would hurt Gazprom's reputation as a reliable energy partner, supplier and generally speaking, as a company selling gas to Europeans. Everything that has happened after December 31 seems to me a delaying tactic ... We [Russians] are losing not a mere propaganda war but a real gas war ...
It is not accidental that countries that have excellent relations with Russia such as Greece, Hungary and Bulgaria, which are among our main European partners, are experiencing the worst difficulties." Actually, it is the very first time that European countries are experiencing a real shortage of gas ever since Russia's supplies began three decades ago. Lukyanov underlined, "Now, each single day of the crisis will distort the European perceptions, which would blame the Russians for everything."

All the same, the Russian political leadership has been careful not to join issue with Washington. Any criticism of the US has been muted. The maximum that Moscow was prepared to go was a reference by the senior Russian politician Andrey Kokoshin who said, "This is a consequence of the policy some figures in Washington have been pursuing over the past few years by trying to tear Ukraine away from Russia and make it a counterbalance to Russia forever."

Clearly, Moscow realized that it might simply walk into a trap set by the hardliners in Washington at this juncture of the transition of power to president-elect Barack Obama. The Kremlin has been cautiously optimistic about a fresh start to US-Russia relations under the Obama presidency. Interestingly, the George W Bush administration has utilized the hullabaloo of the gas war in Europe to wrap up the last act in its Russia policy - concluding a security pact with Georgia on January 9, which according to reports might lead to some form of permanent US presence in the Caucasus for the first time ever. This is by now a familiar pattern - under cover of dust in the Western public opinion over Russia's "expansionism", advance the containment strategy towards Russia by yet another notch and draw an unwilling Europe along. The Bush administration utilized the backdrop of the war in the Caucasus last August to formalize the agreement with Poland for its missile defense deployment about which Europe was lukewarm.

In fact, the American criticism of Russia over the gas war has been so highly vitriolic that it looks every bit contrived. Aslund's outlandish thesis was typical.

Stratfor, which is linked to the US security establishment, said, "Russia is once again threatening to cut natural gas supplies to Europe in the dead of winter. This time, however, Moscow's focus is much tighter. Russia is not only looking to smash the Ukrainian government, but it is looking for some specific changes in Kiev."

The Wall Street Journal saw the gas war as the Kremlin's warning to Obama. The daily commented, "Russia's strongman [Putin] is wielding the energy club to undermine the pro-Western government in Kiev and scare the European Union into submission. The strategic stakes are as high as in Georgia last summer ... For the new Obama administration, Mr Putin has offered yet another tutorial in its coming challenges in Eurasia."

The Washington Post exhorted the Europeans to "grasp the real message of this cold week", as "Mr Putin's regime plainly intends to use Europe's dependence on Russian energy to advance an imperialist and anti-Western geopolitical agenda." Evidently, Putin was the main target of criticism. Old Europe cautiously moves But the shrill propaganda failed to click. The hard-boiled Old Europeans had no time for it. The European Union reprimanded Kiev when Jose Manuel Barroso, president of the European Commission, warned that Ukraine's failure to deliver Russian gas might hurt its aspirations for close ties with Brussels. Other European leaders also refrained from criticizing Russia.

It seems the Europeans eventually saw through the Ukrainian game, despite the adverse media publicity that Moscow received in the early stages. They decided to associate with the new monitoring mechanism suggested by Moscow to ensure that Kiev does not any more steal from the Russia gas transiting to the European market. In the medium term, European countries may also seek to create their own strategic gas reserves with Russian help. Gazprom is reportedly planning to build the biggest gas storage facility near the city of Hinrichshagen (Meklenburg-Upper Pomerania Federal Land) with a huge capacity of 10 bcm of natural gas, with some of it earmarked as strategic reserves for Germany.


Another positive fallout for Russia is that the European countries may take a renewed interest in Russian pipeline projects - the Nord Stream under the Baltic Sea and the South Stream under the Black Sea - which aim at bypassing Ukraine for supply of gas to the European market.

...On balance, therefore, Washington will be disappointed to note that Europe's euphoria over the Orange revolution has all but evaporated. The message was loud and clear when Barroso said with uncharacteristic bluntness, "If Ukraine wants to be closer to the EU, it should not create any problems for gas to come to the EU." Washington underestimated that for Europe, a war over energy security is not the stuff of propaganda, but is a flesh-and-blood issue for their economies especially in these troubled times and uncertain future.

...Again, European countries seem to have concluded that Moscow has been driven by commercial considerations. They see the criticality of the income from gas sales to Europe for the Russian economy. The fact of the matter is that Russia faces a grave economic crisis. Oil prices anywhere below $70 create budget deficits for Russia. The rouble is declining, the stock market has crashed, unemployment is soaring, and social unrest and discontent may erupt despite Putin's popular rating soaring over 80%. In such a surcharged environment, Moscow has no reason to continue to subsidize the Ukrainian economy, especially with a government in Kiev which, under US instigation, has been constantly pursuing an unfriendly policy towards Russia. As Dmitry Peskov, Russian spokesman put it, "We are struggling with the consequences of the world economic crisis, but it does not mean that Russian taxpayers have to sacrifice in order to keep Ukrainian production alive." Besides, there is an inherent double standard in the US rhetoric. In a devastating essay in The Guardian newspaper of London, Mark Almond of Oriel College, Oxford wrote: "Keeping Russia hemmed in is why Ukraine matters to America ... Although its EU allies pay around $500 per unit, Washington wants Gazprom to subsidize the anti-Russian coalition government in Kiev by charging the poor Ukrainians only $175." He concluded, "Western triumphalists marked Russia down for inevitable decline. Certainly, so long as [Boris] Yeltsin let his crony capitalists plunder the country and deposit the loot in London and New York, pessimism was justified. Now, however, Russia's capitalist crew are not fly-by-night asset-strippers but ruthless capitalist politician-businessmen of the sort Britain used to produce." Armistice far away So, is the gas war over? To be sure, Russian gas supply to Europe via Ukraine has resumed. But the great game continues.

Washington can draw satisfaction that only a temporary solution has been found but the final armistice depends on a Russian-Ukrainian gas deal with three interlocking elements: pricing, debts and the volume of gas to be sent across Ukraine. Europe will not find it an easy job to mediate between Russia and Ukraine. At the root of the impasse lies the unresolved question of Ukraine's admission to NATO, which Washington insists on despite European reservations. Washington is determined to have its way and hardliners are hoping Obama will endorse the line, while Moscow has made it clear to the Western world that it is the "red line". And Washington commentators are peeved that Old Europeans do not want to annoy Russia. Increasingly, they run down Germany for expanding its ties with Russia.

Indeed, there are any number of issues over which Washington can instigate Yushchenko to exacerbate tensions in Ukraine's relations with Russia, such as NATO membership, Crimea and the Black Sea fleet, the Russian language, the World Trade Organization membership, territorial disputes, etc - and attempt to draw the EU into them.

On the other hand, it suits Yushchenko politically to distract public opinion as his personal popularity is abysmally low in single digits. According to a recent poll conducted by the Swedish International Development Cooperation Agency, 83.7% of Ukrainians feel gloomy that things are going seriously wrong in their country, with 49% calling it "critical and explosive". An Agence-France Presse dispatch from Kiev recently reported that analysts do not rule out Ukraine sliding toward authoritarian rule. If nothing else, Yushchenko could always turn the pages of history and pick up a lively quarrel with Moscow.

In November, he decided to have an anniversary bash over Holodomor, the tragic Ukrainian famine that Joseph Stalin's collectivization drive caused in 1932-33. Yushchenko sent out invitations for a summit of world leaders and included the Kremlin in his mailing list. President Dmitry Medvedev naturally declined the invitation. Moscow had a different take on that painful slice of Soviet history. What Yushchenko called "genocide", Russian historians interpreted as "sociocide" - a murderous plot against a whole social group instead of a specific ethnic community.

Ambassador M K Bhadrakumar was a career diplomat in the Indian Foreign Service. His assignments included the Soviet Union, South Korea, Sri Lanka, Germany, Afghanistan, Pakistan, Uzbekistan, Kuwait and Turkey.

Can Economists Be Trusted?

Uwe E. Reinhardt from NYT Economix(via Mark Thoma):

"In last week’s post I argued that the analytic structure through which economists behold the world is based on certain quasi-religious beliefs on the rationality of human beings and the efficiency of markets. These beliefs can blind economists to the foibles of the real world.
Matters are worse when, wittingly or unwittingly, economists infuse their analysis with their own (or a political client’s) preferred ideology.

Consider, for example, President Bill Clinton’s 1993-94 health-reform plan. In this plan, President Clinton proposed a mandate on employers to provide their employees with health insurance.

Politically conservative economists predicted that the mandate on employers to provide employees with health insurance would lead to vast unemployment. Economists supporting the Clinton health plan predicted that the negative employment effect of the mandate would be small, and that the effect might even be to increase employment.

It can be shown with a simple mathematical model that an economist’s prediction in this regard is powerfully driven by two assumptions about the behavioral responses to mandated employer-paid health insurance.

The first is the responsiveness of the supply of labor — that is, how many workers are willing to work — to changes in take-home pay. Economists generally believe that employers reduce take-home pay to recoup their contributions to any sort of fringe benefit, including employer-paid health insurance. If workers are very sensitive to changes in take-home pay, one would predict a highly negative employment effect in response to government-mandated, employer-paid health insurance, other things being equal — i.e., the number of people with jobs should go down.

On the other hand, if the supply of labor is relatively unresponsive to declines in take-home pay, one would predict only a small decline in overall employment in response to the mandate. Unfortunately, the empirical literature on this responsiveness offers economists a wide range of estimates from which they can choose judiciously to make their (or their political client’s) preferred case.

The second effect bearing on this issue is the value workers place on having health insurance on the job. If that value is high, then the employment effect of the mandate might even be positive, other things being equal, as people choose to enter the work force just to get health insurance. Some economists in the Clinton era who supported the Clinton health plan appear to have used this hypothesized effect to predict a net increase in employment in response to the employer mandate.

This example starkly illustrates how easy it is for economists to infuse their own ideology – or that of their clients – into what may appear to outsiders as objective, scientific analysis.

We are now seeing a replay of this tendency in the debate on the relative merits of added government spending versus added tax cuts as measures to stimulate the economy.

Writing in The New York Times, for example, the Harvard professor N. Gregory Mankiw, former chief of President Bush’s Council of Economic Advisers, makes a case for stimulating the economy through tax cuts rather than added government spending.

First, he suggests that government usually spends money on things people do not want or need – like bridges to nowhere, or digging ditches and then filling them in again. To buttress his case further, he then cites an empirical study by Valerie A. Ramey, according to which the $1 of added government spending will ultimately increase gross domestic product by only $1.40, while according to another recent study by Christina and David Romer, $1 of tax cuts over time increases G.D.P. by $3.

Noneconomists may ask, of course, exactly how a $1 cut in taxes would translate itself into a $3 increase in G.D.P. at a time when traumatized households, whose wealth has been eroded, might use any new tax savings merely to pay down debt or rebuild their wealth through added savings, rather than spend it, and when businesses unable to sell their output even from existing capacity might hesitate to invest such tax savings in more capacity.

But never mind this fine point.

More interesting is that Christina Romer is to be the head of President-elect Barack Obama’s Council of Economic Advisers. In that capacity, last Saturday she released an analysis of fiscal stimulus alternatives, with a co-author, Jared Bernstein. Curiously — or perhaps not — for that analysis, the two authors assume a much larger four-year multiplier effect for added government spending (1.55) than for tax cuts (0.98), although they do confess to a high degree of uncertainty on the actual sizes of these multipliers.

So there you have the flexibility, shall we say, that economists enjoy when they apply their professional skills to affairs of state in what may seem, to outsiders, like purely scientific analyses.

In the first lecture of my freshman economics course at Princeton titled “The Art of Siffing Among Seasoned Adults,” I demonstrate how seasoned adults routinely structure information felicitously (i.e., “sif”) to further their own agenda, and I point out that economists can be among the most skillful practitioners of this art.

“If at the end of this course you still trust me,” I warn them, “I have failed in my mission. When economists advise on public policy, the operative mantra is Caveat Emptor!”

I am sad to teach it, but consider it fair and full disclosure.

Going the extra mile: staff-owned firms can improve public services

Charles Leadbeater from Guardian:

"The public sector needs more organisations in which employees have a stake in delivering better outcomes for people.

This approach flies in the face of the reforms of the past decade, which shifted power away from frontline producers to consumers, managers and target setters in the central government. The last people who could be trusted with a service were those delivering it.
Yet detailed case studies of leading co-owned public services - Eaga, the energy agency based in the north-east, Sunderland Home Care Associates, community health provider Central Surrey Health, and Greenwich Leisure, which provides services to boroughs across London - tell a different story.

Organisations owned by their staff are less risk averse and more committed to innovation than pure public sector organisations. Staff in the former have a stronger shared interest, which promotes the collaboration often lacking in the silos of public services.

Co-owned organisations are more mission driven than private sector providers, which run contracted-out services with little incentive for innovation. The social mission of co-owned organisations drives their search for innovation, even if there is not much money to be made. Co-owned businesses also have advantages over the pure voluntary sector: they have an entrepreneurial outlook and can raise capital to match their ambitions.

The most important strength of co-owned organisations is their open, egalitarian culture, which encourages the lateral communication that allows people to combine their ideas easily, seek partnership with customers, and mobilises the "can-do" commitment needed to turn ideas into action. Staff in these organisations, because they are co-owners of the business and so have more freedom to respond, often speak of "going the extra mile" for consumers.

The opportunities to create more co-owned public service organisations are huge. In social care, Sunderland Home Care Associates provides a model for motivating low-paid and low-skilled public service staff that many other authorities could usefully follow as they seek more effective ways to meet the needs of an ageing population.

Indeed, co-owned organisations may make sense in some of the most troubled public services: social work with children, and families at risk and in care.
Imagine that, instead of local authority social work departments, the authority contracted out services to a set of competing, employee-owned social work practices, run rather like general practices, with perhaps eight to 10 social workers in each. Social work needs to retain and motivate skilled and committed staff. The co-owned culture of collaboration, peer-to-peer accountability and responsibility to clients is often lacking inside the public sector.
One response to the case of Baby P should be to pilot the creation of co-owned social practices that are owned by the staff but accountable to the public through local authorities that commission their services.

As politicians cast about for new recipes for less bureaucratic, more localised, personalised approaches, co-owned public service organisations should be part of that mix because they do something really potent: they motivate frontline staff to want to deliver a better service.


• Innovation Included: Why Co-Owned Businesses are Good for Public Services, by Charles Leadbeater, is published by the Employee Ownership Association (employeeownership.co.uk)

France, Germany and fissures in the eurozone

David Marsh from FT:

"International challenges spell good and bad news for the European Central Bank. On the positive side, the credit crisis has given the independent ECB and Jean-Claude Trichet, its president, unexpected authority on the world stage. Most observers agree the 10-year-old economic and monetary union has so far moderated the direct fall-out of the financial crisis for eurozone members. On the negative side, Europe this year faces probably the worst recession since the second world war. Depending on how Emu members react, latent nationalism within the single currency area may emerge as a disruptive force.
Battle lines are being drawn between the “stability first” principles of Europe’s strongest economy, Germany, and the more activist growth policies favoured by France. Mr Trichet, a veteran of fierce battles with the Bundesbank as head of the French Treasury in the early 1990s, has emerged as heir to the German central bank’s anti-inflation throne. The ECB’s president and decision-making council have come under sporadic pressure from European politicians to soften their monetary stance. After the mid-September collapse of Lehman Brothers, the US bank, the ECB cut interest rates three times between October and December – the first reductions since Mr Trichet took office in 2003. But despite recent signs of further economic weakening, there are strong indications that Mr Trichet will continue to garb himself in a mantle of Bundesbank-like firmness.
Emu has required improbable compromises – notably, that it would work without substantial fiscal transfers between countries of markedly different economic performance. Using a single currency to lash together 16 disparate nations has had effects similar to those among occupants of a life raft on a storm-tossed sea. The euro has provided members with an aura of robustness but also made them more prone to fissures caused by disturbances in their internal balance of forces.

A warning signal has come from the sharp rise in the gap or “spread” between yields on bonds issued by heavily indebted Emu countries and those on German government bonds. The crisis has driven up these spreads not only because investors take a less forgiving view of the risks on weaker countries’ debt, but also because of the blockages along what Mr Trichet formerly called the “financial channel” for ironing out discrepancies among member states. The yield spreads – now 2.3 percentage points for Greece, 1.3 points for Italy and 1.7 points for Ireland – are much less than the differences of up to 6 points before the euro was set up. Weaker southern and western states still derive considerable benefit from membership, but – should spreads widen further – that may fast diminish.

A prime reason for the widening spreads is that fixing exchange rates among countries with disparate patterns of prices and productivity has led to changes in relative competitiveness. Since 1999, Germany has gained an overall competitive advantage of more than 10 per cent, while Italy has suffered a loss of nearly 40 per cent, according to Organisation for Economic Co-operation and Development figures based on unit labour costs. During much of the euro’s first decade, the positive impact of generally low, stable Emu interest rates largely outweighed the negative influence of disrupted competitiveness. However, as economies contract, papering over the cracks will become more difficult.
That is exemplified by economic policy differences between France’s President Nicolas Sarkozy and Chancellor Angela Merkel of Germany. Continuing a French tradition shown by predecessors François Mitterrand and Jacques Chirac, Mr Sarkozy has irritated the Germans with his suspicion of central banking independence and has been still more outspoken than Mr Chirac in publicly criticising ECB interest rate decisions. Mr Sarkozy has clashed with Peer Steinbrück, Germany’s no-nonsense finance minister, telling him on one occasion Germany’s strictures spelled “the end of Franco-German friendship”.
At the root of France’s carping is the widespread French belief that Germany has gleaned unfair economic advantage from Emu. Germany has swung from a pre-Emu current account deficit of 0.8 per cent of gross domestic product in 1998 to a surplus of 6.4 per cent in 2008, according to the OECD. France, Italy, and Ireland, with surpluses of 2.6, 1.9 and 0.8 per cent of GDP respectively in 1998, registered deficits of 1.6, 2.6 and 6.2 per cent in 2008. Last year Greece, Spain and Portugal ran deficits of 10 per cent of GDP and more.
There has been no sign so far of any overt move to modify Emu’s “no-bail-out” clause, which prevents less well off states from demanding help from stronger members. However, if other Emu countries find borrowing progressively harder, non-German politicians may ask Germany to use its comfortable financial position to alleviate pressures on weaker Emu brethren.
The German government, which has rejected forming more demand to help out less competitive euro members, would certainly say no to changing the no-bail-out clause. If bond spreads rise towards pre-1999 levels, speculation may rise that one or more weaker states could suspend their membership. Mr Trichet dismisses such thoughts as “fantasies”. Yet leading European monetary officials stated months ago that precisely such an option – although unlikely – could not be ruled out. If 2008 has been tough for Emu, 2009 could bring still greater tests.

The writer is chairman of London & Oxford Capital Markets. His book, The Euro: The Politics of the New Global Currency, is published by Yale University Press in January/February

Social Cohesion, Institutions, and Growth

Abstract from a William Easterly paper:

In seeking to unpack the notion of social cohesion, we concede from the outset that some infamous historical figures with a narrow—even sectarian—agenda have invoked social cohesion-type arguments as the basis for their actions.

The desire to cultivate a sense of national unity and “purity” brought us the Holocaust and ethnic cleansing, so we are most surely not arguing that social cohesion equals cultural homogeneity or intolerance of diversity; quite the opposite. On the other hand, nor are we invoking some naïve suggestion that socially cohesive societies are always harmonious, devoid of political conflict or dissent.

Rather, we use the concept of social cohesion to make the general point that the extent to which people work together when crisis strikes or opportunity knocks is a key factor shaping economic performance.
Graphic scenes on CNN during the 1997 financial crisis in South Korea neatly illustrates social cohesion in action: everyday citizens were shown tearfully selling their modest family treasures in the belief that their humble contribution was somehow making a difference to the financial health of their country.

Where this sense of cohesion is lacking—as it was in, say, Indonesia— the response to the crisis was far more sluggish and uneven, heightening a number of other latent and manifest political tensions. Managing these tensions during crises, and ensuring that they do not descend into outright or violent conflict, is a key political task.

One of the primary reasons why even good politicians in countries all over the world, but especially in low-income countries, often enact bad policies is that they experience significant social constraints on their efforts to bring about reform. These constraints are shaped by the degree of ‘social cohesion’ within their country. We show that social cohesion determines the quality of institutions, which in turn has important impacts on whether and how pro-growth policies are devised and implemented.
A country’s social cohesion is essential for generating the confidence and patience needed to implement reforms: citizens have to trust the government that the short-term losses inevitably arising from reform will be more than offset by long-term gains.

The inclusiveness of a country’s communities and institutions (e.g., laws and norms against discrimination) can greatly help to build cohesion.

On the other hand, countries strongly divided along class and ethnic lines will place severe constraints on the attempts of even the boldest, civic-minded, and well-informed politician (or interest group) seeking to bring about policy reform.

We argue that the strength of institutions itself may be, in part, determined by social cohesion.
If this is so, we propose that key development outcomes (the most widely available being “economic growth”) should be more likely to be associated with countries governed by effective public institutions, and that those institutions, in turn, should be more likely to be found in socially cohesive societies.

If social cohesion is so important, how can it be nurtured? While social cohesion is partly shaped by national leaders, social cohesion also depends on some exogenous historical accidents.
A nation-state that has developed a common language among its citizens is more cohesive than one that is linguistically fragmented. This is not to say that linguistic homogeneity is bad or good; most nations started out as very diverse linguistically. Linguistic homogeneity may simply be an indicator of how much a group of nationals have developed a common identity over the decades or centuries that national identity forms.
Where such a common identity is lacking, opportunistic politicians can and do exploit ethnic differences to build up a power base.
It only takes one such opportunistic politician to exacerbate division, because once one ethnic group is politically mobilized along ethnic lines, other groups will.

This should not be interpreted in a pessimistic light – that nations where there are large cleavages of class and language are condemned to poor institutions and low growth.

Of course, nations should not embark on forcible redistribution and mandatory linguistic assimilation. These results only say that on average lack of “exogenous” social cohesion has been exploited by politicians to undermine institutions, which in turn has resulted in low growth. But politicians can choose to build good institutions, unify fractionalized peoples, and defeat the average tendency to divide and rule.
In fact where institutions are sufficiently well developed, there is no adverse effect of ethnolinguistic diversity on growth. The corollary is that good institutions are most necessary and beneficial where there are ethnolinguistic divisions. Formal institutions substitute for the “social glue” that is in shorter supply when there are ethnolinguistic divisions.

The other determinant of social cohesion is whether the historical legacy is one of relative equality or of a vast chasm between elites and masses. Engerman and Sokoloff describe how inequality in Latin America arose out of factor endowments and historical accidents.
The tropical land in Latin America was well-suited for large scale enterprises like silver mines and sugar plantations, worked by slaves or peons. The benefits of these operations largely accrued to the small criollo class. The elite was kept small by restrictions on immigration
from Iberia or elsewhere to the Iberian colonies. The labor force had to be forcibly recruited through the import of African-American slaves and the encomienda system that tied the indigenous people to the elite’s land.

In Canada and in the North of the US, by contrast, the factor endowments were conducive to small-scale production of food grains. A middle class of family farmers developed.
Practically unrestricted immigration and abundant available land (once the tragic process of despoiling the native inhabitants was completed) swelled the size of the middle class. Immigrants voluntarily assimilated into (and actively contributed to) the dominant middle class culture. The American South was a kind of intermediate case between North and South America, with a mixture of free family farmers, elite slaveowners, and African-American slaves.

One potentially important policy lever for enhancing social cohesion is education.
Heyneman identifies three ways in which education contributes to social cohesion.

First, it helps provide public knowledge about the very idea of social contracts among individuals and between individuals and the state.

Second, schools help provide the context within which students learn the appropriate behavior for upholding social contracts, by providing students with a range of experiences in which they learn how to negotiate with people, problems, and opportunities they might not otherwise encounter. As Heyneman puts it, “the principle rationale, and the reasons nations invest
in public education, have traditionally been the social purpose of schooling... The principle task of public schooling, properly organized and delivered, has traditionally been to create harmony within a nation of divergent peoples.”

Third, education helps provide an understanding of the expected consequences of breaking social contracts; indeed, it helps citizens understand and appreciate the very idea of a social contract.

Given the vital role the state has in shaping the context and climate within which civil society is organized, it can, in some cases, also actively help to create social cohesion by ensuring that public services are provided fairly and efficiently (i.e. treating all citizens equally), and by actively redressing overt forms of discrimination and other social barriers.
These happy outcomes are most likely to come about through the empowerment of domestic constituencies rather than via “conditionalities” imposed by external donors and development agencies. This is one of the conclusions of two recent World Development Reports.

We have pointed to the importance of a research agenda that looks into the cohesiveness of societies and the quality of public institutions, and their relationship to sustained growth.
We need to know a lot more about how equitable and fairly to manage the costs and benefits associated with the transformation of society (Bates 2000), especially how to foster a greater sense of cooperation and inclusion in environments where there is (actual and potential) division, exclusion, and disaffection.